Impaired loans are a type of credit impairment with others such as credit deterioration risks and loan losses.
The reasons why impaired loan happens vary- the borrower may have lost their job, gotten sick or injured and had to take time off work, or they may be struggling with some other financial difficulty such as divorce.
What is credit deterioration risk?
When your credit risk increases, you are more likely to miss a payment or default on a loan. The following can cause a credit deterioration risk:
- You don’t have money for rent and utilities.
- You get laid off from work.
- Your child has expensive medical bills that you can’t pay right away (and this isn’t covered by insurance).
Basically when you have an overall decline in financial stability; when you’re unable to meet your financial obligations or pay interest or principal in a timely manner, you run a credit risk.
How do loan institutions account for these risks in financial statements?
In the income statement, credit impairment is reported as a loss. When a loan goes bad and can’t be recovered from or repaid by the borrower, it affects earnings.
In other words, when a borrower defaults on their debt obligations, they’re not only not paying what they owe but also costing the organization more money.
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