Problem Loans

🏦 Credit Risk Management: Problem Loans

The Story of Troubled Loans

Imagine you’re a farmer who lends your extra seeds to neighbors. Most neighbors grow their crops and return seeds with a little extra. But what happens when some neighbors can’t return the seeds? Maybe their crops failed. Maybe they forgot. Maybe they just can’t afford to.

This is exactly what banks face with “Problem Loans.”

Banks lend money like you lend seeds. When borrowers can’t pay back, the bank has a problem. Let’s explore how banks handle these tricky situations!

🚨 Non-Performing Assets (NPAs)

What Are NPAs?

Think of your piggy bank. Every coin inside is an “asset” — something valuable you own. Now imagine some coins are fake or broken. They look like coins, but they’re worthless. That’s what NPAs are for banks!

Simple Definition: A Non-Performing Asset is a loan where the borrower stopped paying back on time.

When Does a Loan Become an NPA?

graph TD
    A["Loan Given"] --> B{Borrower Pays on Time?}
    B -->|Yes| C["Healthy Loan ✅"]
    B -->|No Payment for 90+ Days| D["NPA! ❌"]

The 90-Day Rule:

• If someone doesn’t pay for 90 days or more, the loan becomes “non-performing”
• It’s like a fruit going bad — after a certain time, it’s spoiled!

Real-Life Example 🍎

Ravi’s Fruit Shop:

• Ravi borrowed ₹1 lakh from a bank to open a fruit shop
• He promised to pay ₹10,000 every month
• His shop didn’t do well, and he stopped paying
• After 3 months (90 days) of no payment, his loan became an NPA

Why This Matters:

• Banks can’t count NPAs as “good money” anymore
• It’s like having toy money in your wallet — looks nice but can’t buy anything!

📊 Loan Classification

Sorting Loans Like Sorting Apples

When you buy apples, you sort them:

• Fresh apples → Eat today
• Slightly soft apples → Eat tomorrow
• Bruised apples → Maybe use for juice
• Rotten apples → Throw away

Banks sort loans the same way!

The Four Categories

graph TD
    A["All Loans"] --> B["Standard Assets"]
    A --> C["Sub-Standard Assets"]
    A --> D["Doubtful Assets"]
    A --> E["Loss Assets"]

    B --> B1["Paying on time ✅"]
    C --> C1["NPA for less than 12 months"]
    D --> D1["NPA for more than 12 months"]
    E --> E1["Cannot be recovered 💀"]

Understanding Each Category

Example Story 📖

Three Friends Borrow Money:

1. Priya — Pays every month on time

   • Her loan = Standard Asset ✅

2. Amit — Stopped paying 6 months ago

   • His loan = Sub-Standard Asset ⚠️

3. Deepa — Hasn’t paid for 2 years

   • Her loan = Doubtful Asset ❌

4. Raj — Disappeared, company closed

   • His loan = Loss Asset 💀

💰 Loan Loss Reserves

The Rainy Day Fund

Remember when your parents kept some money aside “just in case”? Maybe for medical emergencies or unexpected expenses?

Banks do the same thing! They keep money aside to cover loans that might never be paid back.

How It Works

graph TD
    A["Bank Earns Profit"] --> B["Keep Some Aside"]
    B --> C["Loan Loss Reserve"]
    C --> D["Used When Loans Go Bad"]

The Provisioning Rule

Banks must set aside different amounts based on loan quality:

Simple Example 🎯

Bank ABC has these loans:

Total Reserve = ₹28.5 Lakh

This money sits safely, ready to absorb the blow if these loans fail completely.

🔧 Loan Workout and Recovery

Saving the Patient

When someone is sick, doctors try different treatments before giving up. Banks do the same with problem loans!

Loan Workout = Trying to help the borrower pay back somehow

Recovery Methods

graph LR
    A["Problem Loan"] --> B{Can Borrower Pay?}
    B -->|Maybe with help| C["Workout Strategies"]
    B -->|No way| D["Recovery Actions"]

    C --> C1["Extend Time"]
    C --> C2["Reduce Interest"]
    C --> C3["Smaller Payments"]

    D --> D1["Sell Collateral"]
    D --> D2["Legal Action"]
    D --> D3["Collection Agency"]

Workout Strategies Explained

1. Extend the Loan Period

• Original: Pay ₹10,000/month for 12 months
• New: Pay ₹5,000/month for 24 months
• Like getting extra time to finish homework!

2. Reduce Interest Rate

• If interest was 15%, reduce to 10%
• Makes monthly payments smaller

3. Payment Holiday

• “Take a break for 3 months, then start paying”
• Helps borrowers get back on their feet

Recovery Actions (When Workout Fails)

1. Sell Collateral

• Remember Ravi’s fruit shop? He gave his shop as security
• If he can’t pay, bank sells the shop

2. Legal Action

• Bank goes to court
• Court orders borrower to pay

3. Collection Agencies

• Special companies that help recover money
• They’re like detectives who find people and remind them to pay

Real Example 🏠

Sunita’s Home Loan:

• Borrowed: ₹30 Lakh for a house
• Problem: Lost her job, couldn’t pay for 4 months
• Workout Solution: Bank gave her 6-month payment holiday
• Result: She found a new job, resumed payments, loan saved! ✅

🔄 Debt Restructuring

Rebuilding the Broken Toy

Imagine your favorite toy breaks. Instead of throwing it away, you rebuild it differently — maybe with stronger parts or a new design.

Debt Restructuring = Rebuilding a broken loan agreement

What Changes in Restructuring?

graph TD
    A["Original Loan Terms"] --> B["RESTRUCTURING"]
    B --> C["New Interest Rate"]
    B --> D["New Payment Amount"]
    B --> E["New Loan Duration"]
    B --> F["New Conditions"]

Types of Restructuring

1. Interest Rate Reduction

2. Loan Term Extension

3. Converting Interest to Principal

• “You owe ₹2 lakh in missed interest”
• “We’ll add it to your loan and let you pay slowly”

4. Partial Write-off

• Bank says: “You owe ₹50 lakh, but pay us ₹35 lakh and we’ll call it even”
• Bank loses money but gets something back!

When Does Restructuring Happen?

✅ Good Candidates:

• Temporary financial problem (job loss, medical emergency)
• Business affected by external factors (pandemic, natural disaster)
• Borrower is willing to pay but needs help

❌ Bad Candidates:

• Borrower is hiding money
• Business model is completely failed
• Borrower has disappeared

Case Study: Hotel Paradise 🏨

The Situation:

• Hotel Paradise borrowed ₹5 Crore to expand
• COVID-19 hit, no guests for 18 months
• They couldn’t pay ₹15 lakh monthly installment

Restructuring Deal:

• 12-month payment holiday
• Interest reduced from 12% to 9%
• Loan extended by 3 years
• Monthly payment reduced to ₹10 lakh

Result:

• Hotel survived the pandemic
• Started paying again in 2022
• Bank recovered most of its money! ✅

🎯 Putting It All Together

The Problem Loan Journey

graph TD
    A["Loan Given"] --> B{Payments?}
    B -->|Regular| C["Standard Loan ✅"]
    B -->|Stopped| D["90 Days No Payment"]
    D --> E["Becomes NPA"]
    E --> F["Loan Classification"]
    F --> G["Bank Sets Aside Reserves"]
    G --> H{Recovery Attempt}
    H -->|Try Workout| I["Restructure Deal"]
    H -->|Can't Save| J["Recovery/Write-off"]
    I -->|Success| K["Loan Returns to Standard"]
    I -->|Fails| J

Key Takeaways 🌟

1. NPAs = Loans not paid for 90+ days (like spoiled milk)

2. Loan Classification = Sorting loans by health

   • Standard → Sub-Standard → Doubtful → Loss

3. Loan Loss Reserves = Bank’s emergency savings for bad loans

4. Workout & Recovery = Trying to save the loan or get money back

5. Debt Restructuring = Rebuilding loan terms to make repayment possible

💡 Remember This!

Banks aren’t villains when loans go bad. They try hard to help borrowers recover. But when nothing works, they must protect themselves and their other customers.

Think of it like a school:

• Some students struggle with subjects (sub-standard loans)
• Teachers try extra help, tutoring, easier tests (workout/restructuring)
• If a student still can’t pass, they might need to repeat (write-off and start fresh)

The goal is always to find a solution where everyone wins! 🏆

Quick Reference