A non-performing loan (NPL) is a loan on which the borrower has stopped making the payments due, or is unlikely to repay in full. The most widely used test is that principal or interest is 90 days or more past due. Banks, supervisors and investors track NPLs closely because they turn expected income into losses, eat into bank capital and are an early sign of stress in a banking system. The share of NPLs in total loans, the NPL ratio, is one of the core financial soundness indicators compiled by the International Monetary Fund (IMF).
Different countries use different labels. India speaks of non-performing assets (NPAs); Pakistan's State Bank refers to classified loans and reports an "infection ratio"; European supervisors use "non-performing exposures", which also covers bonds and off-balance-sheet items. A loan becoming non-performing is a matter of credit risk, the risk that a borrower does not pay a lender.
Non-performing loans in plain terms
Picture a landlord with ten tenants. Nine pay the rent every month. The tenth has not paid for three months and has stopped answering calls. On paper the landlord still owns that rent, but it is no longer arriving, and it may never arrive. Sensibly, the landlord stops counting on it and puts some money aside in case it is lost.
A bank's non-performing loan is that tenth tenant. The loan is still on the books, but it has stopped "performing", which means stopped producing the payments it was meant to. The bank must flag it, stop treating the unpaid interest as income and set aside money to cover the likely loss.
How a loan is defined as non-performing
The IMF's guide to financial soundness indicators treats a loan as non-performing when any of the following applies:
- Payments of principal or interest are 90 days or more past due.
- Interest equal to 90 days or more has been capitalised, refinanced or delayed by agreement.
- Payments are less than 90 days overdue, but there are other good reasons, such as the borrower filing for bankruptcy, to doubt that they will be made in full.
In 2017 the Basel Committee on Banking Supervision published guidelines on the prudential treatment of problem assets, setting a common definition of non-performing exposures (90 days past due, or unlikely to pay without calling on collateral) and of forbearance, where a lender eases terms for a borrower in difficulty. A forborne loan cannot be returned to performing status too quickly, which stops banks hiding problems by repeatedly rescheduling them.
Classification and provisioning
Many supervisors grade problem loans by how long they have been overdue, typically substandard, doubtful and loss, with higher provisions at each stage. Provisions are amounts set aside from profits to cover expected losses, net of any collateral the bank can sell. Accounting standards now look ahead as well: under IFRS 9, banks recognise expected credit losses in three stages, with credit-impaired loans, broadly the NPLs, in stage 3. Loans with no realistic chance of repayment are eventually written off.
The NPL ratio and coverage
The NPL ratio compares problem loans with the whole loan book:
The coverage ratio shows how much of the problem has already been provided for:
A bank with gross loans of 500 billion and NPLs of 40 billion has an NPL ratio of . If it holds 32 billion of provisions against them, its coverage ratio is , and its net NPLs are 8 billion.
Why NPLs build up and how they are resolved
NPLs rise after recessions, interest-rate jumps, currency collapses and lending booms, and fall slowly. High NPLs tie up capital, push up funding costs and make banks reluctant to lend, which can slow the whole economy. Japan in the 1990s, the 2008 financial crisis with its sub-prime mortgages, and several euro-area banking systems in the 2010s all showed this pattern. Banks and governments deal with NPLs by restructuring loans, enforcing collateral, writing them off, selling them to specialist investors or state asset management companies ("bad banks"), or packaging them through securitization. Because high NPLs threaten financial stability, supervisors often set banks targets for reducing old problem loans.
How Pakistan classifies and reports NPLs
The State Bank of Pakistan's prudential regulations classify corporate and commercial loans as substandard once they are 90 days overdue, doubtful at 180 days and loss at one year or more, under ageing rules introduced by BSD Circular No. 7 of 2005; microfinance banks use shorter 30, 90 and 180-day thresholds. Banks in Pakistan moved to IFRS 9 expected-credit-loss accounting from 1 January 2024. The SBP reports the banking system's NPLs and infection ratio in its Financial Stability Review and quarterly performance reviews of scheduled banks, and also tracks how well NPLs are covered by provisions. Related lending is described in bills purchased and discounted and foreign currency loans.