The Influence of Non-Performing Loan Ratio on the Relationship between Short-Term and Total Leverage and Profitability
Keywords:
Non-performing loans; Profitability; Short-term leverage; Total leverage.
Abstract
Financial distress in the financial services sector is known to predict wider economic consequences and some of the principal metrics that could be used to measure these are leverage and loan ratios. Therefore, this study focuses on evaluating the impact of short-term leverage and total leverage on return on assets of eight (8) deposit money banks quoted on the Nigerian Exchange Group, from 2013 to 2021. Additionally, this study examines the moderating role of non-performing loans on the relationships between short-term ratio and total leverage ratio, and return on assets. The Hausman test shows that random effects regression is appropriate. Robust standard errors random-effects regression analysis shows that short-term leverage significantly and negatively affects return on assets and total leverage insignificantly and negatively affects return on assets. In addition, the regression analysis shows that non-performing loans ratio significantly and positively moderates the relationship between short-term leverage and return on assets, while non-performing loans ratio significantly and negatively moderates the relationship between total leverage and return on assets of the sampled companies. The study recommends that management of the studied exchange sub-sector should remain mindful of the consequences of high non-performing loans when they make long and short-term financing decisions.
References
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Singh, S. K., Basuki, B., & Setiawan, R. (2021). The effect of non-performing loan on profitability: Empirical evidence from Nepalese commercial banks. The Journal of Asian Finance, Economics and Business, 8(4), 709-716. Shikimi, M. (2020). Bank loan supply shocks and leverage adjustment. Economic Modelling, 87, 447-460. The Street, (2022). What is leverage in corporate finance? Definition & examples. The Street. https://www.thestreet.com/dictionary/l/leverage. Trung, N. K. T. (2022). Does leverage fit non-performing loans in the COVID-19 pandemic–evidence from the Vietnamese banking system? Cogent Business & Management, 9(1), 2119675. https://doi.org/10.1080/23311975.2022.2119675. Uddin, M. K. (2022). Effect of leverage, operating efficiency, non-performing loan, and capital adequacy ratio on profitability of commercial banks in Bangladesh. European Journal of Business and Management Research, 7(3), 289-295.
Van Eeghen, P. H. (2021). Funding money-creating banks: Cash funding, balance sheet funding and the moral hazard of currency elasticity. International Review of Financial Analysis, 76, 101736. https://doi.org/10.1016/j.irfa.2021.101736.
Wang, C. S., Chen, Y. C., & Lo, H. Y. (2021). A fresh look at the risk-return tradeoff. Pacific-Basin Finance Journal, 68, 101546.
Baron, R. M., & Kenny, D. A. (1986). The moderator–mediator variable distinction in social psychological research: Conceptual, strategic, and statistical considerations. Journal of Personality and Social Psychology, 51(6), 1173–1182. https://doi.org/10.1037/0022-3514.51.6.1173 Birken, E. G. & Curry, B. (2021). Understanding return on assets (ROA). Forbes. https://www.forbes.com/advisor/investing/roa-return-on-assets/ Bunyaminu, A., Yakubu, I. N., & Bashiru, S. (2021). The Effect of financial leverage on profitability: An empirical analysis of recapitalized banks in Ghana. International Journal of Accounting & Finance Review, 7(1), 93-102. Chima, O. (2022). Why Nigeria needs another banking sector recapitalization. This Day Live. https://www.thisdaylive.com/index.php/2019/06/27/why-nigeria-needs-another-banking-sector-recapitalisation/ Cole, T. J. (2015). Setting number of decimal places for reporting risk ratios. BMJ, 350. https://doi.org/10.1136/bmj.h1845. Collin, V. (2022). Survivorship bias. Financial Edge. https://www.fe.training/free-resources/investment-banking/survivorship-bias/#:~:text=In%20finance%2C%20survivorship%20bias%20is,leading%20to%20overly%20optimistic%20conclusions. Çollaku, B., & Aliu, M. (2021). Impact of non-performing loans on bank's profitability: empirical evidence from commercial banks in Kosovo. Journal of Accounting, Finance and Auditing Studies, 7(3), 226-242.
CSL Stockbrokers. (2020). Commentary: Moody’s changes outlook on Nigerian banking sector to negative. Nairametrics. https://nairametrics.com/2020/04/30/nigeria-banking-moodys-changes-outlook-on-nigerian-banking-sector-to-negative/ Dalci, I. (2018). Impact of financial leverage on profitability of listed manufacturing firms in China. Pacific Accounting Review, 30(4), 410-432. https://doi.org/10.1108/PAR-01-2018-0008. Do, H., Ngo, T., & Phung, Q. (2020). The effect of non-performing loans on profitability of commercial banks: Case of Vietnam. Accounting, 6(3), 373-386. Efendi, A., Putri, L. P., & Dungga, S. (2019). The effect of debt to equity ratio and total asset turnover on return on equity in automotive companies and components in Indonesia. In 3rd International Conference on Accounting, Management and Economics 2018 (ICAME 2018), 182-188. Atlantis Press. Elton, E. J., Gruber, M. J., & Blake, C. R. (1996). Survivorship bias and mutual fund performance. The Review of Financial Studies, 9(4), 1097–1120. http://www.jstor.org/stable/2962224. Gao, P., Lim, C. Y., Liu, X., & Zeng, C. C. (2022). Loan loss provisions and return predictability: A dynamic perspective. China Journal of Accounting Research, 15(2), 100224. Hayes, A. (2022). What is financial leverage, and why is it important? Investopedia. https://www.investopedia.com/terms/l/leverage.asp. Hecht, J. (2018). The top pros and cons of short-term financing: Depending on your financing situation, it might be a good idea to take on short-term debt. Inc Africa; Mansueto Ventures LLC. https://incafrica.com/library/jared-hecht-the-top-pros-cons-of-short-term-financing Iyatse, G. Oyebade, W. (2021). Toxic loans, courts may force AMCON’s burdens on taxpayers. The Guardian Nigeria. https://guardian.ng/news/toxic-loans-courts-may-force-amcons-burdens-on-taxpayers/. Kjosevski, J., & Petkovski, M. (2017). Non-performing loans in Baltic States: determinants and macroeconomic effects. Baltic Journal of Economics, 17(1), 25-44. Latif, U. (2018). Early warning signs of financial distress in business: manage it before it is too late. LinkedIn. https://www.linkedin.com/pulse/early-warning-signs-financial-distress-business-too-late-latif-aca/. Janković, M., & Jovanović, D. (2016). Influence of leverage on profitability of companies in the Republic of Serbia. In Contemporary Issues in Economics, Business and Management–EBM 2016: Conference Proceedings, 233-242.
Jolevski, L. (2017). Non-performing loans and profitability indicators: the case of the republic of Macednia. Journal of Contemporary Economic аnd Business Issues, 4(2), 5-20. Kingu, P. S., Macha, S., & Gwahula, R. (2018). Impact of non-performing loans on bank’s profitability: Empirical evidence from commercial banks in Tanzania. International Journal of Scientific Research and Management, 6(1), 71-79. Martiningtiyas, C. R., & Nitinegeri, D. T. (2020, September). The effect of non-performing loans on profitability in banking sector in Indonesia. In International Conference on Management, Accounting, and Economy (ICMAE 2020), 64-67. Atlantis Press. Meghanathi, P., & Chakrawal, A. (2021). Impact of financial leverage on profitability of reliance industries ltd. Journal La Bisecoman, 2(5), 15-22. Mehzabin, S., Shahriar, A., Hoque, M. N., Wanke, P., & Azad, M. A. K. (2022). The effect of capital structure, operating efficiency and non-interest income on bank profitability: new evidence from Asia. Asian Journal of Economics and Banking (ahead-of-print). Mennawi, A. N. A. (2020). The impact of liquidity, credit, and financial leverage risks on financial performance of Islamic banks: a case of Sudanese banking sector. Risk and Financial Management, 2(2), 59-59.
Nairametrics (2020). Nigerian banks non-performing loan ratio blows past CBN regulatory limits. Nairametrics. https://nairametrics.com/2021/01/30/nigerian-banks-non-performing-loan-ratio-blows-past-cbn regulatory-limits/. Platt, H. D. & Platt, M. B., (2006). Understanding differences between financial distress and bankruptcy. Review of Applied Economics, Lincoln University, Department of Financial and Business Systems, 2(2), 1-17. Sadhishkumar, V., & Swarupa, P. The relationship between liquidity, leverage and profitability: an exploratory study of Indian software companies. Journal of Education: Rabindra Bharati University, 23(12), 52-58. Salihu, A. S., & Adediran, S. A. (2021). Effect of firm specific and micro-economic factors on profitability of quoted oil and gas companies in Nigeria. In The Institute of Chartered Accountants of Nigeria: 6th Annual International Academic Conference on Accounting and Finance. 267-284. ICAN. Salihu, A. and Mohammed A. (2022). The effect of financial information on fraud likelihood of quoted consumer goods companies in Nigeria. Journal of Leadership, Accounting Development and Investigation Research, 6(1), 154-162. Segal, T. (2022). Nonperforming loan (NPL) definitions, types, causes, consequences. Investopedia. https://www.investopedia.com/terms/n/nonperformingloan.asp.
Singh, S. K., Basuki, B., & Setiawan, R. (2021). The effect of non-performing loan on profitability: Empirical evidence from Nepalese commercial banks. The Journal of Asian Finance, Economics and Business, 8(4), 709-716. Shikimi, M. (2020). Bank loan supply shocks and leverage adjustment. Economic Modelling, 87, 447-460. The Street, (2022). What is leverage in corporate finance? Definition & examples. The Street. https://www.thestreet.com/dictionary/l/leverage. Trung, N. K. T. (2022). Does leverage fit non-performing loans in the COVID-19 pandemic–evidence from the Vietnamese banking system? Cogent Business & Management, 9(1), 2119675. https://doi.org/10.1080/23311975.2022.2119675. Uddin, M. K. (2022). Effect of leverage, operating efficiency, non-performing loan, and capital adequacy ratio on profitability of commercial banks in Bangladesh. European Journal of Business and Management Research, 7(3), 289-295.
Van Eeghen, P. H. (2021). Funding money-creating banks: Cash funding, balance sheet funding and the moral hazard of currency elasticity. International Review of Financial Analysis, 76, 101736. https://doi.org/10.1016/j.irfa.2021.101736.
Wang, C. S., Chen, Y. C., & Lo, H. Y. (2021). A fresh look at the risk-return tradeoff. Pacific-Basin Finance Journal, 68, 101546.
Published
2023-07-21
Section
Articles
