Interactions between non-performing loans and macroeconomic variables

In recent years, financial institutions such as the commercial banks have a central role in financial stability as much as governmental institutions like central banks. At this point, although the main role of banks is financial intermediation, this role has recently been evolved towards the financial stability provider or vice versa. From this point of view it is observed that the health of banking system became a crucial issue for an economy. However, as clearly seen in the latest 2008 global financial crisis, financial systems are subjected to instability and crisis that create huge costs to society. It is observed that the main source of the financial crisis emerges from the asset side of the banks' balance sheets. Asset quality and credit risk gain more importance in this context. At this point, the questions have been arisen that what the main macro determinants of credit risk are and also whether the potential of the credit risk is to cause a macroeconomic crisis or not. From this point of view, in this research, it has been taken to road in order to improve the understanding of the relevance of credit risk with the macroeconomic fluctuations and its interconnections by the key macroeconomic variables such as growth, unemployment and inflation. VAR methodology is used to analyze the determinants of NPLs and to identify the feedback effects of NPLs on macroeconomy and also Panel VAR methodology is used to analyze the OECD data. Research data are consisted of NPLs Ratio, Credit Volume, GDP Growth, Unemployment and Inflation between 1999 and 2016. Findings suggest that a shock to NPL growth and credit volume have implications on economic activity. Especially the bank credit volume's impact on GDP growth, inflation and unemployment consist the key findings, while the Panel VAR and VAR models also suggest that a deterioration in asset quality leads to a decline in credit and vice versa. It is also suggested that stronger economic activity accompanied by higher GDP growth and lower inflation have a positive impact on asset quality and credit expansion of banking sector. Notably, GDP growth leads to decline in NPLs and to increase in credit volume, while inflation has a role accelerating the NPLs growth and credit volume decline. These impacts on NPLs and credit volume feeds back the economy negatively.