CECL and the Board: New Standards Bring New Responsibilities
One of the MST series of articles on the impact of CECL on institution’s top management
A core responsibility of a financial institution’s board, often in conjunction with its audit committee, is oversight of financial reporting. Given recent and ongoing revisions to major financial reporting standards, the board’s workload relative to financial reporting has significantly increased. Boards will need to pay attention to these new standards to ensure the institution is being transparent in their adoption and implementation and their impact on financial reporting.
We’re in a period of financial reporting standards overload. The project that brought us CECL, or more accurately, “Financial Instruments – Credit Losses,” included revisions to three standards regarding financial instruments. First released were the revisions of “Financial Instruments – Recognition and Measurement.” CECL was the second release, in June 2016, then the third, “Financial Instruments – Derivatives.” As well there have been two other major changes to financial reporting as a result of new standards for revenue recognition and lease accounting. All these standards represent major changes to financial reporting that boards will need to embrace and ensure their institutions’ compliance and understanding of their impact, at implementation and going forward.
The board and audit committee are responsible for establishing the control environment around their financial reporting, their internal controls for financial reporting (ICFR). The audit committee of an SEC-regulated company must issue a statement to the general public that they have reviewed their financial statements with bank management and their external financial auditors and they approve the release of such information. That reporting will now be more complex and require additional work on their part to ensure they understand how those standards have affected their company at implementation and going forward as well as how management has chosen to interpret and implement them.
The board’s responsibility relative to risk management and the risk of errors in the bank’s financial reporting system needs to be updated to account for revisions made to their internal controls for financial reporting. This is another but separate ICFR issue.
The board is also required to participate in the development and approval of the company’s short- and long-term strategic initiatives. Capital adequacy could be impacted substantially by CECL. CECL implementation is likely to increase the institution’s allowance for credit losses (ACL), which will negatively impact earnings and therefore capital. Management typically wants to know sooner than later what that impact will be so they can understand how it affects strategic initiatives and in particular capital. The marketplace is still waiting for the regulators to define how they’re going to filter the impact of CECL on their capital ratios. Overall, the avalanche of revisions to our reporting standards will increase the workload for boards and audit committees, requiring them to understand their impact on their financial statements, not only for financial reporting but also relative to their strategic plans and the need to raise capital or revise business models and strategies to preserve or create capital.
Cybersecurity is generally recognized as today’s number one concern for financial institutions’ boards of directors. As it relates to CECL, the cybersecurity focus will be on revisions to their CECL modeling software, internally generated or purchased. With those revisions come risk, so vendor management will have to remain on the front burner as the new software is being used to meet these standards. The potential impact of the software will have to be part of the cybersecurity analysis.
Conversations with auditors
Also imbedded in all of this change in the financial reporting environment is the requirement to enhance the nature of conversations the institution has with its external financial auditors. The board should be in a position to meet with and discuss financial reporting with its external auditors as part of the sign-off that they’ve read the financial statements and discussed them with management and audit committee. They must understand how the financial auditor adjusted their audit approach as it relates to the adoption of the new standards, what their impression is of how management gained an understanding of the standards and how they applied the revisions to their financial reporting, not only external reporting but internal financial reports. They will want to be sure that their discussion with their auditors includes how they made adjustments, the process they used to implement the revisions, their impact on their financial statements, any disagreements with management relative to understanding and implementation, and any findings relative to expanded procedures and adoption of the new standards.
If the question is “Will CECL increase the workload of the board and its audit committee?” the answer is “Yes.” The implementation of CECL and other revised standards recently and in the immediate years ahead will bring the board multiple additional responsibilities.
Read the other articles in this series.
About the Author
With more than 36 years of experience, Garry’s industry concentration in financial services has included corporate financial auditing, accounting and financial reporting as well as consultation regarding governance, financial systems and internal controls. Now a Senior Advisor with MST Advisory Services, Garry assists institutions in planning their CECL transition.