The primary source of revenue for money deposit banks is loans. These loans are usually from customers' deposits. When loans exceed customers' deposits, it can lead to bank failure. More so, if the revenue from loans cannot result in profit, it erodes the shareholders' fund. To reduce these risks, the CBN urges banks to report their loan provisioning as performing and non-performing. In this article, we examine how these loans are classified.
Classifying as performing and non-performing loans?
Loans for which the borrower pays the agreed installments on the agreed repayment date and on the due date. Performing loans is a way the bank is saying that these are the customers who are not defaulting on the repayment of principal and interest. The payments are made within 30 days.
There are loan categories that may be non-performing, but the borrower makes an agreement with the bank to reschedule the loan. Immediately that is done and repayments are made within the next 30 days, the loan is regarded as a performing loan.
Non-performing loans (NPL), on the other hand, are loans that are in default. That means, the borrower hasn't made a payment for at least 30 days. When debtors make their first failure to repay loans, it becomes an issue for the company. The reason is that CBN policy on banks is that they shouldn't recognize interest revenue from such loans; at the same time, they must make provisions for defaulting loans.
However, whether loans are performing or not, money deposit banks are expected to make a certain percentage of them as provisioning. Performing loans provisions are generally one percent. However, NPLs are further reclassified based on the number of months that are not performing. This is discussed in the next headings.
Watchlist loans are specialized loans that are performing for the current period but the bank believes that they may become non-performing shortly. The loan may have shown some weaknesses that may result in its classification as a watchlist. For example, there is a risk that a government's planned policies or decisions will affect the company negatively.
For example, a company is located in an area where the government planned to demolish some buildings because of a road network plan in the area. As a result, the bank will put such companies on a watchlist. Because it is not certain if the company will continue to make payments on the installment after the demolition.
Categorizing non-performing loans
NPLs are classified as substandard, doubtful, and lost.
Substandard loans
Substandard loans are non-performing loans between 90 and 180 days. That means the repayment of the installment of principal and interest has not been done by the debtor for more than 90 days but less than 180 days.
Doubtful loans
Unpaid debts for more than 180 days and less than 360 days are doubtful. The bank is not sure if it can recover the loan. If they can, it might not recover all outstanding debt from the defaulter. Doubtful loans can also be those loans whose collateral value has fully depreciated. These are for loans with pledge assets as collateral.
Lost loans
Loans for which the principal and interest repayments are more than 360 days are regarded as lost. This implies that it is likely that the bank will not recover them anymore. Lost loans are bad debts and are written off from the company's balance sheet. That is, a 100 percent rate is used as provisioning for the loan.
Loan provisioning and impairment loss
The Central Bank of Nigeria requires money deposit banks to make provisions for loans every month when reporting their monthly report to the apex bank. This is referred to as loan provisions. The CBN set up the regulatory framework on how this should be reported. Below is an example of it:
| Categories | Percentage |
|---|---|
| Performing | 1% |
| Between 1 to 30 days | 5% |
| Between 31 to 60 days | 20% |
| Between 61 to 90 days | 50% |
| Above 90 days | 100% |
Impairment loss is reported to the directors and shareholders. This doesn't mean that the CBN provisioning is not reported to directors. Provisions for loans are not necessarily reported to shareholders. Impairment loss is reported instead in the financial statements of banks. However, the difference between the provisionings and impairment loss is treated as regulatory reserves.
Impairment loss is the IFRS 9 method of accounting for financial assets credit loss. Credit losses are the losses arising from defaulting loans and other financial assets as a result of their volatility and risks. In applying IFRS 9, the way impairment loss is computed is different from that of CBN's provisioning. As a result, the difference is reported as a regulatory reserve under Equity.
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