What is the provision of a loan loss?

The provisions of the loss of credit are the item in the profit statement and the loss of the bank, which is responsible for losses suffered when people or entities borrowing from the bank fail to loans. It is not a cash costs, but rather a fee added to the bank's income to notice for such losses. By using the loan loss, the bank will make sure it has enough capital to survive unsuccessful loans. The amount of the provision should be proportional to the risk of the loan offered by the bank and the overall power of the economy. Banks understand that a small percentage of their customers cannot pay them back or maybe pay back at a slower rate than it is first. In order to take into account these circumstances, the Bank includes in their statement regarding the provisions of the loss of the loan, which is a negative fee against taxation for the simulation of the financial intervention of these starting loans.

Banks use experiences on the marketThey had to determine how much loan loss should include in their accounting. For example, a bank and expects to lend about $ 1,000,000 (USD) in a given year. The past experience showed that on average about 2 percent of the loans offered by the bank had not been paid. In this case, the bank could include a $ 20,000 provision, 2 percent of $ 1,000,000, in the profit and loss statement to prepare for the expected losses.

The above example is simplified and most banks will have to take into account many other factors when determining their specific loan loss. If the bank is in the habit of giving out risky loans, then it should have a relatively high provision to supplement their reserves for the mayors of the default values. On the other hand, a bank, which is particularly conservative about the types of loans it offers, and the clientele that attracts these loans may not have a relatively high provision.

In addition, permeating economic climate also may alsoLivit how much a bank needs when the loan loss is loss. When the bank gives up to receiving its installment for a loan, it is known as a fee. After a period of recession, the bank often receives payments for these loans charged when the economy is recovering and debtors start to regain their financial position. These renewed loans can be used to strengthen the bank's loan loss and allow more aggressive loans.