How to Calculate a Loan Loss Provision Coverage Ratio

How to Calculate a Loan Loss Provision Coverage Ratio

Loan loss provisioning is a systematic way of handling risks rationally, signalling managerial prudence. Banks across the globe follow a dynamic provision policy. Sometimes, a well – designed policy is not enough to safeguard the interests of all the stakeholders. One such prominent and time – honoured modus operandi to face contingencies is the rate of provisioning to be set aside annually to meet any contingencies.

Banks and credit unions are in the business of lending money to individuals, families and businesses. But not every loan is repaid in full; in fact, many banks lend to risky borrowers by charging high interest rates. To stabilize earnings and remain solvent in bad times, banks estimate losses and seek to hold enough capital to absorb future write-offs.

Estimated Losses: Loan Loss Provisions
The loan loss provision is a balance sheet account that represents a bank’s best estimate of future loan losses. Suppose that a bank extends a Rs.5,00,000, five-year loan to a gas station in its community. If one year later the borrower runs into financial problems, the bank will create a loan loss provision. If the bank believes the client will only repay 60 percent of the borrowed amount, the bank will record a loan loss provision of Rs.2,00,000 ((100 percent – 60 percent) x Rs.5,00,000).

 

Loan loss provision

Actual Losses: Net Charge-offs
Some time after creating a loan loss provision for a worrisome loan, a bank will discover how much the borrower is actually able to repay. At that moment the bank will record a net charge-off — the amount of the loan that will never be repaid. In the earlier example, suppose the bank is only able to collect Rs.1,00,000 from the gas station. In this situation the net charge-off would equal Rs.4,00,000 — an amount even greater than the original loan loss provision.

 

Loan Loss Provision Coverage Ratio
The loan loss provision coverage ratio is an indicator of how protected a bank is against future losses. A higher ratio means the bank can withstand future losses better, including unexpected losses beyond the loan loss provision.

The ratio is calculated as follows: (pre-tax income + loan loss provision) / net charge-offs.

In the earlier example suppose that the bank reported pre-tax income of Rs.25,00,000 along with a loan loss provision of Rs.8,00,000 and net charge-offs of Rs.5,00,000. Its loan loss provision coverage ratio would equal 6.6 (25,00,000 + 8,00,000) / 5,00,000.

Insights Into the Economy

Loan loss provisions are important not only to banks but to the broader business community. During difficult economic times, loan loss provisions and net charge-offs spiked as borrowers struggled to repay their debts. Loan loss provisions and net charge-offs can therefore serve as useful indicators of the overall health of the economy.

How Loanyantra helps

The bad debts to the banks make them run short of money and this will always make the banks increase the loan interest rates. Loanyantra’s customers will know it before hand, as our team constantly track the loan’s interest rate and sends alerts. Also know about different banks interest rates and get into the bank whose interest rate is lower and a process where you can finish the loan earlier.

 

PNB-Nirav Modi Scam. What did RBI do?

Is giving Letter of Credit / Letter of Understanding to Nirav Modi is a mistake by PNB?

Actually, according to the banking procedures, there should be  a collateral while lending money. Any lender should not lend money without taking anything as a guarantee.

So, PNB had given a letter of credit stating that PNB guarantees the on time repayment of the loan by Nirav Modi. This had become a common practice by the nationalised banks. For India to grow, these are the small steps taken and the authority given to such high officials. So, to be frank it is not a wrong step by PNB to Nirav Modi.

Another important thing while lending money is, while the borrower is already with an existing loan, the top up loan cannot be sanctioned without looking into the repayment details and guarantor details.

This is the wrong step by the letter of credit issuer and the lending banks that they blindly follow the brand as a guarantee from the borrower instead of looking at the details of their repayment status and credit score. Now, it is  a shock to PNB and the other lenders also as they have to face such huge bad debt.

PNB - Nirav Modi case
PNB-NiravModi Case – A big lesson to the whole Indian Banks and RBI.

PNB-Nirav Modi’s case is the same issue as Vijay Mallya’s case. Under Vijay Mallya’s case, the banks had given credit loan of 25 crores by taking the logo of the company as a guarantee. Under PNB-Nirav Modi’s case, the banks had given loan on one LoU, which is really ridiculous. The common man should roam around multiple banks just to get a simple personal loan to fulfil his needs, Whereas the so called promoters get the loan so easy that they can skip the loan and can roam away from India.

Will this misuse by so called bureaucrats influence common man? How?

The scams like PNB-Nirav Modi, Vijay Mallya, surely influence the banks’ economy and state’s growth. When there is such huge bad credit, the banks will not be in a state to pay the Fixed Deposit Interest Rate or Fixed Deposit withdrawls. This makes the banks increase the loan interest rates atleast by a minimum to cover the loss. So, ultimately, it affects the common man paying the loan interest rates.

Axis Bank (one of the lenders in PNB-Nirav Modi case), had already raised the MCLR to 10 basis points, leading to increased lending rates,the second time in last two months.

How did the NPA (Non Performing Assets ) problem become so big?

There are many reasons and no one reason can be attributed as the biggest problem. In some cases, it was just a case of bad promoters taking too much debt and even siphoning off money instead of trying to run a tight ship. They were in turn abetted by lax bankers who did not do much due diligence and also politicians who helped them get loans. In other cases, there were genuine reasons like telecom or mining licenses being cancelled after much money had already been sunk. In still other cases, it was the shortage of gas supplies from the KG basin, on which the project depended on, or dumping by Chinese in some goods. And then there were cases of over ambition where the promoters bought and expanded indiscriminately without having the management depth or the resources to run the companies properly.

The biggest reason for the NPA problem was that the banks got swayed by big project plans of businessmen and simply did not take enough precautions or enough due diligence.

What did RBI do for a solution after PNB-Nirav Modi case?

The new guidelines have specified framework for early identification and reporting of stressed assets. The Reserve Bank of India (RBI) on Monday came out with a revised framework for expeditious resolution of bad loans, harmonising the existing guidelines with the norms specified in the Insolvency and Bankruptcy Code (IBC).

“In view of the enactment of the Insolvency and Bankruptcy Code (IBC), 2016, it has been decided to substitute the existing guidelines with a harmonised and simplified generic framework for resolution of stressed assets,” the RBI said in a notification issued after the PNB-Nirav Modi case came into light.

All lenders will be required to submit Central Repository of Information on Large Credits (CRILC)- Main Report to the Reserve Bank on a monthly basis effective April 1, 2018.

In addition, the lenders shall report to CRILC, all borrower entities in default (with aggregate exposure of Rs 5 crore and above), on a weekly basis, at the close of business on every Friday, or the preceding working day if Friday happens to be a holiday. The first such weekly report shall be submitted for the week ending February 23, 2018, with a view to harmonise the guidelines with the norms specified in the IBC, said the notification while withdrawing existing mechanism for dealing with the bad debt in the banking system. The new guidelines have specified framework for early identification and reporting of stressed assets.

If this practice is observed strictly, from now on, there are chances for many defaulters to come in light like PNB-Nirav Modi case. There are chances, in future to reduce the bad debts number.

But as of now, because of PNB-Nirav Modi’s case, 11,000 crore debt, it is sure that there will be an increase of lending rates.

You should not be the one to get victimised for such increase of lending rates. Be the first one to know which bank offers the lesser interest rate. Come, be a LOANYANTRA customer and know more tips and tricks about your loan interest rates.