Question

How does Non-performing loan affect the Financial Institutions Capital? Also, in response to Non-Performing loans, banks will increase capital thus what are the drawbacks of a surge in Capital in response to Non-Performing loans. Explain in as much detail as possible.

Answer 1

Non performing loans means such loans whose recoveries are not completely possible because the parties to which it has been lent are not able to pay it because they are in financial distress or they have been engaged in fraudulent activities.

Non performing loans means a burden on the books of accounts because they should not be recorded as assets as their recoveries are not completely possible else the lender will have to who issue the haircut, or the lender will have to write it off into the books of accounts.

when there will be increase in the capital in response to counter such non-performing loans that would mean that the bank would be more prone to allot more of these bad loans and in the long run. the sustainability of the bank would be in highly endangered because it will not be able to repay its deposits if it is only lending on to such loans which are non performing in nature.