Converting the NPL Ratio into a Comparable Long Term Metric
AbstractThe NPL ratio is probably the most widely used metric to measure the credit risk present in the loan portfolio of financial institutions. However, factors other than credit risk, such as the time a loan remains in the NPL condition, the distribution of defaults over time within a certain vintage, the growth rate of the loan portfolio and its term to maturity, may influence its dynamics. Moreover, accounting differences related to recognition and definition of an event of default makes it difficult to compare this metric across different countries. In this paper, we propose an alternative metric to assess the dynamics of credit risk in the loan portfolio. Based on a theoretical portfolio, we develop an analytical model in order to estimate the weighted average of lifetime default ratios of all vintages where the weight is assigned based on the contribution of each vintage to the current stock of loans. We call it implied NPL ratio, which consists of a transformation that adjusts the observed NPL ratio for the effects of changes in the portfolio growth rate and in its average term to maturity, and also takes into account differences in the default distribution across time and the amount of time a past due loan remains in the balance sheet. The results of applying this transformation to the three most relevant types of loans to households in Brazil (auto loans, housing financing and payroll-deducted loans) demonstrate that (a) the implied NPL ratio was a good forecast of the portfolio lifetime default; (b) changes in the components mentioned above affected the dynamics of the NPL ratio and therefore compromised the assessment of credit risk based on this metric (c) the analysis of differences in the evolution of NPL and INPL gives rise to important insights regarding the dynamics of credit risk.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Central Bank of Brazil, Research Department in its series Working Papers Series with number 309.
Date of creation: Jul 2013
Date of revision:
Contact details of provider:
Web page: http://www.bcb.gov.br/?english
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-07-28 (All new papers)
- NEP-BAN-2013-07-28 (Banking)
- NEP-RMG-2013-07-28 (Risk Management)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Philip Lowe, 2002. "Credit risk measurement and procyclicality," BIS Working Papers 116, Bank for International Settlements.
- Mwanza Nkusu, 2011. "Nonperforming Loans and Macrofinancial Vulnerabilities in Advanced Economies," IMF Working Papers 11/161, International Monetary Fund.
- Mathias Drehmann & Claudio Borio & Kostas Tsatsaronis, 2011.
"Anchoring Countercyclical Capital Buffers: The role of Credit Aggregates,"
International Journal of Central Banking,
International Journal of Central Banking, vol. 7(4), pages 189-240, December.
- Mathias Drehmann & Claudio Borio & Kostas Tsatsaronis, 2011. "Anchoring countercyclical capital buffers: the role of credit aggregates," BIS Working Papers 355, Bank for International Settlements.
- Selim Elekdag & Yiqun Wu, 2011. "Rapid Credit Growth," IMF Working Papers 11/241, International Monetary Fund.
- Rinaldi, Laura & Sanchis-Arellano, Alicia, 2006. "Household debt sustainability: what explains household non-performing loans? An empirical analysis," Working Paper Series 0570, European Central Bank.
- Mathias Drehmann & Claudio Borio & Leonardo Gambacorta & Gabriel Jiminez & Carlos Trucharte, 2010. "Countercyclical capital buffers: exploring options," BIS Working Papers 317, Bank for International Settlements.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Francisco Marcos Rodrigues Figueiredo).
If references are entirely missing, you can add them using this form.