What Is a Non-Performing Loan (NPL)?
A non-performing loan (NPL) is a loan in which the borrower has failed to make scheduled payments for a specified period, typically 90 days, and is no longer accruing interest. These loans are considered impaired and unlikely to be repaid in full, representing a significant challenge within the broader category of Banking and Credit. When a loan becomes non-performing, financial institutions must assess its collectability and often categorize it differently on their balance sheet, impacting their overall asset quality. The presence of a high volume of non-performing loans can restrict a bank's ability to extend new credit supply and can signal underlying issues in the economy.
History and Origin
The concept of non-performing loans has existed for as long as lending has been practiced, but their systemic impact became particularly pronounced during periods of widespread financial distress. Major banking crises throughout history have highlighted the critical role NPLs play in destabilizing financial systems. For instance, the Asian Financial Crisis in the late 1990s and the Global Financial Crisis of 2008 saw a significant surge in non-performing loans globally, leading to widespread recognition of their macroeconomic consequences. The International Monetary Fund (IMF) has published extensive research on the dynamics of non-performing loans during banking crises, noting their consistent presence and impact on post-crisis economic recovery.14, 15 Data collected since 1990 reveals similarities in how NPLs build up across various crises, although their resolution patterns can differ significantly.12, 13
Key Takeaways
- A non-performing loan (NPL) is a loan where payments are significantly overdue, typically 90 days or more.
- NPLs are a key indicator of credit risk within a financial institution's portfolio.
- High levels of NPLs can negatively impact a bank's profitability, capital, and ability to lend.
- Regulatory bodies closely monitor NPL ratios as part of their assessment of financial stability.
- Resolution strategies for NPLs include loan restructuring, asset sales, and legal action.
Formula and Calculation
The Non-Performing Loan (NPL) ratio is a key metric used to assess the health of a bank's loan portfolio and is calculated as:
Where:
- Total Non-Performing Loans: The aggregate value of all loans that meet the criteria for being classified as non-performing (e.g., payments overdue for 90+ days).
- Total Gross Loans: The total value of all loans extended by the financial institution before accounting for any loan loss provisions.
This ratio provides a percentage indicating the proportion of a bank's total loan book that is considered non-performing.
Interpreting the NPL
A low NPL ratio generally indicates a healthy loan portfolio and effective risk management by a financial institution. Conversely, a high NPL ratio suggests a deterioration in credit quality, potentially signaling financial distress for the lending institution. For example, in June 2018, the total non-performing loan ratio in Greece reached 47.8%, a significant increase from 5.3% ten years prior, following the global financial crisis and European debt crisis.11
The NPL ratio is often evaluated in conjunction with other metrics, such as the coverage ratio (the percentage of NPLs covered by provisions), to gauge a bank's resilience. An increasing NPL ratio can be a precursor to reduced interest income for banks and may necessitate higher capital reserves, impacting their capital adequacy.
Hypothetical Example
Consider "Bank Alpha," which has a total loan portfolio of $10 billion. After reviewing its outstanding loans, the bank identifies several borrowers who have not made payments for over 90 days. The sum of these overdue loans amounts to $300 million.
To calculate Bank Alpha's NPL ratio:
In this scenario, Bank Alpha has an NPL ratio of 3%. This figure would be compared against industry averages, regulatory benchmarks, and the bank's historical performance to assess its implications. A 3% NPL ratio indicates that 3 cents of every dollar loaned out is currently non-performing. The bank would need to consider the collateral held against these loans and potential recovery strategies.
Practical Applications
Non-performing loans are a critical concern for various stakeholders in the financial system. For banks, managing NPLs is essential for maintaining profitability and solvency. High NPL levels reduce a bank's capacity to lend and can strain its capital base.10 Regulators, such as central banks and financial supervisory authorities, closely monitor NPL trends to ensure the stability of the banking sector and the broader economy.
In a recent example, Piraeus Bank, a major Greek lender, reported that its non-performing exposure (NPE) ratio stood at 2.6% at the end of June 2025, down from 3.3% a year earlier.9 This demonstrates ongoing efforts by financial institutions to reduce their exposure to distressed assets. Policy makers often implement measures to address NPLs, particularly after economic downturns or crises. These measures can include the establishment of asset management companies (AMCs) to acquire and resolve bad loans, as observed in various Asian economies following financial crises.7, 8 Unresolved NPLs can impair banks' balance sheets, depress economic growth, and delay economic recovery by impeding the role of financial intermediaries.6
Limitations and Criticisms
While the NPL ratio is a vital indicator, its interpretation has limitations. Different jurisdictions and accounting standards may have varying definitions of what constitutes a non-performing loan, making cross-country comparisons challenging. For instance, NPLs typically include loans over 90 days in arrears, but precise definitions can differ, potentially affecting the reported NPL ratios across economies.5
Furthermore, the NPL ratio is a lagging indicator, meaning it reflects past credit decisions and economic conditions rather than current or future risks. A sudden recession or unexpected market shock can quickly lead to an increase in NPLs that may not be immediately apparent in reported figures. The International Monetary Fund's Global Financial Stability Report (GFSR) frequently highlights how vulnerabilities, such as high leverage in some financial institutions, can amplify shocks and increase financial stability risks, even when NPLs might appear contained in the near term.3, 4 The resolution of NPLs can be protracted, particularly during severe economic downturns, further impacting banks' ability to lend and contributing to a cycle of reduced economic activity.1, 2
Non-Performing Loan (NPL) vs. Delinquent Loan
The terms "non-performing loan" and "delinquent loan" are related but distinct. A delinquent loan is one where the borrower has missed one or more scheduled payments but has not yet reached the stage of being classified as non-performing. Typically, a loan becomes delinquent as soon as a payment is overdue.
A non-performing loan (NPL), on the other hand, is a specific type of delinquent loan that has been in arrears for a more extended period, usually 90 days or more. At this point, the lender often no longer expects to receive full principal and interest payments and considers the loan to be impaired. All non-performing loans are delinquent, but not all delinquent loans are non-performing. The classification as an NPL triggers more stringent regulatory and accounting treatments, including the need for higher loan loss provisions and potential write-offs. A delinquent loan may still be considered "performing" by the bank if it is expected to resume payments and the missed payments are not extensive enough to classify it as a full default.
FAQs
What causes a loan to become non-performing?
Loans can become non-performing due to various factors, including the borrower's financial difficulties (such as job loss, business failure, or unexpected expenses), macroeconomic downturns like a recession, or poor underwriting standards by the lender.
How do non-performing loans affect banks?
Non-performing loans reduce a bank's interest income, require the bank to set aside capital as provisions for potential losses, and can erode its capital adequacy. This can limit the bank's ability to issue new loans, impacting the overall credit supply in the economy.
Are NPLs always written off by banks?
Not immediately. While NPLs are unlikely to be repaid in full, banks typically explore various resolution strategies, such as loan restructuring, selling the loan to a third party (like an asset management company), or initiating legal proceedings to recover the collateral. A complete write-off is usually a last resort after all recovery efforts have been exhausted.