Finance dissertation on the impact of credit risk on commercial bank’s performance a case study of southeast asian countries

Dissertation submitted in partial fulfillment of the Requirement for the MSc in Finance FINANCE DISSERTATION ON THE IMPACT OF CREDIT RISK ON COMMERCIAL BANK’S PERFORMANCE: A CASE STUDY OF SOUTHEAST ASIAN COUNTRIES LUONG QUYNH ANH ID No: 21071825 Intake SUPERVISOR: DR TRAN MANH HA Banking Academy of Vietnam September 2022 Tai ngay!!! Ban co the xoa dong chu nay!!! 17014126226921000000 EXECUTIVE SUMMARY The financial system is mostly dominated by banks and banks play a vital influence in the economy of countries around the world The financial crisis and worldwide economic recession that started at the end of 2007 in the US had a huge impact on the whole world, substantially hurting the business position of commercial banks As a result, many banks had to declare bankruptcy due to the pursuit of immediate profits without ensuring the operational safety of the banking system, which has raised alarm bells for the credit risk management mechanism This dissertation used the fixed effect model and random effect model with 12-year data (from 2010 to 2021) from commercial banks of 09 countries in Southeast Asia evaluate impact of credit risk on banking performance This dissertation contributes more empirical evidence and provides some useful information on the impact of credit risk on banking performance, thereby ensuring the science of policy recommendations ACKNOWLEDGEMENTS Prior to anything else, I would want to express my thanks to my supervisor, Dr Tran Manh Ha, for his unwavering support of my master's studies and research, as well as for his patience, encouragement, excitement, and vast knowledge His assistance was invaluable during the research and writing of this dissertation For my master's studies, I could not have asked for a greater supervisor and mentor In addition to my supervisor, I would like to extend my deepest and most sincere gratitude to all the teachers and friends who have provided me with highly useful information Without their instructions and assistance, it would not have been possible to complete this dissertation successfully Lastly, I'd like to thank my family and loved ones, who have always encouraged and motivated me to complete this dissertation Hanoi, 18th September, 2022 Luong Quynh Anh STATUTORY DECLARATION I affirm that this is the outcome of my own investigation These are analyses, evaluations, and outcomes based on the fundamentals of the discipline, the information sources, and the data gathered from the key sources of business reports Please be assured that the topic's material has been acknowledged and the citation information has been supplied I accept full responsibility for this Council and School commitment Hanoi, 18th September, 2022 Luong Quynh Anh iii TABLE OF CONTENTS CHAPTER 1: INTRODUCTION Motivation Research objectives and questions Object and scope of research Research Methodology Dissertation structure CHAPTER 2: LITERATURE REVIEW 11 2.1 Credit risk 11 2.1.1 Theories of credit risk 11 2.1.2 The factors affecting credit risk 12 2.2 Performance of commercial banks 14 2.2.1 Theories of bank performance 14 2.2.2 The concept of commercial bank business efficiency 15 2.2.3 Methods to measure the performance of banking business 19 2.3 Impact of credit risk on banking performance 21 Empirical study on the relationship between credit risk and bank performance 21 2.3.1 The view that credit risk increases the efficiency of banking operations 22 2.3.2 The view that credit risk reduces the efficiency of banking operations 22 CHAPTER 3: RESEARCH METHODOLOGY 26 3.1 Research Methodology 26 3.1.1 Pooled OLS classical regression model with panel data 26 3.1.2 Fixed effects model (FEM) and random effects model (REM) 27 3.3 Research model of the impact of credit risk on banking performance 29 3.3.1 Research models 29 3.3.2 Interpret variables and hypotheses 30 CHAPTER 4: ESTIMATION RESULTS AND MAJOR FINDINGS 36 4.1 Descriptive statistics 36 4.2 Correlation matrix 37 4.3 OLS, FEM and REM model regression results 38 4.4 Estimation method testing 43 4.4.1 Hausman test 43 4.4.2 Multicollinearity test 44 4.4.3 Heteroscedasticity test 45 4.4.4 Wooldridge test for autocorrelation 46 4.5 FGLS test (Feasible generalized least squares) 48 4.6 Model results 50 Summary of chapter 51 CHAPTER 5: CONCLUSIONS AND POLICY RECOMMENDATION 52 REFERENCES 55 APPENDIX 63 LIST OF TABLES Table 1: Symbols and definitions of variables 34 Table 2: Descriptive statistics 36 Table 3: Correlation matrix 37 Table 4: Regression model OLS, FEM, REM dependent variable ROA 38 Table 5: Regression model OLS, FEM, REM dependent variable ROE 40 Table 6: Regression model OLS, FEM, REM dependent variable NIM 41 Table 7: Hausman test for ROA 43 Table 8: Hausman test for ROE 43 Table 9: Hausman test for NIM 44 Table 10: VIF test for multicollinearity 44 Table 11: Breusch and Pagan Lagrangian Test for the ROA model 45 Table 12: Breusch and Pagan Lagrangian Test for the ROE model 46 Table 13: Breusch and Pagan Lagrangian Test for the NIM model 46 Table 14: Wooldridge test for ROA 47 Table 15: Wooldridge test for ROE 47 Table 16: Wooldridge test for NIM 48 Table 17: FGLS test for ROA, ROE and NIM 49 CHAPTER 1: INTRODUCTION Motivation Theoretical background Empirical studies related to the assessment of bank performance with the impact of the credit risk variable have been widely performed in different contexts over the past several decades In commercial banks, credit operations carry the most risks Credit risk occurs when borrowers fail to repay their loans to the bank when due, this affects the operation or even determines the existence or bankruptcy of the bank In this sense, credit represents qualitative factors about a bank's financial strength (Duttweiler, 2011) Credit risk is the first sign that a bank is in financial trouble Credit risk not only threatens the safety of individual commercial banks, but also concerns the safety of the entire banking system (Eichberger and Summer, 2005) Currently, there have been many studies analyzing the relationship between credit risk and bank performance over the world While some studies find a positive effect of credit risk on profitability of banks, others show a negative relationship between credit risk and profitability of commercial banks Regression results from the panel data model show that credit risk has a positive relationship with bank performance, showing that banks in Ghana are profitable despite taking on high credit risk Boahene (2012) tested the relationship between credit risk and profitability at 06 commercial banks in Ghana from 2005 to 2009, in which return on equity (ROE) was used as the dependent variable In Vietnam, a research by Huynh Thi Huong Thao (2018) used a data sample of 35 Vietnamese commercial banks in the period from 2008 to 2017 to study financial risk factors affecting the performance of commercial banks in Vietnam by DEA (Data Envelopment Analysis) The study uses the ratio of bad debt to total outstanding loans, the ratio of provision for credit risk to total outstanding loans as independent variables of the model The results showed that the credit risk measurement variable has a positive relationship with the profitability of Vietnamese commercial banks In addition to the above studies, the researches on evaluating the efficiency of banking operations are also interested by many authors such as: Nguyen Thanh Dat (2021); Alshatti (2015), Saeed, M., & Zahid, N (2016), Hamza, S M (2017) However, at present, there is no research on the impact of credit risk on banking operations in many countries in Southeast Asia Therefore, research results need to be verified to improve reliability Practical background The financial system is largely dominated by banks (Diamond and Dybvig, 1983), banks play a significant part in the economics of countries across the world The financial crisis and worldwide economic recession that started at the end of 2007 in the US had a great influence on the whole world, seriously harming the business standing of commercial banks As a result, many banks had to declare bankruptcy due to the pursuit of immediate profits without ensuring the operational safety of the banking system, which has raised alarm bells for the risk management mechanism, especially the risk management mechanism, especially credit risk is underestimated (Moore, 2010) After the financial crisis, the Basel Committee on Banking Supervision (BCBS) published the Basel III accord to strengthen coordination, supervision and risk management in the banking industry Basel III offers numerous new ideas on capital, leverage and credit to enhance regulations on supervision and risk management The financial crisis of 2007-2008, clearly underscored the importance of credit risk and credit risk management for the operation of the financial market in general and the banking industry in particular (Bank for International Settlements, 2010; Bank for International Settlements, 2013) Banks in Southeast Asian countries, although not severely affected by this crisis, are banks safe and efficient or lucky thanks to their low level of integration into the market international finance? For Vietnam, after the financial crisis has had certain impacts, the operating environment and institutions of the banking system have made remarkable changes in terms of internal governance, organizational structure, application technology and the development of modern banking services However, not outside of the general rule, economic instability has caused many significant losses to the banking system in all aspects Since then, in turn, the instability of the banking system affects the economy and causes significant consequences (Nguyen Cong Tam and Nguyen Minh Ha, 2012) In the integration trend, the requirement to manage credit risks and ensure the efficiency of banking performance is more necessary than ever The practical context of Southeast Asian countries shows that Vietnam is one of the countries with low per capita income in the research countries of Southeast Asia, but there are too many banks , but lacks a pillar bank that can compete with other countries in the region (Nguyen Cong Tam and Nguyen Minh Ha, 2012) Therefore, studying the impact of credit risk on the bank performance the case study of Southeast Asian countries in the period 2010 - 2021 also contributes to verifying the impact of credit risk to the efficiency of banking performance in Vietnam Derived from the theoretical context and the practical context, in order to fill the research gaps; therefore, the author has chosen the topic "Impact of credit risk on commercial bank’s performance: a case study of Southeast Asian countries" for the period 2010-2021 In addition, the study combines and compares the results of case studies of Southeast Asian countries and