Non-Performing Loans in the Euro Area: Are Core-Periphery Banking Markets Fragmented?

Abstract

The objective of this study is to examine the causes of non-performing loans (NPLs) in the banking system of the euro area for the period 2003-2013 and distinguish between core and periphery country determinants. The increase in NPLs post crisis has put into question the robustness of many European banks and the stability of the whole sector. It still remains a serious challenge, especially in peripheral countries which are hardest hit by the financial crisis. By employing both Fully Modified OLS and Panel Cointegrated VAR we estimate that NPLs are affected by the same macroeconomic and bank-specific conditions but the responses are stronger in the periphery. Following the FMOLS estimations NPLs in the euro area have performed an upward (much higher in the periphery) shift after 2008 and are mostly related to worsening macroeconomic conditions especially with respect to unemployment, growth and taxes. Fiscal consolidation and interest rate margins are significant for the periphery while credit to GDP is significant only for the core. Quality of management and loans to deposits play an important role, while size is negatively significant only in the periphery. Most of these findings were confirmed by the panel Cointegrated VAR results. A chi-square test comparing the estimated coefficients for the core and periphery NPLs rejects the hypothesis of equality revealing another aspect of banking fragmentation in the euro area. Such findings can be helpful when designing macro-prudential as well as NPL resolution policies, which should be adjusted appropriately to the different responses between core and periphery banks.

The Valuation of Non-Performing Loans

“…Further research by Clementina and Isu, (2014); Khan and Ahmad, (2017), said that in the banking system, the problem of bad loans consisted of old unproductive debt and new loans are not running properly and will have an impact on bank performance. It is important to identify the factors that affect the NPLs and provide some solutions to banks, in accordance with the opinion (Anastasiou et al, 2005) which says that banks should increase credit policy and supervision.…”

Untitled

“…In the regional analysis, there is a negative relationship between NPLs and bank liquidity and regulatory capital, implying that the banking system with greater liquidity and regulatory capital has fewer NPLs. Anastasiou et al (2016) investigated the causes of NPLs in the euro area banking sector for the period 2003-2013 and separate periphery from core country determinants. The increase in NPLs after the crisis has threatened the power of many European banks and the stability of the banking sector.…”

“…NPLs are the most important challenge faced by euro area banks, and especially in the countries that found in IMF-EU support programs, such as Greece, Ireland, and Portugal, seem to be facing the biggest threat. The management of this problem will enable banks to re-contribute to the growth of their economies (Anastasiou et al, 2016).…”

Non-Performing Loans, Banking System and Macroeconomy

“…The decline is more prolonged than the increase and this may imply that ROA decreases when there is a standard deviation innovation to NPLs. This is expected since a growth in NPLs translates into a reduction in ROA, which is a function of profitability (Anastasiou, Louri, Tsionas, 2016).…”