Guidance states that it is the responsibility of a bank’s management team and Board to ensure an adequate ALLL level as part of the institution’s safety and soundness. That responsibility includes several specific components as outlined in the Federal Reserve’s Commercial Bank Examination Manual.
Bank management is expected to outline and then execute written policies and procedures that confirm the bank:
• Has an ALLL methodology that relies on a consistently applied, comprehensive and well documented analysis of the collectability of the loan portfolio
• Maintains an adequate loan review system to identify credit deterioration in a “timely manner”
• Collects and archives sufficient data to power the bank’s ALLL methodology and sufficient reporting capabilities
• Evaluates any proposed credit loss models to ensure they are consistent with GAAP
• Charges off loans (or a portion of the loan) when data proves it to be uncollectible
• Backtests its ALLL methodology, using an independent party, to validate its effectiveness in estimating credit losses compared to actual losses
The Board of Directors is mostly responsible for oversight of the judgments made by the management team, and include
• Annually reviewing and approving the written policies that management prepared
• Assessing the viability of the bank’s loan review system (in relation to the size and complexity of the bank)
• Reviewing management’s ALLL estimation and provision for the period, along with justification of the estimation
• Enforcing a periodic review and, if needed, update to the institution’s ALLL methodology
These recommendations from the Federal Reserve are meant to be a starting point from which individual institutions can build and review their ALLL model. Responsibilities may differ slightly between banks.