The Effect of Non-performing Loans on Bank Profitability, Evidence from the Albanian Banking Sector

Abstract

This paper explores the effect of NPLs on bank profitability in Albania in the period 2014- 2023. Given the importance of banks in funding the private sector and ensuring macroeconomic stability, it is our research objective to test empirically the association between NPL ratios and major profitability indicators; Return on Assets (ROA) and Return on Equity (ROE). The study employs a panel data estimation method to analyze a sample of active commercial banks in Albania and includes control variables: capital adequacy, loanto- deposit, growth, inflation, unemployment. The regression results indicate that there is a significantly negative relationship between NPLs ratio and both proxies for profitability. Growth in NPLs has a significant negative impact on ROA and ROE as we can see, in which reflects the necessity of controlling NPLs in order to maintain financial stability. The results also provide evidence that bank-level factors like ownership structure and capital adequacy impact the sensitivity to credit risk, and there is no clear evidence of macroeconomic variables playing a significant role for the critical estimation specifications. The study also enriches the finance and economics literature by providing policy implications and practical lessons for policy makers as well as bank managers by suggesting the immediate necessity of improving the credit screening process, reinforcing debt recovery, and adopting effective means of management for the reduction of unsustainable NPLS. Especially for the Albanian context, the results are of significance given that the country still faces vulnerability of the banking system to the external shocks and limitations in terms of legal and financial infrastructure by institutions.