The importance of ALLL methodology

The allowance for Loan and Lease Losses (ALLL) is a reserve that banks and other financial organizations establish. This is in relation to the estimated credit risk within the bank’s assets. It was formerly known as the reserve for bad debts and is one of the most important aspect in regards to a bank’s reputation. If the estimated credit risk is high, the ALLL reserve should also be high to compensate for the incurred losses. The ALLL methodology is a vital aspect of any bank‘s safety and reputation. The federal bank examiners ensure that a bank has sufficient amount of money in the allowance reserve. It has a huge effect on the bank’s capital and is hence of importance to also the bank’s management and directors.

LLR methodologyvaries from bank to bank. Banking regulators must ensure that banks have appropriate resources to counter and bear losses that arise from defaulters and non-payment by borrowers.To determine a proper allowance banks should periodically evaluate borrower profiles and pending payment of loans in their portfolio. The ALLL is determined and calculated at the end of each quarter. It may also be done more frequently if it is suggested by the loan review process. This is something that can’t be neglected since the bank or the financial institution’s reputation and image rest on it. This determines the strength of a bank and its long term existence. Economic conditions are also to be kept in mind during the whole process. The future can’t be predicted and that is why an estimate of the possible future losses needs to be made in order to plan a reserve for the same.

There are a few challenges that banks face with regards to allowancefor loan and lease losses estimation. 

These challenges are as follows:

·         The process is manual and time intensive.

·         Proper documentation is necessary and producing that can be a tedious task.

·        

      New accounting standards have to be incorporated as per FASB and federal regulatory bodies.

But these challenges need to be overcome by the banks and financial institutions even though it must be a bit of a task and hence, a good and reputed credit risk management company should be involved in looking after the entire process. Association with a credible company brings in more relief to the bank and the bank can thusly enjoy good reputation and management of their loans at present and in future.