Credit losses: expected-loss allowance and cost of risk
Stages, coverage, allowance roll-forward, cost of risk.
By Surojit Chakraverti, founder of L3VLUP and an investor running a long-short healthcare and technology equities strategy.
On this subject: credit losses: expected-loss allowance and cost of risk.Updated 30 October 2026
What it does
Credit losses under expected-loss accounting are an allowance, not a charge typed in. Each loan book is split into stage 1 (performing, provided for twelve months of expected loss), stage 2 (credit risk has risen, provided for the loan’s lifetime) and stage 3 (credit-impaired). Each stage carries a coverage ratio, and the allowance must equal the sum. The impairment charge is whatever brings the allowance to that requirement after write-offs, plus any management overlay; over average loans it is the cost of risk, in basis points.
Where it lives
The same schedule in each model that carries it, with the rows to open. Open a model in the browser, go to the sheet, and click the lines.
- Assumptions, rows 75–91: Mortgages: stage 2 share of loans, base, Mortgages: stage 3 share of loans, base, Mortgages: stage 1 coverage, Mortgages: stage 2 coverage…
- Credit Losses, row 6: Migration multiplier, selected scenario
- Credit Losses, rows 9–12: Mortgages: stage 2 loans, Mortgages: stage 3 loans, Mortgages: stage 1 loans, Mortgages: expected-loss requirement
- Credit Losses, rows 15–18: Consumer loans and cards: stage 2 loans, Consumer loans and cards: stage 3 loans, Consumer loans and cards: stage 1 loans, Consumer loans and cards: expected-loss requirement
- Credit Losses, rows 21–24: Business and commercial loans: stage 2 loans, Business and commercial loans: stage 3 loans, Business and commercial loans: stage 1 loans, Business and commercial loans: expected-loss requirement
- Credit Losses, rows 27–29: Stage 2 loans, Stage 3 loans, Expected-loss requirement
- Credit Losses, rows 32–40: Opening allowance, Write-offs, Average gross loans, Additional cost of risk (overlay)…
- Credit Losses, rows 43–46: Cost of risk, Stage 3 ratio, Coverage of stage 3 loans, Allowance, % of gross loans
What a reviewer looks for
- A charge typed as a share of loans, so a deteriorating book and a growing one look the same.
- Write-offs taken through the income statement as well as the allowance, counting the loss twice.
- Coverage held flat while loans migrate into stage 2 and stage 3.
Learn it, then build it
Vocabulary: Loss Given Default (LGD), Basis Points (bps).