Credit Risk Assessment Practices And The Level Of Nonperforming Loans In Development Finance Institutions In Kenya

Abstract

Development Finance Institutions (DFIs) in Kenya were set up to provide long-term finance to prioritized sectors as part of the industrialization strategy. Despite the existence of DFIs since the 1960s and 1970s, there is still a glaring development financing gap in Kenya especially on appropriate finance to ensure long-term investment. Statistics from the different Government Ministries shows that most of the DFIs are operating on basis o f ' survival" some in difficult to critical financial situations mostly due capital erosion as a result of non performing debts. This shows that one of the reasons the DFIs are not able to meet their responsibilities in the development process is the high rate of NPLs. The purpose of this study was to establish the credit risk assessment practices adopted by the DFIs, to analyze the level of NPLs related to the DFIs and to establish whether there is any relationship between the credit risk assessment practices and the level of NPLs in the DFIs. This study was a survey of all the five DFIs. The study used primary data which was collected by way of questionnaires and secondary data from the DFIs financial statements. Both descriptive and inferential statistics were used to analyze the data. The study established that the DFIs use mainly financial ratios, the 6C's of credit, credit scoring models and a bit of computer simulation methods though all these not in isolation but in combinations of two to three methods. In conclusion, the study established that the use of financial ratios, computer simulation and credit scoring models all increase the level of loan defaults while the use of the C's of credit do decrease the level of non-performing loans of the DFIs in Kenya. This further means there are other factors affecting the level of non-performing loans in DFI and not necessarily the use of credit risk assessment practices. This may also be attributed by the fact that DFIs have a socioiv economic objective; therefore projects may not necessarily be undertaken due to their level of credit worthiness but in developing and promoting the identified strategic sectors of the economy and other new growth areas. The study therefore recommends that DFIs should adapt clear risk management systems in-order to ensure that risks are well managed and therefore reduce the level of non-performing loans currently being faced by the DFIs. The study also recommends the establishment of a regulatory and supervisory framework, building capacity and capability, as well as enhancing operational efficiency of these institutions.