Click to edit Master title style

TO ANALYZE THE RELATIONSHIP BETWEEN

CREDIT RISK MANAGEMENT INDICATORS,
PERFORMANCE AND PROFITABILITY OF
COMMERCIAL BANKS IN KENYA

1 1
 INTRODUCTION
Click to edit Master title style

Background of study
• In the Kenyan financial sector, commercial banks are the most
active players and in particular, in the financial markets.
• Commercial banks receive deposits from their clients with surplus
and lend the money to clients with deficits(borrowers).
• Credit risk is the main type of risk commercial banks are exposed
to, which arises when non-performing borrowers are unable or
unwilling to payback their loans.
• As a result, credit risk management is one way in which commercial
banks can ensure continuity , growth and profitability of the banks,
financial sector and the Kenyan economy

2 2
 Statement
Click of Problem
to edit Master title style
• Previous empirical studies have established the correlation between credit
risk management and profitability of the banking sector. The results are,
however, inconclusive. There are notable differences in the relationship
between credit risk management and the profitability of banks over the
years.
• To fill this gap. it is crucial to investigate the relationship between credit
risk management indicators, banks’ profitability, and performance.
• This research seeks to explore the impact of credit risk management
indicators on the performance and profitability of the commercial banks in
Kenya listed in NSE since 2016-2020.
• Credit risk management indicators include the non-performing loans, size
of the bank, capital adequacy, loan loss provision, and the debt ratio while
the profitability is measured in terms of various ratios which include ROE
and ROA.

3 3
 Objectives
Click to edit Master title style

Main Objective
•  To study the relationship between credit risk management indicators,
performance, and profitability of commercial banks in Kenya.
  Specific Objectives
•  To model credit risk management indicators using a Fixed or Random-
Effects model.
• To determine the most efficient model between; Pooled OLS, Random
Effects, and Fixed Effects, using the Breusch-Pagan Langrage
Multiplier Test and the Hausman Test.
• To test the significance of credit risk management indicators on banks'
performance and profitability using ANOVA .

4 4
 Significance
Click of the Study
to edit Master title style

• The study is of importance in understanding how credit risk management

impacts the performance and profitability of the commercial banks.
• The study will improve the researchers’ understanding of how viable it is
for the bank managers to invest more in credit risk management.
• The research will provide basis for regulatory framework ,quantifying the
credit risk exposures and mitigating the banks from financial crises.
• These findings will be used as a reference material by future scholars
interested in further research on credit risk management and its effects
on banks’ performance.

5 5
Click to edit
Literature Master title style
Review
• The review of the related studies on the impact of credit risk on banks’
performance and profitability has revealed mixed results, which are either
positive or negative relationships (Abbas et al., 2019).
• Ogboi & Unuafe (2013) analyzed the impact of credit risk and capital
adequacy on the financial banks in Nigeria. They used the fixed effect
model to determine the relationship between different credit risks and
ROA. The empirical results pointed out that good management of credit
risk and capital adequacy has a significant positive impact on ROA while,
loans and advances were reported to have a negative impact on the ROA of
the banks during the study period.

6 6
Click to edit
Research Master title style
Methodology

• The study uses a descriptive research design.

• Secondary data was obtained from the financial statements of the selected banks; Standard Chartered,
KCB, Co-operative, Equity, I&M, and DTB.
• The analysis will involve quarterly data for the stated commercial institutions from 2016-2020.
• The panel data regression is presented as:

• where: represents the constant coefficient of variation.

• for i>0 shows the slope coefficient for the independent variables.
• refers to the error term
• The subscript i represents the index of the commercial bank while the subscript t represents the
quarterly time.
7 7
Click to edit
Research Master title style
Methodology

• The variables used in this study are ROE, ROA, CAR, DR, NPLR, LLPR, and SB as
described in the table below.
• Diagnostic tests performed tested on heteroscedasticity, auto-correlation, poolability and
stationarity using Breusch-Pagan test, Durbin-Watson, Cho-test and Panel unit root test.
• The Panel data models are then performed to determine the best fit model for this
analysis.
• Empirical tests performed to compare the Panel data models were: Hausman Test,
Breusch-Pagan LM test, and the F-test.
• The relationship between credit risk management indicators and performance and
profitability is then analyzed using the identified model.
• An interpretation and analysis is then done on the results obtained.
8 8
Click to under
Variables edit Master
study title style

Variables Description Formula

Y1= ROA Return on Total Assets Net Income/

Total Assets
Y2= ROE Return on Total Equity Net Income/
Shareholder Equity
X1= NPLR Non-performing Loans Ratio Non-performing loans/
Total loans
X2= CAR Credit Adequacy Ratio Total Capital/
Total Risk-Weighted Assets

X3= DR Debt Ratio Total debt/

Total Assets
X4= LLP Loan Loss Provision Ratio Loan Loss Provision/
Gross Loan
X5 =SIZE OF BANK Size of bank The logarithm of Total
Assets
9 9
Click to edit
Diagnostic Master title style
Tests

Breusch- Pagan Test

• The test will be used to test for heteroscedasticity.
• =Presence of Homoscedasticity.
• If P-value <0.05, Reject the null hypothesis and conclude heteroscedasticity is present in the model
• The results obtained are as tabulated below.

1010
Click to edit
Poolability Master title style
Test

• Chow test used to test for poolability in a panel data.

• = Dataset is poolable
• If p<0.05 Reject the null hypothesis and conclude that the banks do not
have the same slop coefficients.

1111
Click to edit Master
Durbin-Watson Test title style

• The test was used to check for autocorrelation between the dependent and independent
variables.
• =The residuals from an OLS regression are not autocorrelated.
• DW=2 , No autocorrelation
• DW= 0 to <2 ,Positive autocorrelation
• DW= >2 to 4, Negative autocorrelation

1212
Click to edit
Empirical Master title style
Tests

Lagrange Multiplier Test

• The test is used when choosing between Pooled OLS and Random effects.
• =Pooled OLS is appropriate than the Random Effects Model.
• If P-value< 0.05 Reject null hypothesis ,Random Effects Model consistent
• If P-value > 0.05 then fail to reject null hypothesis , Pooled OLS chosen.

1313
Click to edit
Hausman TestMaster title style

• The test is used when choosing between fixed and random effects model.
• = Random Effects Model is appropriate than Fixed Effects Model.
• If the P-value > 0.05 fail to reject the null hypothesis and go for Random
Effects Model.
• If the p-value< 0.05 reject the null hypothesis and go for Fixed Effects
Model.

1414
Click toand
Results editFindings
Master title style
• Random Effect model was the consistent model for the analysis based on
the Hausman test.
• The table below shows the findings of the study.

1515
Click toTest
Anova edit Master title style
• Performed to confirm the overall real significance of the credit risk
management indicators to the performance and profitability of commercial
banks.
• The tables below show the findings of the study.

1616
Click to edit
Conclusion andMaster title style
recommendations

Conclusion
• There is a significant relationship between the credit risk management indictors ,financial performance and
profitability of commercial banks in Kenya.
• The better and effective credit risk management is ,the less the exposure to credit risk and the higher the
profitability of the commercial banks.

Recommendations
• Banks should also ensure they have enough cushion to absorb a reasonable amount of losses before they
become insolvent.
• Banks must adhere to prudential banking practices and diversify more in lending to avoid repetitive losses.
• Another area of research could be the inclusion of microfinance banks, Sacco’s and other finance
companies, and cooperatives operating in the Kenyan market.

1717
REFERENCES
Click to edit Master title style

• Sylvie de C., & Gautier,B. (2010). Gestion de la banque du

diagnostic à la stratégie(6th éd., p. 294).
• Hosna, A., Bakaeva, M., &Juanjuan, S. (2009). Credit Risk
Management and Profitability in Commercial Banks.Master Degree
Project No. 2009:36, Gothenburg: School of Business, Economics
and Law, University of Gothenburg. Retrieved from
https://gupea.ub.gu.se/handle/2077/20857
• Scarpioni, Bruna. (2018). Re: Which should I choose:Pooled OLS,
FEM or REM?
• https://www.researchgate.net/post/Which_should_I_choose_Pooled
_OLS_FEM_or_REM/5b8ea73a979fdc2d1e4976d9/citation/downlo
ad/

1818
Click to edit Master title style

“
One of the crucial part of risk management is determining
the priority of risk. This is a team effort! One defines all the
risks that may affect the company ,another analyzes what it
would take to mitigate each risk.
- Andrea Wills

1919
Click to edit Master title style

Thank You !

20