Loan loss provisioning and write-offs: how small lenders account for bad loans
By the LoanTabs teamPublished Last updated 5 min read
Short answer
Loan loss provisioning means setting aside money now for loans you expect not to recover. Lenders usually apply a rising percentage to each aging bucket, so older arrears carry higher provisions. A write-off removes a loan that is judged uncollectable from the books, and recoveries after that are recorded as income.
Some loans will never be repaid. Honest accounting recognizes that before the loss becomes certain, so profit is not overstated and the balance sheet shows what the loan book is really worth. That is what provisioning does. This guide explains the mechanics for small lenders in plain terms. It is not accounting or legal advice: your reporting framework, regulator and auditor decide the required method and rates.
Key terms
- Provision (allowance for loan losses). An estimate of expected losses on the portfolio, recorded as an expense and held against the loans.
- Loan classification. Grouping loans by risk, commonly standard, watch, substandard, doubtful and loss.
- Write-off. Removing a loan from the balance sheet because it is unlikely to be collected. The borrower's obligation may continue and collection may go on.
- Recovery. Money collected on a loan after it was written off.
- Net loan book. Gross loans minus provisions.
Why provision at all?
If you wait until a loan is written off to recognize the loss, your accounts overstate profit and the loan book for months or years. Provisioning spreads the recognition to match the risk: as a loan ages, you expect to lose more of it, so you provide more. It also encourages discipline, because rising arrears visibly cost profit.
Aging-based provisioning
The simplest and most common method applies a percentage to the outstanding balance in each aging bucket. Buckets are the days-past-due groups in your aging report.
An illustrative matrix (your regulator or policy sets the real rates):
| Bucket | Balance | Example rate | Provision |
|---|---|---|---|
| Current | 430,000 | 1% | 4,300 |
| 1-30 days | 30,000 | 5% | 1,500 |
| 31-60 days | 20,000 | 25% | 5,000 |
| 61-90 days | 8,000 | 50% | 4,000 |
| 91-180 days | 7,000 | 75% | 5,250 |
| 181+ days | 5,000 | 100% | 5,000 |
| Total | 500,000 | 25,050 |
Total provisions of 25,050 are about 5% of the portfolio. The provision expense for the period is the change in the required provision: if last month's provision was 22,000, this month's expense is 3,050.
Loan classification
Many regulators require loans to be classified by risk, each class with a minimum provision:
| Class | Typical meaning |
|---|---|
| Standard (pass) | Repaying as agreed |
| Watch (special mention) | Early arrears, needs attention |
| Substandard | Serious arrears, some loss possible |
| Doubtful | Loss likely, recovery uncertain |
| Loss | Considered uncollectable |
The days-past-due ranges that map to each class, and the percentages, are set by the local regulator or your funder. If none applies, set them in your policy and apply them consistently.
Specific and general provisions
- Specific provisions are set against identified problem loans, based on their age and circumstances.
- General provisions cover the rest of the portfolio, including current loans, for losses that exist but are not yet visible. That is the 1% on the current bucket above.
Newer approaches: expected credit loss
Larger institutions using modern accounting standards estimate expected credit losses (ECL) using probabilities of default and loss severity. It is more sophisticated than an aging matrix, but for most small lenders a transparent aging-based method, applied consistently and reviewed, is a reasonable start. Ask your accountant which approach your reporting requires.
Writing off a loan
A write-off is a formal decision, not a quiet deletion. A sound policy specifies:
- When a loan becomes eligible, for example, at 180 days or more past due with no realistic prospect of recovery.
- Who can approve, by amount.
- What evidence is needed: collection history, collateral status, guarantor position.
- What happens accounting-wise: the loan is removed against the provision already held. If the provision was adequate, there is no further profit-and-loss hit.
- What happens next: write-off does not release the borrower. Keep trying to recover if it is worthwhile.
Recoveries
Money received on a written-off loan is a recovery. Record it separately from ordinary repayments, usually as income in the period received. Tracking recoveries shows whether write-offs were premature and how much collection effort is worth.
Restructured loans
Rescheduling a loan can reset its days past due, which lowers provisions if you are not careful. Sound practice keeps restructured loans visible, applies a minimum classification for a period after restructuring, and does not release provisions until the borrower has shown a repayment record. Ask your regulator or auditor about the rules that apply.
Reporting to management and funders
Useful reports include: provisions by bucket, provision coverage (provisions ÷ PAR), write-offs and recoveries in the period, the write-off ratio (write-offs ÷ average portfolio) and a loan classification summary. See what is portfolio at risk. Together they show whether the book is stable and whether provisions are keeping up.
Common mistakes
- Not provisioning at all, overstating profit.
- Provisioning only when a loan is written off.
- Using rates that are too low to look profitable.
- Letting restructuring wipe out provisions.
- Writing off without approval or evidence.
- Not recording recoveries.
- Changing the method without disclosure, which makes trends meaningless.
Provisioning and write-offs in LoanTabs
LoanTabs includes a provisions report driven by a configurable provisioning matrix, a loan classification (standard, watch, substandard, doubtful, loss), an aging report, portfolio at risk, a write-off and recovery report and a loan book and classification report, plus a double-entry ledger with period close. Loans can be closed or written off, with the change recorded as a loan event. The rates and rules you apply are your own; LoanTabs applies them consistently. See collections and arrears reports and accounting.
FAQ
What is loan loss provisioning?
Setting aside money in advance for the loans you expect not to recover, recorded as an expense against the loan book.
What is the difference between a provision and a write-off?
A provision is an estimate held against the portfolio. A write-off removes a specific loan from the books, usually against a provision already made.
When should I write off a loan?
When your policy says it is unlikely to be collected, often after 180 days or more overdue and with approval. Regulations may set the timing.
What percentage should I provision?
Use the rates your regulator or funder requires. Where none apply, set rates by aging bucket based on your own loss history and review them regularly. Ask your accountant.
Can a written-off loan still be collected?
Yes. Writing off is an accounting decision; the borrower's obligation continues unless it is formally forgiven, and any recovery is recorded as income.
Get provisions, classification and write-off reports from your own loan book.
Key terms in this guide
See how LoanTabs handles this in practice.
Keep reading
- What is portfolio at risk (PAR)? Formula, PAR30 vs PAR90 and examplesPortfolio at risk (PAR) measures the share of a loan portfolio that is overdue. Learn the formula, PAR30 vs PAR90, worked examples and healthy benchmarks.
- Days past due and loan aging: how to measure and report late loansWhat days past due (DPD) means, how to count it, how loan aging buckets work and how to read an aging report, with a worked example and common mistakes.
- Loan collections and arrears management: a practical guide for lendersHow to manage loan arrears and collections: the collections cycle, key metrics like PAR and days past due, daily routines, policies and the reports you need.
- How to reduce loan defaults: 12 practical steps for small lendersPractical steps to reduce loan defaults and arrears: better underwriting, right-sized loans, early follow-up, incentives, monitoring and honest reporting.