Overview
Current Expected Credit Losses is a reserve account that is set up to absorb the credit losses from a bank loan. FASB requires that banks estimate the expected credit loss on a loan throughout the life of the loan, and to hold reserves against those expected losses.
The contra account that holds the expected loss is set up at the initiation of the loan, which means that banks will take an immediate loss on any loan at initiation.
Note that in this case, "expected" means a statistical expectation. That is, it is a probability weighted loss, which means that every loan (other than those of the sovereign) will have an expected loss.
Time Frames
The CECL standard requires expected losses to be calculated over the life of the loan. However, the standard does allow for banks to categorize losses into two categories:
- Foreseeable Future - generally taken to be of a period of 24 months, the period beyond which most considerable it is extremely difficult to do economic forecasts.
- Unforeseeable Future - beyond 24 months
Banks will typically forecast losses for the foreseeable future using economic forecasts of the current cycle, and will use through the cycle estimates of loss beyond the foreseeable future.