2 Ways to learn from peer institutions
Aug 6, 2015
For most financial institutions, a primary source of feedback on their stability and back-end processes comes from their respective regulatory agencies. Annual exams are an important gauge for banks and credit unions on their effectiveness in running a sound institution – from lending decisions to risk management and compliance.
These exams are an important source of information, but institutions can also benefit substantially from learning from their peers. While not necessarily direct feedback like that from an examiner, peer data and information on how similar institutions do something are often-overlooked learning opportunities.
Many institutions analyze their peers only to provide benchmarks and context for understanding their own financial results, like earnings and ALLL loss rates.
In order for a bank or credit union to best leverage peer data, however, it’s important the institution has a solid set of criteria to use for identifying peers. As this ALLL Insiders article explains, choosing the right peer group requires a deep look into other institutions’ risk appetite, mix of available products and loan concentration, not simply their geographic proximity and asset size. Whether the peer set is for a look at the ALLL calculation or a full financial comparison, peer selection is a critical part of the data analysis process.
Specific to the ALLL, many institutions find it helpful to break down where their peers stand on the calculation, including average loss rates, Q Factors that may be used, reserve levels to total loans, etc. There are a few different resources from which to gather this data, including an annual Loan Loss Reserve Survey compiled by McGladrey and the ALLL Benchmarks module within Abrigo Bank Information. Both resources offer a variety of data points to use for benchmarking within the reserve.
Properly done, a peer comparison will allow management to more accurately assess the performance of their own bank or credit union.
Internal best practices
While benchmarking data is an immensely helpful practice, it often isn’t granular or actionable enough to yield a complete picture of their process – only the results. Institutions aiming to take full advantage of what their peers can teach them should also gather information on how similar institutions compare on internal processes and best practices. And this also applies to the ALLL.
The 2015 Abrigo Bank & Credit Union Examination Survey offered a number of best practices in managing the ALLL in the context of exams and throughout the year. One Federal Reserve-regulated bank suggested that other institutions “review methodology with outside accountants” to verify that it is sound and that assumptions in the methodology are justified. Another survey respondent suggested challenging the process to find potential holes before the examiners are onsite and recommended ensuring the assessment is forward-looking in regards to qualitative adjustments. For evaluating impaired loans specifically, one survey respondent shared that the methodology they use for calculating impairment has been a “moving target”. However, they are presently using a NPV of cash flow with supportable probability percentage for Best Case, Expected Case and Worst Case situations.
Several larger institutions recommended using a sophisticated or more granular ALLL model that is backed by historical data that incorporates borrower risk ratings and industry (of the borrower) risk ratings. With these methodology improvements, however, documentation can become more difficult so automation for “as much as you can” was also suggested. “Be able to explain the process followed. Document how you arrive at the percentages used,” advised one FDIC institution.
Because qualitative factors (Q factors) are often a challenging aspect of the calculation no matter the size of the institution, an OCC-regulated bank offered this advice: “Make sure your qualitative factors are consistent on a quarterly basis, and be sure that the rationale for any changes is clear and documented.” One credit union executive agreed that defensibility through documentation was imperative: “Document as much as possible around qualitative assessments; break out quantitative sections as low as feasible.”
In addition to surveys, another way to learn about peers’ internal processes is to attend industry conferences. Regulatory agencies host events for bankers or credit union professionals to meet and share best practices. These, plus many other risk management events, offer roundtable discussions specifically for the purpose of swapping ideas and practical applications with peers.
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