Non-Performing Assets and Bank Profitability in South Asia: The Moderating Role of Capital Adequacy
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Abstract
This study investigates the direct link between non-performing assets (NPAs) and bank profitability in South Asia and whether capital adequacy serves as a moderator between the two. The study employs a balanced panel of 10 banks from 5 countries (India, Bangladesh, Pakistan, Sri Lanka, and Nepal) with 100 bank-year observations for the period 2013-2022, and estimates Pooled Ordinary Least Squares (OLS) regressions with heteroskedasticity-robust standard errors. An interaction term (GNPA × CAR) is added to check the interaction between the Capital Adequacy Ratio (CAR) and the NPA-profitability relationship. The Gross NPA (GNPA) ratio is negatively correlated with Return on Assets (ROA) (β = −0.0276, p = 0.030), which is consistent with the fact that poor asset quality leads to lower bank profitability. The interaction term GNPA × CAR is negative (β = −0.0038) and only slightly significant at the 10% level (p = 0.079), but not at the 5% level. This offers only a tentative indication that the sampled banks were not immune to the profitability hit from NPAs even if they had higher capital levels. At the country level, there is significant variation, with the NPA-ROA relationship being strongly negative in India (r = −0.963) and Bangladesh (r = −0.783) and statistically insignificant in Pakistan and Nepal. Capital adequacy is not enough to protect against shocks from poor asset quality. Thus, in addition to having sufficient capital, there is a need to continue to focus on good credit risk management, proper provisioning and strong asset quality oversight. The results are preliminary and should be interpreted with caution, as the interaction effect is not statistically significant and the sample size is small, and should be replicated with panel-data methods (e.g., fixed effects, system GMM) in future studies.
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