Determinants of nonperforming loans: empirical study in case of commercial banks in Ethiopia

Abstract

As noted by Sharon (2007), loans have a vital contribution towards development of economy. However, its nonpayment also leads to incidence of huge loss on banks in particular and country in general. Hence, this study was conducted to examine both bank specific (loan to deposit ratio, capital adequacy ratio, return on asset and return on equity) and macroeconomic (lending rate, inflation and effective tax rate) determinants of NPLs of commercial banks in Ethiopia. To this end, the researcher has selected eight senior commercial banks in Ethiopia judgmentally. This study used secondary sources of data, which is panel data in nature, over the period 2002-2013 These data were collected from NBE and CSA. Furthermore, fixed effect model was used to examine the determinants of NPLs. This research is an explanatory research design that identifies the cause and effect relationships between the NPLs and its determinants. The study shows a down ward sloping of nonperforming loans for commercial banks in Ethiopia. The finding also revealed as LTD ratio had positive whereas INFR had negative, but insignificant effect on NPLs of commercial banks in Ethiopia. However, bank profitability measured in terms of ROE, banks capital adequacy ratio and lending rate had negative and statistically significant effect whereas bank profitability measured in terms of ROA and effective tax rate had positive and statistically significant effect on NPLs of commercial banks in Ethiopia. The finding of this study is significant since once identifying the determinants of NPLs might enable management body to make appropriate lending policies that prevent the occurrence of NPLs. Furthermore, the study recommended as bank managers should emphasize the management of current assets and loans than fixed assets in order to reduce the level of nonperforming loans. Besides, it is better for the loan officers to provide financial counseling to the borrowers on the wise use of loan and also to make decision on timely fashion to meet their need.