The Effect of Credit Risk Management on the Financial Performance of Commercial Banks in Kenya

Abstract

Credit risk has always been a vicinity of concern not only to bankers but to the entire business world because the risks of a trading partner not fulfilling his obligations in full on due date can seriously jeopardize the affairs of the other partner. This study sought to review the effect of credit risk management on the financial performance of commercial banks. The research design used in this study was descriptive research design. The design was appropriate because the study involved an in depth study of credit risk management and the relationship between the two variables i.e. credit risk management and the financial performance of commercial banks was described extensively. Secondary data collected from the commercial banks annual reports (2007-2011) was used. Of the 43 commercial banks in Kenya, full data was attained from 26 banks and thus the study concentrated on the 26 banks. The data collected from the annual reports of the banks was analyzed using multiple regression analysis. The regression output was obtained using Statistical Package for Social Sciences (SPSS version 18). In the model return on equity (ROE) was used as the profitability indicator while non performing loans ratio (NPLR) and capital adequacy ratio (CAR) as credit risk management indicators. This study showed that there is a significant relationship between financial performance (in terms of profitability) and credit risk management (in terms of loan performance and capital adequacy). The results of the analysis states that both non performing loans ratio (NPLR) and capital adequacy ratio (CAR) have negative and relatively significant effect on return on equity (ROE), with NPLR having higher significant effect on ROE in comparison to CAR. Hence, the regression as whole is significant; this means that NPLR and CAR reliably predict ROE.