Non-Performing Loans

When a bank lends money, it expects it back in installments. If the borrower stops making these payments, the loan becomes a problem case. In technical language, such a loan is called a non-performing loan. As a rule of thumb: if payments are overdue for more than 90 days, the loan is considered non-performing. Even without this deadline, it counts as such if it becomes apparent that the borrower will no longer be able to repay in full. The English term for this is Non-Performing Loan, abbreviated NPL – this is how it usually appears in reports and news.

What missing repayments mean for a bank

A bank earns money from the fact that lent funds come back with interest. If this inflow fails to materialize, not only is the profit missing, but possibly the lent capital itself as well. The bank then has to build provisions, that is, set aside money to cover the expected loss. This money is no longer available for new loans.

This is exactly where the greater danger lies. A bank with many bad loans becomes cautious and lends less. Companies then find it harder to get money for investments, and the economy grows more slowly. This was clearly observable in Italy, Greece, and Cyprus during the eurozone crisis after 2010: there, the share of non-performing loans temporarily stood at over 40 percent of all loans.

That is why the so-called NPL ratio is a closely watched metric. It indicates what proportion of all of a bank’s loans are non-performing. In the eurozone, it currently averages around two percent, which is historically low. Regulators such as the European Central Bank nevertheless monitor it very closely, because it rises before a crisis becomes visible.

From payment default to the sale of the loan

The path begins harmlessly. An installment is transferred late, the bank sends a reminder. If payments remain overdue for 90 days, the bank reclassifies the loan. It moves internally out of the normal portfolio into the problem department, often called the workout unit.

Then the bank examines what can still be salvaged. Sometimes the loan is restructured: the term is extended, the installments are made smaller. This is called forbearance, i.e. deferral. If that doesn’t help, the bank liquidates the collateral. In the case of a mortgage loan, in the extreme case this means foreclosure of the house.

Many banks take a different route and sell entire packages of non-performing loans. Buyers are specialized investors who pay significantly less than the face value for them – sometimes only 20 or 30 cents per euro of claim. The bank thereby immediately removes the problem from its balance sheet, but forgoes most of the money. The buyer then tries to collect more than they paid.

Where the term appears in the news and in everyday life

Non-performing loans are most often mentioned in banks' quarterly reports. If the NPL ratio rises, the share price often reacts sensitively. The metric also plays a central role in regulatory stress tests. Since 2022, it has been appearing more frequently again, because higher interest rates have made installments more expensive for many borrowers.

A current example is commercial real estate. Office buildings have stood empty more often since the rise of remote work, their owners receive less rent and fall behind on loan installments. Several German and American banks have therefore had to build up high provisions.

A common misconception: a non-performing loan is not automatically a total loss. Often part of the money still flows back, for example from the sale of collateral. Only when the bank no longer expects anything at all does it write off the loan completely. Non-performing thus describes a state, not the final outcome.