The impact of non-performing loans on bank lending behaviour: Evidence from the capital channel mechanism in Chinese commercial banks

Abstract

Non-performing loans (NPLs) constitute an important concern for banking stability and credit creation, more so for developing countries where commercial banks play a crucial role in economic growth (Bernanke et al., 1994; Markovic, 2006). Much literature has examined the association between the quality of banking assets and their consequences, but little evidence exists on how NPLs impact bank lending through the capital channel. This study tests the relationship between NPL shocks and banks’ lending behaviour, as well as the moderating effect of the capital adequacy ratio (CAR) and common equity tier 1 (CET1) on this link. The research employs two-way fixed effects (TWFE) and dynamic difference generalized method of moments (GMM) on the unbalanced panel dataset obtained from 42 Chinese commercial banks listed between 2013 and 2023. The results show that a rise in the NPL ratio considerably decreases loan growth rates. This means that worsening credit risk reduces banks’ ability to lend money. While neither CAR nor CET1 stimulates lending, a higher CET1 makes NPLs’ adverse influence greater. Thus, capital buffers improve the solvency position, but they cannot protect against the negative supply-side impacts of declining asset quality. This highlights the need for stronger NPL resolution frameworks and countercyclical capital management.