Internal and External Determinants of Credit Risk: Empirical Evidence from Iraqi Commercial Banks
Abstract
Credit risk determinants are highly relevant because prolonged high credit risk can damage the reputation of banks and erode customer confidence. This paper therefore investigates the internal (bank-specific), external (macroeconomic and government-level) determinants of credit risk in Iraq. The model is estimated using unbalanced panel data of 18 conventional banks over the 2005–2024 period by employing the Pooled OLS (POLS) method. Liquidity decreases credit risk, whilst capital adequacy and bank size increase it as banks are more likely to engage in risky lending activities due to inefficiency in the loan approval process or else because of their huge size. In addition, macroeconomic determinants such as GDP, inflation, and political unrest have negative effects on credit risk, which in turn results in a low quality of loan portfolios. Strict capital regulations may even lead to risk-taking behaviour in the banking industry in order to mitigate their compliance costs. High bank profits may also conceal the increasing credit risk in the banks. The banks with stronger regulatory compliance have lower defaults and higher stability. Finally, the findings emphasize the need for appropriate banking policies and practices in Iraq, which would be flexible enough to address the country-specific conditions and which would include management of liquidity and capital cushion. In addition, addressing structural economic and political challenges is needed to restore stability and sustainable development of the banking sector, especially in developing fragile economies. Furthermore, using alternative risk measures and alternative time-periods, we also find robustness in our results. However, the analysis only covers commercial banks, and, due to data limitations, during the conflict years. Future research can utilize banks, including Islamic and private banks, and explore possible nonlinear effects of capital regulation.
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