The coronavirus pandemic has upended so many things and created uncertainty within the financial services industry. Credit risk operations, such as the allowance and stress testing, are not exempt.
When making allowance for loan and lease loss (ALLL) or allowance for credit loss (ACL) calculations, financial institutions must consider the uncertainty presented during our current economic and societal times. The 2008 financial crisis exposed significant weaknesses of relying on incurred losses. In response, the FASB replaced the standard with the current expected credit loss (CECL) model to allow for more timely adjustment of reserve levels. After more than ten years of economic expansion, financial institutions are now grappling with how the pandemic may impact reporting losses. One thing is clear: “directional consistency” with forecasts is not the problem. Financial institutions know if they need to make adjustments up or down, but the problem lies in determining the actual adjustment needed.