Credit Risk, Capital Adequacy and Banks Performance: An Empirical Evidence from Pakistan 27

Credit Risk, Capital Adequacy and

Banks Performance: An Empirical
Evidence from Pakistan
Maryam Mushtaq*, Aisha Ismail**, Rahila Hanif***
Banks need to have adequate capital as a cushion to
Abstract
absorb losses caused by different risk and to increase
Credit risk is one of the major risks in banking operations nowadays. WKHGHSRVLWRUVWUXVWRQEDQNVDQGXOWLPDWHO\SURWDELOLW\
For sustainable financial performance, credit risk management is RI WKH EDQNV 2ODOHNDQ DQG $GH\LQND  %XW
of crucial importance. Non-performing loans are the major element maintaining capital adequacy ratio above an optimum
of credit risk that negatively affects the banking performance. To OHYHO FDQ KDUP WKH SURWDELOLW\ 3RXGHO  &DSLWDO
cater such risk, banks have to maintain certain percentage of adequacy not only improves the performance of banks but
capital as cushion with central bank as per BASEL requirements. also used as credit risk mitigation technique (Ogboi and
Efficient credit risk management contributes positively towards
banking profitability. This study aims to investigate; how credit
risk and capital adequacy affects the performance of commercial
banks in Pakistan. This study identifies the exposure of Pakistani
commercial banks towards credit risk and impact of credit risk
management practices for 6 years. The findings of this study
help the risk managers to ensure prudent credit risk management
practices that will help in reducing non-performing loans and
improving banking performance.
Keywords: Credit Risk, Credit Risk Management, Capital
Adequacy, Non-performing Loans
/ credit risk management to improve their performance in
Financial institutions especially banks are the main pillar
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system improves the economic development and for that ZD\V )UHGULFN  DQG .DD\D DQG 3DVWRU\ 
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their operations; among all these risks credit risk is the
major risk that directly affects the banking performance
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of resources and a vigilant risk management that enhances
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of credit creation process for the survival; credit risk
management is inevitable for long term success and for
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* Virtual University of Pakistan, Pakistan

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28 International Journal of Financial Management
require an integrated credit risk management to mitigate
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and mitigation of sources of the risk; ensuring the capital
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Volume 5 Issue 1 January 2015
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years because of increased competition, technological
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have been reported by these studies(Boahene, Dasah,
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in current uncertain environment and such risksare the
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of credit risk management for the ultimate objective of
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Different studies have been conducted by the researchers
to check the impact of capital adequacy and credit risk
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risk management for the performance of banks, this study
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effective credit risk management through understanding
the important determinants of credit risk and the role of
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as guidelines for the regulators to set the benchmarks
for capital adequacy ratios and for developing credit
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investors to have a look on capital adequacy and credit risk
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introduction, contribution and objectives of the study;
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 Credit Risk, Capital Adequacy and Banks Performance: An Empirical Evidence from Pakistan 29

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of credit risk management and capital adequacy on
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proved the sound credit risk management techniques and
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adequacy ratio, bank size, and assets management
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on risk management practices of selected commercial
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operational risk, and market risk are the major type of
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rating system and risk adjusted rate of return on capital
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proved the importance of capital adequacy and credit
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banks are in great need of proper credit risk management
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risk and capital adequacy ratio on banks performance
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30 International Journal of Financial Management Volume 5 Issue 1 January 2015

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Performance of the banks is measured by return on assets
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 Credit Risk, Capital Adequacy and Banks Performance: An Empirical Evidence from Pakistan 31

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factors are considered for the analysis that contribute
Table 4: Regression Results in the credit risk and ultimately adversely affect the
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