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

Abstract

Banking is the key activity to economic development and this is due to the financial services that banks provide. Banks provide credit to the public who are therefore able to invest into productive activities to enhance economic growth and sustainability of the economy. Lending is the key activity in banking and therefore loans form the largest source of credit risk in banking. There is need to conduct a study to evaluate how the internal factors affect firm profitability. The purpose of this study was to examine the effect of credit risk management on the profitability of commercial banks in Kenya. The study adopted descriptive research design. The target population was 43 commercial banks. Secondary data was collected for 2012-2016. The collected data was analyzed using descriptive, correlation and regression analysis. The analyzed findings indicated an inverse significant relationship was established between asset quality and financial performance of commercial banks in Kenya (r=-0.163, p=0.029<0.05). The study established significant inverse relationship between liquidity and financial performance (r=-0.288, p=0.000). Size had a direct and significant relationship with financial performance of commercial banks (r=0.280, p=0.000<0.05). From regression analysis, the study revealed that capital adequacy had significant effect on financial performance of commercial banks p=0.011<0.05. There was a significant effect of liquidity on financial performance of commercial banks p=0.000<0.05. Bank size had significant influence on performance of commercial banks in Kenya p=0.001<0.05. From correlation analysis, liquidity (r=-0.288) was the most significant factor affecting financial performance followed by size (r=0.280). On the other hand, regression analysis indicated that capital adequacy (2%) had greatest significance on financial performance of commercial banks followed by liquidity (1.6%) and lastly bank size (1.1%). The study concluded thatthere was an inverse significant relationship between asset quality and financial performance of commercial banks in Kenya. There was a significant inverse relationship between liquidity and financial performance. Size had a direct and significant relationship with financial performance of commercial banks. The study recommends that top management of commercial banks in Kenya embrace the use of systems and automation in the credit decisioning process as opposed to just relying on the manual assessment process which mostly is subjective.They should increase liquidity of their banks through sound working capital management practices. The Central Bank of Kenya should formulate progressive policies and guidelines that regulate activities in the banking industry. Commercial banks in Kenya should invest in promotional activities that grow their revenue and income.