The Effect of Economic Factors on Non- Performing Loans: Case of Commercial Banks in Kenya

Abstract

The nature of the business that banking institutions are involved in exposes them to a high level of risk. They include systematic risk, the risk of a change in value, the risk that a company may be unable to meet its short-term goals, risk of default and business risk. All of which are in one way or another affected by the prevailing status of the economy. Various macro and micro economic variables affect the manner in which loans are taken up and repaid. The purpose of this study is to establish various ways in which economic variable affect the levels of non-performing loans. In addition, the study attempts to establish the effect of economic variables on non- performing loans in banking institutions in Kenya. The econometric model used for the purpose of this study is a multiple regression model. The independent variables used are, unemployment, inflation rates and real GDP growth rates. The dependent variable is the ratio of gross non-performing loans to gross loans. Data used was from the year 2000 to 2015, and was obtained from secondary sources. The findings obtained that the proportion of gross non-performing loans to gross loans varies with any change in the independent variables. The trend of the proportion of gross non-performing loans to gross loans was also found to be decreasing in nature over the period of data collected with an increase towards the end of the study period. At the end of the study, recommendations and suggestions of policy adjustments are made. This is to aid in alleviation of the problem of high levels of non-performing loans. Banks and other financial institutions will find this study useful as a guide for effective credit risk management. It will also be useful to the Credit reference bureau as it will show what factors lead to default and how to manage them as effectively as possible to reduce the non-performing loan ratio.