Impact of Non-Performing Loans (NPLs) on the Profitability of Banks: Evidence from Bhutan

Abstract

Banking industry is one of the major contributors of the economic growth of a nation. It must be given high importance as it links the household saving into capital formation. Failure of the banking sector in any country can greatly affect different segmentsof an economy. Non-Performing Loan (NPL), like in any other developing economies, is one of the keyproblems for the banking sector in Bhutan.  In general, NPLs are those loans and advances of a bank where interest or principal or both has not been repaid by the borrower to the bank during specified time period as per the guidelines issued by the central bank of a country, which is the Royal Monetary Authority (RMA) in Bhutan. This study examines the impacts of NPL on the banks’ profit generating capability of banks.  All five commercial banks in Bhutan were taken for study.  Secondary data obtained mainly from the annual reports of each banks and annual statistics book of RMA were analyzed for a period of 2014 to 2019.  We study the impact of NPLs, both gross and net, on the profitability of the banks, measured through return on assets, return on equity and net interest margin.  Further, we also compare the NPLs between public sector and private sector banks in Bhutan.  The regression model has been used to see whether NPLs have impact on the profitability of the banks.  The present study indicates that net non-performing loans have great negative impact on the return on assets.  Net NPLs approximately affects 68% of the return on assets.  In case of public sector banks, a mix pattern of gross NPL ratio is observed from the year 2014 to 2019, but in general it has increased during this period. Gross NPL ratio was higher in the private sector bank than public sector banks as the ratio stood at 7.58% and 3.76 % respectively in 2019.