The effect of non‐performing loans on credit expansion: Do capital and profitability matter? Evidence from European banks

Abstract

We examine whether the effect of NPLs on bank credit growth differs depending upon the level of bank capital and profitability in a panel of up to 521 banks from 28 European countries. Our main finding is that there is a significant positive interaction effect of NPLs and bank capital and NPLs and profitability on the supply of bank credit. Thus, whether NPLs impede the monetary policy transmission mechanism depends substantially on whether or not banks are sufficiently capitalized and profitable. Policy actions aimed at reducing NPLs to sustain bank credit should protect bank capital and profitability if they are to be effective, including by supporting efforts that aim at returning NPLs to good standing.

Non-performing loans and bank lending behaviour

“…Their results revealed that the cost of capital acts as a transmission channel for the negative effect of NPLs on lending supply and liquidity creation (see also Cucinelli 2016;Vo 2018;Chavan and Gambacorta 2019). Our contribution is to look at additional factors through which NPLs may affect bank lending behaviour, similar to the approach by Thornton and Di Tommaso (2020). Their study found that bank capital and profitability mitigate the negative effects of NPLs on credit expansion.…”

“…We use the natural logarithm of total assets for bank i, located in country j, in year t at the end of each year Banksize i,j,t . The expected relationship between bank size and lending is ambiguous and could be either positive (see Thornton and Di Tommaso 2020;Abdul-Karim et al 2014;Hau et al 2013) or negative (see Fang et al 2020;Vo 2018;Košak et al 2015;Puri et al 2011). Capitalization i,j,t is the ratio of equity over total assets for bank i, located in country j, in year t. According to Foos et al (2010) and Kishan and Opiela (2006) banks that are more solvent play an important role in lending.…”

Effects of the NPL on the banks' profitability during the COVID-19 pandemic: The case of the Republic of Serbia

“…After the global financial crisis, the balance sheets of European banks showed that the NPL levels increased significantly, which reduces the capacity of these banks to lend to economic activities (Thornton & Di Tommaso, 2020). This condition of banks led European policymakers to create an NPL reduction strategy with the aim of restoring the stability of the banking system in Europe (Council of the European Union, 2017).…”

Does nonperforming loan securitization affect credit default swap spreads? Evidence from European banks

“…Prior research has focused on the determinants of NPLs (Ghosh, 2015; Louzis et al, 2012) and on the effects on banks' credit supply and profitability (Accornero et al, 2017; Thornton & Di Tommaso, 2021). The few existing studies dealing with bank loan securitization mainly focus on the effect of securitization for the originating banks on bank market value.…”