Provision for bad debt in credit risk

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This method is being used to assess the bad debt provision for companies in their Companies Act Accounts. It has implications in respect of insurance business: 1) which insures bad debt\; and 2) in respect of its own bad debts. The conditions when the method has been used are where there is a large volume of data, and the analysis of claims is relatively stable. Repayment of part of the debt is made monthly. Basic initial analysis is undertaken on various average debt amounts. These are subdivided into arrears categories. It must be remembered that unlike a delay pattern a person can go from arrears 3 to arrears 1 by partial payment of debt. A model is then developed using transition probabilities, which represents the probability of going from arrears case X to arrears Case Y. This model is then used to simulate the provision requirements.