Why Non-Performing Assets Persist: Uncovering the Structural and Macroeconomic Drivers of India’s Banking Stress

Key findings from this study

This research indicates that:

• Currency depreciation significantly increases non-performing assets, contrary to limited influence from GDP growth on asset quality
• Inflation and tighter monetary policy exert moderating effects on NPA accumulation
• Conventional macroeconomic variables explain NPA behaviour selectively, with exchange rate and policy channels dominating over growth transmission mechanisms

Overview

This study investigates structural and macroeconomic determinants of non-performing assets (NPAs) in Indian banking using panel data from 30 banks spanning 2003–2022. The research employs robust statistical techniques to isolate the selective influence of currency movements, inflation, and monetary policy on asset quality while controlling for bank-level heterogeneity and temporal dynamics.

Methods and approach

The analysis combines Robust Least Squares and dynamic modelling techniques applied to annual panel data. Stationarity tests guided model specification to address heteroscedasticity, autocorrelation, and bank-level heterogeneity. The framework incorporates GDP growth, inflation, exchange rate movements, and repo rates as primary macroeconomic regressors while accounting for lagged NPA dynamics.

Results

Currency depreciation emerges as a statistically significant driver of NPA increases, whereas inflation and tighter monetary policy demonstrate moderating effects on asset quality deterioration. GDP growth does not exhibit significant influence on NPAs, suggesting limited macroeconomic transmission through conventional growth channels to banking stress. Dynamic model specifications that incorporate lagged dependencies yield consistent results across specifications, indicating that macroeconomic variables shape NPA behaviour selectively rather than uniformly.

The empirical findings diverge from theoretical expectations regarding GDP's role in asset quality. This divergence implies that banking stress in the Indian context reflects external shock transmission (exchange rate) and policy regime effects more strongly than domestic output fluctuations. The consistent identification of currency and monetary policy channels persists after addressing statistical concerns around model fit and temporal dependencies.

Implications

The selective efficacy of macroeconomic variables suggests that policy interventions targeting banking stability should prioritize exchange rate management and monetary policy calibration over general growth promotion. Currency depreciation warrants specific attention as a risk amplification mechanism for NPA accumulation, potentially through import-competing sector stress or foreign currency exposure channels. Policymakers should recognize that conventional countercyclical policies tied to GDP growth may prove insufficient for managing asset quality deterioration.

These findings indicate that institutional and balance-sheet mechanisms—acknowledged but not empirically tested in this analysis—warrant further investigation to explain NPA persistence. The limited macroeconomic transmission through GDP suggests that structural vulnerabilities in borrower balance sheets or sectoral composition may supersede aggregate demand dynamics. Future research should decompose NPA drivers across borrower categories and integrate bank-specific leverage constraints to refine policy design for emerging market banking systems.

Scope and limitations

This summary is based on the study abstract and available metadata. It does not include a full analysis of the complete paper, supplementary materials, or underlying datasets unless explicitly stated. Findings should be interpreted in the context of the original publication.