Determinants of credit risk of commercial banks in Ethiopia

The purpose of this study is to examine the credit risk determinants in selected Ethiopian commercial banks. Both bank-specific variables and macroeconomic variables were included in the analysis using panel data of selected 10 commercial banks over the period 2010 to 2019. Ten calendar years data had been collected from the audited financial statement of the selected banks available on their official website address. To achieve this planned objective, the study employed purposive sampling techniques and, an explanatory (casual) research design by using quantitative data in a multiple regression model. Quantitative data were collected from the annual financial statement of selected commercial banks. The robustness of the model was statistically checked through multiple regression diagnostics methodology such as normality, heteroscedasticity, multicollinearity, model specification error tests were conducted to decide whether the model used in the study is appropriate and to fulfill the assumption of a classical linear regression model. The relationship between independent and dependent variables was estimated through a fixed-effect model. Panel data models such as fixed-effect models, random effect models, and pooled OLS models were tested to choose the most appropriate model. Consequently, the choice of model was tested by the Hausman test to determine the most suitable model used in this study, and the results showed that a fixed-effect model is appropriate. The study used one dependent variable credit risk measured by nonperforming loan ratio (NPL)nine independent variables that are bank size, loan growth, profitability measured by ROE, efficiency ratio capital adequacy, GDP, inflation, interest rate, and foreign exchange rate are explanatory variables. The result of the study showed that bank size, profitability, inefficiency, and inflation had a statistically positive significant relationship with credit risk. The result also suggests that loan growth, capital adequacy, interest rate, and the foreign exchange rate had an inverse relationship with credit risk. Besides this, GDP does not affect Ethiopian commercial credit risk for the study period. Finally, the study recommended that Ethiopian commercial banks should develop optimal portfolio business diversification to reduce credit risk exposures and mitigate the problem. To improve their portfolio banks need to change their traditional banking income and diversify into non-interest income sources.