Investor's wiki

Problem Loan Ratio

Problem Loan Ratio

What Is the Problem Loan Ratio?

The problem loan ratio is a ratio in the banking industry that compares the percentage of problem loans to the percentage of sound loans. In the banking and credit markets, a problem loan is one of two things: a commercial loan that is no less than 90 days past due, or a consumer loan that is something like 180 days past due.

A problem loan is likewise alluded to as a nonperforming asset. The problem loan ratio is at last a measure of the strength of the banking and lending industries, and the economy as a whole. A higher ratio means a greater number of problem loans as well as the other way around. Problem loans reduce the amount of capital that lenders have for subsequent loans.

On the off chance that a bank has 500 loans and 10 of them are problem loans โ€” late commercial loans (90 days past due date) or late consumer loans (180 days past due date) โ€” the problem loan ratio for this bank would be 1:50, or 2%.

Understanding the Problem Loan Ratio

Banks try to keep their problem loan inventories low in light of the fact that these types of loans can lead to cash flow problems and different issues. In the event that a bank is as of now not able to deal with its outstanding debt, it could lead to the closure of the bank.

When a borrower starts to be late with payments, the financial institution commonly sends notification to the borrower; the borrower is then required to make a move to get the loan current. In the event that the borrower doesn't answer, the bank can sell assets and recuperate the balance of the loan. Problem loans can frequently bring about property foreclosure, repossession, or other adverse legal actions.

In the event that a company is experiencing issues meeting its debt obligations, a lender might restructure its loan. Along these lines, the institution can in any case keep up with some cash flow and might have the option to try not to need to characterize it as a problem loan.

If borrowers have any desire to haggle with the bank to make a problem loan current once more, a bank representative can meet with them to examine the outstanding balance.

The problem loan ratio can be broken down by the level of delinquency of loans, for example, those under 90 days past due versus those all the more seriously financially past due.

History of the Problem Loan Ratio

As markets debilitate, it is entirely expected for the problem loan inventory to increase as individuals battle to make their loan payments. High rates of foreclosures, repossessions, and other legal actions might reduce bank profits.

The Great Recession and the Rise of the Problem Loan Ratio

The problem loan ratio increased across the board during the Great Recession from 2007 to 2009. During this time, the subprime fallout prompted a rise in the number of problem loans that banks had on their books. Several federal programs were instituted to assist consumers with dealing with their delinquent debt, the vast majority of which zeroed in on mortgages.

Prior to the Great Recession, in the mid 2000s, there was an exceptional added to in American household debt. There was likewise a sensational increase in mortgage lending, particularly in the private market. (The share of loans that were insured by government agencies started to decline.) However, as home prices fell, it brought about a monstrous wave of mortgage defaults as consumers battled to meet their debt obligations. This lofty increase in problem debt greatly contributed to the beginning of the recession.

Numerous consumers were sold mortgage products that were not suitable or proper for them. For instance, numerous borrowers were offered hybrid adjustable-rate mortgages (ARM) with exceptionally low, initial interest rates that were intended to allure them. While these products might have caused homeownership to seem affordable at the start, after the initial a few years the interest rates increased. The structure of these mortgages required numerous borrowers to either refinance or fit the bill for an extra loan to meet their debt obligations. Notwithstanding, as home prices began to fall and interest rates increased, refinancing actually became unimaginable for some borrowers, and, in this manner, they defaulted on these loans.

Since the 2000s financial crisis and the Great Recession, stricter lending requirements have been presented. This has assisted with curbing predatory lending rehearses โ€” including not appropriately clarifying the terms of a loan for a borrower โ€” and poor regulation of the financial sector.

Highlights

  • The problem loan ratio is a ratio in the banking industry that compares the percentage of problem loans to the percentage of sound loans.
  • As markets debilitate, it is entirely expected for the problem loan inventory to increase as individuals battle to make their loan payments.
  • In the event that a bank has 500 loans and 10 of them are problem loans, the problem loan ratio for this bank would be 1:50, or 2%.
  • A problem loan is one of two things: a commercial loan that is no less than 90 days past due, or a consumer loan that is no less than 180 days past due.