Does credit risk persist in the Indian banking industry? Recent evidence

Abstract

Purpose
This study aims to capture the “persistence effect” of credit risk in Indian banking industry using the bank-level data spanning over the period of 19 years from 1998/1999 to 2016/17. Alongside, the study explored how the bank-specific, industry-specific, macroeconomic variables alongside regulatory reforms, ownership changes and financial crisis affect the bank's asset quality in India.

Design/methodology/approach
Using two-step system generalized method of moment (GMM) approach, the study derives key factors that affect the bank's asset quality in India.

Findings
The empirical results confirm the time persistence of credit risk among Indian banks during study period. This reflects that bank defaults are expected to increase in the current year, if it had increased past year due to time lag involved in the process of recovery of past dues. Further, higher profitability, better managerial efficiency, more diversified income from nontraditional activities, optimal size of banks, proper credit screening and monitoring and adherence regulatory norms would help in improving the credit quality of Indian banks.

Practical implications
The practical implication drawn from the study is that nonaccumulation of nonperforming loans (NPLs), higher profitability, better managerial efficiency, more diversified income from nontraditional activities, optimal size of banks, proper credit screening and monitoring and adherence regulatory norms would help in improving the credit quality of Indian banks.

Originality/value
This study is probably the first one that identifies in addition to the current year, whether lag of bank industry-macroeconomic affects the level of NPLs of Indian banks. So far, such an analysis has received less attention with respect to Indian banking industry, especially immediate aftermath of the global financial crisis.