In the final quarter of the calendar year, key players at financial institutions are closing the books on 2024 and beginning to look ahead to the new year. While this means different things to different financial institutions, most bankers are shifting their focus from increasing revenue and optimizing processes in the current year to launching plans for future goals, which may include software upgrades, lending policy changes, new marketing strategies, restructuring, and remaining competitive in a rapidly evolving industry.  

Closing the Fiscal Year 

Many banks use the calendar year as their fiscal year, so their new fiscal year coincides with the upcoming new year. Others use a fiscal year that closes during a different month, for example, on October 31st. The months that mark the beginning and the end of an institution’s fiscal year matter significantly because they influence federal tax filings, audit preparation, and budgeting and forecasting. 

Closing the fiscal year requires an organized plan and thorough execution. Financial institutions face strict compliance requirements from the Office of the Comptroller of the Currency (OCC) and there are several steps they must take at year end to ensure accuracy of their financial reports and transparency into their lending policies. Some common year-end tasks for banks may include tax preparation planning with the institution’s financial leadership team and external CPA firm, reconciling bank and balance sheet accounts, and reviewing financial statements.  

Credit Loss Accounting for Banks 

In addition to routine reporting that is required at the close of any period, banks and credit unions must also calculate their allowance for loan and lease losses (ALLL) or Current Expected Credit Losses (CECL). The purpose of these calculations is to estimate credit losses expected with the current loan portfolio and ensure that as much of the net charge-offs as possible are absorbed through a reserve. Using a method that is accepted by the FASB, OCC, and SEC is mandatory because regulators have strict guidelines regarding a bank’s methodology. Ultimately, these calculations become a formal estimate on the institution’s annual financial statements which are then used to reduce the value of leases and loans held by the bank to exclude uncollectable revenues.  

Both ALLL and CECL are accepted methodologies for calculating expected credit losses, however on June 16, 2016, CECL became the standard for credit loss accounting. While the ALLL method focuses on incurred losses, the new CECL model requires financial institutions to use a combination of historical data, market conditions, and reasonable forecasts to estimate the loss over the entire life of a loan or lease. Banks must set aside, and report, a cash reserve depending on the total calculated losses. Since CECL considers losses over the entire life of a loan product, banks are now required to set aside larger reserves. These larger reserve requirements and scrutinized methodologies have created an operational burden for lenders that requires them to develop more sophisticated risk assessment models.   

Looking Ahead 

While the closing of a fiscal year at a banking or lending institution can be cumbersome, planning for the year ahead must also remain a priority. The profits shown in the current year and previous years should be used as a starting point for lenders to optimize their upcoming growth strategies.  Whether next year’s goals include reducing the CECL and minimizing risk, increasing revenues, or improving customer satisfaction, a new year is the perfect time to implement those strategies. Some factors to consider when looking ahead may include: 

  • Minimize risk – Historically banks managed risk using historical data and manual underwriting process, but advanced lending technology has allowed many institutions to migrate to using alternative data. Using digital lending tools, Mastercard’s Small Business Credit Analytics solution can reduce portfolio risk by providing real-time data-driven insights.  
  • Reprice to reduce loss - Another way banks and lenders can minimize financial losses in their loan portfolios is through repricing, which means increasing the interest rate on a loan after the initial repayment terms have been distributed. 
  • Improve account opening – A common theme when planning for future periods, is figuring out how to increase profits. For banks and credit unions, more revenues can be achieved through a growing loan portfolio and increased deposits. For many banks, this can be achieved by streamlining the account opening process. Faster, more user-friendly account opening procedures can help credit unions and banks widen their deposit base by making it easier for potential clients to do business with them.  
  • Portfolio growth through AI – Lenders that can reduce bias in lending decision with the help of AI are able to expand their loan portfolios to include underserved populations, like startup entrepreneurs and small businesses with less than perfect credit history. AI algorithms can analyze transaction history, utility bill payments, and even social media activity to create a comprehensive financial profile, which allows banks to extend credit to individuals who would otherwise be deemed high-risk. 

Bringing it all together 

Completing the calculations, budgeting, and reporting requirements of year end can be exhausting, but banks and lenders can use the information gathered to improve their portfolios in the upcoming year. Using CECL calculations and feedback from tax preparers, financial institutions can consider implementing one or several growth strategies like automated account opening processes or AI-driven credit decisions.