Determinants of loan losses of Indian Banks: a panel study

Abstract

Purpose– The purpose of this paper is to examine the factors that influence the variability of loan losses (termed as non-performing advances or NPA in India) of Indian banks in the public sector during the period of five years from 2001 to 2005.Design/methodology/approach– The analysis is based on a panel approach, which considers both spatial and time dimensions of observations. Panel regression was used to explore the impact of different bank-specific factors on NPAs of 27 public sector banks (PSBs). Standard tests were used to find out suitability of different models of panel data analysis. Eight bank-specific factors were identified for analysis on the basis of review of extant literature.Findings– Certain bank-specific factors, in particular, net interest margin and capital adequacy ratio exhibit negative and significant impact on gross non-performing advances (GNPA) ratio of Indian PSBs. The results also suggest that relative quantum of sensitive sector (SEN) (comprised of commercial real estate, commodity and capital market) advances has a positive relationship with NPA ratio, and such a relationship is statistically significant.Research limitations/implications– The sample is restricted to India and may not be reflective of other countries. The study considers bank-level factors, and there are some macro factors (e.g. gross domestic product, interest rate and inflation rate) which could have explained the variability of GNPA ratio.Practical implications– Provisioning against loan losses is a major issue for stability of the banking system. Identification of appropriate causes of variability of such loan losses is important for managing credit portfolio of a bank. A positive and significant relationship between SEN advances and NPA calls for a more cautionary approach toward lending to those sectors.Originality/value– This paper is believed to be the first attempt to empirically examine the role of bank-specific factors. This study attempts to enrich empirical research in the field and provides an insight into the role of various bank-specific factors on loan losses in the context of Indian PSBs. The study provides contrary evidence regarding the role of priority sector advances on a GNPA ratio.