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What is a Non-Performing Loan (NPL)?
A Non-Performing Loan (NPL) is a loan in which the borrower has failed to make scheduled interest or principal payments for a specified period—typically 90 days or more. When a loan becomes non-performing, it signals heightened credit risk for the lender and weak repayment capacity for the borrower.
Definition
A Non-Performing Loan (NPL) is a loan that is in default or close to default, generally because the borrower has not made scheduled payments for 90 days or more.
Key takeaways
- Indicator of credit risk: A rising NPL ratio signals financial stress in borrowers or the broader economy.
- Common threshold: Most regulators classify loans as non-performing after 90+ days of missed payments.
- Affects bank capital: NPLs require higher provisions, reducing profitability.
- Economic impact: High NPL levels can weaken lending capacity and slow economic growth.
- Regulatory oversight: Supervisors monitor NPL levels to maintain financial system stability.
How loans become non-performing
- Borrower cash-flow difficulties
- Economic downturns or job loss
- Rising interest rates increasing debt burden
- Poor underwriting standards
- Weak collateral values
- Business failure or bankruptcy
Types of NPLs
- Substandard loans: Borrowers face difficulty repaying but may recover.
- Doubtful loans: Full repayment is highly unlikely.
- Loss loans: Considered unrecoverable and written off.
Impact of NPLs on banks
1. Reduced profitability
Banks must set aside provisions to cover expected losses.
2. Lower capital adequacy
High NPLs weaken bank balance sheets.
3. Restricted lending capacity
Banks with large NPL portfolios reduce new lending.
4. Higher funding costs
Investors demand higher risk premiums.
Managing and reducing NPLs
- Loan restructuring: Adjusting terms to support borrower repayment.
- Strengthening credit assessment: Better underwriting and risk evaluation.
- Collateral recovery: Liquidating assets to cover unpaid balances.
- Selling NPL portfolios: Transferring bad loans to asset management companies.
- Regulatory intervention: Stress tests, capital requirements, and supervisory pressure.
NPL ratios
Regulators and investors track the NPL ratio:
NPL Ratio = (Total Non-Performing Loans / Total Loans) × 100
High NPL ratios indicate greater systemic risk.
NPLs in different sectors
- Household loans: Mortgages, personal loans, credit cards
- Corporate loans: SMEs often face higher NPL risk during downturns
- Commercial real estate: Collateral values can fluctuate widely
NPLs and economic cycles
NPL levels typically rise during:
- Recessions
- High unemployment periods
- Interest rate spikes
- Asset price collapses
They fall during periods of economic recovery.
Related concepts
- Credit risk
- Loan provisioning
- Capital adequacy ratio (CAR)
- Stress testing
- Loan restructuring
- Financial stability
Sources
- International Monetary Fund (IMF): https://www.imf.org/
- World Bank – Financial Stability Indicators: https://www.worldbank.org/
- Bank for International Settlements (BIS): https://www.bis.org/
Frequently Asked Questions (FAQ)
1. Can an NPL return to performing status?
Yes. Through restructuring or resumed payments.
2. Are all overdue loans NPLs?
No. Only loans overdue beyond the regulatory threshold (usually 90 days).
3. Do NPLs always cause bank failures?
Not necessarily, but large NPL portfolios strain capital and profitability.
4. What happens to written-off loans?
They are removed from the balance sheet but may still be pursued legally.
5. Why are NPLs closely monitored?
Because they impact financial stability, credit availability, and economic growth.
