Factors Affecting Credit Risk Exposure of Commercial Banks in Ethiopia An Empirical Analysis Kefyalew Tadesse Sendo

Abstract

This study was designed to empirically investigate factors affecting credit risk exposure ofselected commercial banks in Ethiopia. A panel of nine commercial banks each having 11 yearsof observations was included. The banks were selected on the basis of number of annualfinancial report (2005-2015) to come up with sufficient number of observations. Alternativeeconometric estimation models such as fixed effect, random effect, Feasible Generalized LeastSquare, Ordinary Least Square and xtscc were used to indicate whether the results are robustand are convergent irrespective of diagnostic test procedures. The result indicates that totalequity to total assets, proxy of capital negatively and significantly affect credit risk under the fivealternative models in four of the five models at α=1% level of significance. Cash reserve ratio,proxy of banking regulation positively and significantly affect credit risk at α=1% in the three ofthe five estimation models (fixed effect, random effect and Ordinary Least Square). Moreover,Loan to Deposit ratio, proxy of lending structure positively and significantly affect credit riskunder all the five models at α=5% or α=1% level of significance. Liquidity has positive andsignificant effect on credit risk under the four of the five alternative mode at α=1%. It has alsobeen found out that government owned commercial bank has significantly higher credit riskexposure than privately owned banks. Finally, both economic growth rate and bank specificfinancial performances have no significant effect on credit risk. The author suggests that banksneed to reduce the level of their debt; keep their liquidity at optimal level, reduce cash reserveratio only to the level legally required to reduce their risk exposure.