Loan Loss Reserve

A loan loss reserve is money a lender sets aside to cover loans that may not be repaid. The term has two meanings.

1. The accounting reserve. On the balance sheet, the reserve is an estimate of future losses, not a separate pile of cash. Banks long called it the allowance for loan and lease losses (ALLL). Under the current expected credit loss (CECL) standard, it is now called the allowance for credit losses (ACL). It reduces the reported value of the loan book to the amount the lender expects to collect.

The allowance moves in three ways:

• Provision. The lender adds to the allowance by recording an expense, called the provision for credit losses.
• Charge-offs. When a loan is written off, the balance comes out of both the loans and the allowance.
• Recoveries. Money later collected on a charged-off loan goes back into the allowance.

Worked example. A lender has $10 million in loans and an allowance of $200,000. It charges off a $50,000 loan, leaving $150,000. It then recovers $10,000 on an old loss, bringing the allowance to $160,000. If its updated estimate says the allowance should be $220,000, it records a $60,000 provision.

2. A cash reserve. Some programs require a real cash account. As of 2026, an intermediary in the US Small Business Administration (SBA) Microloan program must keep cash in a loan loss reserve fund equal to 15% of its outstanding microloans, until it has been in the program for at least five years. Other funders and guarantee programs set their own rules.

Why it matters for lenders

The accounting allowance tells boards, investors and examiners how much loss is already built into the portfolio. Too small, and earnings and capital look stronger than they are. Too large, and results are understated. Many funders also track reserves as a share of total loans.

A cash reserve ties up money that could otherwise be lent, so lenders track each program's required balance against what they hold.

How it works in practice

A community development financial institution (CDFI) closes its books each quarter. The finance team updates its CECL estimate by loan pool and compares it with the current allowance. After this quarter's two charge-offs and one partial recovery, the team records the provision needed to reach the new estimate.

Separately, the team checks its SBA microloan reserve. New loans grew the portfolio, so the required cash balance rose. The team moves funds to keep the reserve at the required level.

When charge-offs, recoveries and reserve rules live in separate spreadsheets, the loan book and the accounting records drift apart. Tracking each event on the loan keeps them in step.