Effect of liquidity risk and credit risk on banking stability of Nepalese

commercial bank
Graduate Research Project

Submitted To:
MBA (Finance) Program
Office of the Dean, Faculty of Management Studies
Pokhara University

Submitted By:
BijayaBhatta
Roll No: 1630007
Registration No:2016-2-63-0007
In partial fulfillment of the requirements for the degree of MBA
(Finance)

Uniglobe College
Kathmandu, Nepal
2018
 Acknowledgements

This study entitled “eEffect of liquidity risk and credit risk on banking stability of
Nepalese commercial bank " has been conducted to satisfy the partial requirements for
the degree of Master of Business Administration, Pokhara University.

First and foremost, I offer my sincerest gratitude to my supervisor, Dr. Nar Bahadur Bista
for his valuable supervision and guidance in completing this study. I am ineffably
indebted and very thankful for his continuous support and constructive suggestion that
have enabled this research project to achieve its present form.

Furthermore, I would like to express my deepest appreciation to Mr. Jagdish Bista faculty
of Uniglobe College, for his valuable suggestions, inspirations and guidance to complete
this research work successful. I would also like to thank Uniglobe College for providing
the resources for research work and providing library and computing support without
which knowledge and assistance of this study would have not been successful.

At last, I would also like to thank my parents, family, relatives, friends and all those who
helped me during the research work. However, I accept the sole responsibility for any
errors and discrepancies that might have occurred in this report.

……………………………
BijayaBhatta
June 2018
 Certificate of authorship

I hereby declare that this submission of "Effect of liquidity risk and credit risk on
banking stability of Nepalese commercial bank" is my own work and to the best of my
knowledge and belief, it contain no material previously published or written by another
person nor material which to a substantial extent has been accepted for the award of any
other degree of a University or other institution of higher learning, except where due
acknowledgement is made in the acknowledgements.

……………………………
BijayaBhatta
June 2018
 Table of contents

Acknowledgements........................................................................................................ii
Certificate of authorship...............................................................................................iii
Table of contents...........................................................................................................iv
List of tables..................................................................................................................vi
List of figures..............................................................................................................viii
Executive summary.......................................................................................................ix
List of abbreviations....................................................................................................xii
Chapter I.........................................................................................................................1
Introduction....................................................................................................................1
1.1 General background..............................................................................................1
1.2 Statement of problem...........................................................................................5
1.3 Objectives of the study.........................................................................................9
1.4 Significance of the study....................................................................................10
1.5 Operational definitions and assumptions............................................................11
1.5.1 Dependent variables........................................................................................11
1.5.2 Independent variable.......................................................................................12
1.6 Organization of the study...................................................................................17
Chapter II.....................................................................................................................19
Literature survey and theoretical framework...............................................................19
2.1 Review of literature............................................................................................19
2.1.1 Review of major literature...............................................................................19
2.1.2 Review of recent literature..............................................................................25
2.1.3 Review of Nepalese literature.........................................................................31
2.2 Conceptual framework.......................................................................................35
2.3 Concluding remarks............................................................................................36
Chapter III....................................................................................................................39
Research methodology.................................................................................................39
3.1 Research plan and design...................................................................................39
3.2 Description of sample.........................................................................................40
 3.3 Nature and sources of data.................................................................................40
3.4 Methods of data analysis....................................................................................41
3.5 Model specification............................................................................................41
3.6 Analysis plan......................................................................................................42
3.7 Limitations of the study......................................................................................43
Chapter IV....................................................................................................................44
Results and discussion..................................................................................................44
4.1 Structure and pattern of liquidity risk, regulation and bank performance variables
..................................................................................................................................44
4.2 Descriptive statistics...........................................................................................67
4.3 Correlation analysis............................................................................................69
4.4 Regression analysis............................................................................................70
4.5 Concluding remarks............................................................................................74
Chapter V.....................................................................................................................77
Summary and conclusion.............................................................................................77
5.1 Summary.............................................................................................................77
5.2 Conclusion..........................................................................................................82
5.3 Recommendation................................................................................................82
5.4 Future scope........................................................................................................83
Reference..................................................................................................................85
 List of tables

Table 2.1: Review of major studies……………………………………..……………20

Table 2.2: Review of recent studies......………………………………….…………..25

Table 2.3: Review Nepalese studies. .……………………….……………………….32

Table 3.1: Number of commercial banks selected for the study along with the study
period and number of observation ……………………………………......................40

Table 3.2: Description of variables…………………………………………….…….42

Table 4.1: Structure and pattern of z-score return on asset (In percentage)…………...….
….45

Table 4.2: Structure and pattern of z-score return on equity (In percentage)..…..………48

Table 4.3: Structure and pattern of net interest margin (In percentage)……………......51

Table 4.4: Structure and pattern of total assets (In billion) ………………..53

Table 4.5: Structure and pattern of loan to total assets (In percentage))……………….56

Table 4.6: Structure and pattern of liquidity ratio (In percentage)……...59

Table 4.7: Structure and pattern of non-performing loan ratio (In percentage)
………………61

Table 4.8: Structure and pattern ofgross domestic product………..…63

Table 4.9: Structure and pattern of inflation rate……………………...……………67

Table 4.10: Descriptive statistics………………………………………………….…68

Table 4.11: Pearson’s correlation matrix………………………………………….…69

Table 4.12: Estimated regression results of NIM, LIQ, TA , LTA, NPL , INF,GDP on
banking stability (ZROA)…………………………………………………………..70

Table 4.13: Estimated regression results of NIM, LIQ, TA , LTA, NPL , INF, GDP on
banking stability (ZROE)…………………………………………......................72
 List of figures

Figure 2.1: Schematic diagrams of effect of liquidity risk and credit risk on banking
stability……………36
Figure 4.1: Trend of averagez-score return on asset....................................................46

Figure 4.2: Trendofaveragez-score return on equity....................................................49

Figure 4.3: Trend of average net interest margin .......................................................51

Figure 4.4: Trend of average total assets.....................................................................54

Figure 4.5: Trendof average loan to total assets .........................................................56

Figure 4.6: Trendof average liquidity ratio..................................................................58

Figure 4.7: Trendof average non-performing loan ratio..............................................61

Figure 4.8: Trendof average gross domestic product...................................................63

Figure 4.9: Trendof average inflation rate...................................................................66

 Executive summary

Banks are financial institutions that play intermediary function in the economic
development that has taken place in region over recent years. It plays an important role as
financial sector for saver and borrowers in an economy. Commercial banks are the most
dominant financial institutions in Nepal. The main function of commercial banks is the
availing of funds (monetary) to its customers. Thus, for a bank to be in a position to do
so, it must be in a healthy liquidity position. Liquidity management means ensuring that
the bank possesses sufficient cash to satisfy unexpected cash outlets. If the bank is unable
to do this it is known as the liquidity risk. As this risk increases, the bank is considered
unable to meet its obligations (such as deposits withdrawal, debt maturity and funds for
loan portfolio and investment). A bank should acquire proper liquidities when needed
immediately at a sensible cost. Though sustaining the optimal level of liquidity is a real
art of bank’s management. The whole banking system is particularly reliant on the
satisfactory degree of liquidity of a single bank because if single banks suffer the risk,
other bank will have the contagion effect and may ultimately raise the level of systematic
risk. With higher liquidity; banks will have remarkable performance encouraging public
confidence and banking stability. Credit risk is the bank's credit quality. And it is
measured by proportion of non –performing loan to total banks loan. The indicators of
credit risk include the level of bad loans (non-performing loans) problem loans or
provision for loan losses Credit risk is the risk that a loan which has been granted by a
bank, will not be either partially repaid on time or fully and where there is risk of
customeror counter default.
If credit risk are managed the banking systems will be stable and well-functioned When
BFIS are unable to manage the credit risk then banking system break down temporarily
or operate ineffectively, the ability of the firms to obtain funds necessary for continuing
existing projects and establishing new is hindered.

This study attempts to explore the effect of liquidity risk and credit risk on banking
stability of selected commercial banks in context of Nepal. This study is based on the
secondary data for 20commercial banks with 160 observations for the period of 2009/10
to 2016/17. The data and information are collected from various issues of Banking and
Financial Statistics, Bank Supervision Report published by NRB and annual reports of
the selected commercial banks. The

research design adopted in this study is descriptive and causal comparative research
design as this study examines the impact of net interest margin, loan to total assets ratio,
liquidity ratio, non-performing loan ratio, bank size, gross domestic product and inflation
on banking stability of Nepalese commercial banks.

The average z-score return on assets is highest for CTZ (7.702) and lowest for MBL
(1.387). Commercial banks in Nepal have slightly increasing pattern of z-score return on
assets in recent year.The average z-score return on equity is highest for GIME (8.741)
and lowest for MBL (1.3). The average net interest margin is highest for ADBL( 6.052 )
and lowest for LXBL (2.784).The average of total assets is highest for NIBL (90.711)
and lowest for NCC (28.755). The average of non-performing loan is highest for NCC
( 6.575) and NSBI has the lowest of non-performing loan ( 0.231).The average loan to
total assets is highest for SIBL ( 72.045 )and lowest for SCBL (46.128 ).The average
liquidity ratio is highest for HBL (29.77 )and lowest for SUBL ( 7.23).

The descriptive analysis shows that the average z-score return on assets and z-score
return on equity, net interest margin, total assets a loan portfolio, liquidity ratio, non
performing loan GDP and average inflation in Nepalese commercial banks are
1.733percent,21.325percent, 3.355 percent, 3.792 billion, 4.182 billion, 15.536 percent,
1.997percent, 4.192 percent and 9.525 percent respectively.

The correlation analysis reveals that net interest margin and total assets is positively
related to z-score return on equity. The result also shows that there is positive relationship
of liquidity and NPL with z-score return on assets. There is is negative relationship of
loan portfolio with z-score return on assets. Whereas inflation has positive relationship
with inflation and GDP with z-score return on assets.The result shows that net interest
margin is positively correlated with z-score return on equity. Total assets is also
positively correlated with z-score return on equity. However, loan portfolio, liquidity,
non performing loan are negatively correlated with z-score return on equity. Similarly,
gross domestic product and annual inflation rate has also negative relationship with z-
score reurn on equity

The regression result shows that the beta coefficient of net interest margin (NIM) has a
positive and significant impact on the level of banking stability or risk level. Similarly,
the result shows that total assets have positive impact on Z score return on assets.Loan
portfolio (loan to total assets) has negative and significant impact on Z score ROA. The
result reveals that there is negative relationship of NPL, gross domestic product, annual
inflation ratewith z -score ROA. The beta coefficients for NIM has positive and
significant impact with z-score ROE. Similarly, the result shows that beta coefficients for
total assets has positive and significant impact on z-score ROE. However the beta
coefficients are negative and significant for loan to total assets liquidity and NPL with z-
score ROE. The regression analysis of z-score return on equity reveals that the beta
coefficient of GDP and inflation has negative impact on Z-score ROE.

The correlation matrix of selected commercial banks shows that capital adequacy ratio is
positively correlated with return on assets. Similarly, cash reserve ratio has positive
relationship with return on assets. There is positive relationship of bank size with return
on assets. Likewise, Inflation has positive relationship with return on assets. However,
there is negative relationship of leverage ratio, credit to deposit ratio, liquidity ratio and
non-performing loan ratio with return on assets. The result also shows that there is
positive relationship of capital adequacy ratio;cash reserve ratio, bank size and inflation
with earnings per share.Likewise,there is negative relationship of leverage, non-
performing loan ratio, liquidity ratio and credit to deposit ratio with earnings per share.

The regression results indicate that capital adequacy ratio and bank size has positive
impact on return on assets. Similarly, inflation has positive impact on return on assets.
This study also reveals that liquidity ratio, leverage, non-performing loan ratio and credit
to deposit ratio has negative impact on the return on assets. Likewise, results shows that
the capital adequacy ratio and liquidity ratio has positive impact on earnings per share.
Similarly, cash reserve ratio and bank size has positive impact on earnings per share.
Inflation has positive impact on earnings per share. However, results shows that the
leverage ratio, credit to deposit ratio and non-performing loan ratio has negative impact
on earnings per share.

List of abbreviations

LIQ Liquidity ratio

NIM Net interest margin

LTA Loan to total assets

NPL Non-performing loan

TA Bank size

GDP Gross domestic product

INFInflation

ROA Return on assets

ROE Return on equity

ADBL Agriculture development Bank Limited

NABIL NABIL Bank Limited

HBL Himalayan Bank Limited

KBL Kumari Bank Limited

LXBL Laxmi Bank Limited

MBL Machapuchhre Bank Limited

NBBL Nepal Bangladesh Bank Limited

NCC Nepal Credit and Commerce Bank Limited

NIBL Nepal Investment Bank Limited

NMB NMB Bank Limited

NRB Nepal Rastra Bank

SBI Nepal SBI Bank Limited

SIBL Siddhartha Bank Limited

SCBL Nepal Standard Chartered Bank Limited

SUBL Sunrise Bank Limited

CTZ Citizens Bank International Limited

EBL Everest Bank Limited

 Chapter I

Introduction

1.1 General background

One of the most prominent roles performed by banks is the creation of liquid claims on
illiquid assets. This is often done by offering demand-deposit contracts (Diamond and
Dybvig, 1983).The financial sector plays an important role in the development process of
the country. Strong financial institutions are critical for increased investment, economic
growth, employment and poverty alleviation. A sound and efficient banking system in a
better position endures negative distress and contributes more significantly to the growth
of the financial system (Aburime, 2009). The BFIS are the financial institution that have
diversified and complex operations. The banking industry has to operate in business
environment and diversify its product to gain competitive advantages and to be
profitable.(Amidu and Wolfe, 2013).

According to Čihák (2007), the main advantage of this measure is represented by the
easily computation for a financial institution or corporation. On the other side, the main
disadvantage of this method is represented by the fact that it does not catch the
correlation between financial institutions (contagion relation). By developing the idea
furthermore, Groeneveld and De Vries (2009) used the Z-score to two types of banks:
commercial banks and co-operative banks. The result shows that the average Z-score has
a higher value for co-operative banks in comparison to commercial banks. This indicates
that cooperative sector have more stability than other bank and financial system.

For assessing the regulation impact on bank stability for Central and Eastern Europe.
Miklaszewska et al. (2012) identified a sharp decline in bank stability during the
financial crisis, of the years 2009 and 2010, followed by an increase in Z-score. The
trend of increment in Z-score can be analyzed by the bank’s profit reinvestments along
this two years. Andries and Capraru (2011) investigated the Z-score increased
continuously for 17 countries from Central and Eastern Europe (including Romania),
which meant an improvement of the bank’s system financial stability during the period
between the years 2004 and 2008,

Furthermore, in an environment characterized by market imperfections, it is imperative to

protect the depositors against bank failures (Dewatripont & Tirole, 1994). According to
Cecchetti and Schoenholtz (2011),financial risks are categories into four types and these
financial risks include the chance that depositors will suddenly withdraw their deposits
which is termed as liquidity risk, if the borrowers will not repay their loans on time
which is termed as credit risk, if the interest rates will change continuously which is
termed operation rest rate risk, if the bank's computer systems will fail or the human
resource of the bank are unable to perform the day to day activities then it is called as
operational risk). Nevertheless, among these risks, credit and liquidity risks are not only
the most important risks that banks face, but they are also directly linked to what banks
do and why banks fail. Chordia et al(2004) analyzed liquidity is a fundamental concept in
finance. Each and every bank tries to keep up sufficient funds to meet the unexpected
demands from depositors and to mitigate the risk that will arise in upcoming future.

However, Holmstrom and Tirole (2000) found that effective liquidity risk management
helps ensure a bank's ability to meet cash flow obligations, which are uncertain as they
are affected by external events. Liquidity risk is risk that can adversely affect bank’s
earnings and the capital of bank and financial institutions. Therefore, it becomes the
responsiblity of a bank’s management to ensure the availability of sufficient funds to
meet future demands of providers and borrowers, at reasonable costs, so bankers and
regulators try to make their own model to increase bank liquidity position.

Markowitz(2005) indicates that the risks to which a bank is particularly exposed in its
operations are: liquidity risk, credit risk, market risks, exposure risks, investment risks,
sovereign risk, operational risk, legal risk, reputational risk and strategic risk. Liquidity
risk is usually measured as liquidity ratio which is practically calculated in two different
forms. In first type, liquidity is adjusted by size which includes the ratio of cash assets to
total assets (Barth et al. 2003). Thus, managing liquidity risk is to ensure the banks own
liquidity so that the bank can continue to serve its function (Vossenand and Ness, 2010).
Lee and Chih (2013) indicated that big and small banks were differently affected by each
regulation ratio under different macroeconomic environments. Profitability and liquidity
are effective indicators of the corporate health and performance of not only the
commercial banks, but all profit-oriented ventures (Eljelly, 2004). These performance
indicators are very important to the shareholders and depositors who are major publics of
the banks.Further, Maggiolini and Mistrulli (2005) showed a correlation between the
financial stability and the market share of larger banks it indicates that higher the
banking stability lower the market shares of larger banks and vice-versa. According to
Fiordelisi and Salvatore (2013), profit maximization also has a significant impact on the
financial stability.

Net interest margin is one of the indicators used in measuring the efficiency of banks in
developing countries, high net interest margin creates presence of inefficiencies in the
banking system due to costs incurred as a result of the inefficiency which are transferred
to bank customers by charging high interest rates (Fry, 1995; Randall, 1998; and Barajas
et al., 1999). If lower net interest margin is charged by BFIS , the expected social cost
incurred by the public to banking activities undertaken will also be low. The effectiveness
of monetary policy, well maintained financial stability, and competitive banking system
will be shown by efficient intermediation costs. Thus efficient intermediation costs are
indicated by low interest rates. High intermediation costs would reduce the incentive for
economic actors (Hadad et al., 2003). Interest margin should be maintain at a certain
level because it is a major source of the bank’s income to maintain profit and banking
stability. Financial stability can be defined as banks’ ability to efficiently allocate
resources in space and time and to assess and manage financial risk through their own
supervision.
Tabari et al. (2013) showed that bank's size, bank's capital, GDP and inflation leads to
increment in the profitability of bank. However, credit risk and liquidity risk will cause to
decrement in the bank's profitability. Regulator have strict request to the bank in credit
risk and operational risk in the past, although do not focus on liquidity risk. However,
study found that liquidity risk will cause severe consequence to banks following the
subprime mortgage crisis. Besides, the credit crunch of 2007 reminded many banks of the
importance of liquidity risk. (Matz, 2008). Therefore, liquidity risk management is the
important factor for the banking and financial institution and will be the major future
scope for research.

The effect of a country's economy on its banks’ operation should be taken into
consideration. The GDP , which is among the commonly used macroeconomic indicators
in assessing financial stability, can be used for this purpose. GDP and financial stability
has uncertain relationship. Diaconua and Oanea (2014) investigated that GDP is an
important factor affecting cooperative banks’ financial stability; whereas , Diaconua and
Oanea (2015) showed empirically that GDP does not affect financial stability of BFIS.

In the context of Nepal, Pradhan (2014) showed that non-performing loans has
negative relationship with return on assets. Raj bahak et al. (2016) examined that
there is no relationship between foreign ownership and z-index, financial stability,
indicating that foreign ownership does not have any impact of z-index. Paudel
(2012) concluded non-performing loan ratio increases the credit risk in the context
of Nepalese commercial banks. NPLS are determined by different factors such as
level of volume of deposit, return on equity, return on assets, capital adequacy, total
loan, liquidity, bank size, credit growth, excessive lending, interest rate, GDP,
inflation and unemployment (Mileris, 2012; Tomak, 2013;Ahmad and Bashir, 2013;
and Shingjerji, 2013). Ghimire (2014) investigated types of income sources, net
profit margin and return on asset have negative impact on bank performance whereas
return on equity have positive correlation with the bank performance.

Singh (2017) showed a positive impact of liquidity risk on bank performance.

Whereas, Pradhan and shrestha (2017) revealed that capital adequacy ratio and
lquidity management would lower the bank performance of nepalese commercial
banks.. According to Kattel (2014) showed that private owned banks are more
financially sound than joint venture banks. Shrestha (2012) investigated the liquidity
management of commercial bans as well as profitability positions, using various financial
tools. The study revealed a regular trend of average profitability of commercial bank,
although the trend of liquidity ratio of the banks is fluctuating.
The above discussion shown above indicates that studies related to the liquidity risk,
credit risk, and banking stability are of greater importance. There are various studies done
in context of different countries as shown above, but in Nepal such types of finding
consisting of recent data donot exist. Hence, this study focuses on analyzing the effect
liquidity risk, credit risk, and banking stability of Nepalese commercial banks.

1.2 Statement of the problem

Liquidity risk and credit risk are the two most important factors for banking survival. To
investigate the importance of liquidity and credit risks for banks, the study have to
examine how both risks jointly have an effect on bank stability. To promote economic
activities and economic growth in a country, financial intermediation is the major
functions of banks and financial institutions. Berger and Bouwman (2009) empirically
show that the 2007 banking crisis was preceded by a substantial creation of liquidity of
US banks. Vazquez and Federico (2015) analyzed that banks having a low liquidity
structure (risk level of high liquidity) and a high leverage before the crisis were most at
risk of bankruptcy. Demirguç-Kunt and Huizinga (2010) found that the dependence of
banks on the inter-bank market increases the probability oftheir bankruptcy.

(Diamond 1984, Rajan 1992 and Stein 2002) investigate that banks and financial
institutions can acquire information about clients and achieve more efficient resource
allocation by lending to different industries and engaging in multiple business activities
Credit risk is a serious threat to the performance of banks which when unchecked would
lead to the total collapse of banks. Liquidity risk is also one of the major threatening
factor for banks with an unsound risk assessment and control policy. In the face of
current events in the BFIS , these two risks cannot be ignored as they have considerable
bearing on the performance and survival of banks Coycle (2000).
According to Jhingan (2010) showed that bank has to maintain sufficient amount of
liquid assets . The liquidity of assets helps to convert it in cash within short period of
time. The bank must hold a sufficient large proportion of its assets in the form of cash
and liquid assets for the purpose of stablility and profitability . If the bank keeps liquidity
the uppermost, its profit will be low. In the other hand, if it ignores liquidity and aims at
earning more, it will be disastrous for it. Thus while managing the investment portfolio
bank should maintain the proper balance between profitability and liquidity. Which
results in relatively high degree of safety. Berger et al. (2009) and Uhde and Heimeshoff
(2009) determined that when a bank with a relatively high degree of overall stability
pursues a growth strategy, regulatory authorities are more likely to approve its merger
with another bank than they would otherwise for a bank with a variable record of
financial stability.
Dermine (1986) found that liquidity risk is seen as a profit-lowering cost, a loan default
increases the liquidity risk because of the lowered cash inflow and depreciations it
triggers. Therefore, the result highlighted that liquidity and credit risks are positively
correlated with loan default rate. However, during the crisis, banks moved from a risk of
withdrawal of deposits, or even from bank runs, to a risk of drying up other funding
sources, specifically the interbank market (Borio, 2010; Huang &Ratnovski, 2011).

.Iqbal (2012) showed that non-performing loans have a negative relationship with
liquidity risk, while return on assets, return on equity and size have a positive relationship
with liquidity risk. However, evidence suggests that the extent to which banks create
liquidity differs by bank size, ownership structure and the extent to which they are
focused on retail banking activities (Berger et al., 2005).

Imbierowicz & Rauch (2014) showed that there is negative relationship between
coefficient of GDP growth and banking stability. Which indicates that higher the GDP
growth rate in an economy, lower would be the bank stability. This helps reduce the risk
of banking failure. Srairi (2013) found that there is positive relationship between inflation
rate and banking stability, which indicates that if the inflation rises in an economy, there
will be stability in banking sectors. Ugoani (2015) revealed that the weak corporate
governance accelerates bank failures and the credit risk management function is to the
greatest extent the most diverse and complex activity in banking business. The author
concludes that poor credit risk management influences bank failures or it may leads to
bankruptcy.
According to Epure and Lafuente (2012) performance improvements follow regulatory
changes and that risk explains differences in banks and non-performing loans negatively
affect efficiency and ROA while the capital adequacy ratio has a positive impact on the
net interest margin. Al-Khouri (2011) showed that credit risk, liquidity risk and capital
risk are the major factors that affect bank stability. when profitability is measured by
return on assets, while the only risk that affects profitability when measured by return on
equity is liquidity risk.

Vinh and Mai (2016) showed that there is positive relationship between bank size and
banking stability. Which indicates that bigger the bank size the banking system would be
more stable. Diaconu (2014) analysed that the micro fianance and cooperative banks are
more financially stable in comparison to the commercial banks. On the other hand,
Diaconu and Oanea (2015) investigated that there is a negative relationship between net
interest margin and financial stability. which shows that higher the net interest margin
higher would be financial stability.

Miller and Noulas (1997) found that size of the banks has negative relation with
profitability. The negative relationship of the size indicates that higher the firm size lower
the profitability or the diseconomies of scale. Wanzenried (2011) identified a positive
relationship between bank size and bank profitability. In addition, Saleem and Rehman
(2011) studied that there is a positive relationship between liquidity and profitability.
Akhaveinet al.(1997) showed a positive and significant relationship between firm size
and return on equity.
Bilal et al.(2013) found that there is a positive and significant impact of bank size,
net interest margin, and industry production growth rate on return on assets and
return on equity. Non-performing loans to total assets and inflation have negative
significant impact on return on assets, while real gross domestic product has positive
impact on return on assets and capital adequacy ratio has positively significant impact on
return on equity. Ahmed et al.(2007) found that the size of Islamic banks has a positive
and statistically significant relationship with financial risks(credit risk and liquidity risk)
whereas its relation with operational risk is found to be negative and insignificant. The
asset management establishes a positive and significant relationship with liquidity and
operational risk. The debt to equity ratio and non-performing laons (NPLs) ratio have a
negative and significant relationship with credit and operational risk. In addition capital
adequacy has negative and significant relationship with credit and operational risk,
whereas it is found to be a positive and significant with liquidity risk.
In the context of Nepal, Neupane & Subedi (2013) concluded that the impact of bank
liquidity on financial performance was non-linear. Gautam (2016) showed that bank
size and inflation rae have a positive impact on liquidity; while non-performing
loans, profitability and GDP growth rate have negative impact on liquidity of
Nepalese commercial banks. Karki (2004) revealed that liquidity ratio was relatively
fluctuating over the period, return on equity was found satisfactory and there is positive
relationship between deposit asset ratio and loan advanvces and profitability.
Manandhar et al. (2014) concluded that there is positive relationship between liquidity,
inflation and gross domestic product with bank profitability in terms of return on assets
and return on equity. Khatri et al. (2015) revealed that there is positive relationship
between return on assets and size of banking sector, bank loan, gross domestic product
growth rate. Pradhan (2014) found that there is positive relationship between the gross
domestic product and market share with bank profitability, whereas inflation and liquidity
are negatively related to bank profitability. Bhusal (2016) found that there is a significant
positive relationship between liquidity and profitability of commercial banks in Nepal.It
indicates that higher the liquidity higher will be profitability of BFIS. Maharjan et al.
(2016) investigated that return on assest is positively related to non-performing loan and
negatively related to loan to deposit whereas return on equity is positively related to debt
to equity and non-performing loan and negatively related to loan to deposit and lesser
prudence.
This study investigates the factor affecting the effect of liquidity risk and credit risk of
Nepalese commercial banks by using individual 20 banks from 2009/10 to 2016/17. The
study contributes the literature examining strictly regulated Nepalese commercial
banking sector with a new dataset. Though there are above mentioned empirical
evidences in context of other countries and in Nepal on the effect of liquidity risk and
credit risk on banking stability of commercial banks, there is no enough evidence about
the factors affecting the effect of liquidity risk and credit risk on banking stability using
the most recent data.
Therefore, this study deals with following issues:

1. What is the structure and pattern of banking stability, liquidity risk, net interest
margin, non-performing loans, total assets and net interest margin of Nepalese
commercial banks? How they have changed over a period of time?
2. Which of the factor plays an important role in relationship between liquidity risk
and credit risk of Nepalese commercial banks?
3. Is there any correlation of of NIM, total assets, loan portfolio, NPLs with the
banks stability in Nepalese commercial banks?
4. Is there is any statistically significant relationship among the net interest margin,
loan to total assets, loan portfolio, non-performing of Nepalese commercial banks.
5. What is the impact of liquidity risk and credit risk on the banking stability in
Nepalese commercial banks?
6. Is there any impact of loan portfolio on the banking stability of Nepalese
commercial banks.
7. Is there any relationship of macro-economic factors; gross domestic product and
inflation with banking stability of Nepalese commercial banks.

1.3 Objective of the study

The major objective of the study is to assess the effect of liquidity risk and credit risk on
banking stability in Nepalese commercial banks. The specific objectives are as follows:

1. To analyze the structure and pattern of banking stability, liquidity risk and
credit risk of Nepalese commercial banks. .
2. To examine the relationship of liquidity risk and credit risk with stability of
Nepalese commercial banks.
3. To identify the most influencing factor affecting the banking stability of the
Nepalese commercial banks.
1.4 Significance of the Study

Managers and potential investors are concerned about liquidity risk and credit risk of
banks and financial institutions.. Examining the liquidity risk and credit risk is crucial to
the major stakeholders, depositors, shareholders, creditors and tax authorities. This study
provides the information to mitigate the liquidity risk and credit risk of commercial
banks. Liquidity is crucial to the on-going viability of any bank, as illiquidity can have
dramatic and rapid adverse effect on even well capitalized banks. Liquidity risk
management has become heightened in today’s competitive economic world. The
analysis of risk management is very important within the department of the management
of the risk in any banks to maintain an increasing performance of risk management lot of
credits that are granted by the banks are not repaid efficiently, which constitutes a danger
of the performance. The BFIS can analyze the relation between net interest margin,
non-performing, loan portfolio , total assets and stability of banking system in order to
maintain the required regulatory reforms. Since the study also provides the
information regarding the effect of liquidity risk and credit risk on banking stability
, it is useful for policy formulators and academic professionals. This study also helps
particularly those who involve in trade, commerce, and financial institutions to
formulate policies and plans on the basis of the status of the banks.

The study findings also benefit management and staff of banks to gain insight into the
determinants of liquidity risk and credit risk adherence and its effect on risk mitigation
for banking stability of BFIS. A sound and profitable banking system is important factor
for financial system stability and economic growth because it makes the economy more
endurable to negative and external shock (Athanasoglou et al. 2006). Risk management is
an important in the management decision making in financial institutions because risk
management must meet certain objectives to keep firms running efficiently. It helps to
gain competitive advantages. This study evaluates the relation of different risk variables
such as non-performing loans, net interest margin, loan portfoilo liquidity ratio, bank size
with the banking stability of Nepalese commercial banks. Thus, the study acts as a tool
for the bank manager to identify the need to practice prudent risk management in order to
maintain banking stability. Additionally, the result of this study is expected to add value
to researchers, professors and scholars for further studies.

Currently, there is no clear understanding on effect of liquidity risk and credit risk for
bank stability. Previously there were few studies about the effect of liquidity risk and
credit risk for bank stability in Nepalese commercial banking sector. This study
contributes to the existing studies by analyzing the relationship between the selected
variables and banking stability among the Nepalese commercial banks. The study I not
only significant to commercial banks, but also to all the investors, financial institutions
and organizations in various decision making processes. It will provide the information to
the management for various decision making processes. It will also provide the strategic
decision making activities of banks and financial institutions. To some extent , it will
provide some useful feedback to the policy makers of the commercial banks and to the
government and central banks in formulating appropriate strategies for the improvement
in the performance of the commercial banks. Finally, this study will bring new insights in
the banking field and would provide the guidelines for the future research works in
Nepalese banking sector.

In the context of Nepal, though the concept of liquidity risk and credit risk is emerging
concept for banking stability , however the number of research in this field is very less.
Therefore, the banking sectors must have adequate knowledge, market analysts should be
able to predict the consequences due to the effect of liquidity risk and credit risk for
banking stability and policy makers should formulate proper plans and policies in order
to mitigate the risk arises due to liquidity risk and credit risk on BFIS etc.The study
findings add additional literature to the effect of liquidity risk and credit risk on banking
stability of commercial banks. It also provides a basis for further and future study in this
area. Hence, this type of study will be very beneficial.
1.5 Operational definitions and assumptions

This section describes and defines the various independent and dependent variables used
in this study based on the major assumptions made to conduct the study. To identify the
effect of liquidity risk and credit risk on banking stability of Nepalese commercial banks.
This study has used banking stability (proxy for z-score) as dependent variable and net
interest margin, loan portfolio, total assets, non-performing loans, liquidity ratio, GDP,
and inflation as independent variables. These variables have been defined and discussed
as under:

1.5.1 Dependent variables

Bank stability (Bank risk)

Banking stability is used for proxy of Z-score. The idea of using a more simplified
measure for assessing the financial stability motivated Mercieca et al. (2007) to develop
the Z-score. Groeneveld and De Vries (2009), applied the Z-score to two types of banks:
commercial banks and co-operative banks, in order to quantify the financial stability of
these two between the years ( 2002 and 2007). Their findings show that the average Z-
score has a higher value for co-operative banks in comparison to commercial banks. Z-
score is used in the current study to estimate insolvency risk in Nepalese banking sectors.
Z-score can be reflected as an extent to which banks have the ability to absorb the losses
and riskiness. Thus, a higher value of Z-score indicates lower risk and greater stability.
The Z-score has been used widely to measure the stability of financial institutions in
empirical studies (see Iannotta et al. 2007; Liu and Wilson, 2013, and Liu et al., 2013).

In order to compute the Z-score, following indicators should be considered: ROA (return
on assets), total Equity/total Assets ratio and the standard deviation of ROA. Z-score is
computed using formula:

E
RO´ A ij +
T A ij
Z RO A = ( 1)
ij
σ RO A ij
 E
RO´ Eij +
T A ij
Z RO E = (2)
ij
σ RO Eij

Where, ROA and ROE are the average return on assets and average return on equity and
σROA and σROE are average standard deviation of return on assets and return on equity
respectively. E/TA is the current period value equity over the assets of each bank.

1.5.2 Independent variables

Net interest margin

It is a measure of the difference between the interest income generated by banks and the
amount of interest paid out of their lenders relative to the amount of their interest earning
assets. Net interest margin how large a spread between interest revenue and interest costs
management has been able to achieve by close control over eraning assets and pursuit of
the cheapest sources of funding dividing it is calculated by dividing net interest income
by average earning assets. Net interest margin measures the gap between the interest
income the bank receives on loan and securities and interest cost of its borrowed funds.
Keeley (1990) showed that there is a positive relationship between bank’s net interest
margin and banking stability. It indicates that higher the net interest margin, banking
system would be more stable. Anbar & Alper (2011) The net interest margin has an
important impact on profitability. Flannery (1981) investigated the positive relationship
between net interest margin and bank’s profitability.

H1: There is positive relationship between net interest margin and banking stability.

Total assets (Bank size)

Total asset is used as proxy of the bank size. Vinh and Mai (2016) bank size has positive
relationship with the bank stability. Bank size as measured by total assets is one of the
control variables used in analyzing performance of the bank system (Smirlock, 1985).
Bank size is generally used to capture potential economies or diseconomies of scale in the
banking sector. This variable controls for cost differences in product and risk
diversification according to the size of the financial institution. This is included to control
for the possibility that large banks are 52 NRB Economic Review likely to have greater
product and loan diversification. In most finance literature, natural logarithm of total
assets of the banks is used as a proxy for bank size. The effect of bank size on
profitability is generally expected to be positive (Smirlock, 1985). Likely, a positive
relationship between size and bank profitability could be found if there are significant
economies of scale (Akhavein et al. 1997; Bourke 1989; Molyneux and Thornton 1992;
Bikker and Hu 2002; Goddard et al. 2004). In view of theory and empirical evidences, a
positive relationship is expected between bank size and bank’s performance

H2: There is a positive relationship between total assets (size) and banking stability.

Loan portfolio

Loan portfolio can be defined as the ratio of total loan of the banks to its total assets. This
artio provides a general measure of financial position of a company, including its ability
to meet financial requirements for outstanding loans. Loan portfolio has negative
relationship with banking stability. It indicates that higher the loan portfolio higher would
be bank’s exposure to risk of failure which leads to banking instability. Hafidiyah and
Trinugroho (2016) showed that there is positive relationship between loan portfolio and
banking stability(Z-score) i.e proxy for return on assets and return on equity. Loan
portfolio has positive and significant impact on banking stability of commercial banks of
Pakistan. It indicates that higher the loan portfolio the banking system would be more
stable. Demirgüç-Kunt and Detragiache (1998) and Hardy and Pazarbasioglu (1998) also
found that the emergence of a banking failure could be attributed to macroeconomic
shocks. In particular, Demirgüç-Kunt and Detragiache (1998) theorized that banks face
insolvency due to falling asset values when bank borrowers are unable to pay their debt
as a result of adverse shocks to economic activity.

H3: There is a positive relationship between loan portfolio and banking stability.

Liquidity ratio

Liquidity ratio is a measurement of a company’s capacity to pay for its liabilities with its

assets. Liquidity risk is caused by various determinants such as elements of liquid assets
or dependence on external funding, as well as factors of a supervisory, regulatory or
macroeconomic character. Higher the liquidity of the bank lower would be financial
stability. Muharam and Penta Kurnia(2012) investigated the banking system both Islamic
and commercial banking with the impact of risk. They considered the liquidity risk as the
critical risk in both banking system. According to Imbierowicz and Rauch (2014)
liquidity risks has negative relationship with bank stability which indicates that higher
the liquidity risk lower the the banking stability. Iqbal (2012) showed that non-
performing loans have a negative relationship with liquidity risk, while return on assets,
return on equity and size have a positive relationship with liquidity risk. However,
evidence suggests that the extent to which banks create liquidity differs by bank size,
ownership structure and the extent to which they are focused on retail banking activities
(Berger et al., 2005).

H4: There is negative relationship between liquidity ratio and banking stability.

Non- performing loan (NPL)

A loan on which the borrower is not making interest payments or repaying any principal
is classified as non-performing loan. Bloem and Gorter (2001) suggested that there is a
negative relationship between liquidity and non-performing loans. The larger bad loans
portfolios will affect the ability of banks to provide credit. Huge non-performing loans
could result in loss of confidence on the part of depositors and foreign investors who may
start a run on banks, leading to liquidity problems. There is a negative and significant
relationship between non-performing loans and liquidity (Bhattacharya & Roy, 2008).
Iqbal (2012) showed that non-performing loan ratio and liquidity ratios are negatively
correlated to liquidity. Michael (2006) emphasized that NPA in loan portfolio affected
operational efficiency which in turn affects profitability, liquidity and solvency position
of the bank. Based on it, this study develops the following hypothesis:

H5: There is negative relationship between non-performing loan and banking stability

Inflation

Inflation has been measured by change in the consumer price index (CPI). Khan(2014)
concluded that an increase in inflation rates will result into a decrease in performance of
commercial in terms of return on assets, return on equity and net interest margin of
Pakistani commercial banks. Srairi (2013) concluded that the inflation rate has a positive
impact on banking stability. Rasiah (2011) revealed that inflation may affect costs and
thus revenues of any business. Boyd and Champ (2003) found that inflation is negatively
associated with financial performance. Based on it, this study develops the following
hypothesis:

H6: There is negative relationship between inflation and banking stability.

Gross domestic product :

Gross domestic product (GDP) is one of the primary indicators used to gauge the health
of a country’s economy. It represents the total dollar value of all goods and services
produced over a specific period; you can think of it as the size of the economy. Hoggarth
et al. (1998) concluded that the behavior of real GDP growth fails to explain the greater
variability of banking sector stability in the UK than in Germany. But they do not say that
GDP growth variability did not affect financial stability. Ghazali (2008) found that GDP
growth and inflation positively influence the revenue of banks. Banking sector stability is
an important driver of future GDP growth. Periods of stability are generally followed by
an increase in real output growth and vice versa, a finding which appears to be driven
predominantly by periods of relative instability rather than by periods of stability. In
addition, we show that banking sector instability is followed by higher uncertainty about
output growth. According to Imbierowicz& Rauch, (2014 ) the coefficient of GDP
growth has a negative effect on banking stability. Hardy and Pazarbasioglu (1998) found
that bank become vulnerable and credit risk increases during the stagnation and recession
period than during the economic growth one. Mokhova and Zinecker (2014) analyzed the
positive and significant impact of GDP growth on the capital. Sufian and Chong (2008)
showed insignificant positive impact of GDP growth and market capitalization on ROA.
Schumacher (2009) found positive contribution of GDP growth on performance of banks.
This helps reduce the risk of banking failure. Based on it, this study develops the
following hypothesis:

H7: There is positive relationship between GDP and banking stability.

1.6 Organization of the study

Organization of study is the examination of how individuals construct structures,

processes and practices and how these in turn, shape whole research project. It comprises
different areas that deal with different aspect of the research report. The study is
organized in five chapters. The overall background of the study is the statement of the
problem, objectives of the study, and organization of the study. The chapter two consists
of conceptual review, review of literatures related to studies in global context as well as
the review of studies in Nepalese context in the field of liquidity risk and credit risk. The
review of literature has been listed in the tabular form with major date, author name and
variables with relationship with other variables. Besides, this chapter ends up with
concluding remarks associated with the findings and major ideas of the studies. The
chapter three covers the research design, nature and sources of data, selection of
enterprises, models used for data analysis and conclusion along with the limitations of the
study. The chapter four focuses on the systematic presentation, analysis and discussion of
data. The chapter five focus on the summary and conclusion of overview on all works
that carried out in chapter one through four including major conclusions. This chapter
also includes a separate section for recommendations and scope for future study based on
major findings of the study and bibliography and appendices are also presented at the end
of the study.
 Chapter II

Literature Survey and Conceptual Framework

This chapter provides the review of some empirical and theoretical literature on the effect
of liquidity risk and credit risk on banking stability of Nepalese commercial bank and
presents the conceptual framework of the study. It is divided into four sections. First
section consists of theoretical framework which gives an in-depth review of related
studies in the context of both developed and emerging financial markets and the globe.
Second section presents review of related studies in the context of Nepal. Third section
presents a theoretical framework of the study. And finally, the fourth section presents
concluding remarks on the conceptual and empirical review.

A literature review is a text written by someone to consider the critical point of current
knowledge including substantive findings, as well as theoretical and methodological
contributions to a particular topic. In this section, the brief review of existing studies has
been presented.

The review of literature has been organized as under:

1. Review of major literature

2. Review of recent literature
3. Review of Nepalese literature

2.1 Review of major literature

Table 2.1 shows the summary of major literature regarding the effect of liquidity risk and
credit risk on banking stability.

Murdock and Stiglitz (2000) revealed that high net interest margin is indicated with a
high risk premium, while the conditions of increasing competition will encourage
speculative behavior of the banking system that could lead to financial instability. The
study used the Pareto-efficient outcomes model. This paper has been studied to
understand the interaction between financial liberalization and prudential regulation.
Financial liberalization tends to increase the intensity of competition between banks at
the same time that banks are given greater freedom to allocate assets and to determine
interest rates.

Table 2.1: Summary of major literature

Study Findings
Murdock and Revealed that there is negative relationship between net interest
Stiglitz (2000) margin and banking stability.
Boyd and De Showed that an increase in the interest rate for loans may
Nicolo (2006) encourage risk-taking behavior among investors, which leads to
increased probability of bank failure and significantly affects
financial stability
Keeley (1990) Found that the effect of size on financial stability is an inverse U-
shaped as a function of the market share indicator.
Ben-Naceur and Found that bank capitalization and credit risk have positive and
Omran (2008) significant impact on banks' net interest margin, cost efficiency
and profitability.

Felix and Revealed that return on equity (ROE) and return on assets (ROA)
Claudine (2008) both measuring profitability were inversely related to the ratio of
non-performing loan to total loan of financial institutions thereby
leading to a decline in profitability.

Caminal and Showed that banks and financial institutions under a monopole
Matutes (2002) context tends to offer huge risky credits that may increase
banking failure probability.

Tabari et al. Showed that there is negative and significant relationship

(2013) between liquidity risk and bank profitability.
González (2005) Found that there is a positive and significant relationship
between size and bank risk-taking.
Flannery (1981) Examined the significant relationship between market interest
and commercial bank profitability.
Saunders et al. Showed that there is a negative relationship between size and
(1990) bank-risk takings.

Samartín (2003) Analysed that liquidity and credit risk is negatively related to
bank
stability.
Li (2007) Revealed that credit risk and liquidity risk have negative impact
on bank’s profitability.
Horváth (2009) Showed that net interest margin has negative significant impact
on banking stability.
Perry (1992) Revealed that inflation has significant positive affect on bank
 stability.

Flannery (1981) examined the significant relationship between market interest and
commercial bank profitability. The study used computed data of 135 banks from 1959 to
1978. The study employed market discount rate, bank’s profit margin , market condition,
bank cost and bank actual profit variables for it. The study revealed that the market that
the market rate levels has significant effect on intermediary costs and revenues.
Tabari et al. (2015) investigated the impact of liquidity risk on performance of
commercial banks in Iran. The data were collected from the year 2003 to 2010 from the
website of the central bank of Islamic republic of Iran. The study considered bank size,
liquidity risk, gross domestic product, bank’s capital and inflation as a proxy variable of
liquidity risk. The result showed that bank’s size, bank’s capital, gross domestic product
and inflation have positive relationship with the bank profitability. However, there is
negative relationship between liquidity risk and bank profitability in Iran.
Bohara (2017) analyzed the effect of bank capital on profitability and risk of Nepalese
commercial banks. The study was based on secondary sources of data which were
collected for the commercial banks of Nepal from 2009 to 2014. The study considered
return on assets, return on equity and variance of return on assets as dependent variables.
However, the study used capital adequacy ratio, liquidity ratio, foreign ownership,
inflation, GDP are positively correlated to bank performance (ROA and ROE).

Shen et al. (2009) investigated the causes of liquidity risk, using an unbalanced panel data
set of 12 advances economies commercial banks over period 1994-2006. The study has
applied panel data instrumental variables regression, using two-stage least squares
(2SLS) estimators to estimate bank liquidity risk as an important determinant of bank
performance. The causes of liquidity risk include components of liquid assets and
dependence on external funding, supervisory and regulatory factors and macroeconomic
factors. Besides, this study found that liquidity risk is negatively related with bank
performance in market based financial system. The result reveals that the increase in
liquidity risk leads to decrease in the bank performance. However, it has no effect on
bank performance in bank based financial system.
Francis (2013) investigated the key determinants of commercial banks’ profitability in
Sub-Saharan Africa. The analysis used an unbalanced panel of 216 commercial banks
drawn from 42 countries in Sub- Saharan Africa for the period 1999 to 2006. Using the
cost efficiency model, bank profitability was estimated using panel random effects
method in static framework. The study revealed that the importance of bank level factors
such as assets, operational efficiency and macro economic factors such as growth in GDP
and inflation in explaining banking profitability. The study found that credit risk have
positive effect on bank profitability. However, operational efficiency and liquidity ratio
were negatively and significantly related to bank profitability.

Li (2007) investigated the determinants of bank’s profitability and its implications on risk
management practices in United Kingdom. The study employed regression analysis on a
time series data between 1999 to 2006 and six measures of determinants of bank’s
profitability were employed. This study examined liquidity, credit and capital as internal
determinants of bank’s performance. GDP growth rate, interest rate and inflation rate
were used as external determinants of bank’s profitability. Retrn on assets (ROA) was
used found that liquidity and credit risk have negative impact on bank’s profitability.

Allen and Gale (2000) investigated how the level of competition affects diversification
and stability using a sample of 978 banks in 55 emerging and developing countries over
an eight year period 2000–2007. We shed further light on the competition-stability nexus
by examining the complex interaction between three key variables: the degree of bank
market power, diversification and stability. The core finding is that competition increases
stability as diversification across and within both interest and non-interest income
generating activities of banks increases. Our analysis identifies revenue diversification as
a channel through which competition affects bank insolvency risk in emerging countries.
The results are robust to an array of controls including alternative methodology, variable
specifications and the regulatory environments that banks operate in. The study showed
that the banking system is more concentrated when the loan portfolio is risky.

García-Marco and Robles-Fernández (2008), examined the determinants of European

bank risk-taking during major financial crisis. Using a sample of banks from 26 countries
over the period 2005–2015. The study examine the nature of the relationship between
bank risk, bank characteristics, regulatory, institutional and macroeconomic variables.
The study used a dynamic panel data modeling structure to capture the potential
discrepancies in risk-taking behavior. The study sub divide the sample into two sub-
samples (East Europe and West Europe countries). The study show that macroeconomic
and regulatory variables seem to have non-negligible impact on bank risk-taking
attitudes. The study has documented the relationship between bank risk, internal and
external factors differs across samples. The Z-score indicator reveals the degree of
exposure to operating losses, which reduces capital reserves that could be used to offset
adverse shocks. Besides, these authors argue that entities with low capital and a weak
financial margin relative to the volatility of their returns will score high on this indicator.

Liquidity has a negative impact on the performance of commercial banks in Euthopia

and there was an inverse relationship between liquidity and return on equity and the
coefficient of liquid assets to total assets were positively and directly related with return
on equity. The study also found that capital adequacy of all banks in Ethopia were above
threshold, means there were sufficient capital that can cover the risk weighted assets. The
study used different ratio when analyzing liquidity effect on bank performance and these
liquid assets/net profit, liquid/total assets, net loans/net deposits, and interest income/net
deposit and income interest (Works,2006).
Aladade et al. (2014) evaluated the impact of credit risk on profitability of nigerian
banks. Financial ratios as measures of bank performance and credit risk were collected
from annual reports and accounts of sampled banks from 2004-2008 and analysed using
descriptive, correlation and regression techniques. The findings revealed that the credit
risk management has a significant impact on profitability of Nigerian banks. It concluded
that banks profitability is inversely influenced by the levels of loan and deposits thereby
exposing the to great risk explain of illiquidity and distress.
Bourke (1989) analyzed the performance of banks in twelve countries or territories in
Europe, North America and Australia. The data collected were analyzed using both
descriptive and regression analysis statistics. This study used multiple regression model
represented by ordinary least square (OLS) as a technique to examine the impact of
liquidity ratio on the financial performance of selected banks. The study found positive
relationship liquidity ratio and profitability.
Horváth (2009) studied the determinants of interest rate margins of Czech banks
employing bank-level dataset at the quarterly frequency in 2000-2006. The study found
that more efficient banks exhibit lower margins and there is no evidence that the banks
with lower margins would compensate themselves with higher fees. The study found that
net interest margin has negative significant impact on banking stability. Larger banks also
tended to charge lower margins, while higher capital adequacy was associated with lower
margins contributing to banking stability.
Campell (2007) showed the significant relationship between non-performing laons
(NPLs) and bank failure. The study used data from 1997 to 2002. The study considered
both the prevention and control of non-performing loans and in so doing will examine
regulatory and supervisory issues as well as initiatives for dealing with impaired assets.
The need for an effective bank insolvency law is crucial factor which is also addressed.
The study found significant role of non-performing loan on the performance of banks.
Lartey et al. (2013) investigated the relationship between the liquidity and profitability of
banks listed on Ghana Stock Exchange. The financial reports of the seven listed banks
were studied and relevant liquidity and profitability ratio were computed. Seven out of
nine listed banks were involved in the study and the study period was from from 2005 to
2010. The trend in liquidity and profitability were determined by use of time series
analysis. The main liquidity ratio was regressed on the profitability ratio. It was found
that there was a very weak positive relationship between the liquidityand the profitability
of the listed banks in Ghana.
Chang et. al. (2013) determined net interest margin dynamics in 141 countries over the
period 1987 – 2008, finding that there exists an inverse relationship between net interest
margin and change in globalization for each country, implying that globalization
improves the efficiency of banking system. Thus net interest margin can be linked to a
variety of macroeconomic, and bank specific parameters – overall macroeconomic
parameters, internal risk controls, management strategy, etc. This study argues for the
hypothesis that net interest margin should be considered in addition to other asset
profitability indicators for evaluating the effectiveness and stability of a bank.
Madi (2016) examined the different types of determinants of financial stability in UK
banks and building societies. It also studied whether there is a difference in these
determinants before and during financial crisis. The study analyzed two periods
separately (i.e. pre-crisis, from 2005 to 2007, and during the crisis, from 2008 to 2010)
using ordinary least squares regression (OLS). The results showed the value of micro and
macro-economic determinants is different between banks and building societies. The
study also found that these determinants differ before and during crisis.
González (2005) investigated that there is a positive and significant relationship between
size and bank risk-taking. It used a panel database of 251 banks in 36 countries to analyze
the impact of bank regulation on bank charter value and risk-taking. The study used two-
stage least squares analysis that includes the influence of regulatory restrictions
Acharya et al (2002). revealed that diversification of loans does not typically improve
performance or reduce risk in Italian banks. The study used a unique data set of 105
Italian banks over the sample period from 1993 to 1999. The study examined the effect of
focus (specialization) vs. diversification on the return and the risk of banks. The study
revealed that industrial loan diversification reduces bank return while endogenously
producing riskier loans for all banks in the sample. The study further found that sectoral
loan diversification produces an inefficient risk-return tradeoff only for high risk banks,
and geographical diversification results in an improvement in the risk–return tradeoff for
banks with low levels of risk.

Imbierowicz& Rauch, (2014) analysed the coefficient of GDP growth has a negative

effect on banking stability. This indicates that higher the GDP growth lower would be the
banking stability. This helps reduce the risk of banking failure. The study used the data
for a panel of 64 advanced and emerging market economies, this special feature
investigates empirically the link between macro prudential policies and economic
performance as measured by output volatility and growth over a five-year period. Long
before the term even existed, macroprudential policies were used to address financial
stability concerns, particularly among emerging market economies (EMEs). Their
popularity has greatly increased in recent years, especially during and after the Great
Financial Crisis (GFC) of 2007-2009.
Srairi (2013) anayzed the Ownership structure and risk-taking behaviour in conventional
and Islamic banks. The study compares risk-taking behaviour of conventional and Islamic
banks in 10 MENA countries under three types of bank ownership (family-owned,
company-owned and state-owned banks) over the period 2005–2009.The study found
that the inflation rate has a positive impact on banking stability. The study also reveals
that different categories of shareholders have different risk attitudes. Family-owned
banks have incentives to take less risk. State-owned banks display higher risk and have
significantly greater proportions of non-performing loans than other banks. By comparing
conventional and Islamic banks, the empirical findings show that private Islamic banks
are as stable as private conventional banks. However, Islamic banks have a lower
exposure to credit risk than conventional banks.
Perry (1992) analyzed that inflation has significant positive affect on banking stability
when it is anticipated and factored into the pricing process. The coefficient of inflation
(INF) is positive and statistically significant that inflation supports rural bank stability. In
effect, an increase in inflation in one quarter results in an improvement in rural bank
stability in the next quarter.

2.2. Review of recent literature

Table 2.2 shows the summary of recent literature regarding the effect of liquidity risk and
credit risk on banking stability.

Table 2.2: Summary of recent literature

Study Findings

Chiaramonte et al. (2015), Found that there is negative relationship between credit risk and
stability.

Diaconu and Oanea (2015) Examined that there is a significant impact on lending activity with
profitability and stability.

Revealed that there is a negative relationship between bank size and

Laeven et al. (2014)
stability.
 Found that liquidity risk has positive significant impact on bank stability
Adusei (2015)

Amidu and Wolfe (2013) Showed that the high net-interest margin of banks is explained by the d
of market power, credit risk, and implicit interest payments.

Shenet al.(2010) Liquidity risk is negatively related to bank performance in market b

financial system.

Akinyomi & Firm size is an important variable in explaining the organis

Olagunju(2011) performance and have a positive effect on the profitability of Nig
manufacturing companies.

Diaconua and Oanea found that GDP is an important factor affecting cooperative banks’ fina
(2014) stability

Bhagat et al. (2015) found a positive relationship between bank size and bank risk taking.

Diaconu and Oanea 2014) Showed that the financial stability of co-operative banks is mainly aff
by net interest margin and interbank offering rate for 3 months.

Analysed the relationship between financial stability and econ

Creel et al. (2015)
performance

Blot et al. (2015) Examined the relationship between net interest margin and financial stab

Srairi (2013) Revealed that the inflation rate has a positive impact on banking stability

Investigated that bank size has a significant negative impact on bank stab
Köhler (2015)

Jahn and Kick (2012) Founded that the most important indicator for the financial stabili
cooperative banks is the credit-toGDP ratio.

Diaconu (2014) Concluded that the cooperative banks are more financially stab
comparison to the commercial banks.

Mesa et al. (2014) Showed that there is a positive relationship between bank size and
efficiency

Found that profitbaility is significantly affected by the liquidity risk.

Khan (2013)

Louzis et al. (2012) Showed that non-performing loans in the Greek banking system are m
 due to the macroeconomic factors, namely GDP growth.

Moussa (2013) The study revealed that there is positive relationship between capita
financial of the banks.

Altaee et al. (2013)  Analyzed that size (represented by total assets) has no statist
significant impact on bank stability.

Kargi (2011) The findings revealed that credit risk management has a significant impa
the profitability of Nigerian banks.

Observed that regulations and incentives that promote private monitorin

Delis et al. (2011)
restrictions on banks’ activities had a positive impact on efficiency

Imbierowicz & Rauch Revealed that there is negative relationship GDP and banking stability.
(2014)

Analyzed that size has no statistically significant impact on bank stabilit

Altaee et al. (2013)

Hussain (2012) examined the determinants of net interest margin in the Pakistani
Banking Industry. The study showed that past net interest margins, bank soundness,
operating cost, industry concentration; relative market share, inflation, real depreciation
and industrial growth have positive impact on net interest margins. However, the study
also showed that diversification, change in bank size, lagged liquidity, stock market
development have negative effect on net interest margins. The study used bank level data
of 26 commercial banks for the period 2001-2010.

Bhagat et al. (2015) investigated the link between firm size and risk-taking among
financial institutions during the period of 1998-2008 and make three contributions. First,
size is positively correlated with risk-taking measures even when controlling for other
observable firm characteristics. This means that an increase in bank size leads to an
increase in bank risk and consequently to a decrease in bank stability. This is consistent
with the notion that “too-big-to-fail” policies distort the risk incentives of financial
institutions. Second, a simple decomposition of the primary risk measure, the Z-score,
reveals that financial firms engage in excessive risk-taking mainly through increased
leverage. Third, we find that bank corporate governance measured as the median director
dollar stockholding has a substantial impact on reducing firms’ risk-taking , Size,
Leverage, and Risk-Taking of Financial Institutions.

Chiaramonte et al. determined the relationship between bank market concentration and
financial stability of financial institutions this variable represents the credit risk that
banks stand, which could negatively affect their stability. Hence, an increase in this ratio
is expected to be negatively associated with bank stability. The study is based on a
sample of cooperative, savings, and commercial banks from OECD countries. To account
for the impact of the recent financial crisis, the study analyze separately the pre‐crisis
period (2001–2006) and crisis years (2007–2010).

Diaconua and Oanea (2014) showed that GDP is an important factor affecting
cooperative banks’ financial stability. The study used the data for the period from 2008
to 2012. The study sample contained only one cooperative bank and 13 commercial
banks. The study revealed that there is the difference between financial stability
determinants of Romania’s commercial and co-operative banks. They found that GDP
growth and interbank offering rate were significantly related to the financial stability of
co-operative banks. However, the study used only macro-economic indicators. In
addition, it did not take into consideration whether those determinants were different
before and during the crisis.

Diaconua and Oanea (2015) interprets that there is a significant relationship between
GDP and financial stability and it is uncertain. The study examined that GDP doesnot
have any kind of influence on the banking stability or GDP does not affect stability.
Hence, we can say that Gross Domestic Product (GDP) is the commonly used
macroeconomic indicators in assessing financial stability.

According to Jahn and Kick (2012) studied the determinants of Banking Stability: A
Macro-Prudential Analysis. The study introduced a continuous and forward-looking
stability indicator for the banking system based on information on all financial
institutions in Germany between 1995 and 2010. Explaining this measure by means of
panel regression techniques, the study identify significant macro prudential early
warning indicators (such as asset price indicators, leading indicators for the business
cycle and money market indicators) and spillovers. Whereas international spillover
effects play a significant role across all banking sectors, regional spillover effects and the
credit-to GDP ratio are most important for cooperative banks and less relevant for
commercial banks. Their empirical findings showed 80 that macro-prudential indicators
are not useful leading indicators for financial stability. They found that the most
important indicator for the financial stability of cooperative banks is the credit-to GDP
ratio. However, this ratio is not important for commercial banks.

Mesa et al. (2014) studied the main determinants influencing bank efficiency. The study
used a sample of 3952 banks in the European Union and the regression analysis method
and analyze the link between bank efficiency and bank size. The study suggest that the
bank efficiency ratio, obtained from the income statement, is positively related to the size
of a bank in terms of total assets. The findings shows that there is a positive relationship
between bank size and bank efficiency, which indicates that bigger the firm size the firm
will be more efficient at different operations or activities or in other word we can say
that such that increasing bank size leads to increasing efficiency and hence to increasing
bank stability.

Kolapo et al. (2012) analysed the empirical investigation into the quantitative effect and
credit risk on the performance of commercial banks in Nigeria over the period of 11 years
(2000-2011). Five commercial banking firms were selected on a cross sectional basis for
eleven years. The traditional profit theory was employed to formulate profit, measured by
Return on Assets as a function of the ratio of non-performing loans to loan and advances,
ratio of total loan and advances to total deposit and the ratio of loan loss provision to
classified loan as measure of credit risk. Panel model analysis was used to estimate the
bank performance measured by Return on Assets of banks in cross sectional invariant.
That is the effect is similar across banks in Nigeria, though the degree to which individual
banks are affected is not captured by method of analysis employed in the study.
Khan (2013) investigated the potential causes of liquidity risk in Pakistani banks and
evaluated their effect on bank's performance. Data were collected from the income
statements, balance sheet and notes of 15 Pakistani banks during 2006-2011.The study
revealed that liquidity risk affect the bank's profitability. Non-performing loans and
liquidity gap are the two factors which exacerbate the liquidity risk i.e., creating a
negative association with bank’s profitability.

Akinyomi and Olagunju (2011) determined the effect of firm size on the profitability of
Nigerian manufacturing sector. The study was based on the panel data set over the period
of 2005-2012 which was obtained from the audited annual reports of the selected
manufacturing firms listed in Stock Exchange. Return on assets(ROA) was used as a
proxy for performance while log of total assets and log of turnover were used as proxies
for firm size. Furthermore, liquidity, leerage and the ratios of inventories to total assets
were used as a control variables. The results of the study revealed that firm both in terms
of total assets and in terms of total sales has positive effect on the profitability of
Nigerian manufacturing companies.

Akter &Mahmud (2014) examined the relationship between liquidity and profitability in
the banjing industry in Bangladesh during the period just before recession (2006) to post-
recession(2011). This study considered twelve banks in four different sectors
( government banks, Islamic banks, Multinational banks and private commercial banks).
The study used linear regression to find out the extent of relationship between bank’s
liquidity and profitability. The regression results revealed insignificant relationship
between liquidity and profitability individually. The finding of the study revealed that
government banks showed variable liquidity, while other sectors were steady. There were
many fluctuation in profitability in between these times in all the sectors. Finally, the
study concluded that based on the sample and category under consideration. There is no
significant relationship between liquidity and profitability in banks of different sectors in
Bangladesh.

Adusei (2015) examined the impact of bank size and funding risk on bank stability. The
study used panel model analysis and three tests are performed to check the suitability .
measured the number of deviations customer deposits mobilized by a bank would have to
fall from the mean to wipe out equity capital or to call for equity recapitalization to
measure the liquidity risk of commercial banks. The higher the liquidity risk the more
stable the funding sources of the bank. It is, therefore, expected that liquidity risk has
positive significant impact on bank stability. The positive relationship between liquidity
risk and bank stability also has important implications for the current debate on funding
of retail banks.

Laeven et al. (2014) explored the relationship between bank size and banking stability. It
analyses the relationship between bank size and bank stability with data from 52
countries and finds that larger banks, on average, create more risks than smaller banks..
The study starts with a descriptive analysis of how the size of large banks has increased
over time, and along which dimensions large banks differ from small banks, using data
for a large cross-section of banking firms in a broad set of 52 countries.
Köhler (2015) determined the impact of business models on bank stability in 15 EU
countries between 2002 and 2011. The study we include in our sample a large number of
unlisted banks, which represent the majority of banks in the EU. We believe this to be
important, since many unlisted banks typically have a more retail-oriented business
model. The study shows that banks will be significantly more stable and profitable if they
increase in bank size. The study analysed that there is a negative relationship between
bank size and bank stability, which indicates that that larger banks are less stable than
smaller banks.

Altaee, Talo, and Adam (2013) examined the stability of the banking system that
underpins through an effective bank monitoring mechanism since the sector is resilient to
a range of single and combined shocks. Banks financial stability in the Gulf Cooperation
Council (GCC) countries was empirically assessed by using z-score as a dependent
variable. A group of macro and microeconomic independent variables were selected to
measure their effects on banks stability. All banks in this region that are considered
Conventional or Islamic banks were selected. The targeted period was 2003-2010 to
cover pre- and post- financial crisis. It was found that there is no evidence that there is a
significant difference between the financial stability of Conventional and Islamic banks
for the periods 2003-2010, 2003-2007, and 2008-2010. However, Conventional banks
tend to be financially stronger than Islamic banks for the pre- financial crisis. The study
test the stability of banks in the Gulf Cooperation Council countries and find, among
other things, that size (represented by total assets) has no statistically significant impact
on bank stability. The obvious conclusion from the above is that the relationship between
size and stability is inconclusive. Thus, there is scope for the further interrogation of this
relationship. What is the effect of the size of a rural bank on its stability.

Diaconu and Oanea (2015) showed the most important determinants of Credit Coop’s
stability for the period of 2008 to 2013. Using data covering subsidiaries in 34 countries
during the period from 2008 to 2013, they found that there was no relationship between
GDP and financial stability. The study used OLS regression model and used the internal
variables ROA, liquidity, loan to deposit ratio, equity to assets ratio, operating expenses
and macroeconomic variable i.e. GDP growth and per capita income. The study showed
that financial stability affects the profitability of Credit Coop. The study sought to
identify the determinants of profitability and financial stability of cross-country Credit
Coop subsidiaries by taking into account more specific data for each county. It indicated
that the lending activity has a significant positive effect on profitability and negative
effect on stability. The study further concluded that profitability is negatively correlated
to stability. It means that a higher profitability, doesn’t necessary implies a higher
stability.

2.3. Review of Nepalese literature

Table 2.3 shows the summary of Nepalese literature regarding the effect of liquidity risk
and credit risk on banking stability of Nepalese commercial banks.

Table 2.3: Summary of Nepalese literature

Study Findings

Kattel (2014) Showed that private owned banks are more financially sound than
joint venture banks.

Paudel (2012) Concluded that credit risk management is crucial on the bank
performance since it have a significant relationship with bank
 performance.

Bhattarai (2016) Examined the effect of credit risk on performance and found that
non performing loan has negative effect on bank performance which
leads to financial stability.

Concluded that there is positive relationship between return on

Pradhan (2016)
assets and bank size.

Found that there is a negative relationship between liquidity and

Rai et al.(2017)
financial stability.

Revealed that return on assets have positive relationship with bank

Bajracharya
size.
(2017)

Examined that gross domestic product, Inflation, bank size has a

Pradhan and
positive impact on profitability of Nepali Oil Corporation.
Shah(2015)

Revealed that liquidity has a negative impact on the financial

Pradhan &
performance of the banks.
Shrestha (2015)

Explored the various credit risk management indicators that affected

Poudel (2012)
banks’ financial performance and found that the most indicator
affected the bank financial performance was the default rate.

Found that bank size and capital adequacy ratio has impact on ROA,
Singh (2017)
ROE, NIM. Whereas, liquidity ratio has negative and significant
impact on bank performance.

Bhattarai (2016) examined the effect of credit risk on performance of Nepalese

commercial banks. The descriptive and causal comparative research designs have been
adopted for the study. The pooled data of 14 commercial banks for the period 2010 to
2015 have been analyzed using regression model. This study concludes that there is
significant relationship between bank performance and credit risk indicators. The finding
of the study shows that non performing loan has negative effect on bank performance
which leads to financial stability. which indicates that lower the credit risk and non
performing loan of BFIS higher will be the firm stable and far sighted

Bajracharya (2017) investigatedthe impact of liquidity management on profitability of

Nepalese commercial banks based on 160 observations of 16 commercial banks of Nepal
for the period 2005-2014.investment ratio, net credit ratio, bank size, quick-acid ratio and
leverage were selected as independent variables while return on assets and return on
equity are dependent variables. The study revealed that return on assets has positive
relationship with bank size.

Pradhan (2016) studied the impact of working capital management on profitability of

Nepalese commercial banks found positive relationship of return on assets with
banksize , bank age and financial leverage. However return on assets has negative
relationship with credit risk, cash conversion cycle and liquidity management ratio. The
profitability in terms of ROA and ROE and net interest margin were selected as
dependent variables. Cash conversion cycle, liquidity ratio, credit risk, leverage ratio,
bank size and bank age are taken as independent variables and survey was based on 105
observations from 15 commercial banks for the period of 2008-2014.

Kattel (2014) analysed the financial soundness of joint venture banks and private sector
banks in Nepal by using bankometer model for the period covering 2007- 2012. The
bankometer model was used developed according to International Monetary Fund
guidelines. The study has found that all the private and joint venture banks are in sound
financial position. The finding of the study reveals that private sector banks are
financially sounder in comparison to joint venture banks. The study concludes that
bankometer model will help the bank's internal management to mitigate the insolvency
risk within proper control and supervision at the operational level.

Poudel (2012) examined the various parameters pertinent to credit risk management as it
affect banks’ financial performance. Such parameters covered in the study were; default
rate, cost per loan assets and capital adequacy ratio. Financial report of 31 banks were
used to analyze for eleven years (2001-2011) comparing the profitability ratio to default
rate, cost of per loan assets and capital adequacy ratio which was presented in descriptive,
correlation and regression was used to analyze the data. The study revealed that all these
parameters have an inverse impact on banks’ financial performance; however, the default
rate is the most predictor of bank financial performance. BFIS should be able to reduce
the default rate of banking sector because the default rate is the most predictor of bank
financial performance, on the contrary of the other indicators of credit risk management
The recommendation is to advice banks to design and formulate strategies that will not
only minimize the exposure of the banks to credit risk but will enhance profitability.

Bhusal et al.(2015) investigated a relationship between bank size, non-performing laon

with banks performance. This study used multiple regression analysis on 110
observations of 11 commercial banks of Nepal from 2004 to 2013. This study revealed
positive relationship between bank size with return on assets. Whereas non-performing
loan has a negative and significant relationship with return on equity.

Pradhan and Shah (2015) investigated the major factors affecting the profitability in
Nepal Oil Corporation. The study was descriptive and causal comparative research
designs to deal with the fundamental issues associated with the impact ofbank specific
and macro-economic variables on profitability of Nepal Oil Corporation. The study
period was from 2004 to 2014.The results showed that operating cost and interest rate
have a negative impact on profitability whereas Gross domestic product; Inflation and
size have a positive impact on profitability. This implies that the profitability of Nepal
Oil Corporation depends on macroeconomic factors and microeconomic factors. Thus
government policies on employment and investments should be intensified to increase the
profitability of Oil Corporation.

Parajuli (2016) examined the factors influencing the profitability of domestic and foreign
commercial banks of Nepal. The return on assets, return on equity and net interest margin
are selected as the dependent variables. Capital adequacy, assets quality, liquidity and
bank sizes. The analysis was based on a panel data set of 18 commercial banks and 6
foreign banks in Nepal over the period of 2008/9-2012/13. A multiple regression model
has been applied to estimate the relationship between dependent variables and
independent variables. Liquidity is also positively related to bank profitability and
significant with ROA and ROE. Similarly, bank size is positively related to domestic and
foreign commercial banks ROA, ROE and NIM.

Singh (2017) revealed that capital adequacy ratio, bank size and credit risk have positive
impact on bank performance. Regarding the macroeconomics variables, economic growth
and inflation positively related return on assets and return on equity. Estimated regression
models are used to analyze the impact of bank specific and macro-economic variables on
financial performance. The study is based on the 180 observations of 18 commercial
banks for the period of 2009-2014.

2.4 Conceptual framework

A conceptual framework is an analytical tool with several variations and contexts.

Conceptual framework of the study describes the systematic explanation of the impact of
independent variables upon dependent variables for the purpose of clarifying the stability
of Nepalese commercial bank. It helps to define the focus and goal of the research
problem. Based on the objective of the study and the literature review following
conceptual framework is framed to summarize the main focus and scope in terms of
variables included.

This section provides the conceptual framework of study and describes about variables
that have been used in study and the relationship between the variables. In this study,
dependent variable is banking stability (and risk) of the commercial banks of Nepal
which is measured by using Z-score ROA and Z-score ROE. The independent variables
are net interest margin, liquidity ratio, credit risk, total assets, loan portfolio GDP and
inflation. Thus, the following conceptual model is framed to summarize the main focus
and scope of this study in terms of variables included. The conceptual frameworks that
describe the dependent and independent variables used in the study are shown in the
Figure 2.
Figure 2.1: Schematic diagram on effect of liquidity and credit risk on banking
stability
Dependent variables Independent variables

 Liquidity risk
 Credit risk
 Total assets
Bank stability (risk)  Loan portfolio
 NIM
 Inflation
 GDP

Bank stability or risk is measured by Z-score ROA and Z-score ROE. Similarly, net
interest margin (NIM) is the ratio of the difference between interest income and interest
expense divided by total assets, Liquidity risk is defined as ratio of liquid assets to total
assets, Credit risk is defined as the proportion of non-performing loan in total bank
loans, Total assets, loan portfolio defined as loan to total assets, GDP is defined as the
real GDP growth per capita, and inflation is defined as overall percentage increase in
consumer price index for all goods and services.

2.5 Concluding remarks

Financial stability has become an important task for economic policy in every country.
And the investors are also interested in analyzing the riskiness and profitability of bank
operations and their overall performance in banking sector. Financial stability is a system
that can be defined as stability in the absence of excessive volatility and crises. As the
banking system becomes ever more important in its role of a financial intermediary, the
modern concept of asset management and allocation continues to evolve. It therefore
mitigates the likelihood of disruptions in the financial intermediation process which are
severe enough to significantly impair the allocation of savings to profitable investment
opportunities. Laeven et al. (2014) explores the relationship between bank size and
banking stability. Köhler(2015)analysed the impact of business models on bank stability
in the EU banking sector for the period between 2002 and 2011. Among other things, the
study reports that bank size has a significant negative impact on bank stability, which
indicates that that larger banks are less stable than smaller banks. However, Altaee, Talo,
and Adam (2013) showed that the financial stability of banks in GCC countries: Pre and
post financial crisis. Perry (1992) analyzed that inflation has significant positive affect on
banking stability when it is anticipated and factored into the pricing process. Li and Zou
(2014) found that the indicator of Nonperforming loans had positive impact on banks
stability as measured by return on equity (ROE) and return on assets (ROA). Abdelrahim
(2013) concluded that liquidity and bank size affected strongly on effectiveness of credit
risk management.
In context of Nepal, Thagunna and Poudel (2013) found no significant relationship
between efficiency level and ownership structure of bank. The study also found no
notable differences in the efficiency level of banks according to their asset size. Singh
(2013) revealed that effective risk management was critical to any bank for achieving
financial soundness. Bhattarai (2016) examined the effect of credit risk on performance
and found that non performing loan has negative effect on bank performance which leads
to financial stability.which indicates that lower the credit risk and non performing loan of
BFIS higher will be the firm stable and far sighted.

Specifically, this study has attempted to carry out distinctly from other previous studies
in terms of sample size, nature of the sample firms and the research methodology used.
This study has covered 20 banks with eight years of data. Thus, it is being believed that
this study is different from earlier studies of Nepalese context and attempts to analyze the
effect of liquidity risk and credit risk on banking stability of Nepalese commercial banks.
The importance of this study may be viewed from its contribution to fill an important gap
in literature and also findings of this study can add value to the existing body of the
literature.
 Chapter III

Research Methodology

Research methodology is a systematic way to solve a problem. It is a science of studying

how research is to be carried out. Essentially, the procedures by which researchers go
through their work of describing, explaining and predicting phenomena are called
research methodology. Research methodology is used to collect information and data and
sets out overall plan associated with a study. This chapter therefore explains the
methodology that is employed in this study which includes various sections describing
research plan and design, description of the sample, instrumentation, data collection
procedure and time frame, validity and reliability of the study and analysis plan. In the
absence of methodology, it is likely that the conclusions drawn may be misunderstood.
This chapter, therefore, explains the methodology employed in this study. In this chapter,
the context of the study is presented, which provides the background against which the
findings of the study were assessed form which reliability and dependable conclusions
were made. Thus, this chapter provides a description of research plan and design, nature
and sources of data, selection of enterprises, method of analysis and empirical models for
the study.

3.1 Research design

The research design undertaken in this study consists of descriptive and causal
comparative research design to deal with the fundamental issues associated with the
effect. The descriptive research design has been adopted for fact finding and searching
adequate information about the effect of liquidity risk and credit risk on banking stability
of Nepalese commercial banks. Descriptive research is a process of accumulating facts. It
describes phenomenon as they exists. Such design involves the systematic collection and
presentation of data to give clear picture of a particular situation. Descriptive research
design helps to reduce data into manageable form. This study also used the causal
comparative research design to establish the cause and effect of liquidity risk and credit
risk on banking stability. Causal-comparative research design attempts to determine the
cause or consequences of differences that already exist between the variables and the
relationship between independent variables, dependent variables and control variables.
This design has been adopted to ascertain and understand the directions, magnitudes and
forms of observed relationship between liquidty risk and credit risk. It determines the
effect of liquidity risk and credit risk on banking stability of Nepalese commercial banks.

3.2 Description of samples

For the study purpose, banks involving services at least for ten years have been
considered for sample. Since, all of them are not provided scope for the study, 20
commercial banks were taken out of 28 as a sample for the period 2009/10 to 2016/17
making total of 160 observations. The 20 ‘A’ classbanks have been selected as sample
size and the study period is presented in table 3.1:

Table 3.1: List of sample banks selected for the study along with the study period
and number of observations

Observation
S.N. Name of the banks Study period s
2009/10-
8
1 Agriculture Development Bank Limited 2016/17
2009/10- 8
2 Bank of Kathmandu Limited 2016/17
2009/10- 8
3 Citizens Bank International Limited 2016/17
2009/10- 8
4 Everest Bank Limited 2016/17
2009/10- 8
5 Global IME Bank Limited 2016/17
2009/10- 8
6 Himalayan Bank Limited 2016/17
7 Kumari Bank Limited 2009/10- 8
 2016/17
2009/10- 8
8 Laxmi Bank Limited 2016/17
2009/10- 8
9 Machapuchhre Bank Limited 2016/17
2009/10- 8
10 Nabil Bank Limited 2016/17
2009/10- 8
11 Nepal SBI Bank Limited 2016/17
2009/10- 8
12 Nepal Bangladesh Bank Limited 2016/17
2009/10- 8
13 Nepal Credit and Commercial Bank Limited 2016/17
2009/10- 8
14 Nepal Investment Bank Limited 2016/17
2009/10- 8
15 NIC Asia Bank Limited 2016/17
2009/10- 8
16 NMB Bank Limited 2016/17
2009/10- 8
17 Prime Commercial Bank Limited 2016/17
2009/10- 8
18 Siddhartha Bank Limited 2016/17
2009/10- 8
19 Standard Charter Bank Nepal Limited 2016/17
2009/10- 8
20 Sunrise Bank Limited 2016/17

Total Observations 160

Thus, the study is based on the 160 observations.

3.3 Nature and sources of data

The section elaborates on how data were collected to carry out this study. The study is
based on the secondary data which are gathered for 20 commercial banks in Nepal for the
period of 8 years from 2009/10 to 2016/17. The variables used in the study are net
interest margin, loan portfolio, total assets, non-performing loans, liquidity ratio, GDP
and inflation. The secondary data are analyzed using the SPSS package. The secondary
sources of data have been employed to understand and analyze the effect of liquidity risk
and credit risk on banking stability of Nepalese commercial banks. The necessary
secondary data and information has been collected from the Annual Reports of selected
commercial banks, Banking and Financial Statistics and Bank Supervision Report
published by Nepal Rastra Bank.

3.4 Method of data analysis

This section deals with statistical and econometric models used for the purpose of
analysis of secondary data. The methods of data analysis used in the study are divided
into two subsections. First section deals with the methods of secondary data analysis.
This includes descriptive statistics and correlation analysis. Second section describes
different statistical tests of significance for validation of model such as t-test, F-test,
detection of and linear regression analysis. All models are tested for individual effects by
running F test using statistical package for social science (SPSS 16). Details of models
and statistical test of significance have been dealt in the following sections.

3.4.1 Model specification

The model

The following regression model is used in this study in an attempt to examine the
empirical relationship of effect of liquidity risk and credit risk on banking stability of
Nepalese commercial bank. Therefore, the following model equation is designed to test
the hypothesis. From the conceptual framework the function of dependent variables (i.e.
banking stability) takes the following form:
More specifically,

Model 1

lnZ-score ROA =β0+lnβ1LR + lnβ2NPL +lnβ3TA+ lnβ4LTA + lnβ5CAR+

lnβ6NIM+lnβ7INF + lnβ8GDP+ eit

Model 2
lnZ-score ROE =β0+lnβ1LR + lnβ2NPL +lnβ3TA+ lnβ4LTA + lnβ5CAR+
lnβ6NIM+lnβ7INF + lnβ8GDP+ eit

Where,

Z = Z- score to measure the banking stability. It is calculated as:

ZROA= Z score on return on assets

ZROE = Z score on return on equity

LIQ =Liquidity defined as ratio of liquid asset to total liability, in percentage.

NPL = Non-performing loan defined as the ratio of non-performing loans to total gross
loans, in percentage.

NIM = net interest margin defined as net income divided by total assets, in percentage

SIZE = Bank size defined in terms of total assets, in millions of rupees.

LTA = loan portfolio defined as loan to total assets, in percentage.

GDP= Dollar value of all goods and services produced over a specific period

INF = Defined as annual inflation rate of change in consumer price index, in percentage

The following section describes the independent variables used in this study.
More specifically, table 3.2 shows the detail description of the variables.

Table 3.2: Description of variables

No Independent Description Measurement
Variables

1 NIM Net interest Difference of total interest income and

margin total interest expenses divided by total
assets.

2 LIQ Liquidity ratio (in Ratio of liquid asset to total liability

percentage)

3 SIZE Size of bank (Rs) Log of total asset

4 NPLR The level of Non- Non-performing loans/Gross loans and

performing loans advances
(ratio)

5 LTA Total loan Ratio of total loans to total assets.

portfolio

6 GDP Gross Domestic Dollar value of all goods and services

Product(%) produced over a specific period

7 INF Inflation rate (%) Percentage change in consumer price

index
3.5 Analysis plan

This section discusses how the analysis has been carried out in chapter four. It is
necessary to follow certain steps and procedures in analyzing data in order to understand
the results and generalize the findings. The analysis of secondary data intends to study
the relationship and cause and effect between the variables. This section is divided into
various subsections first of which deals with the descriptive statistics of the sample
observations including the mean, standard deviation, minimum and maximum values of
the observations. Correlation analyses have been carried out in the second section
followed by the stepwise regression analysis. Test of significance, standard error of
estimate and multi-co linearity have also been tested to make the results more valid. All
the observed relationship and findings have been interpreted to derive the meaningful
conclusions of the effect of liquidity risk and credit risk on banking stability of Nepalese
commercial banks.

3.6 Limitations of the study

Nepalese economy is developing and banking sector is also in infancy stage. The
economic and financial institutions related policies, acts and laws are in the process of
development and reformation during the process. All these do have significant stake in
the banking sectors revenue generation process either through traditional banking
activities or modern banking practices. Effect of liquidity risk and credit risk on banking
stability of Nepalese commercial banks is one of the most important topics to research in
the Nepalese context as liquidity risk and credit risk one of the emerging issues on BFIS.
As every study has a limitation due to different factors of institutions, study period,
reliability of statistical data, tools, techniques and variances. Despite of the continuous
efforts made for arriving at meaningful conclusions from the study, the following major
limitations have been outlined.

1. The study includes only 8 years data (from 2009/10 to 2016/17) of 20 commercial
banks have been taken for the study due to presence of outliers and unavailability of
data of the commercial banks.
2. The study has considered only the secondary data. The data collection conducting
primary survey has not been taken into consideration. Hence, the result of the study is
not broad and flexible. It is limited to the data available in the annual reports of the
sample banks and financial reports published by Nepal Rastra Bank.
3. The study is based on the assumption of linear relationship between dependent and
independent variables. Thus, this study has not considered the non-linearity biases
those are normally characterized in markets of emerging countries.
4. This study assumes a level of homogeneity across banks, which may not be true,
since banks in the study are of different sizes and have different objectives.
5. Only limited statistical and financial tools have been used in the study. Not using
more scientific and sophisticated tools may limit the validity of the study findings.
6. The findings of this study could not be generalized to manufacturing and trading
enterprises because the study is only based on the banking sector.
7. No attempts are made to examine the reliability of the available secondary data since
they are officially released by the related NRB reports. Thus, the consistency of
finding and conclusions are dependent upon the secondary data and information.
8. This study includes data of “A class financial institution only. Various financial
institutions such as development banks, finance companies and insurance company
are not taken into consideration for the study. So, the conclusion drawn from the
study needs precaution for generalizing the findings.

CHAPTER IV

RESULT AND DISCUSSION

This chapter presents the systematic and orderly results of the study in the form of
presentation, interpretation and analysis of the secondary data. The basic steps in the
analytical process consist of identifying issues, determining the availability of suitable
data, deciding the method appropriate for answering the questions of interest, applying
the methods and evaluating, summarizing and communicating the result. Chapter four
provides systematic presentation, interpretation and analysis of secondary data in order to
deal with various issues associated with the effect of liquidity risk and credit risk on
banking stability of the Nepalese commercial banks.

The purpose of this chapter is to analyze and interpret the data collected during the study.
Various statistical tools described in chapter three have been used for this purpose. This
chapter is divided into five sections. The first section deals with structure and pattern
analysis of data, second section deals with descriptive statistics, third section deals with
the correlation analysis, fourth section deals with step wise regression analysis and the
final section wraps up this chapter with concluding remarks about the result derived for
the secondary data.

4.1 Structure and pattern analysis

This chapter deals with the structure and pattern of net interest margin, liquidity ratio,
NPL, bank size (total assets), GDP, inflation and the bank stability(z-score ROA and z-
score ROE) of Nepalese commercial banks. It includes average values and standard
deviations.

4.1.1 Structure and pattern of banking stability

The banking stability, in this study is the dependent variable which is measuredby Z-
score ROA and Z-score ROE.
The structure and pattern of Z-score of return on assets for the period of 2009/10 to
2016/17 has been presented in Table 4.1.

Table 4.1: Structure and pattern of Z-score return on assets

Bank 2009/ 2010/ 2011/ 2012/ 2013/ 2014/ 2015/ 2016/ Me ST

s 10 11 12 13 14 15 16 17 an D

ADB 4.29 0.0

4.328 4.362 4.366 4.326 4.250 4.265 4.277 4.174
L 3 65

2.08 0.0
BOK 2.089 2.091 2.085 2.095 2.081 2.074 2.092 2.047
2 16

7.70 0.0
CTZ 7.624 7.823 7.755 7.659 7.632 7.653 7.679 7.789
2 76

7.30 0.0
EBL 7.325 7.286 7.314 7.309 7.324 7.294 7.314 7.283
6 16

GIM 4.97 0.0

4.982 4.991 4.940 4.941 5.004 5.020 4.997 4.918
E 4 37

6.08 0.0
HBL 6.122 6.085 6.084 6.089 6.076 6.080 6.095 6.052
5 19

6.87 0.0
KBL 6.910 6.934 6.859 6.856 6.865 6.831 6.869 6.863
3 33

LXB 7.51 0.0

7.658 7.499 7.448 7.464 7.461 7.462 7.526 7.597
L 4 76

1.38 0.0
MBL 1.376 1.383 1.410 1.386 1.367 1.370 1.382 1.422
7 19

NABI 6.76 0.0

6.816 6.752 6.772 6.785 6.767 6.755 6.784 6.696
L 6 35

4.19 0.0
NSBI 4.083 4.184 4.162 4.172 4.218 4.280 4.259 4.236
9 63

NBB 1.54 0.0

1.551 1.548 1.542 1.550 1.536 1.531 1.534 1.540
L 1 08

NCC 2.084 2.097 2.067 2.055 2.068 2.063 2.070 2.028 2.06 0.0
 6 20

7.23 0.0
NIBL 7.124 7.228 7.240 7.253 7.240 7.247 7.352 7.168
1 66

NIC 4.91 0.0

4.878 4.896 4.870 4.910 4.907 4.897 4.899 5.021
A 0 47

3.09 0.0
NMB 3.159 3.175 3.139 3.072 3.071 3.029 3.068 3.032
3 57

PRI 5.73 0.0

5.746 5.775 5.718 5.704 5.717 5.715 5.731 5.744
ME 1 23

5.26 0.0
SIBL 5.251 5.315 5.289 5.291 5.291 5.290 5.324 5.087
7 76

SCB 6.51 0.0

6.479 6.484 6.523 6.529 6.514 6.504 6.567 6.536
L 7 29

SUB 2.39 0.0

2.366 2.460 2.390 2.375 2.369 2.366 2.398 2.414
L 2 32

Mean 4.898 4.918 4.899 4.891 4.888 4.886 4.911 4.882

STD 2.156 2.151 2.150 2.151 2.151 2.151 2.164 2.161

The average Z-score return on assets across the years has fluctuated widely over the
period of time. The structure and pattern of average Z-score ROA of selected Nepalese
commercial banks revealed that average mean is highest for CTZ (7.702) followed by
LXBL(7.514),EBL(7.306), NIBL(7.231), KBL(6.873), NABIL(6.766), SCBL(6.517),
HBL(6.083), PRIME(5.731), SIBL(5.267), GIME(4.874), NICA(4.91), ADBL(4.293),
NSBL(4.1999), NMB(3.093), SUBL(2.392), BOK(2.082),NCC(2.066), NBBL(1.541),
MBL(1.387).

Going through the individual bank the z-score ROA varies widely within individual
banks also. The z-score ROA has increased from 7.124 in 2009/10 to 7.168 in 2016/17
for NIBL, from 6.479 in 2009/10 to 6.536 in 2016/17 forSCBL, from 4.878 2009/10 in
to 5.021 in 2016/17 for NICA, from 7.624 in 2009/10 to 7.789 in 2016/17 for CTZfrom
4.083 in 2009/10 to 4.236 in 2016/17 for NSBL, from 2.366 in 2009/10 to 2.414 in
2016/17 for SUBL and from 5.251 in 2009/10 to 5.087 in 2016/17 for MBL.
However, The z-score ROA has decreased from 7.658 in 2009/10 to 7.597 in 2016/17for
LXBL, from 7.325 in 2009/10 to 7.283 in 2016/17 for EBL, from 6.91in 2009/10 to
6.873 in 2016/17 for KBL, from 6.816in2009/10 to 6.696 in 2016/17 for NABIL, from
6.122 percent in 2009/10 to 6.052 in 2016/17 for HBL, from 4.982 in 2009/10 to 4.918
in 2016/17 for GIME, from 4.328 in 2009/10 to 4.174 in 2016/17 for ADBL, from
2.089 to 2.047 in 2016/17 for BOK, from 2.084 in 2009/10 to 2.028 in 2016/17 for NCC
and from 1.551 in2009/10 to 1.54 in 2016/17 for NBBL. The variation in credit to
deposit ratio as indicated by SD is lowest for HBL followed by EBL, SBL, NIBL, MBL,
NBL, LBL, KBL, SCBL, SUNBL, CBL, NCCBL, ADBL, NBBBL, SBI and NMB.

The variation in z-score ROA as indicated by standard deviation is highest for CTZ
followed by LXBL, SIBL , NIBL , ADBL, NMB, NICA, GIME, NABIL, KBL, SUBL,
SCBL, PRIME, NCC, HBL, EBL, BOK and NBBL.

When the z-score ROA is compared over a period of time for individual banks, it may be
seen that z-score ROA has decreased in majority of the selected commercial banks in
recent years.

Theaverage Z-score return on assets is highest for CTZ in every study period from 2009
to 2016/17. However, it is lowest for MBL.

Figure 4.1 shows the pattern of average Z-score return on assets of Nepalese commercial
banks of Nepal.

Figure 4.1: Trend of Z-score return on assets

4.93

4.92

4.91

4.90
Figure 4.1
4.89
indicates the
4.88
pattern of the
4.87

4.86
2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17
banking stability (average Z-score return on assets) of Nepalese commercial banks shows
ups and downs. The figure shows that score is highest in 2010 representing the stability
of Nepalese commercial banks in terms of return on assets. However, the figure shows
that Nepalese commercial banking industry faced a decreasing trend of stability since
2011/12 to 2014/15 following the liquidity crisis in the market. Yet, the Z-score from
2015 shows that the risk in banking sector is decreased or the stability is increased
significantly.

The structure and pattern of Z-score of return on equity for the period of 2009/10 to
2016/17 has been presented in Table 4.2.

Table 4.2: Structure and pattern of Z-score return on Equity

Bank 2009/ 2010/ 2011/ 2012/ 2013/ 2014/ 2015/ 2016/ Me ST

s 10 11 12 13 14 15 16 17 an D
ADB 2.99 0.0
2.996 2.999 2.999 2.996 2.989 2.990 2.991 2.982
L 3 06
2.43 0.0
BOK 2.431 2.432 2.431 2.432 2.431 2.430 2.432 2.427
1 02
2.84 0.0
CTZ 2.842 2.848 2.846 2.842 2.841 2.842 2.843 2.847
4 03
2.37 0.0
EBL 2.376 2.376 2.376 2.376 2.376 2.376 2.376 2.376
6 00
GIM 8.74 0.4
8.771 8.976 8.305 8.309 9.146 9.357 9.058 8.011
E 1 49
4.17 0.0
HBL 4.170 4.170 4.170 4.171 4.170 4.170 4.171 4.169
0 01
4.64 0.0
KBL 4.640 4.646 4.643 4.643 4.643 4.641 4.643 4.643
3 02
LXB 4.79 0.0
4.790 4.793 4.790 4.791 4.791 4.791 4.795 4.799
L 2 03
1.30 0.0
MBL 1.299 1.300 1.302 1.300 1.298 1.298 1.299 1.303
0 02
NABI 2.80 0.0
2.809 2.809 2.809 2.810 2.809 2.809 2.810 2.808
L 9 01
NSBI 4.677 4.689 4.687 4.688 4.691 4.694 4.693 4.692 4.68 0.0
 9 05
NBB 1.58 0.0
1.591 1.591 1.589 1.591 1.588 1.588 1.588 1.589
L 9 01
2.65 0.0
NCC 2.655 2.657 2.652 2.650 2.652 2.652 2.653 2.646
2 03
4.94 0.0
NIBL 4.945 4.945 4.945 4.946 4.945 4.946 4.950 4.942
6 02
NIC 2.56 0.0
2.564 2.565 2.564 2.566 2.566 2.565 2.565 2.572
A 6 02
2.52 0.0
NMB 2.526 2.529 2.526 2.521 2.521 2.517 2.520 2.517
2 04
PRI 5.40 0.0
5.407 5.412 5.407 5.406 5.407 5.407 5.408 5.410
ME 8 02
2.56 0.0
SIBL 2.565 2.568 2.567 2.567 2.567 2.567 2.568 2.560
6 02
SCB 3.53 0.0
3.531 3.530 3.532 3.533 3.532 3.531 3.535 3.533
L 2 01
SUB 1.50 0.0
1.508 1.514 1.509 1.508 1.508 1.507 1.510 1.511
L 9 02
Mean 3.455 3.467 3.433 3.432 3.474 3.484 3.470 3.417
STD 1.743 1.776 1.670 1.671 1.805 1.840 1.791 1.626

Table 4.2 shows that GIME has highest average Z-score return on Equity (8.741)
followed by PRIME (5.408), NIBL (4.946), LXBL (4.792), NSBL (4.689), KBL (4.643),
HBL (4.17), SCBL (3.532), ADBL (2.993), CTZ (2.844), NABIL (2.809), NCC (2.625),
NICA (2.566), SIBL (2.566), NMB (2.522), BOK (2.431), EBL (2.376), NBBL (1.589),
SUBL (1.509) and MBL (1.3).

The average Z-score return on equity across the years has fluctuated widely over the
period of time. The average ZROE is 3.455 in 2009/10 and it is 3.417 in 2016/17. The
highest average ZROE is 3.484 in the year 2014/15.

The Z-score return on equity varies widely within the individual banks also. It increased
from 5.407 in 2009/10 to 5.408 in 2016/17 for PRIME, from 4.945 in 2009/10 to 4.946
in 2016/17for NIBL, from 4.970 in 2009/10 to 4.972 in 2016/17, for LXBL, from 4.64 in
2009/10 to 4.171 in 2016/17 for HBL, from 3.531 in 2009/10 to 3.532 in 2016/17 for
SCBL,from 2.564 in 2009/10 to 2.566 in 2016/17 for NICA, from 32.565 in 2009/10 to
2.566 in 2016/17 for SIBL, from 1.299 in 2009/10 to 1.3 for in 2016/17 MBL, from
2.842 in 2009/10 to 2.844 in 2016/17 for CTZ,

On the other hand, Z-score return on equity decreased from 8.771 in 2009/10 to 8.741 in
2016/17 for GIME, from 2.655 in 2009/10 to 2.652 in 2016/17 for NCC, from 2.526 in
2009/10 to 2.522 in 2016/17 for NMB and from 1.591 in 2009/10 to 1.589 in 2016/17
for NBBL.

The variation in z-score ROE as indicated by standard deviation is highest for

GIMEfollowed by ADBL, NSBI, NMB,LXBL, CTZ, NCC, PRIME, NIBL,
KBL,NICA,SIBL, BOK, SUBL, MBL, HBL, SCBL, NABIL, NBBL and EBL.

Zigure 4.2 shows the pattern of average Z-score return on assets of Nepalese commercial
banks.

Figure 4.2: Trend of Z-score return on equity

3.50

3.48

3.46

3.44

3.42

3.40

3.38
2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17

Figure 4.2 indicates the pattern of the banking stability (average Z-score return on equity)
of Nepalese commercial banks shows ups and downs. The figure shows that score is
highest in 2014/15 representing the stability of Nepalese commercial banks in terms of
return on equity. However, the figure shows that Nepalese commercial banking industry
faced a stagnant trend of stability since 2011/12 to 2012/13 and it is in increasing trend
from 2013/14 to 2014/15 which indicate that the risk in banking sector is decreased or the
stability is increased significantly. While from the year 2014/15 faced a decreasing trend
following the liquidity crisis in the market.

Table 4.3: Structure and pattern of Net Interest Margin

In percentage
2009/ 2010/ 2011/ 2012/ 2013/ 2014/ 2015/ 2016/
Bank Me ST
s 10 11 12 13 14 15 16 17 an D
ADB 6.05 0.6
7.00 6.73 6.49 6.12 5.34 5.56 5.60 5.58
L 2 22
3.40 0.9
BOK 4.14 4.72 3.93 3.78 3.12 3.07 1.94 2.51
2 12
3.15 0.3
CTZ 2.71 3.32 2.86 3.98 3.33 3.06 2.94 3.00
1 98
3.69 0.5
EBL 3.70 3.88 3.74 4.19 4.14 2.90 2.83 4.18
7 46
GIM 3.20 0.5
2.92 3.86 2.09 3.54 2.92 3.31 3.29 3.75
E 9 69
3.68 0.3
HBL 3.73 4.09 3.51 4.10 3.39 3.23 3.45 3.96
4 37
2.99 0.3
KBL 3.32 3.34 3.26 3.47 2.69 2.48 2.77 2.63
5 90
LXB 2.78 0.4
3.11 3.38 2.47 3.10 2.43 2.28 2.39 3.1
L 4 31
2.85 0.6
MBL 2.63 2.67 1.75 3.12 2.74 2.78 3.12 4.06
8 47
NABI 3.97 0.6
4.01 3.98 4.72 4.82 4.11 2.99 3.40 3.81
L 9 13
2.70 0.6
NSBI 2.17 2.18 1.72 2.51 2.86 3.45 3.08 3.65
2 75
NBB 3.51 1.1
5.51 4.94 2.44 3.15 2.76 2.76 3.13 3.40
L 1 09
3.07 0.4
NCC 3.62 3.54 2.52 3.27 3.11 2.69 3.46 2.42
8 77
3.43 0.4
NIBL 3.66 3.74 3.30 4.23 3.48 2.85 3.02 3.17
1 42
NIC 3.07 0.5
3.67 3.96 3.17 2.71 3.49 2.61 2.43 2.56
A 5 79
NMB 2.32 2.75 2.43 3.04 2.65 2.19 2.76 2.87 2.62 0.2
 7 91
PRI 2.95 0.2
2.75 3.15 2.64 3.21 2.79 3.03 2.92 3.10
ME 0 08
3.01 0.2
SIBL 2.68 3.13 2.90 3.43 3.35 2.83 2.85 2.95
6 64
SCB 3.57 0.6
3.65 3.92 4.47 4.22 3.77 2.94 2.84 2.84
L 9 39
SUB 3.31 0.6
3.46 4.40 2.78 3.78 3.69 2.96 2.57 2.91
L 8 20
Mean 3.54 3.78 3.16 3.69 3.31 3.00 3.04 3.32
STD 1.109 0.967 1.125 0.813 0.681 0.681 0.712 0.755

The structure and pattern of non-interest margin of selected Nepalese commercial banks
shows that ADBL has highest average net interest margin is 6.052 followed by NABIL
(3.979 percent), EBL (3.697 percent), HBL (3.684 percent), SCBL (3.318 percent),
GIME (3.209 percent), CTZ (3.151 percent), NCC (3.078 percent), NICA (3.075
percent), SIBL (3.016 percent), KBL (2.995 percent), PRIME(2.950 percent), MBL
(2.858 percent), LXBL (2.784 percent), NSBI (2.702 percent), NMB(2.627) of the period
of time. The average NIM is 3.54 percent in 2009/10 and it is 3.32 percent in 2016/17.
The highest average NIM is 3.78 percent in 2010/11.

The net interest margin varies widely within the individual banks also. It has increased
from 3.70 percent in 2009/10 to 4.81 percent in 2016/17 for EBL ,from 3.73 percent in
2009/10 to 3.96 in 2016/17 for HBL, from 2.92 percent in 2009/10 to 3.75 percent in
2016/17 for GIME, from 2.71 percent in 2009/10 to 3.00 percent in 2016/17 for CTZ,
from 2.68 percent in 2009/10 to 2.95 percent in 2016/17 for SIBL, from 2.75 percent in
2009/10 to 3.10 percent in 2016/17 for PRIME, from 2.63 percent in 2009/10 to 4.06
percent in 2016/17 for LXBL, from 2.17 percent in 2009/10 to 3.65 percent in 2016/17
for NSBI and from 2.32 percent in 2009/10 to 2.87 percent in 2016/17 for NMB.

The net interest margin has decreased from 7.00 percent in 2009/10 to 5.58 percent in
2016/17 for ADBL, from 4.14 percent in 2009/10 to 2.51percent in 2016/17 for BOK,
from 4.01percent in 2009/10 in 2009/10 to 3.81 percent in 2016/17 for NABIL, from 3.65
percent in 2009/10 to 2.84 percent in 2016/17 for SCBL, from 5.51percent in 2009/10 to
3.40 percent in 2016/17 for NBBL, from 3.66 percent in 2009/10 to 3.17 percent in
2016/17 NIBL, from 3.46 percent in 2009/10 to 2.91 percent in 2016/17 for SUBL, from
2.62 percent in 2009/10 to 2.42 percent in 2016/17 for NCC, from 3.67 percent in
2009/10 to 2.56 percent in 2016/17 for NICA and from 3.32 percent in 2009/10 to 2.63
percent in 2016/17 for KBL.

The net interest margin is biggest for ADBL through the study period i.e. 2009/10 to
2016/17. It is smallest for NSBI in 2009/10, in 2010/11, in 2011/12, in 2012/13, for
LXBL in 2013/14, for NMB in 2014/15 and for BOK in 2015/16.

The variation in net interest margin as indicated by standard deviation is highest for
NBBL followed by BOK, NSBI, MBL, SCBL, ADBL, SUBL NABIL, NICA, GIME,
EBL, NCC, NIBL, CTZ, KBL,HBL, NMB, SIBL,and PRIME

Figure 4.3 shows the pattern of average net interest margin of Nepalese commercial
banks of Nepal.

Figure 4.Trend of net interest margin

4.00

3.50

3.00

2.50

2.00

1.50

1.00

0.50

0.00
2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17

Figure 4.4
indicates the decreasing trend of average non interest margin computed over the
observation period. The average noninterest margin has increased from 3.54 percent to
3.78 percent from the year 2010 to 2011. However it has decreased to 3.16 percent in the
year 2012. Likewise net interest margin has increased to 3.69 percent in 2013. Similarly,
NIM has decreased to 3.31 percent in 2014 3.00 percent in 2015 but it has increased to
3.04 percent in the 2016. It has increased to 3.32 percent in 2017. In overall the figure
shows that the net interest margin has been decreased in Nepalese banking industry after
lots fluctuations in the years.

4.4 Structure and pattern of total assets

The structure and pattern of total assets (TA) for the period of 2009/10 to 2015/16 has
been presented in Table 4.7:

Table 4.4: Structure and pattern of total asset (size) of selected Nepalese commercial
banks for the period of 2009/10 to 2016/17

(Rupees in billions)
2010/1 2011/1 2012/1 2013/1 2014/1 2015/1 2016/1
Banks 2009/10 Mean STD
1 2 3 4 5 6 7

86.23 28.77
ADBL 54.02 59.24 63.52 77.10 86.51 100.81 111.79 137
2 2

44.94 24.59
BOK 23.40 24.76 28.88 32.55 39.03 44.97 79.65 86.30
2 1

34.29 18.49
CTZ 16.52 16.82 20.07 25.98 32.22 41.49 55.12 66.11
1 9

76.14 29.85
EBL 41.38 46.24 55.81 65.74 70.45 99.17 113.89 116.51
8 9

54.80 35.40
GIME 17.20 17.52 30.66 39.02 60.54 69.19 87.70 116.59
3 7

71.06 24.07
HBL 42.72 46.74 54.36 61.15 73.59 82.80 99.86 107.26
0 1

KBL 20.52 20.49 25.13 28.22 31.02 37.37 42.42 62.64 33.47 14.06
 7 8

37.99 17.58
LXBL 20.95 21.56 26.03 29.82 34.98 45.58 54.66 70.39
7 4

39.10 18.57
MBL 20.68 19.61 24.36 30.30 40.72 48.75 59.46 68.93
0 0

90.42 34.21
NABIL 52.08 58.10 63.25 73.34 90.29 118.70 127.30 140.33
4 6

140.697 76.04 30.71

NSBI 46.09 58.06 64.80 61.08 59.28 78.52 99.83
3 3 6

30.30 16.11
NBBL 12.53 14.00 20.17 21.80 30.87 39.48 46.68 56.92
9 5

28.75 18.69
NCC 12.76 13.26 18.59 24.89 25.22 29.94 34.35 71.02
5 0

90.71 34.72
NIBL 57.31 58.36 65.76 73.15 86.17 104.35 129.78 150.82
1 3

50.69 28.63
NICA 20.31 22.09 25.58 45.82 51.50 60.52 80.46 99.27
4 3

38.89 28.16
NMB 13.23 15.95 18.49 25.14 30.61 45.18 75.68 86.87
3 7

PRIM 39.73 19.29

20.22 22.09 27.16 32.41 38.03 45.80 54.40 77.77
E 4 3

44.14 21.53
SIBL 22.80 24.41 29.58 33.65 40.28 50.65 74.40 77.41
7 6

54.03 13.68
SCBL 40.21 43.81 41.68 45.63 53.32 65.06 65.19 77
9 8

34.66 20.30
SUBL 16.92 15.85 21.28 26.13 29.66 37.39 58.56 71.56
8 3

Mean 33.32 30.35 35.92 42.83 50.31 61.32 76.49 92.04

STD 29.184 16.474 17.206 19.026 21.275 26.124 27.871 27.785

The structure and pattern total assets (size) of selected Nepalese commercial banks
showed that average is total assets (size) highest for NIBL (Rs. 90.711 billion) followed
by NABIL (Rs. 90.404 billion), ADBL (Rs. 86.232 billion), EBL (Rs. 76.148 billion),
NSBL (Rs. 76.043 billion), HBL (Rs. 71.060 billion), GIME (Rs. 54.803 billion), SCBL
(Rs 54.039 billion), NICA (Rs. 50.694 billion), BOK (Rs. 44.942 billion), SIBL
(Rs.44.147 billion), PRIME (Rs. 39.734 billion), MBL (Rs. 39.10 billion), NMB (Rs.
38.893 billion), LXBL (Rs. 37.997 billion), SUBL (Rs. 34.668 billion), CTZ (Rs. 34.291
billion), KBL (Rs 33.477 billion),NIBL (Rs 30.309 ) and NCC (Rs. 28.755 billion).

The average total assets (size) across the years have fluctuated widely over the period of
time. The total asset (size) varies widely within the individual banks also. It has all
increased from 57.31billion in 2009/10 to 150.82 billion in 2016/17 for NIBL, from
52.08 in 2009/10 to 140.33 billion in 2016/17 for NABIL, from 54.02 in 2009/10 to 137
billion in 2016/17 for ADBL, from41.38 billion in 2009/10 to 76.148 billion in 2016/17
for EBL, from 42.72 billion in 2009/10 to 107.26 billion in 2016/17 for HBL, from 17.20
billion in 2009/10 to116.59 billionforGIME,from 40.21billion in 2009/10 to 77billion in
2016/17 for SCBL, from 20.31billion in 2009/10 to 99.27 billion in 2016/17 for NICA,
from 23.40 billion in 2009/10 to 86.30 billion in 2016/17 for BOK, from 22.80 billion in
2009/10 to 77.41 billion in 2016/17 for SIBL, from 20.22 billionin 2009/10 to 77.77
billion in 2016/17 in 2016/17 for PRIME, from 20.68 in 2009/10 to 68.93 billion for
MBL, from 13.23 billion in 2009/10 to 86.87 billion in 2016/17 for NMB, from 20.95
billion in 2009/10 to 70.39 billion in 2016/17 for LXBL, from 16.92 billion in 2009/10
to 71.56 billion in 2016/17 for SUBL, from 16.52billion in 2009/10 to 66.11 billion in
2016/17 for CTZ, from 20.52 billion in 2009/10 to 62.64 billion for in 2016/17 KBL,
from 12.53 billion in 2009/10 to 56.92 billion in 2016/17for NBBL and from 12.76
billion in 2009/10 to 71.02 billion in 2016/17 for NCC.

The total assets has been decreased from 140.6973billion in 2009/10 to 76.043 billion in
2016/17 for NSBI for overall study period.
The variation in total assets as indicated by standard deviation is highest for GIME
followed by NIBL,NABIL,NSBI,EBL,ADBL, NICA, NMB, BOK, HBL, SIBL, SUBL,
PRIME, NCC, MBL, CTZ, LXBL, NBBL, KBL, and SCBL.

The total asset (size) is biggest for NIBL in 2016/17,in 2009/10 for NSBI, in 2016/17 for
NABIL, It is smallest for NBBL in 2009/10, for NBBL in 2009/10, for NCC in 2009/10,
for SUBL in 2009/10, for CTZ in 2009/10.

Figure 4.8 shows the trend of average total asset (size) of Nepalese commercial banks.

Figure 4.8: Trend of Total Assets

100
90
80
70
60
50
40
30
20
10
0
2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17

Figure 4.8
reveals that average total asset (size) has increasing trend during the study period. The
average loan has increased to 92.04 billion in year 2016/17 from 33.32, 30.35, 35.92,
42.83, 50.31, 61.32, 76.49billion in year 2009/10, 2010/11, 2011/12, 2012/13, 2013/14
and 2014/15 2016/17 respectively. The figure shows that in every year total assets is

Table 4.5: Structure and pattern of loan to total assets (LTA) of selected Nepalese
commercial banks for the period of 2009/10 to 2016/17.
 (Rupees in percentage)
2009/ 2010/ 2011/ 2012/ 2013/ 2014/ 2015/ 2016/ Mea ST
Bank
s 10 11 12 13 14 15 16 17 n D
ADB 65.7 4.9
62.71 58.17 62.07 64.45 66.10 68.03 71.11 73
L 05 09
71.0 3.0
BOK 71.23 70.56 65.14 69.31 72.51 70.92 73.10 75.42
23 16
69.9 2.7
CTZ 65.30 72.98 70.41 67.60 69.78 68.64 71.91 73.00
53 10
64.1 4.5
EBL 66.59 67.17 64.34 66.01 67.53 54.94 59.67 67.00
56 20
GIM 68.6 1.6
69.53 70.61 66.19 67.18 69.01 70.73 67.52 68.02
E 00 45
65.8 2.6
HBL 65.50 67.54 64.32 64.96 61.59 64.58 67.84 70.28
26 59
70.2 1.0
KBL 71.95 71.38 70.09 68.63 70.59 70.22 69.52 69.87
81 42
LXB 68.4 3.3
69.49 70.50 63.30 66.05 65.19 68.37 72.51 72.00
L 26 22
70.6 3.2
MBL 69.10 73.49 64.06 69.86 71.34 70.27 73.39 73.77
62 17
NABI 62.1 3.6
61.96 65.46 65.78 63.22 60.56 55.18 59.78 65.11
L 34 00
53.5 9.1
NSBI 45.94 46.36 45.03 44.43 57.76 67.44 59.83 62.00
99 57
NBB 61.2 5.1
62.32 60.36 51.22 58.76 60.38 64.16 68.49 65
L 92 01
NCC 62.65 66.61 66.92 61.98 68.45 69.58 71.12 72.67 67.4 3.7
65.7 3.7
NIBL 70.36 70.42 63.32 63.43 60.37 63.46 65.85 69.00
76 63
NIC 69.0 3.3
62.69 67.60 67.41 68.87 70.53 69.64 72.65 73.00
A 49 03
66.3 4.8
NMB 59.03 70.28 65.27 65.61 66.86 60.40 71.02 72.13
26 04
PRI 71.5 3.5
68.98 76.49 69.60 65.50 71.27 71.21 74.03 75.00
ME 11 81
72.0 3.6
SIBL 73.04 75.33 68.35 68.60 67.50 71.75 74.39 77.41
45 31
SCB 46.1 4.1
39.68 42.06 46.97 50.03 48.71 42.55 48.02 51.00
L 28 55
SUB 70.5 2.9
71.19 75.14 67.23 67.86 67.22 70.56 73.21 72.00
L 51 27
Mean 64.46 66.93 63.35 64.12 65.66 65.63 68.25 69.82
STD 8.465 9.051 7.181 6.454 5.867 7.393 6.705 5.898
Table 4.5 shows that average LTA is highest for SIBL (72.045 percent) followed by
PRIME (71.511 percent), BOK (71.023 percent), MBL (70.662 percent), SUBL (70.551
percent), KBL (70.281 percent), CTZ (69.953 percent), NICA (69.049 percent), GIME
(68.6 percent), LXBL (68.426 percent), NCC (67.497 percent), NMB (66.326 percent),
HBL (65.826 percent), NIBL (65.776 percent), ADBL (65.705 percent), EBL
(64.156percent), NABIL (62.134 percent), NBBL (61.292 percent), NSBL (53.599
percent) and SCBL (46.128 percent).

The average LTA across the years have fluctuated widely over the period of time. The
average LTA is 64.46 percent in 2009/10 and it is 69.82 percent in 2016/17.

The LTA varies widely within the individual banks also. It has increased from 74.04
percent to 77.41 percent for SIBL, from 68.98 percent to 75.00 percent for PRIME, from
71.23 percent to 73.77 percent for BOK, from 69.10 percent to 73.77 percent for MBL,
from 71.19 percent to 72.00 percent for SUBL, from 71.95 percent to 69.87 percent for
KBL, from 65.30 percent to 73.00 percent for CTZ, from 62.69 percent to 73.00 percent
for NICA, from from 69.53 percent to 68.02percent for GIME, from 69.49 percent to
72.00 percent for LXBL, from 62.65 percent to 72.67 percent for NCC , from 59.03
percent to 72.13 percent for NMB, from 65.50 percent to 68.00 percent for HBL, from
70.36 percent to 69 percent for NIBL and from 73.04 percent to 74.39 percent for SIBL.
Similarly, LTA has decreased from 61.96 percent to 59.78 percent for NABIL, from
66.59 percent to 59.67 percent for EBL, from 70.36 percent to 65.85 percent for NIBL,
from 62.71 percent to 73 percent for ADBL, from 66.59 percent to 67 percent for EBL,
from 61.96 percent to 65.11 percent for NABIL, from 62.32percent to 65 percent for
NBBL, from 45.94 percent to 53.599 percent for NSBI, and from 39.68 percent to 51.00
percent for SCBL.

The variation in total assets as indicated by standard deviation is highest for NSBI
followed by NBBL, ADBL, NMB, EBL, SCBL, NCC, NIBL, SIBL, NABIL, PRIME,
LXBL, NICA, MBL, BOK, SUBL, CTZ, HBL, GIME, and KBL.
The LTA is highest for SIBL in 2016/17, PRIME in 2010/11, SUBL in 2016/17 BOK in
2016/17 CTZ in 2010/11. The LTA is lowest for SCBL in 2009/10, in 2010/11, in
2014/15 NSBI in 2011/12, in 2012/13.

Figure 4.9: shows the pattern of Average loan to total assets trend of Nepalese
commercial banks.

Figure 4.9: Trend loan to total assets (LTA)

72

70

68

66

64

62

60
2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17

Figure 4.9 indicates the pattern of average loan to total assets of Nepalese commercial
banks shows ups and downs. The figure shows that loan to total assets of Nepalese
commercial banks is rising from 2009/10 to 2010/11, from 2011/12 to 2012/13 and from
2014/15 to 2016/17 while it is decreasing from 2010/11 to 2011/12 and from 2013/14 to
2014/15. From the graph, it is observed that there are fluctuations in the average loan to
total assets so its trend line is upward slopping. The average minimum loan to total assets
is 63.35 percent in the year 2011/12 and average maximum loan to total assets is 69.82
percent in the year 2015/16. Overall, this figure shows that the average loan to total assets
is in increasing trend.
Table 4.6: Structure and pattern of total liquidity ratioof selected Nepalese
commercial banks for the period of 2009/10 to 2016/17.

Bank 2009/ 2010/ 2011/ 2012/ 2013/ 2014/ 2015/ 2016/ Me ST

s 10 11 12 13 14 15 16 17 an D
ADB 29.3 4.2
26.14 25.71 36.65 32.27 30.43 28.74 23.33 31.18
L 1 51
0.9
BOK 8.32 8.1 8.72 9.41 6.82 9.98 8.71 7.71 8.47
81
10.3 3.7
CTZ 9.04 10.13 17.53 13.24 11.48 8.21 6.74 6.34
4 16
16.3 3.9
EBL 15.53 9.55 17.22 15.19 16.19 24.27 16.61 16.52
9 97
GIM 29.7 6.7
14.15 27.23 34.13 32.25 31.11 30.12 35.14 33.54
E 1 66
1.2
HBL 6.76 5.75 8.72 6.08 8.72 8.32 6.27 7.25 7.23
12
2.9
KBL 8.02 5.74 13.52 12.43 13.62 7.48 8.74 9.28 9.85
70
LXB 11.7 4.9
7.24 9.22 19.60 12.33 18.28 12.59 7.17 7.32
L 2 66
3.2
MBL 5.89 5.89 15.34 11.07 9.24 11.02 6.84 7.2 9.06
92
NABI 3.5
3.02 4.90 8.60 9.32 11.32 14.15 6.77 10.02 8.51
L 63
1.1
NSBI 9.03 7.11 8.33 9.58 9.43 10.92 8.33 10.04 9.10
76
NBB 18.1 4.1
14.16 13.58 24.15 21.01 22.98 15.24 15.34 19.03
L 9 65
25.5 6.7
NCC 20.29 15.85 22.90 25.42 23.73 37.64 26.46 31.82
1 44
11.7 4.3
NIBL 7.80 7.77 13.60 16.00 19.20 12.00 7.20 10.51
6 22
NIC 27.3 1.9
26.01 27.4 28.84 29.27 28.68 28.91 23.79 25.8
A 4 63
13.1 5.7
NMB 6.02 6.85 18.91 23.35 13.72 13.32 10.81 12.52
9 81
PRI 12.4 2.4
12.86 10.38 17.80 12.96 11.18 10.83 10.17 13.27
ME 3 91
3.9
SIBL 5.66 5.61 11.86 9.60 17.22 8.63 6.00 8.68 9.16
24
SCB 15.5 7.4
6.74 6.10 22.40 16.43 21.18 24.03 7.98 19.71
L 7 91
SUB 24.25 24.32 32.40 33.51 34.03 30.70 28.31 30.61 29.7
 L 7
Mean 11.85 11.86 19.06 17.54 17.93 17.36 13.54 15.92
STD 7.157 7.850 8.688 8.793 8.281 9.481 8.932 9.548

Table 4.6 shows that average LIQ is highest for SUBL (29.77 percent) followed by
GIME (29.71 percent), ADBL (29.31 percent), NICA (27.34 percent), NCC (25.51
percent), NBBL (18.91 percent), EBL (16.39percent), SCBL (15.57 percent), NMB
(13.19 percent), PRIME (12.43 percent), NIBL (11.76percent), LXBL (11.72 percent),
CTZ (10.34 percent), KBL (9.85 percent), SIBL (9.16 percent), NSBI (9.10 percent),
MBL (9.06 percent), NABIL (8.51 percent), BOK (8.47 percent) and HBL (7.23
percent).

The average LIQ across the years have fluctuated widely over the period of time. The
average LIQ is 11.85 percent in 2009/10 and it is 15.92 percent in 2016/17.

The average liquidity (LIQ) across the years have fluctuated widely over the period of
time. Theliquidity(LIQ)varies widely within the individual banks also. It has all increased
from 24.25percent in 2009/10 to 30.61percentin 2016/17 for SUBL, from 14.15 percent
in 2009/10 to 33.54 percent in 2016/17 for GIME, from 26.14 percentin 2009/10 to
31.18 percentin 2016/17 for ADBL, from 20.29 percentin 2009/10 to 31.82 percent in
2016/17 for NCC, from 14.16 percent in 2009/10 to 19.03 percentfor NBBL, from 15.53
percent in 2009/10 to 16.52 percent in 2016/17 for EBL, from 6.74 percent in 2009/10
to 19.71 percent in 2016/17 for SCBL, from 6.02 percent in 2009/10 to 12.52 percent in
2016/17 for NMB, from 12.86 percent in 2009/10 to 13.27 percent in 2016/17 for
PRIME, from 7.80 percent in 2009/10 to 10.51 percent in 2016/17 for NIBL from 7.24
percent in 2009/10 to 7.32 percent IN 2016/17 for LXBL, from 8.02 percent in 2009/10
to 9.28 percent in 2016/17 for KBL, from 5.66 percent in 2009/10 to 8.68 percent in
2016/17 for SIBL, from 9.03 percent in 2009/10 to 10.04 percent in 2016/17 for NSBI,
from 5.89 percent in 2009/10 to 7.2 percent in 2016/17 for MBL, from 3.02 in 2009/10
to 10.02 in 2016/17 for NABIL and from 6.76 in 2009/10 to 7.25 in 2016/17 for HBL.

The average liquidity is decreasing from 8.32 percent in 2009/10 to7.71 percent in
2016/17 for BOK.from26.01 percent in 2009/10 to 25.8 percent in 2016/17 for
NICA,andfrom 9.04 percent in 2009/10 to 6.34 percent in 2016/17 for CTZ,
The variation in liquidity as indicated by standard deviation is highest for SCBL
followed by GIME, NCC, NMB, LXBL, NIBL, ADBL, NBBL, EBL, SIBL, CTZ,
NABIL, MBL, KBL, PRIME, NICA, HBL, NSBI, BOK and SUBL.

The LIQis highest for NCC in 2014/15, ADBL in 2011/12, SUBL in 2013/2014, in
2012/2013, in 2011/2012, in 2014/2015, GIME in 2011/12, in 2012/2013The LTA is
lowest for SCBL in 2009/10, in 2010/11, HBL in 2010/2011, in 2009/10, MBL in
2016/2017.

Figure 4.6: shows the pattern of total liquidity ratiotrend of Nepalese commercial banks.

Figure 4.6: Trend total liquidity ratio

25

20

15

10

0
2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17

Figure
4.9 indicates the pattern of average liquidity ratio of Nepalese commercial banks shows
ups and downs. The figure shows that liquidity ratio of Nepalese commercial banks is
stagnant from 2009/10 to 2010/11, and it is in increasing trend from 2010/11 to 2012/13
and from 2012 /13 to 2015/16 while it is in decreasing trend and consequently it is in
increasing trend from 2015/16. From the graph, it is observed that there are fluctuations
in the average liquidity ratio so its trend line is downward slopping.

Table 4.7: Structure and pattern of total non-performing loan of selected Nepalese
commercial banks for the period of 2009/10 to 2016/17.

2009/ 2010/ 2011/ 2012/ 2013/ 2014/ 2015/ 2016/

Bank Me ST
s 10 11 12 13 14 15 16 17 an D
ADB 6.46 1.9
8.36 8.99 8.98 5.85 5.46 5.35 4.36 4.36
L 4 92
2.14 0.8
BOK 1.5 1.82 2.3 1.5 1.06 3.47 2.51 3.00
8 22
1.72 0.8
CTZ 0.31 1.17 2.01 2.01 3.4 1.53 1.38 2.02
9 88
0.52 0.2
EBL 0.16 0.34 0.84 0.62 0.97 0.66 0.38 0.25
8 90
GIM 2.33 0.4
2.50 2.85 2.77 2.27 2.55 2.23 1.89 1.6
E 3 28
2.49 1.1
HBL 3.52 4.22 2.09 2.89 1.96 3.22 1.23 0.85
8 63
2.02 1.1
KBL 0.5 1.12 2.21 2.89 4.03 2.49 1.15 1.82
6 32
LXB 0.91 0.4
0.12 0.9 0.62 1.51 1.15 1.3 0.8 0.93
L 6 29
MBL 0.5 1.12 2.21 2.84 1.78 0.64 0.55 0.38 1.25 0.9
 3 20
NABI 1.71 0.5
1.47 1.77 2.33 2.13 2.23 1.82 1.14 0.8
L 1 42
0.23 0.1
NSBI 0.14 0.11 0.54 0.37 0.26 0.19 0.14 0.1
1 54
NBB 0.96 0.5
0.647 1.918 0.429 1.33 1.135 1.33 0.17 0.76
L 5 69
6.57 4.4
NCC 2.88 1.07 1.92 4.15 9.20 10.69 11.19 11.50
5 86
1.41 0.9
NIBL 0.62 0.94 3.32 1.91 1.77 1.25 0.68 0.83
5 08
NIC 1.84 0.8
2.01 2.50 2.42 2.32 2.33 2.07 0.76 0.36
A 6 18
1.28 0.9
NMB 0.7 0.27 2.45 2.45 1.8 0.55 0.42 1.66
8 09
PRI 1.29 0.7
0.42 0.57 0.76 2.23 2.43 1.83 1.23 0.88
ME 4 75
1.44 0.8
SIBL 0.53 0.79 0.52 2.39 2.75 1.8 1.47 1.3
4 34
SCB 0.51 0.2
0.61 0.62 0.78 0.77 0.48 0.34 0.32 0.19
L 4 17
SUB 2.76 1.4
0.9 3.51 3.52 3.74 4.94 2.9 1.22 1.37
L 3 46
Mean 1.421 1.830 2.151 2.309 2.584 2.283 1.650 1.748
STD 1.899 2.010 1.873 1.267 2.075 2.334 2.442 2.514

Table 4.8 shows that average NPL is highest for NCC (6.575 percent) followed by ADBL
(6.464 percent), SUBL (2.763 percent), HBL (2.498 percent), GIME (2.333percent),
BOK (2.148 percent), KBL(2.026percent), NICA (1.846 percent), CTZ(1.729
percent),NABIL (1.711 percent), SIBL (1.444 percent), NIBL (1.415 percent), PRIME
(1.294 percent), NMB (1.288 percent), MBL (1.253percent), NBBL (0.965 percent),
LXBL (0.916 percent), EBL (0.528 percent), SCBL (0.514percent) and NSBI (0.231
percent).

The average NPL across the years have fluctuated widely over the period of time. The
average NPL is 1.421 percent in 2009/10 and it is 1.748 percent in 2016/17.

The NPL varies widely within the individual banks also. It has increased from 2.88
percent to 11.5 percent in 2016/17 for NCC, , from 0.9 percent to 1.37 percent in
2016/17 for SUBL, from 1.5 percent to 3 percent in 2016/17 for BOK, from 0.5 percent
to 1.82 percent in 2016/17 for KBL, from 0.31 percent to 2.02 percent in 2016/17 for
CTZ, from 0.53 percent to 1.3 percent in 2016/17 for SIBL , from 0.62 percent to 0.83
percent in 2016/17 for NIBL, from 0.42 percent to 0.88 percent in 2016/17 for PRIME,
from 0.7 percent to 1.66 percent in 2016/17 for NMB, from 0.647 percent to 0.76 percent
in 2016/17 for NBBL, from 0.12 percent to 0.93 percent in 2016/17 for LXBL, and from
0.16 percent to 0.25 percent in 2016/17 for EBL.

It has decreased from 1.47 percent in 2009/10 to 0.8 percent in 2016/17 for NABIL,
from 8.36 percent in 2009/10 to 4.36 percent in 2016/17 for ADBL from 0.14 percent in
2009/10 to 0.1 percent in 2016/17 for NSBI. from 0.14 percent in 2009/10 to 0.1
percent in 2016/17 for NSBI. from 0.61 percent in 2009/10 to 0.19 percent in 2016/17
for SCBL, from 0.5 percent in 2009/10 to 0.38 percent in 2016/17 for MBL, from 3.52
percent in 2009/10 to 0.85 percent in 2016/17 for HBL, from 2.5 percent in 2009/10 to
1.6 percent in 2016/17 for GIME and from 2.01 percent in 2009/10 to 0.36 percent in
2016/17 for NICA,

The variation in non-performing loan as indicated by standard deviation is highest for

NCC followed by ADBL, SUBL, HBL, KBL, MBL, NMB, NIBL, CTZ, SIBL, BOK,
NICA, PRIME, NBBL, NABIL, LXBL, GIME, EBL.SCBL, and NSBI.

The NPL is highest for NCC in 2015/16, for ADBL in 2010/2011, 2011/12, 2009/10. The
NPL is lowest for NSBI in 2016/17, in 2015/16 in 2010/11, in 2014/15 LXBL in
2010/11, in 2015/16.
 Trend of non-performing loan (NPL)

3.00

2.50

2.00

1.50

1.00

0.50

0.00
2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17

Figure 4.9
indicates the pattern of average non-performing loan of Nepalese commercial banks
shows ups and downs. The figure shows thatnon-performing loan of Nepalese
commercial banks is rising from 2009/10 to 2013/14, from 2013/14 to 2015/16 and from
2015/16 to 2016/17it is in increasing trend. From the graph, it is observed that there are
Table 4.7 Structure and pattern of total GDPof selected Nepalese commercial banks
for the period of 2009/10 to 2016/17.

The growth in GDP is regarded as as dollar value of all goods and services produced over
a specific period in an economy. Table 4.9 exhibits the structure and pattern of inflation
rate from period of 2009/10 to 2016/17. The table shows that the gross domestic product
in percentage .the GDP is maximum in the year 2016/17with 6.94 percent, followed by
the year 2013/14 with 6.00 percent, 2009/10 and 2011/12with 4.80 percent, 2012/13with
4.10 percent, 2010/11with 3.40percent, 2015/16 with 2.73percent.and 2015/16with 0.77
percent. Likewise, the growth of GDP is highest for the year 2016/17(796 percent)
followed by 2013/14 (46.34), 2011/12(-29.16), 2012/13 (-14.58), 2010/11(-29.16),
2014/15 (-54.5)and2015/16 (-71.79)

Table:

Year GDP % Change

2009/10 4.80 -

2010/11 3.40 -29.16

2011/12 4.80 29.16

2012/13 4.10 -14.58

2013/14 6.00 46.34

2014/15 2.73 -54.5

2015/16 0.77 -71.79

2016/17 6.94 796

 Trend of Average of gross domestic product (GDP)

GDP
8
7
6
5
4
3
2
1
0
2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17

The trend of GDP indicates that there is decreasing trend of GDP from 2009/10 to
2010/11. It is increasing from 2010/11 to 2011/12, decreasing from 2011/12 to 2012/13,
increases from 2013/14 and it again decreases in 2014/15

Table 4.8: Structure and pattern of inflation of selected Nepalese commercial banks
for the period of 2009/10 to 2016/17.

The growth in inflation is regarded as rise in general price level of goods and services in
an economy.Table 4.9 exhibits the structure and pattern of inflation rate from period of
2009/10 to 2016/17. The table shows that the inflation rate maximum in the year
2009/10with 12.60 percent, followed by the year 2013/14 and 2016/17 with 9.90 percent,
2009/10 and 2010/11 with 9.60 percent, 2014/15 with 9.10 percent, 2012/13 with 8.30
percent, and 2015/16 with 7.20 percent.Likewise, the growth of inflation is highest for
the year 2016/17 (37.5 percent) followed by 2013/14 (19.28), 2014/15 (-8.08),2012/13 (-
13.54), 2015/16 (-20.88), and for the year 2010/11 (-23.81).

Table:

Year INF % Change

2009/10 12.60

2010/11 9.60 -23.81

2011/12 9.60 0

2012/13 8.30 -13.54

2013/14 9.90 19.28

2014/15 9.10 -8.08

2015/16 7.20 -20.88

2016/17 9.9 37.5

Figure 4.10 shows the pattern of average inflation rate in different fiscal year2010 to
2017 in Nepal.

Figure 4.10. Trend of average inflation rate

 14

12

10

0
2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17

When the inflation rate is compare over the observation period, it is noticed that the
inflation has fluctuated. Figure 4.9 shows the decreasing trend of inflation over the
observation period.

4.2 Descriptive statistics

The descriptive statistics used in this study consist of mean, standard deviation,
minimum, and maximum values associated with variables under consideration. Table
4.10 summarizes the descriptive statistics of variables used in this study during the period
2009/10 to 2015/16 for 20 commercial banks of Nepal.

Table 4.10: Descriptive statistics

Descriptive statistics

(This table shows the descriptive statistics of dependent and independent variables of
commercial banks for the study period of 2009/10 to 2016/17. Dependent variables are
Z-score ROA and Z-score ROE. They can be defined as Z- score to measure the banking
stability and independent variables areNIM ( net interest margin defined as net income
divided by total assets, in percentage), LIQ(Liquidity defined as ratio of liquid asset to
total liability, in percentage), NPL (Non-performing loan defined as the ratio of non-
performing loans to total gross loans, in percentage), TA (Bank size defined in terms of
total assets, in millions of rupees), LTA (loan portfolio defined as loan to total assets, in
percentage) GDP (gross domestic product can be defined as dollar value of all goods
and services produced over a specific period) and INF (annual inflation rate defined as
change in consumer price index, in percentage)

Variables Minimum Maximum Mean Std. Deviation

ZROA 0 8.2 1.733 0.848
ZROE 0.1 76.6 21.325 13.618
NIM 1.72 7 3.355 0.897
TA 2.53 5.02 3.792 0.606
LTA 3.68 4.35 4.182 0.124
LIQ 3.02 37.64 15.536 8.814
NPL 0.1 11.5 1.997 2.072
GDP 0.77 6.94 4.192 1.810
INF 7.2 12.6 9.525 1.455

The net interest margin varies from a minimum of 1.72 percent to a maximum of 7
percent leading to an average of 3.355 percent. Similarly, total assets varies from a
minimum of 2.53 billions to a maximum of 5.02 billions leading to an average of 3.792
billions. The loan portfolio varies from a minimum of 3.68 percent to a maximum of 4.35
percent leading to an average of 4.182 percent. Liquidity varies from a minimum of 3.02
percent to a maximum of 37.64 percent leading to an average of 15.536 percent.
Similarly, non performing loan varies from a minimum of 0.1 percent to a maximum of
11.5 percent leading to an average of 1.997 percent. Similarly, gross domestic product
(dollar value of all goods and services produced over a specific period) varies from
minimum of0.77 percent to maximum of 6.94 percent leading to an average of 4.192
percent. The annual inflation rate varies from a minimum of 7.2 percent to a maximum of
12.6 percent leading to an average of 9.525 percent.

Correlation results

Having indicated the descriptive statistics, Pearson correlation coefficients are computed
and the results are presented in Table 4.12. More specifically, it shows the correlation
coefficients of dependent and independent variables for selected Nepalese commercial
banks.

Table 4.11: Pearson correlation matrix for selected Nepalese commercial banks
(This table shows the bivariate Pearson’s correlation coefficients between dependent and
independent variables of commercial banks for the study period of 2009/10 to 2016/17.
Dependent variables are Z-score ROA and Z-score ROE. They can be defined as Z- score
to measure the banking stability and independent variables areNIM ( net interest margin
defined as net income divided by total assets, in percentage), LIQ(Liquidity defined as
ratio of liquid asset to total liability, in percentage), NPL (Non-performing loan defined
as the ratio of non-performing loans to total gross loans, in percentage), TA (Bank size
defined in terms of total assets, in millions of rupees), LTA (loan portfolio defined as
loan to total assets, in percentage) GDP (gross domestic product can be defined as
dollar value of all goods and services produced over a specific period) and INF (annual
inflation rate defined as change in consumer price index, in percentage)

ZRO ZRO
NIM TA LTA LIQ NPL GDP INF
A E
ZRO
1
A
ZRO
.508** 1
E
NIM .519** .287** 1
TA .107 .419** .125 1
LTA -.249** -.251** -.044 -.136 1
LIQ .070 -.259** .206** -.002 .007 1
NPL .026 -.156* .377** -.019 .167* .503** 1
GDP .041 -.016 .082 -.015 -.007 .092 .033 1
INF .110 -.085 .099 -.347** -.077 -.110 -.056 .585** 1

**. Correlation is significant at the 0.01 level (2-tailed).

*. Correlation is significant at the 0.05 level (2-tailed).

The result shows that there is positive relationship of net interest margin and total assets
with z-score return on assets. This means that higher the net interest margin, the bank
would be more stable. It also indicates that larger the firm’s total assets, higher would be
the bank stability. However, there is negative relationship of loan portfolio with z-score
return on assets. It indicates that increase in loan portfolio leads to decrease in banking
stability position. The result also shows that there is positive relationship of liquidity and
NPL with z-score return on assets. It indicates that higher the liquidity position, bank
would be more stable. Likewise, higher the non performing loan higher would be bank
stability. Similarly, inflation has positive relationship with inflation and GDP. It indicates
that increase in annual inflation rate and gdp, the bank will be more stable.

The result shows that net interest margin is positively correlated with z-score return on
equity. It indicates that increase in net interest margin leads bank more stable. Likewise,
total assets is also positively correlated with z-score return on equity which reveals that
larger the firm size, banking sector would be more stable. However, loan portfolio,
liquidity, non performing loan are neagatively correlated with z-score return on equity.
Similarly, gross domestic product and annual inflation rate has also negative relationship
with z-score reurn on equity. It indicates that increase in gross domestic product and
annual inflation rate leads to banking sector less stable.

Regression analysis

Having indicated the Pearson correlation coefficients, the regression analysis has been
computed and results are presented in the above table. More specifically, it shows the
regression result of dependent and independent variables for Nepalese commercial banks.
 Table 4.12: Estimated regression results of NIM, LIQ, TA , LTA, NPL , INF,GDP
on banking stability (ZROA)

The results are based on the panel data of 20 commercial banks with 160 observations
for the period of 2009/2010 to 2016/17 by using linear regression model. The model
islnZ-score ROA =β0+ β1lnLR + β2lnNPL + β3lnTA+ β4lnLTA + β5lnCAR+
β6lnNIM+ β7lnINF + β8lnGDP+ eit. Dependent variable is Z-score on return on assets
(ZROA). The independent variables are net interest margin (NIM defined as total interest
income minus total interest expenses divided by total earning assets, in percentage),
LIQ(Liquidity defined as ratio of liquid asset to total liability, in percentage), NPL (Non-
performing loan defined as the ratio of non-performing loans to total gross loans, in
percentage), TA (Bank size defined in terms of total assets, in millions of rupees), LTA
(loan portfolio defined as loan to total assets, in percentage), GDP (gross domestic
product can be defined as dollar value of all goods and services produced over a specific
period) and INF (annual inflation rate defined as change in consumer price index, in
percentage).

Ad
Regression result with Z-score ROA j
Inte SE
Mode F
rcep r2 E
l
t
NP IN
NIM TA LTA LIQ GDP
L F

0.491
0.087 0.2 0.7 58.
1 (7.629)
(0.392) 65 26 19
**

0.41
1.168
9 0.0 0.8 1.8
2 (2.75)*
(1.34 05 45 1
*
8)

3 8.842 -1.7 0.1 0.8 10.

 (-
(4.017)
3.23 53 23 44
**
1)**

1.628 0.007
0.0 0.8 0.7
4 (11.95 (0.88 42 48 84
2)** 5)

1.712 0.011
0.0 0.8 0.1
5 (18.31 (0.326 61 5 06
8)** )

0.0
1.652
19 0.0 0.8 0.2
6 (9.724)
(0.5 05 49 67
**
17)

0.06
1.125
0 0.0 0.8 1.9
7 (2.534)
(1.38 06 45 23
*
7)

0.05
-0.121 0.486
9 0.2 0.7 29.
8 (- (7.477)
(0.61 62 28 176
0.298) **
8)

-
0.01 1.53
6.477 0.48
8 5 0.3 0.7 24.
9 (3.247) (7.624)
(0.18 (- 07 05 52
** **
7) 3.37
3)**

10 6.497 0.48 0.01 - 0.003 0.3 0.7 18.

6 1.53 04 07 37
(3.249) (7.544) 2 (0.50
** ** (0.17 3)
3) (-
3.35
 8)**

-
1.32
0.00 2
5.509 0.537 0.004 0.013
8 0.3 0.7 15.
11 (-
(2.717) (7.919) (0.58 (2.176 26 05 99
(0.08 2.86
** ** 5) )*
9) 8)**

-
0.00 1.32 0.0
5.517 0.537 0.004 0.073
8 2 02 0.3 0.7 13.
12 (2.708) (2.708) (0.58 (2.170
(0.08 (2.8 (0.0 16 00 247
** ** 7) )*
6) 58)* 69)
*

-
0.0
0.04 1.26 0.03
4.777 4.777 1.262 0.006 72
9 2 4 0.3 0.7 11.
13 (2.148) (2.148) (2.69 (0.752 (2.1
(0.46 (- (0.58 15 02 431
* * 3)** ) 41)
4) 2.69 7)
*
3)**

Table 4.12 shows that the beta coefficient of net interest margin (NIM) has a positive
and significant impact on the level of banking stability or risk level (Z score ROA). It
indicates that higher the NIM , higher would be banking stability. This result is consistent
with the findings of Bustamanet al, (2017) and inconsistent with the findings of Keeley
(1990). The result shows that total assets have positive impact on Z score ROA.
However, the beta coefficient are not significant. It indicates that total assets have
positive impact on banking stability.This finding is similar with the findings of Fu et al.
(2014) and Soedarmono et al. (2013). This finding is also similar with the finding of
Pradhan(2016)and Vinh and Mai (2016) and Nigmonov (2010).
However, loan portfolio (loan to total assets) has negative and significant impact on Z
score ROA. This finding is similar with the findings of Stiroh (2004) and This finding is
inconsistent to the findings of (Ismail et al., 2014).
Similarly, the result reveals that there is negative relationship of NPL with z score ROA.
Likewise, the beta coefficients are negative for gross domestic product. It indicates that
higher the gross domestic product, banking sector will be less stable. This finding is
consistent with Imbierowicz& Rauch (2014). The beta coefficients are negative for
annual inflation rate. It indicates that higher the annual inflation rate, lower would be
banking stability.

Table 4.13: Estimated regression results of NIM, LIQ, TA , LTA, NPL , INF, GDP
on banking stability (ZROE)

The results are based on the panel data of 20 commercial banks with 160 observations
for the period of 2009/2010 to 2016/17 by using linear regression model. The model
islnZ-score ROA =β0+ β1lnLR + β2lnNPL + β3lnTA+ β4lnLTA + β5lnCAR+
β6lnNIM+ β7lnINF + β8lnGDP+ eit. Dependent variable is Z-score on return on assets
(ZROA). The independent variables are net interest margin (NIM defined as total interest
income minus total interest expenses divided by total earning assets, in percentage),
LIQ(Liquidity defined as ratio of liquid asset to total liability, in percentage), NPL (Non-
performing loan defined as the ratio of non-performing loans to total gross loans, in
percentage), TA (Bank size defined in terms of total assets, in millions of rupees), LTA
(loan portfolio defined as loan to total assets, in percentage) GDP (gross domestic
product can be defined as dollar value of all goods and services produced over a specific
period) and INF (annual inflation rate defined as change in consumer price index, in
percentage).

Interc Regression result with Z-score ROE Ad

ept j
Mod
 SE
r2 F
E
el
NP GD IN
NIM TA LTA LIQ
L P F

4.352
6.724 0.0 13. 14.
1 (3.759
(1.673) 76 087 132
)**

-
14.342 9.406
0.1 12. 33.
2 (- (3.759 71 40 587
2.301) )**
*

-
27.5
136.68
82 0.0 13. 10.
3 (3.868)
(- 57 22 664
**
3.26
6)**

-
27.552 0.401
0.1 13. 11.
4 (13.30) (- 61 19 39
** 3.376
)**

-
1.02
8
23.377
0.0 3.9 13.
5 (-
(15.75 18 63 492
1.99
8)**
1)*

6 21.818 - 0.0 13. 0.0

0.1 06 659 39
(7.986)
 17

** (-
0.1
96)

-
0.79
28.88
4 0.0 13. 1.1
7 (4.042)
(- 01 611 46
**
1.07
0)

-
23.932 3.614 8.738
0.2 12. 23.
8 (- (3.373 (5.514 21 02 584
3.586) )** )**
**

-
21.0
66.408 3.533 8.166
18 0.2 18. 11.
9 (1.995) (3.366 (5.215
(- 53 944 77
* )** )**
2.76
8)**

-
-
20.5
69.503 4.55 7.979 0.493
72 0.3 22. 10.
10 (2.235) (4.535 (5.454 (-
(- 48 22 99
* )** )** 4.875
2.9)*
1)**
*

- -
-
18.4 0.73
5.504 7.898 0.417
59.589 65 2 0.3 10. 18.
11 (4.753 (5.410 (-
(1.873) (- (- 52 96 275
)** )** 3.643
2.55 1.39
)**
3)* )
 - - -
-
18.4 0.73 0.0
5.067 7.893 0.416
59.86 64 5 75 0.3 10. 15.
12 (4.736 (5.387 (-
(1.873) (- (- (- 48 99 136
)** )** 3.605
2.54 1.39 0.1
)**
5)* 2 54)

-
19.4 - - -
0.2
71.978 5.237 7.223 4 0.438 0.74 0.75
78 0.3 13.
13 9 11
(2.063) (4.812 (4.812 (- (- (- 47 062
(-
* )** )** 2.64 3.705 (1.4 0.87
0.4
6)* )** 17) 1)
39)

The regression result shows that beta coefficients for NIM has positive and significant
impact with ROE at 1 percent level.It reveals that higher NIM higher will be the Z-score
ROE and this result is consistent with Horváth (2009)showed that net interest margin has
negative significant impact on banking stability and Hellman, Murdock and Stiglitz
(2000). The result shows that beta coefficients for total assets has positive and significant
impact on Z-score ROE at 1 percent level.This finding is similar with González
(2005)found that there is a positive and significant relationship between size and bank
risk-taking.Similarly, the beta coefficients are negative and significant for loan to total
assets It indicates that loan to total assets has significant negative impact on Z- score
ROE.

Similarly, the beta coefficient is negative and significant for liquidity at 1 percent level.
This indicates that liquidity has significant negative impact on Z-score ROE.This finding
is similar to Adusei (2015)Found that liquidity risk has positive significant impact on
bank stability.The result shows the betacoefficient of NPL has negative impact on Z-
score ROE. It indicates that higher NPL lower will be Z-score ROE. The beta coefficient
of GDP and inflation has negative impact on Z-score ROE. It indicates that higher GDP
and inflation lower will be banking sector stability.this finding is inconsistent with Perry
(1992)and Srairi (2013)which reveals that inflation has significant positive affect on
bank stability.
4.5 Concluding remarks

This chapter reveals the result of analysis regarding effect ofliquidity risk and credit risk
on banking stability of Nepalese commercial banks. The dependent variable used in this
study are represented by z-score of return on assets and z-score of return on equity. while
the independent variables used in this study are net interest margin, non-performing loan,
total assets, liquidityloan to total assets, gross domestic product and inflation.The result
are based on the secondary data which are collected for 20 commercial banks during the
period 2009/10 to 2016/17.

The Z-score ROA of selected Nepalese commercial banks revealed that average mean is
highest for CTZ (7.702) On the other hand, that GIME has highest average Z-score return
on Equity (8.741 percent ) among the selected commercial banks throughout the study
period. The result indicates that the fluctuation of Z-score return on assets and z-score
return on equity shows the level of stability of banking system for different commercial
banks. Overall increasing trend of banking system stability of commercial bank has
observed during the study period. Few ups and downs is observed on z-score return on
assets. Z-score return on assets has average minimum 4.882 in the year 2016/17 and
average maximum z-score return on assets is observed 4.918 in the year 2010/11.

Similarly, z-score return on equity shows irregularities. It has increased from 2009/10 to
2010/11 while it has decreased sharply from 2011/12 to 2012/13. However, it has
decreased from 2012/13 to 2013/14. It is almost stagnant from 2013/14 to 2014/15. After
the year 2014/15, the z-score return on equity has slightly increased. The average
minimum z-score return on equity is 3.432 in the year 2014/15 and average maximum z-
score return on equity is observed 3.484 in the year 2014/15. Overall, this figure shows
that the average z-score return on equity is in increasing trend.

The average z-score return on assets is highest for CTZ (7.702) and lowest for MBL
(1.387). Commercial banks in Nepal have slightly increasing pattern of z-score return on
assets in recent year.The average z-score return on equity highest for GIME (8.741) and
lowest for MBL (1.3). The average net interest margin is highest for ADBL ( 6.052) and
lowest for LXBL (2.784).The average of total assets is highest for NIBL (90.711) and
lowest for NCC (28.755). The average of non-performing loan is highest for NCC
( 6.575) and NSBI has the lowest of non-performing loan ( 0.231).The average loan to
total assets is highest for SIBL ( 72.045 )and lowest for SCBL (46.128 ).The average
liquidity ratio is highest for HBL (29.77 )and lowest for SUBL ( 7.23).

The descriptive statistics for commercial banks reveals that the average z-score of return
on assets is 1.733, average Z-score of Return on equity is 21.325, average net interest
margin is 3.355 percent, , average total assets is Rs. 3.792 billion, average loan to total
assets ratio is 4.182 percent, average liquidity is 15.536percent, average non-performing
loan is1.99percent, average GDP is 4.192 and average inflation is 9.525percent.

The correlation matrix result shows that there is positive relationship of net interest
margin and total assets with z-score return on assets. There is negative relationship of
loan portfolio with z-score return on assets. The result also shows that there is positive
relationship of liquidity and NPL with z-score return on assets. It indicates that higher the
liquidity position, bank would be more stable. Likewise, higher the non performing loan
higher would be bank stability. Similarly, inflation has positive relationship with inflation
and GDP. It indicates that increase in annual inflation rate and GDP, the bank will be
more stable. The result shows that net interest margin is positively correlated with z-score
return on equity. Total assets is also positively correlated with z-score return on equity.
However, loan portfolio, liquidity, non performing loan are neagativelycorrelated with z-
score return on equity. Similarly, gross domestic product and annual inflation rate has
also negative relationship with z-score reurn on equity.

The regression result of z-score return on assets reveals that net interest margin (NIM)
has a positive and significant impact on the level of banking stability or risk level (Z
score ROA). The result shows that total assets have positive impact on Z score ROA.
However, the beta coefficient are not significant. It indicates that total assets have
positive impact on banking stability and loan portfolio (loan to total assets) has negative
and significant impact on Z score ROA. Similarly, result reveals that there is negative
relationship of NPL with z score ROA. Likewise, the beta coefficients are negative for
gross domestic product. It indicates that higher the gross domestic product, banking
sector will be less stable. The beta coefficients are negative for annual inflation rate.

The regression result of z-score return on equity shows that beta coefficients for NIM has
positive and significant impact with ROE at 1 percent level. The result shows that beta
coefficients for total assets has positive and significant impact on Z-score ROE. There is
negative and significant impact of loan to total assetson z-score ROE.It indicates that loan
to total assets has significant negative impact on Z- score ROE. The beta coefficient is
negative and significant for liquidity. The result shows that NPL, GDP and inflation has
negative impact on Z-score ROE.

CHAPTER V

SUMMARY AND CONCLUSION

This chapter presents the brief summary of the entire study and highlights the major
findings of the study. In addition, the major conclusions are discussed in separate section
of this chapter which is followed by some implications and the recommendations
regarding effect of liquidity risk and credit risk on banking stability of Nepalese
commercial banks. Finally, this chapter ends with the scope of the future study in the
same field.
5.1 Summary

Net interest margin is a measure of the difference between the interest income generated
by banks and the amount of interest paid out to their lenders relative to the amount of
their assets.(Lartey et al.2013). NIM is a major source of bank profits in most emerging
economies. Higher interest margins will increase revenues which act as a buffer to bank
failures. Low interest margins, in contrast, may also bring about a positive effect for both
debtors and banks. It also lowers loan interest rates thus, decreases the probability of
borrower credit risks thereby, enhancing banking stability (Jimenez et al., 2013). As a
major source of the bank’s income, interest margins should be kept at a certain level so as
to maintain profits while simultaneously cushioning banking stability.
Loan portfolio is one of the most important determinants of competitiveness. Loan
portfolio is measured by the ratio of total loans to total assets (LTA).Higher the credit
portfolio, higher would be the bank’s exposure to risk of failure and this suppresses
banking stability (Altunbaet al, 2007; Stiroh& Rumble, 2006). There are numerous ways
of measuring banking power.Hafidiyah and Trinugroho (2016) found that loan portfolio
is positively associated with the Z-Score i.e. proxy of return on assets and return on
equity.

Liquidity ratio is a measurement of a company’s capacity to pay for its liabilities with its
assets. Liquidity risk is caused by various determinants such as elements of liquid assets
or dependence on external funding as well as factors of a supervisory, regulator or
macroeconomic character. Vodova (2010) found that liquidity risk is inevitable factor
that determines the performance of banks. Salman (2004) concluded that the maturity
mismatch is not the only source of liquidity risk. Bhunia and khan (2011) realized that the
liquidity ratio is positively related to ROA and statistically significant.

Laeven et al. (2014) explores the relationship between bank size and banking stability. It
analyses the relationship between bank size and bank stability with data from 52
countries and finds that larger banks, on average, create more risks than smaller
banksKargi (2011)The findings revealed that credit risk management has a significant
impact on the profitability of Nigerian banks. It concluded that banks' profitability is
inversely influenced by the levels of loans and advances, nonperforming loans and
deposits thereby exposing them to great risk of illiquidity and financial instability.

Non-performing loan is one of the major determinants in banking sector to know the
financial stability of BFIS. Non-performing loan is the loan on which the borrower is not
making and interest payment or repaying any principal. Adhikari 2006. Zeng (2012)
concluded that non-performing loan erodes the performance of commercial banks and
reduces profitability as well. The non-performing assets in loan portfolio effect the
operational efficiency which inturns influences profitability, liquidity and solvency
position of co-operative banks (Michealet al.2006)

The major objective of this study is to examine the effect of liquidity risk and credit risk
on banking stability of Nepalese commercial banks. The specific objectives of this study
are as follows: To analyze the structure and pattern of banking stability, liquidity risk and
credit risk of Nepalese commercial banks. To examine the relationship of liquidity risk
and credit risk with stability of Nepalese commercial banks. To identify the most
influencing factor affecting the banking stability of the Nepalese commercial banks.

The magnitude of risk taking depends on the structure and size of the market in which
competition takes place. Credit risk is the main financial risk that hinders the
performance of banks. This risk is varying net worth of the assets due to failure of the
contractual debt of the counter party to meet obligation (Pyle,1997). Through effective
management of credit risk exposure, bank not only support the viability and profitability
of their own business but also contribute to systematic and to an efficient allocation of
capital in the economy.

The default of a small number of customers may result in a very large loss for bank
(Gestel and Baesens, 2008).Hakim and Neaime (2001) tried to examine the effect of
liquidity, credit, and capital on bank performance in the banks of Egypt and Lebanon;
they analyzed that there was a sound risk management actions and application of
commercial banks rules, regulations and laws
In Nepalese context, Poudel (2012) explored the various credit risk management
indicators that affected banks’ financial performance, he found that the most indicator
affected the bank financial performance was the default rate. BFIS should be able to
reduce the default rate of banking sector because the default rate is the most predictor of
bank financial performance, on the contrary of the other indicators of credit risk
management. Singh (2013) revealed that effective risk management was critical to any
bank for achieving financial soundness.

The study is based on the secondary data which were gathered for a sample of 20
commercial banks of Nepal within the time period from 2009/10 to 2016/17, leading to
the total of 160 observations. The secondary data have been obtained from Banking and
Financial Statistics, Nepal Rastra Bank Bulletin published by the central bank of Nepal,
annual audited financial statements and websites of respective commercial banks. The
pooled cross-sectional data analysis has been undertaken in the study. The research
design adopted in this study is causal comparative type as it deals with effect of net
interest margin, non-performing loan, liquidity, total assets loan to total assets GDP,
inflation with banking stability as z-score return on assets and z-score return on equity.
The statistical methods used in the analysis are descriptive statistics, correlation analysis
and regression analysis. Based on the analysis of data, the major findings of the study are
summarized as follows:

1. The average z-score return on assets is highest for CTZ (7.702) and lowest for MBL
(1.387). Commercial banks in Nepal have slightly fluctuating pattern of z-score
return on assets in recent year. It indicates that these days Nepalese commercial banks
are being unstable comparison to previous years.
2. 2. The average z-score return on equity highest for GIME (8.741) and lowest for
MBL (1.300). It has been found that z-score return on equity has increased in the
majority of the commercial banks in rcent yearsThe average net interest margin is
highest for ADBL with a mean of 6.052 percent and lowest for LXBL with a mean of
2.784 percent. In overall the figure shows that the net interest margin has been
decreased in Nepalese banking industry after lots fluctuations in the years.
3. The average of total assets is highest with a mean of 90.711 billion for NIBL and
lowest for NCC with an average of 28.755billion. It has been found that is in
increasing trend.
4. The average of non-performing loan is highest for NCC with a mean of 6.575 and
NSBI has the lowest of non-performing loan with a mean of 0.231. It has been found
that non-performing loan is in increasing trend from previous year.
5. The average loan to total assets is highest for SIBL with a mean of Rs. 72.045 billion
and lowest for SCBL with a mean of 46.128 billion. It has been found that loan to
total asset has been increased in the majority of the commercial banks in recent years.
6. The average liquidity ratio is highest for HBL with amean of 29.77 percent and
lowest for SUBL with a mean of 7.23 percent. It is in increasing trend from 2015/16.
7. The descriptive analysis shows that the average z-score return on assets and z-score
return on equity in Nepalese commercial banks are 1.733. and21.325 respectively.
8. The descriptive analysis shows that the average net interest margin, total assets a loan
portfolio in Nepalese commercial banks of 3.355 percent. 3.792 billions. and 4.182
percent respectively.
9. Similarly, descriptive analysis shows that the, average liquidity is 15.536 percent and
average non performing loan is 1.997percent.
10. However, average GDP and average inflation in Nepalese commercial banks is 4.192
percent and 9.525 percent respectively.
11. The correlation analysis reveals that net interest margin and total assets is positively
related to z-score return on equity.
12. From the correlation matrix analysis, it is found that The result also shows that there
is positive relationship of liquidity and NPL with z-score return on assets
13. The correlation result shows that there is is negative relationship of loan portfolio
with z-score return on assets. Whereas inflation has positive relationship with
inflation and GDP with z-score return on assets.

From correlation matrix analysis, the result shows that net interest margin is positively
correlated with z-score return on equity. Total assets is also positively correlated with z-
score return on equity. However, loan portfolio, liquidity, non performing loan are
negativelcorrelated with z-score return on equity. Similarly, gross domestic product and
annual inflation rate has also negative relationship with z-score reurn on equity.

14. The regression result shows that the beta coefficient of net interest margin (NIM) has
a positive and significant impact on the level of banking stability or risk level.
Similarly, the result shows that total assets have positive impact on Z score return on
assets.
15. From the regression result analysis, loan portfolio (loan to total assets) has negative
and significant impact on Z score ROA. Similarly, the result reveals that there is
negative relationship of NPL, gross domestic product, annual inflation ratewithz score
ROA.
16. The beta coefficients for NIM has positive and significant impact with ROE.
Similarly, the result shows that beta coefficients for total assets has positive and
significant impact on z-score ROE. However the beta coefficients are negative and
significant for loan to total assets liquidity and NPL with z-score ROE.
17. The regression analysis of z-score return on equity reveals that the beta coefficient of
GDP and inflation has negative impact on Z-score ROE.

5.2 Conclusion

The major conclusion of this study is that the net interest margin, total assets, loan
portfolio, non-performing loan ratio, liquidity, GDP and inflation are statistically
significant factors that determine the stability of Nepalese commercial banks in Nepal.
The regression result shows that the beta coefficient of net interest margin (NIM) has a
positive and significant impact on the level of banking stability or risk level. Similarly,
the result shows that total assets have positive impact on Z score return on assets. It
indicates that larger the total assets more stable would be the banking system.

From the regression result analysis, loan portfolio (loan to total assets) has negative and
significant impact on Z score ROA. Similarly, the result reveals that there is negative
relationship of NPL, gross domestic product, annual inflation rate with z score ROA. The
beta coefficients are negative and significant for loan to total assets liquidity and NPL
with z-score ROE. It indicates that increase in loan portfolio leads to decrease stability of
banking system.

5.3 Recommendation

Based on findings, the following recommendation has been made:

1. The study observed that net interest margin has positive impact on banking
stability. Hence, the commercial banks willing to stable its banking system should
increase net interest margin without affecting the day to day operations of the
bank by increasing the bank size.
2. The study shows the positive and significant relationship between total assets and
banking stability measured in terms of z-score return on assets. Hence, banks
willing to make more stable the banking system should focus on to increase the
total assets.
3. The study observed a negative impact liquidity on z-score return on assets which
indicates that higher the liquidity the BFIS would be less stable. Hence, the banks
are suggested to decrease to focus on liquidity toward business sector for more
stability of banking system without affecting the day to day operations of the
bank.
4. The study found the negative impact of loan to total assets ratio on the stability of
banking system of commercial banks measured by z-score return on assets and z-
score return on equity. Hence, banks should decrease loan to total assets to
increase stability of banking system.
5. Empirical result suggest that bank size has less significant impact on banking
stability of Nepalese commercial banks which shows that stability is more
influenced by liquidity, NIM, loan to total assets, NPL.Therefore, banks should
focus more on improving those variables which have statistical impact on banking
stability.
6. The result shows the non-performing loan has negative impact on z-score return
on equity. This indicates that higher the non-performing loan, lesser would be the
 banking stability. Hence, the bank should decrease NPL to achieve more stability
on banking system.
7. The regression analysis of z-score return on equity reveals that the beta coefficient
of GDP and inflation has negative impact on Z-score ROE. This indicates that the
higher the GDP and inflation lesser the banking stability. So bank should focus on
these variables to achieve more stability on banking system

5.4 Future scope

The study has examined the effect of liquidity risk and credit risk on banking stability of
Nepalese commercial banks. There remains enough ground of scope in terms of data,
models and methodology for studies in days to come. The study remains enough ground
for the further studies, which are listed below:

1. Only limited statistical and financial tools have been used in the study. Hence, the
future studies can be carried out by including more statistical and financial tools.
2. This study includes data of “A and B” class financial institution only. Various
financial institutions such as finance companies and insurance company are not
taken into consideration for the study. Hence, the future studies can be carried out
by including other financial institution.
3. The findings of this study cannot be generalized to manufacturing and trading
enterprises because the study is only based on the banking sector.Hence, the
future studies can be carried out by including manufacturing and trading
enterprises.
4. There are other risks such as foreign exchange risk, size risk, technology risk,
human resources risk, geographical risk, political risk, economical risk that
influence the stability of the banking system. Thus, the future study can include
these variables that will give additional findings in the study.
5. The future studies can select larger sample and more number of observation years
for the study that lead to much more valid prediction regarding the effect of
liquidity risk and credit risk on banking stability.
6. This research applies common practices in the measurement of banking stability
namely, the Z score. Future studies may use a combination of data drawn from
capital market capitalizations of bank assets and market stability to measure the
modified Z score as a means to assess market feedback.
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