Non-Performing Loans (NPLs) are a drag on economic growth: debtors have limited access to new funding and consequently to new investment opportunities and lenders are less capable of providing credit supply. NPLs have been a problem since the sovereign crisis for many different countries, and Portugal is no different, with the last available figures indicating that the NPL ratio - NPL stock over total credit - is still above 15%. In this study, it is quantified how much reducing NPLs stock – active approach – could boost economic growth in Portugal when compared to a passive approach of waiting for credit supply to grow to decrease the NPL ratio. This is done using the results from Balgova et al. (2016), who estimate the increment in GDP growth of both active and passive reductions of the NPL ratio.
These estimates are achieved by comparing the GDP growth rates in countries who have a high NPL ratio and experience either an active or a passive decrease in NPL ratio, and in countries that, despite having a high NPL ratio, do not experience any reduction in the ratio. Using the Balgova et al. (2016) estimates actively reducing the NPL ratio by two thirds (approximately 10 p.p.) could boost economic activity by 2.3% over the following year and up to 9.5% during the following 4 years. To achieve a result of this order of magnitude using a passive approach - i.e. waiting for loans to increase - credit supply would have to increase more than 200% over the next four years. An ARMA model with good fit to the data predicts credit supply will grow only 13% over the next four years. Moreover, the probability of credit supply growing more than 200% over the next four years is less than 1%. The forecast of 13% growth of credit supply suggests an increment to GDP growth of 0.2% over four years, contrasting with the 9.5% increment when adopting active policies in reducing NPLs. Equivalently, it can be said that active policies would incrementally boost GDP growth by approximately 2.3% per year when compared to a passive approach.
Besides estimating the impact of a reduction of the NPL ratio on GDP growth rate, it is equally important to determine the mechanisms through which NPL ratio affect GDP growth. Using the results from Brinca and Ferreira (2018), who use microdata from Central Credit Responsibility (CCR) – covers all credit supply granted by credit institutions in Portugal to nonfinancial firms operating in Portugal – and Central de Balanços (CB) – yearly economic and financial data on all non-financial firms operating in Portugal – it is identified that one mechanism is the incremental effect the reduction of the NPL ratio has on firms’ investment. This is done using OLS with year and firm fixed effects, which control for unobservable firm characteristics and yearly shocks that are common to all firms. It is concluded that the decrease in NPLs will increase the firms’ credit, which will then generate an increase in corporate investment. A 10 p.p. decrease in the NPL ratio can boost corporate investment by 2.05% in the first year and 1.58% in the following year.