What is a reserve of loan loss?
Reserve for loss of loan is an accounting method used to reflect the risk that not all loans provided by the bank will be repaid. In each accounting period, the bank will be given a certain amount known as the provision for loans loss, which aims to reflect these potential losses as hypothetical costs. The relevant amount can then be listed as an asset on balance sheets. This reserve for the loss of credit ensures that the bank has enough money to cover failure. Instead, they simply reflect the necessary modifications of numbers to make sure that sufficient money is earmarked. Because the money is listed as an expenses as a supplement to assets, the bank will act as if it had spent money. Therefore, the money remains untouched in the bank until it is needed.
As soon as the bank creates a reserve of loan loss. One of them is the fees that occur when the bank gives up an attempt to assemble an excellent loan. This loss is calculated as an expenditure on a profit and loss statement and then is also deductedfrom the reserve number in the balance sheet.
Another change occurs if the loan that has been charged in this way is actually renewed. This is relatively rare. If this happens, the reserve number will increase reasonably.
The third change comes at the end of the accounting period. The Bank usually states the provisions on loans losses to return the loan loss reserve back to the intended level. The amount will therefore correspond to the total amount charged during the accounting period, minus any previously charged loans that have been renewed.
The fourth change is any adjustment that the bank makes to the loan loss reserve to reflect its credit portfolio. The amount is based on the percentage of outstanding loans, so a reserve for loan loss usually increases with increasing the total loan amount, although the percentage used can change depending on how risky bank believes that loans are overall.It is therefore technically possible for the bank to increase the overall value of its loans when reducing the size of its loan loss, or vice versa.