As financial institutions analyze Current Expected Credit Loss standard (CECL) data requirements and begin to run various modeling scenarios in order to ascertain the impact to capital when adopted, some institutions could face substantial adjustments.
On the heels of preparing for the CECL accounting standard, the Economic Growth, Regulatory Relief, and Consumer Protection Act (Relief Act) was signed into law. It is considered as a long overdue partial rollback of the Dodd-Frank Act.
The Relief Act dilutes some of the stringent regulations imposed by the Dodd-Frank Act on the United States financial system, and it is primarily aimed at making things easier for small- and medium-sized U.S. banks. Many of these financial institutions were seen as being affected by the tougher rules in a disproportionate manner compared to their larger rivals.
Is this a coincidence—or, are we seeing an offset balancing reaction? I think we can all agree that the new CECL accounting standard requires financial institutions to look at themselves as if they were an outside investor in the institution and evaluate the risk imbedded in their lending practices and existing portfolio on a mark-to-market basis.
The end result is an assessment of the inherent risk in your portfolio. This ongoing self-evaluation comes with both additional regulatory and operational costs, which certainly is not what the industry needs in this heavily regulated environment.
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CECL results and reality
Relief Act regulations in focus
To some extent, the Relief Act can be construed as an offset to these added costs by including reasonable changes for the community banking segment, which has for years been lumped in with the systemically important financial institution (SIFI) or systemically important bank (SIB) whose failure might trigger a financial crisis.
The new regulation label all banks with more than $50 billion in assets as systemically important financial institutions, and it subjects them to higher regulatory scrutiny, in addition to stricter capital requirements.
Financial institutions below the threshold will save substantially in regulatory compliance costs. Other changes found in the Relief Act were designed specifically for mortgage lending by lessening the regulatory burden on community banks, especially when extending credit for portfolio loans.
Financial institutions that originate less than 500 mortgages a year would be exempt from HMDA requirements, and the reporting costs that go along with those requirements.
Changes to qualifying entities subject to the “Volker Rule” eliminate burdensome reporting for community banks that generally don’t apply, but were mandatory because of the Dodd-Frank Act. It further lessens regulatory costs by extending the examination period out to 18 months versus heretofore 12 months for qualifying institutions for banks with assets of less than $3 billion, and it allows for shorter call reports for qualifying institutions of less than $5 billion, which included a myriad on additional paperwork.
Federal banking agencies must develop a specified Community Bank Leverage Ratio (the ratio of a bank’s equity capital to its consolidated assets) for banks with assets of less than $10 billion. Such banks that exceed this ratio shall be deemed to be in compliance with all other capital and leverage requirements. Furthermore, the bill calls upon the federal banking regulators to raise the asset threshold under the Small Bank Holding Company Policy Statement from $1 billion to $3 billion.
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Pricing and profitability: the other side of CECL
Institutions qualifying for treatment under the Policy Statement are not subject to consolidated capital requirements at the holding company level; instead, regulatory capital ratios only apply at the subsidiary bank level. This rule allows small bank holding companies to use non-equity funding, such as holding company loans or subordinated debt, to finance growth.
Lastly, financial institutions will have a phase period of three years for capital requirement shortfalls as a result of the new reserve calculations, the House of Representatives passed the Small Bank Holding Company Relief Act of 2018, which would direct the Federal Reserve Board to raise the consolidated asset threshold for its Small Bank Holding Company Policy Statement from $1 billion to $3 billion.
The goal of the bill is to ease overregulation on small banks and savings and loans, which would help these institutions raise capital so they can make loans in their community.
Reporting data and the Relief Act
So is it a coincidence that now the CECL data requirements become clearer that revisions to burdensome regulations found in the Dodd-Frank Act were addressed and certain regulatory thresholds for reporting and capital redefined?
Does the Relief Act provide an offset to the added costs and potential impact on capital among the smaller institutions as a result of the new CECL accounting standard?
Even though the dust is still settling, the pieces to this initiative are yet to be fully discovered.