Setting up Loan Loss Provisioning

Loan loss provisioning enables lenders to configure the amount they want to keep aside as loss provision. Loss provisioning is an accounting feature where money can be earmarked as probable loss that might be incurred on contracts of a particular lending product due to loan write-offs when borrowers do not pay up. You can provision for such losses at the lending product level.

When you create a lending product, a default set of loan loss provisions is defined based on the loss provisioning set selected for the product. For example, you may estimate that 51% of amount may not get collected for loans overdue by 30 days. Therefore, you set up 15% of the total outstanding principal on contracts of the lending products as the loan loss provision amount. If you do not select the loss provisioning setup, the default delinquency set for CL Loan is used.

You can edit these rules for calculating the loss provisioning amount for a lending product. In addition, you can define further loss provision setups upon creation of a lending product.

A separate GL account is created to handle the loan loss amounts. For example, Loan Loss Reserve account. In every accounting period, you would make an entry in that GL account, for the loan loss provision amount, based on the provision rules you define. 

When a loan moves across the loss provision intervals, the unpaid principal of both the classes is updated, and accounting entries are accordingly made.  For example, a loan that is delinquent by 30 days may subsequently be delinquent by 45 days, and it hence falls into the next delinquency interval.

Along with provisions based on the number of days by which a loan is delinquent, you can also allocate a percentage of on-time loan portfolio that you expect to default, and add that amount to the loss reserve account. These are loans that might be in Active-Good Standing at a given time, but a certain percentage of them might default in the future.  However, this provision is normally a very small percentage compared to the other provision classes. 

Loan loss provisioning is independent of the partial protect scenario, where the borrower does not make specific number of payments, while keeping the contract in Active-Good Standing status. If you are using the protect functionality to minimize loan losses, then you may reserve relatively lower amounts for loss reserve.