Abstract
PurposeThis study aims to capture the “persistence effect” of credit risk in Indian banking industry using the bank-level data spanning over the period of 19 years from 1998/1999 to 2016/17. Alongside, the study explored how the bank-specific, industry-specific, macroeconomic variables alongside regulatory reforms, ownership changes and financial crisis affect the bank's asset quality in India.Design/methodology/approachUsing two-step system generalized method of moment (GMM) approach, the study derives key factors that affect the bank's asset quality in India.FindingsThe empirical results confirm the time persistence of credit risk among Indian banks during study period. This reflects that bank defaults are expected to increase in the current year, if it had increased past year due to time lag involved in the process of recovery of past dues. Further, higher profitability, better managerial efficiency, more diversified income from nontraditional activities, optimal size of banks, proper credit screening and monitoring and adherence regulatory norms would help in improving the credit quality of Indian banks.Practical implicationsThe practical implication drawn from the study is that nonaccumulation of nonperforming loans (NPLs), higher profitability, better managerial efficiency, more diversified income from nontraditional activities, optimal size of banks, proper credit screening and monitoring and adherence regulatory norms would help in improving the credit quality of Indian banks.Originality/valueThis study is probably the first one that identifies in addition to the current year, whether lag of bank industry-macroeconomic affects the level of NPLs of Indian banks. So far, such an analysis has received less attention with respect to Indian banking industry, especially immediate aftermath of the global financial crisis.
Highlights
The recent global financial crisis of 2007–08 has stimulated the interest of academicians, policymakers and researchers to the key consequences that banking crisis can have on to the nation’s economy
The key objective of this paper is to examine the determinants of credit risk in Indian banking industry for more recent time period, i.e. 1999–2014, covering the period following the global financial crisis
Bank’s profitability (ROA): On discussing the effect of profitability on bank’s asset quality, we note that current year rise in Return on assets (ROAs) by 1% leads to decline in risk of future accumulation of nonperforming loans (NPLs) by (À) 0.0079 to (À) 0.0120%
Summary
The recent global financial crisis of 2007–08 has stimulated the interest of academicians, policymakers and researchers to the key consequences that banking crisis can have on to the nation’s economy. The studies that only examined the macroeconomic factors affecting the credit risk include Baboucak and Jancar (2005), which provide the systematic assessment of the links between loan quality and macroeconomic shocks in the Czech banking industry They found a direct relation between NPLs, rate of unemployment and consumer inflation rate, while an inverse relation with GDP growth in the Czech economy. 3.2 Dynamic panel model estimation This study adopts the two-step system generalized method of moments (GMMs) technique of Blundell and Bond (1998) to test the time persistence in credit risk structure in the Indian banking industry for the following reasons: (1) in the presence of the lagged dependent variable, Yi;t−1, the traditional panel estimators are seriously biased The rejection of the null hypothesis of no second order autocorrelation of the differenced errors implies serial correlation for the level error term and inconsistency of the GMM estimates
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