SINGAPORE banks are in for tough times in 2016, but a collapse of the banking sector is unlikely, despite alarmist calls from a few hedge funds in recent weeks. Investors who fear a banking crisis should take heart that Singapore banks follow stringent and unique domestic standards when setting aside reserves for bad loans.

All banks create reserves, known as allowances or provisions, for lending that is under stress. This is reflected on their income statement, and is a drag on earnings. There are two forms of provisions. One is known as a specific provision that, as the name suggests, is a portion of earnings set aside for specific loans that are under stress. The second is known as a general provision, which is an overall cushion against loans that may, even in the ordinary course of business, come under stress. To do this, banks typically look at historical loan loss data to estimate how much to set aside, and correspondingly, to deduct against operating profit.

Over the three months that make up a reporting quarter, banks try to recover portions of a non-performing loan, typically by restructuring the lending terms or by selling collateral that the loan is secured against. (The simplest example is that of a housing loan. If a borrower defaults on payments, the bank has the right to take possession of the property to recover its loan.)