Classification of non performing loans is simply the divisions of loans that are less than 90 days past due. Especially when there is high uncertainty surrounding future repayments. However, if the debtor resumes payments again on a non-performing loan, it becomes a re-performing loan. Once the debtor has not caught up on all the missed payments. Also, in banking, they consider commercial loans as non-performing when the debtors make zero payments of interest or principal within 90 days. Also, they consider commercial loans to be non performing when they are 180 days past due. Continue reading to discover the types, causes, solutions, and the classification of non-performing loans.
What is a non-performing loan?
A non-performing loan (NPL) is a loan in which the borrower has not made repayments of principal and interest for a specified period. Also, we refer to a situation whereby a customer who borrowed a loan cannot make the scheduled payment for at least 90 days. Usually, the specified period varies on the type of loan and financial institutions
How does a non performing loan work?
The bank considers the loan as default when it deems it non performing. Getting full repayment of these loans from the debtor is unlikely. However, no matter the status of the default payments, re-performing loans automatically become non-defaulting loans. This is after the defaulter makes payments again. Also, note that a default and a loan in arrears do not have the same meaning. Usually, lenders consider a default on a loan as a breach of the loan agreement when the borrower cannot meet his obligations. However, a loan is in arrears when there has been a delay or complete failure in making principal and/or interest payments.
Types of non performing loans
There are various classifications of non-performing loans, but the three most important ones are:
- A loan in which the specified date of repayment of both principal and interest has elapsed, yet the loan remains outstanding.
- Also, a loan in which the debtor has capitalized, refinanced or delayed 90 days’ worth of interest. This is because of a breach in agreement and the inability of the debtor to clear the remaining debt within the specified period.
- Installment loan which is less than 90 days, but the financial institution no longer believes the debtor will make future payments as regards the debt.
What are the causes of non performing loans?
Non performing loans don’t just occur, there are some factors that give rise to them. Some of these factors include:
- Lack of proper skill among loan officials is a key factor in a high percentage of non-performing loans.
- Unhealthy competition among financial institutions reduces loan standards, contributing to a high tendency for non-performing loans.
- High costs of operation, especially the increasing prices of input materials and energy, can have a considerable impact on banks’ non-performing loans. However, these reduce the earnings of businesses, even small and medium enterprises.
- Inability to identify the purpose of the loan and its validity. Usually, this determines how the funds required for the payment of interest and the generation of repayment of capital.
- The character of a borrower as a wilful defaulter is another key factor that has increased the rate of non-performing loans in Ghana.
Impact of non performing loans on banks
Evidently, there are cases when a financial institution or a lender has a large percentage of non-performing loans. Such that the ratio of non-performing loans is higher than the total loan ratio would consequently lead to a high risk of loss. As much as it affects the lender, it leaves the borrower with lesser eligibility for getting loans from the lender in the future.
What is the negative impact of high non performing loans in Ghana?
High non-performing loans stretch most banks thin. In Ghana, these loans adversely affect the banking industry and shareholders. A widespread problem of non-performing loans erodes the strength of banks. Also, it is the regulators’ responsibility to keep these loans from affecting bank reserves.
What are the causes of the increase in non performing loans in Ghana?
There are several factors that give rise to non-performing loans in Ghana. Some of these factors are inherent and within the control of the borrower, and external factors trigger some. We will discuss the factors in these instances.
Some internal factors that can cause high non-performing loans to include:
- Loans that the borrower has managed poorly.
- Funding a business with loans rather than equity or shareholding.
- A flagged character of the borrower.
While some external factors that can cause high non-performing loans will include:
- Existence of high interest rates, including hidden charges.
- Staggering government policies.
- Riots, unrest, and natural disasters.
- Exchange rate fluctuations.
Finally, some banks influence some factors themselves and they include:
- Unethical professional conduct by the bank’s staff or representatives.
- A rigid loan monitoring process.
- Inadequate risk management for credit structure.
What are the solutions to non performing loans?
There are some factors that help to reduce non performing loans. They include:
- Profiling clients: Combining information on assets and consumer behavior can help orchestrate industrialization. However, low-value clients can be addressed within a pre-defined set of actions. Also, high-value clients are addressed by reducing recovery periods and costs.
- Enhancing legal services by considering the value recovered and revising the compensation model accordingly. There is an improvement in recovery time and a reduction in legal expenses.
- Develop a retail strategy library, which will make sure that they offer the best product to clients based on their behaviors, income, and net worth.
- Reforming the business model: redesigning the business model to integrate commercial and credit lending processes to facilitate collaboration across these two departments.
- Monitoring unexpected depreciation is done with advanced analytics, such that information on property value, collateral, borrowers, guarantors is combined. It is possible to reduce loan losses by 5-10% through better collateral management.
- Establishing a collateral recovery data quality program: The evaluation of collateral agreements and defining dedicated crash programs will allow for an improved collateral data set that will assist in better recovering from a crash.
We consider a loan a non performing loan when the tendency of receiving repayment is very low. Criteria for classifying a non performing loan is the number of days past due. Also, the overall financial performance of the borrower, and the assessment of the collateral. Finally, the number of days past due is not the only sign that a loan is to be non performing and not the most accurate predictor of loss in certain cases rather, past due days provide strong indications of the likelihood of default.