Provisioning

From Open Risk Manual

Definition

Provisioning refers to the accounting practice of setting aside amounts to meet probable future expenses of reduction in values of assets.

Examples

  • an Impairment Allowance for non-performing loans. Also loan loss provision or loan loss reserves. Provisioning is a tacit recognition that the extended credit is not likely to be repaid in full and/or in time
  • provisions for employee benefits under some pension schemes

Types of Provisions

  • Specific provisions versus general provisions
  • Individually assessed versus collective provisions

Issues and Challenges

In the context of an Asset Quality Review[1], provisioning approaches are reviewed so that, ex-ante, particular areas of misalignment or aggressive interpretation of accounting rules may be identified.

Focus Areas

The areas for investigation are as follows:

  • Use of impairment triggers by internal client segments, (i.e. residential real estate (RRE), other retail, commercial real estate (CRE), other asset finance (e.g. shipping), small and medium enterprises (SME));
  • Bank policies and practices for monitoring of client performance (e.g. types of covenant, behavioural analysis etc.) by internal client segment
  • Range of haircuts and assumptions applied by the bank to market value of collateral when setting provision levels for collateralised loans
  • Provisioning practices under special circumstances (e.g. where the bank holds multiple tranches of the debtor’s capital structure etc.)
  • Suitability of bank write off approaches
  • Bank treatment and definition of cured assets for provisioning purposes, including forbearance considerations;
  • Appropriateness of use of collective provisioning methodology;
  • Bank application of an emergence period for IBNR calculation;

References

  1. ECB, Asset Quality Review - Phase 2 Manual