An Empirical Investigation of Non-Performing Loans and Governance: A South Asian Perspective

Abstract

Escalation in the per capita investment within the economy and enhancement in the volume of loan extensions have been enlisted as some of the key targets under the 2030 Sustainable Development agenda of the United Nations. Against this backdrop, the critical roles of banks and non-bank financial institutions in the extending credit facilities cannot be overlooked. However, incidences of rise in the number and monetary value of Non-Performing Loans (NPLs) act as severe hindrances for the financial institutions in carrying out their tasks effectively; which in turn exerts a marginalizing impact on the overall development prospects of an economy. The aim of this paper is to shed light on the effects of governance on trends in NPLs across the three lower middle income countries in South Asia: Bangladesh, India and Pakistan. The novelty of this paper lies in its approach of linking governance and multidimensional macroeconomic instabilities to the loan defaulting behavior of the borrowers. This paper bridges this gap in the literature by incorporating annual data from 2000 to 2015 for investigating the linkage between governance and NPL creation within the financial sector. This paper employed pooled ordinary least squares, fixed effects, and random effects panel data estimation techniques. In addition, Vector Error Correction Model (VECM) and Granger causality test were also considered to check the short and long run associations as well. The results reveal that better control over corruption and initiation of rule of law reduce the volume of NPLs in the panel of the three countries considered in this paper. Moreover, this study also finds evidences suggesting long run causal associations between NPL and the governance indicators considered in this paper.

Keywords: NPL, Governance, Causality, Corruption, Rule of Law

JEL Classification: D73, G21, G3, H81, O16