When you apply for a bank loan, there are certain terms and conditions laid out to outline your payback plan and ensure that you are able to return your loan payments and the given interest rates regularly and on time.
However, in certain cases borrowers fail to repay their loans according to the prepared payback plan, and upon evaluating their default payments based on a certain criteria, which we will explain later in this article, their loans are regarded as non-performing.
What is a non-performing loan?
In literal financial terms, a non-performing loan refers to the amount of money which you have borrowed, and failed to return according to the scheduled payback plan for over a period of 90 days.
You loan may not be defaulted right away and you will be given a chance to justify your position, but in some cases, your loan will made a defaulter right away, depending on the policies of the bank you are dealing with.
Once your loan has been considered as non-performing, the chances that the bank will receive the entire payment are considerably low. Once you start making your payback payments on your nonperforming loan, its status will be changed to a re-performing loan, regardless of whether or not you have managed to cover all the payments you missed on the payback schedule.
How does the bank or any lending institution choose to deal with a non-performing loan?
When non-performing loans begin to accumulate, banks and lending institutions seek out other investors to purchase their risk and help them clean away their debts and maintain their balance sheets.
However, buying a non-performing loan involves a high rate of risk and great difficulty in tracking down the creditors and recovering the payments. The institution that buys a non-performing loan has to consider elements like its financial standing, its profit & Loss statements and balance sheets, along with its taxation status.
If a certain defaulter is not making the interest payments or paying the principal amount, the banks counter the loss of this non-performing loan or bad debt according to their own local and state regulations, and also their own financial policies. Banks and lending institutions always set aside loan loss provisions, a certain amount of money that is kept to recover the losses caused by the non-performing loans before classifying them as bad debts in their profit & loss statements.
In certain countries, banks that have accumulated a huge amount of non-performing loans sell them off at a discounted price, and these bad debts are bought by specialised asset management companies. The AMCs specialise tracking down the creditors and recovering as much of the defaulted payment as possible.
What causes the loan to become non-performing?
A non-performing loan is created due to inefficiency, mismanagement, and lack of effective planning on both sides, the lending institute or bank, and the borrower.
Let’s take a look at these causes in detail:
The borrower’s payback schedule is not effective enough to counter all the loan default risk.
In most cases, individuals tend to take loans in order to invest in a venture or business, and their ability to return the loan depends on the profit and success of their ventures and business. In the instance, they fail to land a productive operation or end up making a loss, they will not be able to return their loans according to the agreed payback schedule.
Now, the fault lies with both parties, the bank and the borrower. The borrower did not take into account the possibility that his venture or business might not be profitable and thus, the need to make prior arrangements to counter this problem and avoid delay in payback was not addressed.
The bank, also failed to research and examine the validity, effectiveness and scope of the business plan that was presented when the loan application was being reviewed.
In other instances, borrowers end up borrowing a huge sum and their payback schedule does not support their financial status, their income or perhaps, they are faced by a sudden medical or accidental calamity, which drains them of their ability to make the payments on time.
Hence, borrowers need to address the need of making efficient and effective payback schedules, which facilitate their income, their financial standing and does not create anxiety and financial constraints. It is always best to hire the services of a financial counsellor or loan adviser in such cases.
· The larger the loan size, the greater the risk of falling behind on your payments.
A loan is always a financial risk, and by increasing the sum of your loan, you are also increasing your financial burden, your interest rates, your monthly payback amounts, and your ability to repay the entire principal amount as well as the added interest becomes a huge risk.
If you apply for a shorter loan size, your payback schedules will be easy and conveniently manageable, and there will be no financial burden.
Certain borrowers have no intention of paying back.
There are many borrowers who completely disappear once the loan amount has been sanctioned, and due to the hoax credibility of their loan applications, the banks fail to realise that they are a potential risk and threat to their financial standing.
Such non-performing loans are sold off to Asset Management Companies, who have the expertise to track down creditors and recover the amount or at least, some of it.
Why is it important to prevent loans from becoming non-performing?
Indeed, non-performing loans are a plague to the productive cycle of borrowing and lending all over the globe. The bad debts accumulated by a bank represent the amount of money they have loaned out without any material chances of recovering them.
This poses a problem for both lenders and buyers of that particular bank, as the bank will not only be reprimanded by the FDIC, but also, they will not be able to generate enough to cash to cover their losses and keep their other lenders who are reliable and payback on time.
