EFFECT OF FIRM CHARACTERISTICS ON CREDIT RISK OF TIER III COMMERCIAL BANKS IN KENYA
Abstract
Banks play the intermediary role of connecting investors and savers to achieve economic meaning of financial inclusion. However, these financial institutions have faced severe challenges in performing this noble function due to high exposure to credit risk that continue to threaten their sustainability. Non-performing loans among the Tier III banks in Kenya has been rising over the past five years, threatening the sustainability of these institutions. Despite the stringent measures by the regulatory authority to protect the Tier III commercial banks from financial collapse due to high credit risk, they continue to experience high levels of non-performing loans which undermine their ability to provide credit facilities. This study therefore determined the effect of firm characteristics on credit risk of Tier III commercial banks in Kenya. Specific objectives included to determine the effect of; capital adequacy, bank size, bank competitiveness, and management efficiency on credit risk of Tier III commercial banks in Kenya. Information asymmetry, market power, liquidity preference, and credit risk theories were used. Descriptive research design was adopted and target population was 22 Tier III com banks. Census sampling design and secondary data from 2019 to 2023 using the secondary data collection sheet were applied. The Statistical Package for Social Sciences Version 26 software was used for data analysis, using the panel regression model. Findings were presented in tables and narration to inform their application in research and practice. Capital adequacy had a negative significant effect on credit risk, bank size had a positive significant effect on credit risk, bank competitiveness had a negative significant effect on credit risk, and management efficiency had a positive insignificant effect on credit risk. The study concluded that firm characteristics significantly affect credit risk. To the regulator, the study recommends a review of existing minimum reserve requirements, increasing the requirements to acceptable high levels to shield the Tier II commercial banks from adverse effects of credit risk and enable the financial institutions support realization of Kenyan Vison 2030 of economic growth and development.
Keywords: Bank Competitiveness, Bank Size, Capital Adequacy, Core Capital Credit Risk, Firm Characteristics, Herfindahl-Hirschman Index, Loan Loss Reserve, Logarithm of Asset Value, Management Efficiency, Operating Profit.
References
Adachi-Sato, M., & Vithessonthi, C. (2021). Bank risk-taking and corporate investment: Evidence from the global financial crisis of 2007–2009. Global Finance Journal, 49, 100573.
Afey, D. I., & Warui, F. (2019). Firm Characteristics and Financial Leverage of Companies Listed on the Nairobi Securities Exchange, Kenya. Journal of Finance and Accounting, 3(5), 1-11.
Akomeah, J., Agumeh, R., & Siaw, F. (2020). Credit risk management and financial performance of listed banks in Ghana. Research journal of finance and accounting, 11(6), 39-48.
Andersen, H., & Juelsrud, R. E. (2024). Optimal capital adequacy ratios for banks. Latin American Journal of Central Banking, 5(2), 100107.
Arifaj, A. H., & Baruti, B. H. (2023). The Effect of Credit Risk on the Financial Performance of Commercial Banks in Balkan Countries. Business Strategy Review, 4(3), 18-25.
Auronen, L. (2003). Asymmetric information: theory and applications. In Seminar of Strategy and International Business as Helsinki University of Technology (Vol. 167, pp. 14-18).
Bairagi, V., & Munot, M. V. (Eds.). (2019). Research methodology: A practical and scientific approach. CRC Press.
Baituti, C. M. (2021). Bank characteristics and non performing loans of commercial banks listed at the Nairobi Securities Exchange, Kenya. (Masters dissertation, Kenyatta University).
Bartov, E., & Bodnar, G. M. (1996). Alternative accounting methods, information asymmetry and liquidity: Theory and evidence. Accounting review, 397-418.
Becker, M. (2024). The effect of positive management practices on firm profitability–Evidence from text mining. The Journal of Applied Behavioral Science, 60(2), 280-309.
Bessler, W., Drobetz, W., & Grüninger, M. C. (2011). Information asymmetry and financing decisions. International Review of Finance, 11(1), 123-154.
Bibow, J. (2005). Liquidity Preference Theory Revisited-To Ditch or to Build on It?. The Levy Economics Institute of Bard College Working Paper, (427).
CBK. (2022). Central Bank of Kenya. CBK. https://www.centralbank.go.ke/
Ekinci, R., & Poyraz, G. (2019). The effect of credit risk on financial performance of deposit banks in Turkey. Procedia computer science, 158, 979-987.
Habib, S. M., Hussain, H., Al-Faryan, M. A. S., & Hussain, R. Y. (2022). Impact of firm characteristics and ownership structure on firm efficiency: evidence from non-financial firms of Pakistan. Cogent Economics & Finance, 10(1), 2106628.
Hankir, Y., Rauch, C., & Umber, M. P. (2011). Bank M&A: A market power story?. Journal of Banking & Finance, 35(9), 2341-2354.
Kamau, A. M. (2023). Underwriting risk, firm size and financial performance of insurance firms in Kenya. Eastern Journal of Economics and Finance, 8(1), 1-14.
Kamun, J. J. F., & Olweny, T. (2023). Macro-economic indicators and non-performing loans of public listed commercial banks across securities exchanges in East Africa. Reviewed Journal International of Business Management [ISSN 2663-127X], 4(1), 142-164.
Koskei, L., & Samoei, D. (2024). Bank Lending Rates and Nonperforming Loans of Listed Commercial Banks in Kenya. Asian Journal of Economics, Business and Accounting, 24(3), 19-25.
Koulafetis, P. (2017). Modern credit risk management: Theory and practice. Palgrave Macmillan.
Locurcio, M., Tajani, F., Morano, P., Anelli, D., & Manganelli, B. (2021). Credit risk management of property investments through multi-criteria indicators. Risks, 9(6), 106.
Malik, A., Parks, B., Russell, B., Lin, J. J., Walsh, K., Solomon, K., ... & Goodman, S. (2021). Banking on the Belt and Road: Insights from a new global dataset of 13,427 Chinese development projects. Williamsburg, VA: AidData at William & Mary, 23-36.
Mierzejewski, F. (2009). Towards a general theory of liquidity preference. Journal of Applied Economic Sciences (JAES), 4(08), 261-272.
Moudud-Ul-Huq, S. (2021). Does bank competition matter for performance and risk-taking? Empirical evidence from BRICS countries. International Journal of Emerging Markets, 16(3), 409-447.
Moyo, B., & Sibindi, A. B. (2021). Bank Competition and Credit Access: The Case of Informal Firms in Sub-Saharan Africa. Southern African Business Review, 25, 29-pages.
Muthoni, M. I., Mwangi, L. W., & Muathe, S. M. (2020). Credit management practices and loan performance: empirical evidence from commercial banks in Kenya. International Journal of Current Aspects in Finance, Banking and Accounting, 2(1), 51-63.
Nthimba, A., Jagongo, A., & Wamugo, L. (2021). Fund Size and Performance of Unit Trust Funds in Kenya. Journal of Finance and Accounting, 9(1), 8-15.
Nurwati, N., Prastio, P., & Kalbuana, N. (2021). Influence of firms size, exchange rate, profitability and tax burden on transfer pricing. International Journal of Economics, Business and Accounting Research (IJEBAR), 5(3), 2294-2307.
Nyakieni, A. D., Kimitei E., & Siele, R. (2022). Effect of management efficiency on financial performance of commercial banks in Kenya. Journal of Economics, Finance and Management Studies, 5(6), 1821-1829
Ogiriki, T., & Andabai, P. W. (2014). Liquidity preference theory: A comparison of William Baumol’s and James Tobin’s propositions. African Research Review, 8(4), 143-152.
Ogunode, O. A., Awoniyi, O. A., & Ajibade, A. T. (2022). Capital adequacy and corporate performance of non-financial firms: Empirical evidence from Nigeria. Cogent Business & Management, 9(1).
Om’mbongo, G. A. (2020). Effects of Non-Performing Loans on Profitability of Commercial Banks In Kenya (Doctoral dissertation, United States International University-Africa).
Ray, R., Gallagher, K. P., & Kring, W. N. (2020). IMF austerity since the global financial crisis: New data, same trend, and similar determinants. Boston University Global Development Center, Working Paper, November.
Sampurnaningsih, S. R., Irani, C., Sahroni, S., Zulfitra, Z., & Sunarsi, D. (2021). The effect of capital adequacy ratio (car), loan to deposit ratio (ldr) and net profit margin (npm) on financial performance of bank DKI. Jurnal Ilmiah Ilmu Administrasi Publik, 11(2), 497-506.
Schmid, B. (2012). Credit risk pricing models: Theory and practice. Springer Science & Business Media.
Silvestre, J. (1993). The market-power foundations of macroeconomic policy. Journal of Economic Literature, 31(1), 105-141.
Suchodolski, S. G., Junior, A. M., de Oliveira Bechelaine, C. H., & Costa, L. M. B. (2022). From global to local: subnational development banks in the era of sustainable development goals. In Development and Public Banks (pp. 128-150). Routledge.
Trueck, S., & Rachev, S. T. (2009). Rating based modeling of credit risk: theory and application of migration matrices. Academic press.
Yeasin, H. M. (2022). Impact of credit risk management on financial performance: A study of commercial banks in Bangladesh. Interdisciplinary Journal of Applied and Basics Subjects, 2(1), 14-22.
Yensu, J., Yusif, H. M., Tetteh, E., Asumadu, G., & Atuilik, D. A. (2021). Main determinants of banks’ stability: Evidence from commercial banks in Ghana. Journal of Finance and Economics, 9(2), 42-52.
