Low interest rates lead to more non-performing loans

The COVID-19 pandemic and the economic downturn have strengthened the long-term policy of low interest rates by central banks around the world. The aim of interest rates’ reduction was to boost lending and economies affected by the 2008 crisis. The short-time recovery that followed was interrupted by the closure due to the COVID-19 pandemic, so interest rates remained low to stimulate ailing economies. At first glance, the consequences for lending are clear – there is growth. But what is the quality of these loans?  Matej Maivald and Petr Teply, scientists working for the Faculty of Finance and Accounting at the University of Economics in Prague, are looking for answers.

Low interest rates are a prerequisite for increase in non-performing bank loans in terms of value, according to their research published in 2020. The authors analysed a unique sample of annual data on 823 banks from the eurozone, Denmark, Sweden, Switzerland and Japan for the 2011-2017 period, but their conclusions could be applied to other markets.

The hypothesis of Matej Maivald and Petr Teply stated that a low-interest rate environment would influence banks’ NPL ratio after 1 year. The data confirmed their hypothesis – after 1 year of low interest rates, the level of the NPL ratio increased. Their observations were based on detailed information given by banks. At macro level statistics showed an almost continuous decline in non-performing loans in Europe and in the Eurozone particularly since 2014, measured as portfolio share and absolute value. However, there was a decline in each NPL portfolio that banks sold to specialized companies. So the banking systems’ burden decreased, but a non-performing loan did not disappear once it was sold.

As the market conditions changed, it became a great challenge for banks to generate the same level of profits as in the previous years and they looked for riskier positions in lending, according to the study. Researchers also noted that the indicators for managing credit risk were no longer so reliable. 

Previous studies concluded that there was a direct link between rising interest rates and growth of non-performing loans in absolute terms. However, the period studied by Maivald and Teply was characterized by very low interest rates. At that time central banks were reducing their interest rates to stimulate the world economy that was in recession. The result was expected –  an increase in lending for businesses and individual customers.

In recent years, Bulgaria had very low interest rates on mortgage loans and consumer loans. At the same time the share of NPLs have still declined, albeit in absolute terms there has been growth. The reason – the total loan portfolio of banks is growing faster than the volume of overdue loans. But more and more problem loans are being sold to specialized debt management companies soon after the arrears. So, it reduces their share in bank portfolios.

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