Abstract

Abstract The paper analyses the relationship between the banks’ credit risk and macroeconomic conditions by addressing the following questions; (i) How are macroeconomic shocks transmitted to lending risk depending on the ban-specific features? (ii) Are the effects of macroeconomic shocks different across the loan portfolios in various economic sectors? Unlike the common assumption in the literature, the empirical analysis considers banks’ heterogeneity and diversification across borrowers. It employs heterogeneous panel SVARs and standard SVAR models on a dataset from 2002. Q1 to 2019.Q1. The results suggest that the deterioration in credit quality is affected by both macroeconomic and bank-specific factors, with substantial heterogeneity in the magnitudes and timing in terms of the type of loans in various business sectors and bank characteristics. In particular, we find strong evidence of cyclical sensitivity of loan quality, and about 1/4 of banks’ NPLs increases stronger in response to the shocks to growth, exchange rate, interest rate, and profitability. The highly profitable banks tend to less engage in excessive risk-taking, resulting in lower NPLs, whereas the relation of asset size to NPLs is not significant for the sample. A growth shock plays a prominent role in explaining the variation of NPLs for the trade and mining sectors. Similarly, the loan supply shock is the main determinant for the construction sector’s NPLs, while the exchange rate shock is the most responsible for the manufacturing sector. The interest rate shock and exchange rate shock are the most effective factors on NPLs of consumer loans. Finally, the feedback effect of NPLs shows that deterioration of credit quality slows down economic growth.

Highlights

  • Banking institution plays a crucial role in the financial system and the economy

  • The level of nonperforming loans is negatively affected by the business cycle, tend to decline in response to the economic expansion shock

  • Most of the bank lending is directed to business sectors which are mainly depending on business cycles in Mongolia

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Summary

Introduction

There are many experiences of the financial crisis associated with deteriorating asset quality in the banking system, especially rapidly building‐up of nonperforming loans (NPLs) in both developed and developing countries (see, e.g., Demirgüç‐Kunt and Detragiache, 1998; González‐Hermosillo, 1999). These experiences imply that macroeconomic and financial shocks, as well as credit market distortions, have highly related to each other, which brings considerable costs to the real economy. A credit crunch could lead to subsequent business failures that raise the NPL ratio further up It would generate an inefficient resource allocation through investment and demand, thereby harm the country’s long-run growth prospects

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