During the last decade, many European banks have been troubled with low profitability, while the amount of non-performing loans (NPLs) has increased. This thesis investigates and analyses how the increasing amount of NPL affects banks profitability and the financial system. With econometric models using panel data we examined the relationship between NPL, banks profitability and the economic cycle (GDP-growth). This combined with qualitative economic theories provided a solid analysis of this relationship. We found strong evidence the NPL-ratio has a negative correlation with both the profitability of banks and the economic cycle. With these results in mind we think the NPLs need to be dealt with by the banks and authorities soon. In accordance with our result and analysis we came up with recommendations for the banks and authorities to deal with the issue. We recognize they need to improve the secondary markets for non-performing loans, lifting the loans from their balance sheets, increase the use of Asset Management Companies and improve the NPL-management within banks.