YARDISTICK INTERNATIONAL COLLEGE

DEPARTMENT OF BUSINESS ADMINISTRATION

Determinants of Non-Performing Loans: Case of

Gov't and Private Commercial Banks of Ethiopia

A PROPOSALWILL BE SUBMITTED TO SCHOOL OF POSTGRADUATE IN PARTIAL

FULFILLMENT OF THEREQUIREMENTS FOR THE DEGREE OF MASTERS OF
SCIENCE (MSC) IN BUSINESS ADMINISTRATION

PREPARED BY: Serkalem Kidanemariam

ID/NO:MBAO/9794/14B
Main Advisor to :Melkamu(Ass. Professor)
Email;[email protected]

SEPTEMBER, 2023

ADDIS ABEBA, ETHIOPIA

Table of Contents

Table of Contents
A PROPOSAL WILL BESUBMITTED TO........................................................................................................................... 1
Table of Contents...................................................................................................................................................................... i
List of Figures.......................................................................................................................................................................... 2
List of Tables............................................................................................................................................................................ 3
Acronym................................................................................................................................................................................... 4
1. INTRODUCTION............................................................................................................................................................ 1
1.1 Background of the Study................................................................................................................................................ 1
1.2 Statement of the Problem............................................................................................................................................... 3
1.3 Objective of the Study.................................................................................................................................................... 6
1.4 Research Hypothesis...................................................................................................................................................... 6
1.5. Scope and Limitation of the Study........................................................................................................................... 7
1.6. Significance of the study.......................................................................................................................................... 8
1.7. Operational Definition............................................................................................................................................. 8
1.8. Ethical Issues............................................................................................................................................................ 9
1.9. Organization of the paper......................................................................................................................................... 9
2. REVIEWOF RELATED LITERATURE.......................................................................................................................... 10
2.1.TheoreticalLiterature.................................................................................................................................................... 10
2.3. Conceptual Frame Work............................................................................................................................................. 24
2.4. Summary and Knowledge Gap................................................................................................................................... 26
3. RESEARCH METHODOLOGY....................................................................................................................................... 28
3.1 Research Design and Approach................................................................................................................................... 28
3.2 Nature of Data and Instruments of Data collection...................................................................................................... 29
3.3 Sampling Design.......................................................................................................................................................... 29
3.4 Data Analysis and Presentation.................................................................................................................................... 31
3.5. Study Variables........................................................................................................................................................... 31
Lending Rate/Interest Rate................................................................................................................................................. 35
REFERENCES....................................................................................................................................................................... 40

I
List of Figures

Figure2.1ConceptualFrameworks..................................................................................................2

II
List of Tables

Table2.1. Banking sectors in Ethiopia.......................................................................................13

Table3.1. Expected sign of Variables...........................................................................................39

III
Acronym
BIB: Bunna Bank
ALR: Average lending Rate

ARDL: Autoregressive Distributed

ATM: Automated Teller Machine
BOA: Bank of Abyssinia
CAR: Capital Adequacy Ratio
CBE: Commercial Bank of Ethiopia

CEMAC: Central African Economic and

Monetary Community
CEEC: Central Eastern European
Countries
CESEE: Central, Eastern and southeastern European
CIT: Corporate Income Tax
CPI: Consumer Price Index
CSA: Center of Statistical Agency
ETR: Effective Tax Rate
GDP: Gross Domestic Product
GMM: Generalized Methods of Moments
IMF: International Monetary Fund
INFR: Inflation Rate
LTD: Loan to deposit
MENA:-Middle East and North
Africa NPL:-Nonperforming Loan
OLS: Ordinary Least square
ROA: Returns on Asset
ROE: Return on Equity
IV
SPSS:-Statistical Package for Social
Sciences US: United States
VIF:-Variance Inflation Factors

V
 1.INTRODUCTION
This chapter begins with discussing background of the study that gives some insight on the issues of
nonperforming loans (NPLs). After giving some insight on the issues of NPLs, statement of the problem
part that shows the direction of the study, justifies the reason to carry out this study. Following this, both
general and specific objectives of the study, the research hypothesis those tested against the econometric
results are presented. Lastly, the subsequent section presents significance of the study, scope and
limitation of the study, and organization of the paper, ethical issues and operational definitions
respectively.

1.1 Background of the Study

Banking sectors play a key role in the development of an economy. The development role undertaken by
banking sector determines the step for development of economy. Hence the stability of banking sector is
a key for the development of an economy. The primary function of bank is mobilizing deposits from
surplus units to deficit units in the form of loan and advances to various sectors such as agricultural,
industry, personal and governments. However, in recent times, the banks have become very cautious in
extending loans due to non-performing assets (Sontakke and Tiwari, 2013).

Therefore, commercial banks are one of the banking sectors which are the main source of funding to
business activities as well as other projects throughout the country. They play a key role in the economy
by mobilizing deposits from surplus units to deficit units in the form of loan and advances. As noted by
Daniel and Wandera (2013) they play a vital role to emerging economies where most borrowers have no
access to capital markets. Thus, they are considered as an intermediary between the depositors and
borrowers.

According to Rawlin et al.(2012), the principal aim of any business is to make profits. That is why any
asset created in conduction of business should generate income for the business. Since this issue is
applicable for the banking sector business, banks should give due consideration on the management of
loans because lending is the main business of commercial banks and loan is normally the main assets
and vital source of revenue for the commercial banks (Daniel and Wandera, 2013).

Therefore, banks do grant loans and advances to individuals, business organizations as well as
government in order to enable them operates on investment and development activities as a mean of
contributing toward the economic development of a country in general and aiding their growth in
1
 particular. Deposits in banks are offset by higher margins from creation of credits as loans. However, if
such assets do not generate any income, the banks` ability to repay the deposit amount on the due date
would be in question. Therefore, the banks with such asset would become weak and such weak banks
will lose the faith and confidence of the customers. Ultimately, unrecoverable amounts of loans are
written off as Nonperforming loan (Mallicket al.,2010) as cited in Rawlinet al.(2012).

As many literatures shows, there have been an increased number of significant bank problems both at
matured and emerging economies (Tendia et al. 2012). Banking sectors can perform worst as a result of
inefficient management, low capital adequacy and poor assets quality. Nonperforming assets is also the
single largest cause of irritation of the banking sectors (Sontakke and Tiwari, 2013).

Deterioration in asset quality is much more serious problem of bank unless the mechanism exists to
ensure the timely recognition of the problem. It is a common cause of bank failure. Poor asset quality
leads nonperforming loan that can seriously damage banks “financial position having an adverse effect
on banks operation (Lafuente, 2012).

A lot of studies were conducted on the difficulty of nonperforming loans for banking sectors. For
instance, the study of Calice (2012) for the Tunisian banking sectors found as banking sector suffer from
decline in asset quality. In addition, Blanco and Gimeno (2010) for South African banks and
Kolapo(2012) for the Nigerian banks, NPLs have an adverse effect on banking sectors survival. Thus,
since nonperforming loans had an adverse effect on the banking sectors‟ survival, the cause for NPLs
should be given due consideration. Its causes are different in different countries that might be due to
situational factors such as the level of economic condition in which the banking sectors are operating
and also bank level factors. Accordingly, this issue attracted the interest of different researchers in
different countries. That means a lot of studies are performed on the determinants of NPLs of financial
sectors worldwide. For instance:-

Saba et al.(2012) made study on the determinants of NPLs on US Banking sector and found as lending
rate had negative while inflation and Real GDP per capital had positive and significant effect on NPLs.
Besides, Louzis et al.(2010) examined the determinants of NPLs in the Greek financial sector using
dynamic panel data model and found as real GDP growth rate, ROA and ROE had negative whereas
lending, unemployment and inflation rate had positive significant while loan to deposit ratio and capital
adequacy ratio had insignificant effect on NPLs.

2
The study of Skarica (2013) on the determinants of NPLs in Central and Eastern European countries
through fixed effect model was also found as GDP growth rate, unemployment rate and inflation had
negative and significant impact on NPLs. Similarly, Carlos (2012) based on OLS model estimators found
as NPLs have negative association with GDP growth rate whereas a positive association with
unemployment rate. Besides, Moti et al. (2012), made study on the effectiveness of credit management
system on loan performance and found as credit quality, interest rates charged, credit risk control and
collection policies had an effect on loan performance in Kenya. Similar to the Western and other African
countries, in Ethiopia also Wondimagegnehu (2012) conducted a study on determinants of nonperforming
loans and found as poor credit assessment, failed loan monitoring, underdeveloped credit culture, lenient
credit terms and conditions, aggressive lending, compromised integrity, weak institutional capacity, unfair
competition among banks, and fund diversion for un expected purposes and overdue financing had an
effect on the occurrence of NPLs. Even though as to the knowledge of the researcher, there is only a
single study made by Wondimagegnehu(2012) in Ethiopia which is related with this title without
considering macro economic factors except for bank specific factors.

Thus, given the unique features of banking sector and environment in which they operate and also rapid
expansion of banking institutions in Ethiopia, there are strong wishes to conduct a separate study on the
determinants of NPLs of banking sector in Ethiopia. Besides, inconsistent results in different studies
among researchers are also another motive to conduct this study. To this end, the main objective of this
study is to examine the bank specific and macroeconomic.

Determinants of NPLs of commercial banks in Ethiopia, initiates the bank management and executives
with applied knowledge on the management of identified variables and provides them with
understanding of activities that will enhance their loan quality and play a vital role in filling gap in
understanding the determinants of NPLs.

1.2 Statement of the Problem

Issues of Nonperforming Loans (NPLs) gained increasing attentions in the past few decades. Poor loan
management will contribute to NPLs. It is critical issue for every bank to manage bad loans. Many
countries are suffering from Nonperforming Loans (NPLs) in which banks are unable to get profit out of
loans (Petersson and Wadman, 2004). If the loan is well managed; it will increase the bank’s
profitability and sustainability in the future. However, if failed to do so, it will be the major threat to
their survival (MacDonald, 2006).

3
NPLs affect the bank`s liquidity and profitability which are the main components for the overall
efficiency of the bank. An increase in NPLs provision diminishes income. Again, mismatch of maturities
between asset and liability create liquidity risk for the banks that deteriorate bank`s overall credit rating
including its image (Badar and Yasmin, 2013). Therefore, the determinants of NPLs should be given a
due consideration because of its adverse effect on survival of banks.

The adverse effect of NPLs is attributable to bank managers‟ adverse selection of its borrowers
(Brownbridge, 1998). NPLs are determined by different factors such as level of GDP, inflation,
unemployment, volume of deposit, return on equity, return on asset, capital adequacy, total loan, liquidity,
bank size, excessive lending, interest rate and credit growth. These factors are studied by different
researchers in different countries(Mileris (2012), Tomak (2013), Ahmad and Bashir (2013), Shingjerji
(2013) and etc.).

Though, there are a number of studies that are conducted at a global level to examine the determinants of
NPLs, most of the studies were made with reference to developed countries like Italy, Spain, Greece,
Europe and USA and the like. This means, they do not explain the issues for emerging market particularly
for Ethiopian case.

The operation of modern and organized financial institution is the most crucial part for any country to
ensure the economic growth and development. In case, financial sector of Ethiopian economy is dominated
by banking sectors. So, it is important to examine their asset quality. Further, by having a lot of literature
on the determinants of NPLs of banks across worldwide, it is important to examine in Ethiopia case. This
is due to the fact that, it is difficult to make generalization about the NPLs for the developing economy
based on the result of developed economy without making any research. Besides, since the majority of
bank assets are hold by loans, unless the determinants of NPLs are visualized to enhance the quality of
asset, it is hard for the survival the banking sectors.

Generally, the basic motive for this study is that, different studies were done in Western Europe and
EastAfrican countries (Saba et al. (2012), Louzis et al. (2010), Badar and Yasmin (2013) and Moti et al.
(2012). However, the results of those studies were inconsistent. This inconsistency of results might be
attributable to the method of data analysis used by different researchers and difference in the economic
condition of the countries in which banking sectors are operating. For instance;

The study of Saba et al. (2012) on the title of “Determinants of Nonperforming Loan on US Banking
sector ” found negative significant effect of lending rate and positive significant effect of real GDP per
4
 capital and inflation rate on NPL via OLS regression model. Similarly, the study of Louzis et al.
(2010)examined the determinants of NPLs in the Greek financial sector using dynamic panel data model
and found as real GDP growth rate, ROA and ROE had negative whereas lending, unemployment and
inflation rate had positive significant while loan to deposit ratio and capital adequacy ratio had
insignificant effect on NPLs. However, Swamy (2012) examined the determinants of NPLs in the Indian
banking sector using panel data and found as GDP growth rate, inflation, capital adequacy and bank
lending rate have insignificant effect on NPLs.

Shingjergji (2013) who conducted study on “the impact of bank specific factors on NPLs in Albanian
banks system” utilized OLS estimation model and found as ROE have significant negative on NPLs.
However, Ahmad and Bashir (2013) conducted a study on the “Bank Specific Determinants of
Nonperforming Loan” by static panel data model and found as ROE has insignificant negative association
with NPLs.

Makri et al.(2014) identify the factors affecting NPLs of Eurozone”s banking systems through difference
Generalized Method of the Moments (GMM) estimation. Accordingly, they found as ROA did not show
any significant impact on NPL ratio. However, Selma and Jouini (2013) conducted a study on Italy,
Greece and Spain for the period of 2004-2008 via panel data model and found a significant negative effect
of ROA on NPLs. similarly, Boudriga et al. (2009) conducted a study on the title “Problem loans in the
MENA countries via random-effects panel regression model and found as ROA has significant negative
effect on NPLs.

In addition to the above facts, there has not been much research which is conducted to date on the
determinants of NPLs in countries with emerging economy like Ethiopia except the study made by
Wondimagegnehu(2012).The study of Wondimagegnehu (2012) was assessed the bank specific factors
affecting NPLs via OLS estimation model by the help of SPSS software.

However, this study considers both macroeconomic factors such as inflation rate, tax rate and lending rate
and, bank specific factors like loan to deposit ratio, ROE, ROA and capital adequacy ratio as determinant
factors of NPLs. Besides, fixed effect model and version 12 State software was used in this study to
examine the determinants of NPLs of commercial bank in Ethiopia. Accordingly, banking industry in
Ethiopian has its own unique features that distinguish them from other countries financial market. One of
the feature is the regulation of the country is not allowed foreign nations or organization to fully or partially

5
acquire share of Ethiopian banks.

Besides, there is no secondary market. Moreover, in the country, a rapidly growing industry is the
banking sector. As a result, it is visible to conduct a study on the determinants of NPLs of
commercial banks in Ethiopia which is crucial. In light of the above facts and research gaps, the
purpose of this study is to examine the determinants of NPLs of commercial banks in Ethiopia. To
this end, this study tried to provide real information about the determinant factors affecting NPLs of
commercial banks and feasible recommendation for the impact of identified variables on the levels
of NPLs. Therefore, the researcher uses panel data for the period 2010 to 2022 that obtained from
BIB.

1.3 Objective of the

Study
1.3.1 General
objectives
The main objective of this study is to examine the determinants of nonperforming loan of
commercial banks in Ethiopian.
1.3.2.Specific objectives
1. To examine the bank specific determinants of nonperforming loans(NPLs) commercial
banks in Ethiopia.

2. To examine macroeconomic determinants of nonperforming loans (NPLs) of commercial

banks in Ethiopia.

3. To examine the trends of nonperforming loans (NPLs) of commercial banks in Ethiopia.

6
 1.4 Research Hypothesis

The purpose of this study is to examine the determinants of nonperforming loans (NPLs) of
commercial banks in Ethiopia. The empirical studies made around the world demonstrate various
outcomes on determinants of nonperforming loans of the financial sectors. From the review of
empirical literature, the researcher perceived as there is no consistency in the results for the
determinants of nonperforming loans. For instance, From Ethiopian context, Wondimagegnehu
(2012) on the title of “Determinants of Nonperforming Loans of Banking sector in Ethiopia” found as
interest rate has no impact on the levels of NPLs via OLS regression model. However, the study of
Saba et al. (2012) on the title of “Determinants of Nonperforming Loan on US Banking sector” found
negative significant effect of lending rate and positive significant effect

7
of real GDP per capital and inflation rate on NPL via OLS regression model. Similarly, the study of Louzis et
al.(2010) examined the determinants of NPLs in the Greek financial sector using dynamic panel data model and
found as real GDP growth rate, ROA and ROE had negative whereas lending, unemployment and inflation rate
had positive significant while loan to deposit ratio and capital adequacy ratio had insignificant effect on NPLs.
However, Swami (2012) examined the determinants of NPLs in the Indian banking sector using panel data and
found as GDP growth rate, inflation, capital adequacy and bank lending rate have insignificant effect on NPLs.
According to Shingjergji (2013) and Boudriga et al. (2009) ROA has significant negative effect on NPLs
whereas Makri et al.(2014) found as ROA did not show any significant impact on NPL ratio.

In this section the researcher developed testable hypotheses to examine the relationship between bank specific
and macroeconomic determinants nonperforming loans of commercial banks in Ethiopia. Thus, based on
reviewed related literatures, the researcher developed the following null hypotheses to estimate the sign
relationship of bank specific and macroeconomic determinants with nonperforming loans of commercial banks in
Ethiopia based on empirical evidence reviewed in the literature parts. Since, the null hypothesis is the statement
or the statistical hypothesis that is actually being tested (Brooks, 2008 p.52), the following hypotheses are null
hypotheses. Accordingly, the following hypotheses are going to be tested.

H1.Loan to deposit ratio (LTD) has positive relation with Nonperforming loans of the banks.

H2.Returnon asset (ROA) has negative relation with Nonperforming loans (NPLs) of the banks.

H3.Return on equity (ROE)has negative relation with Nonperforming loans of commercial Banks in Ethiopia.

H4. Capital adequacy ratio (CAR) has negative relation with Nonperforming loans (NPLs) of

banks.H5. Inflation rate (INF) has negative relation with Nonperforming loans (NPLs) of banks.

H6.Lendingrate (LR) has positive relation with Nonperforming loans (NPLs) of banks.

H7.Effectivetax rate (ETR) has positive relation with Nonperforming loans(NPLs) of banks.

1.5. Scope and Limitation of the Study

This thesis is adjusted to fit its objectives of examining the determinants of NPLs of commercial banks
in Ethiopia within the limits of specified time and possibility. The researcher is decided to limit this
study to the commercial banks found in Ethiopia namely commercial bank of Ethiopia, Construction and

8
business bank, Awash international bank, bank of Abyssinia, Wegagen bank, Buna International bank,
Nib International bank and Dashen bank that were registered by NBE before 2010/11. These banks were
selected since they are senior banks and are expected to have more experience on the lending activities.
Besides, this study considers bank profitability (ROA, and ROE), loan to deposit ratio, and capital
adequacy ratio, lending rate, inflation rate, and effective tax rate for the decision and analysis of data. To
this end, this study covers a panel data of the bank over the period 2010 to 2022. Thus, this study is
limited to both bank specific and macroeconomic determinants of NPLs of Commercial banks in
Ethiopia between the above mentioned periods.

1.6. Significance of the study

The finding of this study which details with the determinants of nonperforming loan of commercial
banks in Ethiopia is beneficial for different stakeholders such as Banking sectors(commercial Banks,
National bank of Ethiopia and Buna International bank), researcher and for other researchers as follows.

For National bank of Ethiopia, since such investigation has policy implication, the finding of this study
might be used as a directive input in developing regulatory standards regarding the lending policies of
commercial banks of Ethiopia. In addition, this study will initiate the commercial Bank management to
give due emphasis on the management of these identified variables and provides them with
understanding of activities that will enhance their loan performance. This is due to the fact that knowing
the variables that determine the nonperforming loan will help the bank managers to concentrate on the
quality of loan rather than its quantity. Thus, this study will make the management body to visualize the
determinants of NPLs.

Furthermore, the finding of this study will initiate the researcher for further studies. Last but not least,
this study serves as a reference for other researchers in related area. Thus, it can minimize the literature
gap in the area of study particularly in Ethiopia.

1.7. Operational Definition

Loan and advances:- any financial asset granted by banks to borrower on a contract of an obligation to
repay the principal amount with usually its interest either on due date or demand Nonperforming loans a
loan whose credit quality has deteriorated and the full collection of principal and/or interest as per the

9
contractual repayment terms of the loan/advances is in question and delayed for more than 90 days
(NBE, 2008).

Credit risk–the risk arise as result when the borrower fail to conclude its financial contract according to
the agreement with lender. It is an asset default by counter party.
Borrower:-the one who borrows money from the lender (Bank).

Lending:-provision of loan by one party(lender)to another party(Borrower)

Bank specific factors: - are variables that are under the control of bank management. They can be
directly/indirectly stated in the financial statements of the bank.

Macroeconomic factors: - are variables in which the bank management has no power to control them.
Rather, these variables are related with the fiscal and monetary policies of the country.

1.8. Ethical Issues

Almost all the financial institutions have strict policy implications on the confidentiality of their data.
They can pay the ultimate price for the breach of this duty of confidentiality. Disclosing of information
by employees to a third party can expose the institutions to potential legal conflict. Due to this ethical
issue, they will be fearful in disclosure of such information. However, this fear is addressed by
explaining the core of the study to the information providing agents with the assurance that the data
will be handled professionally through formal letter. Therefore, before data collection, permission will
be obtained from the management body of the selected Bunna International Bank through formal letter.
The formal letter will be taken from Yardstick International College specifically from the research and
graduate studies office of business and economics collage and then will be given to the bank
management and all other concerned office to undertake the tasks freely and confidentially.
1.9. Organization of the paper
The thesis is going to be organized into five chapters. The first chapter will start with presenting
background of the study, statement of the problem, objective of the study, significance of the study,
scope and limitation of the study. The second chapter will focus on both theoretical and empirical
review of related literature. The third chapter will deal with the research methodology. Chapter four
will deal with the data analysis and presentation and the fifth chapter will contain the conclusion and
recommendation of the study including the direction for further study.

10
 2. REVIEW OF RELATED LITERATURE
This section starts with presenting the overview of banking system in Ethiopia. Besides, bank loans
including it determinant factors we represented. Furthermore, concepts relating to nonperforming loans
are discussed. Following this, empirical studies (cross countries and single country) are reviewed by
focusing on determinants of NPLs are presented. Then after, the knowledge gaps from the reviewed
literatures are outlined.
2.1. Theoretical Literature
This part of literatures has three sections. The first section discusses overview of banking system in
Ethiopia. The second section presents bank lending by focusing onits definition, source and factors. Lastly,
the issue of nonperforming loan is overviewed.
2.1.1 Overview of Banking System in Ethiopia Bank
Abyssinia was the first bank established in Ethiopia based on the agreement between Ethiopian
government and National bank of Egypt in 1905 with a capital of 1 million shillings. However, bank of
Abyssinia was closed at in 1932 by Ethiopian government under Emperor Haile Selassie and replaced
by Bank of Ethiopia with a capital of pound sterling 750,000.
Following the Italian occupation between1936-1941, the operation of bank of Ethiopia ceased whereas
the departure of Italian and restoration of Emperor Haile Selassie’s government established the
statebankofEthiopiain1943. However, State bank of Ethiopia was separated into National bank of
Ethiopia and commercial bank of Ethiopia S.C. to separate the responsibility of national bank from
commercial banks in 1963. Then, on December 16, 1963 as per proclamation No.207/1955 of
October1963 commercial bank of Ethiopia control all commercial banking activities (Fasil and
Merhatbeb, 2009). Following the declaration of socialism in 1974, the government extends the extent
of its control over the whole economy and nationalized a large corporations. Accordingly, Addis bank
and commercial bank of Ethiopia share company were merged by proclamation No.84 0f August 2,
1980 to form single commercial bank in the country until the establishment of private commercial
banks in1994.To this end, financial sector were left with three major banks namely; National bank of
Ethiopia, commercial bank of Ethiopia and Agricultural and development bank during the socialist
government. However, following the departure of Dengue regime, Monetary and Banking
proclamation of 1994 established the National bank of Ethiopia is a legal entity. Following this,
Monetary and Banking
11
proclamation No.84/1994 and the Licensing and supervision of banking business proclamation No.
84/1994 laid down the legal basis for investment in banking sectors (Habtamu, 2012). Currently,
banking sectors in Ethiopia are showing progressive developments in terms of number of branches,
total assets, human resource utilization and the like relative to other African developing countries.
This indicates as Ethiopia categorized under banked country with limited outreach (Tseganesh,
2012).Thus, currently number of banking sectors in Ethiopia were reached thirty one as shown it the
following tables.

No Name of Banks Year of Establishment

1 Awash International Bank 1994E.C
2 Commercial Bank of Ethiopia 1963 E.C.
3 Development Bank of Ethiopia 1901 E.C.
4 Construction and Business Bank 1975 E.C.
5 Dashen Bank 1995 E.C.
6 Wegagen Bank 1997 E.C.
7 Bank of Abyssinia 1996 E.C.
8 United Bank 1998E.C
9 Nib International bank 1999 E.C.
10 Cooperative Bank of Oromia 2004G.C.
11 Lion International Bank 2006G.C.
12 Zemen Bank 2008G.C
13 Oromia International Bank 2008G.C.
14 Buna International Bank 2009G.C.
15 Berhan International Bank 2009G.C
16 Abay Bank S.C 2010G.C
17 Addis International Bank S.C 2011G.C
18 Debub Global Bank S.C 2012G.C
19 Enat bank 2012G.c
20 Shabela Bank 2021G.c
21 Mudaye Bank
22 Fajr (Interest free banking )

23 ZamZam Bank 2021G.c

24 Tsedey Bank 2022G.c
25 Siinqee Bank 2021G.c
26 Hijra Bank 2021G.c
27 Tsehay Bank 2022G.c
28 Ahadu Bank 2022G.c
29 Amhara Bank 2021G.c
30 Gadaa Bank 2021G.c
31 Goh Betoch Bank SC 2021G.c

Source: www.nbe.et

2.1.2 Definition and Concepts

2.1.2.1. Overview of Bank Loans and Lending
Commercial bank is a depository institution that is relatively unrestricted instability to make
commercial loan and that is largely permitted to issue checking accounts. Commercial banks are the
most important of all depository institution (Leroy and Vanhoos, 2006). They create money by through
12
lending and purchasing securities (Thomas, 2006). Commercial banks extend credit to different types
of borrowers form any different purposes.
One of the major functions of any commercial bank is providing loan to the business society. Banks
collect money from those who have excess money and lend it to others who need money for different
purpose. Therefore, banks‟ intermediary function plays a vital role in the economic activity. Banks
accept customer deposits and use those funds to give loans to other customers or invest in other assets
that will yield a return higher than the amount bank pays the depositor (McCarthy et al., 2010) cited in
Zewdu (2010). It follows that customers‟ deposit is the primary source of bank loan and hence,
increasing or guaranteeing deposits directly has a positive effect on lending. Therefore, bank credit is
the primary source of available debt financing for most customers whereas good loans are the most
profitable assets for banks. The principal profit making activity of commercial banks are making loans
to its customers. In the allocation of funds to earn the loan portfolio, the primary objective of bank
management is to earn income while serving the credit needs of its community (Reed and Gill,
1989)cited in Zewdu (2010).Therefore, like all debt instruments, a loan entails the redistribution of
financial assets over time, between the lender and the borrower. The borrower initially receives an
amount of money from the lender to pays back, but sometimes not always in regular installments, to
the lender. This service is generally provided at a cost ,known as interest on the debt. As one of the
principal duties of financial institutions is to provide loans, it is typically the main source of income to
banks. Besides, bank loans and credit also constitute one of the ways of increasing money supply in the
economy(Felix and Claudine, 2008).
Loans are the largest single source of income for banks. Bank loan involves personal relationships
between the bankers and borrowers. It has a highest degree of default risk than other bank assets.
Loans yield the higher rate of return among bank assets in compensation for lower liquidity and higher
risk (Thomas, 2006). A loan composition greatly varies among banks based on their size, location,
trade area and lending experts (MacDonald, 2006).
According to Zewdu (2010), lending is the provision of resources (granting loan) by one party to
another. The second party doesn’t reimburse the first party immediately there by generating a debt, and
instead arranges either to repay or return those resources at a later date. Banks function as financial
intermediaries, collecting funds from savers in the form of deposit and then supplying to borrowers as
loans. Those functions benefit both the banks and the borrowers. Lending represents the heart of the
industry and Loans are the dominant asset and represent 50-75 percent to total amount at most banks,
generate the largest share of operating income and represents the bank`s greatest risk

13
exposure(MacDonald, 2006).
2.1.2.2 Factors Affecting Bank Loan
According to Zewdu (2010), the sources of fund for lending are reserve, deposits and capital. All the
resources may be affected by different factors and would have a direct influence on lending. Since
lending is the principal function of banking industry, the management of banks should give due
attention, analyze and take the necessary measures on time on internal and external factors that affect
or limit lending. Without lending, banks‟ incomes especially interest income would highly deteriorate
and affect bank survival. Incase, since nonperforming loans (NPLs) has a direct reflection of poor asset
quality, the factors that influence banks loans have their own impact on NPLs (Rawlin et al. 2012).
According to Reed and Gill (1989) cited in Zewdu (2010) therefore, the factors that influence bank
loans, that might have their own impact on NPLs are:
Capital position: The capital of banks serves as a custom for protection of depositors ‟ funds.
The size of capital in relation to deposits influences the amount of risk that a bank can afford.

Relatively large capital structure can make loans of longer maturities and greater credit risk.
Profitability: Some banks may emphasize earning more than others. Banks with greater need of
earning might adapt more aggressive lending policies. An aggressive policy might call consumer loans,
which normally remade at higher rates of interest than short-term loans.
Stability of deposits:- The fluctuation and type of deposit must be considered. After adequate
provisions have been made for reserves, bank can then engage in lending. Even though, these reserves
designed to take care of predictable deposit fluctuations and loan demands since unpredictable demand
force banks to give consideration to the stability of deposits in formulating loan policy.
Economic conditions: - Stable economy is more conducive to a liberal loan policy than the one that is
subject to seasonal and cyclical movements. Deposit of famine economies fluctuate more violently
than deposit in an economy noted for its stability. Consideration must be given to the national
economy. Factors adversely affect the nation as a whole may, if they are of serious magnitude,
eventually affect local conditions.
Influence of monetary and fiscal policies:- If monetary and fiscal policies are expansive and
additional, reserves are made available to the commercial banking system; the lending ability of banks
is increased. Under these policies banks can have a more liberal loan policy.
Ability and experience of bank personnel:-The expertise of lending personnel is not insignificant in
the establishment of bank loan policy. One of the probable reasons that banks were slow in entering the
consumer lending field was the lack of skilled personnel.

14
Credit need soft hea reaserved:- banks specialized experience on different type of loans
e.g .Mortgage real-estate. The major reasons banks are chartered is to serve the credit needs of their
communities. Banks are morally bound to extend credit to borrowers who present logical and
economically sound loan requests.
According to Black and Daniel (1989) cited in Zewdu (2010) there are also other factors that
affect bank lending and investing activities. These factors include:
The interest rate : represents rate of return available from the various alternative lending and
investing activities. Fundamental problem of bank management is achieving the proper balance
between return and risk.
The liquidity of fund :- it is the amount of liquid funds tied up in varies lending and investing
activities. To maintain adequate liquidity, bank must constantly guard against excessive losses from
lending and investing activities. If bank made too many bad loans, the value of its asset could fall
below the amount of its liabilities.

Tax: corporate income tax rate affect the bank loans in different aspects: one is that high tax burden
enable the banks to shift the tax burden either by increasing lending rate and fees or paying low interest
rate on deposits. The second aspect is that, corporate income tax rate has output and input substitution
effect. The output substitution effect states that increased CIT rate represents a decrease in production
in the incorporated sectors. In this case, the demand for loan gets lower whereas input substitution
effect represents the substitution of equity with other inputs for instance; debt (Albertazzi and
Gambacorta, 2006) . Taxation in banking sectors represents the ability of banks to allocate its
portfolios reduces its taxes. Bank is capable of transferring the tax costs to its customers by raising fees
and interest spreads. The shifting of tax burden to customers through higher lending rate on loan and
lowering interest rate on the deposit has a direct impact on the level of NPLs (Khan et
al.2011).Besides, corporate entities shift their tax burden to other tax payers due to the existence of
double taxation(Kaplow, 2008).
2.1.2.3Nonperforming Loans(NPLs)
There is no common definition of nonperforming loans (NPLs) in the whole country since it is
recognized that it is possible that what is appropriate in one country may not be so in another. There is,
however, some common opinion on this issue. Accordingly the IMF‟s Compilation Guide on Financial
Soundness Indicators, NPLs is defined as:
" A loan is nonperforming when payments of interest and/or principal are
past Due by 90 days or more, or interest payments equal to 90 days or more

15
 have Been capitalized, refinanced, or delayed by agreement, or payments are
less than 90 days over due, but there are other good reasons has a debtor
Filing for bankruptcy to doubt that payments will be made in full" (IMF,2005).

Besides, the Ethiopian banking regulation also defines NPLs follows:

“Nonperforming loan and advances area loan whose credit quality has
Deteriorated and the full collection of principal and/or interest as per the
contractual repayment terms of the loan and advances are in
Question”(NBE, 2008).

Generally, NPLs are loans that are outstanding both in its principal and interest for along period of time
contrary to the terms and conditions under the loan contract. Any loan facility that is not up to date in
terms of payment of principal and interest contrary to the terms of the loan agreement is NPLs. Thus,
the amount of nonperforming loan measures the quality of bank assets (Tseganesh, 2012).
2.1.2.3.1FiveCs of Nonperforming/Bad loans
As noted by MacDonald (2006), there are five Cs of bad credits that represent the issues used to guard
against/prevent bad loans). These are:
Complacency: refers the tendency to assume that because of the things were good in the past, they
will be good in the future. For instance, Assuming the past loan repayment success since things have
always worked out in the past.
Carelessness: indicates the poor underwriting typically evidenced by inadequate loan documentation,
lack of current financial information or other pertinent information in the credit files, and lack of
protective covenants in the loan agreement. each of these makes it difficult to monitor a borrower`s
progress and identify problems before they are unmanageable.
Communication ineffectiveness: inability to clearly communicate the bank`s objectives and policies.
This is when loan problem can arise. Therefore, the bank management must clearly and effectively
communicate and enforce the loan policies and loan officers should make the management aware of
specific problems with existing loans as soon as they appear.

Contingencies: refers the lenders` tendency to play down/ignore circumstances in which a loan might
in default. It focuses on trying to make a deal work rather than identifying downside risk.
Competition: involves following the competitors` action rather than monitoring the bank`s own credit
standards.
Banks, however, still have required expertise, experiences, and customer focus to make them the
16
preferred lender for many types of loan. Lending is not just a matter of making loan and waiting for
repayment. Loan must be monitored and closely supervised to prevent loan losses (MacDonald, 2006).
2.2 Empirical Literature
This portion provides so many evidences which identify them a mjor determinant of bank loans,
particularly, nonperforming loans. In case, some studies are conducted on particular country and the
others on panel of countries. Hence many researchers have conducted a lot of study on determinants
nonperforming loans (NPLs), due to its significance for the bank’s failure. In case, the researcher starts
reviewing empirical related literatures from the study made across country and then single country
studies.

There are a plenty of variables that affect the NPLs of banking sectors. In this study, the researcher
focused on both bank specific and macroeconomic determinants of NPLs of Buna International bank in
Ethiopia. Internal factors are caused by internal functions and activities of bank, and are due to
decisions and practices of officials and staffs functions. These factors are controllable in which the
manager can prevents them through using suitable method, determination and elimination of weakness
and improvement of process. Whereas, external factors can`t be controlled by bank managers and are
caused by external environment including effect on implementation of decisions and also government
policies. For instance; unexpected events, changing in rules and obligations, political and economic
changes(inflation and slump)are external factors(Biabaniet al., 2012).
However, a variety of variables that got more attention and included in this thesis are loan to deposit
ratio, capital adequacy/solvency ratio, profitability(ROA & ROE), lending rate and effective tax rate.
2.2.1. Across Countries Studies
Boudriga et al.(2009) conducted a study on the title “bank specific determinants and the role of the
business and the institutional environment on Problem loans in the MENA countries” for 2002-
2006 periods. They employed random-effects panel regression model for 46 countries. The variables
included were credit growth rate, Capital adequacy ratio, real GDP growth rate, ROA, the loan loss
reserve to total loan ratio, diversification, private monitoring and independence of supervision
authority on nonperforming loans. The finding revealed that credit growth rate is negatively related to
problem loans. Capital adequacy ratio is positively significant justifying that highly capitalized banks
are not under regulatory pressures to reduce their credit risk and take more risks. Also ROA has
negative and statistically significant effecton NPLs. This result supports as greater performance
measured interms of ROA reduces nonperforming loans since reduced risk taking in banks exhibiting
high levels of performance.

17
Skarica (2013) also conducted a study on the determinants of NPLs in Central and Eastern European
countries. In the study, Fixed Effect Model and seven Central and Eastern European countries for2007-
2012 periods was used. The study utilized loan growth, real GDP growth rate, market interest rate,
Unemployment and inflation rate as determinants of NPLs. The finding reveals as GDP growth rate
and unemployment rate has statistically significant negative association with NPLs with justification of
rising recession and falling during expansions and growth has an impact on the levels of NPLs. This
shows as economic developments have a strong impact on the financial stability. The finding also
reveals as inflation has positive impact with justification as inflation might affect borrowers’ debt
servicing capacities.
Makri et al.(2014) identify the factors affecting NPLs of Euro zone‟s banking systems for 2000-
2008periods before the beginning of the recession exclusively pre-crisis period. The study includes
14countries as a sample out of 17 total Euro zone countries. The variables included were growth rate of
GDP, budget deficit (FISCAL), public debt, unemployment, loans to deposits ratio, return on assets,
and return on equity and capital adequacy ratio. The study utilized difference Generalized Method of
the Moments (GMM) estimation and found as real GDP growth rate, ROA and ROE had negative
where as lending, unemployment and inflation rate had positive significant effect on NPLs.

However, ROA& loan to deposit ratio, inflation, and budget deficit did not show any significant impact
on NPL ratio. Similarly, Carlos (2012) on macroeconomic determinants of the Non-Performing Loans
in Spain and Italy found as inflation rate has insignificant effect on NPLs. Selma and Jouini(2013)
conducted a study on three countries namely Italy, Greece and Spain for the period of2004-2008 to
identify the determinants of non-performing loans for a sample of 85 banks. The variables included
both macroeconomic variables (GDP growth rate, unemployment rate and real interest rate) and bank
specific variables (return on assets, loan growth and the loan loss reserves to total loans). They apply
Fixed Effect model and found a significant negative relationship of ROA &GDP growth rate, and also
positive relationships of unemployment rate, the loan loss reserves to total loans and the real interest
rate with NPLs. For a significant positive association between NPLs and real interest rate, they justify
that when a rise in real interest rates can immediately leads to an increase in non-performing loans
especially for loans with floating rate since it decrease the ability of borrowers to meet their debt
obligations. In addition, a significant negative relationship between ROA and the amount of NPLs
justify that a bank with strong profitability has less incentive to generate income and less forced to

18
engage in risky activities such as granting risky loans.
Klein(2013) investigates the determinants and macroeconomic performance of NPLs in Central,
Eastern, and South Eastern Europe (CESEE) for 1998 to 2011 period data for ten banks of each
16countries. The study includes loan growth rate, inflation, unemployment rate and GDP growth rate
as explanatory variables of the study. The study was used fixed effect/ dynamic model and found as
inflation has positive whereas loan growth rate, GDP growth rate have negative significant effect on
the occurrences of NPLs. However, the study found as unemployment rate has no significant effect on
NPLs.

Djiogap and Ngomsi (2012) were investigates the determinants of bank long-term loan in the Central
African Economic and Monetary Community (CEMAC). They used the panel data of 35 commercial
banks from six African countries over the period 2001-2010. They used fixed effect model to examine
impact of bank size, GDP growth and capital adequacy ratio on NPLs. The study found negative
significant impact of CAR on the level of NPLs. Their finding justifies as more diversified banks and
well capitalized banks are better able to withstand potential credit. However, inflation variable is
statistically insignificant in explaining the total business loans ratios of banks.
2.2.2. Single Country Studies

One of the studies in this regard is that of Sakiru et al.(2011) on macroeconomic determinants of
nonperforming loan on banking system in Malaysia. Their study was covered bank`s data for monthly
time series of 2007:1 to 2009: 12 period. In the study, lending rate, producer price and industrial
production index were used as macroeconomic variables that affect the NPLs. The study utilized
ARDL approach and the finding reveals that lending rate has a significant positive effect on NPLs and
justifies that, during the period of high lending rate, NPLs is anticipated to increase causing arise in the
rate of default by borrowers.
Hyun and Zhang(2012) investigated the impact of macroeconomic and bank-specific factors of
nonperforming loans in US for two distinct sub-sample periods that is from 2002-2006 (pre financial
crisis) and 2007-2010(during financial crisis). The variables included both macroeconomic factors
namely GDP growth rate, unemployment rate and lending rate, and bank specific variables such as
Return on Equity (ROE),solvency ratio, inefficiency, bank size and non-interest income. In pre
financial crisis period, the study found as solvency ratio, ROE, lending rate, GDP growth rate and
unemployment rate negatively affect NPLs. Negative effect of lending rate on NPLs implies that an
increase in lending rate curtail peoples‟ /business entity’s ability to borrow, which decreases the
amount of loan and then reduce NPLs. Beside, statistically significant and negative solvency ratio
19
effect on NPLs, implies that the higher the Solvency ratio, the lower the incentives to take riskier loan
policies, and consequently, reduce the amount of problem loans. However, bank size has no effect.
During financial crisis also solvency ratio, GDP growth rate, unemployment rate and ROE all have a
negative impact on NPLs while lending rate has no significant effect on NPLs . Size allows for more
diversification opportunities as larger banks can compose less concentrated portfolios that include
borrowers from different industries, geographical Locations, capital size and other customer segments.
Tomak (2013) conducted study on the “Determinants of Bank’s Lending Behavior of commercial
banks in Turkish” for a sample of eighteen from 25 banks. The main objective of the study was to
identify the determinants of bank`s lending behavior. The data was covered2003 to 2012 periods. The
variables used were size, access to long term funds, interest rates, GDP growth rate and inflation rate.
The finding reveals that bank size, access to long term loan and inflation rate have significant positive
impact on the bank`s lending behavior but, interest rates and GDP are insignificant.

Besides, Ahmed and Bashir(2013) conducted a study on the“ Macroeconomic Determinants of

Nonperforming Loan of Banking Sectors in Pakistan”: The study was conducted on 30 commercial
banks from total of 34 banks in 1990-2011periods.The main aim of the study was to investigate impact
of inflation, credit growth, GDP growth rate, Unemployment rate, consumer price index and
lending/interest rate, on nonperforming loan. They found negative effect of lending rate and GDP
growth rate on NPLs. Their justification for negative association between lending rate and NPLs
implies that as lending rate increase, individuals with funds starts saving with the banks to earn on their
funds but investors with the profitable projects feel reluctant to borrow and invest. Besides, existing
borrowers pay back their loans to keep their credit rating good as to get loans in the future at discount
rates. Similarly, on their study of banks specific factor of NPLs of banking sectors in Pakistan from
2006-2011 in 2013, they found positive significant effect of ROA but insignificant effect of ROE on
NPLs. Their justification for positive significant association between ROA and NPLs implies that in
order to increase the short term earnings, banks management portray wrong picture to the investors
relating the future profitability and positive return prospects. Consequently, investors start borrowing
from the banks and invest in the less profitable projects. This results in the current good performance
and profitability of the banks but because of the wrong forecasting, returns on the investments are not
according to the investors’ expectation, resulting in the inability of the investors in repayment of loans
thus leading to the growth in NPLs.
The study of Saba et al.(2012) on the title of “Determinants of Nonperforming Loan on US banking

20
sector” also investigate the bank specific and macroeconomic variables of nonperforming loans from
1985 to 2010 period using OLS regression model.

21
Louzis et al. (2010) conduct study to examine the determinants of NPLs in the Greek financial sector
using fixed effect model from 2003-2009 periods. The variables included were ROA, ROE, solvency
ratio, loan to deposit ratio, inefficiency, credit growth, lending rate and size, GDP growth rate,
unemployment rate and lending rates. The finding reveals that loan to deposit ratio, solvency ratio and
credit growth has no significant effect on NPLs. However, ROA and ROE has negative significant
effect whereas inflation and lending rate has positive significant effect on NPLs. It justifies that
performance and inefficiency measures may serve as proxies of management quality.
Ali and Iva (2013) who conducted study on “the impact of bank specific factors on NPLs in Albanian
banking system” considered Interest rate in total loan, credit growth, inflation rate, real exchange rate
and GDP growth rate as determinant factors. They utilized OLS regression model for panel data
from2002 to 2012 period. The finding reveals a positive association of loan growth and real exchange
rate, and negative association of GDP growth rate with NPLs. However, the association between
interest rate and NPLs negative but week. And also inflation rate has insignificant effect on NPLs.
Similarly, Shingjergji (2013) conducted study on the “impact of bank specific factors on NPLs in
Albanian banking system”. In the study, capital adequacy ratio, loan to asset ratio, net interest margin,
and return on equity were considered as a determinant factors of NPLs. The study utilized simple
regression model for the panel data from 2002 to 2012 period and found as capital adequacy ratio has
negative but insignificant whereas ROE and loan to asset ratio has negative significant effect on NPLs.
Besides, total loan and net interest margin has positive significant relation with NPLs. The study
justifies that an increase of the CAR will cause a reduction of the NPLs ratio. Besides, an increase of
ROE will determine a reduction of NPLs ratio. Besides, Mileris (2012) on the title of “macroeconomic
determinants of loan portfolio credit risk in banks” was used multiple and polynomial regression model
with cluster analysis, logistic regression, and factor analysis for the prediction. The finding indicates
that NPLs are highly dependent of macroeconomic factors.
However, Swamy(2012)conduct study to examine the macroeconomic and indigenous determinants of
NPLs in the Indian banking sector using panel data a period from 1997 to 2009. The variables included
were GDP growth, inflation rate, per capital income, saving growth rate, bank size, loan to deposit ratio,
bank lending rate, operating expense to total assets, ratio of priority sector`s loan to total loan and ROA.
The study found that real GDP growth rate, inflation, capital adequacy, bank lending rate and saving
growth rate had insignificant effect; whereas loan to deposit ratio and ROA has strong positive effect but
bank size has strong negative effect on the level of NPLs.
22
Similarly, Farhan et al.(2012) on the title of “Economic Determinants of Non-Performing Loans:
Perception of Pakistani Bankers” utilized both primary and secondary data in 2006 years. The data was
collected from 201 bankers who are involved in the lending decisions or handling nonperforming loans
portfolio. Correlation and regression analysis was carried out to analyze the impact of selected
independent variables. The variables included were interest rate, energy crisis, unemployment,
inflation, GDP growth, and exchange rate. The study found that, interest rate, energy crisis,
unemployment, inflation and exchange rate has a significant positive relationship whereas GDP growth
has insignificant negative relationship with the non-performing loans.
According to an Empirical Study made on Commercial Banks in Pakistan by Badar & Yasmin(2013)
on the title of “Impact of Macroeconomic Forces on Nonperforming Loans” the long and short run
dynamics between nonperforming loans and macroeconomic variables covering the period from 2002 -
2011 of 36 commercial banks in Pakistan were assessed. In the stud, inflation, exchange rate, interest
rate, gross domestic product and money supply were included as macroeconomic variables. They
applied vector error correction model. The study found that as there is strong negative long run
relationships exist of inflation, exchange rate, interest rate, gross domestic product and money supply
with NPLs.
Ranjan and Chandra (2003) analyze the determinants of NPLs of commercial banks‟ in Indian in
2002.The objective of the study was to evaluate how NPLs influenced by financial and economic
factors and macroeconomic shocks. In the study, they utilized panel regression model and found that
lending rate also have positive impact on the NPLs justifying that the expectation of higher interest rate
induced the changes in cost conditions to fuel and further increase in NPLs. Besides, loan to deposit
ratio had negative significant effect on NPLs justifying that relatively more customer friendly bank is
most likely face lower defaults as the borrower will have the expectation of turning to bank for the
financial requirements.
Besides, Daniel and Wandera (2013) conducted the study on the effects of credit information sharing
on the nonperforming loan of commercial banks in Kenya. The objectives of the study was to assess
the impact of credit information sharing on nonperforming loans, to identify the factors that account
for bad loans and to determine the economic sector that records higher bad loans and the efforts taken
to reduce the risk in this sector. Data was collected from primary sources and secondary data between
2007 to 2012 period. The variables included in the study were Information Asymmetry;
Interest/lending rates, Management of loans and legal framework and Credit Criteria. The study found
as lending rates has positive significant effect on NPLs. It justifies as these causes make many

23
borrowers not to pay their loans hence leading to many bad loans.
Similarly, Joseph (2011) who conducted study on the title of effects of interest rate spread on the level
of non-performing assets of commercial banks in Kenya was considered interest rate spread/cost of
loan as independent and NPLs ratio as dependent variables. The study applied descriptive research
design. Both primary and secondary data were considered from 43 commercial banks in 2010. It was
analyzed by the help of SPSS software. The finding indicates that cost of loan/lending rate has a
positive significant effect on the occurrences of NPLs. However, Konfi (2012) who conducted study on
the determinants of nonperforming loans on the operations of SINAPI ABA TRUST microfinance
institutions in Ghana found as high interest rate was not significant factors causing the incidence of
NPLs. This study justifies as interest rate is only applicable to loan defaulters who have managed to
pay off outstanding principal and are in default in only interest payment. If a borrower is in default of
both principal and interest, then one cannot assert that high interest rate is the actually the cause of the
loan default.
Besides, the study conducted in Ethiopia by Wondimagegnehu (2012) on “the determinants of
Nonperforming loan on commercial banks of Ethiopia” also found as poor credit assessment, failed
loan monitoring, underdeveloped credit culture, lenient credit terms and conditions, aggressive lending,
compromised integrity, weak institutional capacity, unfair competition among banks, willful defaults
by borrower and their knowledge limitation, fund diversion for un expected purposes and over due
financing has significant effect on NPLs. Besides, the study of Wondimagegnehu (2012) considers
interest rate as banks specific factors and revealed as interest rate has no impact on the level of NPLs
of commercial banks in Ethiopia.
2.3. Conceptual Frame Work
The main objective of this study is to examine the determinants o NPLs of commercial banks in
Ethiopia. Based on the objective of the study, the following conceptual model is framed. As previously
discussed in the related literature review parts, nonperforming loans are affected by both bank specific
and macroeconomic factors. Bank specific factors are profitability, capital adequacy ratio, liquidity,
diversification, bank size, poor credit assessment, failed loan monitoring, under developed credit
culture, lenient credit terms and conditions, aggressive lending, compromised integrity, weak
institutional capacity, unfair competition among banks, willful defaults by borrower and their
knowledge limitation, and overdue financing deposit rate, and capital structure; whereas
macroeconomic factors are interest/lending rate, inflation rate, public debt, exchange rate, money
supply ( Farhan et al.(2012), Shingjergji(2013), Sakiru et al.(2011), Ahmad & Bashir (2013), Saba et

24
al.(2012), Louzisetal(2010), Shingjergji (2013), Swamy (2012), Badar & Yasmin (2013), Ranjan &
Chandra (2003) and Wondimagegnehu (2012)).
Thus, the following conceptual model is framed to summarize the main focus and scope of this study in
terms of variables included. The blue color part represents the dependent variables used in this study.

Figure 2.1.conceptual framework

Macroeconomic Factors
Inflation
Loan
to Lending
Deposi rate
t None performing
lone Effective
Capital Tax rate
Adequacy

Return on Bank Specific Factors

Asset

2.4. Summary and Knowledge Gap

This chapter will be present the theoretical foundation on bank loan and the banking industry in
Ethiopia. In case, Ethiopian current banking system is dominated by the private banks that are
entering to the industry in recent years. The other issues discussed in this chapter is bank
definition and concepts of loan and lending, factors affecting bank loan and sources and
allocations of funds in the banking industry. Further, factors that limit lending such as capital
position, profitability, stability of deposits, economic condition, monetary and fiscal policies that
have their own impact on NPLs were discussed in detail. Lastly, Nonperforming loan issues
including its five Cs were discussed. Besides, Empirical studies regarding the determinants of
nonperforming loan were also discussed. Then, the Knowledge gap is identified and conceptual
framework is developed by the researcher.
There are a plenty of variables that affect the NPLs of banking sectors. In this study, the
researcher focused on both bank specific and macroeconomic determinants of NPLs of
commercial bank in Ethiopia. Internal factors are caused by internal functions and activities of
bank due to decisions and practices of officials and staff functions. These factors are controllable
in which the manager can prevents them through using suitable method, determination and
elimination of weakness and improvement of process. Whereas, external factors can`t be
25
controlled by bank managers and are caused by external environment including effect on
implementation of decisions and also government policies. These factors are policy(monetary
and fiscal) related factors. For instance; unexpected events, changing in rules and obligations,
political and economic changes (inflation and collapse) are external factors (Biabanietal.2012).
However, the variables that got more attention and included in this thesis were loan to deposit
ratio, capital adequacy/solvency ratio, profitability (ROA & ROE), lending rate and effective tax
rate.
A plenty of studies were done on determinants of NPLs in different countries. Even though, the
determinants of NPLs are still debatable among different researchers that might be due to
situational factors like country level factors, bank level factors and the condition of legal and
regulatory framework of the country. Thus, these debates can only be resolved through
quantitative analysis on the determinants of NPLs.
Besides, most of the related literatures reviewed cover different studies made both in developing
and developed countries‟ banking industries. Even if quite numbers of studies have investigated
on the determinants of NPLs, most of these studies have been done in developed countries with
few being done in developing countries. Thus, as to the knowledge of the researcher, there is still
limited number of literatures in Ethiopian banking industry, with the exception of a single study
made by Wondimagegnehu (2012) on the determinants of NPLs of banking industry in Ethiopia.
Hence, this previously done study by Wondimagegnehu (2012)utilized only bank specific
factors. Wondimagegnehu (2012) considers interest rate as bank specific factors and revealed as
interest rate has no influence on the level of NPLs.
Furthermore, bank profitability and capital adequacy ratio that considered as basic determinants
of NPLs were not included in his study since these variables are widely used by different
researchers. Besides, even if taxation is not used in further study before, the researcher add as
one of the determinant factors of NPLs in this study based on theoretical literatures and its
sensitivity in the country specifically in Ethiopia Likewise due to rapid expansion of banking
institution in Ethiopia, it is better to conduct this investigation to ensure their continuous
operation.

This study therefore, seeks to fill this gap by establishing the link between nonperforming loans
and its determinants (bank specific and macroeconomic factors) in case of commercial banks in
Ethiopia..

26
3. Research Methodology

This study aims to examine the determinants of NPLs in the commercial banks found in
Ethiopia. Accordingly, this part will discuss the research procedure that is used to carry out this
study. In case, it starts by discussing research design followed by the nature and instruments of
data collection and sampling design. The subsequent section presents and discusses method of
data process and analysis. Finally, definition of study variables with their measurement and
model specifications are presented.
3.1 Research Design and Approach
Research design is a master plan specifying the methods and procedures for collecting and
analyzing the required data. The choice of research design depends on objectives that the
researchers want to achieve(John, 2007). Since this study is designed to examine the
relationships between NPLs and its determinants, a logical reasoning either deductive or
inductive is required. Deductive reasoning starts from laws or principles and generalizes to
particular instance whereas inductive reasoning starts from observed data and develops a
generalization from facts to theory. Besides, deductive reasoning is applicable for quantitative
research whereas inductive reasoning is for qualitative research. Thus, due to quantitative nature
of data, the researcher will use deductive reasoning to examine the cause and effect relationships
between NPLs and its determinants in this study.

As noted by Kothari (2004), explanatory research design examines the cause and effect
relationships between dependent and independent variables. Therefore, since this study will
examine the cause and effect relationships between nonperforming loans and its determinant, it is
an explanatory research.

The objective to be achieved in the study is a base for determining the research approach for the
study. In case, if the problem identified is factors affecting the outcome having numeric value, it
is quantitative approach(Creswell, 2003). Therefore, the researcher will employ quantitative
research approach to see the regression result analysis with respective empirical literatures on the
determinants of Nonperforming loans. Thus, the researcher will use a panel data from 2010
to2022 period.

27
3.2 Nature of Data and Instruments of Data collection
This study used panel data. The researcher prefers to use panel data since panel data can take
heterogeneity among different units into account over time by allowing for individual-specific
variables. Besides, by combining time series and cross-section observations, it gives more
informative data. Furthermore, panel data can better detect and measure effects that simply
cannot be observed impure cross-section or pure time series data (Gujarati, 2004).

Accordingly, the researcher will use secondary sources of data that is panel in nature. A
secondary source of data is preferred by the researcher since it is less expensive in terms of time
and money while collecting. And also, it affords an opportunity to collect high quality
data(Saunders et al (2007) cited in Belay (2012). Secondary data may either be published or
unpublished data (Kothari, 2004). Accordingly, secondary data is obtained from the audited
annual financial statements of the concerned commercial banks in Ethiopia. These data includes
both bank specific and macro-economic factors. The bank specific which is obtained from the
country’s central bank, National bank of Ethiopia, which regulates the banking sector of the
country and the head office of each selected commercial banks where as one of macroeconomic
variable will be collected from the central statistical agency(CSA).
3.3 Sampling Design
Sample design deals with sample frame, sample size and sampling technique. Sampling is a
technique of selecting a suitable sample for the purpose determining parameters of the whole
population. Population is the list of elements from which the sample may be drawn (John, 2007).
A sample is drawn to overcome the constraints of covering the entire population with the intent
of generalizing the findings to the entire population.

As to August of 2023, there are thirty one banks in Ethiopia. These are commercial bank of
Ethiopia(CBE), Awash international bank(AIB), bank of Abyssinia(BOA), Wegagen bank(WB),
United bank(UB), Nib international bank(NIB), Dashen bank(DB), Development bank of
Ethiopia, Cooperative bank of Oromia, Lion international bank, Zemen bank, Oromia
international bank, Buna international bank, Berhan international bank, Abay bank S.C, Addis
international bank S.C, Debub global bank S.C , Enat banks and 12 more. However, from all the
above listed banks, Development bank of Ethiopia is not Commercial bank (www.nbe.et).

As noted by Kothari (2004), good sample design must be viable in the context of time and funds
28
available for the research study. Besides, judgmental sampling offers the researcher to
deliberately select items for the sample concerning the choice of items as supreme based on the
selection criteria set by the researcher. Accordingly, this study will employ purposive sampling
technique to select the required sample of banks from the above listed banks since it is viable in
line with time and funds available for this study. The selection criteria set by the researcher is
first, the required banks are only Commercial banks in Ethiopia. Second, those commercial
banks should operate before 2010/11 having financial statements for consecutive twelve years.

Therefore, the data for this study will be collected from eight commercial banks in the country.
Out of the eight commercial banks, commercial bank of Ethiopia(CBE) and is state owned bank
whereas the remaining six banks:- Awash international bank (AIB), bank of Abyssinia (BOA),
Wegagen bank (WB), Buna International bank (BIB), Nib International bank(NIB) and Dashen
bank(DB) are private banks that were registered be fore 2010/11 by NBE.

This is due to the fact that since the primary aim of this study is to examine the determinants of
nonperforming loans of commercial banks in Ethiopia, it is better to make generalization for the
banking sector of the country based on data drawn from sample bank which is much more
experienced in the industry. Further, lending is not a one night process rather it comes by
making operation for some consecutive years since the bank should have to accept deposit to
grant loans to reach stage of suffering from poor asset quality.

Thus, as one can understand from objective of the study, the researcher aims to examine the
determinants of nonperforming loans of commercial banks in Ethiopia. In order to achieve the
stated objective, the researcher will classify banks based on years of their operation into those
operated before 2010/11 and after 2010/11 year. And also based on whether they are commercial
banks or not. Accordingly, this study will focused on all banks that were established to give
commercial banking services only and those operate before 2010/11.Thus, the researcher will
use12 years data of selected commercial banks that provide financial statements consecutively
from2010-2022periods.

29
To this end, the sample size of this study is not less than specified sample size required
for ones’ study since the accuracy and validity of the works never guaranteed by
increasing the sample size beyond specified limit. This is due to the fact that
increasing the number of sample size beyond the specified sample size required for
ones‟ study never add value to the accuracy of the study rather it made information
unmanageable due to redundancy (Ayalew, 2011).That is why this study will use eight
experienced commercial bank in Ethiopia from thirty one banks in the country.
3.4 Data Analysis and Presentation
As noted by Kothari (2004), data has to be analyzed in line with the purpose of the
research plan after data collection. Accordingly, secondary data will be collected from
NBE, CSA and head office of each respective bank will be analyzed to determine its
suitability, reliability, adequacy and accuracy. Thus, this study will utilize both
descriptive and econometric analysis based on a panel data from 2010-2022 to
examine the relationship between the NPLs and its determinant factors in commercial
banks found in Ethiopia. The data collected from different sources will be coded,
checked and entered to simple excel program to make the data ready for analysis.
Then the collected data will processed and analyzed through STATA version 12
software packages.

For descriptive analysis; table and percentage will be used to analyze the data.
Besides, results of the descriptive statistics such as mean, standard deviation,
minimum and maximum values are going to be reported to describe the characteristics
of variables under investigation. Furthermore, various diagnostic tests such as
normality, hetero sedatecity, auto correlation and multi colinearity test will be
conducted to decide whether the model used in the study is appropriate and to fulfill
the assumption of classical linear regression model. Thus, in order to examine the
possible degree of Multi-collinearity among variables, correlation matrixes and variance
inflation factor will be used.

To this end, the researcher will use fixed effect regression model analog examine the
effect of each explanatory variable on nonperforming loans of commercial bank in
Ethiopia. Thus, regression results will be presented in a tabular form with the

30
appropriate test statistics and then an explanation of each parameter will be given in
line with the evidence in the literature.

3.5. StudyVariables
Nonperforming loan ratio is dependent variables which will be used in this study. It is
measured in terms of Nonperforming loans to gross loan. Besides, explanatory
variables Will be included in this study are loan to deposit ratio, capital adequacy
ratio, profit, lending rata and effective tax rate. As noted by Brooks (2008) including
more than one explanatory variable in the model never indicates the absence of
missed variables from the model. Thus, to minimize the effect of missed variables
from the model, the researcher will include disturbance term in this study.
3.5.1. Depende
nt variable
Nonperformin
g Loan
Nonperforming loans (NPLs) are loans that are outstanding both in its principal and
interest for along period of time contrary to the terms and conditions under the loan
contract. Any loan facility that is not up to date in terms of payment of principal and
interest contrary to the terms of the loan agreement is NPLs. Thus, the amount of
nonperforming loan represents the quality of bank assets( Tseganesh, 2012).

According to the Ethiopian banking regulation, “Nonperforming loan and advances

are a loan whose credit quality has deteriorated and the full collection of principal
and/or interest as per the contractual repayment terms of the loan and advances are in
question” (NBE, 2008). NPL is aloan that delays for the payment of principal and
interest for more than 90 days. Deterioration in asset quality is much more serious
problem of bank unless the mechanism exists to ensure the timely recognition of the
problem. It is a common cause of bank failure. Poor asset quality leads nonperforming
loan that can seriously damage a banks‟ financial position having an adverse effect on
banks operation (Lafunte, 2012).It distresses the performance and survival of
banks(Mileris,2012).It is measured or indicated by the amount of NPLs to gross loans.

NPL ratio=NPLs
31
 Gross loan

3.5.2. Independent Variables

Independent variables are explanatory variables that explain the dependent variables.
In case, independent variable included in this study are indictors of bank profitability
(ROA and ROE), solvency/capital adequacy ratio(CAR), loan to deposit ratio(LTD),
lending rate(LR), inflation rate(IFR), and effective tax rate(ETR). Majority of these
variables are modified and adopted from previously done studies based on the extent
of their effect on nonperforming loan where as one of these variable, that is effective
tax rate is added from the researcher’s own perception.
Bank Profitability

Bank profitability may reflect the risk taking behavior of bank managements. Banks
with high profitability are less over stressed for revenue creation and thus less forced
to engage risk credit offering. However, inefficient banks are more likely to
experience high level of problem loans since they are tempted to grant and to engage
in more uncertain credits to defend their profitability and meet the prudential rules
imposed by monetary authorities (Boudriga et al.2009). Poor management can imply
week monitoring for both operating cost and credit quality of customers, which will
include high levels of capital losses (Haneef et al. 2012).Thus, both ROA and ROE are
going to be considered as profitability indicators of bank in this study.
Return on Asset (ROA): represents efficiency in asset utilization and shows how
much net income is generated out of assets. It indicates the ability of bank
management to generate profits by utilizing the available assets of the bank. Thus, if
the ratio of ROA is high, it indicates that it is better performance in order to generate
profit. Strong bank profitability measured in terms of ROA might result from high
lending rate, fees and commission that lead bank growth in size and profitability.
Thus, ROA gives an idea as to how efficient management is at using its assets to
generate earnings.
Different researchers found different results regarding the relationship between ROA
and NPLs. For instance:- Ahmed and Bashir(2013) and Makri et al.(2014),) were
examined positive significant relationships between ROA and NPLs. However,
Boudriga et al.,(2009) and Selma and Jouini(2013) found negative association

32
between NPLs and ROA by supporting the arguments that states deterioration of
profitability ratio measured in terms of ROA leads to riskier activities of banks and
then raise the level of NPLs. They justified that since ROA represents efficiency in
asset utilization, poor utilization of assets leads higher NPLs for the banks. Thus, this
ratio is expected to have negative relationships with NPLs in this study. It is measured
by the ratio of net profit to total asset as follows;

ROA=Net profit

Total asset
Return on Equity (ROE): represents the rate of return received from equity invested
in banks. It is the amount of net income returned as a percentage of shareholders
equity. Return on equity measures profitability by revealing how much profit a bank
can generates with them one shareholders have invested. Thus, ROE measures how
much the bank is earning on their equity investment. Many researchers were found
different results between NPLs and bank profitability measured in terms of ROE. For
instance:-Shigjerji(2013) and Ahmed and Bashir (2013) and Makri et al.(2014)found
negative relationships between ROE and NPLs. Therefore, this ratio is expected to
have negative relationships with NPLs. It is measured by the ratio of net profit tototal
equity.

ROE=Net profit

Total equity

Capital Adequacy Ratio(CAR)

Capital adequacy is a measure of bank`s financial strength since it shows the ability to
withstand/ tolerate with operational and abnormal losses. It also represents the ability
to undertake additional business (Habtamu, 2012). As noted by Makri et al.(2014),
CAR determines risk behavior of banks. It is a measure of banks solvency and ability
to absorb risk. Thus, this ratio is used to protect depositors and promote stability and
efficiency of financial systems. According to Makri et al.(2014), there is negative
relationship with NPLs indicating a risky loan portfolio is marked by a high
NPL(equivalent to high credit risk). However, Djiogap and Ngomsi(2012) found
positive association between NPLs and capital adequacy ratio. It is measured by total
33
 Equity to total asset ratio. However, it is expected to have negative association with
NPLs in this study. This implies that well capitalized banks are less incentive to take
risk.
CAR=Total Equity
Total Asset

Loan to deposit(LTD) Ratio

Loan to deposit (LTD) ratio examines bank liquidity by measuring the funds that a
banks has utilized into loans from the collected deposits. It demonstrates the
association between loans and deposits. Besides, it provides a measure of income
source and also measures the liquidity of bank asset tied to loan (Makriet al. 2014)).
This ratio also measures customer friendliness of banks implies that relatively more
customer friendly bank is most likely face lower defaults as the borrower will have the
expectation of turning to bank for the financial requirements ( Ranjan
andChandra,2003). Thus, it represents a bank‟s preference for credit. It is credit
culture that represents a bank‟s preference for credit. It is measured in terms of loan to
deposit ratio. There is empirical evidence that shows as LTD ratio has significant
effect on the level of NPLs of banking sectors in different aspects. In this study, this
ratio is expected to have positive relation with NPLs.

LTD= Total Credit* deposit

LendingRate/InterestRate

Lending rates are one of the primary economic determinants of NPLs. It is the cost of borrowed
funds. Interest rate spread is a measure of profitability between the cost of short term borrow in
g and the return on long term lending. Interest rate spread affect performing assets in banks as it
increases the cost of loans charged on the borrowers (Joseph, 2011). Interest rate is the price a
borrower pays for the use of money they borrowed from the lenders. Interest can be thought of
as rent of money.

Thus, lending rate is a rate of return usually remains in admittance of monetary

regulators(NBE)to manipulate the pursuance of monetary objectives. In case, maximum and
minimum lending rate is set by NBE.

There is empirical evidence showing a positive and negative association between lending rate
34
and NPLs. For instance: - Saba et al.(2012) found negative association between lending rate
and NPLs whereas Farhan et al.(2012) and Ranjan and Chandra (2003)found as there is a
positive relationship with NPLs and lending rate since an increase in interest rate curtails the
paying capacity of the borrowers. Thus, lending rate is expected to have positive association
with NPLs in this study. Accordingly, this study considers average lending rate (average of
Minimum and Maximum Lending Rate) as proxy of lending rate as being commonly used by
commercial banks for pricing loans.

Inflation Rate

It is a situation in which the economies overall price level is rising. It represents sustained and
pervasive increment in aggregate price of goods and services resulting decline in purchasing
power of money. Accordingly, when inflation is high and unexpected, it can be very costly to
an economy. At the same time, inflation generally transfers resources from lender and savers
toborrowers since borrowers can repay their loans with birr that are worthless. It is determined
as the general consumer price index. This indicates that, as inflation increase, the cost of
borrowing gets more expensive and deteriorates the quality of loan portfolio.

There are ambiguous results regarding the relationship between NPLs and inflation rate.
According to Farhanet al.(2012), Skarica(2013), Klein(2013) and Tomak (2013) found as there
is a positive relationship between NPLs and Inflation rate. Theoretically, inflation should
reduce the real value of debt and hence make lending easier. However, high inflation may pass
through to nominal interest rates, reducing borrowers‟ capacity to repay their debt. Through its
attraction with the tax system, it can increase tax burden by artificially increasing income and
profits. Besides, inflation cause firms to increase their costs of changing prices. Finally, it made
individuals to hold less cash and make more trips to banks since inflation lowers the real value
of money holdings. It can negatively affect the borrowers‟ real income when wages are stick.
Besides, price stability is considered as prerequisites for ones ‟countries economic growth
(Skarica,2013).

Thus, Consumer price index is used in this study as the proxy of inflations in most ample
measure of inflation defines a change in the price of consumer goods and services purchased by
households. Increase in CPI requires monetary regulators to use contr-actionary measures by
increasing the interest rate to control inflation which later increase the cost of borrowing and

35
ultimately cause NPLs. Keeping this information in mind, the relationship between NPLs and
inflation is expected to be negative for this study. In case, the figure amount of CPI will be
taken from CSA.

Effective Tax Rate

Taxation in banking sectors represents the ability of banks to allocate its portfolios for its taxes.
Corporate income tax rate affect the bank loans in different aspects. High tax burden enable the
banks to shift the tax burden either by increasing lending rate and fees or paying low interest
ration deposits (Albertazzi and Gambacorta, 2006). Thus, bank is capable of transferring the tax
costs to its customers by raising fees and interest spreads ( Khanet al.2011). Bank with high
debt pay less taxes due to higher interest expense. Accordingly, even if there is no specific
study conducted using taxation as a determinant factor of NPLs , this study expects positive
relationships between tax rate and NPLs. Generally, expected Sign of Variables are presented in
table 3.1as follows.

Table3.1:ExpectedSign(+/-)ofExplanatory Variables inthisStudy

Explanatory Expected Some empirical evidence

Variables Sign
Loan to Deposit + Swamy(2012)
Ratio
Capital Adequacy - Shingjerji(2013),Hyun&
Ratio Zhang(2013),Makri et al.
(2014),
Klein(2013)
Return on Asset - Swamy (2012), Selma
and Jouini (2013),
Bougriga
et al .(2009)
Return on Equity - Makri et al. (2014), Klein (2013),

36
 Shingjerji(2013)
Lending Rate + Farhanetal.(2012), Sakiru et al(2011)
Inflation Rate - Farhan et al.(2012), Skarica(2013),
Klein(2013),Tomak(2013)
Effective Tax Rate + -

sources: Swamy (2012), Shingjerji(2013), Hyun & Zhang(2013), Makrietal.(2014),

Klein(2013),Selma and Jouini(2013), Makri et al.(2014), Klein(2013), Farhan et al.(2012),
Sakiru et al(2011)and other studies included in the study.
Notes: A positive sign “+” indicates direct impact; whereas a negative sign “–” indicates an
inverse impact of explanatory variables on dependent variable

Model Specification
The aim of this study is to examine the determinants of NPLs of commercial banks in Ethiopia.
Similar to the most noticeable previous research works conducted on the nonperforming loans of
financial sectors, this study will use nonperforming loans ratio as dependent variables whereas
Loan to deposit ratio, capital adequacy ratio, return on asset, return on equity, Average lending
rate, inflation rate and effective tax rate as explanatory variables. These variables are chosen
since they are widely existent for the commercial bank in Ethiopia. Accordingly, this study will
examine the determinants of NPLs of commercial banks in Ethiopia by adopting a model that is
existed in most literature. The regression model which is existed in most literature has the
following general form;

Yit= βo + βXit+ εit

Where: -Yit is the dependent variable for firm „i‟ in year„t‟, β 0is the constant term,β is the
coefficient of the independent variables of the study, X it is the independent variable for firm „I
‟in year„t” and εit the normal error term.

Thus, this study is based on the conceptual model adopted from Fawad and Taqadus(2013).
Accordingly; the estimated models used in this study are modified and presented as follow;

37
NPLit=β0+β1(LTD)it+β2(CAR)it+β3(ROA)it+β4(ROE)t+β5(ALR)it+β6(INFR)it+β7(ETR)it+εit

Where;

 β0 is an intercept
 β1, β2 ,β3, β4, β5, β6, and β7 represent estimated coefficient for specific bank I at time t,
 LTD, CAR, ROA, ROE, ALR, INF and ETR represent Loan to deposit ratio,
capital adequacy / Solvency ratio, return on asset, return on equity, Average lending
rate, inflation rate and effective tax rate respectively
 εit represents error terms for intentionally/unintentionally omitted or added
variables. It has zero mean, constant variance and non-auto correlated. The
coefficients of explanatory variable were estimated by the use of ordinary least
quare(OLS)technique.

38
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