Determinants of non-performing loan in development bank of Ethiopia

Abstract

This study aimed to investigate macroeconomic variables, bank specific internal factors and variables that are external to the bank, which explain Non- Performing Loans (NPLs) in Development Bank of Ethiopia. The study used time series data of NPLs and eight macroeconomic variables over the period of 1980‒2016. In addition, cross sectional data for bank specific variables and borrower's related external factors were collected. Multivariate time series model of vector auto regressive and vector error correction model were used and Johansen approach was applied to test the explanatory power of macroeconomic variables. For the cross sectional data, OLS regression model was data. Cross sectional data were collected using stratified sampling technique. The study proved significant negative association of real interest rate, DBE credit growth, and export with the size of non-performing loan in Development Bank of Ethiopia in the long run. Whereas, the variables such as GDP growth, foreign direct investment, and average exchange rate have significant positive association with the amount of non-performing loan. In addition to macroeconomic variables bank specific factors and borrower's related external variables such poor due diligence assessment, insufficient grace period given by the Bank for the repayment, non-credit worthy project financing, financing second hand machines, lack of proactive measures taken against sign of default, willful default, rent seeking character of borrowers, poor financial record system of borrowers, misfortune of borrower, unavailability labor force in the project area, saturation of demand for the product of the project, remoteness from market, and unsuitable agro-ecological condition are explanatory variables that significantly increase the occurrence of NPLs in Development Bank of Ethiopia. In order to minimize the impact of NPL,s Development Bank of Ethiopia need to finance export-oriented projects and minimize long-term financing foreign direct investment, conduct proper due diligence, viability checks, revise policy as per the conditions and assess internal factors and external factors for stability and soundness of the project financing of the Bank