Non-Performing Loan Levels Now Fully Back To Normal

Loans

It actually took a lot longer than we may have thought to fully recover from the Great Recession. Rates of non-performing loans are finally back to before this all started.

One of the meaningful ways that we measure the state of our economy is to look at the percentage of loans that are not performing, in other words, how many of them are currently not being paid back as agreed. We track this by looking at the total amount of loans out there and the percentage of them that are 90 days past due or worse.

These figures normally aren’t that interesting in themselves year over year, and this usually hovers around 1%. During the period between 1995-2007, for instance, we only got outside the range of 0.95%-1.3% once, in 2002, when we spiked at 1.47%. This was still not all that significant of a jump, and things settled down over the next couple of years.

Although we certainly don’t want to see this number too high, we don’t want to see it go too low either, although a healthy credit market will prevent this. Seeing it go too low means that credit markets have contracted, where we’re using too stringent guidelines to qualify borrowers.

This wouldn’t be that hard to do actually if we wanted to, but we don’t and shouldn’t either. We go out of our way to promote a healthy credit market, through monetary policy, and if we raise the bar and make it harder for banks to lend, they will naturally be more selective and be less prone to lend to more marginal clients.

If we imagine though that we have complete control over this, the situation becomes more transparent. If we categorize credit worthiness the way we do with bonds, with AAA, AA1, and so on, default rates increase as one’s rating declines. Banks manage the risk here through charging higher rates to those who are riskier, and those who exceed the risk appetite of banks may find other lenders willing to help them and charge even higher rates.

All we need to do to control this is to legislate a cap on interest, and we could set this a little above prime and bring down the non-performing rate a lot if we wanted to. We don’t though, because this would have a real constricting effect upon the economy.

We don’t want to see lenders do this on their own either, and central banks will set rates such that enough borrowing occurs. The goal here is to encourage enough but not too much. Borrowing does stimulate the economy, and we could even say that it is what stimulates it period these days, but too much stimulation causes too much inflation, something we don’t want either.

Non-Performing Rates Going Up Too Much Can Be Very Damaging

Seeing non-performing loan rates go up too much, on the other hand, is bad for banks of course, but it’s not their bottom line that we worry about as much as how this affects their ability to lend. When this gets affected too much, we have events like the Great Recession, and the Fed goes all-hands-on-deck to stimulate more borrowing to get us to borrow out of such things essentially.

The non-performing rate in 2007 came in at a quite ordinary 1.01%, a very healthy number in fact, but then things took off. We moved up to 2.21% in 2008, and then the domino effect caused by the shrinkage of credit markets took over, jumping to 4.7% in 2009 and then to a startling 5.3% in 2010.

One of the things that we need to realize about these things is that the non-performance rate is very much affected by our ability to consolidate our debt, something that those who try to speak out against the wisdom of debt consolidation don’t appreciate enough. This serves to both lower our rates as well as our payments, and makes it less likely to default generally, not more.

If you are in over your head, as many end up, you may not be able to make your payments now, but if you re-organize your debt, even just spreading it out over a longer period, this serves to get this more in line with your capacity to repay. If this becomes more difficult to do because lenders are more reluctant to lend in riskier times, this in itself can put the non-performing rate up.

The Fed can lower rates but if there is less money out there that banks are willing to lend, this is still going to be a problem, and this is a big reason why the Fed doesn’t have full control over this process and considerably less influence during a real credit market crunch.

We can look at the statistics for non-performing loans and get an idea of the heath of credit markets, but it’s not so much about the losses itself to the banks, it is the less being loaned out during rough times that affects things so much.

When banks lose money, this also restricts their capacity to lend, so it’s not that these losses don’t matter and extend well beyond the bottom line of the banks and the effect upon shareholder value, to the entire economy. Less credit means less money supply, which means less growth and even negative growth if the effect is large enough, which it certainly was during 2007-2010.

We Are Looking Great Now On This Count

The good news is that the non-performing loan rate has been declining every year since 2010, dropping to 4.5% in 2011, 3.95% in 2012, 3.04% in 2013, 2.21% in 2014, 1.67% in 2015, 1.47% in 2016, and 1.22% in 2017. The numbers are now in for 2018 and we’re now down to a very nice 1.02%, right where we started before the Great Recession showed its ugly face.

This is what you call a full recovery, and while this number does bear watching, we might even want to say that we’re in an ideal spot here, where credit is being extended enough to stimulate things but not so much as to produce a lot of problems.

The Great Recession was a case where we clearly went too far with lending, and in particular, mortgage lending, and a lot of defaults clearly is very unhealthy. This does not mean that we don’t lend, and nothing is more important than keeping lending rates up, it means we don’t do too much of this and take on too much risk and risking seeing this collapse upon us as it did not so many years ago.

It is important to understand though that this blade has two sides, this side that hurts us when we borrow too much, and the other side which can do exactly the same thing or worse when we don’t borrow enough. Many people are highly critical of our borrowing levels, but if they understand how vital this borrowing is to our prosperity, they will see that if we did take their advice and borrow a lot less, we would just throw ourselves into a deep recession or worse.

A lot of borrowing is not only healthy but vital really, as long as we can pay what we borrow back as agreed. Credit is the lifeblood of our economy and our prosperity, and any calls for a reduction in this does need to well heed what the implications of our calls for a lot more restraint would actually be. These ideas are a lot more dangerous than we think, if people actually took the advice that is. They don’t, and from the perspective of the economy, it is indeed very good they do not listen to such things very much.