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eBook: PRINCIPLE AND PRACTICE OF BANKING OPERATIONS

CHAPTER EIGHT:
MANAGEMENT OF NON-PERFORMING CREDIT ASSETS

Coordinator: Auwalu Salihu Fada
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Institution:
Kano-State Polytechnic

8.1 Introduction

Credit is one of the most important assets of a banking institution because it enables banks to transform mobilised deposits and other funds into loans and advances for individuals, businesses and governments. However, lending exposes banks to credit risk, which is the possibility that a borrower or counterparty will fail to meet agreed financial obligations. The Basel Committee identifies weak credit standards, poor portfolio risk management and failure to respond to deterioration in borrowers’ circumstances as major contributors to banking problems (Basel Committee on Banking Supervision [BCBS], 2000, 2025).

A credit asset becomes problematic when the borrower experiences difficulty in meeting repayment obligations. In Nigeria, the Central Bank of Nigeria (CBN) Prudential Guidelines classify a credit facility as non-performing when interest or principal is due and unpaid for 90 days or more, or where qualifying interest has been capitalised, rescheduled or rolled over into another facility (CBN, 2010). Non-performing credit assets reduce bank income, increase provisioning requirements, weaken liquidity and capital positions, and may ultimately threaten the safety and soundness of the banking institution.

The management of non-performing credit assets therefore involves more than recovering money after a borrower has defaulted. It begins with sound credit appraisal, continues with continuous monitoring and early identification of warning signs, and culminates in appropriate recovery, restructuring, enforcement or write-off where necessary. Effective management requires appropriate governance, credit administration, risk measurement and internal controls (BCBS, 2025).

This chapter is structured in line with the competency-oriented approach associated with National Board for Technical Education (NBTE) banking and finance curricula, which emphasises practical understanding of banking operations, credit management and the management of financial resources (NBTE, n.d.).

Learning Objectives

At the end of this chapter, students should be able to:

1. Explain the meaning of non-performing credit assets.
2. Identify and explain the major causes of non-performing credit assets.
3. Describe early warning signals associated with deteriorating credit.
4. Explain the procedures for managing and recovering bad debts.
5. Discuss the importance of credit monitoring and recovery to banking operations.
6. Explain the responsibilities of banks in preventing excessive accumulation of non-performing assets.

8.2 Meaning of Non-Performing Credit Assets

A non-performing credit asset is a loan, advance, overdraft or other credit exposure whose repayment performance has deteriorated to the point that the borrower is no longer meeting the contractual repayment terms. In practical banking, the expression covers facilities in which principal or interest has become materially overdue or where there is evidence that the borrower may be unable to meet the repayment obligation.

The CBN Prudential Guidelines provide an important Nigerian regulatory benchmark by defining a credit facility as non-performing where principal or interest remains unpaid for 90 days or more, subject to the conditions specified in the guidelines (CBN, 2010). The CBN also requires banks to classify non-performing facilities according to the level of deterioration, including sub-standard, doubtful and lost categories, with appropriate provisions against potential losses (CBN, 2010).

Non-performing assets are important because loans ordinarily constitute a major component of a bank’s earning assets. When borrowers fail to repay, expected interest income may not be realised while the bank continues to incur administrative and funding costs. The Basel Committee consequently stresses that banks should identify, measure, monitor and control credit risk throughout the life of the credit relationship (BCBS, 2000).

The concept should also be distinguished from a temporary payment delay. A short delay may result from administrative problems, timing differences or temporary liquidity difficulties. A non-performing credit asset, however, represents a more significant deterioration in repayment performance and requires systematic risk classification, monitoring and management. The European Banking Authority (EBA) similarly emphasises specialised governance and operational frameworks for managing non-performing and forborne exposures (EBA, 2018).

Non-performing credit assets can therefore be viewed from three perspectives: financial, because they reduce expected earnings; risk-management, because they indicate deterioration in credit quality; and regulatory, because banks must recognise and provide for potential losses. Effective management seeks to prevent performing loans from becoming non-performing and to recover maximum value from assets that have already deteriorated.

8.3 Causes of Non-Performing Credit Assets

Non-performing credit assets do not arise from a single cause. They usually result from a combination of borrower-specific, bank-specific, sectoral and macroeconomic factors. Understanding these causes is important because prevention is generally less costly than recovery after default.

8.3.1 Poor Credit Appraisal

One of the most important causes of non-performing credit is inadequate credit appraisal. A bank may approve a facility without properly assessing the borrower's character, capacity, capital, collateral and conditions. Failure to analyse cash flows, indebtedness, business prospects and repayment capacity increases the probability of default. The Basel Committee identifies lax credit standards as a major source of serious banking problems (BCBS, 2000).

Banks should therefore establish sound credit-granting procedures, clearly define approval authorities and ensure that lending decisions are based on reliable information. The 2025 Basel principles continue to emphasise sound credit-granting processes, credit administration and monitoring (BCBS, 2025).

8.3.2 Weak Credit Monitoring

A loan that is properly appraised at origination can still become problematic when the borrower’s circumstances change. Failure to monitor account conduct, financial statements, business performance and repayment behaviour can allow a deteriorating facility to remain unidentified. The CBN requires banks to review credit portfolios continuously, at least quarterly, to identify deterioration in credit quality (CBN, 2010).

Effective monitoring should therefore continue throughout the credit life cycle rather than ending immediately after disbursement. The Basel Committee regards credit administration, measurement and monitoring as essential components of sound credit-risk management (BCBS, 2025).

8.3.3 Borrower Mismanagement and Poor Business Performance

Borrowers may default because of poor management, inadequate working capital, excessive operating expenses, poor financial control, diversion of funds or unsuccessful business decisions. A business may receive a loan for productive purposes but later use the money for unrelated expenditure. Weak corporate governance can also result in inappropriate borrowing, insider transactions and poor investment decisions.

Research on bank soundness identifies poor or negligent management and excessive risk-taking among important factors contributing to banking problems (IMF, 1998). The quality of the borrower’s management is consequently an important consideration during credit appraisal and subsequent monitoring.

8.3.4 Economic and Macroeconomic Conditions

Economic conditions can substantially influence borrowers’ ability to repay. Inflation, unemployment, exchange-rate depreciation, high interest rates, declining economic activity and falling commodity prices can increase production costs and reduce household and business income. The IMF notes that changes in fuel costs, export prices, exchange rates and interest rates can contribute to significant increases in non-performing loans (Gorter & Bloem, 2001).

Macroeconomic deterioration can affect many borrowers simultaneously. The IMF observes that credit risk can accumulate during economic expansions but losses may become evident during contractionary periods (Louzis et al., 2012; IMF, 2013). Consequently, banks should conduct stress testing and scenario analysis to determine how major economic changes could affect their loan portfolios.

8.3.5 Fraud, Diversion and Moral Hazard

Fraudulent documentation, false financial statements, fictitious businesses, multiple borrowing and diversion of loan proceeds can cause credit facilities to become non-performing. A borrower may deliberately obtain credit without genuine intention or capacity to repay. Weak internal controls and inadequate verification procedures can facilitate such practices.

The CBN’s Credit Risk Management System (CRMS) is designed partly to strengthen credit-risk management, uniquely identify borrowers and discourage problematic borrowing behaviour (CBN, 2017). Banks should therefore verify borrower identity, existing indebtedness, purpose of borrowing and repayment capacity before approving facilities.

8.3.6 Poor Collateral and Documentation

Inadequate security, defective documentation and failure to perfect collateral can increase recovery losses when default occurs. The CBN requires that, for prudential purposes, banks recognise collateral according to specified realisable values and legal conditions rather than simply relying on nominal collateral values (CBN, 2010).

Poor documentation can also make enforcement difficult. Therefore, banks must ensure that loan agreements, guarantees, security documents, insurance and perfection requirements are properly completed before and after disbursement.

8.4 Early Warning Signals of Non-Performing Credit

Early warning signals (EWS) are indicators showing that a borrower’s financial or operational condition may be deteriorating and that the credit facility may eventually become non-performing. Early identification allows the bank to intervene before the problem becomes severe. This approach is consistent with the Basel emphasis on continuous credit administration, measurement and monitoring (BCBS, 2025).

8.4.1 Payment-Related Signals

The most obvious warning signal is delayed repayment. Frequent late payments, missed instalments, unpaid interest, irregular account activity and requests for repeated extensions should attract immediate attention. The CBN uses repayment performance as one of the criteria for assessing credit quality and requires continuous portfolio review (CBN, 2010).

A borrower who previously paid regularly but begins making partial or late payments may be experiencing cash-flow difficulties. Such changes should not automatically be treated as evidence of bad faith; instead, they should trigger investigation into the underlying cause.

8.4.2 Financial Warning Signals

Deteriorating financial performance is another important signal. Examples include declining sales, falling profit margins, negative cash flow, increasing debt, declining working capital and inability to meet short-term obligations. A business that increasingly depends on new borrowing to service existing obligations may be experiencing serious financial stress.

The IMF literature indicates that both bank-specific and macroeconomic factors can influence non-performing loans (IMF, 2013). Therefore, credit officers should combine borrower-level financial analysis with information about the economic environment.

8.4.3 Account Behaviour

Unusual account behaviour can provide early evidence of financial distress. Examples include frequent overdraft excesses, returned cheques, declining deposits, sudden withdrawals, reduced turnover and transfers to other banks. A sudden deterioration from previously normal account activity should be investigated.

The Basel Committee recommends appropriate credit administration and monitoring systems capable of identifying deterioration in individual credits and portfolios (BCBS, 2000, 2025).

8.4.4 Management and Operational Signals

Changes in business ownership or management, disputes among directors, loss of key employees, declining inventory, closure of branches and deterioration in customer relationships can indicate potential credit problems. Similarly, failure to provide requested financial statements or reluctance to meet the bank’s credit officers may indicate difficulties.

Banks should therefore maintain regular communication with borrowers. The objective is not simply to collect money but to understand the borrower’s financial position and identify problems early.

8.4.5 External and Macroeconomic Signals

External signals include rapid increases in interest rates, inflation, exchange-rate movements, recession, declining commodity prices and regulatory changes affecting the borrower’s industry. IMF research confirms that interest rates, unemployment, exchange rates, asset prices and economic growth can influence non-performing loan levels (IMF, 2013).

A good early-warning system should therefore combine quantitative indicators—such as arrears, cash-flow ratios and debt-service capacity—with qualitative information from account officers, customers, suppliers and industry developments.

8.4.6 Early Intervention

Once warning signals appear, the bank should immediately review the account, contact the borrower, establish the cause of deterioration and determine whether remedial action is possible. EBA guidance emphasises appropriate strategies, governance and operational arrangements for managing non-performing exposures (EBA, 2018).

Early intervention may involve additional monitoring, temporary restructuring, revised repayment schedules, additional security, management support or other appropriate remedial measures. However, restructuring should not merely conceal a genuine deterioration. CBN guidelines specifically caution against simply renewing, rescheduling or rolling over non-performing facilities without considering the borrower’s actual repayment capacity (CBN, 2010).

8.5 Steps in the Recovery of Bad Debts

Recovery of bad debts refers to the systematic process through which a bank seeks to recover principal, interest and other amounts owed by a borrower whose credit facility has become problematic or non-performing. Recovery should be organised, documented, lawful and commercially reasonable.

Step 1: Identify and Classify the Problem Loan

The first step is to identify the facility as problematic and establish its current status. The bank should review the outstanding principal, accrued interest, repayment history, security, guarantees and legal documentation. Under the CBN framework, non-performing facilities are classified into categories such as sub-standard, doubtful and lost based on the degree of deterioration (CBN, 2010).

Step 2: Review the Borrower’s Financial Position

The bank should investigate why the borrower has defaulted. The investigation should cover income, cash flows, assets, liabilities, business operations, other creditors and future repayment capacity. It should also determine whether the problem is temporary or permanent.

This step is important because not every distressed borrower should immediately be subjected to enforcement. EBA guidance supports differentiated strategies for managing non-performing exposures, including appropriate restructuring where viable (EBA, 2018).

Step 3: Contact and Negotiate with the Borrower

The bank should communicate formally with the borrower and seek a realistic solution. Where the borrower remains viable, negotiation may lead to a revised repayment plan, additional security, partial repayment or restructuring.

However, restructuring must be based on realistic repayment capacity. The CBN explicitly states that rescheduling should not be used simply to conceal non-performing credit, and that a rescheduled facility remains subject to appropriate provisioning until satisfactory performance is demonstrated (CBN, 2010).

Step 4: Restructure Where Economically Justified

A viable borrower experiencing temporary difficulty may benefit from restructuring. Possible measures include extending maturity, changing instalment arrangements, granting a temporary moratorium or modifying repayment terms. The purpose is to restore sustainable repayment rather than merely postpone default.

The EBA recommends structured management of non-performing and forborne exposures and the establishment of strategies for sustainable reduction of problem assets (EBA, 2018).

Step 5: Realise Collateral and Guarantees

Where voluntary repayment or restructuring fails, the bank may proceed to realise available security, subject to applicable law and contractual requirements. Before enforcement, the bank should verify ownership, perfection, valuation, priority and legal enforceability of the security.

The CBN requires banks to consider the net realisable value and legal status of collateral when determining provisions against credit losses (CBN, 2010). This illustrates why proper collateral documentation at loan origination is critical to eventual recovery.

Step 6: Use Legal Recovery Procedures

Where negotiation and voluntary recovery fail, the bank may commence appropriate legal proceedings. Legal recovery should be undertaken through competent professionals and in accordance with applicable Nigerian laws and court procedures. The objective is to obtain repayment, enforce valid security or otherwise preserve the bank’s legal rights.

Recovery officers must maintain complete records of notices, correspondence, repayment agreements, security documents and legal proceedings. Effective credit administration and controls are fundamental principles of sound credit-risk management (BCBS, 2025).

Step 7: Write-Off and Continued Recovery

Where a credit facility is considered irrecoverable or has been fully provided for, the bank may write it off in accordance with applicable regulatory and accounting requirements. A write-off does not necessarily mean that the borrower’s obligation has disappeared; where legally permissible, recovery efforts may continue.

The CBN requires substantial provisions for deteriorated facilities, including higher provisions as credit quality moves from sub-standard to doubtful and lost categories (CBN, 2010). Proper provisioning protects the bank’s financial statements from overstating the value of problematic assets.

Step 8: Post-Recovery Review

After recovery, the bank should analyse why the facility became non-performing. The review should identify weaknesses in appraisal, approval, monitoring, documentation, collateral management or recovery procedures. Lessons should then be incorporated into future lending decisions.

The Basel Committee emphasises the importance of an integrated credit-risk framework covering credit standards, administration, measurement, monitoring and controls (BCBS, 2000, 2025).

8.6 Importance of Effective Management of Non-Performing Credit Assets

Effective management of non-performing credit assets is important for the profitability and stability of banks. First, it helps protect bank capital by reducing avoidable losses. Second, it improves liquidity because recovered funds can be redeployed into productive lending. Third, it improves asset quality and strengthens depositor confidence.

Effective management also supports financial stability. Large volumes of non-performing loans can constrain new lending, weaken bank profitability and increase systemic risks. International evidence shows that non-performing loans are influenced by both macroeconomic conditions and bank-specific factors (IMF, 2013).

For Nigerian banks, the CBN’s regulatory framework provides mechanisms for credit classification, provisioning, portfolio review and credit-risk information. The CRMS also supports the identification and monitoring of borrowers across regulated financial institutions (CBN, 2017). Effective implementation of these mechanisms can reduce multiple borrowing and improve credit discipline.

8.7 Summary

Non-performing credit assets represent one of the major risks faced by banking institutions. They arise when borrowers fail to meet contractual repayment obligations and may result from poor credit appraisal, weak monitoring, borrower mismanagement, fraud, inadequate collateral, economic shocks and changes in interest rates, exchange rates and other macroeconomic conditions.

The best approach to non-performing credit assets is preventive. Banks should apply sound credit appraisal, maintain effective documentation, monitor borrowers continuously and operate reliable early-warning systems. Warning signals include delayed repayment, declining account turnover, worsening financial performance, excessive borrowing, management problems and adverse economic developments.

When a facility becomes non-performing, the bank should classify the asset, investigate the cause of default, communicate with the borrower, assess repayment capacity, negotiate where appropriate, restructure viable facilities, realise collateral where necessary and pursue lawful recovery procedures. Proper provisioning and post-recovery review are also essential.

Ultimately, successful management of non-performing credit assets requires a combination of competent credit officers, reliable information, strong governance, effective internal controls, continuous monitoring and appropriate regulatory compliance. The principles promoted by the CBN, NBTE-oriented banking education and international banking standards provide a useful framework for developing competent banking professionals capable of managing credit risk throughout the entire credit life cycle.

Review Questions

1. Define non-performing credit assets.
2. Explain five major causes of non-performing credit assets.
3. What are early warning signals in credit management?
4. Explain five payment-related and financial early warning signals.
5. Why is continuous credit monitoring important?
6. Describe the steps involved in recovering bad debts.
7. Explain why a bank may restructure a non-performing credit facility.
8. What is the role of collateral in the recovery of bad debts?
9. Explain the importance of provisioning for non-performing credit assets.
10. Discuss the relationship between macroeconomic conditions and non-performing loans.

References

Basel Committee on Banking Supervision. (2000). Principles for the management of credit risk. Bank for International Settlements.

Basel Committee on Banking Supervision. (2025). Principles for the management of credit risk. Bank for International Settlements.

Central Bank of Nigeria. (2010). Prudential guidelines for deposit money banks in Nigeria. Central Bank of Nigeria.

Central Bank of Nigeria. (2017). Banking supervision annual report. Central Bank of Nigeria.

European Banking Authority. (2018). Guidelines on management of non-performing and forborne exposures. European Banking Authority.

Gorter, C. N., & Bloem, A. M. (2001). The treatment of nonperforming loans in macroeconomic statistics (IMF Working Paper No. 2001/209). International Monetary Fund.

International Monetary Fund. (1998). Bank soundness and macroeconomic policy. International Monetary Fund.

International Monetary Fund. (2013). Nonperforming loans and financial stability. In Nonperforming loans and financial stability. Oxford University Press/International Monetary Fund.

National Board for Technical Education. (n.d.). Brochure of approved curricula and course specifications, and national occupational standards/national skills qualifications. NBTE.

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