The provision for risk reserves in the banking sector is a requirement based on International Financial Reporting Standards (IFRS) and specific regulations of financial regulatory authorities.
When a bank provides loans and those loans become loans from group 2 onwards, the bank is required to set aside a corresponding portion as a provision for risk. The purpose of setting aside risk reserves in the banking sector is to ensure that banks have sufficient capital reserves to deal with non-repayable loans and other risks in their business operations.
The rate of provision for risk reserves is typically determined based on factors such as loan types, customer types, collateral types, credit quality, and other risk factors. Regulations on provision for risk reserves are usually specifically stipulated by financial regulatory authorities and international organizations such as the Central Bank and the International Accounting Standards Board (IASB).
The provision for risk reserves helps banks to have financial capacity to cope with potential risks and ensures the stability of banks in providing financial services. Additionally, it ensures objectivity and transparency in the financial reports of banks.
Regulations on provision for risk reserves in Vietnam
On July 30, 2021, the State Bank of Vietnam issued Circular 11/2021/TT-NHNN, which prescribing classification of assets, amounts and methods of setting up risk provisions and use of provisions for control and management of risks arising from operations of credit institutions and foreign bank branches.
The specific rates of provision for risk reserves are determined for 5 loan groups. Article 12 of Circular 11 specifies the provision rates as follows:
a) Group 1: 0% (Standard debts)
b) Group 2: 5% (Debts needing special attention)
c) Group 3: 20% (Subprime debts)
d) Group 4: 50% (Doubtful debts)
e) Group 5: 100% (Potentially irrecoverable debts)
For debts from group 3 onwards, they are classified as non-performing loans, and banks or credit institutions are required to set aside specific provisions for the potential risks associated with each specific debts.
In addition to specific provisions, banks and credit institutions are also required to set aside a general provision, which is a reserve for potential risks that have not been specifically identified when setting aside specific provisions.
The general provision is determined as 0.75% of the total balance of loans from group 1 to group 4, based on the provisions in Article 13 of Circular 11.
However, it should be noted that the following items are not included in the calculation of the general provision:
- Deposits with credit institutions or foreign bank branches as regulated by law and deposits with foreign credit institutions.
- Term loans, securities purchased between credit institutions or foreign bank branches in Vietnam.
- Purchased treasury bills, promissory notes, deposit certificates, bonds issued by other credit institutions or foreign bank branches in Vietnam.
- Trading of government bonds as stipulated in point l, Article 1 of Circular 11.