Definition:

Non-Performing Loans (NPLs) are loans in which the borrower is in default and has not made any scheduled payments of principal or interest for a specified period, typically 90 days or more.

Examples

Examples of NPLs include a mortgage loan where the borrower has missed several monthly payments, a business loan where the company has failed to make interest payments for an extended period, or a personal loan that has not been serviced according to the agreed terms.

Formula:

NPL Ratio = (Total Non-Performing Loans / Total Loans) * 100

How to use the metric:

The NPL ratio is used by financial institutions to assess the quality of their loan portfolio. A high NPL ratio indicates a higher risk of default and potential losses, prompting banks to take corrective actions such as tightening credit policies or increasing loan loss provisions.

Limitations:

The NPL metric may not fully capture the risk of default if loans are restructured or if there are differences in classification standards across jurisdictions. Additionally, it does not account for the collateral value that might mitigate potential losses.

Applies to:

NPLs are most relevant in the banking and financial services industries, where lending is a core activity and managing credit risk is crucial.

Doesn't apply to:

NPLs are less applicable to industries that do not engage in lending as a primary business activity, such as manufacturing or retail, because these sectors do not typically manage loan portfolios.

Summary:

Non-Performing Loans (NPLs) are a critical metric for assessing the health of a financial institution's loan portfolio. While useful for identifying potential risks, the metric has limitations and is primarily applicable to the banking sector.