The Impact of Central Bank Independence and Transparency on Banks' non-performing Loans and Economic Stability

The global financial crisis of the past decade had a detrimental impact on banking institutions worldwide. In both developed and developing countries, it is widely documented that the proportion of non-performing loans is often linked to bank collapse and financial crises. Existing studies show that central bank independence and transparency are important for a country's financial stability and institutional quality. Building on this premise, we investigate whether central bank independence and transparency affect the occurrence of non-performing loans. Using panel data from 39 countries, we find that central banks free from political interference reduce non-performing loans. Similarly, transparent central banks with a lower degree of information symmetry reduce the prevalence of non-performing loans. Thus, our findings support that independent and transparent central banks minimize the incidence of non-performing loans. The results imply that independent central banks indirectly impact bank operational outcomes. Our results are robust to a battery of tests and specifications.