In recent decades, financial crises in various countries have often been preceded by the rise in non-performing loans (NPLs) in the banks’ asset portfolios. The increase in NPLs is proven to have adverse impact on the banking sector so that understanding the determinant of NPLs is immensely crucial to ensure the efficiency and soundness of the overall economy. This study aims to shed light on bank-specific factors that affect loan default problems in developing countries whose banking sectors play a major role in the overall economy. This study analyzes panel data sets of 36 commercial banks listed in the Indonesian Stock Exchange during the period 2008-2015. Applying fixed-effects panel regression model reveals that Indonesian banks’ profitability and credit growth negatively influence the number of NPLs. Moreover, banks with higher profitability are proven to have lower NPLs because they can afford adequate credit management practices. Likewise, banks with higher credit growth evidently have lower NPLs in the sense that they demonstrate more specialized lending activity and thus have better credit management systems. These findings imply that, in order to lower loan defaults that can deteriorate banks’ asset quality, banks should maintain their level of profitability and increase, rather than decrease, their credit supply to debtors.
In the last two decades, a remarkable series of financial crises have occurred in several countries. The recent Global Financial Crisis in 2007-2008 that was online installment loans OR caused by credit crunch of the U.S. sub-prime mortgages resulted in an economic crash and instability in the global markets. Previously, financial crises hit fast-growing countries in East Asia in 1997, leading to a significant outflow of foreign investment funds from these economies (Deesomsak, Paudyal, Pescetto, 2004; Machrouch, Soedarmono, Tarazi, 2011). Financial crises are frequently marked by a hike in non-performing loans (henceforth NPLs) in banks loan portfolios. Following the Global Financial Crises, NPLs have been under the surveillance of the government and bank management, since they are considered to be associated with bank failures and crisis (Ghosh, 2015). This phenomenon is exacerbated in countries that heavily rely on banks as financial intermediaries that allocate funds throughout the economy (bank-based economies), such as Indonesia.
In countries with bank-based economic systems, banks play a major role in the sustainability of the financial system and become the main resort for funding, as these countries capital markets are still emerging (Moradi, Mirzaeenejad, Geraeenejad, 2016). Regardless of its prominence in the financial system and economy, the banking sector in Indonesia demonstrates an exceptional attractiveness compared to its neighboring countries due to its high credit growth and profitability. Figure 1 displays the status of credit growth, net interest margin (NIM), and non-performing loans (NPL) of ASEAN-5 countries in 2016. The credit growth of Indonesian commercial banks was 7.9 per cent in 2016.
Among the other ASEAN (Association of South East Asian Nations)-5, this rate is lower than that of the Philippines (16.1 per cent) but higher than Thailand (5.3 per cent), Malaysia (3.1 per cent), and singapore (2.9 per cent). Interestingly, Indonesian banks’ net interest margin (NIM) that reflects profitability is the second highest in the region. The average NIM of Indonesian banks is 5.4 per cent – well above the average of Philippines (3.4 per cent), Thailand (2.6 per cent), Malaysia (2.4 per cent), and singapore (1.7 per cent). Within Indonesian commercial banking, the interest income accounts for 72.4 per cent of total operating income which is mostly generated from credit (Bank Indonesia, 2016). High credit growth in addition to a high interest margin has caused the Indonesian banking sector to become more attractive than that of other ASEAN countries. Unfortunately, these advantages are hindered by the riskiness of these banks, which is reflected in the high NPLspared to other ASEAN-5 countries, banks in Indonesia have NPL ratio of 2.9 per cent, which is a bit lower than Thailand (3 per cent) but far higher than Malaysia (1.6 per cent), singapore (1.2 per cent), and the Philippines (1.9 per cent).