Determinants of loan losses of Indian Banks: a panel study
Purpose – The purpose of this paper is to examine the factors that influence the variability of loan losses (termed as non-performing advances or NPA in India) of Indian banks in the public sector during the period of five years from 2001 to 2005. Design/methodology/approach – The analysis is based on a panel approach, which considers both spatial and time dimensions of observations. Panel regression was used to explore the impact of different bank-specific factors on NPAs of 27 public sector banks (PSBs). Standard tests were used to find out suitability of different models of panel data analysis. Eight bank-specific factors were identified for analysis on the basis of review of extant literature. Findings – Certain bank-specific factors, in particular, net interest margin and capital adequacy ratio exhibit negative and significant impact on gross non-performing advances (GNPA) ratio of Indian PSBs. The results also suggest that relative quantum of sensitive sector (SEN) (comprised of commercial real estate, commodity and capital market) advances has a positive relationship with NPA ratio, and such a relationship is statistically significant. Research limitations/implications – The sample is restricted to India and may not be reflective of other countries. The study considers bank-level factors, and there are some macro factors (e.g. gross domestic product, interest rate and inflation rate) which could have explained the variability of GNPA ratio. Practical implications – Provisioning against loan losses is a major issue for stability of the banking system. Identification of appropriate causes of variability of such loan losses is important for managing credit portfolio of a bank. A positive and significant relationship between SEN advances and NPA calls for a more cautionary approach toward lending to those sectors. Originality/value – This paper is believed to be the first attempt to empirically examine the role of bank-specific factors. This study attempts to enrich empirical research in the field and provides an insight into the role of various bank-specific factors on loan losses in the context of Indian PSBs. The study provides contrary evidence regarding the role of priority sector advances on a GNPA ratio.