Loan Loss Provision

Loan Loss Provision

As a matter of prudential risk management, banks set aside general and specific loan-loss provisions or reserves. General provisions cover the general risk that not all of the loan book will be paid back on time. Certain general provisions are allowable as Tier 2 capital. Specific provisions are made against loans to specific borrowers that the lender has signalled could become delinquent. The International Accounting Standards Board’s International Financial Reporting Standard 9 - Financial Instruments (IFRS 9) introduced an expected credit loss (ECL) framework in 2018 for banks to model credit impairments and make modelled provisions -- even in the absence of evidence of potential impairment. IFRS 9 has three stages of impairment: Stage 1 – a loan-loss allowance is made when a loan is originated based on possible default events within the next 12 months (a so-called 12-month ECL). Stage 2 – if a loan\'s credit risk increases significantly, banks are required to recognise potential ECLs over the life of the loan. Stage 3 – if a loan is considered credit-impaired, interest revenue is calculated based on the loan\'s amortised cost i.e. the gross carrying amount less the loss allowance.

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