(Andries, 2009; Claus and Grimes, 2003; Scholtens and van Wensveen, 2003).

They argue that the advent of technology, deregulation and deepening

financial markets reduce intermediation costs thus making financial intermediaries
useless.
Scholtens and van Wensveen contend that financial intermediaries do not
create value as being touted and thus the theory fails to provide
satisfactory reasons for the existence of financial intermediaries

The the endogenous relationship by examining net worth and agency costs.
Under the economic model, Bernanke, Gertler and Gilchrist assert that borrowers�
net worth and
asymmetric information between lenders and borrowers are important drivers for
financing costs.
During bad economic periods when net worth is low, financing agency costs increase
as lenders
must commit more resources towards researching and monitoring borrowers� credit
worthiness.
However, during good economic times borrowers are able to post more resources as
collateral,
and lenders can commit fewer resources towards credit due diligence. The result is
that high
net worth reduces external financing inefficiencies and lowers the cost of
borrowing. Over
the business cycle, borrowers� net worth increases and decreases procyclically. The
result
of these fluctuations is that external financing becomes more expensive during bad
economic
periods, which amplifies the real business cycle. There are several other
macroeconomic factors
related to the state of the economy that have also displayed correlation with NPL.
Inflation
has been shown in some cases to be significantly correlated with NPL, although
competing
economic effects make the direction of the correlation ambiguous. For fixed rate
loans,
a modest uptick in the rate of inflation can reduce the real cost of interest. A
key
assumption under the hypothesis that inflation can reduce the real cost of
repayment
is that wages must not be sticky. If wages are sticky and wage increases lag
inflation,
the rise in the cost of living could put upward pressure on NPL. Deflation can make

repayment harder as well by increasing the real cost of repayment. Furthermore,

high
inflation or hyperinflation is often occurs during periods of instability and may
be
associated with a high level of non-performing loans. Empirically, Klein (2013)
does
find a significant positive relationship between inflation and non-performing
loans,
but other studies have not estimated a significant relationship between inflation
and
loan performance.
The exchange rate can also affect the ability of borrowers to service their debt.
Movements in the exchange rate can have both a direct and an indirect effect on
loan
performance. Borrowers, particularly those in developing countries where credit may
be
limited or expensive, may have an incentive to borrow in a foreign currency. The
exchange
rate has a direct effect on borrowers if their income or revenue is in the domestic
currency
but their debt obligations are in a foreign currency.

Under such a scenario, a depreciation of the domestic currency would make the cost
of loan
repayment greater when expressed in the domestic currency. Beck, Jakubik and Piloiu
(2013)
study the direct effect that foreign exchange rate changes can have on loan
repayments in
countries with a high level of foreign denominated debt. The authors proxy the
degree of
unhedged lending in foreign currencies using a set of dummy variables indicating
the ratio
of international claims to GDP. By interacting the nominal effective exchange rate
with the
degree of unhedged lending in foreign currencies, the authors find that
depreciation of the
domestic currency negatively affects loan performance (Beck, Jakubik and Piloiu
2013).

In other words, there is significant correlation between non-performing loans and

depreciation
of the domestic currency in countries with high level of foreign currency lending.
This
indicates that it is more difficult for borrowers to repay foreign denominated
debts if the
domestic currency under goes depreciation.

In addition to the direct effect described above, the exchange rate can also
indirectly affect
loan repayment by stimulating the economy. When a country experience depreciation
of it
currency, exports become relatively cheaper abroad and imports become relatively
more
expensive. This reaction manifests itself through an increasing trade balance, and
activity
within the domestic economy will increase. The indirect stimulation effect on the
economy
will show itself as an increase in GDP.