There are five different categories of bank loans, distinguished by quality. And not all of them are returned on time for a variety of reasons. Therefore, reserves are necessary for possible losses on loans. If the loans are not repaid, the bank needs to continue paying. It is for this that a reserve is needed. However, how is it formed, how is it regulated?
The creation of reserves for possible losses on loans is an obligatory action for all banks and organizations that carry out such operations. The main regulatory document for such work is Regulation No. 254-P of the Bank of Russia of 2004. There is a supplement to this document that is mandatory. This is Bank of Russia Ordinance No. 2459-U of 2010, which relates to debt risk assessment.
Size guidelines
In order to determine the required amount of reserves for possible losses on loans, it is necessary to analyze the existing portfolio, and then classify loans already issued according to the quality criteria specified by the Bank of Russia. Of the five categories of this classification, depending on the criteria, there is a risk level of its own. The first category is standard risks, there is no danger of no return, and therefore, in the calculations of the reserve value, it is zero. In the second category, the risk situations are already non-standard, because the calculated risks of non-return are in the range of 0.01 to 0.2. And therefore, reserves will have to be created up to 20% of the amount.
The third category - operations are doubtful, the risk is 0.21-0.5, and the reserve should also be greater - from 21 to 50 percent. Problem loans fall into the fourth category, with a risk of non-repayment from 0.51 to 0.99, and reserves increase up to one hundred percent. In the last, fifth category, operations were literally hopeless, most likely, the amount will not be refunded. Therefore, the reserves for possible losses on loans should be 100%. The assessment is made by banking specialists based on professional analysis.
Criteria for evaluation
First of all, experts analyze all changes in the financial situation of the person who received the loan, as well as his good faith or lack thereof in servicing this debt. If the recipient of a loan with both a financial situation and with servicing a debt is doing well, then the default risks are standard, you can only be afraid of force majeure.
If, in a good financial situation, a bank client with a return on money experiences disruptions, that is, debt servicing is average, then the risks become non-standard. And the formation of reserves for possible losses on loans is already necessary. If a person who is financially successful treats debt payments very badly, then the operation is considered doubtful.
When a person has problems
Risks increase proportionally: with an average financial situation and good debt servicing, the situation is still non-standard, and if this person also makes payments late, his credit history becomes doubtful. It also happens that a person with an average income ceases to repay debt, then the operation on his question becomes problematic. The formation of reserves for possible losses on loans of such a plan should be in full swing.
Well, and the last option: the person to whom the bank issued a loan, the financial situation has become poor, but he is trying his best to pay the bills. Anyway, the operation on his loan is considered doubtful. Who knows how soon he will not be able to pay at all? The reserve for possible losses on loans is compulsory. If this loser does not pay the planned parts and interest on the amount for a long time, this is a problem operation. But when the client ceases to pay at all and nothing portends amendments to his financial situation, there is nothing to expect, this operation is hopeless.
Grouping
In order for the analysis and formation of the RVPS (reserves for possible losses on loans) to be successful, similar criteria (mostly insignificant) are combined into a single portfolio. It is not difficult to guess its name. This is a group of homogeneous loans. In these cases, all calculations can be easily carried out depending on the contents of the portfolio.
Many note that the process of creating a reserve for possible losses on loans is very similar in terms of risk assessment to the procedure for creating insurance reserves. The values of risks and reserves recommended by the Bank of Russia are determined by the method of mathematical statistics.
Norms and their application
The reserve for possible losses on loans is created according to documents provided by the Bank of Russia, and there is a uniform procedure for this purpose. This is a permanent process, and this should never be forgotten. Even yesterday's indicators of the reserve value today should be refined and adjusted. This is because the basic criteria that are taken into account are constantly changing.
Firstly, old loans are repaid and new ones are issued, and secondly, the situation with borrowers is changing, so operations with their loans can freely move between categories - from one to another. For the same reason, the reserve rate is subject to adjustment, although it is specified less frequently - quarterly.
Reserve formation example
There are several rules for the process of creating and updating the reserve rate, but one of them is the main one set out in Regulation No. 254-P (the fourth chapter). If a single borrower has several loans for which debts are accumulated with different estimated quality values, in this case all debts are evaluated at the lowest value. Accordingly, the calculation of the reserve for possible losses on loans is also made.
For example, the borrower was given two loans, which he repays in a timely manner, and they belonged to the category when both the financial situation and the attitude to the obligations of the client are in good faith, that is, “good” and both. However, the borrower burdened himself with another loan taken. And it became clear from the information provided that the financial situation worsened.
This means that the new loan is rated "good-medium" in the risk category of "non-standard", and the probability of default will require the creation of a reserve for loan losses. The next step: two existing loans are moved to the same category. And a reserve is created for them. Although the borrower repaid the first two loans without problems and on time.
Other rules
In the presence of amounts not recovered from the debtor, bank guarantees are provided, but the same rules apply to the assessment of this transaction as to other ordinary borrowers, that is, it is necessary to create provisions for loan losses when risks arise. Amounts secured by mortgages are evaluated according to additional criteria, since an analysis of changes in the value of property that is secured is necessary.
Transactions with finances for which deferred payments are granted or transfers of assets are allowed must be accompanied by the formation of additional reserves, which will cover the absolute value of this financial asset. A syndicated loan (when several borrowers) requires the calculation of a reserve in relation to each member of this syndicate. These rules are enshrined in 2012 by the Bank of Russia (Instruction No. 139-I).
About insurance
The presence of insurance at the client (disability, health, life and the like) is sometimes considered a fact that affects the assessment of the reserve, and sometimes it is not taken into account. This is because the criterion here is only the amount of compensation for the insured event that will be due to the bank, as well as the level of coverage of the amount that the borrower needs in order to continue to properly service his debt.
If the amount due to the bank in the insured event does not cover this client’s debt, the bank does not consider the availability of insurance at all as a factor contributing to the reduction of the provision for possible losses on loans. So, in the worst (fifth) category, by default, it is precisely those amounts that are issued to credit organizations, subsequently deprived of a license. As well as those for which there are no documents confirming the attitude of this loan. And for the fifth category, reserves for possible losses on loans are formed from capital. Everything is simple.
Portfolio provisioning
In these operations, there are quite a few unpleasant nuances that must be borne in mind, and most often they are associated specifically with borrowers who are individuals. Correctly form reserves for loans to individuals based on two divisions. The first portfolio is ordinary individuals, and the second is entrepreneurs. Further loans issued are classified into loans secured by pledge and unsecured. The deposit may be different: car, real estate, any valuable property. Any loans can be repaid in good faith, that is - on time, without delay, and in bad faith - with delay.
It is the above criteria that affect the formation of a portfolio of homogeneous loans. It is very convenient for use: the reserve is entirely calculated according to the contents of the portfolio, and each loan is not analyzed separately. Regulation No. 254-P establishes the sizes of reserve deductions for choice: an option for ordinary individuals and two options for entrepreneurs.
Selection Criteria
You can choose a standard for creating a reserve for possible losses on loans based on a criterion. Which is used by the bank for the classification of mortgage loans. For example, during the formation of portfolios, separate low-risk loans into separate ones. But it depends on the policy of the bank - some do not emit. The second criterion used is also not always the case - when a whole group of loans with small arrears, for example, up to thirty days, is placed in one portfolio. Some banks include them in the group of loans without any delay.
The most important thing is that any applicable procedure for creating a reserve must necessarily be fixed by local regulations. The bank also provides, at the first request of the Bank of Russia, all reports on these issues, where the methods of forming a reserve fund for estimated losses on loans should be disclosed.
How to form a reserve for loans: types
Credit institutions are creating a reserve based on a chart of accounts approved by Regulation No. 385-P of the Bank of Russia in 2012. Thus, according to this plan, the bank reserves the estimated losses on the loan of the sub-account, which is opened to the same account and on which the loan itself is taken into account.
At the same time, analysis of the types of loans can be provided through the use of an account from the plan, plus a debit of the bank's expense account. Purely technically, it turns out that through the formation of a reserve on the balance sheet, the amount of debt of a dubious nature is reduced. And the difference evenly over time relates to the financial result.
The bank must also make provisions for estimated losses on loans in order to evenly allocate losses on loans to expenses directly in the process of risk assessment. Thus, the risks of non-repayment of loans can be managed.
Portfolio risk
Credit risk assessment is carried out in qualitative and quantitative terms, at the same time the analytical method of assessment, statistical and coefficient are used. Application of these methods helps to reduce and avoid the risks of the loan portfolio.
The analytical method assesses the level of risk of the bank. This work is regulated by Regulation No. 254-P of the Bank of Russia of 2004, which refers to the formation of reserves and provides for the classification of loans issued. The credit risk of each loan portfolio is assessed directly by the bank according to the approved criteria.
Criteria for evaluation
The financial condition of the borrower is evaluated with approaches that are used in practice both in the international and in the Russian banking system. The client’s ability to repay not only the main debt, but also the interest due to this amount in favor of the bank, as indicated in the loan agreement, as well as all fees and other payments, which characterizes the quality of service the borrower own debt. The client is checked for the presence of highly liquid and high-quality debt security in the amount that is sufficient to compensate for the principal amount of the loan, the interest specified in the contract, as well as the costs of realization of the security rights. The analysis of the presence of overdue payments and their duration on the principal debt and interest on this amount. The amount of debt re-registration in the course of the contract is established.