Analyzing the Effects of Balance Sheet Approach (Firms-Banks) on Bank's Non-performing Loans

According to review of recent developments in both fields of macroeconomic and banking in Iran, and their assuring effects on economy's recession cycle and rising bank's non-performing loans (NPLs), the ground for the formation of hypothesis tried to examine in this paper is set: "Bank's NPLs are fostered by real sector developments through deterioration of the balance sheets of companies and non-financial firms following financial and real assets price bubble burst". In order to test the hypothesis, the theoretical literature relating to balance sheet approach (firm's and bank's balance sheets) has been reviewed. Our findings indicate that decline in the aggregate demand for loans and the formation of a recession cycle in recent years, especially after 1387, have raised firm's default risk. The phenomena happened following the assets market drop off, especially the real estate market; fall in the bank's lending real rate; and the inappropriate price setting of domestic and foreign services in favor of more imports. These have caused banks to directly suffer from credit risk and NPLs. The most important politic recommendation is financial capital injection to banks without the fiscal stimulus of government and encouragement of aggregate demand by utilization of proper fiscal policy. During recession, since expansionary monetary policies have less affects on demand encouragement, emphasis on discretionary monetary expansion only causes financial and economic instability, resulting in inflation in further economic cycles. Reconstruction of firm's and bank's financial structure could be a major medium-term mean requiring the restructuring of economy's financial structure.