Determinants of Non Performing Loans and Its Feedback Effects on Macroeconomic Performance: The Case of Rwanda

Abstract

This paper investigates the determinants of non-performing loans (NPLs) in the Rwandan banking sector for the period 2012Q1 to 2022Q1. The study uses the bias-corrected fixed effects (BCFE) for the dynamic panel data. The findings reveal that the level of NPLs is explained by macroeconomic conditions such as credit growth, Real Gross Domestic Product (RGDP) growth, and real effective exchange rate. However, inflation is not significant for BCFE, but it is for fixed effect (FE) used as a benchmark. Banks’ specific characteristics, namely real interest rate, growth of loans, size, capital adequacy ratio, operating efficiency, and income diversification, were found to be important determinants of NPLs in Rwanda. The study also affirms the robust feedback mechanisms originating from the banking sector via non-performing loans, exerting a tangible influence on the real economy. The main implication from the findings is that the National Bank of Rwanda should continue ensuring macroeconomic stability while reinforcing banking sector supervision, putting in place policies to ensure that the banks avoid excessive lending by maintaining solid credit standards so as to prevent a sharp buildup of NPLs.