Relationship Between the Level of Non-performing Loans and Financial Performance of Commercial Banks in Kenya

Abstract

Since the main source of income for commercial banks is interest charged when they issue loans, the main risk which the commercial banks encounter is increase in the level of NPLs. The bank’s profitability is highly impacted by the level of NPL because a significant amount of banks revenue is generated from interest charged on the loans issued. Nonetheless, the performance of the banks is highly influenced by the level of NPL. The study aimed on determining the impact of level of NPLs on financial performance of commercial banks in Kenya. This study population comprised all the 43 banks in operation in Kenya as at 2018-year end. The data was acquired for only 37 banks which was equivalent to an 88.1% response rate. The independent variable for the study was NPLs. The control variables were liquidity, capital adequacy, bank size, management efficiency and off-balance sheet financing. In measuring the financial performance return on assets was used and it was the dependent variable. Annual Data, which was from secondary sources, was gathered for a 5 years’ period, 2015- 2019. Research design was descriptive cross-sectional design whereas association between variables was determined by multiple linear regression model. SPSS version 23 aided the achievement of data analysis. An R-square value of 0.316 was revealed implying that around 31.6% of the changes in financial performance can be related to the six chosen independent variables whereas 68.4% in the changes of financial performance was related to other variables that did not form part of this study. From the study findings it was additionally uncovered that the independent variables strongly correlated with financial performance (R=0.562). The ANOVA results exhibited that the F statistic was significant at 5% level with p value of 0.000. Henceforth the model was appropriate in explaining the association amongst the chosen variables. Additional results demonstrated that the level of NPLs negatively and significantly affected financial performance while capital adequacy, liquidity and bank size positive and statistically significant values for this study. The study discovered that management efficiency and off-balance sheet financing are statistically insignificant determinants of financial performance of commercial banks. This gives recommendation that measures ought to be set up to reduce level of NPLs while at the same time boosting capital adequacy, liquidity and bank size as these four have a significant influence on financial performance.