Determinants of Bank Non-Performing Loans in East African Countries: A Dynamic Panel Data Analysis

Abstract

Non-Performing Loans (NPLs) challenge financial stability and economic growth, yet limited research explores their determinants in East Africa. This study investigates macroeconomic, institutional, and bank-specific factors influencing NPLs using an explanatory research design and a quantitative approach. The sample includes seven East African countries with complete data (2012–2023) from the World Bank and Central Bank sources. Data analysis uses the Arellano-Bond GMM estimator to address dynamic panel data, with robustness checks made using the Blundell-Bond estimator. Model validity was assessed through Sargan tests and Arellano-Bond tests, ensuring reliable and robust results. The analysis shows that the average NPLs in East African countries were 6.9%, with lending interest rates reaching up to 60.0%. During the 12 years considered, exchange rates remained stable with only 0.1% annual change, while trade openness (69.8%) and bank capital (10.7%) reflect moderate integration and stability, emphasizing unique regional challenges and opportunities. Prior-year NPL levels positively influence current NPL highlighting variable’s’ persistence. Variables like exchange rate appreciation, regulatory quality, and trade openness were found to be statistically significantly reducing NPLs. Bank-specific factors of controlled credit growth, higher capital, and increased liquidity, were also found to reduce NPL risks. However, GDP growth and inflation macroeconomic variables showed limited effect on NPL. This study emphasizes the need for institutional strength and cautious banking practices to duly address credit risks.