The Effect of Credit Risk Management on the Profitability of Commercial Banks in Kenya

Abstract

Most of the products and services provided by the banks are on credit which includes advancing loans and taking deposits from clients. Banks undertake these operations with the objective of accumulating profit, however, credit risk has increasingly risen over time because of financial crisis and advancement in financial institutions therefore causing loses in this sector. It is therefore prudent for Banks to ensure that they adopt comprehensive credit management policies that will enhance minimization of credit risk exposure for Banks the objective of profit maximization. The objective of this study was to determine the effect of credit risk management on the profitability of commercial banks in Kenya through the application of descriptive research design. The period of study was 5 years ranging 2012-2016 by the use of published financial statements. The analysis of data was conducted by use of descriptive statistic and regression model. The dependent variable was Return on Equity while the independent variables included Loan to Deposit ratio, Non-Performing Loan ratio, Capital Adequacy ratio and Management Efficiency. The relationship of non-performing loans and Return on Equity was negative as revealed by the study. This implies that that an increase in the levels of non-performing loans resulted to a decrease in Return on Equity. The study also revealed a negative relationship between Return on Equity and liquidity as measured by Loan to Deposit ratio. There was a strong positive correlation between capital adequacy and Return on Equity. This implies that an increase in capital adequacy lead to more returns to commercial banks in Kenya. There was a positive relation between Return on Equity and Management Efficiency. This implies that effective credit risk management results in management efficiency of banks hence rise in Return on Equity. The study therefore recommends that banks should adopt a good credit risk management system so as to minimize risk exposure for profits to be maximized.