Non-Performing Loans: Causes and Management

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Non-Performing Loans: Causes and Management

1. Introduction

As the cost of living and inflation levels continue to rise, customers find themselves facing economic challenges more often. To mitigate the increased risk of defaulting and concern about non-performing loans, banks have tightened credit standards. As a result, the net percentage of banks with tightened credit standards has reached as high as 27% across all loan categories.

In this landscape, it is important to have a better understanding of non-performing loans (NPL). In this blog, we’ll explore what NPLs are, what causes them, the different types, how to manage them, and how to choose the best loan management software. 

2. What are Non-Performing Loans (NPL)? 

A Non-Performing Loan (NPL) is a term used in the financial industry to describe a loan that has not been repaid in accordance with the agreed-upon terms, typically for a specified period, often around 90 days. 

An NPL may involve missed instalment payments or the complete failure to make a single payment, and it is also assessed as unlikely to be fully repaid in the future. The precise definition of an NPL can vary between financial institutions and regulatory authorities based on factors such as: 

  • Whether the loan is officially declared as "in default" 
  • The number of days the loan is past due or overdue 
  • Whether the loan is considered "impaired" or not 
  • The level of certainty regarding future payments 

While international entities like the International Monetary Fund (IMF) and the European Central Bank (ECB) provide general definitions, individual banks and regulatory bodies may adapt these definitions to their specific circumstances.

3. Causes of Non-Performing Loans

NPLs can have various causes, including the following factors: 

Economic: Economic downturns and fluctuations in interest rates can exert significant pressure on borrowers, making it increasingly challenging for them to fulfil their loan obligations. A comprehensive grasp of these economic forces is pivotal in managing Non-Performing Loans effectively. 

Borrower-Related: The financial well-being of borrowers plays a pivotal role in the emergence of NPLs. Issues such as insolvency defaults in payment, and even fraudulent activities can be major contributors to loans transforming into non-performing. 

Lender-Related: Financial institutions themselves are not immune to NPL-related issues. The presence of poor underwriting practices and inadequate risk management can result in an uptick in NPL figures. Lenders need to address challenges proactively. 

Legal and Regulatory: Legal disputes, alterations in regulatory frameworks, and compliance complexities can all influence the transformation of loans into non-performing assets. While these external factors may be intricate to navigate, they are paramount to comprehend for effective NPL management.

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4. Types of Non-Performing Loans

Several criteria categorise non-performing loan types, each providing valuable insights into the nature of the loan and its associated risks. These criteria include:

  • Duration of Delayed Payments: This measures how long a borrower has missed payments, often defined by a specific number of days, commonly around 90 days. 
  • Percentage of Outstanding Loan: It evaluates what portion of the loan remains unpaid after various missed payments. 
  • Loan Modifications: Whether there have been alterations or special arrangements for loans that have fallen at least 90 days overdue.

Typically, loans are classified as secured and unsecured, based on the presence or lack of a collateral.

Secured Loans 

Secured loans provide an extra layer of security for lenders. These loans are backed by collateral, which serves to mitigate risk. Collateral can take the form of physical or liquid assets, such as properties, vehicles, collectibles, a down payment, or a savings account. 

In the event that the borrower is unable to repay the loan, the collateral is repossessed and sold to recover the debt. Secured loans are often offered to customers with insufficient credit scores, providing a way for them to secure loans despite their credit history.

Unsecured Loans 

Unsecured loans do not require collateral assets. This makes them riskier for lenders, as recovering debt may necessitate the involvement of collection agencies or legal action should the borrower persistently evade payments. 

Due to the higher risk associated with unsecured loans, they are typically reserved for borrowers with high credit scores, as they are less likely to default. These borrowers are seen as more reliable, making them suitable candidates for loans that do not require collateral for security. 

5. Consequences of Non-Performing Loans

Non-performing loans that remain unresolved can have significant consequences, affecting both borrowers and lenders in various ways. 

For Lenders: If the NPL is unsecured, lenders face the risk of losing the borrowed sum, which can result in financial losses. Furthermore, the efforts to recover such loans can lead to additional operational expenses, such as legal and collection costs. 

For Borrowers: Borrowers with Non-Performing Loans are at risk of damaging their credit rating. In cases where the NPL is secured, they also face the possibility of having the collateral used as security seized, further exacerbating their financial challenges. 

These consequences underscore the importance of proactive NPL management for lenders and borrowers, as timely resolution can mitigate potential damages and losses.

6. How to Manage Non-Performing Loans

Effective management of Non-Performing Loans (NPLs) can significantly boost the success of debt recovery while alleviating customer vulnerability. The key lies in proactive measures that aim to identify at-risk customers before they reach the point of loan default. 

Proactive Identification: Identifying vulnerable customers early on is crucial. The ideal scenario is to detect signs of financial distress before they default on their loans. 

Swift Response and Restructuring: In cases where a loan becomes non-performing, swift action is essential. Lenders should be prepared to react promptly and consider restructuring the due amount as necessary. This approach allows the customer to resume loan repayments, albeit at a more manageable pace than initially agreed upon. It's a preferable alternative to not receiving any payments at all. 

Alternative Recovery Measures: If a customer becomes unresponsive or refuses to make payments over extended periods, lenders must explore alternative means of recovering the loan. This may involve taking legal action, pursuing collateral assets, or even selling the loan itself at a discounted rate to an investor. 

Data Management and Handling: In all circumstances, meticulous data management is of utmost importance in loan management. Lenders require accurate and up-to-date information pertaining to payments, collateral, real property records, contracts, contact details, and addresses. However, managing such a vast amount of information for hundreds or even thousands of customers can be overwhelming. This can lead to an increase in the number of non-performing loans, difficulties in converting them into re-performing loans, and challenges in recovering secured assets. 

By focusing on proactive identification, swift response, and robust data management, lenders can effectively manage NPLs, increasing the likelihood of successful debt recovery while safeguarding the financial well-being of their customers.

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7. Choosing the Right Loan Management Software

Selecting the appropriate loan management software is a critical step in effectively handling non-performing loans and various lending products. When making this choice, you should consider the following key factors: 

  • Loan Restructuring: Non-performing loans often require dynamic restructuring tailored to each client's specific needs. Opt for a solution that streamlines the process, normalizes non-performing loans, and accommodates distinct interest rates per period. 
  • User-Friendly Interface: A user-friendly interface is essential. It should facilitate easy access and modification of customer information, streamline transactions, and allow for swift loan restructuring as required. 
  • Seamless System Integration: Look for loan management software that provides APIs for seamless integration with host and external systems. This includes core banking, payment channels, ERP, and collections systems. 
  • Flexible Delivery Options: The ideal software can be utilised via the cloud, on-premises, or through an open API. This flexibility caters to different organisational regulations and needs. 
  • Security and Compliance: Given the sensitive nature of loans, the software should adhere to banking industry regulatory frameworks. It should offer role-level access control for users to ensure compliance. 
  • Support for All Lending Products: The software should have the capacity to support a wide array of lending products, including secured loans, unsecured loans, commercial real estate, and corporate loans. 
  • Comprehensive Reporting: Effective loan management demands ongoing and ad-hoc reporting capabilities. The software should enable you to effortlessly monitor and generate reports for financial assessments, arrears tracking, payment reconciliations, and more. 
  • Customer Onboarding: An exceptional software solution should streamline customer onboarding and reduce the risk of human errors, regardless of the lending product and its associated details.

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8. Why Choose QUALCO Loan Manager 

If you are searching for robust loan management software that aligns with all the criteria mentioned above, QUALCO Loan Manager stands out as the right choice. It comes equipped with the capabilities to manage a wide range of lending products, whether secured or unsecured, from initial onboarding to disbursement, restructuring, and termination. 

QUALCO Loan Manager excels in: 

  • Normalising non-performing loans with customisable repayment schedules and interest rates. 
  • Partitioning a customer's total debt into manageable account balances, offering continuous monitoring and maintenance. 
  • Utilising cutting-edge technology, including HTML5, CSS3, and Angular, combined with Google's frontend framework and Microsoft's enterprise solution for backend support. 

This makes QUALCO Loan Manager a comprehensive and reliable choice for efficient loan management across various lending products.