Are asset quality weaknesses holding back bank lending? Evidence from MENA region

ABSTRACT

The role of asset quality in impacting bank lending has been examined in several studies. What has however not been examined is how asset quality interacts with monetary policy to influence bank lending or what is popularly referred to as the asset quality channel of monetary transmission. Employing data during 2011–2020, we examine whether there exists an asset quality channel of monetary transmission for MENA country-banks. The findings provide strong support in favour of an asset quality channel of monetary transmission. In particular, the baseline results suggest that a one percentage point increase in the impairment ratio leads to a decline in bank lending by 11%. These findings differ across key bank characteristics such as profitability, capital and funding costs for conventional versus Islamic banks. Relatedly, macroprudential policies play an important role in arresting asset quality deterioration.

KEYWORDS:

• Banking
• non-performing loans
• monetary transmission
• MENA

JEL CODES:

• G21
• E52

Acknowledgements

Open Access funding provided by the Qatar National Library. I would like to acknowledge the comments and analytical insights by an anonymous referee on an earlier draft, which greatly improved the analysis. Needless to mention, the views expressed and the approach pursued in the paper reflect the personal opinion of the author.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 It is possible that credit offtake could increase under a monetary contraction. This could however entail an increase in the pool of risky borrowers, with possibility of higher NPLs in the future.

2 The country list includes Algeria, Bahrain, Egypt, Iran, Jordan, Kuwait, Lebanon, Morocco, Oman, Qatar, Saudi Arabia, United Arab Emirates and Tunisia.

3 We employ Kaufmann (2022) updated database [info.worldbank.org/governance/wgi]

4 From Equation (1), the impact of monetary policy on bank lending in the presence of NPLs equals ${\displaystyle \frac{d\mathrm{LT}{\mathrm{A}}_{\mathrm{bkt}}}{\mathrm{dMY}{P}_{\mathrm{kt}}}=\beta +\delta \mathrm{NP}{L}_{\mathrm{bkt}}}$. The former captures the direct impact of monetary contraction, whereas the latter shows the indirect impact operating via NPLs.

5 In 2020, NPLs of European banks were 2.6% as compared to 7.8% for MENA countries.

6 I am grateful to the referee for pointing this out.

7 The analysis pertains primarily to the pre-COVID-19 period and the range and mix of macroprudential policies were significantly modulated in the wake of the pandemic. This is however, beyond the scope of the present analysis (See, for example, Al-Hassan et al., 2022).