Non-performing loans (NPLs) and non-performance: evidence from South Asian banks

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ABSTRACT

This paper examines the consequences of banks ' performance on bank risk. The paper forms a theoretical model and delivers empirical evidence to identify that banks suffer in performance as the loans become bad. Using panel data from a sample offive (05) South-Asian emerging economies from 2011 to 2019, we have found that the banks are highly influenced by the development of non-performing loans (NPLs). We have primarily used Return on Asset (ROA) followed by Return on Equity (ROE) as a substitution to the performance of the banks and NPL as the proxy of bank risk. Simultaneous regression applying 3sls finds that Non-Performing Loan (NPL) hinders banks' growth, negatively affecting their profitability.

Keywords:

Profitability; Banking; Nonperforming Loans; FGLS; 3SLS.

Introduction

In the last decade, the South-Asian banking sector has evolved significantly. At the same time, compliance loan disbursements have deteriorated, which directly affects banks' performance. There are several determinants of a bank's viability. These are either external or internal factors. Internal factors derive from bank accounts and are represented as bank-related profitability elements. External elements are not linked to bank administration and are placed exogenously on banks.

Macroeconomic indicators and strategies, the regulatory climate, technical advances, the international economy & and politics are among these exogenous variables. The activity and efficiency of financial institutions in an open economy would be influenced by all these conditions (Li, 1999).

The critical performance of banks, which work on the notion of money creation, is credit development; consequently, the likelihood of banks failing if the money they lend is not payback by borrowers is substantial. As a result, banks place a high value on bank credit risk supervision, primarily focused on decreasing the likelihood of borrowers defaulting on the loan payoff, particularly to producing non-performing loans (NPLs). NPLs are loans that have not generated returns for long, i.e., the principal and interest on these loan disbursements have not been paid for a minimum period of 90 days. Nkusu (2011) shows that NPLs are a central causative element in credit market frictions and macro-financial fragility when looking at the link between NPLs and their macroeconomic repercussions. Increases in NPLs, according to the report, are a prelude to debilitating macroeconomic activities. Credit risk administration is crucial to the effective...