Lending Ethics, Credit Screening, Loan Officer Incentives and Loan Performance of Commercial Bank Branches in Kenya

Abstract

Loan performance is pivotal for the economic prosperity of any country because lending by local entities drive commerce, create employment and spurs economic growth. The performance of loans should be traced at the bank branch level, where significant lending exercise is employed to avert many adverse consequences of loan defaults. Ethical lending behaviour can influence lenders and their agents to pursue the maximum common good of those affected by their lending actions. That can benefit various credit market stakeholders through high loan performance, lower interest rates, fewer collateral requirements, reduced credit crunches, and credit rationing. Despite the prominence of ethics as a moral philosophy, hence the essence of ethical lending, lending ethics has not fused into mainstream credit risk management research. There is silence on how lending ethics can enhance loan quality through better applicant screening. Also, the role of loan officers’ incentives on loan quality needs to be unearthed. Against those debates, this study was birthed to examine the effects of lending ethics, credit screening, and loan officer incentives on loan performance. Therefore, the four specific study objectives were to determine the relationship between lending ethics and loan performance, to establish the effect of credit screening on the relationship between lending ethics and loan performance, to establish the effect of loan officer incentives on the relationship between lending ethics and loan performance, and to establish the joint effect of lending ethics, credit screening, and loan officer incentives on loan performance of commercial banks’ branches in Kenya. The reviewed literature generally pointed towards positive relationships, albeit with contextual, conceptual, and methodological gaps. Past research often conducted individual factor causal tests on loan performance, and the conclusions differed. Mediation and moderation tests were rare. The study adopted a positivist research philosophy and descriptive design implemented through primary data from bank managers and the head of the credit section, as well as a structured questionnaire at the branch level. Out of the 1,384 CBK registered bank branches in 2018, the study targetted 415 branches and reached 269 questionnaires. Validity and reliability tests were conducted, and the data was analyzed through regression models. Lending ethics had a significant direct positive effect on loan performance. Credit screening and loan officer incentives also positively mediate and moderate the relationship between lending ethics and loan performance. Lending ethics, credit screening, and loan officer incentives have a significant joint effect on loan performance. The study's main conclusion was that lending ethics positively influence loan performance, credit screening, and loan officer incentives intervene and moderate the relationship. The three have a significant joint effect on loan performance. The results concur with the theories and other past researchers but in a Kenyan context. It extends its propositions to credit risk management concepts, specifically loan performance, through empirical research in developing market commercial banks’ branches. It offers conceptual, methodological, and theoretical foundations for future scholars pursuing research in this area by testing mediation and moderation relationships. Also, the study suggests several policy recommendations to various actors. To commercial banks, the study recommends the enhancement of ethical standards, improvement of screening procedures, and optimization of loan incentive structures by the bank's management to achieve quality lending standards. To the regulator, the study recommends the enhancement of regulatory oversight to curb unethical lending. To the Kenya Bankers’ Association, which acts as the banks’ umbrella body, the study recommends supporting banks in developing and implementing robust training initiatives for ethical lending practices.