All of us have either heard or used cliches to express thoughts on encounters we have in our daily work or personal lives. Long ago, these sayings may have been striking and thought-provoking, but eventually they lost some of their effectiveness simply by overuse.
I can remember my mother using cliches during my adolescence like “Cat got your tongue?” and “Someone woke up on the wrong side of the bed,” to name a few.
Reflecting on these enduring phrases from my youth brought to mind another cliche that may be applicable to those of us in the financial institution industry who have been vigilantly working on the Current Expected Credit Losses (CECL) standard implementation over past several months.
Now, the time has come to see whether the “proof is in the pudding.”
The expression is meant to convey that the real worth, success or effectiveness of something can only be determined by trying it, appearances or promises aside. If the best test of a pudding is to taste it, the needed scrutiny of CECL models is underway by many interested parties who want to make sure the underlying data, methodologies, qualitative adjustments and reporting outputs are within expectations of the new accounting guidance.
While these expectations are primarily directed by regulatory agencies and external auditors, an institution’s board of directors and executive leadership should also be evaluating and monitoring the outputs of the CECL model. As with other risk modeling required by financial institutions, the independent validation of the CECL model will be a cornerstone activity to be performed on regular basis.
CECL model validation
For many institutions, the time for final implementation has arrived with the new year and the 2023 effective date. At this point, your vigorous efforts have translated into either successfully implementing CECL, or you are working toward the final implementation stages based on your respective fiscal-year effective dates.
So, besides any remaining fine-tuning to the CECL model, what is next in the process? Whether you are running a model developed in-house or have partnered with a third-party provider, you’ll need to take into consideration on-going model risk management concerns.
Typically, financial institutions will want to validate their CECL model once it’s up and running. The timing on this may vary, but often it’s preferably undertaken early enough in the CECL implementation process so any tweaks or changes can be identified and incorporated into the CECL running model.
As discussed in the final Interagency Policy Statement on Allowances for Credit Losses, model validation is an essential element to a properly functioning process. Validations are meant to ensure that the models are performing as expected and meeting the objectives of its users.
With all modeling validations, the three key aspects of coverage include:
- Testing of inputs
Ideally, model validation should be completed by an individual or firm independent from the design, implementation, operations and ownership of the model. The validation process will evaluate the model design and theory, assumptions used, validation of loan data integrity, and assessment of the qualitative and forecast adjustments, including supporting documentation. The process will also provide an understanding of management’s knowledge of the model functions output.
How Wipfli can help
Wipfli specialists have dedicated resources to help financial institutions perform independent validations of their CECL models. Gain confidence that your processes are working properly. We bring industry best practices and a strong track record to your institution. Learn more about how we might assist your institution complete its CECL model validation.
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