This paper aims to examine the correlation between average interest rate and non-performing loans in the Romanian banking system during 2006-February 2010. We based our approach on the Pearson correlation coefficient and we realized an empirical study, which demonstrates how these relevant banking elements are connected. Also, the result of this research suggests that there are other indirect channels which affect the non-performing loans.Pearson correlation coeficient, Non-performing loans, Average interest rate, Credit-risk provisions

Iuga Iulia

Socol Adela

English

Research Papers in Economics

  777 
STUDY OF CORRELATION BETWEEN AVERAGE INTEREST RATE AND 
NON-PERFORMING LOANS IN THE ROMANIAN BANKING SYSTEM 
DURING 2006- FEBRUARY 2010 
Socol Adela 
“1 Decembrie 1918” University of Alba Iulia 
Faculty of Science 
Iuga Iulia 
“1 Decembrie 1918” University of Alba Iulia 
Faculty of Science 
 
This paper aims to examine the correlation between average interest rate and non-performing 
loans in the Romanian banking system during 2006-February 2010. We based our approach on 
the Pearson correlation coefficient and we realized an empirical study, which demonstrates how 
these relevant banking elements are connected. Also, the result of this research suggests that 
there are other indirect channels which affect the non-performing loans.   
           
Key Words: Pearson correlation coeficient, Non-performing loans, Average interest rate, Credit-
risk provisions. 
 
JEL Codes: G21, E22, D63.  
 
1. Introduction 
Romania was affected by the deteriorating of the external economic environment, associated with 
the international financial crisis. Unfortunately, since 2007, we frequently use and hear the notion 
of  financial  crisis  and  the  various  causal  factors  at  the  heart  of  the  crisis.  There  are  in  the 
specialized literature multiple trials to explain the elements contributing to the deterioration of 
the economic conditions, in their acceptation of the premises of the crisis.  
We remark the major vulnerability of the banking domain, derived from its key position in the 
financial system. The loan portfolio quality deteriorated during the past periods and the bank 
reported higher levels of overdue and doubtful loans. We attend to a worsening of the payment 
behaviour of the banking borrowers. Romania is in a particular situation regarding the banking 
loans reporting. The national reporting standards impose higher coverage by provisions of bad 
loans in the annual financial reporting statement of the credit institutions from Romania than 
European requirements. 
Based  on  these  clues,  the  paper  identifies  the  worsening  of  the  banking  loan  portfolio  and 
presents this deterioration like a matter of concern. An empirical study is included to demonstrate 
how the average interest rate and non-performing rate are connected. We develop a research 
hypothesis Pearson’s correlation coefficient and we study the situation of the Romanian banking 
system during 2006-February 2010.      
 
2. Theoretical background  
In  Romania,  the  non-performing  loans
495  reveal  past  due  amounted  to  49.101,60  Bn  lei  in 
February 2010, and were up from 4.879,70 Bn lei in January 2006. The first variable of our study 
is the average interest rate. According to the National Bank of Romania’s publications
496, starting 
with January 2007, average interest rates on deposits and loans and average interest rates on new 
business  are  calculated  based  on  the  provisions  of  National  Bank  of  Romania  Norms  No. 
                                                       
495 National Bank of Romania, Monthly Bulletins, February 2010. 
496 National Bank of Romania, Monthly Bulletins, 2006-February 2010.   778
14/2006
497 concerning the statistics of interest rates applied by credit institutions, transposing the 
provisions of Regulation ECB/2001/18 concerning statistics on interest rates applied by monetary 
financial institutions to deposits and loans vis-à-vis households and non-financial corporations. 
Average interest rates are calculated as an arithmetic mean of annualized agreed rates weighted 
by  the  outstanding  amounts  of  loans/deposits  at  the  end  of  the  reported  month  or  by  the 
extended/taken amounts during the reported month in relation to new business. The annualized 
agreed rate is the interest rate agreed between the credit institution and the customer for a deposit 
or loan, converted to an annual basis and quoted in percentages per annum. According to the 
provisions  of  the  above-mentioned  Norms,  average  interest  rates  are  determined  for  the 
institutional sectors “Non-financial Corporations” and “Households” as well as for the following 
balance sheet items: loans (total), bank overdrafts, loans for house purchases, consumer loans, 
loans for other purposes (including loans for business consolidation extended to freelancers and 
household associations), overnight deposits, deposits redeemable at notice, deposits with agreed 
maturity and repos.  
Regarding to the second variable of our research, we underline that Romania has a primary 
regulatory framework governing loan classification and provisioning since 2002
498 and multiple 
amendments.  Any  credit  institutions  have  to  classify  their  loans  in  one  of  the  following 
categories: Standard, Watch, Substandard, Doubtful, Loss. In 2009 National Bank of Romania 
issued a new regulation
499, which established the more flexible criteria for loan classification and 
provisioning. According to this settlement, the collateral relating to exposures representing the 
principal of loans/investments classified under “loss”, where the debt service outstanding exceeds 
90 days and/or where legal proceedings were taken against the operation or the debtor, shall be 
adjusted  by  applying  the  coefficients  set  by  the  lender  for  each  type/case.  The  level  of 
coefficients may not be higher than 0.25. The lender must have the laying-out documents for 
setting  the  level  of  coefficients  laid  down  in  the  regulation.  In  accordance  with  the  new 
regulation, the collateral relating to exposures representing the current/outstanding interest on the 
above-mentioned  loans/investments  shall  not  be  taken  into  consideration,  and  the  coefficient 
applied to the collateral amount shall be equal to zero. The amendment will translate into lower 
provisions for such assets, as the surplus is to be recorded under income, thus benefiting the 
health of financial and prudential indicators
500.    
The role of the interest rate in the banks is recognized by many authors. The values of assets and 
liabilities of financial institutions are considered subject to fluctuations in interest rate by Cox 
and Prasad
501. They studied the differential impact in interest rate changes between assets and 
liabilities  which  is  referred  to,  in  banking,  as  interest  rate  risk.  Of  all  threats  to  bank 
competitiveness this risk dwarfs all others. Banks traditionally have dealt with interest rate risk 
by restructuring their loan portfolios. The authors developed a model to measure interest rate risk, 
called the Degree of Interest Rate Sensitivity (DIRS), and demonstrated its effectiveness for 
banks  to  compete.  The  others  authors
502  examine  the  interest  rate  risk  management  (IRRM) 
practices of UK-listed companies. In particular, they examined the significance of interest rate 
                                                       
497 Published in Official Gazette of Romania no. 679/2006.  
498 Regulation no. 5/2002 issued by the National Bank of Romania, regarding the clasification of loans and 
investments, as well as establishment, adjustment and use of credit-risk provisions, published in Official 
Gazette of Romania no. 626/2002 
499 Regulation no. 3/2009 issued by the National Bank of Romania, published in Official Gazette of 
Romania no. 626/2009 
500 National Bank of Romania, Financial Stability Report, 2009, p. 33  
501 Cox, R.A.K., Prasad, R.M. (1995). Bank competitiveness in the face of interest rate risk, 
Competitiveness Review: An International Business Journal incorporating Journal of Global 
Competitiveness, Vol. 5, Issue 2, pp. 84-89    
502 Dhanani, A., Fifield, S, Helliar, C. and Stevenson, L. (2008). The management of interest rate risk: 
evidence from UK companies, Journal of Applied Accounting Research, Vol. 9, Issue 1, pp. 52-70.   779 
risk (IRR) to these companies as well as the risk management practices adopted, including: the 
methods used to assess the level of IRR and the types of interest rate forecasts used in the 
process; derivatives activity; and corporate governance, reporting and control. The results of this 
research suggest that IRR is important to UK companies and that their IRR hedging strategies are 
geared  towards  managing  shareholder  considerations  and  protecting  banking  covenants  and 
corporate credit ratings. 
We identify the studies that seek to explain the evolution of the non-performing loans in the 
banking industries. For example, Hall
503 presented his opinion about the truth in the scale of the 
Japanese bank’s bad debt and tried to answer to the question: if the situation manageable? The 
author explained a concept of “accounting forbearance”, which is used to mask the true level of 
the banks’ bad debts. The banking industry’s ability to handle the continuing bad debt problem, 
in the face of a significant impairment of economic capital and the market’s relentless drive for 
full disclosure and transparency, also is assessed. 
The others authors
504 examined the factors which affect loss provision for loans and investment in 
Murabaha, Musharka, and Mudarabah for banks in the Gulf Cooperation Council (GCC) region. 
The effect of prior period earnings, legal and statutory reserves, size of the bank, level of debt, 
and loan and investment to deposit ratio on the loss provisions of banks are examined for the 
period 2000-2003. 
In 2007, Bandyopadhyay, Chherawala and Saha
505 empirically calibrated the default and asset 
correlation  for  large  companies  in  India  and elaborate  its implications  for  credit risk  capital 
estimation for a bank. 
 
3. Empirical findings and interpretations 
We studied the correlation between average interest rate and non-performing rate, based on the 
Pearson correlation coefficient.  
 
( ) ( )( )
( ) [ ] ( ) [ ]
2 2 2 2 ￿ ￿ ￿ ￿
￿ ￿ ￿
− −
−
=
Y Y n X X n
Y X XY n
p
                                     (1)
 
 
It indicates the extent of relationship by a number between 1.00 and -1.00. The correlation is 
computed from pairs of scores for each individual in the sample; each individual has a pair of 
scores,  one  on  each  of  the  two  variables  on  which  the  correlation  is  being  computed.  A 
correlation of one indicates a perfect relationship such that if we know that the individual has the 
highest score on one variable, we also know she has the highest score on the other. With a 
negative  correlation,  they  track  one  another  inversely.  A  correlation  of  less  than  one,  either 
positive or negative, indicates that each member of a pair of scores attracts the other less than 
perfectly so that the highest score on one variable in a positive correlation might be accompanied 
by a medium high score on the other variable. The fact that the relationship exists as shown by a 
correlation does not allow us to infer that the relationship is causal. Often the relationship is the 
result of a third variable or a combination of other variables. Regardless of whether a relationship 
is  causal,  a  correlation  allows  prediction;  thus  such  relationships  are  extremely  useful.  An 
extensive body of literature describes predictors of various kinds: to enhance learning conditions, 
                                                       
503 Hall, M.J.B. (2000). What is the truth in the scale of the Japanese bank’s bad debt? Is the 
situation manageable?, Journal of Financial Services Research, 17:1, pp. 69-91 
504 Zoubi, T.A., Al-Khazali, O. (2007). Empirical testing of the loss provisions of banks in the GCC region, 
Managerial Finance, vol. 33, No 7, pp. 500-511 
505 Bandyopadhyay, A., Chherawala, T., Saha, A. (2007). Calibrating asset correlation for Indian corporate 
exposures: Implications for regulatory capital, Journal of Risk Finance, vol. 8, issue 4, pp. 330-348  
   780
to increase the effectiveness of teaching, to predict the stock market, to forecast college success. 
Unless the correlation is perfect, however, the predicted value is always less extreme - that is, 
closer to its mean - than the value from which it was predicted (Krathwohl, 1998).  
Our study is based on the real data, extracted from the annual reports published by the National 
Bank of Romania and the Monthly Bulletins from the mentioned period. We obtain in the case of 
the  active  banks  from  Romania,  the  following  results  for  the  Pearson  correlation  coefficient 
between average interest rate and non-performing rate.  
Table no. 1 – The Pearson correlation coefficient between average interest rate and 
non-performing rate from Romania 
 
Year  The Pearson correlation 
coefficient 
2006  -0.76 
2007  -0.71 
2008  0.97 
2009  -0.95 
2010  -1 
 
Figure no. 1 - Correlation coefficient between average interest rate and non-
performing loans at the level of Romanian banking system  
during 2006-January 2010 
 
 
 
   
Correlation coefficient between average interest rate and non-performing loans
0.00
10,000.00
20,000.00
30,000.00
40,000.00
50,000.00
60,000.00
0 5 10 15 20  781 
Figure no. 2 – Annual Correlation coefficient between average interest rate and 
non-performing loans at the level of Romanian banking system  
 
Year 2006  Year 2007 
Year 2008  Year 2009 
 
4. Conclusions  
In 2006 and 2007, the values of the Pearson coefficient correlation show a connection between 
variables. We suggest that there is an inverse correlation between the average interest active rate 
(cause variable) and the value of the non-performing loans (effect variable). In these conditions, 
we  identify  the  others  conditions  that  affect  the  debt  service  of  the  borrowers.  The  lack  of 
banking settlements and regulation, in the mentioned period the primary banking legislation was 
improper
506. Since 1
st of January 2007, the new banking legislation
507 lays down the principles 
concerning  the  taking  up  and  pursuit  of  the  business  of  credit  institutions  and  financial 
investment companies within Romania’s territory and their prudential supervision, as well as 
supervision of payment systems and financial instruments settlement systems. 
During 2008-2010 (February), the different values of the Pearson correlation coefficient were 
obtained. The values very close to +/-1 show a direct and strong connection between variables. 
                                                       
506 Law no. 58/1998 on the banking activity, republished in Official Gazette of Romania no. 78/2005, as 
subsequently amended and supplemented 
507 Emergency Ordinance no. 99/2006 on Credit Institutions and Capital Adequacy Published in Official 
Gazette of Romania, no. 1027/2006 
0.00
1,000.00
2,000.00
3,000.00
4,000.00
5,000.00
6,000.00
7,000.00
8,000.00
9,000.00
13.5 14 14.5 15 15.5
Series1 Linear (Series1)
0.00
2,000.00
4,000.00
6,000.00
8,000.00
10,000.00
12,000.00
14,000.00
16,000.00
11.8 12 12.2 12.4 12.6 12.8 13 13.2
Series1 Linear (Series1)
0.00
5,000.00
10,000.00
15,000.00
20,000.00
25,000.00
30,000.00
0 5 10 15 20
Series1 Linear (Series1)
0.00
5,000.00
10,000.00
15,000.00
20,000.00
25,000.00
30,000.00
35,000.00
40,000.00
45,000.00
50,000.00
16 16.5 17 17.5 18 18.5 19 19.5
Series1 Linear (Series1)  782
We also suggest that there is an inverse correlation between variables, explained by the following 
causes: the fall of the prices of the loan collaterals, especially real estate; inflation pressure that 
contribute to the growing of the non-performing loans; unemployment and economic contraction.    
 
 References: 
1.  Bandyopadhyay, A., Chherawala, T., Saha, A. (2007). Calibrating asset correlation for Indian 
corporate exposures: Implications for regulatory capital, Journal of Risk Finance, Vol. 8, 
Issue 4, pp. 330-348 
2.  Cox, R.A.K., Prasad, R.M. (1995). Bank competitiveness in the face of interest rate risk, 
Competitiveness Review: An International Business Journal incorporating Journal of Global 
Competitiveness, Vol. 5, Issue 2, pp. 84-89    
3.  Dhanani, A., Fifield, S, Helliar, C. and Stevenson, L. (2008). The management of interest 
rate risk: evidence from UK companies, Journal of Applied Accounting Research, Vol. 9, 
Issue 1, pp. 52-70 
4.  Hall, M.J.B. (2000). What is the truth in the scale of the Japanese bank’s bad debt? Is the 
situation manageable?, Journal of Financial Services Research, 17:1, pp. 69-91 
5.  Krathwohl, D.R. (1998). Methods of Educational and Social Science Research: An Integrated 
Approach, Addison-Wesley Educational Publishers 
6.  Zoubi, T.A., Al-Khazali, O. (2007). Empirical testing of the loss provisions of banks in the 
GCC region, Managerial Finance, vol. 33, No 7, pp. 500-511 
7.  National Bank of Romania, Monthly Bulletins, 2006-February 2010 
8.  National Bank of Romania, Financial Stability Report, 2009 
9.  Law no. 58/1998 on the banking activity, republished in Official Gazette of Romania no. 
78/2005, as subsequently amended and supplemented 
10. Emergency Ordinance no. 99/2006 on Credit Institutions and Capital Adequacy Published in 
Official Gazette of Romania, no. 1027/2006 
11. Norms issued by the National Bank of Romania No. 14/2006 concerning the statistics of 
interest  rates  applied  by  credit  institutions,  transposing  the  provisions  of  Regulation 
ECB/2001/18 concerning statistics on interest rates applied by monetary financial institutions 
to  deposits  and  loans  vis-à-vis  households  and  non-financial  corporations,  published  in 
Official Gazette of Romania no. 679/2006 
12. Regulation no. 5/2002 issued by the National Bank of Romania, regarding the clasification of 
loans and investments, as well as establishment, adjustment and use of credit-risk provisions, 
published in Official Gazette of Romania no. 626/2002 
13. Regulation no. 3/2009 issued by the National Bank of Romania, published in Official Gazette 
of Romania no. 626/2009 
 
 
 
   

3/2009 issued by the National Bank of Romania, published in Official Gazette of Romania no.

5/2002 issued by the National Bank of Romania, regarding the clasification of loans and investments, as well as establishment, adjustment and use of credit-risk provisions, published in Official Gazette of Romania no.

58/1998 on the banking activity, republished in Official Gazette of Romania no. 78/2005, as subsequently amended and supplemented

Bank competitiveness in the face of interest rate risk, Competitiveness Review:

Calibrating asset correlation for Indian corporate exposures: Implications for regulatory capital,

Empirical testing of the loss provisions of banks in

Methods of Educational and Social Science Research: An Integrated Approach,

The management of interest rate risk: evidence from UK companies,

What is the truth in the scale of the Japanese bank’s bad debt? Is the situation manageable?,

STUDY OF CORRELATION BETWEEN AVERAGE INTEREST RATE AND NON-PERFORMING LOANS IN THE ROMANIAN BANKING SYSTEM DURING 2006- FEBRUARY 2010

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STUDY OF CORRELATION BETWEEN AVERAGE INTEREST RATE AND NON-PERFORMING LOANS IN THE ROMANIAN BANKING SYSTEM DURING 2006- FEBRUARY 2010

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