WHAT CAUSES NON-PERFORMING LOANS? EVIDENCE FROM THE ISLAMIC BANKING SECTOR OF BANGLADESH
Keywords:
Bank-Specific Determinants, Islamic Banks, Macroeconomic Variables, Non-Performing Loans.
Abstract
This study aims to investigate the impact of bank-specific and macroeconomic factors on non-performing loans (NPLs), also known as irregular loans, in Islamic banks in Bangladesh. The study is crucial, as the NPL has become a growing concern for Bangladesh's banking sector, which is affecting the country's economy. The data of banks specific factors were collected from the annual reports of the sample. In contrast, macroeconomic factors were gathered from the World Development Indicators covering the period from 2007 to 2018. Different diagnostic tests, including correlations, heteroskedasticity, and VIF (Variance Inflation Factor), were run to confirm that the results from OLS are accurate and reliable. The study further runs fixed effect and random effect models to check the robustness of the findings. The findings indicate that bank-specific factors such as loan growth, loan-to-asset ratio, and net interest margin significantly reduce NPLs. Moreover, macroeconomic factors like GDP growth and inflation significantly influence NPLs under all models. While we divide the samples into some sub-samples, we found almost similar results, confirming the robustness of the findings. The findings suggest banks' management, regulatory bodies, and other stakeholders have necessary initiatives on how to reduce the NPLs.
JEL Classification Codes: F65, G21, G32, H81.
References
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Anderson, T. W., & Hsiao, C. (1981). Estimation of dynamic models with error components. Journal of the American Statistical Association, 76(375), 598-606. https://doi.org/10.1080/01621459.1981.10477691
Bahmani-Oskooee, M., & Wang, Y. (2007). Determinants of credit risk in indian state-owned banks: An empirical investigation. Economic Issues (Stoke-on-Trent, England), 12(2), 27-46. Retrieved from https://mpra.ub.uni-muenchen.de/17301/
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Beck, R., Jakubik, P., & Piloiu, A. (2015). Key determinants of non-performing loans: New evidence from a global sample. Open Economies Review, 26(3), 525-550. https://doi.org/10.1007/s11079-015-9358-8
Berge, T. O., & Boye, K. G. (2007). An analysis of banks' problem loans. Retrieved from http://hdl.handle.net/11250/2504209
Berger, A. N., & DeYoung, R. (1997). Problem loans and cost efficiency in commercial banks. Journal of Banking & Finance, 21(6), 849-870. https://doi.org/10.1016/S0378-4266(97)00003-4
Brownbridge, M. (1998). The causes of financial distress in local banks in africa and implications for prudential policy. Paper presented at the Geneva: United Nations Conference on Trade and Development.
Chowdhury, M. (2018). Causes of non-performing loan and effects on banking sector. The Daily Sun,
Clair, R. T. (1992). Loan growth and loan quality: Some preliminary evidence from texas banks. Economic Review, Federal Reserve Bank of Dallas, Third Quarter, 1992, 9-22. Retrieved from https://www.dallasfed.org/~/media/documents/research/er/1992%20/er9203b.pdf
Clair, R. T., & Tucker, P. (1993). Six causes of the credit crunch. Federal Reserve Bank of Dallas Economic Review, 3, 1-19. Retrieved from https://core.ac.uk/download/pdf/6755144.pdf
Cucinelli, D. (2015). The impact of non-performing loans on bank lending behavior: Evidence from the italian banking sector. Eurasian Journal of Business and Economics, 8(16), 59-71. https://doi.org/10.17015/ejbe.2015.016.04
Dewatripont, M., & Tirole, J. (1994). The prudential regulation of banks MIT press Cambridge, MA. https://doi.org/10.1007/978-1-349-13352-9_8
Dhar, S., & Bakshi, A. (2015). Determinants of loan losses of indian banks: A panel study. Journal of Asia Business Studies, https://doi.org/10.1108/JABS-04-2012-0017
Ekanayake, E., & Azeez, A. A. (2015). Determinants of non-performing loans in licensed commercial banks: Evidence from srilanka. Asian Economic and Financial Review, 5(6), 868-882. https://doi.org/10.18488/journal.aefr/2015.5.6/102.6.868.882
El-Dereny, M., & Rashwan, N. I. (2011). Solving multicollinearity problem using ridge regression models. International Journal of Contemporary Mathematical Sciences, 6(12), 585-600.
Elliott, A. C., & Woodward, W. A. (2007). Statistical analysis quick reference guidebook: With SPSS examples Sage.
Espinoza, M. R. A., & Prasad, A. (2010). Nonperforming loans in the GCC banking system and their macroeconomic effects International Monetary Fund. Retrieved from https://ideas.repec.org/p/imf/imfwpa/2010-224.html
Ghosh, A. (2015). Banking-industry specific and regional economic determinants of non-performing loans: Evidence from US states. Journal of Financial Stability, 20, 93-104. https://doi.org/10.1016/j.jfs.2015.08.004
González-Hermosillo, B., Pazarbaşioğlu, C., & Billings, R. (1997). Determinants of banking system fragility: A case study of mexico. Staff Papers, 44(3), 295-314. https://doi.org/10.2307/3867561
Hausman, J. A. (1978). Specification tests in econometrics. Econometrica: Journal of the Econometric Society, 1251-1271. https://doi.org/10.2307/1913827
Hayek, F. v. (1940). Socialist calculation: The Competitive Solution'. Economica, 7(26), 125-149. https://doi.org/10.2307/2548692
Judson, R. A., & Owen, A. L. (1999). Estimating dynamic panel data models: A guide for macroeconomists. Economics Letters, 65(1), 9-15. https://doi.org/10.1016/S0165-1765(99)00130-5
Karim, M. A., Hassan, M. K., Hassan, T., & Mohamad, S. (2014). Capital adequacy and lending and deposit behaviors of conventional and islamic banks. Pacific-Basin Finance Journal, 28, 58-75. https://doi.org/10.1016/j.pacfin.2013.11.002
Keeton, W. R. (1999). Does faster loan growth lead to higher loan losses? Economic Review-Federal Reserve Bank of Kansas City, 84(2), 57. Retrieved from https://ideas.repec.org/a/fip/fedker/y1999iqiip57-75nv.84no.2.html
Keeton, W. R., & Morris, C. S. (1987). Why do banks’ loan losses differ. Economic Review, 72(5), 3-21.
Klein, N. (2013). Non-performing loans in CESEE: Determinants and impact on macroeconomic performance International Monetary Fund.
Laird, N. M., & Ware, J. H. (1982). Random-effects models for longitudinal data. Biometrics, 963-974. https://doi.org/10.2307/2529876
Li, H., Rozelle, S., & Zhou, L. (2007). Incentive contracts and bank performance: Evidence from rural china. Economics of Transition, 15(1), 109-124. https://doi.org/10.1111/j.1468-0351.2007.00273.x
Louzis, D. P., Vouldis, A. T., & Metaxas, V. L. (2012). Macroeconomic and bank-specific determinants of non-performing loans in greece: A comparative study of mortgage, business and consumer loan portfolios. Journal of Banking & Finance, 36(4), 1012-1027. https://doi.org/10.1016/j.jbankfin.2011.10.012
Makri, V., Tsagkanos, A., & Bellas, A. (2014). Determinants of non-performing loans: The case of eurozone. Panoeconomicus, 61(2), 193-206. https://doi.org/10.2298/PAN1402193M
Malim, N. A. K., & Azizan, S. (2020). The determinants of islamic and conventional banking profitability in asian countries. Management & Accounting Review (MAR), 19(3), 49-67. http://dx.doi.org/10.24191/mar.v19i3.1324
Messai, A. S., & Jouini, F. (2013). Micro and macro determinants of non-performing loans. International Journal of Economics and Financial Issues, 3(4), 852-860. Retrieved from https://dergipark.org.tr/en/pub/ijefi/issue/31960/351961?publisher=http-www-cag-edu-tr-ilhan-ozturk
Montgomery, D. C., Peck, E. A., & Vining, G. G. (2021). Introduction to linear regression analysis John Wiley & Sons.
Mpofu, T. R., & Nikolaidou, E. (2018). Determinants of credit risk in the banking system in sub-saharan africa. Review of Development Finance, 8(2), 141-153. Retrieved from https://hdl.handle.net/10520/EJC-139fd36d52
Nkusu, M. M. (2011). Nonperforming loans and macrofinancial vulnerabilities in advanced economies International Monetary Fund.
Ozili, P. K. (2015). How bank managers anticipate non-performing loans. Evidence from Europe, US, Asia and Africa. Evidence from Europe, US, Asia and Africa, 73-80. Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2595023
Reinhart, C. M., & Rogoff, K. S. (2011). From financial crash to debt crisis. American Economic Review, 101(5), 1676-1706. https://doi.org/10.1257/aer.101.5.1676
Rinaldi, L., & Sanchis-Arellano, A. (2006). Household debt sustainability: What explains household non-performing loans? An empirical analysis. Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=872528
Salas, V., & Saurina, J. (2002). Credit risk in two institutional regimes: Spanish commercial and savings banks. Journal of Financial Services Research, 22(3), 203-224. https://doi.org/10.1023/A:1019781109676
Sarker, M. (2017). Study on credit risk arising in the banks from loans sanctioned against inadequate collateral. Research Department, Bangladesh Bank.
Semuel, H., & Nurina, S. (2014). Analysis of the effect of inflation, interest rates, and exchange rates on gross domestic product (GDP) in indonesia. Analysis of the Effect of Inflation, Interest Rates, and Exchange Rates on Gross Domestic Product (GDP) in Indonesia. Retrieved from https://core.ac.uk/download/pdf/32452864.pdf
Sorge, M. (2004). Stress-testing financial systems: An overview of current methodologies. BIS Working Papers, 165. http://dx.doi.org/10.2139/ssrn.759585
Suzuki, Y., & Uddin, S. S. (2016). Recent trends in islamic banks’ lending modes in bangladesh: An evaluation. Journal of Islamic Accounting and Business Research. https://doi.org/10.1108/JIABR-07-2013-0026
Walker, M., Hall, A., & Basáñez, M. (2013). Ascaris lumbricoides: New epidemiological insights and mathematical approaches. Ascaris: The neglected parasite (pp. 155-201) Elsevier. https://doi.org/10.1016/B978-0-12-396978-1.00007-0
Warue, B. N. (2013). The effects of bank specific and macroeconomic factors on nonperforming loans in commercial banks in kenya: A comparative panel data analysis. Advances in Management and Applied Economics, 3(2), 135. Retrieved from https://www.scienpress.com/Upload/AMAE/Vol%203_2_7.pdf
Washington, G. K. (2014). Effects of macroeconomic variables on credit risk in the kenyan banking system. International Journal of Business and Commerce, 3(9), 1-26. Retrieved from https://www.ijbcnet.com/3-9/IJBC-14-3903.pdf
White, H. (1980). A heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticity. Econometrica: Journal of the Econometric Society, 817-838. https://doi.org/10.2307/1912934
Alexandri, M. B., & Santoso, T. I. (2015). Non performing loan: Impact of internal and external factor (evidence in indonesia). International Journal of Humanities and Social Science Invention, 4(1), 87-91.
Anderson, T. W., & Hsiao, C. (1981). Estimation of dynamic models with error components. Journal of the American Statistical Association, 76(375), 598-606. https://doi.org/10.1080/01621459.1981.10477691
Bahmani-Oskooee, M., & Wang, Y. (2007). Determinants of credit risk in indian state-owned banks: An empirical investigation. Economic Issues (Stoke-on-Trent, England), 12(2), 27-46. Retrieved from https://mpra.ub.uni-muenchen.de/17301/
Bangladesh Bank. (2022). Developments of islamic banking in bangladesh. Retrieved from https://www.bb.org.bd/pub/quaterly/islamic_banking/islamic_jan-mar2022.
Beck, R., Jakubik, P., & Piloiu, A. (2015). Key determinants of non-performing loans: New evidence from a global sample. Open Economies Review, 26(3), 525-550. https://doi.org/10.1007/s11079-015-9358-8
Berge, T. O., & Boye, K. G. (2007). An analysis of banks' problem loans. Retrieved from http://hdl.handle.net/11250/2504209
Berger, A. N., & DeYoung, R. (1997). Problem loans and cost efficiency in commercial banks. Journal of Banking & Finance, 21(6), 849-870. https://doi.org/10.1016/S0378-4266(97)00003-4
Brownbridge, M. (1998). The causes of financial distress in local banks in africa and implications for prudential policy. Paper presented at the Geneva: United Nations Conference on Trade and Development.
Chowdhury, M. (2018). Causes of non-performing loan and effects on banking sector. The Daily Sun,
Clair, R. T. (1992). Loan growth and loan quality: Some preliminary evidence from texas banks. Economic Review, Federal Reserve Bank of Dallas, Third Quarter, 1992, 9-22. Retrieved from https://www.dallasfed.org/~/media/documents/research/er/1992%20/er9203b.pdf
Clair, R. T., & Tucker, P. (1993). Six causes of the credit crunch. Federal Reserve Bank of Dallas Economic Review, 3, 1-19. Retrieved from https://core.ac.uk/download/pdf/6755144.pdf
Cucinelli, D. (2015). The impact of non-performing loans on bank lending behavior: Evidence from the italian banking sector. Eurasian Journal of Business and Economics, 8(16), 59-71. https://doi.org/10.17015/ejbe.2015.016.04
Dewatripont, M., & Tirole, J. (1994). The prudential regulation of banks MIT press Cambridge, MA. https://doi.org/10.1007/978-1-349-13352-9_8
Dhar, S., & Bakshi, A. (2015). Determinants of loan losses of indian banks: A panel study. Journal of Asia Business Studies, https://doi.org/10.1108/JABS-04-2012-0017
Ekanayake, E., & Azeez, A. A. (2015). Determinants of non-performing loans in licensed commercial banks: Evidence from srilanka. Asian Economic and Financial Review, 5(6), 868-882. https://doi.org/10.18488/journal.aefr/2015.5.6/102.6.868.882
El-Dereny, M., & Rashwan, N. I. (2011). Solving multicollinearity problem using ridge regression models. International Journal of Contemporary Mathematical Sciences, 6(12), 585-600.
Elliott, A. C., & Woodward, W. A. (2007). Statistical analysis quick reference guidebook: With SPSS examples Sage.
Espinoza, M. R. A., & Prasad, A. (2010). Nonperforming loans in the GCC banking system and their macroeconomic effects International Monetary Fund. Retrieved from https://ideas.repec.org/p/imf/imfwpa/2010-224.html
Ghosh, A. (2015). Banking-industry specific and regional economic determinants of non-performing loans: Evidence from US states. Journal of Financial Stability, 20, 93-104. https://doi.org/10.1016/j.jfs.2015.08.004
González-Hermosillo, B., Pazarbaşioğlu, C., & Billings, R. (1997). Determinants of banking system fragility: A case study of mexico. Staff Papers, 44(3), 295-314. https://doi.org/10.2307/3867561
Hausman, J. A. (1978). Specification tests in econometrics. Econometrica: Journal of the Econometric Society, 1251-1271. https://doi.org/10.2307/1913827
Hayek, F. v. (1940). Socialist calculation: The Competitive Solution'. Economica, 7(26), 125-149. https://doi.org/10.2307/2548692
Judson, R. A., & Owen, A. L. (1999). Estimating dynamic panel data models: A guide for macroeconomists. Economics Letters, 65(1), 9-15. https://doi.org/10.1016/S0165-1765(99)00130-5
Karim, M. A., Hassan, M. K., Hassan, T., & Mohamad, S. (2014). Capital adequacy and lending and deposit behaviors of conventional and islamic banks. Pacific-Basin Finance Journal, 28, 58-75. https://doi.org/10.1016/j.pacfin.2013.11.002
Keeton, W. R. (1999). Does faster loan growth lead to higher loan losses? Economic Review-Federal Reserve Bank of Kansas City, 84(2), 57. Retrieved from https://ideas.repec.org/a/fip/fedker/y1999iqiip57-75nv.84no.2.html
Keeton, W. R., & Morris, C. S. (1987). Why do banks’ loan losses differ. Economic Review, 72(5), 3-21.
Klein, N. (2013). Non-performing loans in CESEE: Determinants and impact on macroeconomic performance International Monetary Fund.
Laird, N. M., & Ware, J. H. (1982). Random-effects models for longitudinal data. Biometrics, 963-974. https://doi.org/10.2307/2529876
Li, H., Rozelle, S., & Zhou, L. (2007). Incentive contracts and bank performance: Evidence from rural china. Economics of Transition, 15(1), 109-124. https://doi.org/10.1111/j.1468-0351.2007.00273.x
Louzis, D. P., Vouldis, A. T., & Metaxas, V. L. (2012). Macroeconomic and bank-specific determinants of non-performing loans in greece: A comparative study of mortgage, business and consumer loan portfolios. Journal of Banking & Finance, 36(4), 1012-1027. https://doi.org/10.1016/j.jbankfin.2011.10.012
Makri, V., Tsagkanos, A., & Bellas, A. (2014). Determinants of non-performing loans: The case of eurozone. Panoeconomicus, 61(2), 193-206. https://doi.org/10.2298/PAN1402193M
Malim, N. A. K., & Azizan, S. (2020). The determinants of islamic and conventional banking profitability in asian countries. Management & Accounting Review (MAR), 19(3), 49-67. http://dx.doi.org/10.24191/mar.v19i3.1324
Messai, A. S., & Jouini, F. (2013). Micro and macro determinants of non-performing loans. International Journal of Economics and Financial Issues, 3(4), 852-860. Retrieved from https://dergipark.org.tr/en/pub/ijefi/issue/31960/351961?publisher=http-www-cag-edu-tr-ilhan-ozturk
Montgomery, D. C., Peck, E. A., & Vining, G. G. (2021). Introduction to linear regression analysis John Wiley & Sons.
Mpofu, T. R., & Nikolaidou, E. (2018). Determinants of credit risk in the banking system in sub-saharan africa. Review of Development Finance, 8(2), 141-153. Retrieved from https://hdl.handle.net/10520/EJC-139fd36d52
Nkusu, M. M. (2011). Nonperforming loans and macrofinancial vulnerabilities in advanced economies International Monetary Fund.
Ozili, P. K. (2015). How bank managers anticipate non-performing loans. Evidence from Europe, US, Asia and Africa. Evidence from Europe, US, Asia and Africa, 73-80. Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2595023
Reinhart, C. M., & Rogoff, K. S. (2011). From financial crash to debt crisis. American Economic Review, 101(5), 1676-1706. https://doi.org/10.1257/aer.101.5.1676
Rinaldi, L., & Sanchis-Arellano, A. (2006). Household debt sustainability: What explains household non-performing loans? An empirical analysis. Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=872528
Salas, V., & Saurina, J. (2002). Credit risk in two institutional regimes: Spanish commercial and savings banks. Journal of Financial Services Research, 22(3), 203-224. https://doi.org/10.1023/A:1019781109676
Sarker, M. (2017). Study on credit risk arising in the banks from loans sanctioned against inadequate collateral. Research Department, Bangladesh Bank.
Semuel, H., & Nurina, S. (2014). Analysis of the effect of inflation, interest rates, and exchange rates on gross domestic product (GDP) in indonesia. Analysis of the Effect of Inflation, Interest Rates, and Exchange Rates on Gross Domestic Product (GDP) in Indonesia. Retrieved from https://core.ac.uk/download/pdf/32452864.pdf
Sorge, M. (2004). Stress-testing financial systems: An overview of current methodologies. BIS Working Papers, 165. http://dx.doi.org/10.2139/ssrn.759585
Suzuki, Y., & Uddin, S. S. (2016). Recent trends in islamic banks’ lending modes in bangladesh: An evaluation. Journal of Islamic Accounting and Business Research. https://doi.org/10.1108/JIABR-07-2013-0026
Walker, M., Hall, A., & Basáñez, M. (2013). Ascaris lumbricoides: New epidemiological insights and mathematical approaches. Ascaris: The neglected parasite (pp. 155-201) Elsevier. https://doi.org/10.1016/B978-0-12-396978-1.00007-0
Warue, B. N. (2013). The effects of bank specific and macroeconomic factors on nonperforming loans in commercial banks in kenya: A comparative panel data analysis. Advances in Management and Applied Economics, 3(2), 135. Retrieved from https://www.scienpress.com/Upload/AMAE/Vol%203_2_7.pdf
Washington, G. K. (2014). Effects of macroeconomic variables on credit risk in the kenyan banking system. International Journal of Business and Commerce, 3(9), 1-26. Retrieved from https://www.ijbcnet.com/3-9/IJBC-14-3903.pdf
White, H. (1980). A heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticity. Econometrica: Journal of the Econometric Society, 817-838. https://doi.org/10.2307/1912934
Published
2023-02-03
How to Cite
Chowdhury, M. A. I., Uddin, M. S., Ullah, H., Ahmmed, M., & Shadek, M. J. (2023). WHAT CAUSES NON-PERFORMING LOANS? EVIDENCE FROM THE ISLAMIC BANKING SECTOR OF BANGLADESH. International Journal of Accounting & Finance Review, 14(1), 11-21. https://doi.org/10.46281/ijafr.v14i1.1926
Section
Regular Research Article/ Short Communication Article
Copyright (c) 2023 Md. Asad Iqbal Chowdhury, Mohammad Shamsu Uddin, Habib Ullah, Monir Ahmmed, Md Jafar Shadek
This work is licensed under a Creative Commons Attribution 4.0 International License.
