Financial Institutions In Focus Newsletter - Winter 2018

December 2017

BDO-FISF-News-Winter-2018_pic-x675.jpg

Download PDF Version
 

Table of Contents

 


Financial Institutions Revenue Recognition Reminder Checklist

By Paul Bridge and Joe LaClair

On Jan. 1, 2018, ASC Topic 606, Revenue from Contracts with Customers, takes effect for publicly traded organizations, and all other companies must follow suit in 2019. Issued by the U.S. Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) in May 2014, the standard aims to create a more comprehensive picture of revenue recognition—comparable across industries and across countries.

Financial institutions will need to carefully evaluate all services and contracts to determine whether Topic 606 applies.

View the Checklist


Return to Table of Contents
 


Current Expected Credit Loss (CECL) Standard Update: Best Practices for Implementation

By BDO CECL Leadership Team, in collaboration with SS&C Primatics


Introduction to CECL

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, Financial Instruments – Credit Losses (Topic 326).

The current expected credit loss (CECL) standard marks a significant shift in the way credit losses on many financial assets, especially loans, are recorded. Under the standard, the ASU requires that banks estimate and record credit losses on loans and other assets (e.g., HTM debt securities) within the scope of the CECL model based on expected loss over the contractual life of the loan (considering prepayments). The goal of the new standard is to improve investor and financial statement user access to more timely information about credit losses and likely would require banks to record losses sooner than under current GAAP.

The standard applies to all banks, savings associations, credit unions and financial institution holding companies, regardless of asset size. More details on the standard can be found here.

While banks have until 2020 or 2021 to implement CECL, they must plan for adoption now. Most banks do not currently collect the level of disaggregated data that will be required to calculate the life of the loan estimate and should promptly begin exploring the right measurement method and new processes for their organization. Significant judgment will be required in forecasting, and banks should begin speaking with advisors and planning immediately. Bank executives should also start educating their finance executives, investors and stakeholders about the new standard and how it will change their metrics and integrate with budgeting and planning.


CECL Implementation Best Practices

CECL does not require that a particular method is used to estimate expected credit losses. Institutions can leverage practical methods relevant to the circumstance[1]; actual estimation methods will range anywhere from simplistic approaches to sophisticated models. For larger institutions, the decision to leverage predictive models may be straightforward. However, smaller institutions, especially those under $10 billion, are weighing the costs and benefits of a variety of approaches. Given the range of possibilities, many are struggling with the decision.


A Broad Spectrum of CECL-compliant Methods

A wide variety of methods, falling on a spectrum between a model-based and analytical approach will be considered CECL‑compliant.
  • A model-based approach leverages predictive models to forecast future borrower behavior based on statistical analysis of historical loss information. A modeled approach streamlines the reserving process and offers the most potential crossover use for risk management purposes.  But these benefits are not without cost; the initial and ongoing investment in developing and maintaining models can be a significant barrier.
  • An analytical approach consists of personnel using subjective judgment to arrive at the expected credit loss based on analyses performed in spreadsheets. An analytical approach requires relatively low up-front investment and is easy to implement. However, a primarily analytical approach will resemble the qualitative adjustment process under the current collective reserve, which many banks consider to be onerous due to the high level of subjective judgment and manual nature of the process.
Regardless of the method used, the same objectives must be met: relevant variables need to be identified, the relationship between the variables and losses need to be estimated, and the entire end-to-end process will be subject to Sarbanes-Oxley controls.


The Enhanced Analytical Approach

Both the model approach and the analytical approach have advantages and disadvantages but, for some banks, the answer may be somewhere in the middle. SS&C Primatics refers to this as an enhanced analytical approach. Put simply, the enhanced analytical approach combines the advantages of a modeled and analytical approach and minimizes the disadvantages of each. An enhanced analytical approach applies more rigor and consistency to the reserving process than a purely analytical approach and allows the bank to leverage current reserving processes and data. Leveraging a simple, easy to understand model reduces risk and makes model risk management significantly easier than that of a complex model.


The Foundation of a Successful CECL Reserving Process

It is imperative to keep in mind that CECL preparation is more than just a temporary project. In other words, the decisions made between now and adoption (2020 for SEC filers, and 2021 for all others) will be part of a process that will continue indefinitely.

When evaluating a particular method, in addition to asking will this be compliant, banks should ask themselves, how will this contribute to a successful process in the long run? The distinction between compliance and success is an important one. CECL compliance means meeting the requirements in the standard. However, a successful CECL implementation is about more than just checking a box. The elements of a successful CECL reserving process will include:
  • An integrated process that joins the allowance estimate with data, disclosures and analytics in a controlled, scalable and repeatable manner
  • A dynamic reporting framework that conveys a cohesive narrative explaining what happened and why, period over period
  • A controls framework that includes full audit trails, role-based permissions, segregation of duties and data lineage
The basis of a successful CECL transition will require much more than a CECL-compliant estimate. Success will require taking a holistic view of the end-to-end reserving process and leveraging the right tools to get the job done efficiently and effectively.


BDO CECL Leadership Team

  • Laurence Talley, Managing Director and Financial Services champion in BDO’s Risk Advisory Services practice, can be reached at ltalley@bdo.com.
  • Kirstie Tiernan, Managing Director and Leader of BDO’s Forensic Technology practice, can be reached at ktiernan@bdo.com.
  • Steven O’Donnell, Assurance Partner and member of BDO’s Financial Institutions & Specialty Finance practice, can be reached at sodonnell@bdo.com.
  • Sudip Chatterjee, Managing Director in BDO’s Valuation & Business Analytics practice, can be reached at schatterjee@bdo.com


SS&C Primatics CECL Leadership Team

For more information visit CECL.com or email info@primaticsfinancial.com.


About SS&C Primatics

A BDO collaborator, SS&C Primatics solves financial institutions’ most complex challenges with EVOLV, an integrated risk and finance platform. A key differentiator for 13 of the top 30 U.S. Banks, EVOLV streamlines accounting, reserving, and credit functions, enabling clients to operate more efficiently, make better business decisions, and capitalize on growth opportunities.

Return to Table of Contents 
 


FinCEN Advisory on North Korea’s Use of the International Financial System

By Adil Raza and Chuck Pine

On Nov. 2, 2017, the Financial Crimes Enforcement Network (FinCEN) issued an advisory[2] to further alert financial institutions to North Korean schemes being used to evade U.S. and United Nations (UN) sanctions, launder funds, and finance the North Korean regime’s weapons of mass destruction (WMD) and ballistic missile programs.

The advisory was issued in conjunction with a final rule pursuant to Section 311 of the USA Patriot Act prohibiting financial institutions from opening or maintaining a correspondent account for, or on behalf of, Bank of Dandong. These actions follow the targeting, by the Department of Treasury’s Office of Foreign Assets Control (OFAC), of several representatives of North Korean financial institutions on Sept. 26, 2017[3]. The advisory provides a list of red flags that will assist financial institutions in identifying and reporting suspected illicit activity involving the North Korean government and its financial institutions.

FinCEN references the UN Security Council “Report of the Panel of Experts established pursuant to resolution 1874,” (February 2016) which found that North Korean state-owned enterprises typically orchestrate elaborate trade-based payment schemes involving the sale of prohibited natural resources[4], mainly to China-based companies which in turn sell these natural resources to the Asian market.
  
“The North Korean state-owned enterprises indirectly receive payment, from the China-based companies, through a complex layering scheme involving front companies, shell companies, shipping or trade businesses based in Asia (often registered in Hong Kong), and other companies based in various offshore jurisdictions (e.g., British Virgin Islands, Marshall Islands and the Seychelles).”

These front or shell companies are used to purchase and ship commodities, which may include goods that can be used to further the WMD and ballistic missiles programs, to North Korea. 


Red Flags of Potential North Korean Illicit Financial Activity

FinCEN notes that many North Korean-related front companies, financial representatives and corporate service providers working on behalf of the North Korean government often share similar characteristics. Financial institutions should consider the below red flags in reviewing and assessing financial activity to ensure that their correspondent accounts are not being used to facilitate prohibited transactions and to assist in reporting potentially suspicious transactions to FinCEN.
  • North Korean-born representatives often use Chinese aliases or Chinese facilitators to establish and operate bank accounts and front or shell companies. They may also appear as signers for accounts maintained by the front or shell companies.
  • North Korean-born representatives appearing as corporate officers of multiple, seemingly unrelated, front or shell companies that also often transact with each other.
  • Use of multiple companies with the same owners or managers. These companies also frequently share addresses, telephone numbers and employees, and they may transact with similar business partners.
  • Front and shell company addresses frequently recycled and used for multiple business registrations, particularly addresses in the Jiadi Square area in the city of Dandong in the Liaoning province of China, where the North Korea Dandong Consulate is also located.
  • Front and shell companies registered in either the Liaoning province in China—specifically in the municipalities of Dalian, Dandong, Jinzhou and Shenyang—which border North Korea, or in Hong Kong, a major financial center with a variety of corporate service providers.
  • Substantial financial activity involving front or shell companies unrelated to stated areas of business or lacking a business purpose.
  • Lack of online presence despite significant financial activity.
  • Correspondent account transactions conducted by, or on behalf of, Liaoning-based banks, including, but not limited to, institutions located in the cities of Dalian, Dandong, Jinzhou and Shenyang.
  • Financial activity transacted through front and shell companies, often sharing the same address, occurring in cycles, whereby one company will pay a common beneficiary for a period of time and then cease payments, which will then be made through another company sharing the same address. 
  • Front or shell companies using shipping and import/export businesses including textile, garment, fishery and seafood businesses as well as coal and other commodity trading businesses.
About BDO’s Risk and Regulatory Practice
BDO’s Risk and Regulatory Advisory practice provides wide ranging regulatory compliance services. In particular with financial institutions, our professionals have extensive experience with advising, developing and implementing compliance programs to ensure compliance with the Bank Secrecy Act (BSA), OFAC and other federal laws and requirements. With our well-versed knowledge and expertise with BSA, anti-money laundering (AML), and OFAC regulations and pulse with regulatory trends, our professionals are well-equipped to help you meet your BSA/AML and OFAC requirements, and your organization’s specific compliance needs.

Adil Raza, a senior manager in BDO’s Risk and Regulatory Advisory Services practice in New York City, can be reached at araza@bdo.com.

Chuck Pine, consulting managing director at BDO’s Washington, D.C., office, can be reached at cpine@bdo.com.

Return to Table of Contents
 
 

BDO Spotlight
Q&A with Paul Bridge and Joe LaClair

Paul Bridge and Joe LaClair are the national co-leaders of BDO’s Financial Institutions & Specialty Finance (FI-SF) practice. With more than 25 and 33 years of public accounting experience respectively, Paul and Joe provide services to public and privately held financial institutions on a variety of accounting, financial reporting and internal control matters.
 
Return to Table of Contents
 


PErspective in FinTech

U.S.-based fintech startups have pulled in roughly $18 billion through some 1,400 deals with VC participation since the beginning of 2015, according to PitchBook.

Return to Table of Contents
 


For any questions regarding this publication, or the BDO FI&SF practice, please feel free to contact one of the individuals noted below:

Paul Bridge
Assurance Partner
Co-Industry Group Leader of the Financial Institutions & Specialty Finance Practice
West
  Brian Kirkpatrick
Advisory Managing Director
Central
 


 

Joe LaClair
Assurance Partner
Co-Industry Group Leader of the Financial Institutions & Specialty Finance Practice
Atlantic
  Imran Makda
Assurance Partner
Northeast 

 


 

Glenn James
National Tax Leader of Financial Institutions & Specialty
Finance Practice
Atlantic
  Ernie Saumell
Assurance Partner
Southeast
 


 

Tim Mohr
BDO Consulting Principal and National Leader of Financial Services Advisory practice
Northeast
  Laurence Talley
Advisory Managing Director
Central


 

Rick Baab
Assurance Partner
Central
   
 
 

[1]  Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) No. 2016-13, Financial Instruments-Credit Losses (326-20-55-7).
[4] UNSCR 2371 prohibits imports of North Korean coal, iron and iron ore, lead and lead ore, and seafood. UNSCR 2375 prohibits imports of textiles, among other new measures.