Causality Between GPD Growth and Non-performing Loans in Bangladesh: A Toda-Yamamoto Approach

Abstract

Non-performing Loans (NPLs) are those loans of the banks’ from which they are no longer able to receive interest or overdue principal payments. NPL can affect the balance sheet of banks by decreasing banks’ profitability as bank cannot generate interest income from their NPLs. Banks’ may have to face capital erosion due to higher level of NPL. Due to interconnectedness of banking sector with the overall financial system and the economy, there may have ripple effects throughout the financial system thereby adding to financial instability. The percentage of NPLs to total outstanding loans in Bangladesh was 9.3% in 2017. The aim of this paper is to investigate the causal relationship and the direction of causality between economic growth Gross Domestic Product Growth Rate (GDPGR) and the level of NPLs (NPLR) in Bangladesh using annual data covering the period from 2000 to 2017 within a vector autoregressive (VAR) framework using Toda-Yamamoto method. The main merit of the Toda-Yamamoto procedure is that it can be used irrespective of whether the time series in the system are integrated of different orders or non-cointegrated or both. The order of integration of the variables is initially determined using Augmented Dickey Fuller (ADF) unit root tests. The tests reveal that the maximum order of integration for the variables in the system is one. Applying Toda-Yamamoto approach of Granger causality test, an evidence of a unidirectional causality running from NPLR to GDPGR in Bangladesh is found. This research is expected to come out with good findings which will have implications for the policy makers, regulatory authorities and professionals.