Bank Capital Requirements: Federal Reserve, OCC and FDIC Release Joint Proposal Regarding the Implementation of CECL and Their Regulatory Capital Rules

Sullivan & Cromwell LLP - April 24, 2018
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On April 13 and 17, 2018, the Federal Reserve, the OCC and the FDIC released a joint proposal to revise their regulatory capital rules to address U.S. generally accepted accounting principles’ (“GAAP”) upcoming change to the Current Expected Credit Losses (“CECL”) treatment of credit expense and allowances and provide an optional three-year phase-in period for the day-one adverse regulatory capital effects upon adopting CECL. Additionally, the proposal would address which credit loss allowances under CECL would be eligible for inclusion in tier 2 regulatory capital. The proposal would not, however, recalibrate the limits on the inclusion of credit loss allowances in tier 2 capital.

Upon adopting CECL, a company will record a one-time adjustment to its credit loss allowances as of the beginning of its fiscal year of adoption equal to the difference between the amounts of its credit loss allowances under the incurred loss methodology and CECL. The adjustment will be recognized with offsetting entries to deferred tax assets (“DTAs”), if appropriate, and to the new fiscal year’s beginning retained earnings. Because retained earnings form a major component of a banking organization’s common equity tier 1 (“CET1”) capital, the adoption of CECL and the corresponding one-time adjustment is expected to negatively affect most banking organizations’ regulatory capital ratios.