The Effects of Non Performing Loans on Profitability of Commercial Banks in Kenya

Abstract

Kenya commercial Banks have challenges in managing Non-performing loans that are considered to have effects on its operational profitability. The central bank of Kenya together with the Kenya Bankers Associations and Credit reference Bureaus has established various ways of reducing NPLs. This study seeks to find out the effects of NPLs on profitability of commercial banks in Kenya. The study population consisted registered commercial banks in Kenya, (CBK 2016). Profitability measured by return on assets was used as dependent variable and non performing loans measured by NPLs ratio was used as independent variable. To improve the accuracy and reliability of the tests Capital adequacy, Operational efficiency and Liquidity were used as control variables. The research covered all commercial banks in Kenya for the last ten years that is 2006-2016 and used secondary data to analyze and draw conclusions and recommendations. The study indicates that there is negative effect of nonperforming loans ratio on return on assets, confirming that non performing loans negatively affects profitability of commercial banks in Kenya. Managers of Commercial banks in Kenya have to work hard to enhance profitability of commercial banks and reduce occurrences of nonperforming loans. This includes taking measures to mitigate against moral hazard and adverse selections in advancing loans, example, use of credit reference bureaus. Central bank of Kenya should enhance supervision of commercial banks and consider analysis of relationship between ratios of nonperforming loans and profitability to enhance understandability and avoid concentrating on quantum figures alone. Investors and shareholders should also take action to caution against possible use of provisions for losses on non performing loans for smoothing earnings by the managers. This paper therefore provides an insight to commercial banks, central bank and other stake holders on the effect of nonperforming loans on profitability of commercial banks in Kenya and provides a basis for further research.