CECL Model Validation: 5 Best Practices for Community Banks

The Current Expected Credit Loss (CECL) standard has fundamentally changed how financial institutions estimate credit losses. For community banks, validating CECL models presents unique challenges—balancing regulatory requirements with practical resource constraints.

Why CECL Validation Matters

Regulatory examiners are scrutinizing CECL models more closely than ever. A poorly validated model can lead to:

• Regulatory findings
• Inaccurate financial statements
• Flawed strategic decisions
• Capital planning errors

Best Practice #1: Understand Your Model's Methodology

Whether you're using Abrigo, Primatics/EVOLV/EMSM, or a custom model, you need to understand:

• How the model calculates expected losses
• Key assumptions and limitations
• Data inputs and their quality
• Sensitivity to economic conditions

Action: Document the model's conceptual soundness in plain language that management and the board can understand.

Best Practice #2: Validate Data Quality

CECL models are only as good as their data. Validate:

• Historical loss data completeness
• Migration patterns accuracy
• Economic scenario reasonableness
• Segmentation appropriateness

Red Flag: If your model relies on peer data because your historical data is insufficient, document this limitation prominently.

Best Practice #3: Perform Sensitivity Analysis

Test how your CECL estimate changes when you adjust:

• Economic forecasts
• Historical lookback periods
• Qualitative adjustments
• Prepayment assumptions

Action: Present sensitivity results to management quarterly to build intuition around model behavior.

Best Practice #4: Compare to Actual Experience

Track your model's performance over time:

• Compare estimates to actual charge-offs
• Analyze significant variances
• Update assumptions as needed
• Document changes in credit quality

Best Practice: Create a "model performance dashboard" that tracks key metrics monthly.

Best Practice #5: Document, Document, Document

Examiners will ask for:

• Initial model validation reports
• Ongoing monitoring procedures
• Management responses to findings
• Evidence of board oversight

Tip: Maintain a centralized "CECL governance" folder with all documentation organized and accessible.

Common Validation Mistakes

Mistake #1: "The Vendor Validated It"

Vendor validation is helpful but doesn't replace your independent validation responsibility.

Mistake #2: One-and-Done Validation

CECL models require ongoing monitoring and periodic revalidation (typically annually or when material changes occur).

Mistake #3: Ignoring Qualitative Adjustments

Many banks make significant qualitative adjustments but don't validate the methodology behind them.

The RegVizion Approach

We provide SR 11-7 compliant CECL model validation that:

1. Assesses conceptual soundness of the methodology
2. Validates data quality and completeness
3. Tests model performance against actual experience
4. Reviews ongoing monitoring procedures
5. Evaluates qualitative adjustments

Getting Started

If your CECL model hasn't been independently validated in the past year:

1. Schedule a validation review
2. Update your monitoring procedures
3. Ensure documentation is complete
4. Brief management and board on findings

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Ready for a CECL model validation? Contact us to discuss your institution's needs.