In the financial industry, the PLL is typically calculated as a percentage of the outstanding loan balance. The percentage used is determined by the institution*s past experience with loan losses, economic conditions, and other factors. The greater the risk of loss, the higher the PLL percentage will be.
Once the PLL is established, it is allocated to specific loans or loan portfolios based on the risk level of each borrower. For example, loans to a borrower with a higher credit score and stronger financial standing may require a lower allocation from the PLL than loans to a borrower with a lower credit score and weaker financial standing.
When a borrower defaults on a loan, the loss is first deducted from the allocation from the PLL. If the loss exceeds the PLL allocation, the institution*s capital is used to cover the remaining balance. The institution then replenishes the PLL by setting aside additional reserves to cover potential future losses.
In summary, the Provision for Loan Losses is a financial industry term that refers to the reserve that financial institutions set aside to cover potential losses that may arise from loans and other credit products. This reserve is used to manage credit risk exposure and is allocated to specific loans or loan portfolios based on the risk level of each borrower. When a borrower defaults on a loan, the loss is first deducted from the allocation from the PLL and any remaining balance is covered by the institution*s capital.
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