Credit Risk and the Financial Performance of Commercial Banks in Somalia

The operation of commercial banks in Somalia unfolds amidst formidable economic challenges stemming from political instability, ongoing conflicts, and a frail institutional framework. Nevertheless, Somalia’s financial sector exhibits resilience, with several commercial banks endeavoring to address the financial needs of businesses and individuals nationwide. These banks play a pivotal role in mobilizing savings, facilitating transactions, and providing credit, thereby supporting economic activities in Somalia’s predominantly cash-based economy. This study explored the impact of credit risk on the financial performance of Somali commercial banks, employing Modern Portfolio Theory (MPT) as the theoretical framework. Adopting a descriptive survey research design, secondary data from licensed commercial banks and the Central Bank of Somalia were analyzed over ten years (January 2014 to December 2023) using panel regression analysis. Findings reveal a moderate negative correlation between credit risk, measured by Bad Debt Expense Ratio (BDER), and financial performance, indicated by Return on Equity (ROE). Statistical tests confirm the significance of this relationship, emphasizing the importance of robust credit risk management practices for sustaining favorable financial outcomes. Recommendations include uniform improvement in risk management practices across the sector and proactive measures to mitigate emerging credit risk factors. Enhancing risk management frameworks is vital for ensuring continued financial stability and performance in the Somali banking industry.