Assessing the Impact of Non-Performing Loans and Capital Adequacy on Bank Profitability for the Case of North Macedonia

Abstract

This study investigates the influence of non-performing loans on the profitability of banks operating in the Republic of North Macedonia, providing insights into the specific dynamics of the banking sector. Non-Performing Loans (NPL) represent a critical concern for banking institutions worldwide, reflecting potential credit risk and weakening of financial stability. In the context of North Macedonia, where the banking sector has a significant function in driving economic growth and development, understanding the relationship between NPLs and profitability is of great importance. Also, taking into consideration the importance of the ratio of Capital to Risk Weighted Assets (CRWA), this study also investigates the relationship between Capital to RWA and bank profitability. By employing an autoregressive distributed lag (ADL) model, the study intends to uncover the trends and the relationship between variables, by also considering how past values affect the current values of the bank profitability. The results of the analysis disclose a highly significant negative influence of the NPLs on the bank profitability indicators, such as Return on Equity (ROE) and Return on Assets (ROA). Thus, the findings reveal important insights for the policymakers and the banking industry in North Macedonia, aiding in the formulation of effective risk management strategies and regulatory policies aimed at mitigating the adverse effects of NPLs and capital needs on bank profitability. At the same time, the study is expected to contribute to the existing body of literature on the topic by offering empirical evidence specific for the Macedonian banking sector, thus filling the gap in the research landscape.