The effect of credit risk management on the financial performance of commercial banks in Kenya

Abstract

Credit risk in banks is the possibility that loans will not be paid or go in to default with resultant loss to the bank. Proper management of credit risk by commercial banks is therefore crucial to enhancing their financial performance. The objective of this research was to determine the relationship between credit risk management and financial performance of commercial banks in Kenya. This research study adopted a descriptive research design. Regression analysis model was used with the ROA as the dependent variable. Credit risk was the independent variable measured by variability in the ratio of loans to deposits. The research was done on all the commercial banks in Kenya over a five year period. Return on assets was determined as the ratio of Earnings before Interest and Tax to book values of assets. The regression results showed that the constant term was positive and significantly different from zero. The regression the constant term was 0.0179148 which was significantly different from zero indicating that a part of variation in ROA could not be explained by variation in credit risk across commercial banks. However, the coefficient of credit risk was a positive value of 0.00982604 indicating that higher credit risk led to better financial performance for commercial banks in Kenya as measured by an improvement in the ROA. The study recommends that commercial banks in Kenya should be encouraged to share information on their borrowers in order to improve the quality of the loan book. However banks should have better credit risk management practices so as to enhance their financial performance.