dissapointing, page-22

Buyandhold,

If a bank writes a 1 year loan today, then that loan will have an expected loss based on the loan's credit rating. The expected loss is the amount that the bank expects to lose on that loan (effectively the amount is based on a portfolio view). This expected loss is calculated as the probability of default multiplied by the loss given default. For example a probability of default of 1% and LGD of 50% on a $1m loan would have an expected loss of $5,000.

On the day that the loan is written, the bank is not allowed by AASB139 to have a provision for that loan. Under the pre-IFRS accounting standards, banks would have recognised the $5,000 on day 1, so a difference of $5,000).

WBC like all Basel 2 banks calculates the expected loss number (the equivalent of the $5,000) and compares this to the incurred loss number (0 in this example) and deducts the difference from regulatory capital - 50% from tier 1 and 50% from tier 2.

Westpac has deducted $388m from each, so this means that its expected loss number is $776m (2 x $388) more than the value of its provisions.

It is worth noting that the Basel 2 expected loss number is only a 1 year number (I think - did not check this). So given the tenor of much of WBC and other bank portfolios the expected loss provision would be much much bigger than the actual provisions. This is the reason banks wrote back large amount of provisions when IFRS was introduced.