Transcript Determinants of Asset Quality

Empirical Model for Credit Risk: Implications of Results from African
Countries.
by
Charles Augustine Abuka
Director, Financial Stability Department
BANK OF UGANDA
Prepared for the CMI Course on Macro stress testing
Wednesday 21 August , 2013
KSMS, Nairobi, Kenya
Studies of Macro-financial Linkages
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Determinants of Asset Quality
• Studies Relevant to Africa
– Fofack [2005]
– Khemraj and Pasha [forthcoming]
– Babihuga [2007] estimates a model, with the share of
nonperforming loans in total loans as a function of
macroeconomic variables including:
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unemployment,
changes in inflation,
real interest rates in previous years,
the business cycle,
exchange rates.
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Determinants of Asset Quality
• The model controlled for the quality of banking
supervision and other industry characteristics
including income and financial depth.
• The basic specification was as follows:
npli,t = α1 + β1bcyclei,t + β2inflationi,t + β3reeri,t +
β4int_ri,t + β5unratei,t + β6t_trade +β7bcpi,t
+β8bcp*cyclei,t + εi,t (3)
for panel data i = 1,...., 96 and t = 1998,....,2005.
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Determinants of Asset Quality
• The choice of explanatory macroeconomic variables in the
model reflects the evidence provided by the large empirical
literature showing that a collapse in borrowers’ credit
worthiness and the subsequent deterioration in the value of
collateral are the main transmission mechanisms of a
macroeconomic shock to banks’ portfolios:
– Thus during periods of financial distress, credit quality
emerges as an important source of vulnerability and nonperforming loans deteriorate quickly before bank failures.
– Therefore in order to assess the impact of macroeconomic
conditions on asset quality, we focus on macroeconomic
variables that potentially affect borrowers’ credit worthiness.
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Determinants of Asset Quality
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Determinants of Asset Quality
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Determinants of Asset Quality
– The coefficient on the business cycle variable is
negative, significant and robust across all specifications,
implying that economic booms are associated with
improvements in asset quality.
– Higher inflation, interest rates and unemployment
worsen asset quality (increasing NPLs).
– An improvement in the terms of trade index appears to
have a positive effect on asset quality.
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Determinants of Asset Quality
– A real depreciation in the exchange rate appears to have
a negative effect on asset quality.
• However, the overall impact for exporters and producers of
tradable goods, to which the banking system is exposed, will
depend on which effect dominates,
– The quality of regulatory supervision has a positive
impact on asset quality. This finding is consistent with
Podpiera (2004).
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Possible variables for investigation
• Explanatory Variables
–The ratio of nonperforming to
total loans for individual banks;
–The ratio of loan loss reserves to
total loans.
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Possible variables for
investigation
• Macro Variables
– the annual growth in real GDP at time,
– the real interest rates (measured as the
difference between the weighted average
lending rate and the annual inflation rate),
– the real effective exchange rate,
– the annual inflation rate,
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Possible variables for
investigation
• Macroeconomic variables
– Unemployment rate,
– Annual growth rate of M2,
– GDP per capita,
– Output gap or business cycle component of GDP
– Terms of trade
– Investment to GDP ratio
– Real estate price inflation
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Possible variables for
investigation
• Macroeconomic Variables
– Growth of real fixed investment
– Growth of real consumption
– Growth in exports and imports
– Industrial production
– Oil prices
– Nominal interest rates
– Nominal exchange rates
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The NPL Equation Estimation
• Bank Specific Variables
– Size of the ratio of the relative market share of
each bank’s assets that capture the size of the
institution,
– the loans to total asset ratio for bank,
– represents the growth in loans for each bank
– the real interest rates (measured as the
difference between the weighted average
lending rate of each bank and the annual
inflation rate),
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The NPL Equation Estimation
• Bank Specific Variables
– Profit margins,
– efficiency,
– terms of credit (size, maturity, interest rate),
– risk profile (proxied by capital/assets ratio),
– Loan to asset ratio,
– Equity to asset ratio,
– Cost to income ratio,
– Liquidity ratio,
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REFERENCES
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REFERENCES
• Baltagi B.D., 2001 Econometric Analysis of
Panel Data, John Willwy and Sons, LTD.
• Eviews 6 and 7 Users Guides
• Green, W.H., 2005 Econometric Analysis,
Prentice Hall.
• Wooldridge, J.M, 2002 Econometric Analysis
of Cross Section and Panel Data, The MIT
Press.
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