The Relationship Between Non-performing Loans and Financial Performance of Commercial Banks in Ethiopia

Abstract

Banks financial performance is adversely affected by the level of non-performing loans. Non-performing loans have been widely used as a measure of asset quality among lending institutions and are often associated with failures and financial crises in both the developed and developing countries. This study was carried out with the objective of finding out whether the financial performance and non-performing loans of commercial banks in Ethiopia has been related by using performance as well as to test the existence of the relationship between the Capital adequacy, Asset Quality, Management efficiency, and Liquidity with the profitability measures. Since two of the banks are less than five years in operation and the other three are not commercial banks, the study has conducted on the financial performance of fourteen commercial banks examined by using panel data from year 2011 to year 2015. The study used quantitative research approach and secondary financial data are analyzed by using multiple linear regression model for three profitability measures: ROE, R O A and NPM. Fixed effect regression model was applied to investigate the impact and relationship of: NPLR, capital adequacy, Asset Quality, Management efficiency, and Liquidity with bank profitability measures separately. The empirical result shows that Non –performing loans has negative relation whereas capital adequacy, and Management efficiency and liquidity have a slight positive relation, whereas asset quality shows a strong positive relationship with the mentioned profitability measures. Based on the findings, the study concludes that amount of the non-performing loans decreased significantly from the year 2011 to 2015 while the performance of the banks increased in the same period and this showed financial performance and non-performing loans have negatively related.