Current Expected Credit Loss Model (CECL) Based on Firm Loan Loss Elasticity

Abstract

Many banks are confronted with the problem of meeting the Financial Accounting Standards Board (FASB) standard which requires the estimation of a Current Expected Credit Loss (ASC 326) which replaces the older well-established Allowance for Loan and Lease Losses. The new standard requires that management and preparers must make a forward-looking disclosure of expected loss based on characteristics of the loan portfolio. Moreover, the standard requires that the methodology be well supported for a specific institution and situation. The current analysis develops an explanatory variable for estimating credit loss based on an economic elasticity concept which has advantages of comparability and the facility of being enhanced by macro-economic and sector control variables. Comparability, simplicity and flexibility would be particularly useful to smaller institutions that lack the experience, modeling expertise, and the ability to afford complex applications.