The Relation between Efficiency, Non-Performing Loans and Capitalization in the Nordic Banking Sector

Sammanfattning: This paper analyzes relationships between efficiency, non-performing loans and capitalization in the Nordic banking sector (Denmark, Finland, Norway, Sweden and Iceland) based on a panel dataset of 40 banks from the period of 2006 to 2015. Efficiency is measured by the ratio of non-interest expense to net operating income, the ratio of loan loss provision to total loans serves as a proxy for non-performing loans and capitalization is the ratio of equity to total assets. The paper applies the Granger-causality technique and tests four hypotheses as suggested by Berger and De Young (1997): “bad management”, “skimping”, “moral hazard” and “bad luck” and one additional the “regulatory” hypothesis. All five hypotheses are tested based on the relationships between the three variables. The paper finds evidence of the “bad luck” hypothesis only, which suggests that external factors increase the non-performing loans and management deals with this situation by accruing additional resources, which lowers the efficiency of the bank.