The Effect of Credit Risk on the Financial Performance of Commercial Banks Listed at the Nairobi Securities Exchange

Abstract

The study aimed at determining the effect of credit risk on the financial performance of the various commercial banks listed at the Nairobi Securities Exchange. Credit risk was specifically analyzed on its effect on return on equity and return on asset. In furtherance to this, the study reviewed determinants allied to financial performance such as interest rate and exchange rates. Accordingly, the study adopted a descriptive research design. This was done on a population of eleven banks and it utilized secondary data, which was obtained from the financial statement of the commercial banks. It is worth noting that the financial statements were readily available in the specific banks’ website between the years 2012 -2016. Finally to establish the relationship among variables -descriptive, correlation and regression analysis was done. Descriptive statistics indicated that ROA had a mean of 3% with standard deviation of 0.012. ROE recorded a minimum of -10% and a maximum of 30%. Mean ROE was 18% against standard deviation of 0.07. Credit rating based in percentage had a mean of 8% and standard deviation of 0.039 while CAR had mean of 21% and standard deviation of 0.048. Asset quality on the other hand had a mean of 5% and standard deviation of 0.057. LDR and CIR had a mean of 85% and 59% respectively. Standard deviation for LDR and CIR were 0.193 and 0.295 respectively. GDP measured in billion Ksh. had a mean of 3858.7718 and standard deviation of 300.64475 within the 5-year period (2012-2016). Correlation results indicated a very strong and positive correlation between ROA and ROE (r =0.957). This correlation was significant at 95% confidence level (P value = 0.00<0.05). Credit rating had a negative and strong correlation with both ROA and ROE (r =-.811 and -.715 respectively. Capital adequacy ratio (CAR) was found to have positive and weak association with ROA and ROE (r = 0.354 and 0.344 respectively). CAR also had a weak and negative association with CR (r =-0.293) significant at 95% confidence level. Asset quality (AQ) indicated a negative correlation with both ROA and ROE (r = -0.544 and -0.569). LDR indicated a strong and positive association with both ROA and ROE (r = 0.711 and 0.753 respectively). Regression analysis established that Credit Rating (CR) had positive coefficient of 1.019 with ROE at 95% confidence level. CAR had a positive coefficient of 0.067 significant at 95% confidence level. Asset quality (AQ) on the other hand had a negative coefficient of -0.323 and p value of 0.004 < 0.05. Loan to Deposit Ratio (LDR) can predict ROE at 95% confidence level. Only cost to income ratio (CIR) was insignificant with ROE at 95% confidence level. However, on ROA, all variables had significant effect at 95% confidence level. Credit rating, capital adequacy ratio, and load to deposit ratio had a positive effect while cost to income ratio and asset quality had a negative effect. The study concluded that credit risk has an effect on financial performance in commercial banks listed in NSE. Therefore, it adds to the body of knowledge that credit risk has a negative effect on financial performance. The study recommended commercial banks to support credit rating aspect as it gives depositors a sense of safety. Further study can be done to establish the gap between credit rating and implementation.