UPSHOT OF REGULATORY BASED CREDIT RISK MANAGEMENT ON RETURN ON EQUITY OF COMMERCIAL BANKS IN KENYA

Abstract

Kenya has one of the most vibrant banking sectors in the entire East African region. Money lending practices have recently been a major target for almost every commercial bank, a phenomenon that has intensified competition and consequently increased loans default rates hence amplified exposure to credit risk. Central bank of Kenya (CBK) as banking sector regulatory authority adopts CAMEL rating system in its endeavor to improve the credit worthiness assessment process. Specific objectives of the study were to determine the effect of quantitative CAMEL components namely; capital adequacy, asset quality, earnings ability and liquidity adequacy, on Return on Equity (ROE) of commercial banks in Kenya. Descriptive research design was adopted. The population of study was forty-two licensed commercial banks in Kenya from 2011 to 2016 and purposive sampling of 39 banks was done. Multiple linear regression model was used in data analysis and t- statistic at 5% significance level was employed in test of hypotheses.  The model intercept was 0.857 implying 85.7% of changes in ROE of commercial banks were attributable to the predictor variables. The study established that Capital Adequacy had a negative insignificant effect on ROE with a coefficient of -0.258 and a p-value of 0.118>0.05. Asset Quality and Earnings Ability had negative significant effect on ROE with coefficients -0.959 and -0.596 respectively, and p-values 0.000<0.05. Liquidity Adequacy had a regression coefficient 3.370 and a p-value of 0.000 hence a positive significant effect on ROE. The study concludes that regulatory based credit risk management has significant effect on ROE of commercial banks and recommends that CBK carry out a banking sector analysis on the most appropriate and optimal percentage levels for the respective CAMEL components to be maintained by commercial banks.