Bank lending and loan quality: the case of India

This paper analyses how non-performing loans (NPLs) of Indian banks behave through the cycle. We find that a one-percentage point increase in loan growth is associated with an increase in NPLs over total advances (NPL ratio) of 4.3 per cent in the long run with the response being higher during expansionary phases. Furthermore, NPL ratios of banks are found to be sensitive to the interest rate environment and the overall growth of the economy. Notwithstanding differences in management and governance structures, there is a procyclical risk-taking response to credit growth in the case of both public and private banks with private banks being more reactive to changes in interest rate and business cycle conditions.

JEL classification: E320, G210, G010

Keywords: Procylicality, loan quality, bank lending, bank ownership, moral hazard