Non-Performing Loans and Bank Profitability: Study of Joint Venture Banks in Nepal

Abstract

The study investigates the bank-specific & macroeconomic determinants of non-performing loans as well as its impact on profitability. It uses secondary data of 7 joint venture from the year 2006 to 2017 and employs a fixed effect panel model in estimating three different empirical equations. The bank-specific variables taken are capital adequacy, net interest margin, the size of banks measured by total assets & loan to deposit ratio. Similarly, the macroeconomic variables include GDP growth, inflation and loan concentration of the banking industry measured by the Herfindahl-Hirschman Index. A non-performing loan is taken as both the independent and dependent variable; firstly to find out its determinants and the variable that comes significant during the process of finding the determinants is taken as the variable that affects the profitability. The study finds the net interest margin and bank size as the determinants of the non-performing loan & suggest that net interest margin has a positive and significant effect while the bank size has a negative and significant relationship. However, the macroeconomic variables do not relate. Furthermore, when the net interest margin, bank size & non-performing loan are used as an independent variable, its significant effect is seen with the profitability. An insignificant relationship is seen with the return on equity in terms of only bank size. Three conclusions derived from this study are: firstly as the net interest margin rises for the banks so does the bankability to earn from the interest income which increases the profitability. Secondly, the increase in the non-performing loan erodes the interest income reducing the profitability & finally, as the asset size increases so do the bad management practices as there are huge operations to be handled by the bank, therefore hindering the profitability.

Keywords: Nonperforming loan; profitability; determinants.

JEL Classification: G21, G28,G32, L24,