The Impact of Bank Specific and Macro-Economic Factors on Non-Performing Loans in the Banking Sector: Evidence from an Emerging Economy

Abstract

The current study examines macro-economic and bank specific determinants of non-performing loans (NPLs) for commercial banks from 2008–2018. The Pakistani banking sector has observed a significant increase in NPLs. In addition, the current study is undertaken to fill this gap in the literature as most of the prior studies focus on the developed markets. In the current study, we prefer the system GMM estimator. Its reliability depends on the validity of the instruments. To testing the second-order serial correlation, we apply the J test for testing the validity of the instruments and the Arellano–Bond AR (2) test. Using dynamic-GMM estimations, we find that credit growth, net interest margin, loan loss provision, and bank diversification significantly increase NPLs, while operating efficiency, bank size, and ROA lower NPLs. In addition, higher interest rates, exchange rates, and political risk significantly increase NPLs, while GDP growth decreases NPLs. This paper provides a timely insight to management and policy makers about the determinants of NPLs. The findings help management to take corrective actions and policy makers may take into consideration the significance of macro-economic conditions while formulating policy regarding NPLs. Likewise, the study provides insight to potential investors to consider the findings while selecting better investment opportunity. The current study is the first of its kind focusing on the link among bank specific, macroeconomic variables, and non-performing loans within the specific context of an emerging economy, Pakistan.

Determinants of Non-Performing Loans: Banking Sector Listed in Indonesia Stock Exchange

“…Research conducted by Ismail et al (2017) revealed that there is a positive relationship between income diversification and non-performing loans because the more sources of income other than interest, the bank eventually does not fully rely and concentrate on the credit sector, thereby increasing nonperforming loans. Ahmed et al (2021) also supports this statement. Moreover, income diversification increases the volatility of banking companies, thus triggering more nonperforming loans.…”

“…Research conducted by Ahmed et al (2021) used non-performing loans as the dependent variable with the independent variables consist of lagged non-performing loans, credit growth, loan loss provisions, income diversification, operating inefficiency, bank size, profitability (ROA), net interest margin, government ownership, family ownership, interest rate, exchange rate, political risk, and gross domestic product growth. The number of samples used in this study were 20 banks in Pakistan during 2008-2018.…”

“…The number of samples used in this study were 20 banks in Pakistan during 2008-2018. The results of the research by Ahmed et al (2021) show that lagged non-performing loans, credit growth, loan loss provisions, income diversification, government ownership, interest rate, exchange rate, and political risk have a positive effect on non-performing loans, while bank size, profitability (ROA), net interest margin, and family ownership have a negative effect on non-performing loans. Meanwhile, operating inefficiency has no positive effect on non-performing loans, and gross domestic product growth has no negative effect on non-performing loans.…”

The impact of green lending on credit risk: evidence from UAE’s banks

“…For the last result regarding the bank size (BZ) that shows a positive impact on the NPL ratio, this result is in line with some previous studies like the study of Ekanayake and Azeez ( 2015 ); they concluded that the NPLs have a positive correlation with the efficiency of the banks and the size of banks, in their study that addressed the factors that affected the NPLs in the banking sector of Sri Lanka for the period between 1999 and 2012. And in the study of Ahmed et al ( 2021 ) using dynamic-GMM estimations, they found that credit growth and bank diversification significantly increase NPLs, while operating efficiency and bank size decrease NPL ratio. But in the study of Hu et al ( 2007 ), they found that the banks’ size is negatively related to the rate of NPLs, which supports our argument that larger banks have more resources for determining the quality of loans.…”

The effect of capital structure, operating efficiency and non-interest income on bank profitability: new evidence from Asia

“…Furthermore, an efficient banking industry raises the profitability rate of that sector. Hence, to estimate the operational efficiency of the banking industry, the ratio of non-interest expense to total assets has been considered which conforms to (Ahmed et al, 2021). However, Ayalew (2021) estimated cost to income ratio as a measure of operational efficiency of bank.…”