Sources of Modelling Variation in CECL Allowances

Fang Du, Chris Finger, Ben Ranish, Robert Sarama

The current expected credit losses (CECL) framework requires firms to adapt their methods for setting loss allowances. While the extent of the changes to those methods will depend in part on firms’ size and complexity, larger and more complex banks may develop or adapt credit-risk models in order to estimate the expected losses that will form the basis for loss allowances. Smaller and less complex institutions are expected to adjust existing allowance methods to meet the requirements of CECL without the use of costly or complex modelling techniques. This chapter describes how the modelling choices facing larger institutions may generate variation in CECL allowances across these institutions.

The CECL framework requires that firms’ loss allowances reflect expected credit losses based on past loss experiences, current economic situations and “reasonable and supportable” forecasts of future economic conditions. Thus, CECL allowances should exhibit “risk-based” variation – that is, variation due to differences in economic conditions or loan and borrower characteristics across institutions. However, the CECL framework is principle-based, imposing few specific requirements on methodolo

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