Banks’ credit risk, systematic determinants and specific factors: recent evidence from emerging markets

Non-performing loans (NPLs, henceforth) represent the main challenge that jeopardizes the steadiness of the banking sector. The purpose of this study is to explore the main determinants of banks' non-performing loans in emerging markets. To better understand the hidden aspects of these determinants, the current research employs a panel approach and dynamic data estimates through Generalized Methods of Moments (GMM) using data of 53 banks listed in five Middle East and North African (MENA) emerging markets between 2000 and 2019. This study documents that GDP growth, unemployment, bank capitalization, bank performance, bank operating inefficiency, bank ownership concentration, inflation, sovereign debt and bank size are the main determinants of NPLs, whereas, loan growth, bank diversification and interbank competition were found to have an insignificant impact on NPLs. This analysis is motivated by the recent economic changes surrounding the financial systems in emerging countries with the aim to provide new evidence and insights. The results show that non-performing loans can be explained mainly by macroeconomic variables and bank-specific factors with interesting differences in their quantitative impacts. This study has substantial theoretical and practical contributions. It shows strong evidence on the leading indicators of future problematic loans. The identification of these factors would help regulators address appropriate interventions, design ample credit policies and adopt adjusted prudential regulations. Further, it empowers the regulatory authorities with an in-depth understanding of credit risk determinants, allowing them to place emphasis on risk management systems and procedures that minimize borrowers' default in order to avert future financial instability. Our findings underscore the necessity of closely monitoring bank-specific factors along with reinforcing country level mechanisms to reduce banks’ credit risk.