Do non-performing loans matter for bank lending and the business cycle in euro area countries?

We estimate the impact of changes in non-performing loan (NPL) ratios on aggregate banking sector variables and the macroeconomy by estimating a panel Bayesian VAR model for twelve euro area countries. The main findings are as follows: i) An impulse response analysis shows that an exogenous increase in the change in NPL ratios tends to depress bank lending volumes, widens bank lending spreads and leads to a fall in real GDP growth and residential real estate prices; ii) A forecast error variance decomposition shows that shocks to the change in NPL ratios explain a relatively large share of the variance of the variables in the VAR, particularly for countries that experienced a large increase in NPL ratios during the recent crises; and iii) A three-year structural out-of-sample scenario analysis suggests that reducing banks' NPL ratios can produce significant benefits in terms of improved macroeconomic and financial conditions.

Automated summary

The study finds that changes in non-performing loan (NPL) ratios have a significant impact on banking sector variables and the macroeconomy. An increase in NPL ratios leads to a decrease in bank lending, widening of lending spreads, and a fall in real GDP growth and residential real estate prices. Shocks to the change in NPL ratios explain a relatively large share of the variance in the VAR, particularly in countries with a high increase in NPL ratios during recent crises. A three-year scenario analysis suggests that reducing NPL ratios can have significant benefits for macroeconomic and financial conditions.