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Quantitative Study of Bank-Specific and Social
factors of Non-Performing Loans of Pakistani
Banking Sector
Hisham Ul Hassana, Muhammad Ilyasb, Choudahry Abdul Rehmanc
Business School, Superior University, Lahore, Pakistan
a-cE-mail address: iap@superior.edu.pk , m.ilyas@superior.edu.pk , ceo@superior.edu.pk
ABSTRACT
The Non-Performing loans presented picture of a distorted and slow-paced economy. This issue
became more critical when it was observed that NPLs were declining in South East countries except
for Pakistan. This study has dual purposes: Firstly to build up a model clarifying the relationship
between bank-specific, social factors and non-performing loans. Secondly, to investigate this model in
the setting of Pakistani Banking sector as limited interest has been given in existing literature in
defining the relationship between bank specific, social factors and non-performing loans. The
quantitative methodology is used as it is the most suitable for fulfillment of the study objectives. The
results show that various bank-specific factors like credit assessment, credit monitoring and rapid
credit growth have significant affect on Non-Performing Loans, whereas interest has a weak
significance on NPLs. The social factors including political interference and bankers’ incompetence
have significant affects on NPLs and these have been important factors in explaining the Non-
Performing Loans. This ground-breaking work on Non-Performing Loans and its factors will not only
help the entire Pakistani banking sector to control Non-Performing Loans but also its results can be
generalized on other countries as well.
Keywords: Non-Performing Loans; Bank-Specific Factors; Social factors; Pakistan
1. INTRODUCTION
The prime source of incomes of banks is loans and advances. The main objective of
banks, like any other business, is to earn and maximize profit so it is understandable that the
more the banks will lend the money the more they will earn and the better will be their
profitability. But while releasing loans, banks should be very careful and keep a very close
eye. It is quite natural that banks try to lend in safe ventures at one hand and to increase the
profitability on the other. Therefore the banks must be extremely vigilant when it comes to
giving loans at a riskier avenue because the situation can be financially in viable if a large
amount of loans default. It can ultimately lead to insolvency of the banks. Even the collateral
should be analyzed whether it is given or not.
Saba, Kouser, & Azeem (2012) are of the view that Non-Performing Loans are so
important to study as these are responsible for various financial and economic problems of
developed and developing countries. These problems include less per capita income,
International Letters of Social and Humanistic Sciences Online: 2014-11-05
ISSN: 2300-2697, Vol. 43, pp 192-213
doi:10.18052/www.scipress.com/ILSHS.43.192
2015 SciPress Ltd, Switzerland
SciPress applies the CC-BY 4.0 license to works we publish: https://creativecommons.org/licenses/by/4.0/
diminishing profits and financial crisis of banking sector. Due to increase in NPLs, the
economy of US, which is recognized as a superpower, has gone under the worst crisis of its
history. This financial crisis of year 2000 took the entire world in its grip. These NPLs are
basically the result of low purchasing power of the borrowers, unproductive use of loans, high
interest rates and lenient credit terms of banking sector. So controlling the NPLs can lead to
avoid from financial crisis as serious as in the case of US.
The previous studies have shown that the basic factors for determining NPLs are bank-
specific and macro-economic factors. The literature of Greece shows that due to favorable
macro-economic factors its economy flourished and sustained growth during the mid 90s
crisis. But it could not bear the financial crisis of 2007. Due to inefficient management of
advancing loans without regard to credibility of borrowers, compromising regulations and
socio-economic political pressures, the Greece financial sector took a downturn in the
financial crunch of 2007 (Dimitrios P. Louzis, 2012) so this shows that how much banks
should be careful about advancing loans. But in case of unfavorable macro-economic
situations all efforts of banks in this regard become useless. Therefore, there is a need to
deeply look into the macro-economic factors affecting NPLs with utmost care.
There is also literature available which considers bank-specific factors of Non-
Performing Loans. According to Badar & YASMIN JAVID (2013), the role of financial
institutions is very important because it uses the amount of depositors in shape of investment.
So the decision of investing in a particular venture is the responsibility of that financial
institution. If decision is not mature, the loan can turn into a non-performing one. NPLs have
been considered as the main reason for financial instability of a country. Sorge (2004) has
found NPLs as one of the key reason for the US financial crisis of 2007. NPLs are like a
dangerous syndrome which affects two things pretty badly. These two things are profitability
and solvency of a financial institution. The bank-specific factor, namely Manager’s decision
making, has not been given much of importance in the literature.
The basic reason for increasing NPLs in Banks have been the aggressive lending
strategies along with less profitability (Reynolds, Ratanakomut and Gander, 2000). Kwack
(2000) is of the view that NPLs are the basic reasons behind the crisis of Asian financial
markets. During the years 1997 to 1999, the rate of NPLs has shown an increasing trend (from
9% to 50%) in Asian countries like Singapore, Hong Kong, Malaysia, Philippines and
Taiwan. Therefore if NPLs have gained strength in economy of a particular country in a
continent, then it is very difficult for the other countries to ignore these. The NPLs reach at an
alarming rate of 23% in 2003 which shows the inefficiency creeping in Chinese banking
sector. Nanto & Sinha (2002) have termed NPLs as the basic reason behind Asian financial
crisis. Hence it can be concluded that even the state-owned banks are not safe from the
consequences of NPLs despite of a strong government support from a developed country like
China.
The story of Pakistani banking sector does not show a pretty picture either. NPLs have
been on a higher side in Pakistani banking sector but recently they have been enormous which
is very harmful for economy (Masood, 2009) so there is ominous need to find out the factors
affecting NPLs in the context of Pakistani banking sector. The study of Pakistan shows that
NPLs are on an increasing trend. Because of high interest rates, borrowing cost increases thus
increasing loan defaults (SBP, 2010). On the other hand countries like India, Bangladesh
where lending rate show decline. The role of bank-specific and macro-economic factors has
been analyzed in the previous studies but political and social factors have not been questioned
as yet in Pakistani banking background.
International Letters of Social and Humanistic Sciences Vol. 43 193
Previous studies have explained the role of Macro-Economic and Bank Specific
determinants of NPLs (Saba, Kouser, & Azeem, 2012; Badar & YASMIN JAVID, 2013;
Zhang, 2010; Shaer Biabani, 2012). But there is limited number of studies available in the
context of Pakistani Banking Sector. In this study the determinants of NPLs are classified into
two categories which are Bank Specific and Social. This has not been seen in literature till
present date in the context of Pakistani Banking Sector. The review of literature also reveals
that there are some variables on which limited research has been done with context of
developing countries like Pakistan. These include various Bank Specific variables (Regulatory
environment, Corporate Governance) and Social variables (Political instability, Corruption
and War on terror) (Khemraj & Pasha, 2009; Jellouli, 2009; Khan, ur Rehman, Rasli, Khan, &
Mehri).
2. LITERATURE REVIEW
Adebola, Wan Yousaff and Dahalan (2011) are of the view that Non-Performing Loans
are a big threat not only for a single country but for the whole world as it has been witnessed
in case of US financial crisis in recent times. Therefore, it is necessary for the economy for
any country that factors of Non-Performing Loans are identified. According to Nkusu (2011),
there are two threads of literature about NPLs. One explains relationship between NPLs and
its factors, while other links NPLs to financial crisis. It is quite natural that banks try to lend
in safe ventures at one hand and to increase the profitability on the other. Therefore, the banks
must be extremely vigilant when it comes to giving loans at a riskier avenue.
The study of Ayalew (2009) indicates that the borrowers, even in a developed country,
wish to be stated as defaulters. The reason for this is the financial crisis all across the globe
adversely affects the capacity of borrowers to repay their loans. In this way the borrowers find
a legal way of not returning their debts, thus increasing the amount of Non-Performing Loans.
NPLs are realized, as an important factor, being responsible for this financial crisis. The
studies of Detraiuche (1998) and Gonzalez-Hermosillo (1999) have supported the phenomena
discussed above. According to Javid (2013), the role of financial institutions is very important
because it uses the amount of depositors in shape of investment. So the decision of investing
in a particular venture is the responsibility of that financial institution. If decision is not
mature, the loan can turn into a non-performing one.
2. 1. NPLs In Context Of Pakistani Banking Sector
NPLs do not directly influence financial crisis in any country but these have a negative
impact on economy of a country. This concept is supported by studies of Drees &
Pazrbasioglu (1998) and Kaminsky and Rreinhart (1999). During the years 1997 to 1999, the
rate of NPLs has shown an increasing trend (from 9% to 50%) in Asian countries like
Singapore, Hong Kong, Malaysia, Philippines and Taiwan. NPLs in Pakistan are on a roller
coaster ride because according to report of State Bank of Pakistan (SBP), amount of NPLs of
banking sector, in the year 2012, has reached to Rs.176.77 billion. Therefore, there is dire
need of studying about Non-Performing Loans and its factors. The study of Brownbridge
(1998) explains that Non-Performing Loans are one of the chief reasons for the failure of
many banks in the world. In addition if these Non-performing Loans are not controlled then
the resources of a concern are blocked and thus resulting in low profitability.
Banks in recent years are facing default risk, which is one of the major causes of banks’
failure. Pakistani banking sector is facing four types of risks. These are Market risks, Credit
194 ILSHS Volume 43
risks, Liquidity risks and Operational risks. Problem arises when the borrowers fail to return
the loans, thus increasing Non-Performing Loans (NPLs) and declining profitability (Haneef,
et al., 2012). Therefore, there is a need to study the factors of Non-Performing Loans in
setting of Pakistani banking sector.
2. 2. Non-Performing Loans (NPLs)
There is no specific definition of NPLs to be found in literature. Previous studies have
defined NPLs according to their needs. As per Basel committee (2001) NPLs are defined as
loans which are not paid and their overdue time period is 90 days after maturity date. NPLs
are also explained as ,“Loans or advances whom credit quality has deteriorated such that full
collection of principal and interest in accordance with the loan or advances in repayment
terms of the loan or advances in question” (National Bank of Ethiopia). According to SBP
(BSD, Circular No. 2 dated June03, 2010), a loan can be divided into three categories. If
amount of principal and interest is overdue by 90 days, it will be termed as substandard, if it is
overdue by 180 days, it will be termed as doubtful and if it is overdue for a year then a loss.
Furthermore if a loan is not paid 30 days after its maturity date, then it is to be considered as
NPLs in case of MFBs (Micro Finance Banks) and 90 days in case of consumer financing
commercial banks.
2. 3. Bank-Specific and Social Factors of Non-Performing Loans
2. 3. 1. Bank-specific factors
There is a lot of literature available on impact of macro-economic factors on NPLs, but
fewer studies are available which presents the affect of bank-specific determinants of Non-
Performing Loans (NPLs). The banks tend to expand loans in periods of financial stability, so
that they can earn more. In this practice they often give an impression of relaxing the lending
standards. Therefore, this becomes the reason of loan defaults (Weinberg, 1995). Various
researchers have supported this hypothesis (Sinkey, 1992, for US; Salas and Saurina, 2002,
for Spain; Bercoff, di Giovanni, Grimard, & Welcome, 2002).
2. 3. 1. 1. Rapid credit growth and NPLs
The study of Keeton (1999) shows relationship between loans and speedy credit growth.
The author has used a vector auto regression model on commercial banks in United States for
the periods 1982-1996. Empirical studies show that lenient credit terms is one of the factors
which increases NPLs. Boudriga, Boulila, & Jellouli (2009) indicate some factors which can
reduce NPLs. These factors are foreign capital presence, appropriate capitalization and
prudential provisional policy. To expand credit, banks have to ease the standards of credit
terms, monitoring of borrowers and decrease the interest rates (Keeton, 1999). The study of
Sarlija and Hare (2012) indicates that in case of developed countries, lending is at a much
speedy pace. The basic reason is that there are strong legal institutes and laws which give
security to the banks against defaults of loans. The study of Jiménez, et al., (2007) points out
that herd behavior, moral hazard, agency problems and disaster nearsightedness are the basic
factors behind the lenient terms of credit. Furthermore they linked the lenient credit terms
with Non-Performing Loans. When the economy is intensifying, bank managers are found to
exercise leniency in giving credit because lower credit expansion means lesser income
generation which indicates poor performance.
International Letters of Social and Humanistic Sciences Vol. 43 195
2. 3. 1. 2. Monitoring and NPLs
The banks, which incur more expenses on monitoring and assessing the borrowers, are
less efficient in financial operations but these banks have lower NPLs (Hughes et al, 1996).
Various studies show that state-owned banks are less efficient because they concentrate more
on monitoring the NPLs. Salas and Saurina (2002) are of the view that inefficient bank
management causes NPLs. The loans are more secured if the banks keep a continuous check
on the borrowers. The banks need to give their borrowers full attention, so they are not
relaxed at any stage about repayment of their loans. It has been seen that less monitoring of
borrowers lead to NPLs (Agresti et al, 2008).
There are evidences in literature about poor monitoring, on the part of the banks, to be
the main bank-specific factors behind creating NPLs. The banks carry on these practices in
order to increase profit (Agresti et al, 2008; Sinkey, 1992, for US; Salas and Saurina, 2002,
for Spain). There are also some other features present in them as inadequate monitoring
system. The study of Omar (2009) showed that banks are nationalized in the 1970s by the
government. The state-owned banks possess 88% to 96% of NPLs in the whole banking
sector. Due to this poor performance, government reconsidered its thinking. The reforms of
1991 allowed private banks operations in Pakistan. During 1997-2001 the private-owned
banks become more strengthened when further reforms are structured to build an extensive
and competitive environment.
2. 3. 1. 3. Interest and NPLs
Various researchers have given a variety of findings about this relationship. According
to some researchers high interest rate has a significant and positive relationship with Non-
Performing Loans. They are of the view that when banks increase interest rate, there is an
additional payment burden on borrowers resulting in increased defaults (Stiglitz and Weiss,
1981; Reddy, 2002; Boyd and Nicolo, 2005; Keeton and Morris, 1987; Fofack, 2005; Collin-
Dufresne & Goldstein, 2001; Asari et al, 2011). Some of studies have also shown a weaker or
insignificant relationship between interest rate and Non-Performing Loans (Kaplin et al, 2009;
Patnaik and Shah, 2004; Epinoza and Prasad, 2010). The study of Sinkey (2002) shows that
increase in interest rate negatively impacts the loan defaults. Similarly the study of Rajan and
Dhal (2003) indicates a significant association of high cost of borrowing and Non-Performing
Loans (NPLs).
2. 3. 1. 4. Risk assessment and NPLs
A weak Risk assessment can also play a role in increasing NPLs. The repute of
borrowers to repay loan and the market value of securities are not adequately assessed while
giving loans which become key reasons behind NPLs (Petersson, 2004). The study of Ning
(2007) shows that the banks use their personal experiences in giving loans rather than using
historical data, mature credit portfolio management skills and centralized information system.
This causes NPLs to grow at even a higher pace. The banks should access information about
creditability of the customers, so that NPLs can be reduced. In this regard responsibilities of
banks should be clearly defined. It should be ensured that banks exercise effective policies
and adequate risk management (Basel, 2001).
The study of Akerlof (1970) explains that due to adverse selection, the borrowers can be
differentiated with respect to quality. Low quality borrowers cannot use amount of loan in
productive ventures as compared with high quality borrowers. This can result in an increase in
NPLs. The Adverse selection problem indicates that when lenders cannot discriminate good
196 ILSHS Volume 43
from bad borrowers, all borrowers are charged a standard interest rate that reveals their
collective practice. If this rate is elevated than valuable borrowers justify, it will drive some
good borrowers out of the borrowing market, forcing in turn to banks charging even higher
rates to the remaining borrowers. That’s why the banks prefer to chose high quality
borrowers. The selection of borrowers is a challenge in order to control NPLs.
2. 3. 2. Social factors
If we compare the bank-specific and social factors of Non-Performing Loans in the
literature, then we may not find much material relating with the social factors of NPLs.
Therefore, this emerges the need to explain the social factors along with bank-specific factors
of NPLs. In this way this study will be helpful for the banking sectors of other countries as
well because its results can be generalized.
2. 3. 2. 1. Political interference and NPLs
The commercial banks suffer a great deal when the projects which are being financed by
one government face hurdles when there is change of government. In this way the economic
growth of the country stops and also the banks have to bear the brunt of that political
interference by the new government so due to this government interference the chances of
loan default increases (Dinc, 2005). Also the governments tend to favor a particular sector for
their personal benefits, ignoring the future prospects, therefore causing Non-Performing
Loans for the banks (Chijoriga, 1997).
Khwaja and Mian (2005) present the only empirical study related to information sharing
and corruption in setting of Pakistan. This study shows that lending of political firms is 45%
greater than other firms. These political firms incur Non-Performing Loans, 50% more than
any other firms. State-owned banks are main creditors of these political firms as private-
owned banks do not take political pressure. The loans of these State-owned banks are turned
to bad due to weak implementation of legal framework and political pressure. There is a need
to explore the social factors of Non-Performing Loans with reference to Pakistani banking
sector, which are missing in previous literature. Therefore, it can be concluded that there is
limited Literature available on exploring relationship of NPLs and social factors like political
pressure in setting of developing country like Pakistan and certainly indicates a possible gap.
2. 3. 2. 2. Banker’s incompetence and NPLs
According to the study of Masood, Bellalah, & Mansour (2010), the bankers with high
qualification are in a better position to judge the credibility of a customer resulting in decrease
in the Non-Performing Loans than one with lower qualification. Simply we can say that
qualified and experiened bankers ensure lesser NPLs. De Juan (2003) is of the view that the
role played by management in financial crunch is very crucial. Further more if a bank is
following the regulatory frame work, coorective actions as per the situations along with
proper supervision then the effects of the in efficient management can be neutralised.
Mismanagement takes place in two ways; firstly, if the bank and the managerial set up is new;
secondly, if the existing management fails to adapt to the changing enviroment of the
financial market.
For the financial institutions to survive during the financial crunch, the role of
competent bankers who can see the emerging trend of market along with adopting proactive
approach, is imperative (Camerer and Johnson, 1997). As per Kim, Michael Chung, &
Paradice (1997) in order to become a competent banker, the employee may be completely
International Letters of Social and Humanistic Sciences Vol. 43 197
trained to foresee the financial situation so he can groom himself intellectually to be able to
make timely and adequate lending decisions. Therefore, the literature indicates that in today’s
competitive world banks need such competent bankers who can convert their NPLs in good
loans.
3. THEORETICAL FRAMEWORK AND METHODOLOGY
3. 1. Theoretical Framework
3. 2. Methodology
This section includes the methods to collect the empirical data on the impact of Bank-
Specific and Social factors of Non-Performing Loans in Pakistani Banking Sector.
3. 2. 1. Research approach
Since the objective of my study is to propose and test a model of Bank-specific and
Social factors of Non-Performing Loans (NPLs) in the banking sector of Pakistan and to
generalize and compare the results through a large sample, therefore, the quantitative
methodology is the most suitable for the fulfillment of my study objectives. Quantitative
research comprises of various research types such as associational, descriptive and
intervention studies. As the purpose of this study is to examine the relationship between
Bank-specific, Social factors of Non-Performing Loans, therefore, associational approach will
be utilized for the purpose of data analysis. Associational research is basically concerned with
examining the relationship between variables. It is further categorized into correlation and
causal comparative research (Ary et al., 1996).
Bank Specific Factors
Rapid Credit
Growth
Monitoring
Interest
Risk Assessment
Social Factors
Political
Interference
Bankers’
Incompetence
Non-Performing
Loans
198 ILSHS Volume 43
3. 2. 2. Description of sampling
In the current study randomly selected bank managers from public and private banks of
Lahore (Pakistan), having experience of more than five years, are chosen as unit of analysis.
The reason for selecting the criteria of minimum five years of experience is to ensure that
bankers participating in the research have a clear know how about the Non-Performing Loans
and its various factors. The main reason for selecting Lahore as city is that almost all major
banks have their branches in it. This study considers top 12 banks on the basis of their assets
allocation as per report of State Bank of Pakistan. The next task is to select the minimum
sample size for data collection. Some studies consider a range between 50 to 400 as minimum
sample size (Aleamoni, 1976). Therefore, in order to cross the minimum sample size
requirement 150 randomly selected bank managers and other credit officers will be selected in
the province of Punjab and city Lahore.
The following table shows the detail of top ten banks and their assets allocation:
Rank
Name of banks
Type
Assets Allocation
(Million Rs.)
1
NBP
Conventional
11,53,480
2
HBL
Conventional
11,39,554
3
UBL
Conventional
7,53,617
4
MCB Bank Limited
Conventional
6,53,233
5
Allied Bank Ltd.
Conventional
5,15,699
6
Bank Alfalah
Conventional
4,68,173
7
Bank Al Habib
Conventional
3,84,526
8
Standard Chartered Bank
Conventional
3,56,405
9
Askari Bank Ltd.
Conventional
3,43,756
10
Faysal Bank
Conventional
2,92,568
11
Habib Metropolitan Bank
Conventional
288,200
12
Bank of Punjab
Conventional
280,998
Source: (Annual Report of Respective Banks, 2011)
3. 2. 3. Instrument of research and issues of validity and reliability
According to Babbie (2001) the best way to collect data from a large population is
Questionnaire. In order to complete the main objective of the study, data is to be gathered for
the factors of Non-Performing Loans. The factors include bank-specific factors (Credit
Assessment, Credit monitoring, Interest Rate and Rapid Credit Growth) and social factors
(Banker’s Incompetence and Political Interference). Therefore, the survey questionnaire is
divided into two parts. Content validity was ensured in such manner that sample selected
comprised of those respondents who had better understanding of the issue of the research. To
make sure face validity the researcher executed multi method approach i.e. two or more
International Letters of Social and Humanistic Sciences Vol. 43 199
different features measured using two or more diverse approaches. The rationale for using this
data collection procedure is that it requires minimum resources as far as staff, time and cost
are concerned and also it is best suited confidentiality of information is an issue (Dillman,
2000). The participants have been given due consideration to obtain their agreement on
becoming the part of the research procedure by highlighting the need and importance of the
issue being question.
4. DATA ANALYSIS AND RESULTS
The previous chapters presented the introduction, literature review and the research
methodology to be followed. This chapter presents results relating to the bank-specific and
social factors affecting the Non-Performing Loans. This chapter tries to show the results of
the survey conducted in various banks which are already mentioned previously.
4. 1. Survey Results
The questionnaire was distributed among bankers which related to the credit department
including loan officers, relationship managers, credit managers, credit directors, recovery
officers and vice presidents in 12 banks selected from all banks that are operational in
Pakistan and registered before the fiscal year 2012-13. The questionnaire was physically
distributed to 150 employees which related with credit department. Out of 150 questionnaires
139 were completed and returned. So the overall response was 92-7% which is impressive if
we see it in the context of the research culture in the Pakistan.
Table 1. Survey Response Rate.
Sample Size
150
Completed and returned
questionnaires
139
Response rate
92.7%
Source: Survey outcome and own computation
4. 1. 1. Respondent’s profile
As far as employment in bank were concerned 91% of the respondents belonged to
private banks whereas remaining 9% were the employees of state-owned banks.
Table 2. Employment of Respondents.
Employment
Frequency
Percent
Private banks
127
91
State-owned banks
12
9
139
100
Source: Survey outcome and own computation
200 ILSHS Volume 43
4. 1. 2. Respondents’ gender
Out of 139 valid responses, 81.3% were male and 18.7% were female. This shows that
credit departments of most of the banks are dominated by male officers.
Therefore, it can be inferred that the banks prefer male staff while giving jobs related to
loan advancement.
Table 3. Gender of Respondents.
Gender
Frequency
Percent
Male
113
81.3
Female
26
18.7
139
100
Source: Survey outcome and own computation
The survey respondents included 10.8% loan officers, 36% relationship managers,
11.5% credit managers, 20.9% recovery officers, 16.5% credit directors and 4.3% vice
presidents.
Table 4. Positions of the respondents in banks.
Source: Survey outcome and own computation
The survey indicated that by means of experience 28.8% of the respondents had 11-15
years of banking experience.
The second larger number of respondents belonged to the category of above 15 years
experience as their percentage was 26.6%. Similarly 23.7% of the respondents belonged to the
category of 1-5 years of experience which was the third larger.
The last category with lowest percentage (20.9%) belonged to 6-10 years of experience.
This shows that respondents had vast experience in the banking sector which increased the
quality of the survey.
Positions
Frequency
Percent
Loan officers
15
10.8
Relationship
managers
50
36.0
Credit managers
16
11.5
Recovery officers
29
20.9
Credit directors
23
16.5
Vice presidents
6
4.3
International Letters of Social and Humanistic Sciences Vol. 43 201
Table 5. Respondents’ experience in the banking sector.
Years of
experience
Frequency
Percent
Less than 1 year
---
---
1-5 years
33
23.7
6-10 years
29
20.9
11-15 years
40
28.8
Above 15 years
37
26.6
Source: Survey outcome and own computation
As from Table 6 we can see that almost majority of the bankers related to credit
department are highly qualified. This can be seen from the below table in which most of
respondents are above Bachelor level.
Table 6. Qualification of the Respondents.
Frequency
Percent
MPhil/ PHD
6
4.3
Master Degree
120
86.3
Bachelor Degree
---
---
Others
13
9.4
Source: Survey outcome and own computation
4. 2. Factors affecting the Non-Performing Loans
The core objective of this study was to assess the bank-specific and social factors
affecting the Non-Performing Loans. The study required respondents to show their agreement
and disagreement to certain statements which were related with bank-specific and social
factors of Non-Performing Loans. The following table depicts responses on the relationship
between credit assessment and Non-Performing Loans.
Table 7. Factors indicating relation between credit assessment and NPLs.
Strongly
Agree
(%)
Agree
(%)
Neutral
(%)
Disagree
(%)
Strongly
Disagree
(%)
Mean
Standard
Deviation
The borrowers, which
are admitted by
compromising the
assessment conditions
usually default.
35.3
54.0
8.6
2.2
---
4.22
0.692
202 ILSHS Volume 43
If the bank knows
about the customers’
previous credit history,
it will lead to high
loans quality.
33.8
54.0
12.2
---
---
4.22
0.646
Good loan
understanding ensures
loan.
23.0
48.2
25.2
3.6
---
3.91
0.788
Poor risk assessment
would lead to loan
defaults.
24.5
48.2
23.7
3.6
---
3.94
0.791
Source: Survey outcome and own computation
The above table shows that 89.3% respondents agree that the borrowers admitted
compromising the assessment conditions becomes one of the reasons for occurrence of Non-
Performing Loans with a mean response of 4.22 and standard deviation of 0.692. On the other
side 87.8% of respondents agree that if the bank knows about the previous credit history of
the customers, it can increase the quality of loan (mean 4.22 and standard deviation 0.646). As
far as good loan understanding is concerned 71.2% of respondents agree that it is important in
ensuring loan collection.
Tight monitoring of loan can enhance its quality. This has been acknowledged by 68.4%
of the respondents (mean 3.87 and standard deviation 0.779). 72.7% of the respondents agree
that credit monitoring is directly related with occurrence of NPLs. Therefore, we can say that
credit monitoring is directly related to the performance of loans. These can be seen through
figures of the following table:
Table 8. Factors indicating credit monitoring and NPLs.
Strongly
Agree
(%)
Agree
(%)
Neutral
(%)
Disagree
(%)
Strongly
Disagree
(%)
Mean
Standard
Deviation
Strict monitoring of loans
ensures improved loan
performance.
21.6
46.8
28.8
2.9
---
3.87
0.779
Properly monitoring of a
weak loan or advance can
decrease the chances of its
default.
---
5.0
19.4
29.5
46
1.83
0.912
Credit monitoring is
directly related with the
occurrence of NPLs.
29.5
43.2
26.6
0.7
---
4.01
0.771
If bank spends more on
credit monitoring, it can
lower the level of NPLs.
20.1
30.2
40.3
7.9
1.4
3.60
0.946
Source: Survey outcome and own computation
International Letters of Social and Humanistic Sciences Vol. 43 203
Table 9. Factors indicating relation between Interest and NPLs.
Strongly
Agree
(%)
Agree
(%)
Neutral
(%)
Disagree
(%)
Strongly
Disagree
(%)
Mean
Standard
Deviation
Loans having interest
have more chances to
turn to NPL.
0.7
9.4
28.8
35.3
25.9
2.24
0.967
If high interest rates are
charged it can lead to
loan default.
19.4
30.9
28.8
11.5
9.4
3.40
1.196
Interest charged on loan
affects the performance
of loans.
15.8
52.5
23.0
7.9
0.7
3.75
0.843
Source: Survey outcome and own computation
The above table shows that only 10.1% of respondents (mean 2.24 and standard
deviation 0.967) agree that loan due to charging interest can turn a loan into NPLs whereas
50.3% of respondents have the belief that high interest rate can increase Non-Performing
Loans. Therefore, it can be concluded that interest has not a very strong relation with Non-
Performing Loans. Table 10 indicates about the responses generated for describing the
relation between rapid credit growth and Non-Performing Loans.
Table 10. Factors indicating the relation between Rapid Credit Growth and NPLs.
Strongly
Agree
(%)
Agree
(%)
Neutral
(%)
Disagree
(%)
Strongly
Disagree
(%)
Mean
Standard
Deviation
Aggression in giving
loans can lead to higher
NPLs.
41.0
52.5
5.8
0.7
---
4.34
0.620
There are more chances
of high NPLs if
advancement of credit
by bank is rapid.
40.3
43.2
16.5
---
---
4.242
0.718
If integrity in lending is
compromised, it can
lead to loan defaults.
25.9
43.9
28.1
2.2
---
3.94
0.791
Giving loans to a large
number of borrowers
can increase chances of
NPLs.
26.6
46.8
20.9
5.8
---
3.94
0.841
If the bank has the
tendency of taking
greater risks then this
can increase NPLs.
41.0
52.5
5.8
0.7
---
3.73
0.750
Source: Survey outcome and own computation
204 ILSHS Volume 43
Table 11. Factors indicating the relation between Political Interference and NPLs.
Strongly
Agree
(%)
Agree
(%)
Neutral
(%)
Disagree
(%)
Strongly
Disagree
(%)
Mean
Standard
Deviation
Political interference
in the lending decision
is a cause of NPLs in
Pakistan.
42.4
48.2
7.9
1.4
---
4.32
0.681
Political pressurized
bank authorities ready
to extend credit
facilities without
completing
satisfactory
requirements may
cause bad loans.
38.1
48.2
12.2
0.7
0.7
4.22
0.743
Strategic planning
without considering
the business
community is also
causing NPLs in
Pakistan.
19.4
41.7
33.1
5.0
0.7
3.74
0.854
Disbursement of loans
to politicians under
political pressure is
causing NPLs in
Pakistan.
60.4
20.1
6.5
5.0
7.9
4.20
1.246
Source: Survey outcome and own computation
The above table shows that 90.6% of respondents (mean 4.32 and standard deviation
0.681) strongly agree that political interference in the lending decision is a cause of NPLs in
Pakistan. In addition 53.4% of respondents agree that due to political pressure bank
authorities compromise the terms of loan advancement which causes bad loans.
Lastly lets analyze the responses about the relation between bankers’ incompetence and
NPLs. As per table 13, 82.8% of respondents believe that lending officer’s qualification plays
a key role in making wise loan decisions.
International Letters of Social and Humanistic Sciences Vol. 43 205
Table 12. Factors indicating the relation of factors of Bankers’ Incompetence and NPLs.
Strongly
Agree
(%)
Agree
(%)
Neutral
(%)
Disagree
(%)
Strongly
Disagree
(%)
Mean
Standard
Deviation
Lending officer’s
qualification plays a key
role in making wise
loaning decisions.
46.8
36.0
12.9
4.3
---
4.25
0.844
Lending officer’s
experience in the service
and his experience in
dealing with the lending
matter’s plays an
important role in making
wise loaning decisions.
58.3
39.6
2.2
---
---
4.56
0.540
Good and up to date
training of banker’s plays
a very important and key
role in their professional
grooming and enables
them to make wise loaning
decisions.
36.0
44.6
18.7
0.7
---
4.16
0.745
If a lending officer is
groomed in good
supervision, trained well
and is involved in lending
decisions, on the basis of
this exposure he/she can
make wise lending
decisions.
51.8
38.8
7.9
0.7
0.7
4.40
0.730
Manager’s capability to
with stand the pressure
(pressure from customer
and higher authorities)
plays an important role in
making wise loan
decisions.
49.6
36.9
10.8
2.9
---
4.33
0.784
Source: Survey outcome and own computation
5. DISCUSSION OF THE RESEARCH FINDINGS
The main objective of this study was to identify the bank-specific and social factors of
Non-Performing Loans (NPLs). This study has analyzed the affect of each factor on NPLs.
The spotlight of this study is to discuss the bank-specific and social factors of NPLs. In this
regard the questions asked in the questionnaire pointed out bank-specific factors like Rapid
Credit Growth, poor Monitoring, Interest and weak Risk Assessment and social factors like
206 ILSHS Volume 43
Political Interference and Bankers’ Incompetence to be the causes of NPLs. These were
further investigated in this study.
5. 1. Credit Assessment and NPLs
This study showed that 44% respondents agreed that a loan defaults if the borrowers are
admitted by compromising the assessment conditions. The study also highlighted that if the
bank has strong knowledge about the credit history of a borrower then this would lead to high
loan quality. Furthermore the study also indicated that poor risk assessment can also lead to
high NPLs as 97.2% of respondents agreed on that statement in the survey conducted. The
five Cs (Character, Condition, Collateral, Capital and Capacity) are considered basic tools
before lending. In case of failure to conduct adequate risk assessment would lead to missing
any or all of the five Cs resulting in loan defaults. These survey results have been supported in
the literature. Ning (2007) pointed out that poor risk assessment has an impact on the quality
of loan.
5. 2. Monitoring and NPLs
The survey results showed that 92.7% of the respondents agreed that tight monitoring of
loans enhance its quality. This has been verified in the literature as Agresti et al (2008) stated
that regular and adequate monitoring of a loan would result in Non-Performing Loans. The
survey results also show that if a loan is poorly assessed then it can be avoided from default
by adequate monitoring. The results also indicate that credit monitoring directly affects the
occurrence of NPLs. However, survey also indicates that if banks spend more on monitoring
the loans then it is not guaranteed that level of NPLs may decrease. The previous studies also
support this as Salas and Saurina (2002) are of the view that the loans are more secured if the
banks keep a continuous check on the borrowers.
5. 3. Interest and NPLs
Various researchers have given different findings about the relationship between interest
and NPLs. Some researchers find a significant and positive relationship between interest and
NPLs (Khemraj and Pasha 2009; Fofack 2005). They are of the view that when banks
increase interest rate there is an additional burden on borrowers due to which chances of loan
default increase. Some studies have shown a weaker or insignificant relationship between
NPLs and interest (Kaplin et al 2009). This survey does not indicate a very strong relation
between interest and NPLs as only 10.1% of respondents agree that interest can turn a loan
into non-performing. Similarly, 50.3% of respondents believe that high interest rate can lead
to loan defaults, which is not a very high percentage. Therefore, the results of the study match
with the literature that supports a weak relation between interest and NPLs.
5. 4. Rapid Credit Growth and NPLs
The survey results indicate that rapid credit growth is connected with NPLs as 83.5% of
the respondents agree that there are more chances of high NPLs if advancement of credit by
banks is rapid. Furthermore, 93.5% of the respondents consider aggression in giving loans as
a strong reason behind NPLs. Likewise, respondents also believe that if integrity is
compromised in giving loans or there is large number of borrowers or there is tendency of
bank to take greater risks, can lead to higher NPLs. This result has been supported by the
studies of Berger and De Young (1997) and Pain (2003).
International Letters of Social and Humanistic Sciences Vol. 43 207
5. 5. Political Interference and NPLs
The literature shows that political interference has a significant impact on NPLs. The
study of Chijoriga (1997) specifies that when government tends to favor a particular sector for
its personal benefits, ignoring the future prospects resulting in occurrence of NPLs for the
banks. The study of Khawaja and Mian (2005) reveals that majority of loans taken by the
political firms in Pakistan, due to political pressure, are defaulted. The results of this study are
quite similar as 90.6% of the respondents agree that political interference in the lending
decisions is a cause of NPLs in Pakistan. Majority of the respondents also agree that if terms
of loan advancement are compromised then it can lead to even higher NPLs. In addition the
respondents strongly believe that loans being disbursed under political pressure to politicians
causes NPLs in Pakistani banking sector. However only 19.4% of respondents strongly agree
that strategic planning without considering the business community is causing NPLs in
Pakistan.
5. 6. Bankers’ Incompetence and NPLs
The survey results show that respondents consider bankers’ incompetence, another
factor, affecting NPLs. As per Table 12, 82.8% of the respondents agree that lending officers’
qualification play a key role in making wise loan decisions possible. 58.3% of the respondents
strongly agree that lending officers’ experience in dealing with loan advancement matters take
active part in making appropriate lending decisions. In addition majority of the respondents
also agree that up to date training, grooming, exposure and capability to sustain pressure also
play a vital role in making prudent loan decisions. These all factors altogether lead to an
increase in quality of loans. The literature indicates that in today’s competitive environment,
banks need such competent bankers who can convert their NPLs into performing ones.
According to the study of Masood, Bellalah and Mansour (2010) the bankers with high
qualification are in a better position to judge the credibility of a loan resulting in lesser levels
of NPLs than ones with lower qualification.
6. RECOMMENDATIONS, CONCLUSION, FUTURE RESEARCH PERSPECTIVES
AND LIMITATIONS
After the detailed examination and analysis of the research finding the following
recommendation are suggested:
1. Bank should have such mechanisms that can ensure the verification of five C’s before
lending loans. These five C’s include condition, collateral, capital, and character.
2. Banks should ensure the following of the adequate monitoring system which should
start before giving loans by identifying the status of a borrower and should continue
until and unless the loan is matured.
3. Bank should realize that before monitoring of loan, its adequate assessment is
necessary. Therefore, latest assessment procedure should be adopted on selection of
customers, credit analysis and sanctioning process.
4. Bank should follow a balanced policy between profit maximization and risk taking. It
should be ensured that bank may not enter in an unhealthy and unnecessary risky
competition.
5. The Banks should be properly supervised and guided about the regulations in loan
disbursement process by State bank. Prudence of policies that govern bank loans
208 ILSHS Volume 43
should continuously be ensured along with comparison with international processes,
macroeconomic conditions and level of development of banks and the economy by the
State bank of Pakistan.
6. There is a need to educate the Pakistan banking sector to conduct various training
programs for the bankers who are involved in lending process. Also the banks should
be given awareness about the consequences of rapid credit disbursement in order to
improve quality of loans.
7. The banks’ management should be made so much autonomous that it could work
independently without taking any pressure weather it’s from inside i.e. owners or
outside i.e. political.
8. The government should play a positive role in ensuring that politicians do not
pressurize or influence the loan advancement decision of banks especially the state
owned banks.
6. 1. CONCLUSIONS
The extensive objective of this research was to determine the bank-specific and social
factors of NPLs. On the basis of this, various number of precise research questions were
developed. To fulfill the main objective the study used quantitative research approach. More
exclusively the study used survey of banks’ employees dealing with loan advancement and
decision making. From the views of respondents, the results show the following factors
affecting the occurrence of Non-Performing Loans (NPLs) in Pakistani banking sector:
The study has indicated that the borrowers which are admitted by compromising the
assessment conditions, banks’ knowledge about the previous credit history of customers, good
understanding of loans and poor risk assessment have caused impact on NPLs. The research
also shows that strict monitoring of loans has an impact on NPLs. The results also point out
that if a loan is not properly assessed then it can turn into NPLs even if it is appropriately
monitored. The study further explained that interest has a weak relation with NPLs and not an
important factor affecting the former. In addition the study also reveals that rapid credit
growth has a significant impact on NPLs. This research shows that due to competition, terms
of loans are compromised or riskier investment options are utilized by the banks which cause
NPLs.
Along with bank-specific factors, social factors are also identified in this research. The
study indicates a strong relation of bankers’ incompetence and political interference with
NPLs. This research shows that banks do get pressurized under political influence and
compromise credit terms leading to NPLs. Furthermore, research results show that proper
trained and qualified bankers increase quality of loans.
6. 2. Future research perspectives:
1. There is a need of mixed approach using quantitative as well as qualitative
approaches while determining the factors of NPLs.
2. Various factors of NPLs like war on terrorism, corporate governance on NPLs still
needed to be explored.
3. NPLs may be classified into various classes and each class’s factors can be
determined separately.
4. More social factors affecting NPLs needed to be investigated e.g. legal system,
corruption etc.
International Letters of Social and Humanistic Sciences Vol. 43 209
6. 3. Limitations
1. This study was based on collecting survey questionnaires only from Lahore.
2. Some of the questions in the questionnaire were related to sensitive issues like
political interference, so the information collected may be biased.
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