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

The Influence of Credit Risk Management on Financial Performance of Commercial Banks in Kenya.

ABSTRACT

Financial risk in a banking organization is the possibility that the outcome of an action or event could bring up adverse impacts. Such outcomes could either result in a direct loss of earnings or capital or may result in the imposition of constraints on the bank’s ability to meet its business objectives.

This study evaluates the influence of credit risk management on the financial performance of Commercial Banks in Kenya.

Descriptive, correlation, and regression techniques were used in the analysis. The findings revealed that credit management has a significant impact on the financial performance of Kenyan banks.

Therefore, it is recommended that Commercial Banks need to be cautious in setting up a credit policy that might not negatively affect their financial performance.

 

TABLE OF CONTENTS

CHAPTER ONE.. 1

1.0 INTRODUCTION.. 1

1.1 Statement of the problem.. 2

1.2 General Objective. 3

1.2.1 Specific Objectives. 3

1.3 Research Questions. 4

1.4 Research Scope. 4

CHAPTER TWO.. 5

LITERATURE REVIEW5

2.1 Credit Risk Management Strategies. 5

2.2 Theoretical Review.. 9

2.2.1 Portfolio theory. 9

2.2.2 Arbitrage Pricing Theory (APT) 10

2.2.3 Information Theory. 10

2.3 Conceptual Framework….10

2.3 Empirical Review.. 11

CHAPTER THREE.. 14

THE METHODOLOGY.. 14

CHAPTER FOUR.. 15

RESULTS AND FINDINGS. 15

4.1 Credit guarantee. 15

4.2 Credit monitoring. 15

4.3 Loan Security. 16

4.4 Credit approval process. 16

4.5 Credit appraisal analysis. 16

4.6 Credit risk scoring. 17

4.7 Conclusion and Recommendations. 17

REFERENCES. 19

APPENDIX 1:LIST OF COMMERCIAL BANKS. 22

CHAPTER ONE

1.0 INTRODUCTION

Lending is an integral element of the banking business; it is itself at the heart of an economy’s financial architecture. It, therefore, behooves policymakers to continually review the credit market to minimize inefficiencies that hinder faster economic growth.

Credit risk is the current and prospective risk earnings or capital arising from an obligor’s failure to meet the terms of any contract with the bank or otherwise to perform as agreed (Kargi, 2011).

Credit risk management is a structured approach to managing uncertainties through risk assessment developing strategies to manage it, and mitigation of risk using managerial resources.

The strategies include transferring to another party, avoiding the risk, reducing the negative effects of the risk, and accepting some or all of the consequences of a particular risk.

Credit risk management is very important to banks as it is an integral part of the loan process.

It maximizes bank risk, adjusted the risk rate of return by maintaining credit risk exposure with a view to shielding the bank from the adverse effects of credit risk

When banks grant loans, they expect the customers to repay the principal and interest on an agreed date. A credit facility is said to be performing if payment of both principal and interest are up to date in accordance with agreed repayment terms.

The non-performing loans (NPLs) represent credits which the banks perceive as possible loss of funds due to loan defaults. They are further classified into substandard, doubtful, or lost.

Bank credit in the lost category hinders banks from achieving their set target (Kolapo et al., 2012).

Financial performance is the company’s ability to generate new resources, from the day-to-day operations, over a given period of time; performance is gauged by net income and cash from operations.

A bank is a commercial or state institution that provides financial services, including issuing money in various forms, receiving deposits of money, lending money and processing transactions, and the creating of credit (Campel, et. al., 1993).

Credit risk management models include the systems, procedures, and control that a company has in place to ensure the efficient collection of customer payments and minimize the risk of non-payment.

The high level of non-performing loans is a challenge to many commercial banks in Kenya, which is evidence that commercial banks are faced with a big risk of their credit.

Commercial banks are the vital institutional framework for national development because they contribute about 50 percent of the Gross Domestic Product.

Lending in commercial banks is the main source of making profit hence the need for efficient credit risk management practices within the industry.

Financial institutions are exposed to a variety of risks among them; interest rate risk, foreign exchange risk, political risk, market risk, liquidity risk, operational risk, and credit risk (Yusuf, 2003; Cooperman, Gardener, and Mills, 2000).

In some instances, commercial banks and other financial institutions have approved decisions that are not vetted; there have been cases of loan defaults and non-performing loans, a massive extension of credit, and directed lending.

Policies to minimize the negative effects have focused on mergers in banks and NBFIs, better banking practices but stringent lending, review of laws to be in line with the global standards, well-capitalized banks which are expected to be profitable.

Liquid banks that are able to meet the demands of their depositors, and maintenance of required cash levels with the central bank which
means less cash is available for lending (Central Bank Annual Report, 2004).

This has led to reduced interest income for commercial banks and other financial institutions and by extension reduction in profits (De Young et al, 2001). Banks are investing a lot of funds in credit risk management modeling. The case in point is the Basel 11 accord.

1.1 Statement of the problem

The Banking sector is currently facing pressure from both the Government and the Public to lower the interest rates on loans. On the other hand, Banks are facing various challenges like non-performing loans, stagnant interest rates, mobile money transfer services which have greatly affected their profitability.

Hence Commercial Banks in their efforts to reduce the impact of non-performing loans and mobile money transfers, have adopted new Credit Risk Management techniques and Agency Banking.

According to Besis (2005) Risk management is important to Bank management because banks are ‘risk machines’ they take risks; they transform them and embed them into banking products and services.

Risks are uncertainties resulting in adverse variations of profitability or in losses.

Various risks faced by commercial banks include credit risk, market risks, interest rates risk, liquidity risk, and operational risk. (Shubhasis,2005).

A surge in bad debts and flat growth in interest income has slowed down Equity Bank’s profitability.

The banks are feeling the heat of a new Central Bank of Kenya directive on the treatment of non-performing loans which has inflated their bad debts book and forced them to set aside additional cash as a provision for defaulters. (Business Daily dated 24th February 2014).

Locally Ndung’u (2003) in his study on the determinants of profitability of quoted Commercial Banks in Kenya finds that sound asset and liability management had a significant influence on profitability.

 

REFERENCES

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Basel, I. I. (2004). International convergence of capital measurement and capital standards: a revised framework. Bank for international settlements.
Basle Committee on Banking Supervision.(1995). International convergence of capital measurement and capital standards.Basle Committee on Banking Supervision.
Brownbridge, M. (1998, March).The causes of financial distress in local banks in Africa and implications for prudential policy.United Nations Conference on Trade and Development.
Claessens, S., Demirgüç-Kunt, A., & Huizinga, H. (2001). How does foreign entry affect domestic banking markets?. Journal of Banking & Finance, 25(5), 891-911.

CSN Team.

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