What Is a Doubtful Loan?
A doubtful loan is one for which full repayment is questionable and uncertain. The degree of repayment of loans in question ranges from a complete loss to an uncertain loss unless corrective actions are taken. Doubtful loans are usually nonperforming loans on which interest is overdue and the full collection of principal is in jeopardy.
How a Doubtful Loan Works
A loan classified as doubtful has all the characteristics of a substandard loan and credit weakness, making full collection questionable and improbable. This means that a doubtful loan is:
- Not adequately protected by the debtor’s current worth or capacity to pay
- Not adequately supported by collateral
- Characterized by a weakness or weaknesses that call the potential liquidation of the debt into question
Furthermore, when a loan is characterized as doubtful, it is considered that its weaknesses make collection in full extremely unlikely or improbable, although not so improbable as to necessitate writing off the loan entirely. Fifty percent of loans classified as doubtful are deducted from adjusted bank capital in computing regulatory capital adequacy.
Just because a loan has been classified as doubtful doesn’t necessarily mean that a bank will never be able to collect on it. Banks often sell nonperforming loans to recoup some of their losses or partner with a collection agency to attempt to collect at least some of the money.
A doubtful loan is one for which full repayment is questionable and uncertain, although not so improbable as to necessitate writing off the loan entirely.
Types of Doubtful Loans
Loans can become doubtful due to a variety of causes. Weaknesses can include substandard underwriting, such as an underwriter’s initial failure to adequately assess the borrower’s risk level prior to the making of the loan, or the underwriter’s failure to successfully enforce repayment of the loan. Doubtful loan weaknesses can also be out of the borrower’s or lender’s control, such as a general deterioration of economic conditions or changes in the competitive landscape.
Other weaknesses in a doubtful loan can include unstable or nonexistent borrower income or low borrower asset reserves. A borrower who does not have money, stocks, or other assets in reserve is one who is unlikely to repay a loan. Poor creditworthiness is also a weakness of a doubtful loan because it reflects poorly on the borrower’s ability to repay other obligations, pay regular expenses, and manage debt. Finally, a lack of experience with loans or credit on the part of the borrower can be considered a weakness of a doubtful loan, especially if the loan is associated with a business, commercial real estate, or other ventures that are more likely to be successful in the hands of an experienced proprietor.