The onset of the COVID-19 pandemic and subsequent passage of the Coronavirus Aid, Relief, and Economic Security Act postponed the deadline for current expected credit loss (CECL) implementation from Jan. 1, 2020, to Jan. 1, 2023. This postponement provided many banks some helpful breathing room, but the new date is now less than a year away. It’s time for banks that have not yet coordinated a model validation plan to set gears into motion.
1. Allot time for enacting recommendations and revisions
The sooner the model validation process can begin, the better. Findings from CECL model reviews likely will include essential revisions to structure, methodology, and documentation that must be completed before the 2023 deadline.
Both internal teams and an external model vendor might be required for this work. Forcing completion within the final month of the year can cause extra stress and unforeseen challenges.
Key consideration #1: Allot time for enacting recommendations and revisions. Planning ahead can help your team meet the deadline on time.
Organizations should plan for extra work within their timetables, such as:
- Fixing errors in data and calculation
- Addressing oversights on assumptions, such as utilization rate or prepayment rate
- Calibrating models to align more closely with bank performance or a peer group
- Identifying and excluding qualitative factors captured in historical loss rate calculation
- Modifying adjustment ranges
Additionally, model validators can be asked to divide their recommendations between essential revisions and those that can be completed after the deadline, if possible. Every recommendation might not carry equal urgency, so it’s best to focus attention on the issues that can’t wait.
2. Confirm the scope of validation services provided
Key consideration #2: Confirm the scope of validation services provided. CECL models might be subject to heightened scrutiny
CECL models can involve significant management judgment, which could make them subject to heightened scrutiny. An intensive review of the organization’s CECL model is well worth the investment if it provides a more stable foundation for adoption and future reviews.
Some validation services might offer lower costs, but they do so by providing less extensive evaluations. Thorough validators will dig deep into data analysis and replicate model results.
Before making any commitment for model validation services, organizations should ask potential model validators how broadly their process will extend; how deep into the design, data, and implementation of a model they will investigate; and how extensively they’ll document their findings.
A CECL model can also influence management behaviors, including risk appetite and estimations. Validation findings might be of great interest to regulators and to an organization’s internal auditors and board as well. A comprehensive validation and reporting process can help answer more questions about a CECL model and the influence it might have on management behavior.
3. Shore up your model risk management governance
Organizations often lack appropriate model risk management governance. A preliminary review of risk management policies and procedures – even before the validation process begins – can help keep banks one step ahead and save time and resources closer to the validation deadline.
Important model risk management governance items to confirm and review should include:
- Documentation that details key model components such as:
- Portfolio segmentation
- Model design
- Assumptions and limitations
- Alternative approaches
- Data sourcing and preparation
- Outcome analysis
- A change control procedure and log to track model changes, including definitions of how changes are documented, tested, reviewed, and approved
- A detailed model operation procedure
- An ongoing monitoring plan that outlines, at minimum, frequency of monitoring, tests to be performed, metrics to be tracked, and corrective actions to be taken after potential breaches
Get objective, responsible CECL model validation
Crowe model validation specialists know how to help derive clear and actionable modeling decisions.
Crowe model validation specialists are uniquely positioned to provide CECL model validation. As a CPA firm with deep experience in model validation for a multitude of banks, we understand how to meet regulatory expectations. We also know how to help banks derive the clearest and most actionable model information to drive their credit-based decisions.
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