The Effect of Asset Quality on the Risk Adjusted Returns of Tier One Banks in Kenya

Abstract

The main aim of the research was to study the effect of asset quality on the risk adjusted returns of tier one banks in Kenya. The issue of problem loans and how they affect overall bank performance came under investigation. The research focussed on tier one commercial banks in Kenya since they hold almost half of the banking industry assets in Kenya. Using the causal research methodology the study employed data from six commercial banks that are classified by the regulator as having first tier status using a composite metric of loan book size, amount of deposits and number of customers. The study found a positive relationship between asset quality and the risk adjusted returns which conforms to previous studies that have found that lower credit risk increases profitability. It is useful from the findings of the research paper to consider if operating on scale generates efficiency that can compensate for excessive risk taking in lending.