How do you calculate a bank's cost of risk?

Take the credit impairment charge from the income statement, annualise it if the period is shorter than a year, and divide by the average gross loans for the period. Multiply by 10,000 to express it in basis points. A half-year charge of US$15m on average loans of US$12bn is US$30m annualised, or 25 basis points. Check the bank's own definition first, because the denominator and the treatment of recoveries vary.

What is a good cost of risk for a bank?

There is no good level in isolation. A book of residential mortgages produces far lower losses than one of unsecured consumer lending, with business lending usually in between, and every book's cost rises in a downturn. The useful comparisons are with the same bank's history across a cycle, with peers lending to similar borrowers, and with the loss the bank priced into its loans. A figure far below all three is as worth questioning as one far above.

Why can cost of risk be negative?

Because the charge is net. When a bank's economic outlook improves, loans return from stage 2 to stage 1 or an overlay is no longer needed, the allowance released can exceed the new charges for the period, and the impairment line becomes a gain. Recoveries on loans written off years earlier add to it. A negative figure means the bank provided more in the past than it now expects to lose, not that lending earned money from bad debts.

Is cost of risk the same as the loan loss provision?

No. The [loan loss provision](/glossary/loan-loss-provision), or allowance, is a balance: the total the bank holds on its balance sheet against expected losses on its loans. Cost of risk is built from the charge, broadly the change in that balance plus the amounts written off, recognised in the income statement for the period. A bank can hold a large provision and report a low cost of risk, if the provision was built in earlier years.

// WORKED EXAMPLETHE ARITHMETIC A DECISION RESTS ON

Cost of Risk: a Worked Example

The ratio can fall in the year the write-offs more than double.

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED 2026-11-07

// THE SHORT ANSWER

Cost of risk tells a reader how much of a bank's lending was consumed by credit losses in a period, scaled so that banks of different sizes, and years of different growth, can be compared. It is the impairment charge in the income statement, annualised, over the average loan book, and it is usually quoted in basis points, hundredths of a per cent. Because expected credit loss accounting provides for losses a bank can foresee, the ratio rises when the outlook darkens and can fall while write-offs are still climbing. It reports what the bank charged this year, not what its borrowers will cost next year.

BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.

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// 01 — WHAT THE RATIO MEASURES AND WHY IT MATTERS

A bank earns a margin on its loans and loses part of it to borrowers who do not repay. The impairment charge is that loss as the accounts record it, and it sits between the bank's net interest margin and its profit. Divided by the loan book, it becomes a rate that can be set beside the margin: a bank earning 2.2 per cent on its loans and charging 0.3 per cent for credit losses keeps the difference to pay its costs and its shareholders.

Investors use the rate to compare lenders and years. Inside a bank, finance and credit teams use it to compare lending segments with the loss that was priced into their loans when they were written, because every loan price carries an allowance for expected loss. A segment whose cost of risk keeps running above that allowance is losing money on credit even if its margins look healthy.

// 02 — HOW IT IS CALCULATED

Annualised charge = charge for the period × 12 ÷ months in the period

Average loans = (opening gross loans + closing gross loans) ÷ 2

Cost of risk = annualised charge ÷ average loans × 10,000 (basis points)

The ratio is not defined by any accounting standard. Each bank defines it in its results, and the choices differ: some average monthly or daily balances, some divide by closing loans, some include commitments or loans to other banks in the denominator. The numerator is usually the whole credit impairment charge, net of recoveries on loans written off in earlier years. Two banks quoting the same figure may be measuring slightly different things, so the definition is read before the number.

Under IFRS 9, and the New Zealand and Australian standards that mirror it, the charge has several moving parts. New lending brings a twelve-month allowance on the day it is made. A loan whose credit risk has risen significantly moves to stage 2 and carries an allowance for its whole life. A loan that becomes credit-impaired is provided against individually or in a pool. Changes in the economic scenarios move every allowance at once, and a management overlay may add to or release from the modelled result. Any of these can push the charge up with no loan yet in default.

// 03 — THE EXAMPLE

A regional lender, constructed for this page, grows its loan book from US$22bn to US$26bn in its first year and to US$28bn in its second. Every figure below is the example's.

Year 1 US$m

Average loans (22.0 + 26.0) ÷ 2 = US$24.0bn

New lending, twelve-month allowance 9

Loans moved to stage 2, lifetime allowance 21

New defaults, provided individually 36

Weaker economic scenarios 6

Recoveries on loans written off earlier −6

Impairment charge 66

Cost of risk 66 ÷ 24,000 × 10,000 = 27.5bp

Write-offs 18 ÷ 24,000 × 10,000 = 7.5bp

Year 2 US$m

Average loans (26.0 + 28.0) ÷ 2 = US$27.0bn

New lending, twelve-month allowance 5

Loans returned to stage 1, allowance released −12

New defaults, provided individually 20

Better economic scenarios −4

Recoveries on loans written off earlier −3

Impairment charge 6

Cost of risk 6 ÷ 27,000 × 10,000 = 2.2bp

Write-offs 45 ÷ 27,000 × 10,000 = 16.7bp

The second year is the one in which the lender actually lost the most money: US$45m of loans written off, most of them loans that defaulted, and were provided for, in year one. Yet its cost of risk fell by more than nine-tenths, because the loss had been charged a year earlier and the year's own news was better. A reader who saw only the 2.2 basis points would think credit had improved sharply. Some of it had; some of it was the accounting doing what it was designed to do, charging for the loss in the year the trouble showed, not in the year the loan was written off.

// 04 — THE MEASURES A LENDER READS BESIDE IT

Cost of risk is a flow: what was charged this year. Three other numbers complete the picture. The write-off rate is what was actually given up, and it lags. The provision coverage ratio is a stock: how much the bank holds against the loans already in trouble, which says whether a low charge was earned or borrowed from the cushion. And expected loss, where a bank estimates it from its risk grades, is the loss the book should produce in an average year. A cost of risk well under expected loss in a calm year is common, since expected loss describes an average year; one under it for several years running, while the stage 2 share rises, deserves a question.

DEFINED IN ONE PARAGRAPH → · PROVISION COVERAGE RATIO → · EXPECTED LOSS, WORKED →

// 05 — WHERE IT DECIDES A FILE

A business borrower meets cost of risk without seeing it. When a sector's cost of risk runs above the loss priced into its loans, the bank's appetite for that sector tightens: lower limits for new names, higher margins and more security at renewal, more frequent reporting. A borrower with a clean record in that sector feels the change too, because the bank is pricing the sector as well as the file. That is one reason a bank may reprice a loan when nothing in the business has changed.

For a reader of bank results, the ratio is the start of a question, not the end. A falling cost of risk after years of growth, with overlays being released and the stage 2 share rising, can describe a book that has not yet shown its losses.

HOW TO READ BANK RESULTS → · WHY YOUR BANK REPRICED YOUR LOAN →

// SOURCES

The documents the statements on this page rest on. Each was opened and checked when cited.

IFRS Foundation, IASB publishes its review of impairment requirements relating to financial instruments, 4 July 2024 — The IASB's post-implementation review found that the expected credit loss requirements have led to more timely recognition of credit losses, which is why the charge in the example arrives a year before the write-offs — section 03.

// QUESTIONS PEOPLE ASK

How do you calculate a bank's cost of risk?: Take the credit impairment charge from the income statement, annualise it if the period is shorter than a year, and divide by the average gross loans for the period. Multiply by 10,000 to express it in basis points. A half-year charge of US$15m on average loans of US$12bn is US$30m annualised, or 25 basis points. Check the bank's own definition first, because the denominator and the treatment of recoveries vary.
What is a good cost of risk for a bank?: There is no good level in isolation. A book of residential mortgages produces far lower losses than one of unsecured consumer lending, with business lending usually in between, and every book's cost rises in a downturn. The useful comparisons are with the same bank's history across a cycle, with peers lending to similar borrowers, and with the loss the bank priced into its loans. A figure far below all three is as worth questioning as one far above.
Why can cost of risk be negative?: Because the charge is net. When a bank's economic outlook improves, loans return from stage 2 to stage 1 or an overlay is no longer needed, the allowance released can exceed the new charges for the period, and the impairment line becomes a gain. Recoveries on loans written off years earlier add to it. A negative figure means the bank provided more in the past than it now expects to lose, not that lending earned money from bad debts.
Is cost of risk the same as the loan loss provision?: No. The [loan loss provision](/glossary/loan-loss-provision), or allowance, is a balance: the total the bank holds on its balance sheet against expected losses on its loans. Cost of risk is built from the charge, broadly the change in that balance plus the amounts written off, recognised in the income statement for the period. A bank can hold a large provision and report a low cost of risk, if the provision was built in earlier years.

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WHAT THEY HEAR · THE BANK · FUNDING AND LIQUIDITY

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THE GLOSSARYIN ONE PARAGRAPHCost of risk What is cost of risk for a bank, and how is it calculated?