THE INFLUENCE OF CREDIT RISK MANAGEMENT ON FINANCIAL PERFORMANCE
OF COMMERCIAL BANKS IN KENYA
OYUGI FREDRICK OTIENO
STUDENT REG.NO.HD 433-C004-1681/2013
DBA 4112 FINANCE SEMINAR
ABSTRACT
Financial risk in a banking organization is possibility that the
outcome of an action or event could bring up adverse impacts.
Such outcomes could either result in a direct loss of earnings or
capital or may result in imposition of constraints on bank’s
ability to meet its business objectives. This study evaluates the
influence of credit risk management on financial performance of
Commercial Banks in Kenya.
Descriptive, correlation and regression techniques were used in
the analysis. The findings revealed that credit management has a
significant impact on the financial performance of Kenyan banks.
i
Therefore, it is recommended that Commercial Banks need to be
cautious in setting up a credit policy that might not negatively
affect their financial performance.
ii
TABLE OF CONTENTS
ABSTRACT.......................................................i
CHAPTER ONE....................................................11.0 INTRODUCION................................................11.1 Statement of the problem...................................21.2 General Objective..........................................3
1.2.1 Specific Objectives....................................31.3 Research Questions.........................................41.4 Research Scope.............................................4
CHAPTER TWO....................................................5LITERATURE REVIEW..............................................52.1 Credit Risk Management Strategies..........................52.2 Theoretical Review.........................................9
2.2.1 Portfolio theory.......................................92.2.2 Arbitrage Pricing Theory (APT)........................102.2.3 Information Theory....................................10
2.3 Conceptual Framework……………………………………………………………………..…………………………………………….10
2.3 Empirical Review..........................................11
CHAPTER THREE.................................................14THE METHODOLOGY...............................................14
CHAPTER FOUR..................................................15RESULTS AND FINDINGS..........................................154.1 Credit guarantee..........................................154.2 Credit monitoring.........................................15
iii
4.3 Loan Security.............................................164.4 Credit approval process...................................164.5 Credit appraisal analysis.................................164.6 Credit risk scoring.......................................174.7 Conclusion and Recommendations............................17REFERENCES....................................................19
APPENDIX 1:LIST OF COMMERCIAL BANKS...........................22
iv
CHAPTER ONE
1.0 INTRODUCION
Lending is an integral element of banking business; it is itself
at the heart of an economy’s financial architecture. It therefore
behoves policy makers to continually review the credit market to
minimize inefficiencies that hinder faster economic growth.
Credit risk is the current and prospective risk earnings or
capital arising from an obligor’s failure to meet the terms of
any contract with the bank or otherwise to perform as agreed
(Kargi, 2011). Credit risk management is a structured approach to
managing uncertainties through risk assessment developing
strategies to manage it, and mitigation of risk using managerial
resources. The strategies include transferring to another party,
avoiding the risk, reducing the negative effects of the risk and
accepting some or all of the consequences of a particular risk.
Credit risk management is very important to banks as it is an
integral part of the loan process. It maximizes bank risk,
adjusted risk rate of return by maintaining credit risk exposure
with view to shielding the bank from the adverse effects of
credit risk
When banks grant loans, they expect the customers to repay the
principal and interest on an agreed date. A credit facility is
said to be performing if payment of both principal and interest
are up to date in accordance with agreed repayment terms. The
non-performing loans (NPLs) represent credits which the banks
perceive as possible loss of funds due to loan defaults. They are
1
further classified into substandard, doubtful or lost. Bank
credit in lost category hinders bank from achieving their set
target (Kolapo et al., 2012).
Financial performance is company’s ability to generate new
resources, from day- to- day operations, over a given period of
time; performance is gauged by net income and cash from
operations. A bank is a commercial or state institution that
provides financial services, including issuing money in various
forms, receiving deposits of money, lending money and processing
transactions and the creating of credit (Campel, et. al., 1993).
Credit risk management models include the systems, procedures and
control which a company has in place to ensure the efficient
collection of customer payments and minimize the risk of non-
payment. The high level of non-performing loans is a challenge to
many commercial banks in Kenya, which is evidence that commercial
banks are faced by a big risk of their credit. Commercial banks
are vital institutional framework for national development
because they contribute about 50 percent of the Gross Domestic
Product. Lending in commercial banks is the main source of making
profit hence need for efficient credit risk management practices
within the industry.
Financial institutions are exposed to a variety of risks among
them; interest rate risk, foreign exchange risk, political risk,
market risk, liquidity risk, operational risk and credit risk
(Yusuf, 2003; Cooperman, Gardener and Mills, 2000). In some
2
instances, commercial banks and other financial institutions have
approved decisions that are not vetted; there have been cases of
loan defaults and non-performing loans, massive extension of
credit and directed lending. Policies to minimize on the negative
effects have focused on mergers in banks and NBFIs, better
banking practices but stringent lending, review of laws to be in
line with the global standards, well capitalized banks which are
expected to be profitable, liquid banks that are able to meet the
demands of their depositors, and maintenance of required cash
levels with the central bank which
means less cash is available for lending (Central Bank Annual
Report, 2004). This has led to reduced interest income for the
commercial banks and other financial institutions and by
extension reduction in profits (De Young et al, 2001). Banks are
investing a lot of funds in credit risk management modeling. The
case in point is the Basel 11 accord.
1.1 Statement of the problem
The Banking sector is currently facing pressure from both the
Government and the Public to lower the interest rates on loans.
On the other hand Banks are facing various challenges like non-
performing loans, stagnant interest rates, mobile money transfer
services which have greatly affected their profitability.
Hence Commercial Banks in their efforts to reduce the impact of
non-performing loans and mobile money transfer, have adopted new
Credit Risk Management techniques and Agency Banking.
3
According to Besis (2005) Risk management is important to Bank
management because banks are ‘risk machines’ they take risks;
they transform them and embed them to banking products and
services. Risks are uncertainties resulting in adverse
variations of profitability or in losses.
Various risks faced by commercial banks include credit risk,
market risks, interest rates risk, liquidity risk and operational
risk. (Shubhasis,2005).
A surge in bad debts and flat growth in interest income has
slowed down Equity Banks profitability.The banks are feeling the
heat of a new Central Bank of Kenya directive on the treatment of
non-performing loans which has inflated their bad debts book and
forced them to set aside additional cash as provision for
defaulters. (Business Daily dated 24th February 2014).
Locally Ndung’u (2003) in his study on the determinants of
profitability of quoted Commercial Banks in Kenya finds that
sound asset and liability management had a significant influence
on profitability.
Ngumi (2013) found that Bank innovations namely automated teller
machines, debit and credit cards, interest Banking, mobile
banking, electronic funds transfer and point of sale terminals
had statistically significant influence on financial performance
of Commercial Banks in Kenya.
4
Based on these studies performed and risk of non-performing loans
and competition faced by Banks in Kenya, there is need to conduct
a study to evaluate the influence of Credit Risk Management on
Financial Performance of Commercial Banks in Kenya.
1.2 General Objective
The study will seek to establish the effects of Credit risk
management on Financial Performance of Commercial Banks in Kenya.
1.2.1 Specific Objectives
i) To determine the effect credit guarantees have on financial
performance of commercial banks in Kenya.
ii) To determine the effect of loan security on financial
Performance of commercial banks in Kenya.
iii) To determine the effect of credit risk scoring on financial
performance of commercial banks in Kenya
iv) To determine the effect of credit appraisal analysis on
financial performance of commercial banks in Kenya.
v) To determine the effect of credit approval process and
sanctions on financial performance of commercial banks.
vi) To establish the moderating effect of Central Bank of Kenya
regulations.
vii) To establish the moderating effect of Government Regulations
1.3 Research Questions
i) What is the effect of credit guarantees on the financial
performance of Kenyan commercial banks
5
ii) What is the effect of loan security on the financial
performance of commercial banks in Kenya?
iii) Does credit risk scoring impact on the financial
performance of banks in Kenya?
iv) What is the effect of credit appraisal analysis on the
financial performance of Kenyan banks?
v) Does credit approval process and sanctions impact on a
bank’s financial performance
vi) What is the moderating effect of central bank of Kenya’s
regulations?
vii) What is the moderating effect of government regulations?
1.4 Scope
The study covered 42 commercial banks licenced by the CentralBank of Kenya. The commercial banks that formed the units of analysis are those that were in operation by close of business on 31st December, 2013.
6
CHAPTER TWO
2.0 LITERATURE REVIEW
A bank exists not only to accept deposits but also to grant
credit facilities, therefore inevitably exposed to credit risk.
Credit risk is by far the most significant risk faced by banks
and the success of their business depends on accurate measurement
and efficient management of this risk to a greater extent than
any other risks (Gieseche, 2004). According to Chen and Pan
(2012), credit risk is the degree of value fluctuations in debt
instruments and derivatives due to changes in the underlying
credit quality of borrowers and counterparties. Coyle (2000)
defines credit risk as losses from the refusal or inability of
credit customers to pay what is owed in full and on time. Credit
risk is the exposure faced by banks when a borrower (customer)
defaults in honoring debt obligations on due date or at maturity.
This risk interchangeably called ‘counterparty risk’ is capable
of putting the bank in distress if not adequately managed. Credit
risk management maximizes bank’s risk adjusted rate of return by
maintaining credit risk exposure within acceptable limit in order
to provide framework for understanding the impact of credit risk
management on banks’ profitability (Kargi, 2011). Demirguc-Kunt
and Huzinga (1999) opined that credit risk management is in two-
fold which includes, the realization that after losses have
occurred, the losses becomes unbearable and the developments in
the field of financing commercial paper, securitization, and
7
other non-bank competition which pushed banks to find viable loan
borrowers.
The main source of credit risk include, limited institutional
capacity, inappropriate credit policies, volatile interest rates,
poor management, inappropriate laws, low capital and liquidity
levels, direct lending, massive licensing of banks, poor loan
underwriting, laxity in credit assessment, poor lending
practices, government interference and inadequate supervision by
the central bank (Kithinji, 2010).An increase in bank credit risk
gradually leads to liquidity and solvency problems. Credit risk
may increase if the bank lends to borrowers it does not have
adequate knowledge about.
2.1 Credit Risk Management Strategies
The credit risk management strategies are measures employed by
banks to avoid or minimize the adverse effect of credit risk. A
sound credit risk management framework is crucial for banks so as
to enhance profitability guarantee survival. According to
Lindergren (1987), the key principles in credit risk management
process are sequenced as follows; establishment of a clear
structure, allocation of responsibility, processes have to be
prioritized and disciplined, responsibilities should be clearly
communicated and accountability assigned. The strategies for
hedging credit risk include but not limited to these;
i. Credit Derivatives: This provides banks with an approach which
does not require them to adjust their loan portfolio. Credit
8
derivatives provide banks with a new source of fee income and
offer banks the opportunity to reduce their regulatory capital
(Shao and Yeager, 2007). The commonest type of credit derivative
is credit default swap whereby a seller agrees to shift the
credit risk of a loan to the protection buyer. Frank Partnoy and
David Skeel in Financial Times of 17 July, 2006 said that “credit
derivatives encourage banks to lend more than they would, at
lower rates, to riskier borrowers”. Recent innovations in credit
derivatives markets have improved lenders’ abilities to transfer
credit risk to other institutions while maintaining relationship
with borrowers (Marsh, 2008).
ii. Credit Securitization: It is the transfer of credit risk to a
factor or insurance firm and this relieves the bank from
monitoring the borrower and fear of the hazardous effect of
classified assets. This approach insures the lending activity of
banks. The growing popularity of credit risk securitization can
be put down to the fact that banks typically use the instrument
of securitization to diversify concentrated credit risk exposures
and to explore an alternative source of funding by realizing
regulatory arbitrage and liquidity improvements when selling
securitization transactions (Michalak and Uhde,2009). A cash
collateralized loan obligation is a form of securitization in
which assets (bank loans) are removed from a bank’s balance sheet
and packaged (tranched) into marketable securities that are sold
on to investors via a special purpose vehicle (SPV) (Marsh,2008).
9
iii. Compliance to Basel Accord: The Basel Accord are
international principles and regulations guiding the operations
of banks to ensure soundness and stability. The Accord was
introduced in 1988 in Switzerland. Compliance with the Accord
means being able to identify, generate, track and report on risk-
related data in an integrated manner, with full auditability and
transparency and creates the opportunity to improve the risk
management processes of banks. The New Basel Capital Accord
places explicitly the onus on banks to adopt sound internal
credit risk management practices to assess their capital adequacy
requirements (Chen and Pan, 2012).
iv. Adoption of a sound internal lending policy: The lending
policy guides banks in disbursing loans to customers. Strict
adherence to the lending policy is by far the cheapest and
easiest method of credit risk management. The lending policy
should be in line with the overall bank strategy and the factors
considered in designing a lending policy should include; the
existing credit policy, industry norms, general economic
conditions of the country and the prevailing economic climate
(Kithinji,2010).
v. Credit Bureau: This is an institution which compiles
information and sells this information to banks as regards the
lending profile of a borrower. The bureau awards credit score
called statistical odd to the borrower which makes it easy for
banks to make instantaneous lending decision. Example of a credit
10
CONCEPTUAL FRAMEWORK
12
ModeratingVariables CBKRegulations
DependentVariables
TotalIncome
ModeratingVariablesGovernment
Profitbefore tax
CustomerDeposits
Return onInvestment
s
CRED
IT R
ISK
MANA
GEME
NT
IndependentVariables
CreditGuarantee
Creditapproval
Creditappraisal
BANK
FIN
ANCI
AL P
ERFO
RMANCE
Loan Security
CreditMonitoring
2.2 Theoretical Review
2.2.1 Portfolio theory
Since the 1980s, companies have successfully applied modern
portfolio theory to market risk. Many companies are now using
value at risk models to manage their interest rate and market
risk exposures. Unfortunately, however, even though credit risk
remains the largest risk facing most companies, the practice of
applying modern portfolio theory to credit risk has lagged
(Margrabe, 2007)
Companies recognize how credit concentrations can adversely
impact financial performance. As a result, a number of
institutions are actively pursuing quantitative approach to
credit risk measurement. This industry is also making significant
progress toward developing tools that measure credit risk in
portfolio context. They are also using credit derivatives to
transfer risk efficiently while preserving customer
relationships. Portfolio quality ratios and productivity
indicators have been adapted (Kairu 2009). The combination of
these developments has vastly accelerated progress in managing
credit risk in a portfolio context.
Traditionally, organizations have taken an asset-by-asset
approach to credit risk management. While each company’s method
varies, in general this approach involves periodically evaluating
the quality of credit exposures, applying a credit risk rating,
14
and aggregating the results of this analysis to identify a
portfolio’s expected losses. The foundation of the asset-by-asset
approach is a sound credit review and internal credit risk rating
system. This system enables management to identify changes in
individual credits, or portfolio trends in a timely manner. Based
on the changes identified, credit identification, credit review,
and credit risk rating system management can make necessary
modifications to portfolio strategies or increase the supervision
of credits in a timely manner. While the asset-by-asset approach
is a critical component to managing credit risk, it does not
provide a complete view of portfolio credit risk, where the term
risk refers to the possibility that actual losses exceed expected
losses. Therefore, to gain greater insight into credit risk,
companies increasingly look to complement the asset-by-asset
approach with a quantitative portfolio review using a credit
model (Mason and Roger, 1998). Companies increasingly attempt to
address the inability of the asset-by-asset approach to measure
unexpected losses sufficiently by pursuing a portfolio approach.
One weakness with the asset-by-asset approach is that it has
difficulty identifying and measuring concentration. Concentration
risk refers to additional portfolio risk resulting from increased
exposure to credit extension, or to a group of correlated
creditors (Richardson, 2002).
2.2.2 Arbitrage Pricing Theory (APT)
A more interesting alternative was the Arbitrage Pricing Theory
(APT) of Ross (1976). Stephen Ross's APT approach moved away from15
the risk vs. return logic of the CAPM, and exploited the notion
of pricing by arbitrage to its fullest possible extent. As Ross
himself has noted, arbitrage-theoretic reasoning is not unique to
his particular theory but is in fact the underlying logic and
methodology of virtually all of finance theory. This theory
subscribes to the fact that an estimate of the benefits of
diversification would require that practitioners calculate the
covariance of returns between every pair of assets. In their
Capital Asset Pricing Model (CAPM), Morris (2001) solved this
practical difficulty by demonstrating that one could achieve the
same result merely by calculating the covariance of every asset
with respect to a general market index. With the necessary
calculating power reduced to computing these far fewer terms
(betas), optimal portfolio selection became computationally
feasible.
2.2.3 Information Theory
Derban, Binner and Mullineux (2005) recommended that borrowers
should be screened especially by banking institutions in form of
credit assessment. Collection of reliable information from
prospective borrowers becomes critical in accomplishing effective
screening as indicated by symmetric information theory.
Qualitative and quantitative techniques can be used in assessing
the borrowers although one major challenge of using qualitative
models is their subjective nature. However according to Derban,
Binner and Mullineux (2005), borrowers attributes assessed
through qualitative models can be assigned numbers with the sum16
of the values compared to a threshold. This technique minimizes
processing costs, reduces subjective judgments and possible
biases. The rating systems will be important if it indicates
changes in expected level of credit loan loss. Brown Bridge
(1998, pp.173-89) concluded that quantitative models make it
possible to numerically establish which factors are important in
explaining default risk, evaluating the relative degree of
importance of the factors, improving the pricing of default risk,
screening out bad loan applicants and calculating any reserve
needed to meet expected future loan losses.
2.3 Empirical Review
There have been debate and controversies on the impact of credit
risk management andbank’s financial performance. Some scholars
e.g., (Li Yuqi 2007; Naceur and Kandil 2006; Kinthinji 2010;
Kolapo, Ayeni and Ojo 2012; Kargi 2011;) amongst others have
carried out extensive studies on this topic and produced mixed
results; while some found that credit risk management impact
positively on banks financial performance, some found negative
relationship and others suggest that other factors apart from
credit risk management impacts on bank’s performance.
Specifically, Kargi (2011) found in a study of Nigeria banks from
2004 to 2008 that there is a significant relationship between
banks performance and credit risk management. He found that loans
and advances and non-performing loans are major variables that
determine asset quality of a bank.
17
Kolapo, Ayeni and Ojo (2012) using panel data regression for the
period 2000 to 2010 found that the effect of credit risk on
bank’s performance measured by the Return on Asset (ROA) of banks
is cross sectionally invariant. They concluded that the nature
and managerial pattern of individual firms do not determine the
impact. Also, Hosna, Manzura and Juanjuan (2009) reemphasized the
effect of credit risk management on profitability level of banks.
They concluded that higher capital requirement contributes
positively to bank’s profitability. Muhammed, Shahid, Munir and
Ahad (2012) used descriptive, correlation and regression
techniques to study whether credit risk affect banks performance
in Nigeria from 2004 to 2008. They also found that credit risk
management has a significant impact on profitability of Nigerian
banks.
Boahene, Dasah and Agyei (2012) used regression analysis to
determine whether there is a significant relationship between
credit risk and profitability of Ghanain banks. They followed the
line of Hosna, Manzura and Juanjuan (2009) by using Return of
Equity as a measure of bank’s performance and a ratio of non-
performing loans to total asset as proxy for credit risk
management. They found empirically that there is an effect of
credit risk management on profitability level of Ghaninian banks.
The study also suggests that higher capital requirement
contributes positively to bank’s profitability. Li yuqi (2007)
examined the determinants of bank’s profitability and its
implications on risk management practices in the United Kingdom.
18
The study employed regression analysis on a time series data
between 1999 and 2006. Six measures of determinants of bank’s
profitability were employed. Theyproxied Liquidity,credit and
capital as internal determinants of bank’s performance. GDP
growth rate, interest rate and inflation ratewere used as
external determinants of banks profitability. The six variables
were combined into one overall composite index of bank’s
profitability. Return on Asset (ROA) was used as an indicator of
bank’s performance. It was found that liquidity and credit risk
have negative impact on bank’s profitability.
Poudel (2012) appraised the impact of the credit risk management
in bank’s financial performance in Nepal using time series data
from 2001 to 2011. The result of the study indicates that credit
risk management is an important predictor of bank’s financial
performance. Fredrick
(2010) demonstrated that credit risk management has a strong
impact on bank’s financial performance in Kenya. Meanwhile,
Jackson (2011) towed the line of Fredrick (2010) by using CAMEL
indicators as independent variables and return on Equity as a
proxy for banks performance. His findings were also in line with
that of Fredrick who also concluded that CAMEL model can be used
as proxy for credit risk management. Musyoki and Kadubo (2011)
also found that credit risk management is an important predictor
of bank’s financial performance; they concluded that banks
success depends on credit risk management.
19
Onaolapo (2012), while analyzing the credit risk management
efficiency in Nigerian commercial banking sector from 2004
through 2009 provides some further insight into credit risk as
profit enhancing mechanism. They used regression analysis and
found rather an interesting result that there is a minimal
causation between deposit exposure and bank’s performance.
Kithinji (2010) analyzed the effect of credit risk management
(measured by the ratio of loans and advances on total assets and
the ratio of non-performing loans to total loans and advances on
return on total asset in Kenyan banks between 2004 to 2008). The
study found that the bulk of the profits of commercial banks is
not influenced by the amount of credit and non-performing loans.
The implication is that other variables apart from credit and
non-performing loans impact on banks’ profit. Kithinji (2010)
result provides the rationale to consider other variables that
could impact on bank’s performance.
The Basel Committee on Banking Supervision(1999) asserts that
loans are the largest and most obvious source of credit risk,
while others are found on the various activities that the bank
involve itself with. Therefore, it is a requirement for every
bank worldwide to be aware of the need to identify measure,
monitor and control credit risk while also determining how credit
risk could be lowered. This means that a bank should hold
adequate capital against these risks and that they are adequately
compensated for risk incurred. This is stipulated in Basel II,
which regulates banks about how much capita they need to put
20
aside against these types of financial and operational risks they
face.
In response to this, commercial banks have almost universally
embarked upon an upgrading of their risk management and control
systems. Also, it is in the realization of the consequence of
deteriorating loan quality on profitability of the banking sector
and the economy at large that this work is motivated.
21
CHAPTER THREE
THE METHODOLOGY
The study used descriptive research design. The target population
of this study was management staff working in commercial banks of
the top, middle and low level management ranks. The sample size
was about 440 respondents. The data collection instruments were
questionnaires. Qualitative datacollected was analyzed by
descriptive statistics using SPSS and presented through
percentages,means, standard deviations and frequencies. For this
study, the researcher was interested inmeasuring the effect of
credit risk management on the financial performance of commercial
banks in Kenya. The factors are β (independent variables) and
dependent variable isY.
The study adapted a model similar to that used by Gakure, R. W.,
Ngugi, J. K., Ndwiga, P. M., &Waithaka, S. M. (2012). Which
studied the effect of credit risk management techniques on the
performance of unsecured bank loan employed by commercial banks
in Kenya?
Y= β0+ β1X1+β2X2+ β3X3+ β4X4+ β5X5+ β6X6 +α
Where;
Y =Bank performance (Profit before tax)22
β0=Regression coefficientβ1, β2, β3, β4, β5= Slopes of regression equation.
X1 = Credit guarantee
X2 =Credit monitoring
X3=Loan security
X4=Credit approval process
X5 =Credit appraisal analysis
X6 =Credit risk scoring
α= Error term (assumed to be zero)
The equation was solved by the use of statistical model applying SPSS.
CHAPTER FOUR
RESULTS AND FINDINGS
4.1 Credit guarantee
From the findings, it was observed that credit guarantee affects
financial performance of commercial banks to a moderate extent as
indicated by a mean of 2.7. This is because most of the customers
wishing to take up banks services like loans do not have
sufficient guarantee hence most of them would rather not take up
the service. This is lost business opportunity for the bank hence
low profits.
23
4.2 Credit monitoring
From the findings, the respondents indicated that risk monitoring
moderately affected bank’s performance as indicated by a mean of
2.4. The respondents indicated that controls in place and
responses in place affected the bank’s profitability to a great
extent as indicated by a mean of 2.6, the respondents indicated
that reporting and review affected the performance to a moderate
extent as indicated by a mean of 2.5 and Internal control
affected the performance as indicated by a mean of 2.4. Results
indicate that credit approval guidelines and monitoring of
borrowers affect the profitability to a great extent as indicated
by a mean of 1.8 and that Clear established process affect the
performance of the bank to a great extent as indicated by a mean
of 1.5.
According to the findings, the respondents strongly agreed that
frequent contact with borrowers, creating an environment that the
bank can be seen as a solver of problems and trusted adviser and
that monitoring the flow of borrower's business through the
bank's account affect banks performance as indicated by a mean of
2.6, the respondents strongly agreed that developing the culture
of being supportive to borrowers whenever they are recognized to
be in difficulties and are striving to deal with the situation
affect the performance as indicated by a mean of 2.5, the
respondents agreed that Regular review of the borrower's reports
as well as an on-site visit affect the performance of the bank as
indicated by a mean of 2.1 and the respondents agreed that
24
updating borrowers credit files and periodically reviewing the
borrowers rating assigned at the time the credit was granted
affect the banks financial performance as indicated by a mean of
2.0 and 1.9 respectively.
4.3 Loan Security
Respondents indicated that loan security affect financial
performance of a bank moderately as indicated by a mean of 2.5
since it is an issue already known that for anyone to get a loan
from a bank then they must have a form of security. The findings
indicated that suppose there was no security then banks would
have had more customers but not necessarily improved
profitability since the default rate would also be high.
4.4 Credit approval process
Respondents indicated that credit approval guidelines and
monitoring of borrowers affect the banks performance to a great
extent as indicated by a mean of 1.8 and that Clear established
process affect the performance of the bank to a great extent as
indicated by a mean of 1.5. From the findings, the respondents
strongly agreed that clear established process for approving new
credits and extending the existing credits has been observed to
be very important while managing Credit Risks in banks and banks
must have in place written guidelines on the credit approval
process and the approval authorities of individuals or committees
as well as the basis of those decisions affect the performance of
25
the bank as indicated by a mean of 2.0, the respondents agreed
that monitoring of borrowers is very important as current and
potential exposures change with both the passage of time and the
movements in the underlying variables affect the performance of
bank as indicated by a mean of 1.9, the respondents agreed that
prudent credit practice requires that persons empowered with the
credit approval authority should not also have the customer
relationship responsibility, some approval authorities will be
reserved for the credit committee in view of the size and
complexity of the credit transaction and that credits to related
parties should be closely analyzed and monitored so that no
senior individual in the institution is able to override the
established credit granting process affected bank performance as
indicated by a mean of 1.8.
4.5 Credit appraisal analysis
From the findings, the respondents indicated that credit
appraisal affect the performance of banks to a moderate extent as
indicated by a mean of 2.5, Classification affect customer
deposits to a great extent as indicated by a mean of 2.2, Risk
evaluation affect the profitability of bank to a great extent as
indicated by a mean of 1.9, Risk estimation affect bank
performance to a great extent as indicated by a mean of 1.7 and
determining risk reduction measures affected the financial
performance to a great extent as indicated by a mean 1.6.
Respondents strongly agreed that risk analysis and assessment
comprises identification of the outcomes as indicated by a mean
26
of 2.2, the respondents strongly agreed that risk analysis and
assessment comprises estimation the magnitude of the consequences
as indicated by a mean of 1.9, the respondents agreed that risk
analysis and assessment comprises the probability of those
outcomes as indicated by a mean of 1.6.
4.6 Credit risk scoring
From the study, it was observed that risk scoring affects banks
financialperformance to a moderate extent as indicated by a mean
of 2.5; Inspection by branch managers affected the performance to
a great extent as indicated by a mean of 2.3; financial statement
analysis also affected the performance to a great extent as
indicated by a mean of 2.1; Establishing standards affected the
performance banks to a great extent as indicated by a mean of
1.7, Credit scoring affected the performance of banks to a great
extent as indicated by a mean of 1.6, Risk rating and collateral
and Credit worthiness analysis affected the performance of banks
to a great extent as indicated by a mean of 1.5. The study
revealed that the credit manager established the crucial
observation areas inside and outside the bank as indicated by a
mean of 2.5, that the departments and the employees are assigned
with responsibilities to identify specific risks as indicated by
a mean of 1.7, and that risk identification is positively
significant to influence risk management practices as indicated
by a mean of 1.6.
27
4.7 Conclusion and Recommendations
The study investigated the influence of credit risk management on
financial performance of commercial banks in Kenya. From the
findings it is concluded that banks financial performance is
inversely influenced by level of loans and advances, non-
performing loans and deposits thereby exposing them to great risk
of liquidity and distress. Therefore, management need to be
cautious in setting up a credit policy that will not negatively
affect profitability and also they need to know how credit policy
affects the operation of their banks to ensure judicious
utilization of deposits and maximization of profit. Improper
credit risk management reduce the bank’s profitability, affects
the quality of its assets and increase loan losses and non-
performing loan which may eventually lead to financial distress.
Central bank of Kenya for policy purpose should regularly assess
the lending attitudes of financial institutions. One direct way
is to assess the degree of credit crunch by isolating the impact
of supply side of loan from demand side taking into consideration
the opinion of the firms about bank’s lending attitude. Finally,
strengthening the securities market will have positive impact on
the overall development of the banking sector by increasing
competitiveness in the financial sector. When the range of
portfolio selection is wide, people can compare the return and
security of their investment among the banks and the securities
market operators. As a result banks remain under some pressure to
improve their financial soundness.
28
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APPENDIX 1
LIST OF COMMERCIAL BANKS
1. ABC Bank (Kenya)2. Bank of Africa3. Bank of Baroda4. Bank of India5. Barclays Bank (Kenya)6. CFC Stanbic Bank7. Chase Bank (Kenya)8. Citibank9. Commercial Bank of Africa10. Consolidated Bank of Kenya11. Cooperative Bank of Kenya12. Credit Bank13. Development Bank of Kenya14. Diamond Trust Bank15. Dubai Bank Kenya16. Ecobank17. Equatorial Commercial Bank18. Equity Bank19. Family Bank20. Fidelity Commercial Bank Limited21. First Community Bank22. Giro Commercial Bank23. Guaranty Trust Bank24. Guardian Bank25. Gulf African Bank26. Habib Bank27. Habib Bank AG Zurich28. I&M Bank29. Imperial Bank Kenya30. Jamii Bora Bank31. Kenya Commercial Bank32. K-Rep Bank33. Middle East Bank Kenya34. National Bank of Kenya35. NIC Bank
34
36. Oriental Commercial Bank37. Paramount Universal Bank38. Prime Bank (Kenya)39. Standard Chartered Kenya40. Trans National Bank Kenya41. United Bank for Africa[2]
42. Victoria Commercial Bank
APPENDIX IIANALYSIS TABLE
Very
gr
eat
mean
stde v
Riskidentification
affect 2 8 31 54 8 2.5 0.5Inspection by
branch Financialstatement
CreditworthinessThe creditmanager
establish thecrucialThe departments
and
the employeesare 0 0 13 46 41 1.7 0.
7Riskidentification
is
35
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