Resolution of Bad Loan Problem: Bank-Level Evidence from a Low-Income Country

Abstract

How do banks resolve a severe bad loan problem in a capital-constrained, low income economy when a government bailout is not an option? We address this question by examining new evidence of a sharp decline in bad loan ratios in a panel of domestic commercial banks in Bangladesh. On the aggregate level, the bad loan ratio in this market has dropped from 41% in 1999 to only 7% in 2010. We find that at a micro-level this dramatic improvement is driven by bank management and governance quality that were substantially enhanced during a decade of large-scale regulatory reforms.