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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. 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.
2.3 Conceptual Framework……………………………………………………………………..…………………………………………….10
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 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 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.
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.
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.
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.
The study will seek to establish the effects of Credit risk management on Financial Performance of Commercial Banks in Kenya.
The study covered 42 commercial banks licenced by the Central Bank 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.
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