The Effect of Use of Financial Statements in Making Lending Decisions on Level of Nonperforming Loans Among Commercial Banks in Kenya

Abstract

NPLs have the potential to curtail the performance and sustainability of a commercial bank. In developed countries, financial statements are important in making lending decisions, which in turn affect the levels of NPLs. In Kenya, there’s little evidence on the utilization of financial statement information in arriving at lending decisions and whether this affects the level of NPLs. This study aimed at determining the effect use of financial statement in making lending decisions has on the level of NPLs among Kenyan banks. The study collected data on perceptions of importance of financial statements in lending decisions of Kenya bank officers, the characteristics of banks, use of financial statements in the banks and their levels of NPLs from a total of 37 out of the 42 commercial banks registered in Kenya. Descriptive statistics were used to characterize banks staff respondents and the banks they worked for. Ordinary least squares regression model was use to analyze the data for the effect of financial statement use in making lending decisions on the level of NPL. The study findings indicate that key bank staffs in lending sections view financial statements as not very useful in making lending decisions. The effect of use of financial statement information in decision making was not statistically significant. However, tier 3 and tier 4 banks have significantly higher levels of NPL than tier 1. The study recommends that accounting and banking experts implement measures to help SMEs raise the reliability of financial statements in order to improve their utilization in lending decisions.