The effect of non-performing loans on the LMICs with a focus on the macroeconomy and institutional quality

This paper investigates the effects of the bank’s non-performing loans (NPLs) as a percentage of gross private sector credit in the 21 Lower Middle-Income Countries (LMICs) including the four major South Asian economies during 1998 to 2015, with a focus on the macroeconomy and institutional quality. The static and dynamic country Fixed Effect (FE) and the Generalised Methods of Moments (GMM) approach are used to analyse the impact of the macroeconomic and institutional qualities on NPLs. Whereas, the Panel-Vector Autoregressive (PVAR) approach is used to examine the reverse impact of NPLs on the real economy. It is found that the NPLs attributes to both macroeconomic conditions and institutional quality, moreover, it is affected significantly by around 70% by previous year’s NPLs. On the other hand, NPL has an adverse impact on GDP, employment, credit and exchange rate. Therefore, this paper suggests that the high NPLs in LMICs would adversely affect their sustainable growth which recalls the early Schumpeterian (1911; 1917) advocacy for taking a balanced position considering the demand and supply sides of the credit for the policy modelling.