Top insights into the loan loss reserve methodology of banks

severities, experienced loss frequencies and historical delinquency terms. The reserves for loans take into account the portfolio’s inherent losses which are projected to be discerned in the 12 months to follow.

Credits in loan loss reserve validation which emerges with a rating of 1 to 11 are declared ‘pass’, credits with rating 12 are assigned ‘pass watch’, 13 gets ‘special mention’, 14 is ‘substandard’, 15 becomes ‘doubtful’, and 16 is ‘loss’. The total of 13, 14, 15 and 16 are collectively defined as ‘criticized’ loans.

Further, loan classification also takes place under the header of FAS 114 impaired loans. Loss reserves are then finally established in consideration of the loan type and grade, migration trends and severity of loss. The experience that took place most recently is assigned most weight.

A third party reviewer conducts analyzing, testing and validation of the methodology that underlies the general and specific loan allocations. The portfolio experience of the past 3 to 10 years are taken into consideration which involves study of loan grades migration, robustness of the loan grading system, alterations in portfolio mix, and loss experience.

Further, portfolio risks trends are also analyzed in consideration of the concentrations like loan and collateral types, large loan exposures, loan policy maintenance, and industry and loan grades. Other factors that are pertinent to the