Question

Loans can turn bad and increase banks’ impaired loan position (non-performing loan). The impaired loans would increase credit risk to the detriment of bank insolvency.

Discuss this issue complete with thorough analysis of the issue, causes, bank actions and solutions to minimize loss from rising credit risk and bank insolvency.

I have a 3,000 word essay. I only want general overview to discuss for each section. What points should I talk with reference to Issue analysis, what to talk with reference to Causes and what to talk about with reference to bank actions and solutions. So pointers for each section for me to focus.

Answer 1

Impaired credit

Impaired credit occurs when there has been a deterioration in the creditworthiness of an individual or entity. This is usually reflected through a lower credit score, in the case of an individual, or a reduction in the credit rating assigned to an entity or debt issued by a rating agency or lender. The borrower whose credit has been impaired will generally have lesser accessibility to credit facilities and will have to pay a higher rate of interest on loans. Impaired credit may either be a temporary situation that can be reversed, or an early sign that the borrower could face potential major financial distress down the road.

Several techniques are available to assess credit impairment, or more specifically, credit analysis. Common methods begin the four "Cs" of credit:

• Capacity: The ability to service debt levels
• Collateral: Any posted collateral as a buffer against market value losses
• Covenants: Loose or tight covenants to indentures
• Character: Management's experience, values, and aggressiveness

Non-Performing Asset (NPA)

A nonperforming asset (NPA) refers to a classification for loans or advances that are in default or in arrears. A loan is in arrears when principal or interest payments are late or missed. A loan is in default when the lender considers the loan agreement to be broken and the debtor is unable to meet his obligations.

• Nonperforming assets (NPAs) are recorded on a bank's balance sheet after a prolonged period of non-payment by the borrower.
• NPAs place financial burden on the lender; a significant number of NPAs over a period of time may indicate to regulators that the financial health of the bank is in jeopardy.
• NPAs can be classified as a substandard asset, doubtful asset, or loss asset, depending on the length of time overdue and probability of repayment.
• Lenders have options to recover their losses, including taking possession of any collateral or selling off the loan at a significant discount to a collection agency.

Recording Non-Performing Assets (NPA)

• Banks are required to classify nonperforming assets into one of three categories according to how long the asset has been non-performing: sub-standard assets, doubtful assets, and loss assets.
• A sub-standard asset is an asset classified as an NPA for less than 12 months. A doubtful asset is an asset that has been non-performing for more than 12 months. Loss assets are loans with losses identified by the bank, auditor, or inspector that need to be fully written off.
• They typically have an extended period of non-payment, and it can be reasonably assumed that it will not be repaid.