| Abstract: | Effective credit risk management is fundamental for bank profitability and financial stability. This
study investigated the effect of credit risk management practices on financial performance of
private commercial banks in Ethiopia. The research examined data from a five-year period (2018-
2022) of five selected private commercial banks in Ethiopia. Secondary data obtained from
published audited annual financial reports of the selected banks was used to calculate the CAMEL
rating system components (capital adequacy, asset quality, management efficiency, earning
quality, and liquidity) which were used as measures of credit risk management, while return on
equity (ROE) served as a key indicator of financial performance. Multiple linear regression
analysis yielded statistically significant associations between several CAMEL components and
ROE. Positive relationships were observed between management efficiency and liquidity with
ROE, highlighting the importance of streamlined operations and balanced liquidity management
for profitability. A negative association was found between asset quality and ROE, aligning with
the notion that higher levels of non-performing loans hinder profit generation. An unexpected
finding emerged with capital adequacy and earning quality. Contrary to expectations, the results
indicated a negative association between capital adequacy ratio (CAR) and ROE. This might be
explained by increased regulatory requirements forcing Ethiopian banks to hold more capital
reserves, potentially hindering lending activities. While a positive association was anticipated, the
results revealed a negative correlation between earning quality and ROE. This may suggest a
potential focus on short-term profit strategies. Based on these findings, the study offers
recommendations for Ethiopian banks: optimizing capital adequacy through policy dialogue,
enhancing asset quality through stricter lending practices, maintaining liquidity, improving
management efficiency, and scrutinizing earning quality metrics to emphasize core business
activities |
