The Relationship Between Profitability and Non Performing Loans in the Kenyan Banking Sector

Abstract

Commercial banks operate in very sensitive markets with considerable risk and uncertainty. This study was carried out with a view of investigating the problem of non-performing loans in the Kenyan commercial banking sector and the likely effect on their profitability and returns. To achieve the objective of the study, regression model was developed with Return on Assets (ROA) as the dependent variable and the amount of credit (measured as a ratio of total loans to total assets), level of nonperforming loans (measured as a ratio of the nonperforming loans to total loans) and the level of shareholders equity (measured as a ratio of the total asset to the shareholders equity) as the independent variables. The period of analysis was eleven years from 2000 to 2010. The study sought to analyze the trends of other model variables: the management of capital, level of nonperforming loans and amount of credit are all on the downward trend over the 11 year period under study. The model summary shows that the R = 0.239, indicating a weaker relationship between predictors and dependent variable; this is confirmed by coefficient of determination ( R2 ) value of 0.057. One of the major recommendations is for the banks to set up more robust Credit Risk Management systems and structures. The weak relationship between dependent variable and the chosen independent variables indicate there are more factors that affect banks’ profitability. This is the reason the study recommends a more comprehensive ways of managing risks in more comprehensive enterprise-wide way. Other measures such as improving the credit information sharing platform and developing robust monetary policies will go a long way in making the returns of the banks better.