What is the ratio of problematic loans?
The problem loan ratio is a ratio in the banking industry that compares the percentage of ready for problems the percentage of healthy loans. In the banking and credit markets, a problem loan is one of two things: a business loan that is at least 90 days past due or a consumer credit that is at least 180 days past due.
A problem loan is also called a non-performing asset. The problematic loan ratio is ultimately a measure of the health of the banking and lending sectors, and of the economy as a whole. A higher ratio means more problem loans and vice versa. Problem loans reduce the amount of capital available to lenders for subsequent loans.
If a bank has 500 loans and 10 of them are problem loans (overdue business loans (90 days overdue) or overdue consumer loans (180 days overdue) – the problem loan ratio for that bank would be 1:50, or 2%.
Key points to remember
- The problem loan ratio is a ratio in the banking industry that compares the percentage of problem loans to the percentage of healthy loans.
- A problematic loan is one of two things: a business loan that is at least 90 days past due or a consumer loan that is at least 180 days past due.
- If a bank has 500 loans and 10 of them are problem loans, the problem loan ratio for that bank would be 1:50, or 2%.
- As markets weaken, it’s not uncommon for problematic loan inventory to increase as people struggle to repay their loans.
Understanding the problematic loan ratio
Banks try to keep their inventory of problematic loans low, as these types of loans can lead to cash flow and other problems. If a bank is no longer able to manage its outstanding debt, it could cause the bank to shut down.
Once a borrower begins to be in arrears, the financial institution usually sends notices to the borrower; the borrower is then required to take steps to get the loan up to date. If the borrower does not respond, the bank can sell assets and collect the loan balance. Problematic loans can often result in ownership foreclosure, repossession or other adverse legal actions.
If a business is having difficulty paying off debts, a lender can restructure their loan. This way the institution can still maintain some cash flow and may be able to avoid having to classify it as a problem loan.
If borrowers wish to negotiate with the bank to reset a problematic loan, a representative of the bank can meet with them to discuss the outstanding balance.
The problem loan ratio can be broken down based on the level of default on loans, such as those less than 90 days past due versus those that are more seriously past due.
History of the problematic loan ratio
As markets weaken, it’s not uncommon for problematic loan inventory to increase as people struggle to repay their loans. High rates of foreclosures, foreclosures and other legal actions can reduce bank profits.
The Great Recession and the Rising Problem Credit Rate
The problem loan ratio generally increased during the Great Recession from 2007 to 2009. Meanwhile, the fallout from subprime mortgages led to an increase in the number of problem loans banks had on their books. Several federal programs were enacted to help consumers cope with their past due debts, most of which focused on mortgages.
Before the Great Recession in the early 2000s, there had been an unprecedented increase in US household debt. There has also been a dramatic increase in mortgage lending, especially in the private market. (The share of loans insured by government agencies began to decline.) However, when house prices started to fall, it led to a massive wave of defaults as consumers struggled to honor their debts. This sharp increase in problematic debt was a major contributor to the onset of the recession.
Many consumers have been sold mortgage products that are not right or right for them. For example, many borrowers were offered Variable Rate Hybrid Mortgages (ARMs) with very low initial interest rates that were supposed to attract them. While these products may have made home ownership seem affordable initially, after the first two or three years, interest rates rose. The structure of these mortgages required many borrowers to refinance or qualify for an additional loan in order to meet their debts. However, as house prices started to drop and interest rates rose, refinancing became impossible for many borrowers and as a result they defaulted on these loans.
Since the financial crisis of the 2000s and the Great Recession, stricter loan requirements have been introduced. This has helped curb predatory lending practices, including poorly explaining loan terms to a borrower, and poor financial sector regulation.