Credit Risk Analysis of Ethiopian Banks: A Fixed Effect Panel Data Model

Abstract

The role of banks is very vital in the overall development of a given country. While Credit risk is one of the main risks of banks and affects the development of the financial system, little study is done to examine its determinants. This study was conducted to investigate the factors that affect credit risk of Ethiopian commercial banks. It covers a time period from 2003 to 2009. Both macroeconomic and bank specific credit risk factors were investigated using fixed effect panel data model. The credit risk of the sampled bank was 7.08% for the test period. It was higher than its international limit which is 2%. The study showed that leverage, operating inefficiency, loan growth, ownership and loan to deposit ratio are significant determinants of credit risk of Ethiopian commercial banks in the test period. The empirical finding of the study also showed an existence of a clear difference on credit risk level between government and private owned commercial banks. Particularly government owned banks should devise ways to lower their credit risk since they are found to be more risky than private ones. Generally, in this study bank specific variables have more significant effect than macroeconomic variables. So, bank managers and policy makers should deal with bank specific factors effectively.