How do non-performing loans affect productivity? Evidence from Tunisian banks using a parametric hyperbolic distance function

Abstract

As solving the problem of the high level of non-performing loans presents a key factor in strengthening the soundness of the banking system, Tunisian government has considered the reduction of the nonperforming loans burden of a paramount importance. In this paper, we construct a new total factor productivity (TFP) index using a parametric hyperbolic distance function, which simultaneously credits for an expansion in economic outputs (loans and others earning assets) along with contractions undesirable output (nonperforming loans). This new TFP index provides more fruitful and meaningful economic decomposition. In addition to the first three parts (technical change, efficiency change and scale effect change), our index offers one more part related to undesirable output reflecting its effect on productivity. Subsequently, this index is employed to evaluate the TFP change for 10 listed Tunisian banks during 1992–2014. The results indicate that over the studied period, the banking sector experienced a progress in term of Efficiency change as well as a technical change by 0.5%, and 0.3%, respectively.  However, these improvements were offset by regress in term of scale effect change and NPLs effect change. Thus, over the entire period (1992-2014), there was no significant change in the average TFP. Public banks are found to have been more successful than the private ones in capturing benefits from changes in technology and efficiency. In addition, the scale changes and undesirable output effects are found to be problematic for the private and public banks indicating that they do not operate at an optimal scale and do not efficiently manage their risk.