Loan Risk Classification and Allowance

Chinese source: 贷款风险分类与拨备 Locale: en-US Audience: Internal learning

Concept

Loan risk classification assesses asset quality. Allowance is the reserve the bank records for expected credit losses.

Loan core must support risk identification, classification migration, impairment measurement, allowance booking, charge-off, and post-charge-off recovery.

Five-Grade Classification

Grade	Plain Meaning
Pass	Borrower is expected to perform normally.
Special Mention	Adverse factors exist, but repayment is not clearly impaired.
Substandard	Repayment ability has meaningful problems; loss is possible.
Doubtful	Loss is likely and requires close action.
Loss	Recovery is unlikely or expected to be minimal.

Classification Inputs

Risk classification commonly considers:

• Days past due and delinquent installments.
• Borrower business condition and cash flow.
• Collateral value and enforceability.
• Repayment willingness and collections result.
• Extension, restructuring, litigation, or charge-off status.
• Regulatory rules and bank policy.

Allowance and Impairment

Allowance is the bank's buffer for expected credit loss. Higher risk generally requires higher allowance.

Risk grade worsens -> expected loss rises -> allowance increases -> profit is affected

The system should keep classification result, reason, approval workflow, allowance amount, and accounting trail.

Charge-off and Recovery

Charge-off does not necessarily mean the bank gives up collection. It removes or writes down an asset for accounting purposes, while collection, collateral realization, or guarantor recovery may continue.

Distinguish:

• Risk classification change.
• Impairment or allowance booking.
• Loan charge-off.
• Post-charge-off recovery.
• Recovery of charged-off loans.

Risks

Risk	Explanation
Classification relies too much on manual judgment.	Results become inconsistent and hard to defend.
Delinquency data is inaccurate.	Classification and allowance become wrong.
Collateral value is stale.	Loss estimate is distorted.
Post-charge-off recovery is not managed.	Asset recovery and accounting records break.
Classification adjustment lacks approval trail.	Audit and regulatory risk increases.

Related Topics

Topic	Use
Delinquency, Collections, and Loan Status	Understand key risk inputs.
Collateral, Pledges, Mortgages, and Guarantees	Understand collateral impact on loss estimate.
Disbursement, Repayment, and Accounting Entries	Understand allowance, charge-off, and recovery accounting.