Disentangling the transmission channel NPLs-cost of capital-lending supply

Abstract

This paper analyses the effects of non-performing loans (NPLs) on the cost of capital, and on lending and liquidity supply, for a sample of 225 Eurozone banks over the period 2002Q1-2016Q4. Our results demonstrate that NPLs increase the cost of capital, which reduces both lending supply and liquidity creation. This phenomenon is comparatively more significant for periphery county banks than for core country banks.

The dynamic effects of non-performing loans on banks’ cost of capital and lending supply in the Eurozone

“…Importantly, our results show that the higher the NPL ratio, the higher the CAPM beta ( ), thus confirming that banks accumulating impaired loans are perceived as relatively riskier than their counterparts. In line with previous results (Chiesa and Mansilla-Fernández, 2018), the cost of capital displays an increasing trend with respect to the NPL ratio, thus confirming that relatively risky banks are required to pay higher equity returns. In the same line, we also observe that the average value of the profitability gap ( − ) also increases as the bank accumulates NPLs, which suggests that accumulating impaired loans might lead equity investors to require higher than book value returns.…”

“…This paper contributes by demonstrating that NPLs increase both long-and short-term capital costs for banks, and that this impacts negatively on lending and liquidity creation. Our results complement the static analysis performed in Chiesa and Mansilla-Fernández (2018). Whilst previous research has focused on the deleterious impact of NPLs on the book value of bank capital (Bogdanova et al 2018;Fell et al 2018), this study is, to the best of our knowledge, one of the first to analyse the persistent effect of NPLs on the bank cost of capital.…”

“…[Insert Table 6 here] As expected, the negative and statistically significant estimates on the contemporaneous parameter( 2 ) suggest that increases in the cost of capital might reduce the supply of credit to to the transmission channel under investigation in this study, equity investors perceive these institutions as relatively riskier than core country banks (see, Chiesa and Mansilla-Fernández 2018). 13 Following Vides et al (2018) who perform a thorough analysis of the integration of European stock markets after the sovereign-debt crisis, we include the CDS of sovereign debt at the country level to avoid confounding effects.…”

“…(1) < 0), thus reflecting that the volume of impaired loans was significantly higher during the crisis period. Taken into consideration that NPLs were one of the main risk sources for the Eurozone banks during our period of analysis (Accornero et al 2017;Chiesa and Mansilla-Fernández 2018;Anastasiou et al 2019), our results reflect that equity investors required banks to satisfy increasing returns on equity, potentially in excess of book value returns, during the crisis years.Finally, the test also rejects the null for banks' credit supply (LOANTAit), and liquidity creation ( ⁄ and ′ ⁄ ), thus confirming that banks' production figures dropped significantly after the crisis.…”

“…The estimates on the contemporaneous parameters ( 2 ) are positive and statistically significant, indicating that banks accumulating impaired loans are required to pay relatively higher equity market returns in the short term (see, Chiesa and Mansilla-Fernández 2018).…”