BAM36020 - Non-performing loans: bad debt provisions in the accounts

Accounting periods beginning before 1 January 2005

Specific provisions

When a debt is impaired, the bank will make a specific provision. The provision reduces the carrying value of the loan to the amount the bank ultimately expects to receive. The debt is reduced to its net present value (NPV) by discounting expected future cash flows at the bank’s average cost of funds. The difference between the unadjusted book value and the NPV is the bad debt provision. If the prospects of recovery deteriorate even further in a later accounting period, a further deduction will be claimed. The bank writes off the debt when there is no realistic prospect of recovery. At that point, the difference between any outstanding balance and the amount already debited as a bad debt provision will be written off in the profit and loss account. Alternatively, if the prospects recover, the provision will be reduced with a credit to profit and loss. See also BAM21055 and BAM21060.

General provisions

A bank will make a general provision for loans that are believed to be bad or doubtful at the accounting date but have not been individually identified. They are usually quantified by reference to economic, sector and political information rather than information about the individual debtor. The movement in the general bad debt provision is taken to the profit and loss account in the same way as specific provisions. See also BAM21065.

The accounts

The balance sheet of a bank shows the total loans outstanding with a separate entry showing the total (specific and general) provisions made against these loans.

What is shown in the accounts of a UK bank is governed by the Companies Act 1985 and normal accountancy principles as well as the recommendations made in the Statement of Recommended Practice (SORP) on advances issued by the British Bankers’ Association. See BAM21050 to BAM21070 for details of the SORP on advances.

The Companies Act 1985 requires that charges for amounts written off and provisions made in respect of loans and advances are both included under the heading ‘provisions for bad and doubtful debts’ in the profit and loss account.

Since the level of bad debt provisioning can have a significant effect on a bank’s results the Chairperson’s report and the overall financial review of the bank will normally mention the level of provisioning and any significant factors which have helped determine these levels.

The bank may publish an analysis of outstanding debt within the overall portfolio. This may, for example, show:

• the figure for domestic and foreign debt,
• amounts owing on business or corporate debt, sometimes sub-divided into business sectors,
• amounts owing on mortgages, personal lending and other areas where the bank has significant exposure.

Although not shown in the accounts, the bank will probably also have records showing the amounts written off and provisions for loan losses in relation to each of the categories. This will be required for the bank’s own risk management purposes as it charts the bank’s exposure to risk in each sector.

The computation

General provisions are not allowable for tax purposes because they do not pass the test in FA96/SCH9/PARA5(1), see CT12471. The provision is therefore added back in the tax computation.

A specific provision will normally be allowable for tax purposes but only if it satisfies the requirements of FA96/SCH9/PARA5 (1). Where the specific provision does not comply with FA96/SCH9/PARA5(1) an adjustment will be made in the computation.