Impact of Non-Performing Loans on Deposits and Financial Stability: An Empirical Analysis in Developing European Countries

Abstract

This research investigates the relationship between non-performing loans (NPLs) and the impact on deposits and financial stability in developing European nations for the years 2010–2024, using a quantitative method with panel data from the World Bank Open Data. Using econometric models of Ordinary Least Squares (OLS), Robust OLS (OLSR), Fixed Effects (FE), Random Effects (RE), and Generalized Method of Moments (GMM). Paper discusses an intricate relationship between NPLs and deposits, suggesting supportive evidence in the baseline models, contrary to the hypothesized negative association in the research theoretical framework. That is to suggest, depositors may be more resilient than predicted. In complete contrast to the relationship with deposits, NPLs are found to negatively affect financial stability. Private sector lending (PSL) and bank liquid reserves (BLR) consistently drive deposit growth (p<0.001), while NPLs negatively impact financial stability in FE and RE models (p<0.01), supporting heightened systemic risk. This observation warrants support in the FE and RE models in support of the hypothesis - risk is undoubtedly possible with greater systemic risk, while on the other hand, a plethora of control variables (private sector loans, bank liquid reserves, unemployment, inflation, and real interest rates) represent significant predictors of both outcomes, with variability based on the econometric model used (due to the endogeneity and dynamic effects). Study highlights country-specific heterogeneity and identifies a literature gap in the dual analysis of NPLs’ impact, offering implications for enhancing credit risk management and liquidity buffers, and recommending tailored policy interventions and further research into nonlinear dynamics.