Credit Risk Management on the Profitability of Commercial Banks in Kenya

Abstract

Purpose: Credit risk management (CRM) function is a critical function in commercial banks because the improper management of credit exposure will result in the rise of non-performing loans, loan losses and financial costs which will have an impact on the profitability of commercial banks. This study investigated the link between the credit risk management and profitability of commercial banks in Kenya. Inconsistencies in the preceding empirical work on the relationship between the practice of credit risk management and profitability of banks motivated the study.   Design/Methodology/Approach: The research philosophy that the researcher used in this study was positivist because it was influenced by the Default Risk Theory and the research design used was longitudinal. The data were panel data obtained from the Central Bank of Kenya and the published financial statements of 38 commercial banks in Kenya during the period 2014–2023, and consisting of 380 bank-year observations. Diagnostic tests were used to check the suitability of the data for panel regression analysis and the Hausman specification test was employed to select the estimation model. Findings: The findings indicate that the credit risk management has a positive impact on the financial performance through its role in the quality of the loan portfolio and the decrease in the risk of credit losses. The study finds that the management of credit risk is an important factor affecting profitability of commercial banks in Kenya Implications/Originality/Value: It thus suggests that the commercial banks should improve their credit appraisal, borrower assessment, credit monitoring, loan recovery and risk mitigation mechanisms to reduce credit losses and increase profitability. The results give empirical evidence for the need of effective credit risk management in sustaining the financial performance of commercial banks in Kenya.