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The Treatment of Impaired Assets in Latvia.
When should a loan or security be considered nonperforming? How should various degrees of partial impairment of an asset be assessed?
According to the Financial and Capital Market Commission's Regulations on the Income and Expense Accounting for Banks and Credit Unions, non-performing loans are loans whose payment is more than 90 days overdue, or, in cases where the payment has not become due, but loans or assets of other types have been classified lower than close-watch loans.*
According to the Regulation for Assessing Assets and Off-Balance-Sheet Liabilities there are 3 methods of determining the amount of specific loan loss provisions.
a) Based on classification
Where a class assigned to an asset or an off-balance sheet liability is lower than standard, the credit institution shall make specific provisions of at least:
- 10% for any close-watch item;
- 30% for any sub-standard item;
- 60% for any doubtful item;
- 100% for any lost item
b) As the difference between the asset's carrying amount and the present value of expected future cash flows discounted at the loan's original effective interest rate.
c) As the difference between the carrying amount of an asset and the fair value of collateral where the asset depends on collateral.
* According to the Regulation for Assessing Assets and Off-Balance-Sheet Liabilities (Section 3) loans shall be classified as standard, close-watch, sub-standard, doubtful and lost as follows:
3.9 A standard loan shall mean a loan that undoubtedly will be repaid. A loan shall be classified as standard where:3.9.1 the borrower is not expected to face repayment difficulties because the present and projected cash flows are sufficient to repay the debt; the repayment schedule as established by the agreement is being followed or the delay in debt repayment does not exceed 5 days;
3.9.2 the value of collateral (also in case of a forced sale) for a collateral-dependent loan equals or exceeds the amount of the debt, collateral is marketable and the credit institution faces no legal barrier to disposing of it. 3.10 A close-watch loan shall mean a loan under intensified control of the credit institution's management because of an inherent potential unreliability, which, unless averted, may influence the debt repayment and inflict loss on the credit institution. A loan shall be classified as close-watch where:
3.10.1 economic or market conditions may unfavourably influence the borrower;
3.10.2 the borrower's business performance is deteriorating or there are unmatched positions in the borrower's balance sheet that are nonetheless not important enough to jeopardise recovery of the debt;
3.10.3 the delay in debt repayment does not exceed 30 days;
3.10.4 debt repayment is delayed for 31 - 90 days, but the secondary repayment source is reliable;
3.10.5 for a collateral-dependent loan, the condition of collateral and the possibility to control collateral are doubtful;
3.10.6 proper monitoring of the loan is impeded by the quality of the agreement;
3.10.7 deviations from the policy and procedures established for managing credit risk have been detected.
3.11 A sub-standard loan shall mean a loan whose evident unreliability makes repayment doubtful and there is a threat of loss to the credit institution unless the unreliability is averted. A loan shall be classified as sub-standard where:3.11.1 the borrower's cash flow is insufficient to ensure regular payments;
3.11.2 the current information to the credit institution on the borrower's financial standing is unsatisfactory or the documents certifying collateral and repayment sources are inadequate;
3.11.3 the delay in debt repayment is 31 - 90 days;
3.11.4 the borrower's financial standing grows unsound, the delay in debt repayment exceeds 90 days, but the secondary repayment source is reliable.
3.12 A doubtful loan shall mean a loan that is likely to inflict loss on the credit institution; it is impossible to measure the loss at the time of assessment though there is a reasonable hope to recover part of the amount due. A loan shall be classified as doubtful where:3.12.1 the borrower is facing liquidity problems and shows signs of actual insolvency;
3.12.2 the borrower is in liquidation and the value of his/her assets is insufficient to meet the credit institution's claim in full;
3.12.3 the delay in debt repayment is 91-180 days and the secondary repayment source is unreliable. 3.13 A lost loan shall mean a loan that does not have real value at the moment of assessment. A loan shall be classified as lost where:
3.13.1 the delay in debt repayment exceeds 180 days;
3.13.2 the borrower is dead, missing or has terminated the business activity;
3.13.3 there is a court ruling to recognise the borrower as bankrupt (the bankruptcy procedure has been initiated).
Ludmila Mjagkiha
Senior Economist
Monetary Policy Department
Bank of Latvia
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