Determinants of Credit Risks in the Kenyan Banking Sector

Abstract

Credit risk is a wide concept in the financial sector literature. It has broadly been defined as the uncertainty on whether a borrower defaults on a loan by unfulfilling payments as agreed. This risk is mainly to the lender and it includes lost principal and interest, unbudgeted costs of collection and cash flows disruption. In Kenya, the percentage growth of credit risks has been higher than that of borrowings overtime. Since 2011, the percentage of loans that are categorized as non-performing has been increasing over the periods. The growth of credit risk has been found to be constant over the years, and the concern is how it can be reduced. The study focused on finding the main micro and macro factors that determine credit risk in the country. It used a sample of 25 banks from the 44 banks listed in the Central Bank. Panel data model was adopted with a combination of both fixed and random effects model where there were 350 observations (25 banks over the periods 2002-2015). In analyzing micro variables, a fixed effect model was used, while on macro and a combination of the two; random effects model was used. It was found that deposit rates and return on assets were the most important micro determinants of credit risks in the country, while unemployment and domestic credit to the private sector were the most important macro determinants of credit risk in the country. Exchange rate, inflation rates, GDP growth rates, bank size, bank ownership and management efficiency were all not found to be important factors in explaining credit risks in the banking sector of Kenya.