DETERMINANTS OF NON-PERFORMING LOANS IN THE MALAWI BANKING SECTOR MASTER OF ARTS (ECONOMICS) THESIS SANGWANI M. PHIRI UNIVERSITY OF MALAWI CHANCELLOR COLLEGE FEBRUARY, 2019 DETERMINANTS OF NON-PERFORMING LOANS IN THE MALAWI BANKING SECTOR MASTER OF ARTS (ECONOMICS) THESIS By SANGWANI M. PHIRI B.Soc. Sc. (Economics) - University of Malawi Submitted to the Department of Economics, Faculty of Social Science, in partial fulfillment of the requirements for a Master of Arts Degree (Economics) UNIVERSITY OF MALAWI CHANCELLOR COLLEGE FEBRUARY, 2019 DECLARATION I, the undersigned hereby declare that this thesis is my own work which has not been submitted to any other institution for similar purposes. Where other people’s work has been used acknowledgements have been made. SANGWANI M. PHIRI _______________________________________ Full legal name ______________________________ Signature _______________________________ Date CERTIFICATE OF APPROVAL The undersigned certify that this thesis represents the student’s own work and effort and has been submitted with our approval. Signature: _____________________________Date: _________________ EXLEY SILUMBU, PhD (Senior Lecturer) First Supervisor Signature_____________________________ Date: ________________________ PATRICK KAMBEWA, PhD (Associate Professor) Second Supervisor DEDICATION I dedicate this work to Whom It May Concern. ACKNOWLEDGMENTS First and foremost, I thank God for giving me the courage, patience and wisdom with which I have completed this program. To my supervisors, Dr. Silumbu and Dr. Kambewa, I pay my deepest gratitude for the support, encouragement and comments in every step that led to the completion of this dissertation. Your time was not taken for granted. Lastly, I express my sincerest gratitude to my family. Without whom the prospects of pursuing a Master’s Degree would have been just a dream. ABSTRACT Default risk as evidenced by the level of Non-Performing loans (NPLs) in Malawi commercial banks has been increasing. NPLs which describe the Asset Quality of the banks is a measure of bank performance therefore it has an overall impact on the financial stability of the banks. NPLs result into funds being locked up in the unproductive sectors of the economy hence impeding economic growth and impairing economic efficiency. This study’s main objective was to determine the causes of NPLs in the commercial banks of Malawi. The study used panel data from seven banks from the year 2005 to 2014 in Malawi to analyze the bank-specific, industry-specific and macroeconomic determinants of NPLs using a Generalized Methods of Moments (GMM)/Dynamic Panel model. The model employed the Arellano-Bond (1991) one- step estimation technique which provides unbiased estimators when compared to a pooled regression model. The results obtained found that all bank-specific variables (bank size, loans to total assets ratio, ownership and growth rate of loans) were statistically significant. The variable bank and loans to assets ratio had positive significance. While ownership and growth rate of loans had negative impact. The industry-specific variable lending rate was found to have a negative impact. Among the only macro-economic variables (inflation, real exchange rate and growth rate of GDP), only the growth rate of GDP was found to be statistically significant. While inflation was found to be statistically significant only after taking its one period lag. vi TABLE OF CONTENTS ABSTRACT .................................................................................................................. vi TABLE OF CONTENTS ............................................................................................. vii LIST OF FIGURES ....................................................................................................... x LIST OF TABLES ........................................................................................................ xi CHAPTER ONE ............................................................................................................ 1 INTRODUCTION ......................................................................................................... 1 1.1 Background of the Study ...................................................................................... 1 1.1.1 Sectorial Distribution of Loans ..................................................................... 2 1.2 Statement of the Problem ..................................................................................... 4 1.3 Research Objectives ............................................................................................. 6 13.1 Main Objective ............................................................................................... 6 1.3.2 Specific Objectives ......................................................................................... 6 1.4 Hypotheses ........................................................................................................... 7 1.5 Significance of the Study ..................................................................................... 7 1.6 Organization of the Study .................................................................................... 8 CHAPTER TWO ........................................................................................................... 9 OVERVIEW OF THE MALAWIAN FINANCIAL SECTOR ..................................... 9 2.1 Introduction .......................................................................................................... 9 2.2 Structure of the Banking Sector ........................................................................... 9 2.3 Overall trend in NPLs and some stylized facts .................................................. 11 2.3.1 Ownership Structure of the banks ............................................................... 12 2.3.2 The Liquidity Crisis ..................................................................................... 12 2.3.3 Cashgate Scandal ........................................................................................ 13 vii 2.3.4 Trends in overall NPLs and Lending Rates ................................................. 13 2.3.5 Trends in NPLs for National Bank .............................................................. 14 2.3.3 Trends in NPLs for Standard Bank.............................................................. 15 2.3.4 Trends in NPLs for NBS Bank ..................................................................... 15 2.3.5 Trends in NPLs for First Merchant Bank (FMB) ........................................ 16 2.3.6 Trends in NPLs for INDEbank Limited ....................................................... 17 2.3.7 Trends in NPLs for NedBank (Malawi) Ltd................................................. 18 2.3.8 Trends in NPLs for Opportunity International Bank of Malawi (OIBM).... 19 2.4 Summary ............................................................................................................ 20 CHAPTER THREE ..................................................................................................... 21 LITERATURE REVIEW ............................................................................................ 21 3.1 Introduction ........................................................................................................ 21 3.2 Theoretical Review ............................................................................................ 21 3.2.1 Asymmetric Information Theory .................................................................. 21 3.2.2 Agency Theory ............................................................................................. 23 3.2.3 Skimping Hypothesis.................................................................................... 23 3.3 Empirical Literature Review .............................................................................. 24 3.4 Causes of Non-Performing Loans ...................................................................... 25 3.5 Summary ............................................................................................................ 27 CHAPTER FOUR ........................................................................................................ 29 METHODOLOGY ...................................................................................................... 29 4.1 Introduction ........................................................................................................ 29 4.2 Model Specification and Estimation Techniques ............................................... 29 4.3 Variable description and expected signs ............................................................ 30 4.4 Data sources ....................................................................................................... 35 viii CHAPTER FIVE ......................................................................................................... 36 EMPIRICAL RESULTS AND DISCUSSION ........................................................... 36 5.1 Introduction ........................................................................................................ 36 5.2 Descriptive Statistics .......................................................................................... 36 5.3 Diagnostic Tests ................................................................................................. 39 5.4 Regression Results ............................................................................................