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

Abstract

Commercial Banks earn profits principally by obtaining funds at relatively low interest rates and then lending the funds or investing in securities at higher interest rates. They adopt different credit risk management policies majorly determined by ownership of the banks (privately owned, foreign owned, government influenced and locally owned) credit policies of banks, credit scoring systems, banks regulatory environment and management styles of the banks. The very nature of banking business is so sensitive because more than 85% of their liability is from depositors (Saunders’s and Cornett, 2005). It’s from these deposits that banks use to generate credit to their borrowers .This credit creation process exposes banks to high default risk which might lead to financial distress including bankruptcy. The objective of the study was to establish the effect of credit risk management on the financial performance of commercial Banks in Kenya. A descriptive study was undertaken in order to ascertain and be able to describe the characteristics of the variables of interest in the study. The independent variables included Loss Reserves/ Gross Loans (LLR R), Non-Performing Loans (NPL R) and CAR with ROA (Net Income/Total Assets) as the dependent variable. Secondary data from commercial banks annual reports (2008-2012) was used. Of the 43 commercial banks in Kenya, full data was attained from 30 banks and thus the study concentrated on the 30 banks. The data was then analyzed, summarized and tabulated. The study concluded that here is a significant relationship between the bank performance (ROA) and credit risk management (Loan Loss Reserve and loan performance). Better credit risk management results in improved bank performance. Thus bank managers need to practice prudent credit risk management, safeguard the assets of the bank and protect the shareholders’ interests. They also need diversify their loan portfolio as a way of mitigating credit risk