Credit Risk Management and Profitability of Commercial Banks in Kenya

The fact that banks control 97% of the world's money supply makes them a vital institution. Banks are the engine of our modern financial system and a source for economic growth. The bank's ability to create credit can have destructive effects; the Great Depression of 1929 and the Great Recession of 2008. In both cases, banks spurred on an asset bubble through overextending credit to aid the purchase of assets. The result was an economic collapse that wiped out wealth and reduced credit creation which stalled productive investments. The lessons of the two great economic collapse support the notion proposed by the author, that bank credit for transactions that do not contribute to the economy should be restricted.

Unfortunately, the improvements in earnings and loan losses have not extended to Banks’ operating revenues. Banks’ operating revenues are not growing due to “lower servicing income (down $8 billion), reduced gains on loan sales (down $4.8 billion), and lower income from service charges on deposit accounts, which fell by $2.1 billion (5.9 percent).” (FDIC Quarterly, p.2)

In business affairs, in a nation’s economy, and in the international scene, money has made its permanent imprint thus credit has been clearly indicated and pertinently stressed. Credit’s advent has brought about numerous benefits to its users and misfortunes to others who get caught in the web of its unwise use. According to Fajardo (2011), credit is the ability to acquire something of value, such as goods, services, securities or money. Moreover, he added that credit transaction usually involves either to pay a definite sum of money. Whenever credit is mentioned, risk on the creditor’s part becomes apparent, thus businesses find best credit risk management.

Credit risk is the risk that the bank will not be able to repay funds when they ask for them.

Since the onset of the financial crisis 2008, the sovereign debt crisis in western economies and the new financial regulation with Basel III coming up, the financial industry faces the challenge of reinventing itself. The ring-fence for Commercial and Investment Banking, and new economic and regulatory capital requirements will determine the kinds of products banks will be able to distribute. It will have a huge impact in the Investment Banking business, which will suffer tough regulation and supervisory procedures. At the same time, credit risk models will be reviewed because they have failed to predict the crisis of 2008. The current financial and economic crisis doesn’t have any precedent in the past.

Each time a bank makes a credit, new cash is made. In the keep running up to the budgetary emergency, banks made tremendous aggregates of new cash by making credits. In only 7 years, they multiplied the measure of cash and obligation in the economy. Furthermore, used this money to push up house prices and speculate on financial markets. The money-making process turns up not so useful while portion of the money made wen t to increasing in the house price and others in different sector of the business. Loaning vast wholes of cash into the property showcase pushes up the cost of houses alongside the level of individual obligation. Premium must be paid on every one of the advances that banks make, and with the obligation rising speedier than salaries, inevitably a few people wind up noticeably unfit to stay aware of reimbursements. Now, they quit reimbursing their credits, and banks end up in risk of going bankrupt. Over all in the process financial crisis is caused. Only if we could constrain the financial system's creation of private credit and money we could prevent financial crisis (turner,

……19-20 3.1. Statement of the problem……………………………………………………………..……… .20 3.2. Scope and delimitation of the study……………………………………..…….. ………… 21 3.3.

Market risk is the risk associated with an investors day to day investments, that are affected by constant fluctuations in the markets. With investment banking, a banks reputation is a critical in its success, reputational risk describes the trustworthiness of a business. A firm with a poor reputation will not get as much business, meaning a bad reputation results in a loss in revenue. Concentration Risk is the risk showing the spread of a banks’ accounts to various debtors to whom the bank has lent to. The Basel II accord stated that ‘operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events’. This risk covers the very wade basis of a company’s operations, there are many different factors involved here: people, employees actions and company processes.

The ongoing plunge in bank capital is already forcing banks to significantly cut back on outstanding loans, and businesses’ plans for major investment projects are being scaled back. These capital losses are resulting in financial institutions going bankrupt or merging with stronger banks. “Financial services companies have cut more than one-hundred thousand jobs this year and deeper layoffs may come” (Berenson, 2008). Even while cutting back on long-term loans seems to be unbearable, short-term loans pose a greater threat to the survival of the financial system.

The financial institution has received earning but at the same time has lost revenue. This was due to the recession the world was going through.

Low interest rates will continue to squeeze the amount banks earn on their lending, keeping a lid on their profits and revenues, many analysts and portfolio managers say. Regulations adopted following the financial crisis, which were designed to make banks safer, will also continue to restrain profitability by pushing lenders out of some business and forcing them to sell riskier assets and hold more capital, crimping returns. (para. 3)

The regulations caused banks to incur larger capital costs, therefore cutting profitability and their willingness to hold bond inventories. This led to a 10% fall in the trading assets of the six largest American banks since 2009.

According to Campbell Harvey, an economist, known for his work on asset allocation with changing risk and risk premiums and emerging markets finance, credit generally refers to the ability of a person or organization to borrow money, as well as the arrangements that are made for repaying the

It should be noted, prior to the crisis, there was already an increasing concern of economists and critics about the credit quality that was provided by the financial sector at the time when there was low interest rates that were applied by the government. There were also issues about the inappropriateness or ineffectiveness of the standards that were used in extending credit by the financial sector (Calvo, 171).

Further Improvements (5) Efficiency Gains (3) User’s Perspective Your Grade Financial Modelling Joaquim Cadete 2 Risk Management: the main concern… Counterparty risk Credit risk Interest rate risk Capital risk and solvency Funding risk Risk Management