Determining Risk Factors that Diminish Asset Quality of Commercial Banks in Pakistan

Controlling the higher level of non-performing loans (NPLs) has become one of the key objectives of the central banks, as it may impact banking and macroeconomic stability adversely. The purpose of this research is to find out those risk factors which diminish the asset quality of commercial banks in Pakistan because of the increasing higher level of non-performing loans (NPLs). Various risk factors included were 1. Capital Risk (the Level of Capital adequacy ratio), 2. profitability risk (ROA and ROE), 3. diversification risk in a Less diversified portfolio (Ratio of non-interest income), 4. Efficiency risk as a result of Poor Operating and Managerial Efficiency (Ratio of operating cost), 5. Credit Risk (credit to asset, and credit to deposit), 6. Operational Risk (ratio of operating expenses), 7. Liquidity Risk (Ratio of liquid assets), and 8. Market Risk (Price Earning, Earning Per Share). We also included size as a control. The Assets quality is measured by Nonperforming Assets (Non-Performing loans to Gross Advances Ratio). Panel data included the financial data of 8 Pakistani Commercial Banks; which consist of 48 observations; each bank's data was taken from 2015 to 2020 (06 years). The regression model has been employed to examine the determinants of NPLs or NPAs. We found that the size of assets, ROA, and market risk (PE) seem to increase the non-performing assets ratio, whereas operating cost, and ROE seems to decrease non-performing assets. In general, the empirical analysis shows that central bank regulatory and supervisory departments are key indicators of early identification of banks with potential asset quality declines, lower capital levels, lower profitability, and low operational efficiency may be considered. Operational risk, liquidity risk, and market risk are therefore analyzed here