How to Decide Whether to Build or Buy CECL Model Software01.08.2018
Most non-public business entities aren’t required to implement the current expected credit loss (CECL) model until fiscal years starting after Dec. 15, 2020. However, many financial institutions are heeding the advice of the Financial Accounting Standards Board (FASB), and have begun taking steps to ensure effective implementation of this major change in estimating losses. The model will require more inputs, assumptions, analysis and documentation, making the option to automate and modernize the process significantly more attractive for many banks and credit unions. If banks are considering software to comply with the regulations, they may choose to build their own solution or work with a third-party vendor. In either case, banks have several considerations.
Data is the foundation of historical loss experience calculations. Clarify what third-party providers offer as relates to data archive, data architecture and data adequacy services and compare that to in-house capabilities. Consider costs for data cleanup, archiving and assurance, and understand best practices and expectations for data remediation. Compare the degree of automation and flexibility available for each option.
As data issues inevitably become apparent during execution of CECL implementation, having options for electing various methodologies will provide flexibility to financial institutions. Consider the costs for developing and maintaining the options in-house vs. what methodology options are available from various third-party providers. How automated and flexible are the various options? What, specifically, is the process for calculating, evaluating and changing methodologies? Consider what advisory assistance and support is available for each of the methodologies.
The expected life of each segment and/or prepayment behavior will need to be determined prior to performing any calculation. As such, institutions should have a clear understanding of responsibilities and costs specific to calculating and supporting material inputs. It is also important to understand the availability, expertise and costs/fee structure related to any training, advisory services and technical support. Does the bank have those resources internally or will it need to add those?
Model Risk and Auditability
Documentation and support is an area that is often the most time-consuming exercise in today’s allowance for loan and lease losses (ALLL) processes. The new standard will require more inputs, assumptions and analysis at the pool level. Tracking, consolidating and displaying all information necessary to review, support and recalculate will be a critical function of any homegrown or vendor-based solution. Consider what level of transparency and auditability is offered by any third-party solution under consideration, and take into account costs associated with model risk and/or time spent preparing documentation and support.
For more information on how to apply expected credit loss estimations to loan concentrations, see the CECL Methodology Webinar Series.
Reprinted with permission from Sageworks, a financial information company that provides analytical services and solutions to financial institutions.