Financial institutions had to take many steps to calculate an allowance for loan losses under the current expected credit losses (CECL) methodology. With implementation now behind us, making sure your institution is ready for its next regulatory exam or financial statement audit is critical. Based on both CPA firm and regulator recommendations, many financial institutions are opting to have a model validation performed to ensure their newly designed CECL loss estimation process is appropriate for their size, complexity and risk profile. If your institution is contemplating whether it should have a CECL validation performed, Doeren Mayhew’s Financial Institutions Group offers five reasons for your consideration. 

1. Following regulatory guidance. Management should periodically validate the loss estimation process, so a validation is required. The validation process should include procedures for review by a party with appropriate knowledge, technical expertise, and experience who is independent of the institution's credit approval and allowances for credit losses (ACL) estimation processes. 

2. Prepare for a financial statement audit or regulatory exam. If your external audit or regulatory exam is approaching, it’s important to be well-documented. Regulatory guidance states that documentation should include ACL calculations, qualitative adjustments and any adjustments to the ACLs required as part of the internal review process. In addition, it will be helpful to gain a better understanding of how your methodology compares with your peers. 

3. Identify any potential weaknesses now. Gain valuable insight into your model’s shortcomings or potential weaknesses, such as inappropriate volatility, and allocate time to strengthen them. Based on the results of a mid-year model validation, management may elect to restate its day one CECL estimate. 

4. Assist governance in gaining a clear understanding of the model, how it works and how to interpret outputs. Ensure senior management and others have an accurate picture of the functionality of the CECL model and the outputs. As part of a model validation, request training for governance and management. 

5. Examine overall internal controls. Request the validation assess the internal controls surrounding the model to confirm the controls are appropriately designed in accordance with generally accepted accounting principles (GAAP) and interagency guidelines for your institution's size and complexity. 

Having an independent validation performed will help your institution gain confidence that its CECL model is presented fairly, in accordance with GAAP and is transparent for regulatory examinations before auditors and examiners arrive.