A Methodology for Calculating the Allowance for Loan Losses in Commercial Banks

21 Pages Posted: 7 Oct 2004

See all articles by Robert Gray

Robert Gray

University of Sydney

Frank Clarke

University of Newcastle, Australia - Department of Accounting & Finance

Abstract

Severe disturbances in the financial markets in many countries during the 1980s and 1990s caused many stakeholders to examine whether commercial banks had adequate reserves for future loan losses. In the United States, bank regulators considered an adequate Allowance for Loan Losses a 'safety and soundness' issue while the SEC became increasingly concerned over the possibility of banks using the Allowance as a method to 'manage earnings'. Both regulators demanded more rigorous calculations from banks to support their accounting entries. Also the FASB and the IASB have expressed concerns about a lack of harmonization and convergence in standards. An analysis of measurement standards in the United States, Canada, Japan, the United Kingdom and Australia, as well as by the Basel Committee on Banking Supervision and the IASB, reveals the partially conflicting goals for the Allowance: (a) promote harmonization (IASB), (b) increase transparency (SEC), (c) promote safety and soundness (bank regulators) and (d) maintain reasonable flexibility in recognition of the subjective aspects in determining an appropriate Allowance (bankers). The article offers a methodology which an individual bank may utilize to reconcile the conflicting goals of all interested parties.

JEL Classification: M41, M44, M47, G21

Suggested Citation

Gray, Robert and Clarke, Frank, A Methodology for Calculating the Allowance for Loan Losses in Commercial Banks. Abacus, Vol. 40, No. 3, pp. 321-341, October 2004. Available at SSRN: https://ssrn.com/abstract=597845

Robert Gray (Contact Author)

University of Sydney ( email )

University of Sydney
Sydney NSW 2006, NC
Australia

Frank Clarke

University of Newcastle, Australia - Department of Accounting & Finance ( email )

University Drive
Callaghan 2308, New South Wales
Australia
+61 2 434 84136 (Phone)
+61 2 434 84101 (Fax)

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