Concentration risk: the CECL magnifying glass

Amnon Levy, Pierre Xu and Masha Muzyka

Accounting Standards Update 2016–13, also known as the current expected credit loss (CECL) standard, was issued as the FASB’s answer to the 2007–09 global financial crisis. Its objective is the early recognition of expected credit losses, allowing banks to proactively react to actual and expected future changes in the credit environment. CECL is one of the few accounting standards that has caused tremendous controversy and speculation regarding its impact on allowance and earnings, and the potential of unintended consequences on lending and credit markets. This issue becomes increasingly relevant in times of significant market volatility, as demonstrated by the 2020 recession as its social and economic impacts reverberated throughout the credit markets while future expected credit losses mounted.

By design, CECL is more reactive to changes in the credit environment. Most notably, CECL incorporates forecasts into the loss estimate and requires measurement on a collective or pool basis when similar risk characteristics exist. Allowance can exhibit material sensitivity to changes in the credit environment, resulting in credit losses, when a pool contains significant product