Mortgage consultant

There is a huge gulf between theories about how banks should manage credit risk and actual practices of most banks. A few of the better managed, larger banks are able to implement many of the above approaches but even in these instances their methods are only sophisticated when compared with methods used by other banks. In absolute terms much work still needs to be done before most banks can follow such programs and be confident about the results. Market risks are more amenable to VaR type approaches but even here the core assumptions are still open to question and regulators feel compelled to add a safety factor of at least three to the actual result for the purposes of calculating regulatory capital requirements. Provisioning has little to do with managing credit risk and everything to do with accounting and regulatory reporting requirements and efforts by bank management to report these numbers in such a way that they meet their own objectives. Most management look to report numbers that paint the most positive picture, and this often ends in them reporting numbers that understate credit losses or at least delay their recognition.
The key to understanding the economic consequences of bank provisioning for credit losses is that they affect the timing of the recognition of those losses but have no direct impact on the actual level of losses incurred. This subtle distinction has wide-ranging ramifications in terms of reported earnings and balance sheet numbers. These in turn affect investor and bank creditor perceptions of the soundness of the bank. Policies adopted also have a direct impact on regulatory capital and potentially on the need to raise capital.
The names given to the balance sheet accounts (e.g. provisions for credit losses, allowance for bad debts, reserves for credit loss) and the corresponding items in the earnings state- ment (e.g. bad debt charge, provision charge) are not uniformly adopted around the world. We will use the terms “provision” for the balance sheet item and “bad debt charge” for the P&L item.
In general, provisions should be established for losses that can be reasonably expected but have not yet been realized. Many banks, however, only provide for expected losses on loans that have already been identified as being impaired and some only when the loan concerned has met specific default criteria.