Small and medium-sized enterprises (SMEs) in Singapore take up business loans to finance the growth of their businesses, which exposes them to the possibility of incurring a non-performing loan. Meet John, the owner of a SME in Singapore in the construction industry. He takes up a business loan with a financial institution but fails to pay the loan by the stipulated deadline. In this case, his loan will go into default due to failure to make payments for interest or principal amounts of the debt.
Before diving into the explanation of non-performing loans, let’s briefly look at the main types of business loans businesses available.
Business Loans SMEs can Take Up
Secured Business Loan Debt
As its name implies, secured loans are loans that are backed up by collateral, ranging from a house, car and many more. For instance, John takes up a loan to buy a truck needed for the transportation of raw materials for his construction business and he uses the truck itself as a collateral. If John subsequently accumulates a lot of overdue payment, the lender could reacquire the truck and use it to recoup their losses.
Unsecured Business Loan Debts
Unsecured loans do not have collateral backing it, but lenders still retain the legal right to pursue business loan repayment in case of default. For example, personal loans and short term business loans by private lenders might not require collateral, just like Poss’s Quik financing solution for SME in Singapore.
Now, we move on to understand non-performing loans and how they come about.
Non-Performing Loan (NPL)
Loan defaults or loans that are close to default because of the borrower’s inability to perform scheduled payments for a specified period of time are known as NPLs. They can also be known as non-performing assets. According to the International Monetary Fund (IMF), a non-performing loan should meet these criterias:
- Debtors have not paid interest or principal payments in at least 90 days or more
- Interest payments equal to 90 days or more have been capitalised, refinanced, or delayed by agreement
- Payments have been delayed by less than 90 days, but come with high uncertainty or no certainty the debtor will make payments in the future
Causes of Non-Performing Loan
Multiple reasons cause non-performing loans and we will explore some of them from the perspective of the borrowers such as SMEs in Singapore.
1. Defaults in Payment
Borrowers may encounter cash flow issues, making it difficult to meet their original loan payment schedules. Temporary setbacks like delayed receivables or unexpected expenses cause payment defaults. A loan default occurs.
2. Industry Downturns
Certain industries may face cyclical downturns during specific periods, such as the retail sector during e-commerce booms. Businesses in these struggling sectors may face reduced revenues and increased defaults.
Other possible reasons that might lead to an industry downturn include buyers who are unable to pay for products that they have purchased from the SME. This way businesses won’t have the finances they originally forecasted to repay the loan, thus leading to loan default.
Consequences of Non-Performing Loan
When businesses face financial difficulties, such as declining sales or poor management, they may become insolvent. Businesses are then unable to meet their debt obligations, leading to missed payments and loans turning non-performing. Insolvency can ultimately lead to businesses winding up, where the business is liquidated.
Stocks are sold off and creditors are paid off. The business’s sole focus becomes completing the liquidation and distributing assets, before the company dissolves. Secured debts are typically given priority, meaning that the proceeds are first used to repay creditors who hold collateral against the debt. Businesses will then have to pay off unsecured loans on a pari passu basis, i.e. they are paid out of the company’s assets equally.
Additionally, the presence of NPLs on a credit report can have serious consequences for SMEs that borrow. When loan default happens, it will significantly lower your business’s credit rating. As a result, future business loan agreements will be challenging to obtain or approved with higher interest rates, as lenders view your business as a higher risk. Overall, NPLs on a credit report can make it much more challenging to obtain credit and manage financial stability.
The Bottom Line
Before taking out any form of loan, it’s essential to thoroughly evaluate your business’s financial health and repayment capacity. Overextending your borrowing beyond what your business can comfortably repay can lead to severe consequences, such as garnishment of wages. These measures can significantly strain your SME’s financial resources.
It’s important to borrow responsibly, to ensure that the loan fits within your financial strategy and doesn’t jeopardise your business’s long-term viability. Proper assessment and planning of cash flows are key to maintaining financial health and avoiding loan default.
Fast Track Your SME Growth with Poss Capital
Be it secured loans or unsecured loans, Poss Capital’s business financing solutions are here to help. Poss understands the struggles SMEs face when trying to meet business loan payments. Hence, in times of financial difficulty due to unforeseen circumstances, SMEs can reach out to Poss for business loans without affecting your credit rating. With our business financing solutions, Quik and Payd, worry less about incurring non-performing loans. Reach out to us today!
