Abstract:
The objective of study was to assess the effect of credit risk on financial performance of commercial
banks in Kenya. The study covered the period between year 2005 and 2014. Credit risk was measured by
measured by capital to risk weighted assets, asset quality, loan loss provision, loan and advance ratios and
financial performance by return on equity (ROE). The study used the balance sheets components and financial
ratios for 43 commercial banks in Kenyaregistered by year 2014. Panel data techniques of fixed effects
estimation and generalized method of moments (GMM) were used to purge time–invariant unobserved firm
specific effects and to mitigate potential endogeneity problems. The pairwise correlations between the variables
were carried out. F- test was used to determine the significance of the regression while the coefficient of
determination, within and between R2, were used to determine how much variation in dependent variable is
explained by independent variables. From the results credit risk has a negative and significant relationship with
bank profitability. Poor asset quality or high non-performing loans to total asset is related to poor bank
performance both in short run and long run. Based on the study findings, it is recommended that management of
commercial banks in Kenya should enhance their capacity in credit analysis and loan administration.Clear
credit policies and lending guidelines should be established.
