A Graduate Research Project Presentation on

Impact of nonperforming loan on bank profitability:

A case of Nepalese commercial banks.

Presented by
Ravi Bhanadari

Uniglobe College, New Baneswor, September 13

Table of content
Introduction

Literature Review

Research Methodology

Data Analysis

Conclusion
• Credit creation is the main income generating activity of banks. But
this activity involves huge credit risks.

• Credit risk plays an important role on bank’s profitability since a

large chunk of banks’ revenue accrues from loans from which
interest is derived (Drehman et. al. 2008).

• Poor credit quality has a negative effect on bank profitability. This

relation exists because an increase in the doubtful assets, which do
not accrue income, requires a bank to allocate a significant portion
of its gross margin to provisions to cover expected credit losses.

• The cause of credit risk occurs due to the prevalence of Non-

Performing Loan (NPL).
• Non-performing loan is the percentage of loan values that are not
serviced for three months and above (Ahmad & Ariff, 2007).

• The main cause of bank failures finds that asset quality is a

statistically significant predictor of insolvency. (Dermirgue-Kunt,
1989) and (Barr & Siems, 1994) indicated that failing banking
institutions always has high level of non-performing loans prior
to failure.

• A high level of NPL suggests high probability of a large number

of credit defaults that affect the profitability and net-worth of
banks and also erodes the value of the asset (Parul, 2012) .

• Nonperforming loans are not only argued to adversely affect the

financial performance of financial institutions, but they also have
other far reaching implications (Wangai et.al, 2013).
 Purpose of the study

The major objective of the study is to analyze the impact of

nonperforming loan to bank profitability in context of Nepalese
commercial banks. The specific objectives are as follows:

• To investigate effect of nonperforming loan to total loan on

profitability of Nepalese commercial banks.
• To examine the effect of loan loss provision on profitability of
Nepalese commercial banks.
• To assess the impact of total loan to total deposit on profitability in
Nepalese commercial banks.
• To analyze impact of bank's size on profitability of Nepalese
commercial banks.
• To identify the relationship between capital adequacy on
profitability of Nepalese commercial banks.
 Research Hypothesis
H1 • NPLTL is negatively related to ROA.

H2 • NPLTL is negatively related to ROE.

H3 • LLP is negatively related to ROA.

H4 • LLP is negatively related to ROE.

H5 • There is a positive relationship between

TLTD and ROA.
H7 •Th ere is a po sitive relationship between TLTD and ROE.

H5 •Ba nk size is positively related with ROA

H6 •Ba nk size is positively related with ROE.

H7 •Ca pita l a dequa cy ratio is positively related with ROA.

H8 •Ca pita l a dequa cy ratio is positively related with ROE.

LITERATURE REVIEW
 Table 2.1: Major findings of literature reviewed of nonperforming loan
effect on profitability.
Study Major Findings
Bourke (1989) Non Performing Loan is negatively related with Profitability.

Godlewski (2004) Non Performing Loan is negatively related with Return on Asset
(ROA)
Michael et al. (2006) NPL in loan portfolio affect operational efficiency which in turn
affects profitability, liquidity and solvency position of banks.
Felix and Claudine Return on equity ROE and return on asset ROA all indicating
(2008) profitability were negatively related to the ratio of non-performing
loan
Kithinji (2010) The findings revealed that other variables other than credit and
non-performing loans impact on profits.
Stuti & Bansal (2013) Non-performing Assets are threatening the stability and
demolishing bank’s profitability through a loss of interest income,
write-off of the principal loan amount itself.
Kargi (2014) The bank’s profitability is inversely influenced by the levels of
non-performing loans thereby exposing them to great risk of
illiquidity and distress
 Table 2.2: Major findings of literature reviewed of loan loss provision on
profitability.
Study Major Findings
Ahmed, Takeda and It observed that loan loss provision has a significant positive
Shawn (1998) influence on non-performing loans and suggests that an increase
in loan loss provision indicates an increase in credit risk and
deterioration in the quality of loans consequently affecting bank
performance adversely.

Mustafa, Ansari and The study found that the loan loss provision of the banks plays a
Younis (2012) paramount importance in affecting its profitability.

Funso, Kolade and

Ojo (2012) The study revealed that there exist a negative association between
loan loss provision and return on assets (ROA) and a 100 percent
increase in loan loss provision also reduces profitability by about
0.65 percent.
 Table 2.3: Major findings of total loan to total deposit effect
on profitability
Study Major Findings
Kithinji (2010) There exists positive relationship between Return on Assets
(ROA) and Total Loan.

Gul, Irshad and There exists positive relationship between Return on Assets
Zaman (2011) (ROA) and Total Loan.

Funso, Kolade and The study revealed that there exist a positive association between
Ojo (2012) total loan and advance with return on assets (ROA) and a 100
percent increase in loan loss provision also reduces profitability
by about 9.6 percent.

Aghababaei1, Ataei, There exists positive relationship between Return on Assets

and Azizkhani (2013) (ROA) and Total Loan.

Kargi (2014) There exists negative relationship between Return on Assets

(ROA) and Total Loan to Total Deposit.
 Table 2.4: Major findings of literature reviewed on effect of firm’s size on
firm’s profitability
Study
Majmumdar (1997)
Ammar et al., (2003)
Ozgulbas, Koyuncugil, & Yilmaz
(2006)
Papadogonas (2007)
Amato & Burson (2007)
(Serrasqueiro & Nunes (2008)
Lee (2009)
Major Findings
Found evidence that larger firms are less productive
but more profitable.
Found a significant difference in terms of
profitability between small, medium and large firms.
Found that big scale firms have a higher
profitability.
For all size classes, firms’ profitability is positively
influenced by firm size.
With the linear specification in firm size, the authors
revealed negative influence of firm size on its
performance but wasn’t statistically significant.
Large firms are more likely to exploit economies of
scale and enjoy higher negotiation power over their
clients and suppliers and hence higher firm’s
profitability.
Results showed that absolute firm size plays an
important role in explaining profitability.
Table 2.5: Major findings of literature reviewed on effect of capital
adequacy ratio on firm’s profitability

Study Major Findings

Furlong & Kelley Found positive correlation between returns and capital
(1989) adequacy ratio.
Athanasoglou, Higher CAR supports the bank's business and act as a
N.B., & D.D. buffer in case of adverse situation and hence
(2005) profitability.
Sangmi & Nazir Capital adequacy ratio has direct effect on the
(2010) profitability of banks by determining its expansion to
risky but profitable ventures or areas.
Dang & Uyen CAR is positively related with bank’s profitability.
(2011) Capital adequacy ratio shows the internal strength of
the bank to withstand losses during crisis.
Ochei (2013) Found positive relationship between capital adequacy
ratio and commercial banks profitability.
 Table 2.6: Major findings of Nepalese literature
Study Major Findings
Adhikary et. al. The study found that with the financial sector reform program,
(2007) implementation of the standard manuals and guidelines related to
lending, collection of loan and changes in lending practice form
collateral based into objective based reduce nonperforming loan in
government owned commercial banks.

Dhungana & The study found that the lending policies and optimum portfolio
Upadhyaya (2011) management of financial institutions as well as an effective regulation
and supervision of financial institution ensure the significant reduction of
NPL and enhance the banking efficiency.

Jha & Hui (2012) The study found positive relationship of nonperforming loan, capital
adequacy ratio (CAR) and total loan to total deposit with return on equity
(ROE) and negative relationship of nonperforming loan, capital
adequacy ratio (CAR) with of return on assets (ROA).

Poudel (2012) The study found capital adequacy ratio (CAR) and non performing loan
(NPL) negatively related with return on assets (ROA).
Conceptual Framework

Firm’s
Profitabilit
y
Return on
Assets
Non (ROA)
Performing
Return
Loan on
to Total
LoanEquity
(NPLTL)
(ROE)
Loan Loss
Provision (LLP)
Total Loan to
Total Deposit
(TLTD)
Bank Size (Size)
 Research Methodology
• The study is based on secondary data gathered from
16 Nepalese commercial banks for the period from
2003/04 to 2012/13, leading to the total of 160
observations.
• Hjj
• fgh
 The secondary data have been obtained from official
website of concern commercial banks, Nepal Stock
Exchange Limited (NEPSE), Security Board of Nepal
(SEBON), and Nepal Rastra Bank (NRB).
 Table 1: Number of commercial banks selected for the study
S.N Name of Commercial Banks Indicator Study Period No. of
observations
1 Nepal Bank Ltd. NBL 2003/04– 2012/13 10
2 Rastriya Banijya Bank RBB 2003/04– 2012/13 10
3 Nabil Bank Ltd. Nabil 2003/04– 2012/13 10
4 Nepal Investment Bank Ltd. NIBL 2003/04– 2012/13 10
5 Standard Chartered Bank SCB 2003/04– 2012/13 10
6 Himalayan Bank Ltd. HBL 2003/04– 2012/13 10
7 Nepal Bangladesh Bank Ltd. NBB 2003/04– 2012/13 10
8 Nepal SBI Bank NSBI 2003/04– 2012/13 10
9 Everest Bank Ltd. EBL 2003/04– 2012/13 10
10 Bank of Kathmandu BOK 2003/04– 2012/13 10
11 Nepal Credit and Commerce Bank Ltd. NCC 2003/04– 2012/13 10
12 Lumbini Bank Ltd. LBL 2003/04– 2012/13 10
13 Machhapuchhre Bank MBL 2003/04– 2012/13 10
14 Kumari Bank Ltd. KBL 2003/04– 2012/13 10
15 Laxmi Bank Ltd. Laxmi 2003/04– 2012/13 10
16 Siddhartha Bank Ltd. SBL 2003/04– 2012/13 10
Total number of observations 160
 Research Model

Profitability = f (NPLTL, LLP, TLTD, SIZE, CAR)

The model to be estimated is specified as under:

ROAit = α0 +α1 NPLTLit + α2LLPit + α3TLTDit + α4SIZEit + α5CARit +eit…………(1)

ROEit = α0 +α1 NPLTLit + α2LLPit + α3TLTDit + α4SIZEit + α5CARit +eit. ………...(2)

NPLTLit = Non performing loan to Total loan of bank i for the time period t
LLPit = Loan loss provision of bank i for the time period t
TLTDit = Total loan to total deposit of bank i for the time period t
SIZEit = Natural log of total asset of bank i for the time period t
CARit= Capital adequacy ratio of bank i for the time period t
DATA ANALYSIS
Fig 4.1: Pattern of average value of return on assets (ROA) of commercial banks from
2003/04 to 2012/13
3.5

2.5

2
Return on Total Assets (in %)

1.5

1 ROA

0.5

0
2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13

-0.5

-1

-1.5
Fig 4.2: Pattern of average value of return on equity (ROE) of commercial banks
from 2003/04 to 2012/13
50

40

30
Return on Equity (in%)

20

ROE

10

0
2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13

-10

-20
Fig 4.3: Pattern of nonperforming loan to total loan (NPL/TL) of commercial banks
from 2003/04 to 2012/13

12

10
Non performing loan to total loan ( in %)

6 NPL/TL

0
2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13
Fig 4.4: Pattern of loan loss provision (LLP) of commercial banks from 2003/04 to
2012/13
4

3.5

3
Loan Loss Provision( in Rs. billion)

2.5

2 LLP

1.5

0.5

0
2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13
 Fig 4.5: Pattern of Total loan to total deposit (TLTD) of commercial banks from
2003/04 to 2012/13

0.8

0.7
Proportion of total loan to total deposit

0.6

0.5

0.4 TL/TD

0.3

0.2

0.1

0
2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13

dsds
 Fig 4.6: Pattern of average value of total assets (size) of commercial banks from
2003/04 to 2012/13

60

50

40
Bank Size ( in Rs. billion)

30 Bank Size

20

10

0
2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13
Fig 4.7: Pattern of average value of capital adequacy ratio (CAR) of commercial banks
from 2003/04 to 2012/13
14

12

10
Capital Adequacy Ratio (in %)

CAR

0
2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13
 Variables N Mean SD Min. Max.
Descriptive Statistics
ROA
160 1.44 3.24 -18.92 18.04

ROE
160 14.26 54.99 -475.25 194.06

NPLTL 160 6.37 10.63 0.02 57.64

LLP
160 1.91 2.6 0.00 18.82

TL/TD
160 0.68 0.19 0.00 1.20

Size 160 28.08 20.75 1.91 101.52

CAR
160 7.16 14.37 -50.30 29.13
 Table 4.9: Correlation matrix for variables of Model 1
Variables ROA NPLTL LLP TLTD SIZE CAR

ROA 1          

NPLTL -0.215** 1        

LLP -0.547** 0.395** 1      

TLTD 0.026 -0.519** -0.211** 1    

SIZE 0.208** -0.029 0.123 -0.413** 1  

CAR 0.095 -0.764 -0.331** -0.585** 0.279** 1

‘**’represents 1% level of significance

‘*’ represents 5% level of significance
Table 4.10: Correlation matrix for variables of Model 2
Variables ROE NPLTL LLP TLTD SIZE CAR

ROE 1

NPLTL -0.058 1

LLP -0.04 .393** 1

TLTD 0.08 -.519** -.210** 1

SIZE -0.104 -0.029 0.128 -.413** 1

CAR .193** -.764** -.331** .585** -.279** 1

‘**’represents 1% level of significance

‘*’ represents 5% level of significance
Table 4.10: Estimated relationships between firm’s profitability (ROA) with non performing loan
Models Intercept Regression Coefficient of R2 SEE F
NPLTL LLP TLTD Size CAR

1 1.856 -0.65 0.046 3.18 7.64

(6.337) (-2.763)**
2 2.74 -0.681 0.299 2.72 67.49
(10.256) (-8.215)**
3 1.131 0.452 0.01 3.25 0.11
(1.150) (0.325)
4 -12.219 0.811    
(-2.389) (2.674)**
5 1.286 0.29 0.09 3.24 1.43
(4.496) (1.194)
6 -11.417 -0.064 0.787 0.087 3.12 7.47
(-2.274) (-2.738)** (2.648)**
7 -15.536 -0.724 1.089 0.376 2.58 47.37
(-3.736) (-9.156)** (4.403)**
8 -17.49 2.360 1.028 0.058 3.17 4.87
(-2.877) (1.586) (3.102)**
9 -15.517 0.990 0.037 0.069 3.15 5.78
(-2.923) (3.17)** (2.064)*
10 -11.491 -0.063 0.032 0.790 0.087 3.13 4.95
(-1.743) (-2.207)* (0.018) (2.293)*
11 -16.423 -0.719 0.407 1.125 0.377 2.58 31.43
(-3.309) (-8.927)** (0.330) (4.157)**
12 -17.193 1.013 1.052 0.031 0.071 3.15 3.95
(-2.836) (0.576) (3.180)** (1.428)
13 -17.798 -0.015 -0.742 1.042 1.180 0.004 0.379 2.60 18.79
(-3.014) (-0.408) (-8.505)** (0.685) (3.794)** (0.148)
 Table 4.11: Estimated relationships between firm’s profitability (ROE) with non performing loan
Models Intercept Regression Coefficient of R2 SEE F
NPLTL LLP TLTD Size CAR

1 16.183 -.302 .003 55.07 0.54

3.186 (-.735)
2 15.908 -.858 .002 55.11 0.26
2.930 (-.509)
3 -1.925 23.716 .006 54.98 1.02
-.116 (1.008)
4 130.571 -6.903 .011 54.86 1.74
1.480 (-1.320)
5 8.981 .737 .037 54.13 6.08
1.877 (2.466)
6 134.577 -.318 -7.020 1.359 .056 54.93 1.17
1.521 (-.776) (-1.340) (2.956)**
7 .141 -.526 22.170 .007 55.14 0.55
.008 (-.305) (.918)
8 7.681 .553 .770 .038 54.28 3.07
1.213 (.314) (2.425)*
9 1.873 -.079 -.429 20.099 1.362 .056 55.31 0.37
.088 (-.154) (-.233) (.726) (2.611)**
10 -2.235 -1.115 -.169 1.357 .056 53.94 3.08
-.263 (-1.740) (-.094) (2.938)**
11 108.939 23.245 -5.112 .865 .044 54.45 1.79
1.091 (.766) (-.895) (2.251)*
12 14.941 -1.055 -.134 9.209 -.639 1.384 0.57 54.27 1.85
(.121) (-1.418) (.942) (.289) (-.098) (2.612)**

gf
 Findings
• The average return on assets is highest for Nabil and lowest for
LBL. The average values of return on assets have increased slowly.

• The average return on equity was observed highest for Nabil

whereas lowest was for NBL during study period. The average
values of return on equity have decreased.

• Lowest average non-performing loan ratio was shown by Laxmi

Bank whereas highest non-performing loan ratio was found to be of
RBB. The average nonperforming loan have been decreasing during
study period.

• Similarly, NBB showed highest average loan loss provision whereas

lowest was shown by Laxmi Bank . Loan loss provision have been
fluctuating throughout the period.
 Findings
• SBL showed highest average total loan to total deposit whereas lowest was
observed for RBB. The trend of average total loan to total deposit of
commercial banks during study period was found to be increasing steeply.
• The average firm size was highest for RBB and lowest for LBL during. The
trend of average size of commercial banks during study period was found to be
increasing.
• Highest average capital adequacy ratio was found to be of SCB during study
period whereas lowest average capital adequacy ratio was found to be of RBB.
The trend of capital adequacy ratio is found to be first decreasing and then
increasing during observed period.
• The average return on assets and return on equity of total observation
throughout the study period was observed to be 1.44% and 14.26%.
• Similarly, average of nonperforming loan to total loan, loan loss provision, and
total loan to total deposit of total observation was observed to be 6.37, 1.91 and
0.68 respectively during study period.
• The average size and capital adequacy ratio of whole observation was found to
be Rs. 28.08 billion and 7.16 respectively during study period.
 Findings
• From correlation analysis, return on assets is found to have positive relation with total
loan to total deposit, firm size, and capital adequacy ratio whereas negative relationship
with non performing loan to total loan and loan loss provision.
• Similarly, return on equity is found to have positive relation with total loan to total
deposit and capital adequacy ratio. And negative relationship was found to be with firm
size, non performing loan to total loan and loan loss provision.
• From regression analysis, non performing loan to total loan and loan loss provision
showed negative relationship with return on assets.
• It was found that firm size, total loan to total deposit and capital adequacy ratio was
negatively related with return on assets.
• Similarly, nonperforming loan to total loan, loan loss provision, firm size showed
negative relationship with return on equity.
• It was found that total loan to total deposit and capital adequacy ratio was positively
related with return on equity.
• The result showed in first model nonperforming loan to total loan, loan loss provision,
firm size and capital adequacy ratio have significant impact on return on assets.
• Similarly in second model of regression analysis among the other independent variable
capital adequacy was significantly positive related with Return equity.
 Conclusion
• The major conclusion of this study is that there is negative
impact of nonperforming loan to total loan on firm’s
profitability in context of Nepalese commercial banks.
Nonperforming loan to total loan (NPLTL) showed negative
relationship with different proxies of firm profitability (i.e.,
ROA and ROE). Thus, it can be said that the nonperforming
loan to total loan (NPLTL) make negative impact on firm’s
profitability. The result shows that higher the non performing
loan lowers the profitability of Nepalese commercial banks.
• This study also concludes that firm size, total loan to total
deposit and capital adequacy were found to have positive
relationship while loan loss provision has negative relationship
with firm profitability.