Assessment of Loan Portfolio Quality on Financial Performance of Commercial Banks in Kenya

Abstract

Deteriorating loan portfolio quality is negatively impacting the financial performance of commercial banks in Kenya. Though, Kenya’s banking sector is well established and plays key part in developing county’s economy, it is facing constraints in terms of absolute growth due to this declining loan portfolio quality. Consequently, stakeholders of these commercial banks especially creditors, depositors and shareholders are incurring huge financial losses in absolute terms on their deterioration. Although, there are studies that have established the factors that affect commercial banks’ financial performance, until the time of the study there were unresolved issues. This calls for commercial banks need to be proactive like modernizing their risk mitigation measures to more precise measures to deal with expected credit losses. Banks need to change in this time of enhanced financial information, computing power and data analytics for best-in-class fair projection of credit risk for tangible competitive benefits. Study has demonstrated need for robust approach to commercial banks’ lending in dynamic financial markets for sustainable commercial banking financial performance in Kenya. Study aimed at assessing loan portfolio quality on financial performance of commercial banks in Kenya. Study objectives were to: determine significance of loan loss provision on financial performance of commercial banks in Kenya, evaluate allowance for loan loss impact on financial performance of commercial banks in Kenya and gauge bearing of gross impaired loans and advances on financial performance of commercial banks in Kenya. Researcher classified loan portfolio quality indicators as independent variables, regulatory frameworks, market and infrastructural dynamics as intervening variables, and measures of financial performance of return on assets and equity of commercial banks in Kenya as dependent variables. Research utilized descriptive design using percentages, mean, standard deviation, correlations, and panel data regression model. Researcher narrowed down targeted population to 38 fully operational commercial banks in Kenya by end of year 2020. Study applied census approach and relied on published audited financial reports. Researcher used document review secondary data collection tool and analysed data using SPSS program Version 24.0 supported by Microsoft excel windows 2010. Tables and figures were used to present study outcome. There was largely positive significant correlation between each independent and dependent variable proxies.  Although on contrary, allowance for loan loss and gross impaired loans and advances association with return on equity were positive and negative insignificant correspondingly. Study general conclusion was that loan portfolio quality largely had positive significant association with Kenya’s commercial banks’ financial performance. Ccoefficient of determination of return on assets and return on equity were 0.1620 and 0.0363 respectively. That meant loan portfolio quality was responsible for 16.20% and 3.63% change in Kenya’s commercial banks’ financial performance in terms of return on assets and equity respectively. Overall, it is resolved, loan portfolio quality parameters; loan loss provision, allowance for loan loss and gross impaired loans and advances are determinants of financial performance (return on assets return on equity) of Commercial banks in Kenya.The study recommends management of these banks need to vigorously pursue measures to effectively manage loan portfolio quality to realise rising returns on assets and equity.