Abstract
As financial intermediaries, the commercial banks to a large extent depend on the performance of their lending as a critical source of earning. Due to increasing loan failures, the share of non-performing advances has increased substantially in recent years, thereby adversely impacting their profitability. The paper has examined the NPAs and profitability relationship by estimating the determinants of profitability of 39 public sector and private banks for the time period from 2005 to 2019. Using a set of bank specific and macroeconomic predictors of profitability, we found that NPA has negative impact on the rate of profit of the Indian banks. The study suggests that the banks must reduce their NPAs and operating cost to improve their profitability.
Highlights
Growing incidence of non performing advances or loans can have potential adverse impact on the performance of the banks by squeezing their earnings, thereby reducing their profitability
The results show a negative association of Return on Assets (ROA) with Non-Performing Advances (NNPA) and CapT1
From the panel data estimation of 39 Public Sector and private banks, we found that the increase in non-performing advances has negative impact on the rate of profit
Summary
Growing incidence of non performing advances or loans can have potential adverse impact on the performance of the banks by squeezing their earnings, thereby reducing their profitability. A loan or advance becomes non-performing assets (NPAs) when a borrower defaults on the repayment of either the principal amount or unable to serve its debt. An NPA makes an asset unproductive, banks fail to recover the principal capital. The interest earning of the bank declines; on the other side, there is a risk of recovery of principal amount. Falling interest income while directly impacts the profitability of a bank, under recovery of principal capital can result in erosion of bank’s capital base. The combination of both can potentially affect the stability a bank
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