A bank’s allowance for loan and lease losses (ALLL) represents one of the most significant estimates on the institution’s financial statements. Regulators require strict adherence to guidance when examining financial institutions’ ALLL methodology, so a thorough understanding and application of the regulatory requirements is paramount for a sound and effective ALLL.
Under the new Current Expected Credit Loss (CECL) model proposed by the Financial Accounting Standards Board (FASB), financial institutions will be required to use historical information, current conditions and reasonable forecasts to estimate the expected loss over the life of the loan. Final guidance was issued on June 16, 2016.
Interagency guidance states that the allowance calculation must be comprehensive, well-documented and consistently applied. The overall calculation should be objective in nature, and any changes must be well-documented and justified.
Four governing bodies are responsible for the oversight of thousands of financial entities in the United States. These consist of:
Regulatory bodies expect financial institutions to practice effective risk management regardless of whether they perform the activity internally or through a third party. As institutions consider an allowance solution to use for the expected loss model, there may be other criteria to consider, including readiness, responsiveness and flexibility with the third party.