The Impact of Non-Performing Loans on Commercial Bank Profitability: Evidence From the Western Balkans

Our results show that there is a clear negative relationship between return on assets and NPLs, suggesting that an increase in NPLs leads to lower bank profitability.The objective of this study is to investigate whether non-performing loans (NPLs) have an impact on the profitability of commercial banks in the Western Balkans Countries (WBC hereafter) namely Albania, Kosovo, Montenegro, Northern Macedonia and Serbia. Our sample includes all commercial banks in the WBCs for the period 2010-2020.We define return on assets (ROA) as a proxy for bank profitability, which is the dependent variable in this study. Our main explanatory variable is the ratio of NPLs to total loans (NPLs). In addition, we consider the following control variables: CAR (Capital to Risk-Weighted Assets); OCE (Operational Cost Efficiency); LIQ (liquidity).Our study suggests that financial institutions and policymakers in general should keep an eye on NPL holdings, as any additional inflow of "dubious" loans into the financial sector increases the likelihood of banks running into profitability problems. Several policy implications arise from the findings of this study, not only for practitioners and bank managers but also for regulators and policymakers. On the one hand, bank managers should thoroughly check customer data before granting credit in order to reduce information asymmetry and minimise potential NPL values. On the other hand, regulators need to closely monitor banks' capital adequacy and profitability ratios to mitigate a potential bank failure due to the accumulation of high NPL values.