The Role of Non-performing Loans for Bank Lending Rates

Abstract Based on bank level data from the euro area, I investigate the role of non-performing loans (NPLs) for lending rates on newly granted loans. The focus is on an effect caused by the stock of NPLs that extends beyond losses that banks have already incorporated into their reported capital positions. The paper assesses the channels through which such an effect occurs. The results indicate that a higher stock of NPLs is associated with higher lending rates. This relation is driven by net NPLs, which constitute the part of NPLs that is not covered by loan loss reserves. Although the stock of NPLs affects banks’ idiosyncratic funding costs as well, the latter do not seem to constitute an important link between the stock of net NPLs and lending behaviour. This is because the relation between idiosyncratic funding costs and lending rates turns out to be rather weak. Furthermore, NPLs do not strongly affect the banks’ interest rate pass-through.