When reading an article about banking industry I came up with two questions. I'd be very pleased If somebody could clarify them:

  1. How concepts of unrecovered debt and NPL are related?
  2. When banks write off debt (remove from balance sheet)? Only when they sell them to Asset Management Companies or when it became unrecovered?
  • $\begingroup$ Welcome to quant.SE! You may consider splitting the questions into two in order to obtain appropriate answers. It could also be helpful to indicate your own thoughts to give the community an opportunity to answer according to your knowledge in that field! $\endgroup$ – muffin1974 Jan 18 '16 at 12:38

debt/loan lifecycle could be described as:

1) origination

2) debt is outstanding; borrower makes regular interest payments and prepays (scheduled or unscheduled) if any. debt/loan is considered performing

2.1) if borrower misses interest payment, debt/loan becomes delinquent, grace period starts

2.2) grace period expires, still no payment - debt becomes distressed. negotiation between borrower and creditors kicks-off. possible resolutions (credit events):

2.3a) debt is restructured and haircut applied (if any);

2.3b) borrower files for bankruptcy and seeks protection from creditors. trustee in bankruptcy is appointed; company assets are sold off - recovered funds go to creditors. remaining debt (defaulted balance - recoveries) is considered liquidated.

3) debt/loan is fully repaid on or before maturity date

so to answer your first question - non-performing-loan starts from 2.2) grace period expiry and up until 2.3b) when debt becomes liquidated (unrecovered)

to answer your second question - debt holder has two options handling (writing off) bad debt: 1) sell it to distressed debt investors and get money back asap; 2) participate in bankruptcy 2.3b) and seek proceeds from company liquidation.

please be aware the above is just to give you a flavor/direction and the devil is in legal details

  • $\begingroup$ Thank you for you reply. I think now I understand the lifecycle of a loan. $\endgroup$ – Yury Morozov Jan 19 '16 at 13:29
  • $\begingroup$ Am I right, that unrecovered debt is always written off the books, and it is that part of debt that can not be recovered after bankruptcy procedures are finished. NPL gives criterea when we could initiate bankruptcy proceedings and it's not a criterea for unrecovered debt. $\endgroup$ – Yury Morozov Jan 19 '16 at 13:35
  • $\begingroup$ @YuryMorozov that sounds correct to me – once urecovered (liquidated) debt amount is determined there will be no further claims to borrower, it's a done deal - no more uncertainty; whereas NPL is an indication and nothing is yet determined for sure. $\endgroup$ – Nicholas Jan 19 '16 at 21:35

You can think of it as a 3 state Markov Chain: when a loan is made it is considered GOOD. As long as it is good, the bank automatically accrues earnings on this loan. When the bank notices that a payment from the customer has been missed for a certain time (usually 90 days) the loan becomes NPL or non performing loan; the bank stops recognizing income on this loan, but it is still on the books as an asset and the bank still hopes to recover something. If the customer is able to resume payments, the loan becomes good again. If some time passes, with no progress made, they can sell it to another company, in which case it goes off the books, or they can declare it UNRECOVERABLE and write it off (again it disappears from the books) (partially or totally). Declaring the loan unrecoverable is a judgement the bank has to make and like many painful decisions in life banks often delay this step as much as possible. Ultimately it is the central bank or the bank supervisor that insists that action be taken and perhaps defines criteria for this step. Procedures vary widely by country and situation.


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