Elucidating the Non-Performing Assets in Indian Banking Sector: Does Macroeconomic Factor Matter?*

Abstract

Using the system generalized methods of moments on panel data set of 45 selected Indian commercial banks from 2005–2006 to 2019–2020, the study investigates the determinants of non-performing assets (NPAs), taking into account macroeconomic and bank-specific factors. The study finds evidence of a persistent effect in stressed assets. The profitability ratio, operational capacity, cost efficiency and aggressive lending negatively and significantly affect the NPAs. The negative impact of the profitability ratio implies that less efficient banks are more exposed to bad loans. While cost efficiency discourages the NPAs, on the other hand, higher credit deposit ratio (operational capacity) suggests that a well-diversified portfolio leads to lesser probability of loan defaults. The probability of loan default is high when more advances are released to the economy’s weaker and vulnerable sectors (high-priority sector lending). Small-sized banks are more efficient in NPAs management than large-sized banks. Various macroeconomic variables, such as lending rates and credit growth in the banking industry, significantly affect the NPAs. The higher lending rate adversely affects borrowers’ repayment capacity, leading to more stressed assets. Therefore, to maintain bad assets within a bearable limit, policymakers should take macroeconomic determinants into consideration.