Challenges and solutions for qualitative allowance

Isidore Verla

The art and science of qualitative allowance have always been critical components in the incurred loss allowance model. With the ongoing transition to CECL, where much emphasis is placed on historical data and sophisticated models paired with well-defined reasonable and supportable forecasts, the importance of qualitative allowance has increased, in direct contrast to earlier expectations. This chapter will explore new challenges to qualitative allowance under CECL, and introduce a framework for integrating both quantitative and qualitative dimensions into the standard Q-factors. The economic uncertainties brought about by the unprecedented grip of COVID-19 have elevated qualitative components of the allowance process to the centre of the allowance estimation for institutions that adopted CECL in early 2020.

While there is increasing complexity in qualitative allowance, the core principles of a comprehensive, systematic, well-documented and consistently applied process remain at the heart of all considerations, to satisfy the mandates of regulators, auditors, investors and senior management. Therefore, this chapter will focus on the results of an informal survey of peers to get