Does bank supervision impact nonperforming loans : cross-country determinants using agregate data ?

Abstract

The paper empirically analyses the cross-countries determinants of nonperforming loans and the potential impact of regulatory factors on credit risk exposure. We employ aggregate banking, financial, economic and legal environment data for a panel of 59 countries over the period 2002-2006. Empirical results indicate that higher capital adequacy ratio and prudent provisionning policy seem to reduce the level of problem loans. We also report a desirable impact of private ownership, foreign participation and bank concentration. Our findings do not support the view that market discipline leads to better economic outcomes and to reduce the level of problem loans. In contrast, all regulatory devices either exert a counterproductive impact on bad loans or do not significantly enhance credit risk exposure for countries with weak institutions, corrupt business environment and little democracy.Our results are interesting for regulators, bankers and investors as well. To reduce credit risk exposure, the effective way to do it is through enhancing the legal system, strengthening institutions and increasing transparency and democracy, rather than focusing only on regulatory and supervisory issues.Banks, Nonperforming loans, Financial system stability, Banking regulation