The impact of non-performing loans on the profitability of listed Euro-Mediterranean commercial banks

Abstract

The banking sector in Europe has experienced an increasing amount of problematic loans during the past years, which was mainly driven by the aftermath of the 2007-2008 global financial crisis. The Euro-Mediterranean area had a major role in such problematic loans as it represented a considerable fragment in Europe. Problematic loans usually referred to as Non-Performing Loans (NPLs) have contributed to a considerable proportion of the total value of the bank’s loan portfolio. In countries such as Greece and Italy in particular, this problem reached soaring levels. Indeed, NPLs in some banks even managed to reach 50% of their total loan portfolio. Commercial banks more than others have found themselves in a gridlock between their liquidity or solvency whilst at the same time trying to keep an ongoing credit function. Eventually, when these problems escalated, commercial banks started to realize reduced profitability figures or to some extent even negative profitability figures. Specifically, this study attempts to analyse the impact of NPLs on listed commercial bank’s profitability, in particular their ROA (Return on Assets), in the Euro-Mediterranean area. The purpose of this study is to determine whether the change in the level of NPLs in listed commercial banks is either positively or negatively impacting the ROA of the concerned banks. Furthermore, knowing that the liquidity and the solvency of a bank are both equally important to maintain a robust financial position, a Liquidity (LQDT) and Solvency (SLVT) ratio were considered to help explain the variances with NPLs and ROA. A purposive research design was adopted using panel data (2013-2017) from data published on the Thomson Reuters Eikon or annual reports of the 35 listed commercial banks in the Euro-Mediterranean region. The study executed Descriptive Statistics and four regression models, namely; the Pooled OLS regression model, Fixed Effects (FE), Random Effects (RE) and the Arellano-Bond (AB), through STATA/IC 15.1. Findings show that there is a negative impact of NPLs on ROA, indicating that problematic loans negatively impact listed commercial bank’s profitability in the Euro-Mediterranean region. Also, it was indicated that the Solvency ratio (SLVT) is the only controlling factor that can significantly explain variances within NPLs and ROA. These results carry with them significant consequences for the bank’s financial stability within the Euro-Mediterranean countries, and the role of the risk management function of listed commercial banks.