`What is NPL?

A nonperforming loan (NPL) is a loan that is in default because the borrower has failed to make payments on time for a specified period. Although the precise elements of nonperforming status can vary depending on the terms of a particular loan, "no payment" is typically defined as zero principal or interest payments.

Nonperforming Loan (NPL)

The specified duration varies based on the industry and type of loan. Typically, the period is either 90 or 180 days. A nonperforming loan (NPL) is a loan in which the borrower is in default and has not made any principal or interest payments for a specified period of time.

When a borrower is 90 days past due on a commercial loan, the loan is deemed nonperforming in the banking industry. The International Monetary Fund classifies as nonperforming loans that are less than 90 days delinquent if there is a high level of uncertainty regarding future payments.

However, neither a standard nor a definition exists for NPLs. Some banks choose to sell NPLs to other banks or investors in order to free up capital and/or concentrate on performing, income-generating loans.

How a Nonperforming Loan (NPL) Works

A nonperforming loan (NPL) is in default or on the verge of default. Once a loan becomes delinquent, the likelihood that the debtor will repay it in full diminishes significantly. If the debtor resumes payments on an NPL, the loan becomes a reperforming loan (RPL), even if the debtor has not yet made up for all missed payments.

In banking, commercial loans are deemed nonperforming if the borrower has made no interest or principal payments within 90 days or is 90 days delinquent. 180 days past due on a consumer loan classifies it as an NPL.

When principal or interest payments are late or missed, a loan is in arrears. A loan is in default when the lender deems the loan agreement to have been breached and the borrower is unable to meet the obligations.

Types of Nonperforming Loans (NPLs)

A debt can become a nonperforming loan in a number of ways. 

• A loan for which 90 days' worth of interest has been capitalized, refinanced, or delayed as a result of an agreement or amendment to the original agreement.

• A loan in which payments are late by less than 90 days, but the lender no longer believes the borrower will make future payments.

• A loan in which the principal repayment date has passed, but a portion of the loan balance remains outstanding.

In order to collect on nonperforming personal loans, the Fair Debt Collection Practices Act prohibits specific abusive or deceptive practices. However, this law only applies to debt collectors and investors, not to the original lender.

Definitions of Nonperforming Loans (NPLs)

Multiple international financial authorities provide specific criteria for identifying nonperforming loans.

European Central Bank

To evaluate risk exposures among euro area central banks, the European Central Bank (ECB) requires asset and definition comparability. When it conducts stress tests on participating banks, the ECB specifies multiple criteria that can lead to an NPL designation. The ECB has performed a comprehensive analysis and developed criteria to define nonperforming loans as those that are: 

• 90 days past due, even if they are not defaulted or impaired; 

• Impaired in accordance with the accounting specifics for U.S. GAAP and International Financial Reporting Standards (IFRS) banks

Non-compliant with the Capital Requirements Regulation

A 2018 addendum specified the timeline for lenders to set aside funds to cover nonperforming loans: between two and seven years, depending on whether or not the loan was secured. As of the year 2020, eurozone lenders still hold approximately $1 trillion in nonperforming loans.

International Monetary Fund

The International Monetary Fund (IMF) also establishes multiple criteria for government loans that are not performing.

The IMF defines nonperforming loans as those whose terms include:

Interest payments equal to 90 days or more have been capitalized or refinanced or delayed by agreement. Payments have been delayed by less than 90 days, but there is high uncertainty or no certainty that the debtor will make future payments

Nonperforming loans may damage the borrower's credit rating, making future borrowing more difficult and expensive.

Nonperforming Loan (NPL) vs Reperforming Loan (RPL)

Nonperforming loans are defaulted loans. Reperforming loans are previously nonperforming loans that are now performing. Once delinquent for at least 90 days, the reperforming loans are now performing again.

Frequently, reperforming loans are loans for which the borrower has filed for bankruptcy and has continued to make payments in accordance with the bankruptcy agreement. Typically, this agreement permits the borrower to become current on their debt through a modified loan program.

Nonperforming Loan (NPL) - Example

Imagine a borrower who is unable to make loan payments because of job loss. After ninety days of nonpayment, the bank or lender will consider the loan delinquent. The bank would place the loan on its list of nonperforming loans and continue to pursue payment.

Multiple options are available to the creditor. Sending the debt to a collections agency, that will be paid a percentage of any money it recovers, is one of the most common methods of debt collection. Additionally, the lender can sell the debt to a debt purchaser for a fraction of its face value. Although the creditor will incur a financial loss, this is frequently a better option than attempting to collect on a nonperforming loan.

Borrowers with nonperforming loans may be able to negotiate debt relief with their creditors. However, this may harm their credit rating, making future borrowing more difficult and costly.

What Happens to the Nonperforming Loans?

Banks can sell nonperforming loans to other banks or investors. If the borrower begins making payments again, the loan may also become delinquent. In other instances, the lender may repossess the collateral to satisfy the loan balance.

What is the Reason for Non-Performing Loans?

During economic downturns, when delinquencies are prevalent, nonperforming loans are common. They occur when the borrower fails to make payments for an extended time period (such as 90 to 180 days).

Why do banks sell loans that are Nonperforming Loans?

Banks may sell nonperforming loans in order to concentrate on monthly income-generating loans. It may be more profitable to sell the loans at a discount than to attempt to collect from a delinquent borrower.

Who Buys the Nonperforming Loans?

As well as real estate investors, other banks or distressed debt investors may consider investing in nonperforming loans.

How is a nonperforming loan resolved?

The resolution of a nonperforming loan involves getting payments back on track. This may be accomplished through a loan modification agreement with the lender.

The Bottom Line

During economic instability, the number of nonperforming loans tends to rise. These are the loans for which the borrower cannot or does not make payments. If no payment is received for a predetermined amount of time (usually 90 or 180 days, depending on the lender), the loan becomes non-performing.