Are NPAs really interlinked with capital, efficiency, and priority sector lending? An empirical study on Indian SCBs

This paper attempts to probe the prevalence, if any, of interrelationships between NPAs, capital, cost efficiency and priority sector lending among Indian scheduled commercial banks (SCBs). The study was based on secondary time series information for 22 years (from 1995–96 to 2016–17) on 18 bank-specific variables in respect of 65 banks (26 in public sector, 18 in private and 21 foreign banks). For each of the banks, Cost Efficiency Scores (used as an additional variable in the study) were estimated at various points in time through SFA-based translog cost function. Besides, two dummy variables (DMYP for Private Banks and DMYF for Foreign Banks) were also considered so as to study differentials among the three types of banks. Interlinkages among NPAs, Capital Adequacy Ratio (CART), Cost Efficiency (CEFF), and Priority Sector Lending (PSTL) were examined through simultaneous equations modelling with SURE approach of estimation under panel data framework (via R-programming).

As per the main findings, PSTL had a direct influence on NPAs, possibly owing to higher likelihood of the loans in priority sector (specifically, agriculture & allied activities) to get transformed into NPAs. On the other hand, each of CEFF and CART induced an indirect effect on NPAs, which implied that the banks associated with severe extent of bad loans would have to incur more cost in handling and managing collection process of NPAs. Consequently, the increased cost would result in depletion of the capital as also the cost efficiency of the banks. Therefore, serious efforts need to be made to somehow check the rising menace of the problem of rising NPAs. Curtailment of the risk weighted assets (which may also delimit erosion of banks’ capital) may be one of the steps in the right direction.