The Impact of Impairment of Financial Assets on the Financial Performance of Commercial Banks in Kenya

Abstract

A critical aspect of individual and corporate growth is access to credit. Given that banks rely on the volume of credit business as the primary source of revenue they are primed to address any source of depletion in this revenue source. Whenever there is a financial crisis, the market price for collateral assets falls thereby impeding the bank’s ability to rely on collateral for the issuance of new loans and impairing their ability to extent new credit facilities, which in turn dampens investment. A financial crisis such as the COVID-19 pandemic changes the parameters relating to credit risk models since it raises the share of NPLs thereby increasing the number of impaired loans owing to the reduced rate of recovery from expected and collateral cash flows. The objective of the study was to establish the impact of impairment of financial assets on financial performance of commercial banks in Kenya. The study was supported by three theories, namely: Prospect Theory, Capital Asset Pricing Model, and the Theory of Financial Distress. The study’s independent variable was Non-Performing Loans while its control variables were Asset Quality, Capital adequacy and Liquidity. A descriptive research design was used to enable the articulation of the study participants’ traits. The study found that the sampled banks were able to maintain relatively stable levels of performance as measured by the ROA% during the period under review. However, the sampled banks showed a huge variation in the ratios for independent and control variables owing to the wide variation in the size of the banks. The beta coefficient analysis showed that two of the variables, Asset Quality and Capital Adequacy were statistically significant and are critical determinants of the Performance of Commercial Banks. The study recommended that the commercial banks in Kenya should comply with the prudential credit risk management requirements of IFRS 9 given the protection that it offers both to depositors and the long-term operations of the commercial banks. Commercial banks in Kenya irrespective of size, need to consider maintaining stable levels of liquidity as to as to reduce their vulnerability to adverse credit risk. Banks that have been found to have high levels of NPLs need to address this by reinforcing their debt collection mechanisms as well as their risk profiling of borrowers so as to not be exposed to higher likelihood of NPLs.