Impact Analysis of Macroeconomic Condition and Governance on Non-Performing Loans in Asia and Pacific Banking System

Abstract

The interactive role of governance in the linkage between the macroeconomic environment and credit risk has been conceptually assessed but not empirically tested for the Asia and Pacific region. To that end, this paper investigates the growing influence of governmental institutions on the macroeconomic environment and nonperforming loan nexus in 19 East Asian and Pacific countries between 2009 and 2020. A panel dataset on macroeconomic variables and non-performing loans was obtained from the World Development Indicators database, while governance quality variables were collated from the World Governance Indicators database. The System Generalized Method of Moments (SGMM) technique was employed to estimate the models. The results showed that GDP per capita growth contributed significantly to a reduction in NPLs. Similarly, domestic credit expansion is found to be associated with a decrease in NPLs. Further, without interaction terms, only institutional quality contributed to a significant decline in NPLs, whereas the economic index, political index, and aggregate governance indicator are positively and significantly related to NPLs, meaning that these facets of governance institutions contribute to increasing NPL levels. Moreover, the contingency impact estimation showed that the combined impact of GDP per capita growth, which is the macroeconomic variable of interest, and the four facets of governance on NPLs is significant across all models estimated. This implies that the impact of the macroeconomic environment on the NPL ratio is significantly determined by the quality of the governmental institutions. Specifically, the conditioning influence of institutional quality and the aggregate governance index are found to correlate with 0.2% and 0.4% reductions in NPLs, respectively. On the other hand, economic and political indexes show that a 1% change in the interaction terms correlates with a 0.1% and 0.2% rise in NPLs, respectively. This result has implications for the quality of governance, which has adverse effects on the level of credit risk in the region.

JEL Codes: E10; E50; H10