Have you ever heard the term non-performing loan or NPL? For many people, this term may sound complicated and unfamiliar, but actually, NPL is one of the important concepts in the banking world that can have a major impact on the financial health of a financial institution. Simply put, NPL refers to loans that have become non-performing or are no longer being paid by borrowers according to the agreed-upon schedule.
In this article, you will find a complete explanation of what non-performing loans are, as well as what causes them. In addition, we will also discuss solutions that can be taken to deal with NPL and the formula used to calculate it. Let's read the following article.
Key Takeaways:- Non-Performing Loan, which means bad debt, is a defaulted loan that occurs because the debtor does not make payment on interest or principal loan payments according to the predetermined time period.
- The main factor that most affects credit implementation is economic instability and interest rate fluctuations.
- Very healthy: NPL < />
- Healthy: 2% < npl="" />< />
- Fairly healthy: 5% < npl="" />< />
- Less healthy: 8% < npl="" />< />
- Unhealthy: NPL > 12%
Understanding Non-Performing Loan (NPL)
Quoting Troy Segal, a writer at investopedia.com with over 20 years of experience writing on personal finance topics, wealth management, and business news, as well as founder of the ""Personal Business"" section of Business Week, which covers taxes and investments, Non-Performing Loan, which means bad debt, is a defaulted loan that occurs because the debtor does not make payment on interest or principal loan payments according to the predetermined time period (Troy Segal, 2022).
The determined time period also varies, depending on the industry and type of loan. However, in general, that time period is 90 days or 180 days.
In the banking context, Non-Performing Loan becomes an indicator that can reflect the health level of a financial institution. You can determine the evaluation of profitability conditions, credit risk, capital conditions, liquidity, and market risk from NPL information.
Therefore, it can be concluded that a high NPL ratio reflects negative financial institution performance. However, conversely, if a bank's NPL ratio is low, then it can be concluded that the bank's performance has been good and effective.
Causes of Non-Performing Loan (NPL)
According to blog.qualco.eu, which provides management software, several factors that cause Non-Performing Loan (NPL) include:
Economic Conditions
The main factor that most affects credit implementation is economic instability and interest rate fluctuations. This can put significant pressure on creditors, making it difficult for them to pay off their loans.
Debtor Problems
The financial well-being of debtors can also lead to increased NPL. For example, bankruptcy, default, fraud, and others can also result in bad debt.
Creditor Problems
Who says creditors cannot affect NPL levels? Poor underwriting processes, inadequate risk management, and similar problems at financial institutions can also result in increased NPL numbers.
Law and Regulations
Legal aspects can also cause NPL numbers to fluctuate. This includes legal disputes, regulatory changes, complexity, and other external factors that need to be well understood in order to create effective NPL management.
Debt for Consumptive Needs
Currently, consumptive lifestyles often occur just to fulfill prestige. Many people are willing to borrow money or go into debt to buy things they don't need.
Solutions to Overcome Non-Performing Loan
If you are experiencing economic problems and having difficulty paying installments, you can try negotiating with the bank. Here are three ways to overcome bad debt according to Hukumonline (2013):
Rescheduling
The first step is to reschedule. Rescheduling is a condition where the creditor provides an extended tenor for debtors. The adjustment of tenor length will be adjusted to the negotiation results regarding the debtor's ability. The longer the tenor given, it is expected to reduce the debtor's burden in paying monthly installments.
For example, a debtor has credit with a 2-year tenor. However, due to the COVID-19 pandemic, the debtor experienced payment difficulties. After applying for rescheduling, the creditor agreed to extend the tenor to 3 years.
Restructuring
The second way is by applying for credit restructuring or often known as restructuring. If the debtor is deemed to meet the requirements, then the creditor can change the payment schedule, time period, and other terms with the provision that the maximum credit limit is not changed.
Reconditioning
The last way is you can apply for realignment or reconditioning. The creditor can provide credit relief by changing arrears into new principal credit, which will reschedule the loan tenor.
In addition, creditors can also lower the interest rate charged to debtors. In fact, if the debtor is deemed unable to repay their debt after various efforts have been made, the creditor may consider not charging interest on their debt. So the debtor only needs to pay the remaining principal debt.
Formula to Calculate Non-Performing Loan
Referring to Bank Indonesia Regulation No.06/10/PBI/2004 issued on April 12, 2004 regarding the Rating System for the Health Level of Commercial Banks, the Non-Performing Loan (NPL) ratio considered safe is 5%.
The higher the NPL ratio of a financial institution reflects the greater risk of profit decline that will be received by that institution. Therefore, it is important for you to know how to calculate NPL in order to choose a financial institution that is trustworthy and can handle problem loans.
The formula to calculate the NPL ratio is:
NPL Ratio = (Total NPL / Total Credit) x 100%
After calculating the NPL ratio, you can determine how healthy the financial institution is based on the categories below:
Conclusion
Non-Performing Loan (NPL) is an important indicator that reflects the financial health of a financial institution. A high NPL ratio indicates significant risk to profits and reflects problems in credit management. The causes of NPL can come from various factors, such as unstable economic conditions, problems with debtors and creditors, to legal and regulatory factors.
However, by understanding and calculating the NPL ratio, as well as implementing solutions such as rescheduling, restructuring, and reconditioning, financial institutions can manage this risk effectively. For those who want to understand further, calculating the NPL ratio and knowing the health category of financial institutions is the right step to assess safety in choosing a trustworthy financial institution.
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