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IAI Actuarial Core Principles · Business Economics · Impact of the macroeconomic environment on business

During a recession, a lender's non-performing loans typically rise. Which of the following is the most direct reason for this, as it affects financial services firms?

Non-performing loans rise in a recession because falling incomes, lower profits and higher unemployment reduce borrowers' ability to service debt. Defaults therefore increase, hitting bank and insurer credit portfolios. The other options describe conditions of boom or unrelated effects.

  1. AFalling incomes and profits make borrowers less able to service their debtsCorrect
  2. BHigher inflation reduces the real value of all deposits
  3. CRising consumer confidence leads households to borrow more than they can repay
  4. DThe government raises the supply of money, lowering interest rates to zero
  5. Exports rise, which increases corporate repayment capacity

Explanation

In a downturn, household incomes and firm profits fall and unemployment rises, so borrowers struggle to meet repayments. This raises defaults and impairment charges for banks. The other options describe conditions that are either not typical of recession or would reduce defaults.

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