Translation: Expected Credit Losses - ECL.

Simplified Definition: It is a preventive accounting procedure, representing a financial "safety cushion" that the bank sets aside from its operating profits to face any potential future losses due to some clients (individuals or companies) defaulting on their loans. In other words, it is an early and calculated recognition by the bank's management that part of the funds lent may not be returned, and thus this part is deducted from profits today as a precaution before the problem actually occurs.

How is it recorded in the statements? (Total operating income) - (Operating expenses + Provisions) = (Net profit before zakat and taxes).

Note (Factors for building provisions): Provisions are built based on a strict international accounting standard (IFRS 9) that classifies loans into three stages:

  • Stage One (Performing Loans): The client is committed to repayment, but the bank sets aside a very small provision in anticipation of any emergencies.
  • Stage Two (Loans Under Watch): Risks have increased (for example, the client is 30 days late or their sector is affected by interest rates), here the bank raises the size of the provision.
  • Stage Three (Non-Performing Loans): The client has stopped repaying (exceeded 90 days), here the provision becomes very large to cover the full expected loss.

Example: Suppose a bank achieved a "Total Operating Profit" of 10 billion riyals. However, management noticed that high interest rates are putting pressure on some borrowing companies, so it decided to set aside 1 billion riyals as "credit provisions." The declared "net profit" will be 9 billion riyals. This billion set aside has not disappeared or left the bank as "cash"; rather, it has been frozen on the books. If conditions improve and those companies repay their loans, the bank will reverse the provisions in the next quarter, meaning it will return this billion and combine it with new profits, suddenly boosting net profit.

What does it mean for you?

  • Increased Provisions: It strongly pressures the current "net profit" and shows it as weak, but it indicates that management is "cautious," careful, and managing risks efficiently, which protects the bank from any sudden crises.
  • Decreased Provisions or (Reversal): It significantly raises "net profit." It indicates the quality of the loan portfolio, an improvement in the economic environment, and the removal of risks that the bank was previously concerned about.
  • Sector Differences: This indicator is the "heartbeat" for reading the statements of banks and financing companies; because "lending money" is their core activity. While its importance diminishes significantly in other sectors like retail or technology, where it is known by simpler names like "provision for doubtful debts" and its impact on profits is marginal.

Common Question: Why do we sometimes see the stocks of some banks maintain their stability or even rise, despite announcing a decline in "net profit" due to a huge jump in provisions?

Answer: Because financial analysts read between the lines. Provisions are "non-cash accounting expenses" (Non-cash item) at the moment. When an analyst sees that the profit decline is not due to weakness in core activity (decline in deposits or decrease in loans), but rather due to "excessive hedging" and setting aside huge provisions, they realize that the bank is keeping cash for tough days. If these tough days do not come, then these huge provisions will later turn into net profits (through reversing the provisions), making the stock a future investment treasure.