Investigating the Impact of Non-performing Loans on Banking Lending Behavior: Implications for Regulatory Provisions to Non-performing Loans Reductions in the Iranian Banking System in a Bayesian Analysis

Among the various indicators of financial stability, non-performing loans (NPLs) of banks are very important, as the NPLs affect asset quality, credit risk, and resource allocation efficiency in manufacturing sectors. In this paper, the effect of NPLs on lending behavior is presented with the aim of presenting regulatory adjustments for NPLs in the Iranian banking system by using data from 16 banks over the period 1976-2006, with the framework of a Bayesian autoregressive with distributed lags model. The results show that in the short run, one percent increase in the ratio of NPLs in the current period and the t-1, resulted in a 0.27 percent and 0.24 percent decrease in banks' lending growth, respectively. This short-term impact will intensify in the long run, reaching 0.34% (after 1.7 years).On the other hand, the positive effect of the deposit-to-loan ratio on the lending power of banks indicates that banks experiencing NPLs problems, through the channel of increased deposits, eliminate the problem of lack of lending funds. It is therefore recommended that, while closely monitoring the central bank's compliance with applicable international law and imposing penal rules on banks for offenses and statutory ratios, an integrated e-government system could be used for exclusion of costumers. Banking, financial and social services will also be provided for fines for costumers with NPLs (high risk) and for encouraging well-meaning costumers (low risk) through preferential rates.