The use of financial ratios for credit evaluation by commercial banks in Kenya

Abstract

The ways banks do their evaluation of loans vary from one lending institution to another. In most cases the banks tend to rely on the data generated by the credit reference bureau (CRB). A number of studies have also established that financial institutions use ratios when evaluating their customer’s for purposes of lending. While evaluating their customers banks look at different aspects of the financial statements and each bank has its area of emphasis. The question is which these ratios which are commonly used in Kenya and what level of importance is attached to each of them. The focus of this study is whether the banks in Kenya also use ratios and if so to what extent do they use them. A descriptive research was used in this study which involved a total of 28 banks, and as at the time of the study 43 registered banks were operating under the banking Act. A questionnaire was used as a tool for data collection. The descriptive statistics used included arithmetic mean, mode, median, standard deviation, maximum and minimum values, tables were then generated to help in simplifying the results. The study established that all the banks have in place a credit risk management team. The banks used ratios always in making their evaluation of corporate customers and that the most important ratios in credit evaluation are the liquidity ratios, and that profitability ratios also play a key role. The study recommends that each bank should have its own internal method of credit evaluation, to subsidize credit reference bureau [CRB],This is because CRB has a weaknesses of delay in the updating of data and also the data is generated based on information from other banks which may not be very accurate.