Allowance For Loan Lease Losses

Challenge: Banks are required to reserve an Allowance for Loan and Lease Losses (ALLL) as protection against likely losses given the loans currently in the bank’s portfolio. In doing so, they need an approach that can satisfy regulatory and accounting standards, which are not always in line with one another.

Solution: ERisk provides two approaches to the complicated issue of developing an ALLL reserve: a one-year loss cushion solution or a multi-year expected loss calculation. The first method leverages ERisk’s proprietary loss distribution analytics in its Abacus software to provide a bank with loss magnitudes at various confidence thresholds. For example, after developing a bottom-up credit loss distribution based on the current portfolio and risk drivers such as PD, LGD, maturity and correlations, the bank will be able to report what the magnitude of a one-in-twenty (95% confidence level) one-year loss might be. The second approach to calculating ALLL is to assess the current portfolio’s expected loss over the remaining life of the portfolio. The expected loss calculation is based on the current exposures, risk ratings and collateral strength. This approach also captures the effect of credit degradation by analyzing how loans migrate from one rating to another over time.

Benefits: This project will allow you to develop an objective and efficient approach to measure your allowance that is consistent with regulatory and accounting standards.

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