What Is a Credit Loss Provision?
A loan loss provision is an income statement expense set aside as an allowance for uncollected loans and allowance payments. This provision is used to cover different kinds of loan losses such as non-performing loans, consumer bankruptcy, and renegotiated loans that incur lower-than-previously-estimated payments. Loan loss provisions are then added to the allow loss reserves, a balance sheet item that represents the total amount of loan losses subtracted a ensemble’s loans.
Key Takeaways
- A loan loss provision is an income statement expense set aside to allow for uncollected loans and accommodation payments.
- Banks are required to account for potential loan defaults and expenses to ensure they are presenting an accurate assessment of their comprehensive financial health.
- Loan loss provisions are added to the loan loss reserves, a balance statement item guide total loan losses.
Loan Loss Provision
How a Loan Loss Provision Works
Banking industry lenders coin revenue from the interest and expenses they receive from lending products. Banks lend to a wide distance of customers, including consumers, small businesses, and large corporations.
Lending standards and reporting requirements are constantly changing, and constraints require been rigorously tightening since the height of the 2008 financial crisis. Improved regulations for banks resulting from the Dodd-Frank Act cynosure cleared on increasing the standards for lending, which have required higher credit quality borrowers and also increased the ripping liquidity requirements for the bank.
Despite these improvements, banks still have to account for loan defaults and expenses that chance as a result of lending. Loan loss provisions are a standard accounting adjustment made to a bank’s loan loss reserves covered in the financial statements of banks. Loan loss provisions are consistently made to incorporate changing projections for losses from the bank’s contributing products. While standards for lending have greatly improved, banks still experience late loan payments and credit defaults.
Because the loan loss provision appears on the income statement as an expense, it will lower operating profits.
Because the loan loss provision appears on the income statement as an expense, it will lower operating profits.
Allowance Loss Reserves in Accounting
Loan loss reserves are typically accounted for on a bank’s
Example of Loan Loss Groceries
Some of the biggest banks in the U.S. added sizable loan loss provisions in the first quarter of 2020 due to the coronavirus pandemic and the startling economic downturn it has caused. Combined, the five biggest lenders in the U.S. built a war chest of $24 billion in loan disappearance provisions. For example, JPMorgan Chase & Co.—the largest U.S. bank—set aside almost $7 billion in reserves for possible trouncing debits from consumer debt defaults in 2020.