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Impact of Credit Risk Management on Profitability of Commercial Banks in Bangladesh: An Estimation of Dynamic Panel Data Model

Author

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  • Raad Mozib Lalon

    (Department of Banking and Insurance, University of Dhaka, Dhaka, Bangladesesh)

  • Farhana Morshada

    (Department of Banking and Insurance, University of Chittagong, Chittagong, Bangladesesh)

Abstract

This paper attempts to reveal how several credit risk factors are affecting the profitability of commercial banks considering the econometric models estimated with Random effect, Fixed effect, Pooled OLS and GLS method followed by dynamic panel data model estimated with one-step system GMM approach to incorporate the issue of endogeneity, unobserved heterogeneity and profit persistence of data set covering from year 2010 to 2019 in Bangladesh. We have also adopted several diagnostic checks such as Model specification test, test of heteroskedasticty, cross sectional dependence test followed by test of autocorrelation and unit root test to examine the validity of the models selected for this study. The first part of our empirical investigation of the estimated models considering all methods reveals that out of all the independent credit risk factors only provision for loan losses to NPL ratio is significantly affecting the dependent variable measured with NIM (Net interest margin) ratio of banks under fixed effect method.The next part of our empirical results considering same methods divulges that NPL to total loans ratio, NPL to Total equity ratio and Provision for loan losses to total equity are also significantly affecting the dependent variable measured with ROE of banks. The third segment of our empirical findings of estimated models considering same approaches shows that only NPL to total loans ratio is statistically significant under all methods but the NPL to total equity ratio is significant under fixed effect andGLS method and Provision for loan losses to total equity is significant under GLS method only in explaining the changes in ROA measuring profitability of banks. Further investigation reveals that the dynamic impact of the said credit risk factors on profitability measured with ROE of banks has been successfully adopted by one-step system GMM approach considering all conditions required for estimation.

Suggested Citation

  • Raad Mozib Lalon & Farhana Morshada, 2020. "Impact of Credit Risk Management on Profitability of Commercial Banks in Bangladesh: An Estimation of Dynamic Panel Data Model," International Journal of Finance & Banking Studies, Center for the Strategic Studies in Business and Finance, vol. 9(3), pages 131-147, July.
    • Handle: RePEc:rbs:ijfbss:v:9:y:2020:i:3:p:131-147
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    References listed on IDEAS

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    1. Psillaki, Maria & Tsolas, Ioannis E. & Margaritis, Dimitris, 2010. "Evaluation of credit risk based on firm performance," European Journal of Operational Research, Elsevier, vol. 201(3), pages 873-881, March.
    2. Sorokina, Nonna Y. & Thornton, John H. & Patel, Ajay, 2017. "Why do banks choose to finance with equity?," Journal of Financial Stability, Elsevier, vol. 30(C), pages 36-52.
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