Impact of loan portfolio concentration on risk-return of selected commercial banks

Abstract

In this study, the influence of loan portfolio concentration on the risk-return profile of commercial banks in Nepal, to which sectoral lending strategies influence the financial performance and credit risk of commercial banks, is explored. Using secondary data collected from annual reports and Nepal Rastra Bank literature, the study analyzes five prominent Nepalese commercial banks [Global IME Bank, Rastriya Banijya Bank, Nabil Bank, Agricultural Development Bank, Prime Bank] over ten years (2068/69–2078/79 B.S.). It is a quantitative approach, using descriptive statistics, Pearson correlations, multicollinearity diagnostics, and multiple regression modeling, and the association between concentration of the loan portfolio (HHI) and its effects on NPL, on the other hand, as independent variables, with Return on Assets (ROA) and Return on Equity (ROE) as dependent variables. We found that the concentration of loan portfolios has a positive effect on ROE, so that sectoral specialization contributes with knowledge of and targeted lending to improve return on equity for the shareholders, but it is insignificant on ROA and does not seem to positively affect ROA. This is also the main reason that non-performing loans were the most important negative factor for ROA and ROE which implies that financial discipline in managing credit risk holds importance to the profitability of a financial organization. CAR had a positive impact on both profitability metrics, indicating that adequate capitalization is essential, and leverage (TD/TA) leads to higher ROE but not by much to the ROA, stressing the importance of the need for a disciplined approach in managing debt. Concentration may provide higher returns for the company in a few sectors, but it also leads to greater exposure to sector-specific shocks, and a comprehensive approach with diversification, sound capital, and healthy credit risk management remain important components for the sustainability in financial performance, said the study. Implications should be given to managers, auditors and regulators as well, have a high risk assessment, and comply with capital requirements to reduce financial instability. It is also a basis to study sector specificities of Nepal banking sector and macroeconomic and shock effects on risk return outcomes under future research.