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CECL best practices: Ongoing management of the allowance model

November 3, 2023
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Top 5 CECL best practices and their benefits

Now that CECL is implemented, follow these recommendations for ongoing management to provide confidence and be more efficient. 

You might also like this webinar, "Conquering CECL model validation: Prepare for success."


Processes and approaches for the ACL

What are CECL best practices?

Adopting the current expected credit loss model, or CECL, has been a critical effort at financial institutions over the last few years. Now that it’s implemented, it’s crucial to ensure ongoing compliance and efficient management of the allowance for credit losses (ACL).

Developing this estimate is important enough that a smart approach is to follow some CECL best practices for ongoing management of the ACL. Read on to learn what these practices are and how they can benefit your financial institution.

The recommendations for CECL management described below refer to processes and approaches that have been effective among financial institutions as they have implemented the accounting standard since it became effective for the largest banks in 2020.

They also refer to actions after implementation that have helped financial institutions calculate the allowance for credit losses on an ongoing basis with consistency. They are based on experience directly implementing and running the CECL calculation as well as working with thousands of banks and credit unions to navigate CECL compliance through automation.

Learn how credit unions have been impacted by CECL in this on-demand webinar, "CECL aftermath: Credit union trends and future considerations."

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Reduce stress; instill confidence

Benefits of adopting CECL best practices

The allowance for credit losses is the single biggest estimate on the balance sheet, so your financial institution needs to have confidence in its ACL. Examiners, auditors, board members, and other stakeholders can gain confidence in the estimate, the model used, and ongoing processes when you’ve followed standard steps to ensure an accurate, compliant estimate.

In addition, a major aspect of managing the ACL is explaining the calculation and the resulting data to boards, auditors, and regulators. However, each financial institution is different, so one likely handles the process of estimating the reserve slightly differently from the next. Examiners, auditors, and their areas of focus can vary, too. Following some CECL management best practices can ease the stress of conversations with those parties. Knowing you’ve taken steps to maintain and manage the CECL calculation can prevent sleepless nights ahead of these meetings.

Finally, adopting these approaches will build operational efficiencies for the allowance process, especially when adopted during implementation. 

 Getting them set up and into action immediately afterward is still valuable, though. A standardized line of attack makes the calculations themselves (and defending them) easier every quarter, so staff become more efficient at it, and preventable problems don’t cause delays.

“The allowance for credit losses is the single biggest estimate on the balance sheet.”

Data and documentation

Top 5 CECL best practices for institutions

Ongoing data validation

Be aware of any changes to data files and sources, whether from core system changes, actions by loan operations, or others. Unsuspected data changes can lead to incorrect model results or validation/audit findings. Make sure to incorporate CECL data validation procedures into your regular process, including validation of key fields, such as payment type and maturity date. Changes to files should not occur without proper controls and approvals from the model owner.

Documentation and cross-training

Document the institution’s CECL process thoroughly, not just when you implement CECL but on an ongoing basis. Detail your models, the decisions you’re making, and the entire process of running monthly or quarterly models. Consider developing a playbook for your model creation. This involves creating play-by-play instructions (which can be captured with screenshots from your CECL software) so that someone could run the model in the absence of key staff. Cross-train to make sure others are involved and know the process. Documenting and training assist with auditing and examination and can ensure staff changes or unexpected situations don’t derail the allowance.

Updated policies

Examine policies and procedures to ensure they are up-to-date and aligned with your CECL process. In particular, watch out for outdated language and terminology used before CECL adoption. Don’t confuse policies and procedures. Policies should describe how to govern the CECL process, including methodologies and other high-level decisions. Procedures should describe the operational processes, some of which might change throughout the year depending on staffing or other reasons.

Qualitative factors documentation and support

Be ready to defend qualitative factors with support and documentation. Support can include using (and documenting) internal metrics like levels of past due, levels of non-performing assets, external data like economic trends, and management commentary. Monitor trends and changes in qualitative factors over time. This should include tracking, documenting, and even presenting to your board what’s behind changes in the mix of qualitative vs. quantitative factors as contributions to the estimate.

Backtesting and ongoing monitoring

Perform regular backtesting on your CECL model to ensure it is still performing as expected and reflects your risk profile. Periodically review the methodology, assumptions, and inputs, including forecast inputs and sources. Have you added new lines of business, or is a particular segment evolving or growing? Those are among the reasons an institution may need a change in methodology or the addition of a new one. Finally, document both backtesting and reviews. The allowance is especially material to your balance sheet, so you need to document your controls, monitoring, and testing to ensure confidence in the process and program in place for developing this estimate.


Active steps to support CECL compliance

Financial institutions that routinely validate data, backtest their CECL models, review policies, and document the CECL process and the development of qualitative factors are taking active steps to support an accurate and compliant allowance. If you need help with best practices or general support with CECL, Abrigo’s CECL software and CECL consulting have helped more than 1,000 financial institutions reduce their regulatory burden.

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