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
- ↑ ECB, Asset Quality Review - Phase 2 Manual