CHAPTER 1

INTRODUCTION

Background of the study

Banks are considered one of the main components in the growth of a country's financial

system, so they play an important role in the global economy. As a result, if the banking

system fails to function properly, it will have a significant effect on the country's entire

economic system (Bătae et al., 2021). In the economy, banks are commonly characterized as

a middleman between depositors and borrowers. They take deposits and lend credit to all

sectors to move funds from the surplus to the deficit unit in the economy. Economic growth

is increased by an established banking system, while economic growth is decreased by a non-

developed banking sector, so we can conclude that economic growth in any country is based

on a sustainable and effective banking sector (Zeqiraj et al., 2020).

Regarding the negative impact of non-performing loans on commercial banks' financial

results and viability, there have been a bunch of new studies on the factors that influence non-

performing loans over the years (Wood & Skinner, 2018). Knowing the major factors on

nonperforming loans allows banks to monitor their upward progression, limiting their

constraining effect on bank performance. Understanding the effects of non-performing loans

also aids in the development of a sound and balanced financial system capable of supporting

economic growth. The growth in nonperforming loans indicates that the amount of economic

units having difficulty paying their loans is rising, raising the risk of credit default (Koskei,

2020). Owing to losses suffered as a result of debt write-offs, the valuation of bank assets

deteriorates and the wealth decreases under such a situation. Furthermore, the surge in non-

performing loans has been seen to play a major role in the frequency of bank crises (Koskei,

2020).
In banks, the funding decision is also one of the most critical decisions that affect future cash

flow, profitability, and liquidity. The utilization of the ideal funding mix is critical because it

lowers the cost of capital in the business, raises the valuation of the company, and increases

the bank's beneficial investment prospects, which motivates the bank to analyze financial

leverage to ascertain the bank's financial strengths and limitations since the bank requires

funds to finance its operations (AL-Shatnawi et al., 2021). Hence, Financial leverage,

according to Mahran Dr (2015), is the facility's utilization of third-party capital to maximize

the return on the facility's borrowers and operators, which is represented by the debt-to-total-

assets ratio. Also, financial leverage is described by most financial management writers and

studies as the number of long-term liabilities on total assets, although there are exceptions

(Esmaeil et al., 2020).

Furthermore, several variables, including internal factors and external banks, can be used to

predict the frequency of non-performing loans (NPLs). Bank internal factors can be seen in

the financial ratios such as “bank size (SIZE), capital adequacy ratio (CAR), and operating

expenses to operating income (ROA), while bank external factors can be seen in macro-

economic conditions such as GDP growth and inflation rate”(Alexandri & Santoso, 2015).

According to Khan et al. (2020), NPLs and ROA have a direct relationship; the lower the

ROA, the higher the NPLs, and vise - versa.

Since the banking sector is very important in many countries around the world, many studies

investigate different aspects of bank efficiency, profitability, and competitiveness, and the

scope of these studies is expanding. The condition of a bank's assets is a key predictor of

potential bankruptcy, and it can have an impact on efficiency and stability. that the literature

reports that nonperforming loans (NPLs) have a detrimental impact on a bank's efficiency and

stability because they degrade the valuation of the bank's properties (Partovi & Matousek,

2019). When it comes to GDP and liquidity, Liquidity is a recurrent theme. The period of
economic growth determines the liquidity ratio concerning total reserves and deposits. A low

rate of liquidity in the banking system is associated with higher GDP growth (Ahamed,

2021). Further, the most often used metric for macroeconomic indicators is GDP, which is

used to determine how external variables impact banking liquidity risks. Long-term deposits

are attracted by economic inflation, which decreases the holdings of liquid assets. As a result,

GDP growth is predicted to be positively correlated with liquidity risks (Ahamed, 2021).

National banks have traditionally used the exchange rate targeting regime to execute

monetary policy; but, for nearly three decades, they have favored the inflation targeting

regime. Price stability is a prerequisite for maintaining steady economic growth and full

employment, while high inflation is harmful in the long run. Central banks use the IT regime

to keep rates under check by setting inflation targets (Bekareva et al., 2019). The rate of

inflation, in principle, has a negative impact on third-party funds. When inflation is high,

consumers are less likely to invest in funds. As a result of the influence of inflation, the costs

of products and services in general rise. Besides that, because of the high rate of inflation,

capital owners continue to spend their money on fixed assets such as properties, homes, and

another real estate. As a result, inflation affects the economic market condition, which is

typically measured by the percentage rise in price rates over the previous financial year

(Doktoralina & Nisha, 2020). As a result, if inflation is high, the community's disposable

income will begin to decline, leaving people less able to use banks.

Inflation reduces debt repayment and discourages investment because the currency is worth

more now than it was in previous years, and thus inflation impacts the liquidity of

commercial banks. The rate of inflation has a negative effect on banks' liquidity positions

(Assfaw, 2019). As a result, during periods of inflation, the living costs will increase,

deposits will be decreased, and liquidity will suffer as a result. On the opposite, it has a

beneficial effect on bank liquidity (Ahmad & Rasool, 2017).

Besides, the gross domestic product (GDP) is the most important macroeconomic indicator of

an economy's progress (GDP). GDP growth has a substantial negative impact on NPLs. This

is because rising GDP provides more job prospects, which raises borrowers' income levels

and, as a result, lowers NPLs (Koju et al., 2018). Moreover, managing the necessary liquidity

status and mitigating liquidity risk is critical for everyday operations because banks are

largely responsible for supplying liquidity in the financial system. Liquidity refers to a

financial intermediary's or bank's ability to maintain a constant equilibrium by effectively

handling inflows and outflows (Ahamed, 2021). The imbalance between the demand and

supply of funds will cause liquidity risk.

Pakistan is a developing country (Reference), its economy mostly depends on the banking

sector(reference). As a result of this research’s findings on NPL, ROA and GDP, and bank

credit, the private sector might help in restructuring the better policies and regulation for the

banking sector. While Pakistan's banking sector is not yet mature, it has the potential to use

proactive strategies and adapt to any situation, which is why Pakistan's banks have a bright

future ahead (M. J. Khan et al., 2020).

Problem statement

This research is an attempt to observe the effect of NPL Financial Leverage, Return on Assets,

Bank Efficiency (cost-to-income), Gross Domestic Product (GDP), and Inflation on Liquidity

Risk. Enough prior research has been conducted on the NPL and financial stability, but in the context

of Pakistan, little research work has been done on the NPL of banks in Pakistan.

Not all bank loans are risk-free; some of them have a high level of risk and can adversely

affect the bank's sustainability. Credit quality must be maintained. One of the most terrifying

forms of credit danger is the banking credit squeeze, where a large number of non-performing

loans can be extremely damaging to a bank (Wood & Skinner, 2018). System-wide NPL

issues may have a detrimental effect on banking stability, thus jeopardizing a country's
development prospects. The bad loan problem prevents banks from extending credit to the

rest of the economy. To begin with, their profitability declines as a result of lower profits

from bad assets (Koskei, 2020). Furthermore, since banks with large NPLs have little

capacity to expand new credit, NPLs dampen new lending. All in all, banks with high NPLs

have low profitability and expansion and resolving these issues will take a long time

(Constâncio, 2017). NPLs threaten to stifle interest income, limit investment opportunities,

and trigger liquidity problems in the financial system, resulting in bankruptcy and banking

financial turmoil, as well as a poor economic system (Vouldis & Louzis, 2018). Increased

non-performing loans could reduce financial returns while also lowering capital and raising

the banks’ risk profile, potentially leading to financial turmoil.

Significance of the study

This study contributes to existing research in several ways, both realistically and

theoretically. This study considers whether commercial banks operating in Pakistan are

effective, as well as the macro and micro regulatory environment. The contribution of this

research is that it has provided fresh concepts about how investors should make investment

decisions that can maximize returns while reducing costs. Also, the research examines a

representative group of commercial banks from a more recent time frame, presenting the

most relevant and up-to-date analytical data. The research has further shed light upon the

impact of Non-Performing loans, Financial Leverage, Return on Assets, Bank Efficiency

(cost-to-income), Gross Domestic Product (GDP), and Inflation on Liquidity Risk. The

results would certainly help researchers, investors, and practitioners achieve their goals.

Besides, this study aims to help in the growth of Pakistan's banking sector. Also, the study

will allow academics and practitioners to make significant changes in the Banking Sector of

Karachi, Pakistan. This research can also assist practitioners in determining the long-term

impact of Investment Decisions on investors. Moreover, the results can help establish a
framework for estimating and assessing budgetary variables in profitability analysis and

credit risk, which is an important part of a central bank's financial stability unit's research.

Finally, because the vast majority of research on this topic has been undertaken in developed

countries, academics and practitioners can gain even more insight from this study, which is

being conducted in a developing country, Pakistan.

Scope of the study

This research aims to investigate the impact of Non-Performing loans, Financial Leverage,

Return on Assets, Bank Efficiency (cost-to-income), Gross Domestic Product (GDP), and

Inflation on Liquidity Risk in the Banking (Conventional) Sector of Pakistan. The

independent variables are Non-Performing loans, Financial Leverage, Return on Assets, Bank

Efficiency (cost-to-income), Gross Domestic Product (GDP), and Inflation while Liquidity

Risk is the dependent variable. The study uses annual Reports and financial Statements of the

banks and the time period ranges from 2009 to 2020. The study considers all commercial

banks working in Pakistan for a period of 10 years i.e., from 2010 to 2020. panel in nature. nd

the data of macroeconomic variables of Pakistan is collected from the official website of the

World Bank.

Organization of the thesis

The thesis is comprised of five chapters. Chapter 1 of the thesis includes the Introduction,

which consists of the context, problem statement, purpose of the analysis, research questions,

significance, and limitationsTthe second chapter consists of Literature review comprising of

the theoretical background, hypothesis development, empirical studies, and conceptual

frameworkChapter 3 (Methods) covers the data and the methodology Chapter 4 concludes the

findings of the studyThe conclusions, policy implications, limitations and future

recommendations are addressed in chapter 5.

 CHAPTER 2

LITERATURE REVIEW

Theoretical Background

Bad management theory

Berger and DeYoung (1997) first proposed the bad management theory, which states that in

response to an uptick in non-performing loans caused by adverse selection, bank management

appears to devote more energy to handling and tracking bad loans. In the long term, this

means that operating costs would rise more than interest revenue, resulting in a higher cost-

to-income ratio. As a result, a higher cost-to-income ratio indicates poor bank management in

terms of loan underwriting, supervision, and control (Muratbek, 2017).

In the one hand, the bad management theory claims that non-performing loans impair cost

effectiveness when non-performing loans are affected by external incidents. As a result of the

increased operational costs associated with dealing with these issue loans, the bank's

productivity suffers. These additional running expenses may be attributed to a variety of

factors, including the control of indebted creditors and the value of collateral, as well as the

costs of seizing and disposing of collateral in default. As a result of this theory, we foresee a

decrease in cost-effectiveness as the number of non-performing loans rises (Podpiera &

Weill, 2008).

The “bad management” theory, on the other hand, suggests that cost efficiency has a bearing

on nonperforming loans when bad managers do not effectively track loan portfolios (Podpiera

& Weill, 2008). The central point is that bad management raises the risk of a bank failing.

Indeed, due to a lack of loan appraisal capabilities or an insufficient allocation of resources to

loan supervision, inefficient managers do not properly track loan portfolio management. As a
result, the number of non-performing loans rises. As a result, this theory suggests that lower

productivity has a favorable impact on non-performing loans (Podpiera & Weill, 2008).

Moreover, Low calculated cost-effectiveness, according to this theory, is a symptom of weak

senior management practices, which extend to all day-to-day activities and loan portfolio

management (Rajha, 2016). Managers who aren't up to scratch don't keep a close eye on and

monitor their running costs, which shows up in poor calculated cost performance almost

instantly. After some time has passed, the loan portfolio gets seasoned, and delinquencies

continue to grow, poor underwriting and reporting procedures contribute to a large number of

nonperforming loans (Rajha, 2016). Low-cost productivity is therefore predicted to arise

before or trigger higher nonperforming loans under the bad management theory. Since this

hypothesis predicts the reverse temporal order to the bad luck hypothesis, both hypotheses

assume that nonperforming loans would have a negative impact on cost performance (Rajha,

2016).

Bank Size

 The bank Size is a critical factor in determining its assets. The total assets of a company will

be used to determine its size (Yulianti et al., 2018). Banks with big deposits have a lot of

loans to distribute, therefore, they can lower the interest rate. Low-interest rates would make

lending payments easier, reducing the number of problematic debts that banks will have to

deal with. The total assets owned by a bank will be used to determine its size. When the

outcomes of their operations are closely monitored, banks with significant reserves have the

potential to produce larger income. Bank size has a favorable and partly meaningful impact

on NPLs, according to studies conducted by Yulianti et al. (2018). Though Dewi and

Ramantha (2015) discover a different finding, namely that bank size has a negative impact on

non-performing loans. The more money spent on an asset, the stronger the corporation's

assets. The cumulative assets held by the company are then used to make the determination.
A big bank has a high overall asset base, as well as funds liquidity, credit risk management,

and an effective assessment mechanism (Yulianti et al., 2018).

Return-on-Assets (ROA)

The net income to total assets ratio (ROA) is used to determine a bank's profitability (Rajha,

2016). A high return on assets (ROA) indicates that the banks' financial status is stable, and

they are not concerned with engaging in costly loans because they are under less pressure to

raise revenue. Return on Asset (ROA) depicts the company's results (return) on gross assets.

Furthermore, ROA is a more accurate indicator of a company's success because it

demonstrates how often management uses assets to produce revenue. Also, it is a metric for

determining whether or not an investment is capable of producing the desired returns

depending on the assets held (Asikin et al., 2020). Furthermore, ROA is a better indicator of a

company's success because it demonstrates how often management uses assets to produce

revenue. In simple words, the return on Asset (ROA) shows you how much money you made

from your money (asset). The return on Asset (ROA) for public corporations can vary

significantly and is highly dependent on the sector. As a result, it's better to equate ROA to a

company's previous ROA figures or a related company's ROA by using it as a comparison

indicator (Sausan et al., 2020).

Capital Adequacy Ratio (CAR)

The capital ratio (CAR) tests a bank's ability to include backup funds in the event of a

financial emergency, as well as management's ability to detect, assess, supervise, and monitor

risks that may impact capital. Banks with a strong capital base would make more money and

they are more selective in their lending channels, allowing CAR to have a favorable impact

on ROA (Swandewi & Purnawati, 2021). The capital adequacy ratio has a favorable impact

on return on assets, according to Swandewi and Purnawati (2021). CAR has a detrimental

impact on ROA, according to DAO and NGUYEN (2020). Since CAR, as a capital ratio, is a
deciding factor for the activity of banking activities in raising funds and funneling them back,

it may be used as a mediating variable between the impacts of NPL on ROA. CAR is a

measure of a bank's willingness to deal with unforeseen uncertainties (Anggari & Dana,

2020). Regulatory authorities use CAR to assess a bank's capital adequacy and conduct stress

tests. The disadvantage of using CAR is that it would not take into account the possibility of a

bank run or what will happen in a financial crisis. Capital adequacy ratios reduce the risk of

banks going bankrupt, ensuring the quality and integrity of a country's financial system. A

bank with a high capital adequacy ratio is generally thought to be stable and capable of

meeting its financial obligations (Madugu et al., 2020).

Non-Performing Loans (NPL)

Loans that have not been returned are referred to as nonperforming loans (NPLs) (Zheng et

al., 2020). According to the IMF, a loan is deemed nonperforming if it has not generated

interest or the principal amount for at least 90 days. NPLs are an undesirable side product of

performing loans and are referred to as "financial waste" due to their negative impact on

economic development. NPL levels above a certain threshold will cause a financial crisis by

making banks bankrupt (Fallanca et al., 2021), which has a negative effect on economic

development. NPLs create confusion, which leads to banks’ lending less, which affects

overall demand. Governments in developing nations are in a tough position and must find a

solution for nonperforming loans. Furthermore, a significant amount of NPLs puts banks at

risk of failure because, regardless of their roots, they cost banks money consistently. If state

banks are required to hold these NPLs, the banking sector will lose depositor interest,

resulting in a crisis (Kabui, 2020).

Economic Growth (GDP)

The cumulative monetary or consumer value of all final goods and services manufactured

within a country's boundaries in a given period is known as GDP. It serves as a holistic

scorecard of a country's economic health because it is a general indicator of total domestic

output (Zainol et al., 2018). According to the anonymous literature reviews, there is a

negative association between real GDP and NPLs. A rise in the amount of real GDP growth

influences favorably the level of income in line with the decline in NPLs, according to the

relationship. In this case, the borrower's redemption potential is improved, effectively

resolving the bad debt problem. On the other hand, a collapse of the economy; a fall or

negative increase in GDP contributes to unpaid debts (Zainol et al., 2018). High GDP growth

indicates that the economy is doing well and that citizens' wages are rising. Growing profits

show the debts can be repaid. Annual GDP growth will imply that bank loans will continue to

work efficiently (Leka et al., 2019). GDP is a measure of a country's economic health that is

used to approximate its size and rate of growth. GDP can be measured in three different

ways: expenses, production, and income. To provide more information, it can be modified for

inflation and population. Despite its shortcomings, GDP is an important mechanism for

governments, investors, and companies to use when making strategic decisions (Mazreku et

al., 2018).

Inflation

Inflation is the gradual loss of a currency's buying power over time. The rise in the stated

amount of a collection of chosen goods and services in an economy over time can be used to

calculate a quantitative measure of the rate at which buying power declines. The rate of

inflation and the rate of interest will affect lenders' ability to repay their debts. For instance, if

the country is experiencing high inflation, creditors can find it difficult to repay their loans

due to rising capital costs (Zainol et al., 2018). Inflationary pressures would make borrowing

more expensive, lowering the quality of loan diversification. Higher inflation reduces

household income and, as a result, affects debtors' ability to pay. According to an analysis of

Albania's banking system, when inflation is high for some time, the amount of nonperforming
loans in the country decreases (Coibion et al., 2020). Since a high rate of inflation will reduce

the number of loans, the value of debt will decline and loan servicing will become simpler.

As a result, a high degree of inflation would boost borrowers' credibility. The Consumer

Price Index (CPI) and the Wholesale Price Index (WPI) are the two most widely used

inflation indices (WPI). Many with tangible assets, such as real estate or stocked goods, can

benefit from inflation because it increases the value of their holdings. People who keep cash

may dislike inflation because it reduces the value of their cash (Ghauri et al., 2019).

Relationship between bank size and non-performing loan

Under the presumption of constant returns to scale, Partovi and Matousek (2019) investigate

looked at technological and allocative efficiencies in Turkish banks between December 2002

and December 2017. Study used a modified version of the Data Envelopment Analysis

(DEA) technique, which utilizes a directional distance model to provide efficiency estimates,

with an emphasis on Non-Performing Loans (NPLs) as a negative output. In addition, using

panel data and quantile regressions, the study measures the factors that influence

performance. The findings reinforced the theory that nonperforming loans have a negative

effect on technological performance, confirming the “bad management” hypothesis in the

banking sector. The productivity of Turkish banks varies depending on the ownership

structure in place, according to the study. According to the results of the study, drastic

regulatory procedures should be enforced in order to preserve and boost banks' financial

stability, as well as reduce their risk of failure and improve their profitability.

Rachman et al. (2018) aim to shed light on bank-specific factors that influence loan default

problems in developing countries with significant banking sectors. The panel data sets of 36

commercial banks listed on the Indonesian Stock Exchange from 2008 to 2015 were

examined in this report. The number of NPLs is negatively influenced by the profitability and

credit growth of Indonesian banks, according to a fixed effects panel regression model.
Furthermore, banks with greater profitability have been seen to have lower nonperforming

loans (NPLs) because they can afford good credit management practices. Similarly, banks

with faster credit growth have lower NPLs because they engage in more specialized loans

and, as a result, have stronger credit management structures. These results suggest that banks

can preserve their profitability and raise, rather than decrease, their credit supply to debtors in

order to reduce loan defaults, which may deteriorate banks' asset quality.

Ravikumar et al. (2020)investigate the relationship between non-performing assets and

factors such as credit risk, asset quality, capitalization, and bank scale. The return on assets

(ROA) and return on equity (ROE) is used to assess non-performing assets. Six commercial

banks listed on the Muscat Securities Exchange were included in this analysis. The research

was carried out between 2010 and 2019. The findings revealed that the independent variables

had an effect on both ROA and ROE. This means that before offering loans, bankers should

exercise extreme vigilance. If a bank's non-performing loans rise, it impacts not just its

performance but also its stability. As a result, it is the banks' duty to assess the credit

worthiness of creditors in order to limit non-performing assets to the bare minimum.

For a sample of MENA banks from 2004 to 2017, Boussaada et al. (2020) examine the

nonlinear association between liquidity risk and nonperforming loans (NPLs). The results of

the Panel Smooth Transition Regression model show that there is a threshold impact in the

relationship between liquidity risk and NPLs. More importantly, the analysis discovered that

the loan-to-deposit ratio and liquidity risk also greatly raise the amount of nonperforming

loans (NPLs). However, the NPLs are strongly and favorably associated with the liquidity

ratio, as are net assets to deposits and short-term financing ratio. NPLs are also more

vulnerable to bank performance, bank capital, bank size, the international financial crisis, and

the rate of inflation, according to the report. However, not below nor above the thresholds,
the influence of ownership concentration and board characteristics was found to have a major

effect.

Alexandri and Santoso (2015) investigated the impact of internal and external bank factors on

the level of non-performing loans (NPL) in Indonesia's Regional Development Bank (BPD).

This is a comprehensive study that used panel data regression analysis and covered the years

2009 to 2013. The study's focus was on 26 banks. Panel data models Random Effects Models

were being used as estimation models. According to the findings of this report, a bank's level

of efficiency (ROA) has a positive significant impact on NPL. SIZE and GDP have an

insignificant but negative effect on the NPL. The NPL was not affected by CAR or inflation

in a significant way.

Yulianti et al. (2018) looked at the impact of capital adequacy and bank size on non-

performing loans in Indonesian public banks from 2012 to 2016. The secondary data for this

study came from Bank Indonesia's Financial Statements. This analysis was a hypothesis-

testing experiment. The study used a purposive sampling process, and the final samples

consisted of 81 samples. To evaluate the hypotheses, multiple linear regression analysis with

panel data estimation was used. The findings suggested that non-performing loans are

influenced by capital adequacy ratios, bank size, and loan-to-deposit ratios all at the same

time. Partially, the findings suggested that capital adequacy ratio has a positive impact on

nonperforming loans, while bank size has a negative impact on nonperforming loans, and

loan to deposit ratio has a negative impact on nonperforming loans.

Relationship between CAR and NPL

Swandewi and Purnawati (2021) examined the impact of non-performing loans on ROA

using the capital adequacy ratio as a mediator. With a complete sample of 24 banks, this

study is performed at banking companies listed on the Indonesia Stock Exchange. The data

was gathered by looking at the company's financial records. Path analysis was used as the
analysis method. The findings revealed that non-performing loans and capital adequacy ratio

had a detrimental and significant relationship. Return on assets has a favorable and

substantial association with capital adequacy ratio. Return on assets has a detrimental and

significant association with non-performing loans. The Capital Adequacy Ratio is seen to

mediate the impact of non-performing loans on return on assets, according to the findings of

the study.

Farooq et al. (2019) investigated the factors that influence non-performing loans in the Gulf

Cooperation Council region. This study examined the key factors that influence non-

performing loans in the banking sector in this area, taking into account both bank-specific

and macroeconomic factors. Non-performing loans are a severe problem that requires action,

according to the results of the model developed by the bad management theory, and bank

profitability as measured by Return on Average Assets has a major and negative impact on

Non-Performing Loans. This suggested that banks in this area have a greater ability to

maximize return by leveraging liquidity and actively controlling funds donated by

shareholders.

Over the period 1991-2015, Wood and Skinner (2018) investigated the bank-specific and

macroeconomic determinants of non-performing loans in Barbados' commercial banks. The

empirical findings show that bank-specific factors such as return on equity, return on assets,

capital adequacy ratio, and loan to deposit ratio are significant determinants of non-

performing loans, whereas macroeconomic variables such as GDP inflation, unemployment,

and interest rate are also significant determinants.

Using both static and dynamic panel estimation methods, Koju et al. (2018) aimed to analyze

the macroeconomic and bank-specific determinants of non-performing loans (NPL) in the

Nepalese banking system. The research examined 30 Nepalese commercial banks from 2003

to 2015, using seven bank-specific and five macroeconomic variables to measure the effect of
banking management and economic indicators on nonperforming loans. NPLs have a

significant positive relationship with the export-import ratio, inefficiency, and asset size, but

a negative relationship with GDP growth rate, capital adequacy, and inflation rate, according

to the results. The findings of the empirical study point to low economic growth as the

primary cause of high NPLs in Nepal, implying that for a stable financial system and

economy, efficient management and effective financial policies are necessary.

Nugroho et al. (2021) conducted this analysis to see whether the independent variables of

Allowance for Impairment Losses, NPL, and the sum of Third Party Funds (TPF) have some

impact on the dependent variable Capital Adequacy Ratio, either partly or concurrently. The

banks studied in this analysis are the central government-owned Bank Mandiri, Bank Negara

Indonesia, Bank Rakyat Indonesia, and Bank Tabungan Negara from 2011 to 2018. The

partial allowance for credit losses had no substantial impact on the bank's capital adequacy

ratio, according to the findings. Non-performing loans (NPLs) and third-party funds (TPFs)

have had a minor impact on the bank's capital adequacy ratio. The three independent

variables have a major impact on the dependent variable i.e. the capital adequacy ratio, at the

same time.

Between 2014 and 2018, Serrano (2021) examined the effect of the stock and flow of non-

performing loans on the lending practices of a sample of 75 European banks using a dataset

comprised of bank-specific details and country aggregates. Higher rates of non-performing

loans, when combined with other factors, are linked to slower growth rates of performing

loans. This influence holds across many econometric specifications and is more noticeable

for banks with poorer performing loan growth rates. Similarly, study’s econometric research

revealed that banks with lower non-performing loan rates are more likely to lend to the real

economy, an impact that is particularly strong at the right tail of the distribution.

Relationship between ROA and NPL

The performance of the Vietnamese banking sector from the start of the Global Financial

Crisis in 2008 to 2016 was assessed in this study by Le et al. (2020). According to a report,

the technological efficiency of the Vietnamese banking system decreased during the

liberalization period. However, there is still an efficiency gap between banks with different

ownership structures, implying that privatization is essential for improving performance.

According to the report, medium-sized banks are more productive than large and small banks.

This result means that the ongoing consolidation scheme that encourages banks to expand

their scale by capital build-up should be carefully considered.

Over the period 2011–2019, Mohamad and Jenkins (2020) looked at the effect of country-

wide corruption on banks' credit risk in 16 countries in the region. The findings suggested a

positive substantial correlation between corruption and bank non-performing loans by using

the interactive fixed effects calculation methodology on a model of both macro and bank-

specific variables and data from 197 banks (NPL). Also in banks with high risk aversion,

corruption was found to have a favorable relationship with credit risk.

M. A. Khan et al. (2020) Studied the factors that influence nonperforming loans (NPLs) in

the banking sector in Pakistan from 2005 to 2017. The banking sector (i.e., commercial

banks) listed on the Pakistan Stock Exchange from 2005 to 2017 is included in the sample.

The estimations were made using STATA software and regression modelling with random

and fixed effects. The results revealed that operating efficiency and profitability metrics have

a negative but statistically meaningful relationship with NPLs, while capital adequacy and

revenue diversification have a negative but statistically negligible relationship with NPLs.

Irawati et al. (2019) conducted an analytical test on GCG variables as well as other

regulatory-driven factors such as Capital Adequacy Ratio (CAR), Non-Performing Loans

(NPL), and bank size. The data is based on secondary data from 30 banks that are registered

in the BEI for the years 2011-2015. Then, using analysis methods such as Eviews, it was
discovered that Capital Adequacy Ratio, Managerial Ownership, and Bank Size all have a

positive impact on financial performance, while NPL has an insignificant negative impact,

and Committee Audit has a positive but insignificant impact on banking financial efficiency.

Zheng et al. (2020) conducted this study to see how industry-specific and macroeconomic

determinants of non-performing loans (NPLs) affected Bangladesh's entire banking system.

The findings of this study indicate that both industry-specific and macroeconomic influences

have a substantial impact on NPLs. Bank loan growth, net operating profit, and deposit rates

all have statistically significant negative effects on NPLs, while bank liquidity and lending

rates have a significant positive relationship with NPLs. Rise in the gross domestic product

(GDP) and unemployment are two macroeconomic indicators that have a negative

relationship with NPLs. Domestic credit and exchange rates, on the other hand, have a

significant favorable relationship with NPLs.

Using the framework GMM dynamic panel data estimator, Bayar (2019) investigated the

macroeconomic, structural, and bank-specific factors behind nonperforming banking loans as

a predictor of banking sector functioning in emerging market economies from 2000 to 2013.

Nonperforming loans were negatively influenced by economic growth, inflation, economic

independence (institutional development), return on assets and equity, regulatory capital to

risk weighted assets, and non-interest income to total income, while they were positively

affected by unemployment, public debt, credit growth, lagged prices of nonperforming loans,

cost to income ratio, and financial crises according to the findings of the dynamic panel

regression analysis.

Relationship between macroeconomics factors and NPL

From 2005 to 2014, Umar and Sun (2018) examined macroeconomic and banking-industry-

specific determinants of non-performing loans for Chinese banks. The coefficients of

independent variables were measured using the method GMM estimation methodology. GDP
growth rate, effective interest rate, inflation rate, foreign exchange rate, bank form, bank risk

taking activity, ownership concentration, leverage, and credit quality are all significant

determinants of NPLs in Chinese banks, according to the study. Furthermore, the factors that

influence NPLs vary between listed and unlisted banks. NPLs of listed banks are influenced

by GDP, bank risk-taking activity, and credit quality. Unlisted bank NPLs, on the other hand,

are influenced by GDP, inflation, foreign exchange rate, bank risk taking, leverage, and credit

rating.

Mazreku et al. (2018) conducted this analysis to demonstrate the impact of macroeconomic

factors on the level of NPL in transition countries. Factors such as GDP growth, inflation,

unemployment, and export growth will be weighed, with a number of econometric models

and parameters, including Fixed and Random Effects Models, and Arellano-Bond Dynamic

Panel estimation, used to ensure robustness. For a study of transition countries between 2006

and 2016, researchers used data from the World Bank and the International Monetary Fund.

GDP growth and inflation are both negatively and strongly associated with the degree of

NPLs, while unemployment is positively correlated with NPLs, according to the findings.

The function of GDP rise, inflation, unemployment, Money Aggregate M2, Exchange rate,

and loan interest rates in the level of NPLs was statistically checked in this study by Leka et

al. (2019). The information was gathered from the World Bank and the Bank of Albania's

databases. This link was found to be negatively correlated with GDP growth, which began to

lift after 2013, and positively correlated with M2, which has seen a slight rise in recent years;

and interest rates on loans, which have remained low in Albania since 2001. These

macroeconomic factors should be taken into account by Albanian authorities when

developing their plans and policies, according to the study.

Using annual data from 2005 to 2016, Kjosevski and Petkovski (2020) explored selected

macroeconomic and bank-specific determinants of non-performing loans (NPLR) for a panel

of 21 commercial banks from the Baltic States (Estonia, Latvia, and Lithuania). The most

significant macroeconomic factors driving NPLR, according to empirical findings, were GDP

growth, public debt, inflation, and unemployment. In terms of bank-specific determinants,

study discovered that the equity-to-total-assets ratio, return on assets, return on equity, and

gross loan growth all have an impact on the sum of NPLR.

The OLS, fixed effects, Arellano and Bond GMM, and VAR models were used by Abdelbaki

(2019) to empirically analyzed the macroeconomic determinants of non-performing loans in

the Gulf Cooperation Council (GCC) from 1998 to 2016. Non-oil GDP growth, domestic

credit to private sector to GDP ratio, and inflation rate all have negative effects on non-

performing loans, according to the key findings. Non-performing loans are positively affected

by interest rates and financial crises. The results also show that in the short term, the domestic

credit-to-private-sector-to-GDP ratio is the most important factor influencing non-performing

loans. Although interest rates are the most important factor influencing the scale of non-

performing loans in the long term, they were growing at a higher pace prior to the financial

crisis.

Zainol et al. (2018) investigated the macroeconomic factors that influence non-performing

loans (NPLs) in Malaysian banking and financial institutions. According to the findings, GDP

is significant and has a negative impact on NPLs, while BLR and ID are significant and have

a positive impact on NPLs, as predicted. Nonetheless, contrary to our expectations, INF

resulted in a negligible relationship with NPLs. The study concludes that Malaysian

macroeconomic variables such as GDP, Base Lending Rate (BLR), Inflation (INF), and

Household Income Distribution influence the level of NPLs in the country (ID).
Summary of Literature Reviews

Construct Definitions Source

Bank size is the ownership of assets by banks
represented by this ratio. Banks with a large fund (De Haan &
Bank Size
base will provide more financial resources at a Poghosyan, 2012)
lower cost.
It is used to determine a bank's profitability.  A
high ROA indicates that the banks' financial status
(Rajan, 1994;
ROA is stable, and they are not concerned in engaging in
Rajha, 2016)
costly loans because they are under less pressure to
raise revenue.
It is a calculation that compares a bank's accessible (Bateni et al.,
CAR
assets to its risk-weighted credit exposures. 2014)
Loans that have not been returned are referred to
as nonperforming loans (NPLs). According to the
NPL IMF, a loan is deemed nonperforming if it has not (Rajha, 2016)
generated interest or the principal amount for at
least 90 days.
The cumulative monetary or consumer value of all
final goods and services manufactured within a
country's boundaries in a given time span is known (Soytas & Sari,
GDP
as GDP. It serves as a holistic scorecard of a 2003)
country's economic health because it is a general
indicator of total domestic output.
Inflation is the gradual loss of a currency's buying
power over time. The rise in the stated amount of a
collection of chosen goods and services in an
Inflation (Olive, 1990)
economy over time can be used to calculate a
quantitative measure of the rate at which buying
power declines.

Research Hypotheses

Following are the hypotheses of the study:

H1: There is a positive/ negative effect of bank size on NPL. (write all hypothessi in this

manner.

Bank size has a significant effect on NPL.

H2: CAR has a significant effect on NPL ( what significant effect, positive or negative).

H3: ROA has a significant effect on NPL.

H4: GDP has a significant effect on NPL.

H5: Inflation has a significant effect on NPL.

 CHAPTER 3

METHODOLOGY

Research approach and type

The current study approach has been determined as quantitative approach. The quantitative

approach has been employed on the basis of explanation of the phenomenon as well as

confiding the variables distinction. The applicability of the quantitative research approach is

determined suitable based on the primary induction that follows the scientific methods,

focused on the hypothesis and theory testing, relatively (Antwi & Hamza, 2015).

Furthermore, the research type is explanatory which is determined to be applicable with the

quantitative approach as it provides concurrency in the testing of hypothesized variables

seems constructive (Triwahyuni & Ekowati, 2017).

Research design

The design of the current study has been determined to be correlational. As mentioned by,

Frazier (2013) the correlational design provides concurrent investigation of the relationship

between the variables comprised in the study. Also the emphasis of the correlational design

helps to determine whether the variables are interrelated (Bloomfield & Fisher, 2019).

Sample and population

The study uses secondary data of financial information from the annual reports and financial

statements of the banks and financial statement analysis (FSA) reports published by State

Bank of Pakistan. In this context, the study uses data for the period of 12 consecutive years

from 2009 to 2020 while data was based on annual series comprising of total 156

observations. The study uses 13 conventional private banks mentioned in Appendix 1. ( take

this table to the end of thesis before references).

 Table 1: List of Sample Banks
No. Bank Names
1 ALLIED BANK LTD.
2 ASKARI BANK LTD.
3 BANK AL-HABIB LTD.
4 BANK ALFALAH LTD.
5 FAYSAL BANK LTD.
6 HABIB BANK LTD.
7 HABIB METROPOLITAN BANK LTD.
8 JS BANK LTD.
9 MCB BANK LTD.
10 SILKBANK LIMITED
11 SONERI BANK LTD.
12 SUMMIT BANK LTD.
13 UNITED BANK LTD.

Econometric model

The study uses the following model to investigate …………

(NPL)it = αit + β1 (SIZE)it + β2 (CAR)it + β3 (ROA)it + β4 (GDP)it + β5 (INF)it + ɛit equation (1)

In the above econometric model, NPL represents non-performing loans of ith bank at a

specific time t and it is the endogenous series in the model. In regards to bank-specific

variables, SIZE represents banks size measured by natural log of total assets of ith bank at a

specific time t, CAR represents capital adequacy ratio of ith bank at a specific time t, and

ROA represents return on assets of ith bank at a specific time t. In regards to macroeconomic

indicators, GDP represents economic growth (measured as an annual percentage GDP

growth) of Pakistan at a specific time t and INF represents inflation (measured as consumer

price index, annual percentage) of Pakistan at a specific time t. Lastly, α represents constant

term, β represents regression coefficient for each exogenous series and ɛ represents

error/residual term.

Conceptual model
 Figure 1: Research Model

Statistical techniques

Data analysis for the current study has been carried out through descriptive statistics as well

as pooled regression. Descriptive statistics are used to define the features of the data in the

study and is considered effective with the correlational research design (Wang et al., 2019).

Furthermore, the data analysis carried out with pooled OLS is based on the model estimation

through panel data which is determined to have better formulation of results and statistical

review (Mark & Sul, 2011; Stimson, 1985).

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