Determining Risk Factors that Diminish Asset Quality of Indian Commercial Banks

Abstract

Controlling higher level of non-performing loans (NPLs) has become one of the key objectives of the Reserve Bank of India (RBI), as it may impact banking and macroeconomic stability adversely. In this respect, the present study tries to determine risk factors that diminish asset quality of Indian commercial banks in and around the asset quality review period. Pooled and panel logit model has been employed to examine the determinants of NPLs. We find that banks with lower level of capital, reduced profitability, less diversified portfolio, poor operating and managerial efficiency are at greater risk of having diminished asset quality, whereas the size of the bank is positively linked with the higher level of NPAs. In general, empirical analysis proposes that to identify the bank whose asset quality is likely to deteriorate well in advance, the Regulatory and Supervisory Department of the Central Bank may consider lower level of capital, deteriorating profitability and poor operational efficiency as a leading indicator.