Every loan portfolio contains some risk that borrowers will not repay in full. Banks estimate those expected losses before every specific outcome is known.
The allowance is an estimate
The allowance for credit losses is a valuation account that reduces the reported amount expected to be collected from applicable financial assets.
Under the current expected credit losses methodology, banks use relevant historical experience, current conditions and reasonable forecasts to estimate expected losses over the assets’ contractual lives.
Provision and allowance are related—not identical
A provision for credit losses is an expense recorded through earnings. It is one way the allowance balance increases when expected losses rise.
The allowance is the balance-sheet estimate available to absorb recognized credit losses; the provision is the period’s income-statement effect.
What happens at charge-off
When a loan or portion of a loan is considered uncollectible, the bank charges it against the allowance. Recoveries can later restore part of that amount.
Because estimates change with portfolio performance and economic expectations, the allowance requires continued review rather than a one-time calculation.
Read the primary material
Banking Explained prioritizes regulators, official publications and first-party announcements.