Exploring the Role of Bank-Specific Factors in Nonperforming Loans: A Study of Islamic Banks in Bangladesh

Nonperforming loans (NPLs) have posed a significant challenge to the banking sector in Bangladesh for decades, particularly within Islamic banks, where little research has been conducted to assess the relationship between agency costs and nonperforming loans. This study explores the role of agency costs and other bank-specific factors in determining nonperforming loans (NPLs) in Islamic banks in Bangladesh. This study employs pooled ordinary least squares (OLS) regression with panel data from Q1 2013-14 to Q4 2023-24 to analyze the relationship between the cost-to-income ratio (as a proxy for agency costs), return on assets (ROA), loan-to-deposit ratio (LDR), capital adequacy ratio (CAR), and NPL ratios. The study confirms that agency costs play a central role in influencing NPLs, alongside other bank-specific factors such as profitability, capital adequacy, and lending practices. The results indicate that a high level of operational inefficiency significantly influences NPLs, whereas ROA and CAR act as mitigating factors for credit risk. Conversely, aggressive lending practices, as indicated by an increased LDR, are associated with higher NPLs. Islamic banks face significant institutional flaws, and agency costs reflect deeper governance issues that cannot be ignored. The study further argues for the need to improve governance, operational efficiency, and prudent lending practices within Islamic banks.