Use Shadow Loss Analysis to Test a New Methodology

John Closs, MST

If there was one common topic of discussion among bankers as they met and talked during the recent MST 2015 National Conference, it was about adopting a new methodology to comply with CECL. Understanding that CECL could impact reserves by 30, 40, as much as 50 percent, bankers agreed that the time is now to start experimenting with methodologies to determine which approach they want or even can use.

Recently we published papers on what we’re calling “shadow loss analysis.” Like shadow accounting, a shadow loss analysis allows the bank to compare its existing ALLL methodology to a different, prospective approach. A shadow loss analysis makes great sense as a way to compare not only methods but also results.

What are the advantages of a probability of default/loss given default method? Can we track loss migration? Do I have the data necessary for a forward-looking estimation? A shadow loss analysis can answer these critical questions.Even taking CECL out of consideration, a shadow loss analysis is a useful preliminary. You’ll want to test the waters to ensure a new methodology is appropriate, reasonable, and accessible to management, auditors and regulators. So run a parallel analysis along with your existing approach to test viability and compare results before you decide to, or have to, commit to a new methodology.

Click here to read our recent white paper, “Shadow Loss Analysis: A Second, Revealing Look at the ALLL.”