Background: This research investigates the connection between non-performing loans (NPL) and the capital adequacy ratio (CAR) in a group of banks from Sweden and Italy over the years 2018–2022. Special attention is given to the effects of the COVID-19 pandemic.

Purpose: The aim of the thesis is to examine if a rise in NPL levels correlates with a decrease in CAR, and whether this connection varies among countries with differing banking conditions. Also to examine whether the pandemic had a significant impact on the relationship between NPL and CAR. 

Theory: The theoretical framework relies on Capital Buffer Theory and Signaling Theory. The first describes how banks modify capital buffers to withstand losses and ensure adherence to regulations. The second explains how managers may under report credit risk by reducing loan loss provisions (LLP) in order to protect capital ratios.

Method: The research utilizes a quantitative method, utilizing secondary data from the yearly reports of 20 chosen banks (10 Swedish and 10 Italian). Descriptive statistics and regression analysis are employed to assess the relationship between NPL ratios and CAR in both countries. 

Results: The findings showed that NPL and CAR in both countries had a negative relationship. Banks that have a strong CAR also tend to increase their LLPs during the pandemic. However no significant effect of the pandemic on NPL levels was found.

Conclusion: The study confirms a negative link between NPL and CAR, while no significant COVID-19 impact was found.