Non-Performing Loan (NPL)

A Non-Performing Loan (NPL) is a loan in default or close to default. Here are more details about how Non-Performing Loans work: 

1. It may result from events like bankruptcy, loan restructuring, or prolonged non-payment. 

1. If interest or principal remains overdue for more than 90 days in India, then RBI (Reserve Bank of India) classifies a loan as an NPL. 

1. The chances of full recovery of loan are low if a loan becomes non-performing, indicating the borrower’s financial distress. 

1. Lenders are impacted by NPLs by reducing profitability, increasing provisioning requirements, and limiting their capacity to issue new loans. 

Types of Nonperforming Loans 

Based on different types of borrowing and lending patterns, there are various types of nonperforming loans that are listed below: 

1. Personal Loans: Unsecured loans taken for personal use can become nonperforming if repayments stop. 

1. Business Loans: If the business struggles financially, loans provided to businesses for operations or expansion may turn out to be nonperforming. 

1. Mortgages: When borrowers fail to make timely mortgage payments, home loans become nonperforming. 

1. Credit Card Debt: Overdue and unpaid credit card balances can also be classified as nonperforming loans. 

Causes of Nonperforming Loans 

There are several factors that may make a loan nonperforming, and the factors are: 

1. Economic Downturns: Loan repayment becomes difficult under situations like recessions and slowdowns that cause job losses and income reduction. 

1. Poor Loan Underwriting: The risk of loan default increases due to Inadequate assessment of a borrower’s repayment capacity. 

1. High-Interest Rates: Rising interest rates raise borrowing costs, leading to repayment challenges for borrowers. 

1. Business Failures: Financial distress from poor management, competition, or market shifts can prevent companies from repaying loans. 

1. Personal Financial Issues: Defaults on personal loans may happen due to various events, such as medical emergencies, divorce, or the death of an earning member. 

Effects of NPL on Banks 

The effects of NPLs on banks are mentioned below: 

1. Reputation Damage: A high NPL ratio can damage a lender’s image, reducing trust among customers and investors. 

1. Decline in Profitability: Bank’s overall earnings get lowered due to nonperforming loans that stop income generation. 

1. Higher Provisioning Requirements: Banks must reserve funds to cover potential NPL losses, reducing resources for lending and growth. 

1. Capital Erosion: The ability to absorb losses and stay stable is adversely affected by excessive NPLs as it weakens the capital base of the bank. 

1. Regulatory Impact: Banks with high NPLs may face penalties or restrictions from regulators, hindering their operations. 

How are Non-Performing Loans Managed by Financial Institutions? 

The lenders must minimise the loss and recover the amount due when the loans become non-performing. The methods used to manage non-performing loans are mentioned below: 

1. Asset Seizure: To recover dues lenders may repossess and sell collateral (like property or vehicles) for secured loans, though low resale value often leads to losses. 

1. Debt Collection: To follow up on repayments, recovery agents are hired, but the process is costly and often yields low recovery as defaulters usually lack funds. 

1. Loan Restructuring: To help borrowers manage their debt, lenders may ease repayment by offering lower interest rates, extended tenures, or partial write-offs. 

1. Legal Proceedings: Lenders can file recovery suits in courts or tribunals, but this method is typically lengthy, costly, and uncertain, used only as a last resort. 

1. Selling NPLs: Instead of managing the loan directly, lenders may sell non-performing loans to asset reconstruction companies or private investors. 

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