Disentangling the transmission channel NPLs-cost of capital-lending supply

ABSTRACT

This paper analyses the effects of non-performing loans (NPLs) on the cost of capital, and on lending and liquidity supply, for a sample of 225 Eurozone banks over the period 2002Q1-2016Q4. Our results demonstrate that NPLs increase the cost of capital, which reduces both lending supply and liquidity creation. This phenomenon is comparatively more significant for periphery county banks than for core country banks.

KEYWORDS:

• Cost of capital
• credit supply
• liquidity creation
• leverage
• NPLs

JEL CLASSIFICATION:

• G11
• G21
• G32
• H63

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Levels of NPLs above a threshold might incentivize banks to assume higher risk in the future in a ‘gamble to resurrection’ (Bowman and Malmendier 2015; Eisdorfer 2008), and reduce banks’ performance (Zhang et al. 2016).

² Eurozone members included in our sample are Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, and Spain.

³ Chiesa and Mansilla-Fernández (2018, 45) list the components of LC_it.

⁴ Carbó-Valverde, Mansilla-Fernández, and Rodríguez-Fernández (2017) demonstrate that the degree of competition is a determinant of the lending supply.