Regulations, Governance, and Resolution of Non-Performing Loan: Evidence from an Emerging Economy

Abstract

How do banks resolve a severe bad loan problem in a capital-constrained, low-income economy when a government bailout is not an option? We address this question by examining new evidence of a sharp decline in bad loan ratios in a panel of conventional commercial banks in Bangladesh. On the aggregate level, the bad loan ratio in this market has dropped from 41% in 1999 to only 10.0% in 2012. We find that at a micro-level this dramatic improvement is associated with bank management quality and internal governance that were substantially enhanced during a decade of large-scale regulatory reforms. The bank-level findings persist even after controlling for market monitoring, bank- and industry-level factors and macroeconomic variables. Both economic growth and financial development paved the way for the banks operating in this macroeconomic environment to reduce nonperforming loan over time.

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