Backtesting for Accuracy and Defensibility
The purpose of backtesting the ALLL is to compare actual credit losses with model forecasts during a defined period to validate the accuracy of the model, or the lack thereof. When comparing ALLL levels to actual incurred losses, institutions can examine the variance in their forecasts and determine the performance of their model.
In exams, having a backtesting procedure in place can be used as an added layer of defensibility if it shows that the model has been repeatedly accurate in previous periods. What’s more, institutions can use these reports during Board meetings to display trends in the ALLL and convey the efficacy of their model.
Related Asset - Whitepaper:
Backtesting: Measuring the Effectiveness of Your ALLL Methodology
Backtesting: Measuring the Effectiveness of Your ALLL Methodology - Download the PDF
Related Asset - Slides:
Backtesting Your ALLL Methodology