Loan Loss Reserve
IntermediateA loan loss reserve is the total amount a bank has set aside on its balance sheet to cover expected losses on its loans. It reduces the reported value of loans to the amount the bank expects to collect.
The loan loss reserve, also called the allowance for loan losses, is built up over time by loan loss provisions charged as expenses. It sits on the balance sheet as a deduction from total loans.
When a loan is finally written off as uncollectable, it is removed from both total loans and the reserve. The write-off itself does not hit profit again, because the expected loss was already recorded through earlier provisions.
For example, a bank with 2,000 million of loans and a reserve of 50 million reports net loans of 1,950 million. If it writes off a 5 million loan, total loans fall to 1,995 million and the reserve falls to 45 million, so net loans stay at 1,950 million. The reserve may then be topped up with new provisions.
The size of the reserve relative to total loans, or to nonperforming loans, shows how well prepared a bank is for losses. A reserve that is small compared with problem loans may mean future provisions, and lower profits, are likely.
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