Impact of credit risk on the performance of commercial banks in Ethiopia

The objective of the study is to empirically examine the quantitative effect of credit risk on the performance of commercial banks in Ethiopia, considering variables related to lending activities, over the period of 5 years (2008-2012). The empirical investigation uses the accounting measure of Return on Assets (ROA), which is the dependent variable, to represent Banks’ performance. The study fundamentally involves both descriptive and econometrics techniques. The econometrics method used in the study basically involves assessing the impact of selected internal variables, the provision to total loans, loan to total asset, credit administration (cost to total loans) and natural logarithm of total asset (Economies of scale), on the performance of the banking sector. To this end multiple linear regression model is used to measure the relative weighting of the independent variables above on a dependent variable. Basic descriptive statistics was appliedfor trend analysis. A non- probability method in the form of judgmental sampling technique is employed in selecting the eight Banks into the sample and the data are sourced from the Annual Reports of the same Banks which account for over eighty percent of the total loan and advance in the industry. The study finds that the selected variables: the provision to total loans, loan to total asset, credit administration (cost to total loans) and Size (Economies of scale) have significant effect on the performance of Banks. However, a certain variation in the magnitude and direction of their effect on the selected profitability measure, Return on Asset. Based on the study it is recommended that Ethiopian banks need to develop their credit risk management capacity, there should also be control over overhead costs related to lending, and increasing the loan book size without compromising the sound credit planning should be a priority task.