Full Length Research Paper
The impact of credit risk management on the financial performance of Banks in Kenya for the period 2000 – 2006 Danson Musyoki1, Adano Salad Kadubo2 Catholic University of Eastern Africa P.O. Box 00200 – 62157 Nairobi 2 Catholic University of Eastern Africa P.O. Box 00200 – 62157 Nairobi 1
Corresponding Author: Danson Musyoki Recieved: August 8, 2011 Accepted: September 7, 2011
Abstract The objective of study was to assess various parameters pertinent to credit risk management as it affects banks’ financial performance. Such parameters covered in the study were; default rate, bad debts costs and cost per loan asset. Financial reports of 10 banks was used to analyze profit ability ratio for seven years (2000-2006) comparing the profitability ratio to default rate, cost of debt collection an cost per loan asset which was presented in descriptive, regression and correlation was used to analyze the data. The study revealed that all these parameters have an inverse impact on banks’ financial performance, however the default rate is the most predictor of bank financial performance vis-à-vis the other indicators of credit risk management. The recommendation is to advice banks to design and formulate strategies that will not only minimize the exposure of the banks to credit risk but will enhance profitability and competitiveness of the banks. Keywords: Return on assets, Cost per loans, Default rate, Bad debts cost JEL Classification: G0
INTRODUCTION Financial performance is company’s ability to generate new resources, from day- to- day operations, over a given period of time; performance is gauged by net income and cash from operations. A portfolio is a collection of investments held by an institution or a private individual (Apps, 1996).Risk management is the human activity which integrates recognition of risk, risk assessment, developing strategies to manage it, and mitigation of risk using managerial resources.( Apps, 1996). Whereas Credit risk is the risk of loss due to a debtor’s nonpayment of a loan or other line of credit(either the principal or interest (coupon) or both) (Campel, et. al., 1993) default rate is the possibility that a borrower will default, by failing to repay principal and interest in a timely manner (Campel, et. al., 1993). 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 is very important to banks as it is an integral part of the loan process. It maximizes bank risk, adjusted risk rate of return by maintaining credit risk exposure with view to shielding the bank from the adverse effects of credit risk. Banks are investing a lot of funds in credit risk
management modeling. The case in point is the Basel 11 accord. There is need to investigate whether this investment in credit risk management is viable to the banks. This study therefore seeks to investigate the impact of credit risk management on a bank’s financial performance in Kenya. The general objective of the study was to establish the impact of credit risk management on the financial performance of banks. The specific objectives were: to establish the impact of default rate on performance; to establish the impact of debt collection cost on perforce, and; to establish the impact of cost per loan asset on performance The study covered the banks operating in Nairobi; ten banks were involved in the study. All the banks have offices in the central business district. The study was based in Nairobi because the banking activities cover all sectors of the Kenyan economy and are a cosmopolitan town. The study covered the period between...