Economic Loan Loss Provision and Expected Loss

Stefan Hlawatsch () and Sebastian Ostrowski ()
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Stefan Hlawatsch: Faculty of Economics and Management, Otto-von-Guericke University Magdeburg
Sebastian Ostrowski: Faculty of Economics and Management, Otto-von-Guericke University Magdeburg

No 9013, FEMM Working Papers from Otto-von-Guericke University Magdeburg, Faculty of Economics and Management

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.

Keywords: loan loss provision; expected loss; IAS; Basel II (search for similar items in EconPapers)
JEL-codes: G18 G21 M41 (search for similar items in EconPapers)
Pages: 21 pages
Date: 2009-04
New Economics Papers: this item is included in nep-acc and nep-rmg
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