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The instinct of bankers is to keep the borrowers alive through recycling and renewals of bad loans into loans, a window
dressing exercise; or worse yet, advancing additional fresh loans to effectively insolvent borrowers to tide over what is
perceived as cash flow problems and forthcoming illiquidity, thereby getting deeper into financial distress. In this sense,
insolvency occurs first, illiquidity follows later. Increase in the intermediation costs lead to increase in Non-performing
Loans (NPLs). The intermediation cost reflects the operating efficiency of banks. If credit risk is not managed properly it
eventually shows up in NPLs, or the concentration of banking credit in a few sectors of the economy, or in a few
segment of borrowers, or a rising proportion of riskier loans in its portfolio during times of rapid expansion of banking
credit. This paper studies intermediation costs in credit markets within a dynamic Stiglitz and Weiss (1981) framework.
The theoretical predictions of our model gains support by Pakistani banks’ quarterly data for the period 2007-09. Data
suggests that an increase in intermediation costs results in an increase in NPLs. Analyses show that, if intermediation
cost is administered properly, it ultimately lowers NPLs. We argue that minimization of intermediation costs improves
financial soundness.
Azam Ali. (2010) Intermediation Cost and Non-Performing Financing: A Case Study of Pakistan, Journal of Independent Studies and Research-Management, Social Sciences and Economics, Volume-08, Issue-2.
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