Current Expected Credit Losses, or CECL, is changing the world of finance but most people don’t understand what it is or what it means. Being aware of CECL coming into practice is important for the business and finance world and for you personally. Here is a brief explanation of what it is and why it is important to you.
Background
After the banking crisis of 2008, the Financial Accounting Standards Board began reassessing how banks look at loans and risk management. The conclusion they came to was that the original model, Allowance for Loan and Lease Losses or ALLL, was not secure enough because it made assumptions about loans being paid back correctly and on time in ways that shouldn’t be relied on. FASB, the Financial Accounting Standards Board, came up with the CECL model after that. The new model takes expected losses into account in order to make loans safer. Among other changes, CECL changes the way lenders take qualitative and environmental factors into account when recording the value of loan assets.
What Is CECL?
CECL can seem complicated to a person unfamiliar with finance, but it is simple when broken down. Basically, the current standard of ALLL will look at your current and previous loans to create a lending portfolio. This will contain all of your previous losses and other financial information a bank would consider important. The new system of CECL, however, will not look simply at your past but also your future. CECL uses general financial understanding and dynamics alongside your personal financial history to create a forecast for you. This will be able to assess and understand your risk and take it into account when considering loans.
What Makes This Important?
The impact of CECL will be very significant in the financial sector and will have far-reaching results in everyday life. This new model changes how loans are decided and accepted and will also change how people’s financial history is looked at. Rather than simply looking at the past banks will now try to look into the future. This risk management will mean that people’s financial portfolio will be less certain but it will have the potential to predict risk and prevent unexpected losses.
CECL could be one of the biggest changes in America’s financial history. This will always have a significant impact on the public. Being aware of the changes and understanding them is important to you and your finances.
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