Credit risk from activities not specific to lending?
Like the entire credit risk review system, determining an effective scope for an institution’s credit risk review process begins with focusing on the institution’s specific risk characteristics. An effective scope for the review typically includes various types of loans, such as loans over a certain size, past-due loans, loans with high credit lines, etc., the new guidance says. A new addition to the guidance is that an effective scope for the review typically also includes “exposures from non-lending activities that pose credit risk.”
Some financial institutions commenting on the addition have argued that adding non-lending activities to the list of exposures that should be within the scope of a loan review would significantly expand the standard’s reach and replicate some audit areas. Nevertheless, the final guidance retained the reference, and regulators again pointed to the need for institution-specific credit risk review planning.
“The agencies recognize that credit risk may arise from activities that are not specific to lending and encourage institutions to consider whether such activities should be included in the scope of the credit risk review function,” regulators said in comments accompanying the guidance. “For example, institutions that hold investment securities or engage in capital markets, treasury, or automated clearinghouse activities may elect to include the credit risk related to these activities in the scope of a review. While the examples of non-lending credit activities cited here are not exhaustive and may not apply to all institutions, they illustrate other areas that management and the board of directors may consider in the development of a review plan that reflects the risk profile of the institution.”
Credit risk review helps with CECL
As it relates to CECL-connected changes, the guidance, in general, clarified that credit risk review helps make sure that the allowance adequately reflects the bank or credit union’s risks. When applicable, loans and portfolio segments selected for review are typically evaluated for, among other things, “the appropriateness of credit loss estimation for those credits with significant weaknesses including the reasonableness of assumptions used, and the timeliness of charge-offs.’’
“The calculation of estimated ACL or ALLL is not the role of credit risk review,” regulators said. “However, effective credit risk review results help ensure that the ACL or ALLL adequately reflects risk in the credit portfolio. In performing its assessment of reasonableness, credit risk review can leverage work performed in this area by other functions, such as internal audit.”