Credit Losses and Credit Risk Review Systems
Happy Monday, compliance friends!
As explained in a previous blog, the National Credit Union Administration (NCUA) signed on to an interagency policy statement on allowances for credit losses. The statement intends to promote consistency in the interpretation and application of the Financial Accounting Standards Board's (FASB’s) accounting standard in ASC Topic 326 which introduces the current expected credit losses (CECL) methodology. The interagency policy statement will be effective at the time of each institution's adoption of the credit losses accounting standard. NAFCU and NCUA continue to advocate for credit unions to be exempt from CECL
In case you missed it, the blog does a good job of setting forth the relevance and importance of the policy statement. It explains, “The Policy Statement cautions credit unions to consider whether adjustments to historical loss information need to be made to the extent that current conditions and reasonable and supportable forecasts may differ from the historical loss timeline.”
In addition to the policy statement on allowances, on May 8, NCUA signed on to a statement on credit risk review systems. This statement presents principles for establishing a system of independent, ongoing credit risk review in accordance with safety and soundness standards. The statement emphasizes that credit risk review is a significant risk management function separate from the determination of the appropriate reserve for credit losses.
The statement goes on to state credit unions should be flexible and thoughtful in creating a credit risk review system. Systems will vary based on a credit union’s size, complexity, loan types, risk profile, and risk management practices. For example, in smaller or less complex credit unions, a credit risk review system may include qualified members of the staff, including loan officers, who are independent of the credits being assessed. The statement suggests that having the same external auditor review both financial statements plus the allowance for credit losses systems may not appropriate. The statement explains that an independent party may be from an internal audit function, a risk management unit of the institution, or a contracted third party. This way, the person reviewing the allowance for credit losses may maintain integrity and be ready to report any deficiencies. Larger or more complex credit unions, a credit risk review system may require a dedicated credit risk review function. How a credit union decides to create and task its credit risk review system will be a risk-based business decision for each credit union.
The policy statement emphasized a credit risk review system should accomplish the following:
- “Promptly identifies loans with actual and potential credit weaknesses so that timely action can be taken to strengthen credit quality and minimize losses.
- Appropriately validates and, if necessary, adjusts risk ratings, especially for those loans with potential or well-defined credit weaknesses that may jeopardize repayment.
- Identifies relevant trends that affect the quality of the loan portfolio and highlights segments of those portfolios that are potential problem areas.
- Assesses the adequacy of and adherence to internal credit policies and loan administration procedures and monitors compliance with applicable laws and regulations.
- Evaluates the activities of lending personnel and management, including compliance with lending policies and the quality of their loan approval, monitoring, and risk assessment.
- Provides management and the board of directors with an objective, independent, and timely assessment of the overall quality of the loan portfolio.
- Provides management with accurate and timely credit quality information for financial and regulatory reporting purposes, including the determination of an appropriate ACL or ALLL, as applicable.”
The statement notes that establishing periodic review is an essential element in reducing credit risk. The statement suggests that a credit union may review its loans annually, on renewal, or more frequently when circumstances show the existence of higher risk. The statement goes on to discuss the scope of credit risk reviews, appropriate follow up, and communication of findings to management.
Credit unions may want to review both interagency policy statements as they prepare to implement CECL and update internal policies and procedures.