What Is a Non-Performing Loan?

Non-performing loans (NPLs) arise when borrowers fail to make scheduled payments for an extended period, leaving the loans unable to generate income for lenders. These NPL loans pose significant risks to a financial institution's profitability and liquidity, making them a critical focus area for maintaining stability.

According to the Reserve Bank of India (RBI), the gross Non-Performing Asset (NPA) ratio of Indian lending institutions dropped to a multi-year low of 2.8% in March 2024. While this is a positive trend, the effective management of NPL loans remains essential to minimising financial risks and ensuring economic resilience.

In this article, we’ll explore what a non-performing loan is, the different types and examples, and how they differ from reperforming loans (RPLs). We'll also discuss the strategies lending institutions employ to effectively deal with a non-performing loan.

What Are Non-Performing Loans?

When borrowers fail to meet repayment obligations for an extended period, the loan is classified as a non-performing loan. This situation can arise with any loan type, including personal, home, and business loans. Typically, lending institutions classify a loan as non-performing when no payments – neither principal nor interest — have been made for 90 days or more.

Non-performing loans pose significant challenges to lending companies as they reduce profitability and increase credit risk. They also increase the overall loan default risks, making efficient management of NPL loans essential for maintaining financial stability.

What Are the Types of Non-Performing Loans?

To better understand the meaning of non-performing loans, let us explore the types of loans that fall under this category:

Secured Loans:

Secured NPLs are loans backed by the collateral pledged by the borrower, such as property, vehicles, or other financial assets. While such loans carry less risk for lenders due to the collateral, repossessing and liquidating the assets to recover dues can be time-consuming and complex.

Unsecured Loans:

Unsecured NPLs are loans that are not backed by any collateral, making them riskier for lenders. Recovery efforts for such loans often involve legal actions or lengthy negotiations, as there are no assets to recover the outstanding loan amount.

What Are the Examples of NPL Loans?

The definition of NPLs can be best understood through real-life examples. Consider a borrower who takes out a personal loan to fund a wedding but fails to make three consecutive monthly payments due to unexpected unemployment. In this case, the lender will classify the loan as non-performing after 90 days of non-payment.

Another example of a non-performing loan can be a borrower who uses a personal loan for medical expenses but struggles to repay due to high ongoing costs. Without collateral to recover the loan amount, the lender may face a higher likelihood of a write-off or extended loan recovery efforts to obtain outstanding dues through legal means.

In India, small and medium enterprises (SMEs) are slightly more vulnerable to debt repayment issues. Factors such as cash flow restraints, market volatility, or higher interest rates can lead to NPL loans.

These examples highlight the importance of borrowing responsibly and making timely payments to avoid the consequences of NPLs, including damaged credit scores and financial instability.

Difference Between Non-Performing Loans (NPL) and Reperforming Loans (RPLs)

The reperforming and non-performing loan classification is based on repayment behaviour and financial status.

NPLs are loans where borrowers have defaulted and payments have been overdue for 90 days or more. These loans are considered high-risk because they do not generate income for the lender and are likely to result in financial loss if not recovered.

On the other hand, RPLs are loans that were previously classified as NPLs or distressed loans but have returned to performing status. This typically happens when borrowers resume payments after undergoing loan restructuring, negotiation, and other relevant recovery methods.

For instance, an NPL loan can transition to an RPL when a borrower successfully negotiates revised terms, such as lower interest rates or extended loan tenures, and resumes timely payments.

While NPLs reflect high risk and borrower default, RPLs signify recovery, improved asset quality, and reduced potential losses for lenders.

How Does a Financial Institution Handle Non-Performing Loans?

Managing a non-performing loan is a multi-step process requiring proactive measures and effective strategies. Financial institutions typically begin by identifying early signs of financial distress among borrowers through rigorous monitoring systems. Early intervention, such as sending payment reminders or offering financial counselling, helps prevent loans from becoming non-performing.

However, once a loan is classified as a non-performing loan, lenders often explore restructuring options to help borrowers resume payments. This could include reducing interest rates, extending repayment periods, or offering temporary moratoriums. Since loan restructuring can benefit both parties, it is often used to restore income for the lender and provide relief to the borrower.

In the case of a secured non-performing loan, lenders may initiate legal actions under frameworks like the SARFAESI Act to repossess and liquidate collateral for the recovery of outstanding dues. For unsecured NPLs, financial institutions may turn to recovery agencies or pursue settlements through negotiations with borrowers.

Another common approach while handling a non-performing loan is selling them to Asset Reconstruction Companies (ARCs). Specialising in loan recovery, these entities help free up capital for lenders and reduce their recovery burden.

In recent years, technology-driven tools like data analytics have enhanced lenders' ability to predict loan performance and mitigate risks. By identifying potential defaults early, these tools complement traditional strategies such as restructuring and legal action. Together, these measures help financial institutions minimise losses and strengthen their financial health.

Wrapping Up

Non-performing loans can pose significant challenges for lending institutions, affecting liquidity and profitability over time. Addressing NPL loans effectively requires proactive measures such as diligent loan monitoring, borrower support, and efficient recovery processes.

At SMFG India Credit, we prioritise responsible lending practices, offering competitive interest rates, flexible repayment tenures, and transparency with no hidden fees or charges. Through our customised online portal, you can easily access your loan details and stay on top of your repayment schedule. Our dedicated support team is also available via phone or email to assist with any queries about your account.

If you’re seeking financial support to achieve your personal or business goals, explore our personal loans of up to INR 30 lakhs*. Apply online or visit your nearest branch to learn more.