Impact of non-performing loans on smaller US bank profitability and value in the post-crisis period

Abstract

Credit quality is an important constituent of a bank’s asset portfolio. Asset quality and inadequate capital reserves were two significant triggers of the Global Financial Crisis (GFC) in 2009. Since then, there has been substantial regulatory and internal risk management changes within the US banking industry. There are no previous specific studies on smaller US banks. This study reviews the empirical literature on the topic of asset quality, bank profitability and market value along with statistics specific to the US banking industry. The impact on profitability is assessed through the return on equity ratio (ROE) and the impact on market value is assessed through the market to book ratio (MTBR). Along with the non-performing loan ratio (NPL), three other CAMEL ratios were also used as independent variables: capital adequacy (TRWCA), liquidity (LIQ) and management efficiency (MAN) to assess their impact on profitability and market value. Panel data has been collected for fifteen smaller US banks and the Generalised Method of Moments (GMM) of estimation is used robustly to estimate the effects of CAMEL ratios on bank profitability and market value. The link between NPL and other ratios on bank profitability and market value in smaller US banks has been assessed. The importance of the NPL ratio for bank profitability and market value is once again confirmed.