What is the loan loss reserve?

Definition / Examples of Loan Loss Reserve

A loan loss reserve is something that banks do to allocate funds to cover loans that are in default or trouble. It is an expense on the income statement that banks can take advantage of when borrowers are late in their payments and unlikely to repay their loans.

How does the Loan Loss Reserve work?

In many ways, the loan loss reserve acts as an internal insurance fund. It protects the bank in case the borrower is late on payments or unable to repay the entire loan. To defend the bank, the loan loss reserve can provide coverage for these incurred losses.

Notable Events

During the 2008 crisis, many banks did not have sufficient loan loss reserves to cover their actual losses. In the years that followed, banks began allocating resources to increase their loan loss reserves to defend against rising defaulted loans.

When Congress passed the Dodd-Frank Act to reform and protect Wall Street in 2010, one of its goals was to improve the financial stability of the United States. Under the Dodd-Frank Act, grants were provided to help community development financial institutions create their own loan loss reserve funds to help manage losses on underperforming loans.

As a result of the 2020 crisis, many banks reviewed their loan loss reserves to address the economic downturn. Some banks increased their reserves by more than double. In the second quarter of 2020, bank reserves for loan losses totaled approximately $242.79 billion, a slight decrease from $263.11 billion in the first quarter of 2010 after the Great Recession.

Source: https://www.thebalancemoney.com/what-is-a-loan-loss-provision-5202196