Computing nonperforming loan prices in banking efficiency analysis

Abstract

Within the framework of banking efficiency analysis, we propose a methodology for computing unobservable shadow prices for nonperforming loans (NPL). Our approach is to include NPL as an undesirable output variable in a distance function stochastic frontier analysis. We conduct a panel study of US and European banks during the most recent financial crisis by adopting a semi-nonparametric Fourier specification, which ensures convergence to the true values of both the estimated function and the related efficiency. Computing NPL prices has several advantages, such as identifying approaching crises, quantifying the responsibilities of governments and banks for credit risk and determining appropriate regulatory interventions.