Provision coverage ratio
The provision coverage ratio is loan loss provisions held divided by non-performing loans. It shows how much provision is held for each unit of non-performing loans, often expressed as a percentage.
Example
For illustration, if a lender holds 70 in provisions against 100 of non-performing loans, the calculation is 70 ÷ 100 = 70%. That is 70 held for every 100 of non-performing loans.
How coverage ratios are calculated
For the NPL measure, use the non-performing loan balance as the denominator for its segment. The reserve ratio uses total loans instead.
For illustration, with provisions of 12 and total loans of 300, the reserve ratio is 12 ÷ 300 = 4%. If annual net charge-offs are 6, provisions of 12 cover 12 ÷ 6 = 2 years of charge-offs.
Reading coverage across lending segments
Secured books can have lower coverage because collateral may recover part of a loss. Read the ratio in the context of the segment’s collateral and write-off policy.
A low or falling ratio means less provision is held for each unit of non-performing loans than at the comparison point. It is a reason to look at the figures behind the ratio, not a standalone conclusion about the lender’s overall position.
Questions we get asked
Does a 70% coverage ratio mean 70% of loans are expected to be recovered?
No. The ratio compares provisions with non-performing loans, not expected recoveries. A 70% ratio means 70 is held in provisions for every 100 of non-performing loans.
Can the provision coverage ratio be above 100%?
Yes. It exceeds 100% when provisions are greater than non-performing loans. For example, provisions of 120 against 100 of non-performing loans give a ratio of 120%.
Is provision coverage a measure of annual charge-offs?
No. Provision coverage compares provisions with non-performing loans. Years of charge-offs covered compares provisions with annual net charge-offs.
Decisimo’s free provision coverage calculator calculates NPL coverage, the reserve ratio and years of charge-offs covered by segment, plus the shortfall to a target.
