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Impact of Nonperforming Loans on Profitability of Banks of Bangladesh

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Impact of Nonperforming Loans on Profitability of Banks of Bangladesh IMPACT OF NONPERFORMING LOANS ON PROFITABILITY OF BANKS OF BANGLADESH The Dissertation submitted to University of Dhaka For the Degree of Doctor of Philosophy In Finance By Muhammad Monirul Hoque Juwel, M.Phil.(DU) Under Supervision of Professor Dr. Jamal Uddin Ahmed Department of Finance University of Dhaka Dhaka, Bangladesh May, 2019 DEDICATION To My dearest respected persons whose sacrifices, affections and bent my life: Mrs. Mafia Khatoon & Mr. Md. Shamsul Hoque (Freedom Fighter) My Parents i DECLARATION I hereby declare that the research work entitled “Impact of Nonperforming Loans on Profitability of Banks of Bangladesh” has been carried out under the Department of Finance, Faculty of Business Studies, University of Dhaka in fulfillment of the requirement for the Degree of Doctor of Philosophy is solely my own work unless otherwise references or acknowledged from published literature. This has not been submitted in part of full to this University or to any other Institution for the award of any Degree or Fellowship. Dhaka Muhammad Monirul Hoque Juwel M.Phil.(DU) May 24, 2019 PhD Researcher Department of Finance University of Dhaka Dhaka, Bangladesh ii CERTIFICATE OF SUPERVISOR I have the pleasure to certify that the dissertation entitled “Impact of Nonperforming Loans on Profitability of Banks of Bangladesh” submitted by Muhammad Monirul Hoque Juwel is an original work carried out under my guidance and supervision. I assert that to the best of my knowledge, this research work has neither in part nor in full been submitted to any other university or institution for the award of any Degree or Fellowship. Furthermore, I acclaim that the submission of the dissertation is ascertained after a thorough review of the final draft. Dhaka Dr. Jamal Uddin Ahmed May 29, 2019 Supernumerary Professor Department of Finance University of Dhaka Dhaka, Bangladesh & Supervisor iii "In the name of ALLAH, The Beneficent and The Merciful" Praise be to Almighty ALLAH who stretches me an opportunity to complete this research. At the beginning, I am very much grateful and indebted to my distinguished supervisor Professor Dr. Jamal Uddin Ahmed, Department of Finance, University of Dhaka for his persistent encouragement, scholastic direction and creative suggestions to carry out the research without which this works would not have been come to light. I am extremely thankful to Professor Shibli Rubayat Ul Islam, Dean of Faculty of Business Studies for his advice and support while conducting the research. I am also prodigious thankful to Professor Shabbir Ahmad, Chairman, Department of Finance, University of Dhaka for their sincere cooperation and moral support. I would like to extend my sincere thanks to Prof. Dr. Mahmod Osman Imam, Prof. Dr. M. Sadiqul Islam, Prof. Dr. A. A. Mahboob Uddin Chowdhury and Prof. Dr. M. Masud Rahman, Department of Finance for their valuable advice during of the first and second seminars. Also, my thank goes to other faculties, the administrative officials and all other staffs in the Department of Finance for their kind support over the years. Finally, my sincere appreciation goes to Dr. Gazi Mohammad Hasan Jamil, Associate Professor of Finance Department for editing the final draft of this thesis. I would like to extend my gratitude and appreciation to the officials of BIBM and Bangladesh Bank for providing me with the necessary information and data. Last but certainly not least, I owe to the most special group of people in my life. My family act a pillar of support for me during this PhD process. My noble mother and father have always played the most special and important roles in my life journey. They are always encouraging me and constantly giving me the full support. I am eternally indebted to them. I must with gratitude give thanks to my wife, Mrs. Nargis Akter and my children Fatima Hoq Sumaiya and Abdullah Al Yasa Hoq for the endurance they went through during the five years of study and research. I also thank my only younger brother Abdullah Omar Hoq for his brotherly love and moral support. Above all, I remain absolutely grateful to Almighty Allah for his great love, protection, wisdom, mercies and guidance and also for making this study and my other areas of interest a huge success and continuing. He remains glorified in my life forever. I thank Almighty Allah for all mercies. iv ABSTRACT PhD Thesis Title: Impact of Nonperforming Loans on Profitability of Banks of Bangladesh Supervisor: Professor Dr. Jamal Uddin Ahmed Department: Finance Background: The reforming financial sector of Bangladesh is progressing towards a sustainable economy. However, some crucial factors such as nonperforming loan (NPL), high provision and extensive credit risk are encumbering the profit growth of commercial banks. These issues are not only alarming for Bangladeshi banker, but also for the global policy makers. Different measures are reinforcing the credit policy to fend the loan loss. This thesis focuses on the NPL status of Bangladesh and global perspectives, it also scrutinizes the sector-wise loan provisioning status in banking industry of Bangladesh. Purpose: To empirical investigate the impact of nonperforming loans and other determinants on profitability of banks in Bangladesh using multiple regression models. Methods: This study adopted an explanatory approach and causality research design by employing balance panel data to fulfill the above purposes. This thesis completed custom of data acquired from the financial statements and annual reports for a period of one decade (2008- 2017) of 20 commercial banks in Bangladesh. Statistical packages like STATA, EViews and Microsoft Excel were employed to investigate the data and to build interpretations. This study was to evaluate the effects of bank-specific factors; NPL, credit risk, loan growth, ADR, cost efficiency, bank size and economic & industry factors on profitability of banks in Bangladesh. The research employed descriptive statistics, correlation analysis and multiple regression estimation methods such as, Ordinary Least Squares (OLS), Fixed Effects (FE), Random Effects (RE) and General Methods of Moments (GMM). A retrospective exploratory case study approach was also used. Findings: The Research findings emphasized the need for improvements in commercial banks' management of NPL. Finally, the empirical results indicate that nonperforming loans are negatively associated with the level of profitability of banks of Bangladesh. Conclusion: The bank-specific factors determine nonperforming loans more than macroeconomic & industry factors in Bangladesh. It is recommended that macroeconomic policy should be directed at sustaining economic growth as it curbs nonperforming loans in the banking industry. Finally, this study explores the positive recovery trend of NPLs as a sign of improvement, mainly due to the prudent policies taken to strengthen the instruments of default loan recovery. Keywords: Commercial Banks, Nonperforming Loans, Credit Risk, Bank Profitability. v TABLE OF CONTENTS Contents Page No. DEDICATION i DECLARATION ii CERTIFICATE OF SUPERVISOR iii ACKNOWLEDGEMENT iv ABSTRACT v TABLE OF CONTENTS vi-x LIST OF TABLES xi-xii LIST OF FIGURES xiii LIST OF CASES xiii LIST OF ACRONYMS xiv-xv Chapter/ Section/ Sub-Section CHAPTER ONE INTRODUCTION 1-12 1. 1 Background of the Study 1 1. 2 Statement of the Problem 3 1. 3 Research Questions 4 1. 4 Objectives of the Study 5 1. 5 Hypothesis of the Study 5 1. 6 Motivation of the Study 6 1. 7 Contributions of the Study 7 1. 8 Structure of the Study 9 1. 9 Limitations of the Study 11 CHAPTER TWO LITERATURE REVIEW 13-38 2. 1 Banking System 13 2. 2 Bank Profitability 15 2. 3 Nonperforming Loans 16 vi 2. 4 Bank-Specific Determinants 18 2. 5 Macroeconomic Determinants 22 2. 6 Industry Determinants 23 2. 7 Bangladesh Context 24 2. 8 International Context 27 2. 9 Summary of Literature 33 CHAPTER THREE RESEARCH METHODOLOGY 39-51 3. 1 Research Design 39 3. 2 Population of the Study 40 3. 3 Sample Size of the Population 41 3. 4 Period of the Study 41 3. 5 Sources of Data 41 3. 6 Research Variables 42 3. 6. 1 Dependent variables 42 3. 6. 2 Independent variables 43 3. 6. 3 Macroeconomic variables 44 3. 6. 4 Industry specific variables 46 3. 7 Methods of Data Analysis 47 3. 8 Diagnosis Tests 48 3. 9 Econometric Specification 50 CHAPTER FOUR BANKING SYSTEM OF BANGLADESH 52-73 4. 1 Financial System of Bangladesh 52 4. 2 Development of Banking Sector in Bangladesh 53 4. 3 Banking Reforms in Bangladesh 54 4. 4 Structure of Banking Sector 56 vii 4. 5 Regulator of the Banking System 58 4. 6 Present Banking Scenario in Bangladesh 62 4. 7 Categorize of Commercial Banks 63 4. 8 The Overview of Banking Sector over the Period 2008-2017 66 4. 9 Recent Developments in Banking Sector of Bangladesh 69 CHAPTER FIVE THEORETICAL APPROACH 74-100 5. 1 Meaning of Nonperforming Loans 74 5. 2 Prudential Accounting & Loans Terms 76 5. 3 Loans Types 77 5. 4 Loan Classification 80 5. 5 Loan Provisioning 84 5. 6 Loan Rescheduling 86 5. 7 Policy on Single Borrower Exposure 88 5. 8 Policy for Loan Write-off 90 5. 9 Collateral for Awareness of NPL 93 CHAPTER SIX NONPERFORMING LOANS IN BANGLADESH: 101-1555 CAUSES, IMPACTS AND REMEDIES 6. 1 Overview 101 6. 2 Overall Nonperforming Loans Scenario of Bangladesh 102 6. 3 Objective-1: To access the present magnitude and trend of 104 nonperforming loans of banks of Bangladesh. 6. 4 Objective-2: To Determine the Causes, Impacts and Remedies of 115 Nonperforming Loans of Banks of Bangladesh 6. 4. 1 Academic aspect 115 6. 4. 2 Entrepreneurs related internal factors 117 viii 6. 4. 3 Business related internal factors 120 6. 4. 4 Lending related internal factors 121 6. 4. 5 External Factors 124 6. 5 Impacts of Nonperforming Loans 131 6.
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