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Determinants of Nonperforming Loans: A Review of Empirical Evidence

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DOI: 10.1108/978-1-80043-968-920211015

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Chapter 15

Determinants of Nonperforming Loans:

A Review of Empirical Evidence
Aamir Aijaz Syed

Abstract
Purpose: The main purpose of this chapter is to thoroughly investigate the
diverse literature available concerning nonperforming loans (NPLs) and its
determinants by studying and analyzing the empirical studies from 1985
to 2019.
Design/Methodology: A qualitative approach is being incorporated, and by
using content analysis, various previous studies are reviewed and impor-
tant issues like the objectives, methodology, key findings, and variables are
reported.
Findings: The study tries to compile the main findings from the various
studies done concerning NPLs and its determinants. The study shows
how various determinants both bank-specific and macroeconomic affect
the banking structure and thus the NPLs, in different countries and at
different periods of time. The study also highlights how countries’ bank-
ing structure got affected by various economic phenomena like recession,
contagious effect of the financial crisis, banking Basel norms, and NPL
management strategies. Further major issues like data acquisition, lack of
data reporting, countries specific banking conditions, methodologies used
in the analysis, scarce resources, and disclosure hindrance which are faced
by previous studies were also reported.
Originality/Value: As there are very few studies that provide a detailed
viewpoint on NPLs and its determinants in this area, this research will
provide a concise and detailed framework for the researchers to analyses
the diverse literature on NPLs and its determinates.

New Challenges for Future Sustainability and Wellbeing, 287–316

Copyright © 2021 by Emerald Publishing Limited
All rights of reproduction in any form reserved
doi:10.1108/978-1-80043-968-920211015
288    Aamir Aijaz Syed

Keywords: Nonperforming loans; macroeconomic; bank-specific; review;

Basel norms; international banking; GMM; VECM; content analysis

JEL Codes: E2; E3; G21

1. Introduction
Banks are considered as the main flag bearer of any economy, they help in chan-
nelizing funds from the public and help in mobilizing those savings for the devel-
opment of an economy. A healthy banking structure serves as a paradigm for the
successful development of a country. Contrary to this if the banking structure of
a country is not good then that will consequently affect the economic structure of
a country (Ali & Daly, 2010). This can be seen from the various economic slow-
downs which took place in different countries of the world due to weak banking
structure (Inekwe, 2013).
Countries around the world have faced various financial crises from time to
time, some of the prominent crisis which took place in different parts of the world
is like Savings and loan crisis of United States which resulted into the failure of
747 out of 3,234 savings and loan association of United States due to failure of
Non-repayment in 1980s and 1990s, similarly Finnish banking crisis took place
in 1991–1993 because of economic disturbance and banking specific problems,
resulting in government takeover of the banks and providing monetary assis-
tance to banks. Venezuela crisis is also another example of banking failure which
resulted in the closure of 17 out of 49 commercial banks representing 53% of sys-
tem assets (Berge & Boye, 2007). Asian financial crisis of 1997 is another big crisis
which resulted due to excessive foreign debt, and currency devaluation resulted in
overextension of credit in real-estate sector and resulted in economic meltdown
due to contagion effect and lastly one of the most prominent crises which took
place in the history of banking is the global financial crisis of 2007–2012 which
resulted in the collapse of large financial institutions, bailing out of large banks,
and slowing down of world economy (Umar & Sun , 2018).
The main conclusions which we can draw from these crises are that economic
disturbance and banking structure are highly correlated if any untoward incident
happens in the economy than that will affect the banking structure and vice versa
(Espinoza & Prasad, 2010). It has also been found that high lending by banks
toward different sectors and negative sector-wise growth blocks banks’ money
thus resulting in banking failures and affecting economic growth negatively
(Fofack, 2005). The reasons which are attributed to bank failures are their lend-
ing pattern and non-recovering of dues within the stipulated time period.
Nonperforming loans (NPLs) are considered as the main reason for banking
failure around the world. We can see that different countries are suffering from
this problem like Russia, Ukraine, India, Pakistan, Greece, etc. Thus, the purpose
of this chapter is to collect the diverse literature available on NPLs and its deter-
minants covering banks’ specific and macroeconomic determinants and also to
provide a comprehensive framework suggesting appropriate remedial measures
for the same.
 Determinants of Nonperforming Loans    289

2. Research Design
2.1. Need of the Study
NPLs are considered a serious threat to banking structure as well as it acts as
a trigger point for the onset of financial crisis which we can see from the vari-
ous previous financial crisis like the Asian financial crisis, Finnish crisis, Swe-
den financial crisis, etc. IMF economists (Laeven & Valencia, 2008) depicted the
various banking crisis between 1970 and 2007. Systematically, banking crisis is
defined as when country banking or financial industry experiences a large number
of defaults in repayment of dues which led to a large number of nonperforming
assets (NPAs) and a huge reduction in banking capital base. Although various
studies have been conducted on NPLs and its determinants, there is no compre-
hensive study that provides a detailed overview of determinants affecting NPLs
and the overall comprehensive findings which cover the strategies to overcome
NPLs, which is the main objective of this detailed study. Knowledge about mac-
roeconomic and bank-specific determinants of NPAs and implementation will be
helpful to the regulators to take policy-oriented remedial steps.

2.2. Objectives of the Study

The specific objective of the study is:

⦁⦁ To provide a comprehensive and detailed up-to-date review of all the literature

covering the NPLs and its determinants.
⦁⦁ To analyze the pattern of previous researchers, the methods they have used and
findings they have suggested related to NPLs and to also to cover the remedial
measures they have recommended to overcome this menace.

2.3. Source and Methodology

To achieve the objective of this study, this chapter has employed a model of Qual-
itative approach using the content analysis framework given by Mayring (2000,
2008). Referring to Mayring (2008), one may distill four main steps forming the
process model of (qualitative) content analysis (cf. Kassarjian, 1977; Krippen-
dorff, 1980; Mayring, 2000):

1. The material to be analyzed is delimitated and the unit of analysis is defined

(material collection).
2. Formal characteristics of the material are assessed, providing the back-
ground for subsequent content analysis (descriptive analysis).
3. Structural dimensions and related analytic categories are selected, which are
to be applied to the collected material (category selection).
4. The material is analyzed according to the (analytic)dimensions (material
evaluation).
290    Aamir Aijaz Syed

In reference to the above four steps, a thorough and comprehensive review

of the previous empirical literature is conducted, detailed of which are summa-
rized in Table 1. Article published in various reputed journals and indexes were
explored, these include Elsevier, Emerald, Wiley, SSRN, JSTOR, Science direct,
Repec Archive, Google Scholar, and Research gate profile. Apart from that, ref-
erences cited in published articles were also explored along with working papers
and government reports. In addition to the above, published studies which relate
to NPLs and its determinants were also reviewed.
Managerial Finance, Global Business Review, Journal of Risk Finance, Delhi
Business Review, Asian Journal of Accounting Research and Qualitative Research
in Financial Markets, and other journals were also explored to gather the infor-
mation. These journals provide the admirable work of various scholars world-
wide, which ultimately helps the researchers to conduct their work conveniently.
Moreover, cross-country studies and reports of various government agencies
were also incorporated which gives more insight on NPLs and country-specific
strategies to overcome NPLs issues. An exhaustive review is being done to come
up with the main implications relating to NPAs around the world. Hence, by
applying a critical and interpretive approach through content analysis of the lit-
erature, important measures like methods of research, time period, main findings,
objective, and conclusion were reported. This study brings a strong model for
the researchers by compiling and analyzing the empirical literature from 1985 to
2019.

3. Critical Analysis and Findings

The banking sector has gone through a huge transformation both in terms of
regulation and business competition, entry of foreign players into the domestic
market and the urge of increasing market size has made banks more prone to
different types of risks. NPLs are one of the major issues from which different
banks are suffering. NPLs reduce the lending capacity of banks and it also ham-
pers banks’ profitability by unnecessarily creating negative pressure on the bank
balance sheet. The impact of NPLs on banking structure can also be seen from
the different financial crisis which has taken place around the world, and these
crises have either led to bank closure or liquidity crunch in the banks. NPLS of
banks are also get affected by various macroeconomic and bank-specific factors
like growth rate, unemployment, inflation, bank’s capital adequacy ratio, bank’s
credit to deposit variation, etc. Various studies have been done which have tried
to study the determinants of NPLS and their impact on banking structure which
have been compiled in Table 1. The major issues and restraints have been identi-
fied through a detailed review of previous literature.

3.1. Content Analysis and Appraisal

The main factors which are considered during the content analysis of empirical
literature are summarized below:
Table 1.  Empirical Studies Related to NPLs and Their Determinants for Risk Management.

Country‐Specific Review
Author Country and Period Variables Methods Findings
of Study
Keeton and 2,470 commercial bank NPLs net of charge-offs, Linear regression tools The findings revealed that local
Morris of the United States Economic growth, Sector economic conditions and bad
(1987) during 1979–1985 wise growth sector-wise performance are the
reasons for mounting NPLs
Sinkey and Large commercial bank Lending rates, volatile Linear regression tool Findings showed that micro
Greenawalt of the United States funds, high-interest rate factors like lending rates, volatile
(1991) from 1984 to 1987 funds, high-interest rate positively
affect the commercial bank’s
NPAs
Berger and US banks from 1985 Loan quality, Cost Granger causality Cost efficiency may be an
De Young to1994. efficiency, Bank capital techniques: they important indicator of future
(1997) formulate possible problem loans and problem banks
mechanisms, namely
“bad luck,” “bad
management,”
“skimping,” and “moral
hazard,” relating
efficiency and capital
adequacy
(Continued)
Determinants of Nonperforming Loans    291
Table 1.  (Continued)
Country‐Specific Review
Author Country and Period Variables Methods Findings
of Study
Keeton (1999) Big commercial banks Credit growth and Survey and reports Findings from the study show
of the United States default loans that a high amount of credit with
from 1982 to 1996 low credit standards helps in the
accumulation of higher default
292    Aamir Aijaz Syed

loans
Saurina et al., Spain (Banco de Credit provision, credit Government and Bank They analyzed that during the
(2000) Espana) losses, and bank credit report boom period credit disbursement
is high; loans are provided without
considering the quality of credit
thus this results in high default
during the downturn period
Chu (2001) Brazilian banking sector Gross domestic product VAR (Vector The study concluded that from
(1994–2000) (GDP), spread, interest Autoregression) model out of all the macroeconomic
rate, and unemployment factors, GDP, spread, interest rate,
and unemployment are the most
influential factor for the problem
of the Brazilian loan
Nishimura et Japanese banking sector Long-term relationships Government reports The study suggested that a
al., (2001) from 1990 to 2000 between banks and and surveys major portion of the loan which
entrepreneurs is given during the economic
boom becomes bad loans as the
economy shows a receding trend
Salas and Spanish commercial GDP, capital ratio, bank Panel data approach The findings revealed from the
Saurina and saving bank during size, and market power study that the above variables have
(2002) 1985–1997 a profound effect on the bad loans
whereas differences in the bank
size and institutional framework
also affect the bad loan scenario
of Spanish banks
Kalirai and Loan loss provision of Interest rate, market Value at risk Results suggested that decline in the
Scheicher Austria banks during confidence, industrial methodology (VAR) stock market, Market confidence,
(2002) 1990–2001 production, stock market rise in short-term interest rates and
a sluggish industrial production
adversely affect the loan loss
provision of Australian banks
Ranjan and Indian commercial Credit, bank size induced Panel regression model The findings from the analysis
Chandra banks in 2003 risk preferences and show that higher costs of credit
(2003) macroeconomic shocks give rise to NPAs, on the other
hand, factors like the horizon of
maturity of credit, better credit
culture, favorable macroeconomic
and business conditions lead to a
lowering of NPAs
Jimenez The Spanish banking GDP growth, high real Dynamic model and a This study attributes the latter to
and Saurina sector from 1984 to interest rates, and lenient panel data set disaster myopia, herd behavior, and
(2003) 2003 credit terms agency problems that may entice
bank managers to lend excessively
during the boom period
(Continued)
Determinants of Nonperforming Loans    293
Table 1.  (Continued)
Country‐Specific Review
Author Country and Period Variables Methods Findings
of Study
Hu et al. 40 Taiwanese commercial Government and private Fixed and Random OLS They were on the opinion that
(2004) banks during 1996–1999 shareholding on the NPA government shareholding induces
political lobbying whereas private
294    Aamir Aijaz Syed

ownership favors corrupt private

owners
Baboucek and Czech banking GDP, Unemployment, Impulsive response The detailed analysis shows
Jancar (2005) structure coverin inflation and unrestricted VAR inflation unemployment is the
g the period from 1993 approach early sign which shows that the
to 2003 credit portfolio is going to worsen
Ahmed (2006) Bangladesh private Bank size, Macroeconomic Panel regression analysis The findings showed that the size
banks during shocks, and conditions of of banks and the maturity period
2006–2011 credit of loans have a longing effect
on the NPL situation of private
commercial banks in Bangladesh
Berge and Nordic banking sector Economic growth, Empirical models based Analyzing both the household
Boye (2007) covering the period employment, interest rate on panel regression and the enterprise sector author
from 1993 to 2005 concluded that development in
the interest rate and employment
sector assist in the reduction
of problem loans in the Nordic
banking sector
Quagliariello Italian banking sector Economic cycle A static and dynamic The study confirms that cyclic
(2007) period from 1985 to panel approach fluctuations have a significant
2002 effect on loan loss provisions and
new bad debts
Podpiera and Czech banking covering Cost efficiency, Granger causality, The author concluded that bad
Weill the period from 1994 to management discipline, and Dynamic GMM management is the reason for
(2008) 2005 productivity of higher default loans and the
banks regulatory body should focus on
managerial efficiency to enhance
the financial stability and this
measure will also help in the
reduction of NPLs
Greenidge Banking structure of GDP, inflation, market size, Autoregressive Integrated The findings suggested that
and Barbados from 1996 to loan growth Moving Average macroeconomic variable like the
Grosvenor 2008 (ARIMA) models and GDP, inflation have a significant
(2009) multivariate (ARDL) impact on the NPAs
Louzis et al. Greek banking sector Macro, GDP growth, Dynamic panel data Loan problems are explained
(2011) over the period 2003– Unemployment rate, methods. mostly by macroeconomic
2009 Lending rates, Sovereign variables (real GDP growth rate,
debt Bank-specific factors, unemployment rate, interest rates,
Return on the equity and public debt). They are also
Solvency ratio explained by some bank-specific
factors such as performance and
efficiency indicators
Sakiru et al. Malaysian banking Industrial production, The study utilized the The conclusion draws from the
(2011) structure from 2007 to producer and lending rate ARDI approach for study revealed that the lending rate
2009 – monthly basis analysis has a positive influence on NPA
Determinants of Nonperforming Loans    295

(Continued)
Table 1.  (Continued)
Country‐Specific Review
Author Country and Period Variables Methods Findings
of Study
Vogiazas and Romanian banking Monetary aggregates, Univariate regressions The findings revealed that
Nikolaidou sector during 2001–2010 interest rates, financial macroeconomic variables like
(2011) markets, inflation, GDP, unemployment, GDP, inflation,
unemployment and Greek crisis specific variables
296    Aamir Aijaz Syed

have a significant contribution to

the credit risk of the Romanian
banking system
Swamy (2012) Indian banking sector GDP growth rate, inflation, ARDL panel approach The study found that real GDP
using panel data from capital adequacy, bank growth rate, inflation, capital
1997 to 2009 lending rate, saving, bank adequacy, bank lending rate,
size, ROA and saving growth rate had an
insignificant effect; whereas loan
to deposit ratio and ROA has a
strong positive effect but bank size
has a strong negative effect on the
level of NPLs
Hyun Jung US banking sector GDP, unemployment, OLS regression analysis In the pre-financial crisis period,
and Zhang focusing pre and post- lending rate as the study found as the solvency
(2012) recession period from macroeconomic variable ratio, ROE, lending rate, GDP
2002 to 2006 and from and return on equity, growth rate, and unemployment
2007 to 2010 solvency ratio, bank size as rate negatively affect NPAs
banking variable
 Commercial banks in The variables used were Regression Analysis The finding reveals that bank size,
Turkey for a sample of size, access to long-term access to the long-term loan and
18 banks from 2003 to funds, interest rates, GDP inflation rate have a significant
2012 growth rate, and inflation positive impact on the bank`s
rate. lending behavior but, interest rates
and GDP are insignificant
Iva (2013) Albanian banking The interest rate in the OLS regression model The finding reveals a positive
system from 2002 to total loan, credit growth, association of loan growth and
2012 inflation rate, real exchange real exchange rate, and a negative
rate, and GDP association of GDP growth rate
with NPLs
Inekwe (2013) Nigerian banking sector GDP growth Pearson Product- The study shows a positive
during 1995–2009 Moment Correlation correlation between GDP growth
Coefficient and NPLs which is quite contrary
to previous literature
Bhattarai 10 commercial banks of Economic growth, inflation, Data collection from The result from the study shows that
(2016) Nepal Questionnaire- political condition 140 workers who are in energy crisis, political disturbance,
based the loan portfolio budgetary constraints are the main
reasons for increasing NPLs in
Nepal commercial banks
Blanco and Default loan in the Interest rate, OLS technique The findings revealed that the
Gimeno household sectors of 50 unemployment, growth, increase in unemployment is the
(2012) provinces of Spain from inflation main driver of default loan in Spain
1984 to 2009 during the period from 2007 to
2009 and also the fall in the interest
rate during 2008 contributed to
moderating the upward path of
Determinants of Nonperforming Loans    297

default ratios in 2009

(Continued)
Table 1.  (Continued)
Country‐Specific Review
Author Country and Period Variables Methods Findings
of Study
Viswanadham National Bank of Interest rate, GDP, the Data collection from Findings revealed that interest
(2015) Commerce, Tanzania concentration of lending 152 respondents and rate, GDP, bank loan supervision
during 2008–2012 activities, bank’s loan the statistical method capacity, and economic condition
298    Aamir Aijaz Syed

supervision capacity and employed, cross- influence the level of NPLs.

Ivana Tomas Croatia covering the
Žiković (2015) period from 4Q2001–
1Q2014
Boakye-Adjei Ghana banking sector
(2015) during 1998–2009
economic condition sectional survey design However, the results did not
suggest that concentration of
lending activities increases the
level of NPLs
Economic growth, OLS regression The findings show that the
interest rate, inflation, technique economic cycle is a prominent
unemployment factor affecting both the sectors.
Unemployment ratio is a
significant reason for corporate
default loans and interest rate
plays a mixed response, in the long
run, NPL
Net interest margin, bank Generalized method of Study shows that big banks are
size, loan growth, GDP, moment technique affected both by banking specific
inflation, and exchange rate and Macro specific variables
whereas for small banks banking
variables are more important as
compared to macro variables
Khaled Subhi Jordanian banking GDP, Inflation, Bank Panel data regression Findings revealed that bank-
Rajha (2016) sectors during 2008–2012 efficiency, Interest rate, approach specific factors and the ratio of
Profitability, the total asset loans to total assets were the
of banks most important factors that affect
NPLs positively. Concerning the
macroeconomic factors, they
found that economic growth and
inflation rate have a negative and
significant effect on NPLs
Evgeniya Russian banking sector Overdue loans and Adjusted regression Findings show financial crisis
Vasileva using bank-level data corporate loan model are the reasons for overdue loans
(2016) during 1990–2009 and apart from that quality of
bank management also helps in
lowering the overdue loans in the
Russian financial sector
Marouf and Algerian banking sector GDP, money supply and Ordinary least square, The results further show that credit
Guellil (2017) from 1980 to 2014 political stability Granger causality test risk had a positive relationship
with money supply and political
stability whereas a negative
relationship with the growth rate
Umar and Chinese banks spanning GDP growth rate, effective Generalized method of Findings show that GDP growth
Sun (2018) from 2005 to 2014 interest rate, inflation rate, moment technique rate, effective interest rate, inflation
foreign exchange rate, rate, foreign exchange rate, type of
type of bank, bank risk- bank, bank risk-taking behavior,
taking behavior, ownership ownership concentration, leverage,
concentration, leverage, and credit quality are significant
and credit quality determinants of NPLs in Chinese
banks
Determinants of Nonperforming Loans    299

(Continued)
Table 1.  (Continued)
Country‐Specific Review
Author Country and Period Variables Methods Findings
of Study
Cross‐Country Review:
Demirgüç- The panel of developed GDP, inflation, Interest Multivariate logit The result suggests that the bank
Kunt and countries from 1980 to rate, Balance of payments econometric model crisis is the result of the slowdown
300    Aamir Aijaz Syed

Detragiache 1994 in the macroeconomic environment

(1999) or other words when growth is
slow whereas inflation is high. The
study also points that interest rate
and adverse balance of payments
also aggravate the problem of the
banking crisis
Fofack (2005) Banking and the Economic growth, real Econometric and The variables like economic
financial crisis among interest rate, exchange rate, causality analysis growth, real interest rate, exchange
the Sub Sahara African net interest margin, and rate, net interest margin, and
nation during 1990 interbank loans interbank loans show a significant
relation with NPLs among the Sub
African countries. The increase in
problem loan is highly attributed
to macroeconomic volatility
and reflects the vulnerability of
undiversified African economies,
which remain heavily exposed to
external shocks
Lown and Credit and economic Loan standards, policy and Vector autoregression The authors also tried to find
Morgan conditions on the panel reforms (VAR) and Vector the relationship between loan
(2006) data of US and Canada auto-correction model standards, policy, and its influence
(1968–2000) (VECM). on the output. The study points
out that credit shocks can be a
driver of economic instability and
stability and it has procyclic effects
Richard 65 countries and Banking sector BCP assessment results The findings suggested a positive
Podpiera covering the period from performance and quality and significant relationship
(2006) 1998–2002 of supervision and between banking supervision
regulation as prescribed by and NPLs and interest margin
Basel after giving due consideration to
economic factors and financial
control variables
Bohachova OECD and non-OECD Capital adequacy, inflation Linear mixed model The author finds out that the
(2008) (2001–2005) OECD country tends to hold a
higher capital ratio during the
boom period contrary to Non-
OECD countries. The findings
also suggest that during the
expansion phase of the business
cycle bank tend to generate more
loss asset because of higher credits
similarly higher inflation generate
higher capital ratios
(Continued)
Determinants of Nonperforming Loans    301
Table 1.  (Continued)
Country‐Specific Review
Author Country and Period Variables Methods Findings
of Study
Jappelli & US, UK, European Household debt and their Panel regression On the whole, the evidence suggests
Marco (2008) countries, 2008 linkages with financial that insolvencies tend to be
onwards instability associated with greater households’
302    Aamir Aijaz Syed

indebtedness, supporting the

Boudriga et MENA countries Credit growth rate,
al. (2009) during 2002–2006 CAR, real GDP growth
rate, ROA, the loan loss
reserve to total loan ratio,
diversification, private
monitoring
Espinoza and GCC banking system Interest rate and growth
Prasad (2010) during 1995–2008 rate
financial fragility hypothesis.
The panel data on insolvencies
show that European countries
that experienced relatively fast
debt growth also featured larger
increases in insolvency rates
Pooled regression The result shows that the credit
approach growth rate is negatively related
to problem loans and Capital
adequacy ratio is positively
significant
Victor autoregression After a comprehensive analysis,
model they found that the high-interest
rate increases NPLs but not
significantly
Ali and Daly Australia and the United GDP, Interest rates, The structural and The same set of macroeconomic
(2010) States for 14 years (the Industrial production, approach reduced-form variables display different default
first quarter of 1995 to Debt-to-GDP ratio approach. rates for both countries. GDP,
the second quarter of short-term interest rates, and
2009) total debt explain default risk
for two economies Compared
to Australia, the US economy is
much more susceptible to adverse
macroeconomic shocks
Nkusu (2011) 26 advanced countries GDP, Inflation, VAR The findings point out that NPL
and covering the period unemployment, interest rate plays a significant link between
from 1998 to 2009 credit risk disturbance and
macro-financial vulnerabilities.
The results confirm that slower
growth, higher unemployment or
falling asset prices is linked with
debt service problem and result in
rising NPLs
De Bock and 25 Emerging countries Macroeconomic variables Vector autoregression The study highlights that
Demyanets during 1996–2010 and credit panel economic growth, exchange
(2012) rate, and loan growth are the
major significant variables of the
problem loans.
(Continued)
Determinants of Nonperforming Loans    303
Table 1.  (Continued)
Country‐Specific Review
Author Country and Period Variables Methods Findings
of Study
Skarica 7 Central and Eastern Loan growth, real GDP Fixed Effect Model The finding reveals as GDP growth
(2013) European countries from growth rate, market interest rate and the unemployment rate has
2007 to 2012 rate, Unemployment, and a statistically significant negative
inflation rate association with NPLs with the
304    Aamir Aijaz Syed

justification of rising recession

and falling during expansions and
growth has an impact on the levels
of NPLs
Messai and Greece, Italy, and Spain GDP, unemployment, and Pooled regression Findings revealed that loans vary
Jouini from 2004 to 2008 interest rate in the macro method negatively with the growth rate of
(2013) segment and return on GDP, the profitability of banks’
assets, loan loss reserve as assets, and positively with the
banking variables unemployment rate, the loan loss
reserves to total loans, and the real
interest rate
Castro Greece, Ireland, Unemployment, Growth A dynamic approach Banking credit risk is significantly
(2013) Portugal, Spain, and rate of GDP, Interest rate to account for the time affected by GDP growth, housing
Italy (GIPSI), spanning (the long-term interest rate, persistence in the credit price indices, unemployment rate,
the period from the first the real interest rate, and the risk structure interest rate, credit growth, real
quarter of 1997 to the spread between the long and exchange rate, and the recent
third quarter of 2011 short-term interest rates), financial crisis
Overall credit growth, Growth
rate of the share price indices,
Quarterly housing price index
Messai and 85 banks of three GDP, unemployment, Dynamic Pooled The result from the study shows
Jouini (2013) countries (Greece, Italy, interest rate, return on regression that problem loans varies
and Spain) pre-sub- assets, loan loss provisions, negatively with the growth rate
prime crisis period, i.e., and loan loss reserves to of country, profitability, and
2004–2008 total loan. positively with unemployment,
loan loss reserve to total loan, and
interest rate
Makri et al. NPLs of Euro zone’s GDP, the budget deficit Generalized Method of The study utilized the difference
(2014) banking systems for (FISCAL), public debt, the Moments (GMM) GMM estimation and found as
2000–2008, 14 countries unemployment, loans to real GDP growth rate, return on
panel deposits ratio, return on assets and Return on Equity (ROE)
assets and return on equity ROE had negative whereas lending,
and capital adequacy ratio unemployment, and inflation rate
had a positive significant effect on
NPLs. However, ROA & loan to
deposit ratio, inflation, and budget
deficit did not show any significant
impact on NPL ratio
Chaibi and France and Germany GDP, interest rate, Dynamic panel model The findings show that all the
Ftiti (2015) during 2005–2011 unemployment, exchange macroeconomic variables like GDP,
rate, loss provision, and interest rate, unemployment, and
inefficiency exchange rate affects NPLs except
inflation among both the countries.
Bank specific determinants reveal
that for French banking system loan
loss provision and inefficiency are
more accountable and for German
banks bank leverage is accountable
Determinants of Nonperforming Loans    305

(Continued)
Table 1.  (Continued)
Country‐Specific Review
Author Country and Period Variables Methods Findings
of Study
Angela and 28 European Union Growth, unemployment, Generalized method of The empirical findings suggest
Irina (2015) countries for the period domestic bank credit moment technique that growth, unemployment,
2001–2013 and domestic bank credit are the
major determinants of NPLs. The
306    Aamir Aijaz Syed

study also confirms that public

finances are important constituent
for mitigating NPLs menace
Beck (2015) 75 countries covering Gross Domestic Growth, Lagged effect regression Using a year lagged affect, the
the period from 2000 share price, exchange rate, model findings show explanatory power
to 2010 and lending rates. for variables like Gross Domestic
Growth, share price, exchange
rate, and lending rates
Shahidul South Asian countries Bad management, cost Generalized method of The findings suggested that the
Islam and covering the period inefficiency, income moment technique bad selection of borrowers and
Nishiyama from 1997 to 2012 diversification, bank size; bad moral hazard between bank
(2016) industry concentration management and depositors are
ratio, inflation, and GDP the main reasons for higher NPAs
among the south Asian countries
Vasilis 31 countries on panel Fiscal measures, Linear panel model and Fiscal measures which assist in the
Siakoulis data for 15 years Unemployment, GDP, GMM reduction of Unemployment and
(2017) inflation, interest rate upliftment of economic growth
also assist in the reduction of
NPLs
Anastasiou et Panel data of EU Credit growth, Economic Impulsive response and The findings suggested that higher
al. (2016) countries growth, unemployment, VECM credit growth and economic
inflation growth may facilitate lower NPLs
in the short run whereas, in the
long run, the effect of these
variables dies off
Nikolaidou Credit risk of 5 Sub Return on assets, return on ARDL and co- The findings suggested that an
and Vogiazas Saharan African equity, real exchange rate, integration modeling increase in money supply help in
(2017) countries (Kenya, money supply, growth of reducing NPAs, and for South
Namibia, South Africa, external debt, loan to asset Africa and Uganda, bank-specific
Zambia, and Uganda) ratio, loan to deposit ratio, variables are more significant as
and commodity prices compared to Kenya and Zambia
where country-specific variables
are more profound
Staehr and Panel Quarterly data GDP, inflation debt, current Dynamic panel The findings suggest that macro-
Uusküla of European Union account balance, and real regression financial and macroeconomic
(2017) countries covering the house prices factors are very significant in
period from 1997 to 2017 ascertaining NPAs. GDP, lower
inflation, and lower debt are
significantly substantial for NPLs
and show a negative relationship
with problem loans.
(Continued)
Determinants of Nonperforming Loans    307
Table 1.  (Continued)
Country‐Specific Review
Author Country and Period Variables Methods Findings
of Study
Ozili (2019) 6 regions world Foreign bank presence Sensitivity analysis The findings reveal that NPLs are
(financial liberalization), along with the positively associated with financial
private credit by banks regression model development measured as (private
308    Aamir Aijaz Syed

to GDP ratio (financial credit by banks to GDP ratio,

intermediation), and bank implying that banking sectors with
deposit to GDP ratio (size greater financial development (via
of the banking sector) greater financial intermediation
and foreign bank presence)
experience higher NPLs
Khan et Pakistan covering the Profitability, operating Random and fixed effects Results show that the operating
al(2020) period from 2005 to 2017 efficiency, capital adequacy through STATA software efficiency and profitability
and income diversification indicators have a negative
association with NPLs but were
statistically significant, while
capital adequacy and income
diversification have a negative
association with NPLs but were
statistically insignificant
 Determinants of Nonperforming Loans    309

3.1.1. Sample/Respondent Criteria.  Review of different previous studies show

that majorly the studies are based on secondary data source collected generally
from central banks of different countries, World Bank database, Bank scope,
while some of the studies are also based on primary data collected generally
from questionnaire and personal interviews. The main element of respondents
are generally bankers and people who are working at senior positions in various
international organizations like World Bank, International Monetary Fund, etc.
Bankers who are working on the credit division of banks have also collaborated
in some of the previous research.
3.1.2. Variable Discussed in Previous Studies.  Researchers have generally
explored those determinants which generally affect NPLs, some of the studies
have incorporated just bank-specific variables like credit policy, capital adequacy
ratio, credit to deposit ratios, lending rates, the relationship between banks and
entrepreneurs, profitability ratios, etc., while some have incorporated macroeco-
nomic factors like the growth rate of the country, unemployment rate, inflation,
interest rates, ownership in banks, political conditions, household consumption,
etc. whereas some of the studies have incorporated both the determinants, that is,
bank-specific and macroeconomic variables. Most of the studies have also high-
lighted the major challenges banks are facing and the strategies they are employ-
ing to overcome these hurdles.
3.1.3 Research Methods Employed.  The analysis of NPLs and its determi-
nants is done using a dynamic panel approach in nearly most of the papers. The
analysis is done using time series data of different variables and countries covering
different time periods. Descriptive analysis is done to show the variations among
the data and values over the period of time. Major of the studies have incor-
porated structural equation modeling taking NPLs as dependent variables and
host of other factors as independent variables. The methodology studies used are
regression modeling, Vector Error Correction Model (VECM), Autoregressive
Distribution Lag (ARDL), Impulsive Response System, Generalized Method of
Moments (GMM), Value at Risk Methodology (VAR), Autoregressive Integrated
Moving Average (ARIMA), Fixed and Random OLS, and Sensitivity analysis.
Some other techniques which are used by researchers are survey analysis, struc-
tural interview, impulsive response, and Granger Causality.
3.1.4. Significant Contribution in Previous Research.  Banks all over the world
are suffering from the problem of NPLs. These NPLs hamper the productivity of
banks and also create a negative pressure on the economic structure of the coun-
try, as we can see from the example of Greece, Russia, and even India struggling
with NPAs of more than 9% of their total loans. Moreover, different countries
are spending considerable time and resources in overcoming this issue either by
capital infusion in banks, writing off NPLs, developing strategies for overcom-
ing NPLs, and by establishing various agencies and law tribunal to speed by the
recovery process.
The analysis of the review literature covers studies from almost all parts of the
world. Researchers have vivaciously tried to find out the reason for NPL men-
ace. Various studies have pointed out that bank failures are the reason for the
financial crisis, and after every financial crisis, researchers have tried to find out
310    Aamir Aijaz Syed

the main reason for bank failures. Majority of the studies like Keeton and Morris
(1987), Chu (2001), Salas and Saurina (2002), Jimenez and Saurina (2003),
Louzis et al. (2011), Swamy (2012), Žiković (2015), Skarica (2013), Ozili (2019),
and Hashem.(2018) shows that the main reason for increasing NPLs is macro-
economic factors like the growth rate of the country, inflation growth, unem-
ployment, unhealthy competition, market confidence, industrial production,
political disturbance, wars, recession, and exchange rate volatility. Studies have
also explored the bank-related variables which led to an increasing credit default.
The main bank-specific factors which are explored in previous literature are
increase competition among banks, bad bank management, high-interest rates,
bank profitability ratios, cost efficiency, the relationship between banks and entre-
preneurs, bank size, credit growth, interbank loan, quality of supervision and
regulation by the bank as quoted by Berger and De Young (1997), Sinkey and
Greenawalt (1991), Nishimura et al., (2001), Podpiera and Weill (2008), Hyun
Jung and Lei (2012), and Umar and Sun (2018).
Moreover, studies have also highlighted that economic boom promotes higher
credit growth which turns into default during recessionary phases apart from
that government holding promotes political lobbying and which ultimately leads
to higher long disbursement due to undue pressure from political parties (Hu,
Li, & Chiu, 2004). Studies have also addressed that market-based economies like
France and others are more prone to credit risk as compared to the bank-based
economy like Germany (Chaibi & Ftiti, 2015).
Many studies like Nkusu (2011), Berger and De Young (1997), Baboucek and
Jancar (2005), Fofack (2005), Syed and Aidyngul (2020), Syed (2020), and Ozili
(2019) have also highlighted various measures which can be used for overcom-
ing NPLs. The main measures which are suggested in various previous literature
are the creation of better Asset Management Company (AMC) like that are in
China which assisted in reducing NPL from 20% in 1995 to less than 1% in 2017,
Speedy tribunal and courts for default loans, stringent measures for loan defaulters
like barring them from flying outside the country which is present in some Euro-
pean countries, political holds on banks to be reduced, market-based competition
among bankers for meeting targets need to be minimum, implementation of strict
Basel norms for capital adequacy, Stress testing and forecasting by the supervisory
authority, banking management needs to be monitored, more powers to central
banks, securitization, loans to be deal with situation-specific models, loan approval
position need to be on a rotational basis, less investment in risky securities and real-
time monitoring on loans need to be done. Studies have provided various measures
based on their country-­specific conditions, along with that certain cross-countries’
studies have been also explored where researchers apart from competitive analysis
also presented the risk classification of NPLs and their risk management strategies.

4. Recommendation of the Study

Based on the above review and discussion, the following recommendation is pro-
vided to bankers and researchers.
 Determinants of Nonperforming Loans    311

4.1. Recommendation to Researchers

Almost all the studies have covered macro and bank-specific determinants of
NPLs, but in major of the studies, the variables are mostly repetitive so research-
ers can opt for new variables that are mostly ignored in previous studies.
⦁⦁ Basel Implementation across the world is going in progress so what impact
Basel 1, II, and III have on NPLs can also be explored and compared over the
years.
⦁⦁ Even after so many studies and report NPLs are still rising, so remedial meas-
ures and their success level toward reducing NPLs can be a new area which new
researchers can cover.
⦁⦁ Researchers have studies NPLs at an aggregate level but NPLs classification
into category wise like education loan, home loan, an auto loan can also be
done and comparative analysis can be done.
⦁⦁ Securities that are more prone to risk can also be explored along with their
quantum of risk, which will provide a safe platform for bankers at the time of
loan disbursement.
⦁⦁ Countries which have reduced their NPL considerable can also be analyzed
and their strategies can be implemented or suggested to countries facing huge
default loan issues.

4.2. Recommendation to Bankers/Policymakers

Macroeconomic conditions of a country should be properly scrutinized before
large or long-term loan disbursement as chances of default will be higher when
economic conditions are not favorable.
⦁⦁ During the time of boom in the economy, extra caution has to be taken and
only after proper scrutiny investment has to be done in different securities to
reduce the chances of repeating sub-prime crisis like situation.
⦁⦁ Banks need to maintain and keep adequate capital to overcome any unforeseen
situation like Canada and Australian bank practices.
⦁⦁ The bank needs to be given more power, and political influence need to be
reduced.
⦁⦁ Unnecessary target-based banking needs to be scrutinized.
⦁⦁ In place of a large number of banks, few banks to be maintained which are
highly competent and capitalized.
⦁⦁ Basel implementation need to be quick and comprehensive (Kaur & Kapoor,
2015).
⦁⦁ The line of authority for loan disbursement needs to be clear so that the person
directly involved in loan clearance can be tracked.
⦁⦁ Better Asset Management Companies need to be formed which are profession-
ally managed.
⦁⦁ Tracking of loan has to be continuous.
⦁⦁ Strict norms to be formed for repetitive offenders.
⦁⦁ Insolvency proceeding need to be quick.
312    Aamir Aijaz Syed

Fig. 1.  Comprehensive Model Based on Literature Review.

A Comprehensive Framework of Determinants and Suggestive Remedial

Measures are shown in Fig. 1.

5. Conclusion
This chapter has examined vast literature focusing on the issue of the NPL, by
incorporating both macroeconomic and bank-specific factors. Study shows that
economic and bank-specific situation always hinders the repayment capacity of
borrowers and thus increasing the chances of default. As bad loans are the major
cause of financial distress and financial crisis, thus a proper analysis of factors is a
must and along with this, the review also incorporates the finding and strategies in
the form of recommendation to the banks and policy reformers. This chapter also
provides future scope for further research on the above topic which will benefit
the future researcher.

6. Practical Implication for Asian Countries

Asian countries are facing the threat of banking downfall and falling growth rates
due to various reasons like Banking low profitability due to NPLs, trade wars,
geopolitical challenges, and political concerns (Jacob Dahl). Many researchers,
academicians, and policymakers are researching NPL issues and their manage-
ment strategies in different countries and Asia as well. Thus, this chapter will be
very helpful for the researchers, policymakers, and academicians who are working
in this area. First, this chapter provides a complete and comprehensive review of
 Determinants of Nonperforming Loans    313

all the previous papers relating to NPLs, aiding researchers in not only findings the
variables but also helping them in choosing the right methodology for conducting
their research in this field. Secondly, this chapter helps policymakers in findings
the main determinants which are affecting NPLs including both macroeconomic
and bank-specific, along with that this chapter also helps them in finding suitable
strategies that are used by different countries in controlling their NPLs through
the findings of different papers. Thirdly, this chapter help academician in findings
the research gap so that they can further explore the unexplored domain of this
topic, and lastly, this chapter also provides a comprehensive model continent wise
showing major determinants which are affecting NPLs along with suitable rem-
edies based on previous literature and author contribution, thus further enriching
the above topic and providing a significant contribution in the field of banking
and risk management will be useful for Asian business apart from other countries.

Acknowledgment
This research received no specific grant from any funding agency in the public,
commercial, or not-for-profit sectors.

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