Independent Review of ACL Estimation Processes

Independent Review of ACL Estimation Processes

The Allowance for Credit Losses (ACL) is a critical component of a bank’s financial reporting and risk management framework. Regulators expect banks to maintain a sound and well-documented ACL estimation process. One key element of this expectation is the requirement for an independent review of the ACL methodology. While not all banks are subject to formal model risk management guidance, the Interagency Policy Statement on the Allowance for Credit Losses (updated April 2023) makes it clear that validation of the ACL process is essential for all institutions, regardless of size or complexity.

The purpose of an independent review is to ensure that the ACL estimation process is reasonable, consistent with accounting standards, and free from bias. This review should be performed by individuals who are not involved in the development or execution of the ACL methodology. The goal is to provide an objective assessment of the process, including data inputs, assumptions, and controls.

Regulatory Expectations for Independent Review

The Interagency Policy Statement outlines several expectations related to the validation of ACL estimation processes. These expectations apply to all banks, even those not directly subject to the Supervisory Guidance on Model Risk Management (SR 11-7 / OCC 2011-12). Examiners will typically look for the following elements when assessing a bank’s compliance with ACL validation requirements:

  • Qualified Reviewers: The individuals conducting the review must possess the necessary knowledge, skills, and experience to evaluate the ACL estimation process effectively. This includes a strong understanding of credit risk, accounting standards (such as CECL), and internal control frameworks.
  • Independence: Reviewers must be independent from the bank’s credit approval and ACL estimation functions. This separation helps ensure objectivity and reduces the risk of conflicts of interest.
  • Appropriate Review Functions: Acceptable reviewers may include internal audit staff, an independent risk management team, or qualified third-party contractors. The choice of reviewer should be based on the complexity of the ACL process and the availability of internal resources.
  • Frequency and Scope: The review should be conducted periodically, with a scope that is appropriate to the size and complexity of the institution. The review should cover key components of the ACL process, including data quality, model assumptions, documentation, and governance.
  • Documentation and Reporting: The results of the review should be clearly documented and reported to senior management and the board of directors. Any findings or recommendations should be tracked and addressed in a timely manner.

Examiner Insights and Practical Considerations

In practice, examiners will assess whether the bank’s ACL validation process is robust and independent. They will expect to see evidence that the review was conducted by qualified personnel and that it included a thorough evaluation of the methodology, assumptions, and controls. Examiners may also review how management responded to any findings and whether corrective actions were implemented.

Smaller banks that lack internal resources may engage external consultants to perform the review. While this is acceptable, the bank remains responsible for ensuring the quality and independence of the review. Examiners will also expect the bank to understand and be able to explain the results of the review, even if it was conducted by a third party.

Ultimately, the independent review of the ACL estimation process is not just a regulatory requirement, it is a sound risk management practice. It helps ensure that the bank’s credit loss estimates are reasonable, well-supported, and aligned with accounting and regulatory expectations.

To learn more about how GLOBAL ABAS can support your compliance program, visit our website or subscribe for future updates.

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