The economic determinants of non-performing loans : a vector error correction model

Abstract

Purpose: The aim of this study is to analyze the macroeconomic determinants of non-performing loans. Non-performing loans in the US decreased more rapidly than non-performing loans in the EU and so analyzing the effects of macroeconomic determinants and regulatory quality might indicate the reason behind this downward trend. Methodology: Data for the US on five main variables was obtained. Regulatory quality data was on an annual basis and was converted to quarterly using cubic interpolation. In addition, an ARIMA was fitted to obtain values for the four quarters of 2018. Then, the vector error correction model was used to analyze the relationship between non-performing loans and the macroeconomic variables. Findings: It was found that in the long run, interest rates and GDP are important determinants of non-performing loans. Inflation was not found to be significant both in the long run and in the short run. However, the housing index and regulatory quality were found to be significant in the short run. Conclusion: It is proposed that regulatory quality is assessed in more detail when a new country wishes to join the EU because regulatory quality is an important determinant of non-performing loans.