How do reserve releases work?

th3doctorWhen a bank takes a provision (adds to reserves) on its income statement, this shows up as a loss/expense (or even a gain, yes you can add to income this way). The term "releasing reserves" means just as you put it, charge-offs/loans written off as noncollectable (and loans that were provisioned for being sold) exceeding provisions, causing reserves to fall. Charge-offs however don't impact the income statement, only the level of reserves on the balance sheet (and the amount of gross loans on the books).

Releasing reserves can either be justified or not justified, based on the quality of the loan portfolio. Whether or not reserve releases are justified is typically measured by Reserves/NPLs (non-performing loans). If this level is lower than it has been historically, the bank probably released reserves just to boost earnings and will have to take bigger provisions in the future to make up for it (unless loan quality improves further), or if the ratio stayed the same / went up, the release was probably okay.

This is sort of a simplistic view of the issue, but it should give you a start at thinking about it. The basic point is, management at banks has quite a bit of discretion in determining earnings and anyone looking at a bank's income should always be wary of this.

Great thanks, so essentially, banks just reduce the provisions on the income statement to boost earnings. I thought there was a line item called "Reserve release" which just added to income, but this is helpful!

thanks

th3doctorWhen a bank takes a provision (adds to reserves) on its income statement, this shows up as a loss/expense (or even a gain, yes you can add to income this way). The term "releasing reserves" means just as you put it, charge-offs/loans written off as noncollectable (and loans that were provisioned for being sold) exceeding provisions, causing reserves to fall. Charge-offs however don't impact the income statement, only the level of reserves on the balance sheet (and the amount of gross loans on the books).

Releasing reserves can either be justified or not justified, based on the quality of the loan portfolio. Whether or not reserve releases are justified is typically measured by Reserves/NPLs (non-performing loans). If this level is lower than it has been historically, the bank probably released reserves just to boost earnings and will have to take bigger provisions in the future to make up for it (unless loan quality improves further), or if the ratio stayed the same / went up, the release was probably okay.

This is sort of a simplistic view of the issue, but it should give you a start at thinking about it. The basic point is, management at banks has quite a bit of discretion in determining earnings and anyone looking at a bank's income should always be wary of this.

I'm still very unclear as to how the income statement is directly affected. Is it as newfirstyear mentioned?

Could you please provide a very simplistic example?

If you or anyone could clarify here or in pm, would really very much appreciate it. Thanks.