Effect of Credit Risk on Financial Performance of Commercial Banks Kenya

Abstract

The objective of study was to assess the effect of credit risk on financial performance of commercial banks in Kenya. The study covered the period between year 2005 and 2014. Credit risk was measured by measured by capital to risk weighted assets, asset quality, loan loss provision, loan and advance ratios and financial performance by return on equity (ROE). The study used the balance sheets components and financial ratios for 43 commercial banks in Kenyaregistered by year 2014. Panel data techniques of fixed effects estimation and generalized method of moments (GMM) were used to purge time–invariant unobserved firm specific effects and to mitigate potential endogeneity problems. The pairwise correlations between the variables were carried out. F- test was used to determine the significance of the regression while the coefficient of determination, within and between R2, were used to determine how much variation in dependent variable is explained by independent variables. From the results credit risk has a negative and significant relationship with bank profitability. Poor asset quality or high non-performing loans to total asset is related to poor bank performance both in short run and long run. Based on the study findings, it is recommended that management of commercial banks in Kenya should enhance their capacity in credit analysis and loan administration.Clear credit policies and lending guidelines should be established.