FACTOR AFFECTING CREDIT RISK MANAGEMENT AND ITS EFFECT ON THE FINANCIAL PERFORMANCE OF COMMERCIAL BANKS IN ETHIOPIA

Abstract

This study through to the critical relationship between credit risk management and the financial performance of commercial banks in Ethiopia. Employing a quantitative approach and a ten-year panel data analysis, the research sheds light on how effectively managing credit risk can significantly impact a bank's financial health. The findings reveal that key credit risk management strategies, like maintaining strong capital adequacy and liquidity ratios, play a vital role in boosting a bank's return on assets (ROA). The analysis further exposes the detrimental effects of poorly managed credit risk. Non-performing loan ratios, indicative of borrower defaults, and wider interest spreads, potentially reflecting riskier lending practices, both exhibit a negative and statistically significant correlation with ROA. Interestingly, the study suggests that inflation has a negative but statistically insignificant impact on ROA, highlighting the importance of considering a broader range of factors beyond just traditional risk management practices. In conclusion, the study underscores the undeniable link between effective credit risk management and the financial well-being of Ethiopian commercial banks. By implementing sound credit risk management policies that prioritize strong capital adequacy, liquidity, and controlling non-performing loans, banks can pave the way for sustainable financial performance and contribute to a more stable financial system in Ethiopia.