DETERMINANTS OF CREDIT RISK OF COMMERCIAL BANKS IN ETHIOPIA

Abstract

This study was conducted to examine bank specific and macroeconomic factors that play in determining the credit risk of Ethiopian commercial banks. To achieve the intended objective this study employed explanatory research design. Deductive (quantitative) approach is used to test a theory or explanation by specifying narrow hypotheses and the collection of data to support or refute the hypotheses. Nonperforming loans was used as Credit risk measure. To this end, the researcher has selected seven senior commercial banks in Ethiopia as to which subjects best fits the criteria of the study. The study used secondary sources of data, which is panel data in nature, over the period 2001-2014. These data were collected from NBE and MoFED. Furthermore, fixed effect model was appropriate to examine the determinants of credit risk. The study shows a down ward sloping trend of credit risk for Ethiopian commercial banks within the sample period. The assumptions needed to be fulfilled for OLS were tested and the model was found fit for the purpose. Results using fixed effect panel regression exhibited that, loan growth, return on equity, bank size, capital adequacy, loan to deposit, managerial efficiency and gross domestic product have negative and statistically significant effect on banks CR. On the other hand, variables like state ownership have a positive and statistically significant effect on banks CR. Based on the findings, the study suggests that focusing the banks alongside the key drivers of credit risk could reduce the probability of loan default in Ethiopian commercial banks. Banks should be diversifying their lending activities to productive sectors to mitigate credit risk in order to reduce the level of credit risk. Besides, capitalized banks are good in absorbing more losses. Thus, the overall findings indicates that both macroeconomic and bank specific factors do have statistically significant effects on credit risk.