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Sanderson Abel
A non-performing loan can be defined as the sum of borrowed money upon which the debtor has not made his or her scheduled payments for at least 90 days. A non-performing loan is either in default or close to being in default. Once a loan is non-performing, the odds that it will be repaid in full are considered to be substantially lower. Alternatively we can say an NPL is a loan on which the borrower is not making interest payments or repaying any principal.

At what point the loan is classified as non-performing by the bank, and when it becomes bad debt is usually a regulatory issue.
Banks normally set aside money to cover potential losses on loans (loan loss provisions) and write off bad debt in their profit and loss account which leads to the problem of financial disintermediation.

Defaulted loans force banks to take certain measures in order to recover and securitise them in the best way. In other words once a bank realises that a loan has become non-performing they will usually make efforts to recover amounts owed to them. Methods for resolving non-performing loans include the following:
Commencing collection proceedings
Commencing legal actions to seize collateral

Writing off these amounts, transferring them to specific subsidiaries in charge of collections and authorising those subsidiaries to recover what they can with respect to these amounts or to sell these loans to third parties; and

With respect to large corporations, commencing or participating in voluntary workouts or restructurings mandated by the courts.
Banks play an important role of allocating and distributing people’s savings for use in most productive investment. Banks’ intermediary function is essential for economic activity as it enhances the productivity and efficiency of the economy as a whole.

If banks’ amount of disposal of non-performing loans continue to exceed their profits, the banks’ net worth is reduced and lowers their risk-taking capacity, making it difficult to invest funds in risky projects and to realise potentially productive businesses.
This will then lead to the problem of financial disintermediation.

Non-performing loans have the effect of eroding a banks’ profitability. This can happen through two channels. First, non-performing loans incur heavy disposal expenses.
Simply making provisions for credit losses and postponing the final disposal of non-performing loans would cause additional losses, if the collateral value of underlying asset declines.
Secondly, holding non-performing loans for a long time without disposing them would incur costs other than the amount of disposal of non-performing loans. That is to say, by continuing to hold non-performing loans, or assets that do not generate returns, banks would lose returns that they would have earned if they had collected the loans
Non-performing loans can lead to efficiency problem for banking sector because banks don’t optimise their portfolio decisions by lending less than demanded.

There is a negative relationship between the non-performing loans and performance.
Performance of the banks can be measured by the rate at which they turn deposits into loans and the capability to collect those loans.

Those people who borrow from the banks ought to understand that banks are merely intermediaries hence resources that they lend to them are other client’s investments. When investors place their investments with banks they have an expectation to receive their investment back plus a return at the appropriate time as agreed with their bankers.

It is the duty of the bank to lend these resources to those who want to borrow at an interest with also an expectation that the money will be returned timeously. If the borrower then fails to pay back the amount they borrowed, this then impairs the ability of a bank to meet the withdrawals demands of its depositors which can cause a lot of problems in the banking system sometime leading to panic withdrawals.

Under such circumstances, the bank find itself in a very uncomfortable position as clients lose confidence in its intermediation function.
Banks when continuously faced with the default problem, they may continue to lend out on the basis that the client offers adequate collateral. This is one of the major reasons for banks demanding that a borrower pledges collateral which the bank can dispose when the borrower defaults.

Under this arrangement the bank has a legitimate expectation to get the money back or else they will put the pledged collateral under the hammer and the financial intermediation process will continue.

There is need for the clients of the banks to understand that non-performing loans becomes a huge cost on the economy when they begin to interfere with the normal financial intermediation role of banks.

If the non-performing loans are kept on bank books and are continuously rolled over, the resources are effectively locked up in unprofitable sectors; thus, hindering the economic growth and impairing the economic efficiency.

An amount of NPLs reflects the amount of money some of the deficits units in the country are experiencing and failing to access for productive purposes.
Money must go round in the economy if the economy is to function properly and grow.

Let’s act responsibly and pay our obligations.

Sanderson Abel is an Economist. He writes in his capacity as Senior Economist for the Bankers Association of Zimbabwe. For your valuable feedback and comments related to this article, he can be contacted on [email protected] <mailto:[email protected]> or on numbers 04-744686 and 0772463008