Research Of China’s Commercial Bank Loan Loss Provisions

Loan impairment provision is an important part of the risk management ofcommercial banks. The method of China’s commercial banks’ internal provision forloan impairment preparation is consistent with the provisions of the InternationalAccounting Standards. The provision is calculated by the book value and estimatedfuture cash flows. This method which is based on the "incurred loss model" incurs aseries of problems existed in the provision process. What is more, the outbreak of thefinancial crisis in2008has brought the “incurred loss model” into criticism. Therefore,the Council of the International Accounting proposed “expected loss model” insteadof the “incurred loss model”. However, whether the model is applicable for ourcountry remains to get further discussion. In view of this, this paper analyzes theexisting problems of China’s commercial bank loan impairment provision in theprocess, in addition, the paper explores the “expected loss model” and pointed out thatthe model does not applicable for our country. At last, the paper put forward somerecommendations for the current provision process improvements.This paper adheres to the rule of identifying problems, analyzing problems andsolving the problem specification to analyze the ideas of China’s commercial banksloan impairment provision. Firstly, the theoretical basis of the provision for loanimpairment is based on the two aspects of the commercial bank risk managementtheory and financial accounting theory. Then, the paper discussed the systemdevelopment process of China’s commercial banks loan impairment charges. Thecurrent loan impairment provision policy is based on the "incurred loss model", sothis article points out these problems in the loan impairment provision process afterthe analysis of the existing condition in commercial banks. Here we selected ninecommercial banks of Shanghai Stock Exchange as research objects. The paper liststhe data and information disclosed by the financial statement from2007to2011.Afterthis analysis, the paper points out that there are a lot of problems existed in theprocess of China’s commercial bank loans impairment provision, for example, toomuch subjectivity and incomplete information disclosure,“cliff effect” in loan interestincome, and the strong pro-cyclical problem. In2009, the IASB proposed “expectedloss model” in order to solve the problems in the current use of the “incurred loss model”.“Expected loss model” requires commercial banks consider the credit lossduring the hole loan period when make the initial recognition of the loan, so as tomaintain the stability of the financial system. This article describes the backgroundand nuclear content of the “expected loss model”, then analyze of the defects of themodel. Undeniable, the original intention of the model which is proposed by IASB isgood. However, the external market environment and internal accounting system ofChina’s commercial banks is not sufficient to support the "expected loss model" in theimplementation of the country. China’s commercial banks should not adopt a foreignpropose model. What they should do is to learn the idea of forward-looking provisionfor loan impairment allowances in the "expected loss model". Finally, the paper putforward suggestions for improvement from four aspects. On one hand, improve theimplementation details of the loan impairment provisions. On the other hand, set upan independent organization to assess risk of collateral loan. What is more, use thegeneral reserve to mitigate pro-cyclicality. Last but not the least, improve theinformation disclosure system of the commercial bank loan loss provisions. Throughimplement of these suggestions, Chinese commercial bank loan impairment provisioncan safeguard the security and stability of the financial system and provide strongprotection for data in true and reliable financial statements.