Nonlinear linkages between bank asset quality and profitability: evidence from dynamic and quantile approaches using a global sample

Abstract

PurposeThe purpose of this study is to examine whether the relationship between asset quality and profitability is linear or nonlinear, using a global dataset containing 2,943 banks from advanced and emerging economies.Design/methodology/approachThe authors use the U-shape test to investigate the existence of a nonlinear relationship between asset quality and profitability. In addition, the dynamic panel generalised method of moments (GMM) and quantile regression are used to examine the nonlinear effect of profitability on nonperforming loans (NPLs).FindingsAfter controlling for macroeconomic and bank internal factors, the authors find empirical evidence supporting the existence of a nonlinear relationship in the form of a U-shape. This is also confirmed through the three-stage U test procedure. After distinguishing between advanced and emerging economies, the authors also find that, in advanced markets, the credit policy responds more rapidly to changes in credit market conditions than in emerging markets, providing insights into credit market dynamics.Research limitations/implicationsFurther research can check the robustness of this study’s findings in different markets and investigate the existence of nonlinearity in other bank variables.Practical implicationsIn a nutshell, the results demonstrate potential implications for policymakers who need to carefully monitor banks' lending behaviour to ensure that banks do not lower lending standards. In addition, banking regulators and supervisors should consider the possible nonlinear relationship in their risk assessments and macrostress tests. Further, these results are important for bank managers, who should monitor the performance of their loan portfolios to ensure that their credit officers do not lower credit standards. Likewise, for banks located in an emerging economy, investing in human capital and advanced technologies can enable them to respond more effectively to changes in the credit market.Originality/valueTo the best of the authors' knowledge, this study is considered the first to provide empirical evidence for the nonlinear relationship between asset quality and profitability.

Non-Performing Loans and Net Interest Margin in the MENA Region: Linear and Non-Linear Analyses

“…One of the important factors in banking literature is NPL, which is widely used as one of the determinants of bank profitability. While most of the empirical studies on the NPLs-profitability relationship focused on linear approaches (Akter and Roy 2017;Serrano 2021;Thornton and Di Tommaso 2021;Ugoani 2016;Rosenkranz and Lee 2019), a few studies investigated the possible non-linear relationship (Alqahtani et al 2022;Neves et al 2020;Kusi et al 2020). Boubaker et al (2022a) examined the role of bank affiliation in bank efficiency using a fuzzy approach, including bank NPLs as one of the relevant control variables that might affect bank stability.…”