Contributing Author: Tim Biddle
One of the earliest and most critical decisions in your CECL compliance journey is how to handle reserve modeling. The basic decision is simple: will you create your own CECL models or will you use a vendor model?
This decision must be considered very carefully as it will have very significant downstream impacts on CECL implementation and continued compliance activities.
The case for an in-house solution
In-house modeling may be desirable if you already have:
- A very good understanding of CECL
- Robust data governance, data management and data analytic capabilities
- An understanding of and access to the internal and external data that will be required to support CECL calculations
- The technical expertise and resources to run what could be thousands of loan pool/reserve methodology variations to determine the best mix and match for calculating CECL reserves
- Model validation procedures to ensure that models are working as disclosed and that results are understood
- A modeling process that is flexible and scalable enough to handle changes to the business, including significant loan growth, acquisitions, new loan products or services or other factors
- Comfort that the modeling results are consistently logical, reasonable and supportable when compared to peer or industry trends and when scrutinized by auditors and regulators
If your response to all of these questions is “Yes”, then an in-house solution probably makes sense.
The case for a 3rd party solution
On the flip side, if your answer to any of the above questions is anything less than a confident affirmation, you might want to consider a third-party model. But first you need to do some soul-searching: where do we want to be on the sophistication scale when it comes to CECL compliance? Less sophistication might lead to an evaluation of more standardized software, while a desire for highly sophisticated reserve capabilities would lead to more customized and flexible platforms. There are tradeoffs associated with both – more standardization is generally less expensive and less flexible, potentially less accurate and may require some operational or process tweaks to accommodate it. Customized solutions are generally more expensive, more flexible, potentially more accurate and may be a better fit if you have a more varied or complex portfolio. Third party models generally come with built-in scalability, more data availability, best-practice level data integrity and security, SOX compliance and consistency.
Make the decision now
The bottom line: the in-house vs. 3rd party modelling decision is critical and needs to be addressed now. CECL modeling is complex, so staying in-house may require significant process redesign or documentation and control work to ensure that the end-result will readily support CECL compliance. Choosing to employ a third-party model may be safer and more mainstream but will require a selection process that could take more time than anticipated. It’s time to get started!