DEFINITION of Problem Loan Ratio

A ratio in the banking industry that denotes the percentage of problem loans to sound ones. In the banking and credit markets, a problem loan is one of two things; it can be a commercial loan that is at least 90 days past due, or a consumer loan that it at least 180 days past due. This type of loan is also referred to as a nonperforming asset (loan). The problem loan ratio is ultimately a measure of the health of the banking and lending industries and the economy. A higher ratio means a greater number of problem loans and vice-versa.

BREAKING DOWN Problem Loan Ratio

Banks try to keep their inventories low of problem loans because they can lead to cash flow problems and other issues, including a possible closure of the bank if the bank is no longer able to manage its outstanding debt. Once the borrower begins to be late with payments, the financial institution typically sends notices to the borrower and will require the borrower to take action to get the loan current. If the borrower does not respond, the bank can sell assets and recover the balance of the loan. If borrowers want to negotiate with the bank to make a problem loan current again, a bank representative can meet with them to discuss the outstanding balance.

Problem loan ratio and The 2007-2009 Recession

The problem loan ratio can be broken down by the level of delinquency of loans, such as those less than 90 days past due versus those more severely in arrears. Problem loans can often result in property foreclosure, repossession or other adverse legal actions. As markets weaken, it is not uncommon for the problem loan inventory to increase as people struggle to make their loan payments. High rates of foreclosures, repossessions, and other legal actions may reduce bank profits. The problem loan ratio increased across the board during the 2007-2009 recession and subprime fallout that led to a rise in the number of problem loans that banks had on their books. Several federal programs were enacted to help consumers deal with their delinquent debt, most of which focused on mortgages.