This is the recovery of the full debt, including any missed repayments, interest and fees. It marks the end of the relationship with the customer.

It is a step that is only taken when there is no other option for the bank.

It may involve legal action against the debtor to recover the debt and will have a significant impact on the debtor’s credit rating and ability to borrow money in the future.

If the borrowing is secured by collateral, for example property, it will require the bank to realise the collateral, returning any surplus after costs to the debtor.

Banks can undertake the activity themselves or outsource it to a collection or debt recovery agency and may sometimes sell the debt.

Selling the Debt

After a certain period, depending on each bank’s rules and regulations, banks can sell bad debt portfolios to companies that are specialised in collecting such debts. Normally they buy such portfolios with very good discounts, which is a good deal for the banks as they have already provided for the results of such losses through reserves on bad debts.

Bad Debt Provisions

The effort on collection sometimes does not generate any result and because of that, from time to time banks and financial institutions must maintain provisions for bad debts that are built on the basis of actual portfolio behaviour.

A bank can use many criteria to build the provision. Normally it uses the score as a base to define the percentage of provision to be built. Banks also use the historic behaviour of similar accounts and portfolios. Continuous analysis of the portfolio may also reduce or increase the amount on provision. Equally, external factors such as recessions, or specific events in segments of the economy may require an increase or decrease of the provision. As example, during the pandemic, provisions for hotels, bars and restaurants were increased because of the lockdowns that affected the revenue of such small businesses.