How does bank liquidity creation affect non-performing loans in the MENA region?

Purpose The study aims to empirically examine the effect of bank liquidity creation on non-performing loans (NPLs) in the Middle East and North Africa (MENA) region. Design/methodology/approach Berger and Bouwman's (2009) three-step methodology was employed to calculate the level of liquidity creation of a selected sample of 111 commercial banks in ten MENA countries from 2010-2017. Next, the two-step system generalized method of moments (GMM) estimator was used to investigate the linkage between bank liquidity creation and NPLs. Findings The results demonstrated a significant negative effect of bank liquidity creation on NPLs in the short and long term, implying that liquidity creation through both on- and off-balance sheet activities decreases NPLs. These findings accord with the "economic-enhancing" view. Furthermore, regression analysis investigated whether this relationship remained similar for Islamic and conventional banks. The results showed that liquidity creation diminishes Islamic and conventional bank NPLs. Research limitations/implications The empirical findings raise several significant policy implications. Bank liquidity creation may decrease rather than increase NPLs, although the process of liquidity creation is viewed as risky by rendering banks more illiquid. Therefore, policy-makers should encourage bank liquidity creation to stimulate the economy. In a robust economy, borrowers are more likely to repay their debts, consequently diminishing banks' NPLs. Originality/value To the best of the author's knowledge, the current study is the first to provide empirical evidence on the effect of bank liquidity creation on NPLs in MENA countries.