There’s always the problem child. Being a picky eater, disappearing at the worst times, and getting a lollipop stuck to your new haircut. Not cool, problem child.
If you had five kids and only one problem child of the five, your problem child ratio is 20%, or a 1:5 ratio. Now switch out problem child with problem loan, and you’ve got the picture.
A problem loan ratio is the ratio of problem loans to well-behaved loans. Problem loans are either late commercial loans (90 days past due date late) or they’re late consumer loans (180 days past due date late). If there were 500 loans and 10 of them were problem loans, the problem loan ratio would be 1:50, or 2%.
Knowing the proportion of problem loans to not-problem loans is a leading indicator of health in the financial sector, as well as for the economy as a whole. Many economic theories, including the in-vogue Keynesian theory, rely on spending and borrowing as a way to keep the economy going. So...kind of a big deal when we’ve got a high problem loan ratio. As you could imagine, the problem loan ratio was high during the recession that started in 2007.
On the firm-level, problem loans can cause cash flow problems. The bank’s got bills to pay too, and money to lend. Eventually, the bank will foreclose mortgages or take action for other types of loans...whatever it takes to get the problem loan handled and disposed of.
