Financial Soundness Indicators with Emphasis on Non-performing Loans in Iran’s Banking System

This paper analyzes the financial soundness indicators in Iran`s banking system. In the first part it emphasis on asset quality measure by the non-performing loans ratio. The non-performing loans grew rapidly in last decade in Iran’s banking system and it reached higher than 25 percent of total loans in 2010. We conclude that NPLs increase have impact on real part of economy in the concept of credit crunch and bank lending decline when NPLs exceeds a specific level of total loans. This paper also analyzes the relationship between three financial soundness indicators (asset quality, capital adequacy and profitability) and key macroeconomic, bank-specific, and structural variables. The results show that asset quality and capital adequacy are influenced by business cycle. Lending interest rate over two previous years has a negative effect on asset quality. Capital adequacy is affected by short term deposit interest rate and changes in the exchange rate. Profitability fluctuates with inflation rate and NPLs ratio.