How does a high level of non-performing loans impact banks' lending standards?

A high level of non-performing loans (NPLs) typically leads banks to adopt stricter lending standards. When banks experience a surge in loans that are not being repaid as agreed, this signals an increase in credit risk. As a result, banks become more cautious in their lending practices to mitigate further potential losses.

Stricter lending standards can manifest in various ways. Banks may require higher credit scores, increased collateral, or more comprehensive documentation from borrowers to ensure that they are capable of repaying their loans. By tightening these standards, banks aim to protect their capital and reduce the likelihood of future NPLs. The goal is to create a more cautious approach in extending credit, which reflects the realities of previous lending experiences where high defaults had occurred.

In summary, the presence of high levels of non-performing loans compels banks to assess their lending criteria more rigorously, aiming to prevent additional risk from impacting their financial stability. This fosters an environment where only borrowers who meet higher thresholds for creditworthiness can access loans, thereby tightening the overall lending landscape.