Debt Arrears and Nonperforming Loans

1. Debt Arrears and Nonperforming Loans http://unstats.un.org/unsd/nationalaccount/AEG/papers/m2accrualprinciples.pdf http://unstats.un.org/unsd/nationalaccount/AEG/papers/m2loans.pdf http://unstats.un.org/unsd/nationalaccount/AEG/papers/m2FAWGCommentsLoans.pdf http://unstats.un.org/unsd/nationalaccount/AEG/papers/m3loans.pdf

2. Debt arrears Debt arrears are amounts that are past due-for-payment and still unpaid. They may refer to interest, principal, or a combination of both. • Important issue in some countries: • Arrears by government; • Arrears by central bank; • Inter-company arrears. • May wish to show separately. • Used as a way of handling financial shortfalls.

3. Debt arrears Differences in recording debt arrears among the Manuals was an issue brought up during the revision of BPM5: • BPM5, External Debt Statistics, and the Government Finance Statistics Manual impute repayment of debt and the creation of a new short-term liability. • SNA and Monetary and Financial Statistics Manual continue to record the same instrument until it is extinguished.

4. Debt Arrears: decisions Conclusions BOP Committee and AEG: • The macroeconomic statistics should be harmonized; • No transactions should be imputed when a liability goes into arrears; • If the original contract provided for a change in characteristics, this should be recorded as a reclassification; • If the contract is renegotiated, this should be shown as new transactions extinguishing the old and creating a new instrument; • Integrate the above in the discussion on nonperforming loans.

5. Nonperforming loans • Electronic Discussion Group during July 2002-July 2004: http://www.imf.org/external/np/sta/npl/eng/discuss/index.htm. • No standard definition. However, widely accepted is: A loan is nonperforming when payments of interest and/or principal are past due by 90 days or more. • Compilation Guide on Financial Soundness Indicators adds: A loan also is nonperforming if interest payments equal to 90 days or more have been capitalized, refinanced, or delayed by agreement, or • Payments are less than 90 days overdue, but there are good reasons (debtor filing for bankruptcy) to doubt that payments will be made in full.

6. Nonperforming loans • Both NPLs and arrears are aspects of loan impairment. • NPLs are different from arrears: • Arrears only part past due (NPL is whole debt) • Arrears from Day 1 (NPL is usually after 90 days)

7. Nonperforming loans • Nonperformance does not imply that losses will occur in all cases. Sufficient collateral may be available. • International accounting and banking standards often refer to the slightly different concept of impairment of loans (indicating that probably that not all amounts due will be collected). The standards prescribe recognition by reducing the carrying amount and discontinuing interest accrual. • Issue: SNA records loans at nominal value irrespective of change in quality and continues to accrue interest.

8. Nonperforming loans: pros and cons of current SNA • Pro: Reflects (legal) position of the creditor. Avoids debtors showing reduced obligations. Avoids imputing a valuation, which may be an ambiguous operation. • Con: The true financial positions are not reflected. In particular, too rosy picture of banks’ net worth and interest receivable on NPL. Financial crises of the 1990s and artificially high Thai GDP. Business accounting standards may adopt fair valuation (for assets). • Accounting standards reduce carrying amount of assets but continue measuring liabilities at nominal values. Not possible in the SNA that needs full consistency.

9. Nonperforming loans: change the SNA? • Canvas undertaken by EDG in July 2004. Not everybody was happy with the procedures, but from the results the EDG moderator was able to conclude the following: • Broad consensus exist that information of loans at both nominal and market-equivalent values should be given. • The accounts themselves should show nominal values; • Market-equivalent values of all loans and interest arrears on NPLs should be mandatory memorandum items; • After more experience has been gained, market valuation of loans should be considered in the accounts. • AEG December 2004: Yes in principle, but please clarify several issues.

10. July 2005 AEG decisions after clarification by IMF • Use the Compilation Guide definition of nonperforming loans as guideline; • Supplementary valuation basis (market-equivalent value) should be fair value, or otherwise nominal value less expected losses; • These data should be “standard items” for financial institutions and government as creditors; “supplementary items” for other sectors; • Further E-discussion on how to treat FISIM; • Further consideration how long interest should accrue; • The above applies in principle also to other instruments like trade credits and deposits.