An empirical analysis on the macroeconomic determinants of non-performing loans in non-financial corporations in European countries

Abstract

Non-performing loans (NPLs) are an important indicator of the health of the banking system. This dissertation presents an empirical analysis of the macroeconomic determinants of NPLs for the core banking system in Malta as well as eight other European countries for Non-Financial Corporations (NFCs). NPLs are defined as loans which are doubtful and irrecoverable. According to Banking Rule BR/09, doubtful loans are credit facilities whose capital and/or interest are overdue by 90 days and over. Such loans also include facilities which, irrespective of the repayment not being overdue by 90 days, are considered by banks as giving rise to doubts regarding their recoverability. The thesis focuses on NPLs emanating from businesses outside the financial sector. It reviews their developments over time, including their fluctuations over the course of the business cycle, as well as their sectoral composition. The review of the literature looks at the main macroeconomic determinants of NPLs. According to the literature, the variables that will be used include the interest rates, measures of economic activity and various asset prices, such as house prices. I will test whether these variables, which have been found to explain NPLs in other countries, are also important determinants of NPLs in all nine European Countries. This assessment will be carried out through regression analysis, namely using an Error Correction Model (ECM). This approach assumes that there exists an equilibrium relationship between NPLs and a set of macroeconomic variables and that any deviations from equilibrium must be temporary. The residuals from the equations are tested for normality, serial correlation and heteroscedasticity, thus ensuring that the parameter estimates satisfy the best linear and unbiased estimator properties.