Loan loss provision.

In plain English

A loan loss provision runs through the income statement and builds a reserve, so it lowers reported profit in the period the bank recognizes expected credit losses, not the period a loan defaults. Under current accounting standards, banks estimate losses over the full expected life of a loan at the moment it is made, using forecasts of unemployment and other conditions. The reserve on the balance sheet rises with provisions and falls when loans are charged off. If conditions improve, a bank can release reserves, which raises reported profit without any new lending. Provisioning is therefore one of the largest judgment calls in a bank's results.

01Why it matters

Rising provisions across the banking system are an early warning that lenders expect households and businesses to struggle, which usually shows up next as tighter approval standards for borrowers.

02The math, step by step

Say a bank books $2 billion of new loans and expects 1.5 percent lifetime losses. It records a $30 million provision immediately, cutting pretax profit by that amount. Two years later a $12 million loan is charged off, which reduces the reserve and does not touch that year's profit.

Illustrative example. The amounts here are hypothetical, chosen to show how the math works, not real quoted rates or figures.

03What this is NOT

04Receipts

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