Credit Risk and the Financial Performance of Commercial Banks in Kenya

Abstract

The research is on Credit risk and the financial performance of commercial banks in Kenya. The purpose of the study was to assess the relationship between credit risk and the financial performance of commercial banks in Kenya. The study focused mainly on commercial banks in Kenya. The purpose of the study was to assess the effects of credit risk and the financial performance of commercial banks in Kenya. The research used the purposive sampling method for convenience since the data of the banks selected was readily available. The study covered the period from 2011 to 2015. From a population of forty-twobanks, a total of seven commercial banks were selected on a Purposive basis for the five years. Data was collected from the financial statements of the banks and the central bank of Kenya. The return on assets (ROA) and return on equity (ROE) were used as the financial performance measures with credit risk measured in terms of Portfolio at Risk which was derived at using the loans and advances to customers and the non-performing loans, Recovery Rate that used the value of collateral held by the bank and the value of the loan, Non-Performing Loans which used the ratio of total loan portfolio to the non-performing loans and Bad Debts Written Off that used the value of the loan written off and the average gross portfolio. The descriptive, correlation and regression analysis results were derived with the help of SPSS to perform the data analysis. Significance was tested at 5% level. The findings were presented using tables and narratives. The findings of this study show that the constant term was significantly different from zero indicating that a Part of the variation in ROA and ROE could not be explained by variation in credit risk across commercial banks. This indicates that Credit Risk had a positive effect on the financial performance of commercial banks. However, credit risk did not actively explain variation in ROA and ROE. Thiswas confirmed by the weak value of the coefficient of determination and the analysis of variance. This leads to the conclusion that even though proper credit risk management is essential in determining the financial performance of commercial banks; it is not an essential driver of profitability of commercial banks in Kenya. Most commercial banks in Kenya fail due to poor governance. The mean ROA for the seven banks was 0.894 with a standard deviation of 0.176. The study showed that credit risk did not have a significant effect on the financial performance of commercial banks in Kenya. A rise in Credit risk led to the decrease of financial performance and vice versa. The study established that most of the bank's poor financial performance is not caused by credit risk but by poor governance. It is recommended that banks put in place measures and guidelines that will compel banks to share information about their borrowers to ensure that loans are granted to the honest borrowers. The study can be done with a broader population across all countries in East Africa. The East African community is an emerging market that is affecting the Horn of Africa Region. A study conducted in the region will provide handy and current input for decision making concerning effects of fraud on the performance of commercial banks in the East Africa region.