Your credit union’s ALLL model may be due for a check-up

by: Tom Danielson

Like visiting a doctor for a physical, your financial institution should periodically test the health of its Allowance for Loan and Lease Losses (ALLL) model. It’s not just a good business practice (an underfunded ALLL overstates equity and earnings and casts doubt on management’s ability to accurately report the institution’s financial condition), it’s a regulatory requirement.

The Interagency Policy Statement on the Allowance for Loan and Lease Losses says the validation process should include “procedures for a review, by a party who is independent of the institution’s credit approval and ALLL estimation processes, of the ALLL methodology, and its application in order to confirm its effectiveness.”

The statement goes on to say that the independent party could be:

  • The internal audit staff
  • A risk management unit of the institution
  • An external auditor (subject to applicable auditor independence standards)
  • Another contracted third party from outside the institution
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