Non-Performing Loans and Financial Performance of Commercial Banks in Kenya

Abstract

All financial institution all over the world are facing the enormous risks of the non-performing loans which has led to the decline in the portfolio quality of the non-performing loans. The nonperforming loans are not in existence for any particular institution or even an economy but they affect both developed and developing economies. The Central Bank of Kenya prudential guideline classifies loans that either the principal or interest are past due for more than ninety days as non-performing loans. The general objective of this study was to establish the effects of non-performing loans on the financial performance (return on assets) of commercial banks in Kenya. The specific objectives of the study were: To identify the influence of the size of nonperforming loans on financial performance of commercial banks, to investigate the relationship between age of non-performing loans and financial performance on commercial banks, to identify the relationship between collateral of non-performing loans with respect to financial performance of commercial banks and to investigate the effects of cost of nonperforming loans on the performance of the commercial banks. The study was guided by the credit crunch theory, moral hazard theory and the theory of performance. The study population was all the commercial banks in Kenya. The mode of data collection was extraction of collated secondary data in the form of annual banking supervisory reports by the Central Bank of Kenya derived from respective published annual financials of commercial banks. The study period was five years starting from the year 2011 to year 2016. The dependent variable in the study was the financial performance of commercial banks in Kenya while the independent variables were size, age, collateral and cost of nonperforming loans. The study used a regression analysis to find the relationship between the independent variables and the dependent variables. The study found a negative significant relationship between nonperforming loan size, age and cost with the return on assets of commercial banks in Kenya. The study found a positive significant relationship between financial performances of commercial banks in Kenya with the value of collateral of nonperforming loans. The study found a negative significant relationship between the financial performance of commercial banks in Kenya and the size of nonperforming loans, age of nonperforming loans and cost of nonperforming loans. The study findings supported moral hazard theory that states that moral hazard problems may be occasioned by asymmetric information which makes it difficult to distinguish between good and bad borrowers. The study recommends loan policies, practices and watching mechanism that will ensure reduce transition of loans from watch to substandard category and or eliminate movement of loans from substandard to doubtful as such movements have commercial implication on the overall financial performance of commercial banks in Kenya. The study recommends issuance of short term credit facilities in appreciation of the expected credit life loan provisioning that is coming into effect by the adoption of IFRS 9 on 01/01/2018. The study also recommend a proper and working relationship management of loan facilities and a monitoring mechanisms and actions on early warning signs of nonperforming loans with appropriate corrective actions.