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Impact of bad loans in the bank performance-Study
on Albanian bank system
Remzi SULO
Albanian University
Faculty of Applied Sciences and
Economy
Tirana Albania
Ana KAPAJ
Agriculture University of Tirana
Faculty of Economy and Agribusiness
Tirana, Albania
Etleva MUÇA
Agriculture University of Tirana
Faculty of Economy and Agribusiness
Tirana, Albania
Abstract—Nonperforming loans were one of the most serious
obstacles that banks in the transition countries faced. They are
still present in many transitional places. If in the first period of
transition the causes of nonperforming loans were mainly in the
inefficiency of state owned banks and enterprises, now the
attention is more focused on the micro and macroeconomic
environmental factors where banks operate. The Albanian
Banking System has gone through significant changes in its
development performance, especially in the last two decades.
These changes present numerous difficulties and challenges
which help further consolidation of the system. One of the
problems facing the banking system is bad loans, whose
treatment has taken a great importance in recent years,
especially in the period after the global financial crisis. During
this study we are trying assesses the effect of bad loans on the
lending potential and financial performance of banks. Secondary
data from a period of 5 years (2010-2014) are used. This data are
sourced from the annual reports of four major banks of Albania.
The hypothesis we have tested are; Bad loans significantly make
a negative effect on the lending potential of banks in terms of
yearly financial allocation for SMEs lending, and Bad loans
significantly make a negative effect on the net profit of banks in
terms of return on investment. Statistical Pearson’s correlation
test and regression analysis are used to get the needed results. A
high negative correlation between bad loans and lending
potential is found at 5% level of significance, r = -0.741. Also, bad
loans make a high negative correlation with return on investment
or net profit at 5% significance level, r = -0.802. Bad loans
significantly predict lending potential at 5% significance level,
where bad loans account for 71.4% of the variation in this
respect. It is therefore evident that banks would have to hedge
against the realization of bad loans to maximize their financial
performance, and to improve access to credit facilities to
creditworthy borrowers.
Keywords- Albanian Banking System, nonperforming loans,
lending potential, financial performance of banks, Pearson’s
correlation, regression analysis
I. INTRODUCTION, BANKING SYSTEM IN ALBANIA
The basic function of the banking system is the channeling
of savings or free cash surplus units towards deficient entities.
Bank credits constitute one of the most potential sources of
financing economic activities of enterprises, while banks serve
as the instrument that enable the flow of funds in the economy.
Other financial intermediaries have not been able to play their
role in Albanian fragile economy. On the other hand the
malfunctioning of Tirana Stock Exchanges reduces alternatives
for fund raising ventures, as the capital market and debt
instruments market, for example. In transition economies, such
as the Albanian economy, the combination of poor heritage
with numerous structural problems makes it really hard the
functioning efficiently of financial intermediaries, leaving more
space for businesses to be financed in riskier ways, such as
borrowing in the informal economy market. Moreover, the low
level of recognition, structural distortions and the lack of
confidence, make our country a market devoid of operating
capitals and securities. By this filing, it is clearly evidenced
that the financing channel through bank credit economy takes a
special importance and therefore the role and responsibilities
that policymakers, bankers, business people should undertake,
are numerous. Albanian Banking System is associated with
significant changes in the performance of its developments. It
also presents difficulties and challenges that help to further
consolidate the system.
The main threat to stability and development of the banking
system today are troubled credits. The financial and economic
crisis that the global economy is facing today has created a
climate not conducive to the economic development, and the
development of the banking system. The number of bad loans
has increased since the beginning of the recent financial crisis.
Despite the efforts some commercial banks are making
together with the Central Bank of Albania, bad loans are still in
trouble. The quality of the loan portfolio in the banking system
was very high until 2007. Levels of bad loans began to have a
higher level since 2008. So, the level of bad loans reached
3.4% by the end of 2007 and 18.8 % in late 2011. However,
more than half of the banks in the banking system believe that
the level of bad loans is higher than reported.
According to sources of the Bank of Albania, the amount of
loans granted, of which the banks have no hope these loans to
be paid off, has reached the sum of 310 million Euros at the
end of 2012, it was around 220 million Euros at the end of
2011, amounting to one third of total loans problems.
Compared to the end of 2011, problematic loans have increased
nearly 4 percentage points, slowing down the pace of growth;
they rose with 5.3% compared to the end of 2010. Problematic
loans reached the maximum level in November 2012 with
23%.
Bad loans belong mostly to business loans, which reflect on
the one hand -the general economic difficulties, and on the
The 4th Virtual Multidisciplinary Conference
December, 12. - 16. 2016, www.quaesti.com
Economics and Business eISSN: 2453-7144, cdISSN: 1339-5572
10.18638/quaesti.2016.4.1.270 - 51 - ISBN: 978-80-554-1301-3
other hand- the poor quality of businesses, financed by banks
during the credit boom years, the period 2004 - 2008. In this
perspective, we can say that the Albanian banking system
should be very careful with problematic loans, especially in
periods of crisis which favors the increasing of bad loans. In
fact at the end of 2012, loans to the economy reached the sum
of 554.7 billion (ALL), marking an increase of 2.4% on an
annual basis, or 12.8 billion (ALL). The increase of the loans in
2012, in absolute terms, turns to be about 6 times lower than a
year ago. The annual growth rates of loans in 2012 were the
lowest of the decade. The main reason for low rates of credit
growth has been the increasing of problematic loans. This has
made banks focus on managing existing portfolios and be more
selective in new lending.
Terms "problematic loans and credit outstanding" show the
banking system's exposure to credit risk. At the same time low
and declining values of this ratio indicate a limited exposure to
this risk. Taking into consideration problematic loans,
(doubtful loans, substandard), they have had an upward trend,
especially after 2008 onwards. The growth of this category of
loans was due to the global financial crisis of 2008 which had
its impact in Albania.
According to a report by the Bank of Albania, by the end of
2010, from the total loans received, the construction sector is
the most problematic. The level of nonperforming loans of this
sector is 19.8%, while the lending value of the sector is 13.9%
of the total. The list of problematic sectors is followed by the
manufacturing industry with 15.2%, while trade, repair of
vehicles and household items is measured to 13.8%. Parts of
other sectors having bad loans are: hotels and restaurants along
with telecommunications, which have high levels of
nonperforming loans within the sector, but from the total
portfolio, the role they play is low. It is noted that the loans
taken by businesses at the end of 2011, represent 73.5% of the
total loan portfolio and 26.5% loans taken from individuals.
The economic problems these sectors faced reflected in the
increase of bad loans.
II. METHODOLOGY AND BASE RUN DATA
A quantitative research technique is employed in this study,
where the study’s hypothesis is tested using inferential
statistical procedures and tools. Secondary data on banks’ rerun
on investment, capital allocation for SMEs lending and bad
debts is used in this study. The source of this data is four
commercial banks in Albania. Data used span a period of 5
years (three monthly); 2010-2014. Therefore, 20 observations
of the variables are incorporated in data analysis. Pearson’s
correlation test and ordinary least squares regression analysis
are used to analyze data. These statistical tools are used with
respect to their specialized function in terms of correlation
analysis. Data analysis is based on the assumption that data
employed are normally or approximately normally distributed.
All the data calculations are done in SPSS.
According to the data analysis for the first hypothesis:
H1: Bad loans significantly make a negative effect on the
lending potential of banks,
We got the following results:
TABLE I. COEFFICIENTS (ANNUAL LOAN SIZE)
Source
Value
Standard
Error
t-stat
P-Value
Intercept
7.25
0.25
29
.000
Bad loans
-2.54
0.048
-52.9
.000
Table 1 shows the coefficients of predicting annual loan
size from bad loans. From the table, bad loans significantly
predict annual loan size at 5% significance level (t = -52.9, p =
.000<0.05). Moreover, a unit change in bad loans decreases the
conditional mean of annual loan size (i.e. SME lending
potential) by 2.54. This means that bad loans have a negative
effect on annual loan size. The relationship between the two
variables can be expressed as follows:
Annual Loan Size = 7.25 – Bad Loans*2.54
For the second hypothesis:
H2: Bad loans significantly make a negative effect on the net
profit of banks
We got the following results:
TABLE II. COEFFICIENTS (NET PROFIT)
Source
Value
Standard
Error
t-stat
P-Value
Intercept
0.58
0.095
6.1
.000
Bad loans
-0.06
0.01
-6.0
.000
Table 2 shows the coefficients of predicting net profit from
bad loans. From the table, bad loans significantly predict net
profit at 5% significance level (t = -6.0, p = .000<0.05).
Moreover, a unit change in bad loans decreases the conditional
proportion of net profit by 6%. This means that bad loans have
a negative effect on net profit. The relationship between the
two variables can be expressed as follows:
Net Profit = 0.58 – Bad Loans*0.06
The relationship indicates that bad loans have a limiting
effect on banks’ financial performance, and possibly financial
growth in each financial year. The two hypotheses of this study
are therefore confirmed. The conclusion is that net profit and
banks’ SME lending potential are highly hindered by bad
loans.
III. RESULTS AND CONCLUSIONS
Findings of this study indicate that bad loans make a major
negative effect on banks’ lending potential and financial
performance in terms of return on investment. The evidence
drawn in this paper is that there is a high negative correlation
between bad loans and amount allocated each year by banks for
lending to SMEs at 5% level of significance, r = -.741, p =
.000. This means that as the banks encounter a higher amount
of bad loans; their annual financial allocation for SME lending
The 4th Virtual Multidisciplinary Conference
December, 12. - 16. 2016, www.quaesti.com
Economics and Business eISSN: 2453-7144, cdISSN: 1339-5572
10.18638/quaesti.2016.4.1.270 - 52 - ISBN: 978-80-554-1301-3
reduces at a large extent. The essence of this support is that the
negative effect of bad loans on lending potential is a practical
and general phenomenon. Yet, the evidence is that bad loans
make a high negative correlation with return on investment or
net profit at 5% significance level, r = -.802, p < .05. Relative
to financial performance, bad loans make a smaller effect on
lending potential. Thus bad loans affect financial performance
(71.4%) more than it affects lending potential. This is logically
because money lost to bad loans could be used in other non-
lending banking activities that would make positive effect on
financial performance. Banks inability to have access to
sufficient funds to implement their financial activities, owing to
a realization of bad debts, makes a major effect on their
financial expectations relative to reinvesting in loans. Support
for this study’s result is weak on the basis of the fact that
previous evidences are not based on empirical findings. This
situation constrains comparative analysis on the strength of the
relationship between bad loans and lending potential, and bad
loans and financial performance. In line with the
recommendation of Karim et al. (2010), there is therefore the
need for more empirical studies to be conducted to estimate the
actual effect of bad loans on financial performance and ending
potential.
Based on findings of this study, it is concluded that bad
loans make a major negative effect on banks’ lending potential
and financial performance in terms of return on investment.
This conclusion is made by testing the two hypotheses of this
paper. The evidence is that there is a high negative correlation
between bad loans and amount allocated each year by banks for
lending to SMEs. This means that as the banks encounter a
higher amount of bad loans; their annual financial allocation
for SME lending reduces at a large extent. Also, bad loans
make a high negative correlation with return on investment or
net profit.
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The 4th Virtual Multidisciplinary Conference
December, 12. - 16. 2016, www.quaesti.com
Economics and Business eISSN: 2453-7144, cdISSN: 1339-5572
10.18638/quaesti.2016.4.1.270 - 53 - ISBN: 978-80-554-1301-3
