The Economic Impact of Reducing Non-Performing Loans

Abstract

Non-performing loans (NPLs) are a burden for both lender and borrower; they contract credit supply, distort allocation of credit, worsen market confidence and slow economic growth. So what is the best way to deal with them? This paper compares three different scenarios: actively reducing NPLs, waiting until fast growth of new loans renders the NPL problem obsolete, or doing nothing. We find that reducing NPLs has an unambiguously positive medium-term impact on the economy. And while countries that experience an influx of fresh credit grow the fastest, the economies that actively seek to resolve NPLs do comparably well. When the NPL problem is ignored, economic performance suffers.