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Economic Loan Loss Provision and Expected Loss

Author

Listed:
  • Stefan Hlawatsch

    (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg)

  • Sebastian Ostrowski

    (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg)

Abstract

The intention of a loss provision is the anticipation of credit's expected losses by adjusting the book values of the credits. Furthermore, this loan loss provision has to be compared to the expected loss according to Basel II and if necessary, equity has to be adjusted. This however assumes that the loan loss provision and the expected loss are comparable, which is only valid conditionally in current loan loss provisioning methods according to IAS. The provisioning and accounting model developed in this paper overcomes the before mentioned shortcomings and is consistent with an economic rationale of expected losses. We introduce a de¯nition of expected loss referring to the whole maturity of the loan and show that this measure can be reasonably compared with loan loss provisions. Additionally, this model is based on a close-to-market valuation of the loan. Suggestions for changes in current accounting and capital requirement rules are provided.

Suggested Citation

  • Stefan Hlawatsch & Sebastian Ostrowski, 2009. "Economic Loan Loss Provision and Expected Loss," FEMM Working Papers 09013, Otto-von-Guericke University Magdeburg, Faculty of Economics and Management.
    • Handle: RePEc:mag:wpaper:09013
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    References listed on IDEAS

    as
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    Keywords

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    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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