Can a financial institution’s allowance be lower under CECL?
Will examiners challenge financial institutions if the current expected credit loss method (CECL) results in a lower allowance than under the incurred loss model? Banking agencies addressed this question during a recent webcast.
Objectivity in Adjustments
There are various measures institutions can take to add objectivity to the otherwise subjective task of qualitative and environmental risk factors. These consist of incorporating a qualitative scoring matrix into your Q factor analysis, ensuring directional consistency, and sticking to the nine recommended Q factor adjustments, among other things.
The ALLL calculation should be objective in nature; that is, when attributing qualitative and environmental factors to the allowance, there should be sound reasoning as to why certain adjustments were made. An objective ALLL ensures that there is no management bias or partiality to skew the results of the calculation one way or another.
Institutions must perform the ALLL calculation in such a manner that the assumptions from one period to the next are justified and consistent. From calculation to calculation, assumptions should reflect any changes in the loan portfolio, management adjustments be directionally consistent with the environmental landscape and the methodology should be largely repeatable.