Loan Loss Research Articles

Policies of Credit Restructuring Relaxation as Moderation Variable on the Relationship between Financial Ratios and Banking Performance in Indonesia

This study investigates the impact of Indonesia's newly implemented restructuring relaxation policies as moderating variables on the banking sector's performance. Utilizing panel data regression analysis on a sample of 105 banks from 2017 to 2022, the research examines the relationships between non-performing loans (NPL), loan loss provisions (LLP), efficiency ratios, and bank return on assets (ROA). The findings indicate that prior to the policy implementation, the efficiency ratio negatively affected government banks' ROA, while both LLP and the efficiency ratio negatively impacted private and foreign banks' ROA. Post-implementation, the interaction between these policies and each variable (NPL, LLP, and efficiency ratio) was found to be significant for government banks, whereas none of them showed significance for private or foreign banks. This research contributes to understanding financial regulation dynamics and provides insights for policymakers and banking institutions navigating market complexities.

Effects of Non-Performing Loan and Operational Efficiency on Profitability of Nepalese Commercial Banks

This study examines the effects of non-performing loan and operational efficiency on profitability of Nepalese commercial banks. Return on asset and return on equity are selected as the dependent variables. Similarly, loan to deposit ratio, capital adequacy, loan loss provision, non-performing loan, operating income and operating expenses are selected as the independent variables. This study is based on secondary data of 15 commercial banks with 105 observations for the study period from 2015/16 to 2021/22. The data were collected from Banking and Financial Statistics published by Nepal Rastra Bank(NRB), annual reports of the selected commercial banks and reports published by Ministry of Finance. The correlation coefficients and regression models are estimated to test the significance and importance of loan to deposit ratio, capital adequacy ratio, loan loss provision, and non-performing loan, operating income and operating expenses on the profitability of Nepalese commercial banks. The study showed that that loan loss provision ratio, non-performing loan ratio and capital adequacy ratio are the positive impact return on assets (ROA). It indicates that higher the loan loss provision ratio, non-performing loan ratio and capital adequacy ratio, higher would be the bank return on assets (ROA) of commercial banks in Nepal. Similarly, the study also shows that loan to deposit ratio, operating income ratio and operating expenses ratio have a negative impact on return on assets (ROA). It indicates that higher the loan to deposit ratio, operating income ratio and operating expenses ratio lower would be the return on assets of Nepalese commercial banks.

DO POLITICALLY CONNECTED BANKS PERFORM BETTER IN A DEMOCRATIC ENVIRONMENT?

This paper elucidates the intricate relationship among bank performance, political connections, and the democratic environment. The existing body of evidence is notably limited in illustrating the impact of a democratic environment on bank performance. Our study examines a sample of 397 banks spanning 14 countries and districts, encompassing both politically affiliated and non-politically affiliated banks in both democratic and non-democratic settings. The empirical findings reveal a reduction in non-performing loans but an escalation in loan loss provision within a democratic environment. This phenomenon may be attributed to the diminished level of financial constraints prevalent in democratic settings. Furthermore, our investigation revealsthat political connections exert a deleterious effect on the non-performing loans (NPL) ratio, coupled with a salutary impact on loan loss provision. Conclusively, our research identifies that the stock return of politically connected banks in democratic environments is inferior to their counterparts in non-democratic environments. Additionally, the non-performing loans ratio (NPL) of politically connected banks in democratic environments tends to be higher compared to their non-democratic counterparts. Conversely, the loan loss provision of politically connected banks in democratic environments tends to be lower than that in non-democratic environments. This nuanced analysis contributes to a more comprehensive understanding of the interplay between democratic environments, political connections, and bank performance.

Climate risk and financial stability: evidence from syndicated lending

We study the impact of unexpected climate shocks on banks' individual and systemic risks. Employing climate risk measures developed using the Billion-Dollar Weather and Climate Disasters data from the National Oceanic and Atmospheric Administration (NOAA) and Dealscan syndicated lending data, we find that climate risk exposure acquired through cross-state lending increases banks' individual and systemic risks. We also find that bank profitability helps offset some of the adverse effects of climate risk. Banks reduce lending and increase loan loss reserves after the experience of an unexpected climate shock. The loan-level analysis reveals that the effect of climate risk exposure on bank risks is more pronounced for loans granted for operating and capital expenditures. We contribute to a growing literature on the impact of climate risk on financial stability and the development of robust measures of climate risk for banks.

Impacts of the Transition to the Expected Loss Model on the Portuguese Banking Sector

This study addresses the implementation of the International Financial Reporting Standard 9 (IFRS 9) in the European Union as of 1 January 2018, replacing the International Accounting Standard 39 (IAS 39) to introduce a new model for recognizing Loan Loss Provisions (LLP), based on Expected Credit Loss (ECL). This model responds to criticisms of the former Incurred Credit Loss (ICL) system for its inability to reflect credit losses in a timely manner, potentially exacerbating the effects of financial crises. This study focuses on the effects of adopting the ECL model on the level of Loan Loss Allowances (LLA) in loans, own equity, and the Common Equity Tier 1 (CET1) ratio across 13 Portuguese commercial banks. A mean comparison test is used to evaluate scenarios before and after the application of the ECL model, highlighting the importance of regulator actions and the adequacy of loss recognition policies, including the effects of European Union. The results obtained demonstrate significant negative impacts on the net values of loans, own equity, and the CET1 ratio upon adopting the IFRS 9 ECL model due to the widespread increase in LLAs.

Determinant of Probability of Indian Listed Commercial Bank

This study investigates the determinants of profitability among commercial banks in India over the period from 1999 to 2022, utilizing unbalanced panel data comprising 108 banks. By examining both internal bank-specific characteristics and external macroeconomic factors, we assess how these variables impact profitability across different types of banks. Our findings suggest that liquidity conditions, as measured by the loan-to-asset ratio, do not significantly affect profitability. However, credit risk, represented by the ratio of loan loss provisions to total loans, demonstrates a positive relationship with profitability for foreign and private banks. Diversification has conflicting effects on profitability, with SBI & Associates banks and public banks benefiting from it, while new private banks experience negative impacts. The influence of overhead costs on profitability varies across bank types, positively impacting return on equity for all banks and foreign banks, but negatively affecting return on equity for public banks. Conversely, it positively impacts return on assets for all banks but negatively impacts return on assets for private banks. Capital strength exhibits a negative association with profitability across all banks and a positive association for public banks, with inconclusive results for private banks. Bank size does not show a significant relationship with profitability across all bank types. Regarding macroeconomic factors, while indicators like money supply growth and inflation do not significantly impact return on equity, they positively influence return on assets, albeit with variations across ownership types. In conclusion, this study highlights the complexity of factors influencing bank profitability in India and underscores the importance of tailored management strategies to navigate these complexities effectively.

Macroeconomic Dynamics and Profitability of Insurance Firms Listed at Nairobi Securities Exchange, Kenya

Kenya’s insurance industry has been growing steadily since 2013, with premium revenue and capital investment increasing. However, Return on Assets has declined over the past four years and reached an all-time low in 2022 compared to the previous five years which was partly attributed to the reforms introduced to cater the impact of Corona virus pandemic on and the need to close infrastructure gaps. As a result, as gross domestic product grows, firm deposits and loans rise along with interest income and loan losses. This study focused on understanding how macroeconomic dynamics affect the profitability of insurance companies listed on NSE in Kenya. It particularly looked into how changes in exchange rates, interest rates, and the overall price rise in the economy (inflation) influence these companies' profits. The study was guided by the theoretical frameworks of purchasing power parity, deflation, the balance of payment, the classical theory of interest, and the balance scorecard model. The study adopted an explanatory research design and targeted the six insurance firms listed on the NSE. The secondary data collection for this study involved the utilization of secondary data sheets. Data was obtained from the official audited financial statements of the insurance firms for the fiscal years 2016 through 2022. Data analysis involved both descriptive and inferential analysis. Inferential analysis incorporated both correlation analysis and panel regression analysis. The study found that key macroeconomic dynamics had significant impact on the profits of insurance companies listed on the NSE, explaining 57.71% of the changes in profits (R-squared = 0.5771). It discovered that while changes in the exchange rate do not significantly affect profits (β = 0.0761, p = 0.5358), higher interest rates lead to higher profits (β = 2.1647, p = 0.0233), and inflation negatively impacts profits (β = -0.3447, p = 0.0011). The study's validity is supported by strong statistical evidence (F-statistic = 21.0100, p-value = 0.0000). It suggests that insurance companies in Kenya should focus on managing risks related to economic changes to improve their financial performance. This research adds to the understanding of how macroeconomic dynamics affect the profitability of insurance firms in the context of the NSE. Keywords: Exchange rates, insurance profitability, interest rates, inflation impact, Nairobi Securities Exchange

The mediating effect of bank risk on the relationship between diversification strategies and discretionary loan loss provisions

Purpose This study aims to investigate the effect of income and asset diversification on earnings management using discretionary loan loss provisions (LLP) in banks, and the role of risk level in mediating this effect. Design/methodology/approach A sample of banks operating in Middle East and North Africa countries was used to test the mediation model of Baron and Kenny (1986) with different measures of diversification and risk. Findings The results show that bank income and asset diversification have unique and combined effects on earnings management. The results also support the idea that a risk-mediating effect contributes to explaining this relationship among banks. Specifically, bank diversification strategies positively affect LLP-based earnings management by increasing bank risk. This result is relevant for conventional banks. However, only a direct and positive effect of diversification strategies on LLP-based earnings management can be observed in Islamic banks, and the indirect effect is not supported. Originality/value This study extends previous research by examining the unique and combined effects of income and asset diversification strategies on earnings management in the banking sector. Specifically, it provides new evidence that diversification strategies increase LLP-based earnings management, both directly and indirectly, through bank risk.

Model-based financial regulations impair the transition to net-zero carbon emissions

AbstractInvestments via the financial system are essential for fostering the green transition. However, the role of existing financial regulations in influencing investment decisions is understudied. Here we analyse data from the European Banking Authority to show that existing financial accounting frameworks might inadvertently be creating disincentives for investments in low-carbon assets. We find that differences in the provision coverage ratio indicate that banks must account for nearly double the loan loss provisions for lending to low-carbon sectors as compared with high-carbon sectors. This bias is probably the result of basing risk estimates on historical data. We show that the average historical financial risk of the oil and gas sector has been consistently estimated to be lower than that of renewable energy. These results indicate that this bias could be present in other model-based regulations, such as capital requirements, and possibly impact the ability of banks to fund green investments.

The effects of economic uncertainty and economic policy uncertainty on banks’ loan loss provision in Brazil

This paper investigates the effects of economic uncertainty and economic policy uncertainty on banks’ loan loss provision in Brazil, and it seeks to identify which uncertainties have the greatest impact on loan loss provisions. Regarding uncertainties, it is possible to proxy economic uncertainty and economic policy uncertainty through disagreements among professional forecasters and through news-based proxies. Thus, as a novelty, disagreements among professional forecasters are used to proxy both economic and economic policy uncertainties, and for checking robustness, news-based proxies are employed. The disagreements in expectations are divided into two groups: the first focuses on uncertainties related to economic policy instruments (i.e., monetary policy interest rate and primary surplus), and the second on uncertainties related to economic outcomes (i.e., inflation, exchange rate, GDP growth, and public debt). Regarding the news-based proxies of economic policy uncertainty and economic uncertainty, two indicators were employed: the first is the Economic Policy Uncertainty index, and the second is the index of economic uncertainty unrelated to economic policy that we calculate. Based on dynamic panel data analysis for 125 Brazilian banks, the findings suggest uncertainties in economic outcomes have greater influence on banking provisions than uncertainties in economic policy. The study validates the results using news-based indexes and a subsample representing the post-global financial crisis period.

Are Financial Ratios Able to Predict Bank Stock Prices During the COVID-19 Pandemic?

Fundamental analysis, such as financial ratios, is important to ensure capital markets move efficiently. This analysis represents 69% of the variation in stock prices in the capital market. However, fundamental analysis has not been widely carried out because expertise is needed to analyze qualitative and quantitative data from company characteristics that underlie the movement of a stock. In 2020 – 2022, bank performance experienced fluctuations due to the Covid-19 pandemic which caused bank share prices to also fluctuate. On the other hand, banks have an important role as intermediary institutions or intermediaries to support the funding needs of the real sector or the business world. However, previous research on fundamental analysis largely excluded companies in the financial sector. Therefore, this article aims to find out whether financial ratios are able to predict bank share prices during the Covid-19 pandemic. There are five financial ratios used in this research, namely loan loss provision ratio, total capital ratio, profit margin ratio, current ratio, and solvency ratio. The population in this study are financial companies listed on the Indonesia Stock Exchange for the period 2020 - 2022. The sample was selected using a purposive sampling method and obtained 38 companies and 114 observations. The results of multiple regression analysis show that the loan loss provision ratio has a significant negative effect and the total capital ratio has a significant positive effect on bank share prices. Meanwhile, the net profit margin ratio, current ratio and solvency ratio do not have a significant effect on bank share prices. This research has implications for encouraging banks to improve disclosure policies and encouraging investors to hone fundamental analysis skills to reduce mispricing and make markets more efficient.

Regulatory and contextual factors influencing earnings and capital management decisions: evidence from the European banking sector

This study investigates whether some regulatory and contextual features influenced Euro Area listed banks decisions to manage earnings and regulatory capital through discretionary provisions in the period 2013–2018. The new regulation factors are the pressure to increase high-quality regulatory capital (Basel III) and more timely recognition of loan losses (IFRS 9). The contextual features are the intensified banking competition at a national level, and the significant money market pressure. Results demonstrate that the pressure to increase high-quality regulatory capital for banks with lower Common Equity Tier 1 capital (CET1) in year t − 1 is negatively associated with upward earnings and capital management in year t. The more timely recognition of loan losses in year t compared to year t + 1 is negatively associated with upward earnings and capital management in year t. The strengthening of banking competition is positively associated with upward earnings management, but not associated with upward capital management. The increasing money market pressure is negatively associated with upward earnings management, but not associated with upward capital management. This study should be helpful to standard-setters, regulators, investors and academics interested in incentives and constraints to earnings and capital management by providing evidence regarding how listed banks reacted to the regulatory, accounting, and contextual factors, observed holistically during a unique historical period (i.e., 2013–2018) and regulatory setting (i.e., European banking sector).

Bank Loan Loss Provision Determinants in Non-Crisis Years: Evidence from African, European, and Asian Countries

Loan loss provision is an important accounting accrual in the banking sector. There have been numerous debates about the determinants of loan loss provision in several contexts. This study extends the debate by investigating the determinants of bank loan loss provision in non-crisis years for 28 countries from 2011 to 2018. The non-crisis years cover the periods after the global financial crisis and the periods before the COVID-19 pandemic while the countries consist of African, European, and Asian countries. Using the generalized linear model regression and the quantile regression methodologies, the results show that institutional quality is a significant determinant of bank loan loss provision, indicating that the presence of strong institutions decreases the size of bank loan loss provision in non-crisis years. In the regional analyses, it was found that economic growth is a significant determinant of bank loan loss provisions in African and Asian countries. Loan loss provision is higher in times of economic prosperity in African and Asian countries. Bank overhead cost is a significant determinant of bank loan loss provisions in Asian countries. Meanwhile, bank loan loss provision determinants are insignificant in European countries.

Does banking sector support for achieving the sustainable development goals affect bank loan loss provisions? International evidence

Does banking sector support for achieving the sustainable development goals affect bank loan loss provisions? International evidence

Impacts of the Expected Credit Loss Model on Pro-Cyclicality, Earnings Management, and Equity Management in the Portuguese Banking Sector

This article delves into the pro-cyclicality of loan loss provisions (LLPs) and earnings management, along with equity management, in Portuguese banks against the backdrop of implementing the IFRS 9’s expected credit loss (ECL) model. It concentrates on how LLPs mirror economic cycles and financial management practices, providing valuable insights into the operational dynamics of the Portuguese banking sector, marked by distinct economic and regulatory challenges. The research examined a sample of five Portuguese commercial banks, chosen from a group of seventeen in the Portuguese Banking Association. Data spanning from 2013 to 2022 were manually gathered. A multiple linear regression model was employed to scrutinize the relationship between LLPs and variables indicative of economic cycles and the earnings and equity management. The methodology use was a multiple linear regression model. The analysis indicates a pro-cyclicality in LLPs within the Portuguese context, with a positive response of LLPs to economic indicators like unemployment. Contrarily, the extent of earnings and equity management under the ECL model was less marked compared to the incurred credit loss (ICL) model, suggesting the impact of more stringent regulatory measures. The research corroborates the pro-cyclicality of LLPs in Portuguese banks under the ECL framework, underscoring the necessity for ongoing monitoring and refinement of models for forecasting and recognizing credit losses. The findings point to an area for improvement in financial management practices, despite regulatory enhancements, to promote transparency and ensure financial stability.

The Impact of Non-Interest Income on Commercial Bank Profitability in the Middle East and North Africa (MENA) Region

This study examines the effects of non-interest income on bank performance in the Middle East and North Africa (MENA) region, addressing existing research gaps and conflicting results. The analysis is based on data from 40 banks (5 banks from each country) operating in Bahrain, Egypt, Jordan, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates between 2010 and 2022. Using correlation analysis and three regression models (OLS, FE, and RE), this study explores the relationship between non-interest income, overheads, capital adequacy, loan loss provision, bank size, and return on assets. The findings reveal positive associations among banks’ overhead, size, capital adequacy, and loan loss provision. Additionally, a favorable correlation is observed between non-interest income and bank performance. Non-interest income significantly influences the profitability of MENA region banks across all three models, supporting the main hypothesis. While the study’s limitations include sample size and geographic focus, the findings of this study provide valuable insights for policymakers, allowing them to recognize the positive impact of increasing non-interest income on commercial bank profitability in the MENA region and consider implementing policies that encourage and support banks in diversifying their income sources.

Private mortgage securitization and adverse selection—New evidence from expected loan losses

This paper studies expected loan loss and adverse selection in private mortgage securitization. The research extends the previous literature on securitization that has focused on default probability. Expected loan loss incorporates both the probability of default and loss given default and represents a comprehensive measure of loan quality that has the ultimate impact on lenders and investors. This new measure of loan quality reverses some of the findings in the previous literature. The disparity in results between the alternative measures is more pronounced among loans with higher expected loss given default. Our results provide new evidence of adverse selection in prime loans. This cherry-picking behavior does not hold for subprime loans.

Directors’ Compensation and Earnings Management Practices: Evidence from the Nigerian Banking Sector

Compensation contracts is one of the tools recommended by theorists and scholars towards ensuring that directors perform their function of effective monitoring of an organisation. However, this may induce earnings management (EM) practices as a result of being tied to accounting earnings or stock prices. The study thus evaluated the effect of directors’ compensation on EM practices within the Nigerian banking sector anchored on the Agency Theory. Adjusted population of eleven listed commercial banks was used as the census sampling method was employed. Directors’ compensation was measured using a mix of executive directors and non-executive directors (NEDs) compensation while EM practices was proxy by discretionary provision for loan loss (DPLLs) measured using the Beaver and Engel (1996) model. Using the ordinary least square (OLS) regression, all forms of directors’ compensation except executive compensation were found to have positive effect on EM practices. However, only NEDs fees and allowances was found to have a significant effect on EM practices necessitating the regulation of directors’ compensation. The study concluded that directors’ compensation does affect EM practices of listed banks in Nigeria though to varying extent depending on the kind of compensation. The study recommended a shift of focus from just Chairman compensation to include the totality of NEDs compensation and an institution of guidelines for mandatory disclosure of directors’ compensation. The study thus provides practical contribution for regulatory authorities towards ensuring that the accounting process is rid of EM practices as well as investors by consolidating confidence in the Nigerian banking sector.

Uncertainty and bank risk in an emerging market: The moderating role of business models.

The paper explores the role of business models in the link between uncertainty and bank risk. From the perspective of banks, given that future outcomes tend to be less predictable if banking uncertainty rises, we highlight a framework that a larger dispersion of bank shocks to bank-specific variables might mirror such decreased predictability as a consequence of increasing uncertainty. To compensate for the persistence of bank risk and address the endogeneity issue, we applied the system generalized method of moments (GMM) estimator as the main regressions. Analyzing a panel of commercial banks from Vietnam between 2007 and 2019, we find that higher levels of banking uncertainty may increase bank risk, as gauged by banks' credit risk (loan loss reverses and non-performing loans) and default risk (Z-score index). This detrimental influence of uncertainty appears to be most pronounced with banks relying on pure lending, and it decreases with more non-interest income. A deeper investigation after estimating the marginal effects with plots reveals an asymmetric pattern that bank risk is immune to uncertainty in banks with the highest level of income diversification. Interestingly, we also provide evidence that uncertainty may lower the default risk level when income diversification exceeds a sufficiently high level. Our findings demonstrate that diversified business models are an efficient buffer against higher bank risk in times of increased uncertainty.

The Effects of Regulatory Office Closures on Bank Behavior

AbstractWe investigate if the decentralized structure of regulatory office networks influences supervisory outcomes and bank behavior. Following the closure of an office, banks previously supervised by that office increase their lending and risk‐taking. As a result, affected banks have larger loan losses and higher failure rates during the 2008–09 financial crisis. Analysis of the channels suggests that proximate supervisors enforce timelier provisioning practices, restrict large cash payouts, and provide advice that increases a bank's risk‐adjusted returns. Overall, our findings imply that geographical proximity reduces informational frictions in supervisory monitoring and leads to more stable banks.