Nonperforming Loan (NPL)

When a borrower falls far behind on payments, the loan is classed as nonperforming. Banks no longer expect to collect interest and principal as agreed, and may not recover the full amount.

For example, if a business borrower has not paid interest or principal on its loan for four months, the bank would normally classify the loan as nonperforming.

Banks track the NPL ratio, which divides nonperforming loans by total loans. If a bank has 50 million of NPLs out of 1,000 million of total loans, its NPL ratio is 5%. A rising ratio signals growing credit problems.

Nonperforming loans reduce a bank's income, because interest is not being received, and require banks to set aside money to cover expected losses through loan loss provisions. High levels of NPLs can weaken a bank's capital, limit its ability to lend and, if widespread across a banking system, slow the whole economy. Banks deal with NPLs by restructuring loans, seizing and selling collateral, selling the loans to specialist investors or writing them off.