Credit Risk Management Practices of Commercial Banks in Kenya

Abstract

Purpose: The purpose of the study was to investigate the current practices of credit risk management by commercial banks in Kenya. The study was guided by the following specific objectives: to evaluate the extent to which commercial banks use credit risk management practices and techniques in dealing with different types of risk; to assess the factors that influence effectiveness of Credit Risk Management practices used by commercial banks; and to examine the internal performance measures of bank lending used by commercial banks.Methodology: To undertake the study, a descriptive research design was used. The population consisted of all the commercial banks in Kenya. The sampling frame was obtained from the Central Bank of Kenya and included 45 elements. Stratified random sampling technique was used to select 33 respondents. A semi-structured questionnaire was used to collect the data from the banks. The data pertaining to background of the respondents was analyzed using content analysis while data pertaining to objectives of the study was analyzed using descriptive statistics; mean median and the mode. Correlations were undertaken. The data was presented using frequency tables, charts and bar graphs. Correlations, the statistical technique that can show whether and how strongly pairs of variables are related, was used to ascertain the relationships between factors influencing effectiveness of CRM and the internal performance measures.Findings and Discussions: The study discloses that commercial banks in Kenya make use of credit risk management practices that include; thorough loan appraisal, asking for collateral and checking the credit history of the borrowers. Additionally, the bankers use covenants, credit rationing, loan securitization, and loan syndication as risk management defensives. The factors that influence effectiveness of credit risk management systems used by commercial banks in Kenya include establishment of a credit policy that clearly outline the scope and allocation of bank credit facilities, maintenance a credit administration system that with adequate controls over credit; top management support; communication of credit guidelines to every officer in the credit department, screening of potential borrowers, employing well trained staff, constant review of the borrowers’ liquidity and the use of supportive technology in credit analysis. The internal performance measures of bank lending used by commercial banks in Kenya include the Basel II criteria and bank profitability, including return on equity, return on assets and return on investment. Other indices are the developed benchmarks that include cost per each completed loan, cost per thousand dollars of loans, non-interest revenue from each loan, loans per employee.

Keywords: Commercial Bank; Agency Theory ; Information Asymmetry; Credit Risk Management; Risk; Moral Hazard and Adverse Selection