Provisioning is the accounting practice of recognising, before losses happen, the amount a lender expects to lose on loans and other credit exposures, by booking an allowance against the asset and a charge to profit. It applies to banks, consumer lenders, BNPL providers and any fintech holding receivables. Under IFRS 9, effective since 1 January 2018, performing Stage 1 loans carry 12 months of expected losses, while Stage 2 and credit-impaired Stage 3 exposures carry lifetime losses; US GAAP's CECL recognises lifetime losses from origination. Expected loss is built from PD, LGD and exposure at default, so moving loans between stages can lift the allowance sharply. Buyers test staging against roll rates and write-offs, since understated provisions become price adjustments.
How does loan loss provisioning work under IFRS 9
IFRS 9, effective since 1 January 2018, uses an expected credit loss (ECL) model with three stages. Stage 1 exposures, with no significant increase in credit risk since origination, carry a provision equal to 12 months of expected losses. Stage 2 exposures, where credit risk has increased significantly, carry lifetime expected losses. Stage 3 exposures are credit-impaired and also carry lifetime losses, with interest income recognised only on the net carrying amount.
Two rebuttable presumptions anchor the staging. Credit risk is presumed to have increased significantly once contractual payments are more than 30 days past due, and default is presumed to occur no later than 90 days past due.
How to calculate expected credit loss
ECL is usually built from probability of default (PD), loss given default (LGD) and exposure at default. Illustrative: a lender holds €10m of consumer loans in Stage 1 with a 12-month PD of 2% and an LGD of 60%, so the provision is €10m × 2% × 60% = €120,000.
Now €1m of those loans moves to Stage 2 with a lifetime PD of 15%. That slice alone needs €1m × 15% × 60% = €90,000, against €12,000 while it sat in Stage 1. Deterioration in a tenth of the book lifts the total allowance from €120,000 to €198,000, and the extra €78,000 goes straight through the income statement.
CECL vs IFRS 9
US GAAP uses the current expected credit loss model (CECL), introduced by the FASB in ASU 2016-13. CECL has no staging: lifetime expected losses are recognised from the day each loan is made. It applied to most SEC filers from 2020 and to other entities, including private lenders, from 2023. The same new portfolio therefore usually shows a higher allowance at origination under CECL than under IFRS 9.
Provisioning in fintech M&A
Provisions are where reported lending profit is most easily flattered. Buyers of a lender or P2P lending platform test the staging rules against actual roll rates, compare the allowance with realised write-offs by vintage, and check the NPL ratio after cures. In the example above, a buyer who finds that the €1m slice should already have been in Stage 2 has found €78,000 of losses missing from the accounts, a price adjustment rather than a footnote. For banks, EU prudential rules add a minimum coverage backstop for non-performing exposures, deducted from capital when accounting provisions fall short.