Primary Risks

The primary risks associated with ACLLL include:

Credit Risk

Credit risk is the risk of default on repayment of loans or investments. The size of the ACLLL account grows comparatively to the level of credit risk inherent in the credit union’s loan portfolio. If a credit union’s CECL allowance methodology calls for a balance increase in the ACLLL account, the related CLE will increase, thereby reducing earnings and potentially net worth.

Compliance Risk

Compliance risk is the risk of violations resulting from non-compliance with applicable laws and regulations resulting in:

  • Fines

  • Penalties

  • Damages

  • Voiding of contracts

The NCUA regulation § 702.113, Full and fair disclosure of financial condition, requires credit unions to fully and fairly disclose their financial condition. A credit union’s failure to analyze and fund the ACLLL account in accordance with GAAP increases compliance risk and misstates financial statements and Call Reports.

Strategic Risk

Strategic risk is the risk to earnings or net worth arising from adverse business decisions, improper implementation of decisions, or lack of responsiveness to industry changes.

To make sound strategic decisions, management needs accurate financial statements that reflect the credit union’s financial position. Management does this by reviewing and promptly identifying problem assets, then making necessary ACLLL account adjustments; this can include write-offs. Failure to adjust the allowance account mispresents the credit union’s true financial position and could lead to poor strategic decisions based on inaccurate financial data.

Transaction Risk

Transaction risk is the current and prospective risk to earnings and net worth resulting from errors, omissions, material misstatements, or fraud. Credit unions can mitigate this risk with sound recordkeeping practices and an effective system of internal controls.

The ACLLL account is susceptible to transaction risk through unintentional errors or intentional manipulation. Some activities that pose transaction risk include:

  • Posting CLE incorrectly

  • Posting recoveries and charge-offs incorrectly, delaying posting of recoveries and charge-offs, and failing to post recoveries and charge-offs

  • Charging inappropriate expenses to the ACLLL account, such as collection-related expenses

  • Using inaccurate data or using unpersuasive or incorrect valuation approaches in the CECL methodology

  • Failing to include or consider all loans in the CECL methodology calculation

  • Miscalculating the methodology formulas

  • Revising the methodology to increase or reduce the funding requirement without validation

  • Failing to adhere to internal policies or procedures

Operational Risk

Operational risk is the risk of loss resulting from people, processes, systems, or external events that can disrupt the flow of business operations.

Operational risk related to ACL estimation processes depends on credit union specific factors, such as:

  • Volume and complexity of the financial assets

  • Adequacy of personnel (for example, experience, competency, and number)

  • Quality of credit risk review systems

  • Effectiveness of collaboration between parties involved in ACL processes

  • Adequacy of risk management systems and internal controls

  • Quality of reports to management and the board

  • Data integrity

  • Effectiveness of model risk management practices

Key for controlling operational risk is the quality of the audit function, governance, third-party risk management, and controls protecting the confidentiality, integrity, and availability of credit union information. If ongoing monitoring or periodic validation of ACL methodologies is not conducted effectively, ACL estimation processes may not produce reliable ACLs in accordance with GAAP. Errors or omissions in ACL estimates may not be timely detected and cause financial misstatements and regulatory reporting errors.

Reputation Risk

Reputation risk is the potential that negative publicity regarding a credit union’s business practices, whether true or not, will cause a decline in the member base, costly litigation, or revenue reductions.

Publicized measures of asset quality, such as the level of non-performing loans, or other credit metrics, may subject the credit union to an unfavorable market perception. Enforcement actions involving a credit union’s restatement of prior period financial results or a need to improve its processes for determining and maintaining ACLs may also affect a credit union’s public perception and reputation.

Last updated on June 05, 2023