Impact of non-performing loans on US product and labor markets

Using time-series data on the US banking industry for the period 1984Q1-2016Q2, the present study aims to examine the impact of both aggregate and sector-specific non-performing loans (NPLs) on aggregate and sectoral product and labor markets.

Using both single equation ordinary least squares and instrumental variables regressions, the study compares the sensitivity of sector-specific gross domestic product (GDP) and employment growth to changes in both aggregate and sectoral NPLs. Moreover, the paper uses vector autoregressions (VARs) to dynamically trace the impact and duration of NPLs on different types of real economic activity..

Rise in total NPLs reduces US real GDP growth that is most accentuated for construction sector GDP. Likewise, total NPLs significantly lowers both total and non-farm employment growth, financial activities and construction sector employment growth, with the latter showing most sensitivity. Moreover, NPLs in commercial and industrial sector, consumer lending, non-farm non-residential, construction and land development, single- and multi-family residential sectors reduce corresponding sectoral employment growth. The VARs largely confirm these findings with shocks to total NPLs having the most immediate and persistent inimical impact on construction-sector GDP growth.

The deleterious impact of different categories of NPLs on both aggregate as well as sector-specific product and labor markets illustrate that a distressed banking sector is a serious obstacle to the real sector. The findings underscore the need not only to clean up NPLs for the sake of banks financial soundness but also to reduce their pernicious effects on the health of the US economy. For bank regulatory authorities in the USA, it indicates constant monitoring of banks in their jurisdiction and identifying early warning signals to mitigate the potential real sector losses due to rising NPLs.

The extant literature on NPLs has mainly focused on explaining its underlying determinants but not on its real sector consequences. The present paper examines the impact of NPLs on different facets of real economic activity, an issue that has been rarely studied and especially not on the US economy. Moreover, the overwhelming majority of existing literature focuses on aggregate NPLs. The relationships derived in such studies, while useful, can mask important differences between different types of NPLs and real economic activity. The present paper explores the impact of disaggregated NPLs in the US banking industry on corresponding sector-specific product and labor markets, again an issue that has not been studied previously.