Dynamic implications of fiscal policy on NPLs: theoretical analysis and panel-regression empirics

Khemraj, Tarron and Pasha, Sukrishnalall (2025): Dynamic implications of fiscal policy on NPLs: theoretical analysis and panel-regression empirics.

Abstract

This paper examines the interplay between fiscal policy and non-performing loans (NPLs), a topic which is not widely considered in the existing literature. Using Guyanese bank-level and quarterly data from 2009: Q4 to 2024: Q4, the paper finds an inverse relationship between the overall fiscal balance – defined as total government revenues minus total government expenditures – and NPLs (or bad loans), implying that an improvement in the fiscal balance reduces credit risk and a fiscal expansion increases the percentage of bad loans (credit risk). Expanding the industrial organization model of banking and drawing on liquidity preference theory, the paper proposes a generalized theoretical framework to explain why a fiscal contraction might decrease NPLs in a bank’s portfolio. Panel-regression estimates also reveal several auxiliary results consistent with the existing literature: oil price and an oil production dummy variable are negatively associated with NPLs, while capital adequacy and inflation are positively related to NPLs. Other macroeconomic factors, such as economic growth, real effective exchange rate, inflation, as well as bank-specific variables that capture diversification, liquidity, and efficiency, are not important determinants of NPLs, according to our estimates.

• Item Type: MPRA Paper
• Language: English
• Keywords: Fiscal policy, liquidity preference, credit risk, non-performing loans, panel regression
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Interest Rates: Determination, Term Structure, and Effects; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E51 - Money Supply ; Credit ; Money Multipliers; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E62 - Fiscal Policy; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages; H - Public Economics > H3 - Fiscal Policies and Behavior of Economic Agents > H32 - Firm

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