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The determinants of non-performing loans: an econometric case study of Guyana[1]

Tarron Khemraj
Assistant Professor of Economics
New College of Florida

Sukrishnalall Pasha
Lecturer
University of Guyana

ABSTRACT

The study attempts to ascertain the determinants of non-performing loans in the Guyanese banking sector using a panel dataset and a fixed effect model similar to Jimenez and Saurina (2005). Consistent with international evidence we find that the real effective exchange rate has a significant positive impact on non-performing loans. This indicates that whenever there is an appreciation in the local currency the non-performing loan portfolios of commercial banks are likely to be higher. Our empirical results show that GDP growth is inversely related to non-performing loans, suggesting that an improvement in the real economy translates into lower non-performing loans. We also find that banks which charge relatively higher interest rates and lend excessively are likely to incur higher levels of non-performing loans. However, contrary to previous studies, our evidence does not support the view that large banks are more effective in screening loan customers when compared to their smaller counterparts.

Key Words: Non-performing loans, Panel regression model, Guyana.

I. INTRODUCTION

It is widely accepted that the quantity or percentage of non-performing loans (NPLs) is often associated with bank failures and financial crises in both developing and developed countries. In fact, there is abundant evidence that the financial/banking crises in East Asia and Sub-Saharan African countries were preceded by high non-performing loans. The current global financial crisis, which originated in the US, was also attributed to the rapid default of sub-prime loans/mortgages. In view of this reality it is therefore understandable why much emphasis is placed on non-performing loans when examining financial vulnerabilities.[2] The aim of this study is to analyse the sensitivity of non-performing loans to macroeconomic and bank specific factors in Guyana. In particular, it employs regression analysis and a panel dataset covering 10 years (1994 to 2004) to examine the relationship between non-performing loans and several key macroeconomic and bank specific variables. To the authors’ knowledge this is the first study to examine the determinants of non-performing loans in Guyana. As such, it will contribute to the existing literature by providing evidence on the causes of impaired loans in a small developing country. The study employs firm-level data which are rarely used by analysts who study non-performing loans. Therefore, the paper extends the literature on non-performing loans and utilizes both macroeconomic and bank specific variables. Apart from contributing to the literature, the paper may also have important practical implications for commercial bankers and bank regulators/supervisors in the Guyanese banking system. For instance, the findings may be used to develop a framework for measuring and assessing credit risk – an important element of study for the financial stability unit of a central bank. The article finds that both bank specific and macroeconomic factors impacts on the loan portfolios of commercial banks in Guyana. In particular, we find a significant positive relationship between non-performing loans and the real effective exchange rate. This means that deterioration in international competitiveness of the local economy (as reflected by an appreciation in the real effective exchange rate) may result in higher levels of non-performing loans. Our evidence shows that changes in real income – as reflected by growth in real GDP – exert a significant negative effect on NPLs. We also find that commercial banks that are aggressive and charge relatively higher interest rates incur greater NPLs. However, contrary to expectations, the evidence reveals that large banks are not...
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