Credit Risk and Financial Performance of Banks Listed at the Nairobi Securities Exchange, Kenya

Abstract

Introduction: Banks are often faced with risks that are mostly financial in nature. Effective management of risk is a prerequisite for sound financial performance of financial institutions. This study therefore analyses the effect of credit risk on financial performance of commercial banks listed at the Nairobi securities exchange. The specific objective was to determine the effect of credit risk on financial performance of commercial banks listed at the Nairobi securities exchange. Theories and models reviewed were the Capital Asset Pricing Model, Portfolio Theory, theory on risk and leverage and credit risk theory. Methods: A positivism research philosophy was adopted.The study used a longitudinal research design. A target population of 11 Commercial banks listed at the Nairobi securities exchange was considered. The data was analyzed using Statistical package of social studies version 20.0. The data was analyzed using Karl Pearson correlation and regression inferential statistical techniques. Results: The results showed that there was a significant strong correlation between credit risk and financial performance as proxied by ROE (r = -.601**, p =.003). The study found that credit risk significantly affects ROE (? = -.601, p = 007, ?<0.01). The model had an adjusted r square value of 0.323 implying that 32.3% of the total variation of financial performance of commercial banks is explained by credit risk. Conclusion: The study findings affirm that credit risk has a significant negative effect on banks financial performance. Upsurge in the banks ratio of nonperforming loans to total loans & advances results into the reduction of the bank’s financial performance. Recommendations: The management of commercial banks should determine effective credit risk management strategies that could help in reduction of loan default rates by customers. Extensive loan underwriting should be conducted to avoid over or under charge on prospective customers. Progressive implementation of the Basel Accord should be prioritized as opined by the Basel Committee submission on Banking Supervision. Credit risk inherent to the entire portfolio as well as the risk in individual credits as transaction practice should be managed well. Standardized approach, internal ratings based approach such as foundation and advanced approach should be considered by financial institutions when assessing credit risk.