What Are the Benefits of Scenario Building?
Jan 21, 2015
In this video, a Sageworks consultant likens scenario building to the process of stress testing and provides examples where scenario building is applied. He mentions that scenario building benefits institutions in many ways, inclusive of demonstrating to examiners that you have taken into account a deeper level of analysis in your ALLL calculation.
The context of the ALLL scenario building is something I liken to the process of stress-testing. It is a way to look at different aspects of your calculation to see what the difference would be if you move those levers. Some common examples that we see in our clients are different loss-rate periods, different look-back periods – even as far as different loss-rate methodologies. This might even be looking at one example that would allow for a historic loss-rate calculation and another scenario that would allow for migration analysis calculation. This tends to be very regulator friendly; a lot of times our clients are asked by regulators, “What would this look like if you used (for example) a 12 quarter look-back versus an 8 quarter look-back?” The ability to answer that question quickly has benefits in terms of your exam, but also for knowing and being comfortable overall with your allowance number.