Accounting Profitability of Banks Vis-a-Vis to Non-Performing Assets, Financial Leverage and Interest Rate

Abstract: The performance of banking sector considers as the backbone of all the economies especially the ones those are in their developing phase. But the non-performing assets (NPAs) usually pose a serious threat for the functioning of the system and make it inefficient in several ways, especially the profitability of the banks. Therefore, the researcher aims at analyzing how the interest rates, NPAs, and financial leverage (FL) impacted the profitability of Indian public sector banks (PSBs) between 2011 and 2023. Partial Least Squares (PLS), Fixed Effects (FE), and Random Effects (RE) models employing a range of bank-specific and macroeconomic predictors have been used to analyze panel data to assess profitability. This study suggests that financial leverage and NPAs have a negative effect on the profitability of public sector banks. But the result suggests that interest rate has affected banks profitability significantly and positively. However, other factors like deposits, growth rate of GDP, and Inflation rate have revealed positive coefficient but not found significant. The results suggest a random effect model is appropriate for estimating the profitability of PSBs by employing the Hausman test. The research concludes that banks must decrease bad loans and be efficient in their use of financial leverage to improve their profitability. The inferences drawn from this research would help regulatory bodies in designing policies which would curtail NPA`s and enhance profitability in Indian banks.

Keywords: Financial leverage, Panel Regression Model, Interest Rate, GDP Growth Rate, Inflation Rate, Non-Performing Assets

JEL Classification Number: G21, M41