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The Effect of Credit Risk Management on Financial Performance of Commercial Banks in Kenya by Applying a Descriptive Research Design

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The Effect of Credit Risk Management on Financial Performance of Commercial Banks in Kenya by Applying a Descriptive Research Design THE EFFECT OF CREDIT RISK MANAGEMENT ON FINANCIAL PERFORMANCE OF COMMERCIAL BANKS IN KENYA BY NGULI ROSEMARY NDUKU A RESEARCH PROJECT SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE AWARD OF MASTER OF BUSINESS ADMINISTRATION OF THE UNIVERSITY OF NAIROBI NOVEMBER 2016 DECLARATION This research project is my original work and has not been presented for examination in any other university. Signature …………………………………… Date ………………………. NGULI ROSEMARY NDUKU D61/79011/2015 This research project has been submitted for examination with my approval as the University Supervisor Signature …………………………………….. Date ………………………. HERICK O. ONDIGO Lecturer, Department of Finance and Accounting School of Business, University of Nairobi ii ACKNOWLEDGEMENTS I am thankful to God for his providence that was necessary to complete my studies. I would like to express my deepest appreciation to my supervisor Mr. Herrick Ondigo whose advice and insightful criticism aided the completion of my research project. I am also thankful to my parents, brother and sisters for being a great source of motivation. Finally, I place on record my sense of gratitude to all my classmates who supported me in this undertaking. iii DEDICATION This research project is dedicated to my family for their support and prayers all the way iv TABLE OF CONTENTS DECLARATION .............................................................................................................. ii ACKNOWLEDGEMENTS ............................................................................................ iii DEDICATION ................................................................................................................. iv LIST OF TABLES ......................................................................................................... viii LIST OF ABBREVIATIONS ......................................................................................... ix ABSTRACT ....................................................................................................................... x CHAPTER ONE: INTRODUCTION ............................................................................. 1 1.1 Background of the Study ................................................................................................. 1 1.1.1 Credit Risk Management ................................................................................................ 2 1.1.2 Financial Performance .................................................................................................... 3 1.1.3 Effect of Credit Risk Management on Financial Performance ....................................... 5 1.2 Research Problem .................................................................................................................. 7 1.3 Research Objective ................................................................................................................ 9 1.4 Value of the Study ................................................................................................................. 9 CHAPTER TWO: LITERATURE REVIEW .............................................................. 10 2.1 Introduction .......................................................................................................................... 10 2.2 Theoretical Review .............................................................................................................. 10 2.2.1 Capital Asset Pricing Model ......................................................................................... 10 2.2.2 Arbitrage Pricing Theory .............................................................................................. 11 v 2.2.3 Enterprise Risk Management Theory ........................................................................... 13 2.3 Determinants of Financial Performance ........................................................................ 14 2.3.1 Capital Adequacy .......................................................................................................... 15 2.3.2 Management Capability ................................................................................................ 15 2.3.3 Asset Quality ................................................................................................................. 16 2.3.4 Liquidity ........................................................................................................................ 17 2.4 Empirical Review................................................................................................................. 17 2.5 Conceptual Framework ................................................................................................... 19 2.6 Summary of Literature Review ............................................................................................ 21 CHAPTER THREE: RESEARCH METHODOLOGY ............................................. 23 3.1 Introduction .......................................................................................................................... 23 3.2 Research Design................................................................................................................... 23 3.3 Population ............................................................................................................................ 23 3.4 Data Collection .................................................................................................................... 23 3.5 Data Analysis ....................................................................................................................... 24 3.5.1 Analytical model ........................................................................................................... 24 3.5.2 Test of significance ....................................................................................................... 25 CHAPTER FOUR: DATA ANALYSIS, RESULTS AND DISCUSSION ................ 26 4.1 Introduction .......................................................................................................................... 26 4.2 Descriptive Statistics ............................................................................................................ 26 vi 4.3 Correlation Analysis ............................................................................................................ 27 4.4 Regression Analysis ............................................................................................................. 28 4.5 Interpretation of the Findings ............................................................................................... 31 CHAPTER FIVE: SUMMARY, CONCLUSIONS AND RECOMMENDATIONS 32 5.1 Introduction .......................................................................................................................... 32 5.2 Summary .............................................................................................................................. 32 5.3 Conclusions .......................................................................................................................... 33 5.4 Recommendations for Policy and Practice .......................................................................... 33 5.5 Limitations of the Study ....................................................................................................... 34 5.6 Suggestions for Future Research ......................................................................................... 34 REFERENCES ................................................................................................................ 35 APPENDIX I: Licensed Commercial Banks in Kenya as at 31st December 2015 ... 41 APPENDIX II: Return on Equity of Banks ................................................................. 43 APPENDIX III: Non-performing loans ratio of Banks ............................................. 44 APPENDIX IV: Size of Banks ....................................................................................... 45 APPENDIX V: Interest Sensitivity Ratio of Banks ..................................................... 46 APPENDIX VI: Capital Adequacy Ratio of Banks ..................................................... 47 APPENDIX VII: Loan-To- Deposit ratio of Banks ..................................................... 48 vii LIST OF TABLES Table 4.2.1 Descriptive Statistics...................................................................................... 26 Table 4.3.1 Correlation Analysis ...................................................................................... 27 Table 4.4.1 Summary Regression Output ......................................................................... 28 Table 4.4.2 Analysis of Variance ...................................................................................... 29 Table 4.4.3 Regression Coefficients ................................................................................. 30 viii LIST OF ABBREVIATIONS ANOVA Analysis of Variance APT Arbitrage Pricing Model CAPM Capital Asset Pricing Model CAR Capital Adequacy Ratio CBK Central Bank of Kenya CRM Credit Risk Management ERM Enterprise Risk Management ISR Interest Sensitivity Ratio KDIC Kenya Deposit Insurance Corporation LATD Loan and Advances to Total Deposits Ratio LTD Loan-To-Deposit ratio NPLR Non-Performing Loan Ratio RAROC Risk-Adjusted Return on Capital ROA Return on Assets ROE Return on Equity SSA Sub-Saharan Africa ix ABSTRACT Credit risk is the probability of incurring
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