Asset quality determinants of Indian banks: Empirical evidence and policy issues

Abstract

The Indian banking industry has been suffering from a huge number of nonperforming loans, and the loan asset quality has been deteriorated over the years. This has led to significant capital erosion of many banks in India. The surge in corporate defaults leading to an enormous rise in nonperforming loan assets has been impairing the performance of Indian banking industry in particular and economic growth in general. Hence, it is intuitive to ask what are the determinants of poor asset quality of Indian banks. To answer this question, using a sample of 47 commercial banks over a sample period of 2000 to 2014, our study examines the bank‐, industry‐, and macroeconomic‐specific determinants of asset quality of Indian banks. Our empirical analysis also accommodates the impact of different ownership structures (public and private sector) and the impact of financial crisis while analysing the determinants of poor asset quality of Indian commercial banks. Results reveal that bank‐, industry‐, and macroeconomic‐specific factors are responsible for the burgeoning nonperforming loan assets of Indian commercial banks. The results are qualitatively similar across different ownership structures. The findings suggest that forecasting models for nonperforming assets should also consider macroecomomic‐ and industry‐specific factors along with the bank‐ specific factors.