Corporate lending practices and their impact on banking system stability

Abstract

One of the most important roles of commercial banks and a contributing factor to economic development is channeling the capital into the business sector with the use of corporate loans. The composition, scale and credit quality of corporate loan portfolios, however, have a significant impact on the stability of the banking system. The relationship between the corporate lending policy and systemic bank risk is analyzed in this study by utilizing the quantitative analysis panel data approach as well as qualitative analysis based on expert opinions. The relationship between lending variables (such as loan-to-deposit ratio, non-performing loan ratio, sectoral credit concentration, collateral adequacy, and covenant compliance) and bank stability indicators (such as the Z-score, capital adequacy ratio (CAR), and liquidity coverage ratio (LCR)) was analyzed using data from 48 scheduled commercial banks in six South and Southeast Asian economies from 2013 to 2023. The results suggest that there is a strong correlation between systemic vulnerability and high concentration of the loan portfolio in risky sectors, especially the housing and infrastructure sectors. Enforcement of weak covenants and lack of borrower monitoring are factors that lead to higher loan losses, while the use of models that simulate credit risk, strict collateral valuation, and a diversified loan book help to make loans more resilient during periods of decline. The study also highlights the issue of regulatory arbitrage as a "structural weakness that is a constant threat to banking stability". It suggests improving prudential regulation, the stress-testing regimes and embedding early-warning indicators in corporate credit appraisal processes. The findings can provide regulators, banking supervisors, and risk managers with useful information to support their efforts for a sustainable credit growth and financial sector resilience, and can be helpful for policymakers in this regard.