ISSN: 2320-5407 Int. J. Adv. Res.

7(1), 811-
849
Journal Homepage: -www.journalijar.com

Article DOI:10.21474/IJAR01/8392
DOI URL: http://dx.doi.org/10.21474/IJAR01/8392

RESEARCH ARTICLE

FACTORS AFFECTING CREDIT RISK MANAGEMENT PRACTICES, THE CASE OF

SELECTED PRIVATE COMMERCIAL BANKS IN ETHIOPIA.

Fikremariam Zergaw.
Wolaita Sodo UniversityCollege Of Business And EconomicsDepartment Of Accounting And Finance.
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Manuscript Info Abstract
……………………. ………………………………………………………………
Manuscript History This study tried to asses factors that affect credit risk management
Received: 12 November 2018 practices of some selected private commerial banks in Ethiopia. In light
Final Accepted: 14 December 2018 of this, the study identified some dimensions of service quality such as ,
Published: January 2019
credit granting process, credit risk measurment and monitoring process,
Key words:- market risk, operational risk, legal risk, the establishment of credit risk
Credit Risk Management, Credit Risk environment. So as to come up with the desired results data were
Environment, Credit Granting Process. collected from four private commercial banks, namely; Oromia, Birhan,
Debub global and Anbessa. A total of 106 respondents participated in
this study selected purposively. In the study both descriptive and
explanatory designs were used. Frequency percentage, mean, standard
deviation, pearson correlation cofficient as well as regression were used
for data analysis process using SPSS version 20. The result of
correlation cofficient showed that all variables are statistically
significant and positively correlated with the credit risk management
practices of the mentioned private banks.
Hence, the banks credit risk management practices were significantly
affected by lack of appropriate credit environment, followed by
challenges of credit appraisal measurment and monitoring, lack of
market risk analysis , operational risk and challenges of sound credit
granting process. Legality of risk assessment is found to have a
negative relation and insignificant impact on credit risk management
practices of the mentioned banks. As per the regression cofficient
which vividly shows the effect of the independent variables on
dependent variables , lack of appropriate credit risk environment
(beta = .993, t = 9.612, p = < .000), followed by lack of operational risk
management (beta = .713, t =1.003, p = .318) and lack of credit
measurement and monitoring process (beta =.610, t= -571, p < .569)
respectively and significantly affect credit risk management practices
of the studied private banks. Having all this big crystals of truth in
hand,the study gave some recommendations that the management body
may need to take so as to come up with a more effective and efficient
risk management practices.

Copy Right, IJAR, 2017,. All rights reserved.

……………………………………………………………………………………………………....
Corresponding Author:-Fikremariam Zergaw.
Address:-Wolaita Sodo UniversityCollege Of Business And EconomicsDepartment Of Accounting And
Finance. 811
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Introduction:-
The financial sector plays an important role in the development of the economy and growth in any country. The
banking sector is considered as an important source of financing for most businesses. The past decade has seen
dramatic changes in managing risk in this industry. In recent years, supervisors and financial institutions have
increased the focus on the importance of risk management (Davide and Thangavel, 2008).

According to Edward (2006) risk management defined as the identification, assessment, and prioritization of risks
followed by coordinated and economical application of resources to minimize, monitor, and control the probability
and/or impact of unfortunate events or to maximize the realization of opportunities.

Credit risks can come from uncertainty in financial markets, project failures, legal liabilities, credit risk, accidents,
natural causes and disasters as well as deliberate attacks from an adversary. The strategies to manage risk include
transfering the risk to another party, avoiding the risk, reducing the negative effect of the risk, and accepting some or
all of the consequences of a particular risk (Yuqi Li, 2006)

Credit risk is by far the most significant risk faced by Banks and the success of their business depends on accurate
measurement and efficient management of this risk to a greater extent than any other risk. Increases in credit risk
will raise the marginal cost of debt and equity, which in turn increases the cost of funds for the Bank (Basel
Committee, 2011).

Credit creation is the main income generating activity for the Banks. But this activity involves huge risks to both the
lender and the borrower. The risk of a trading partner not fulfilling his or her obligation as per the contract on due
date or anytime thereafter can greatly jeopardize the smooth functioning of Bank‟s business. On the other hand, a
Bank with high credit risk has high bankruptcy risk that puts the depositors in jeopardy. To maintain adequate profit
level in this highly competitive environment, Banks have tended to take excessive risks. However, it exposes the
banks to credit risk. The higher the Bank exposure to credit risk, the higher the tendency of the Banks to experience
financial crisis and vice-versa (Cebenoyan, 2004). The Basel Committee on Banking Supervision (2003) asserts that
loans are the largest and most obvious source of credit risk.

Having an effective risk management is a crucial for banking business. Without a doubt, in present day‟s
unpredictable and explosive atmosphere all banks are in front of enormous risks such as, credit risk, liquidity risk,
operational risk, market risk, foreign exchange risk and interest rate risk, along with other risks, which may possibly
affect the survival and successes of banks (Richard, 2011).

Credit risk management is very important to banks as it is an integral part of the loan process. It maximizes bank
risk, adjusted risk rate of return by maintaining credit risk exposure with view to shielding the bank from the adverse
effects of credit risk. Banks are investing a lot of funds in credit risk (Tibebu, 2011).

Banking industry in Ethiopia was dominated until very recently by the public owned commercial banks namely
Commercial Bank of Ethiopia and Development Bank of Ethiopia. The sector was opened for private investors since
the early 90s. Since then some 16 private banks have been established and have been a significant engine for the
growing economy. Private commercial banks in Ethiopia extend credit (loan) to different types of borrower for
many different purposes. However, as the private banks in the country are very young they can be threatened by the
lack of effective credit management practice. Therefore, it is important to assess private banks risk management
practice and identify major factors which affect Private commercial banks‟s credit risk management practice.

Statement of the Problem:-

In its simplest form, credit risk management involves the identification, evaluation and management of a company's
exposures to loss. In other words, credit risk management attempts to mitigate the occurrence of losses while
initiating advance planning to assure that adequate funds will be available to cover those losses that occur (Yong,
2003).

While financial institutions have faced difficulties over the years for a multitude of reasons, the major cause of
serious banking problems continues to be directly related to credit standards for borrowers and counterparties, poor
portfolio risk management, or a lack of attention to changes in economic or other circumstances that can lead to a
deterioration in the credit standing of a bank‟s counterparties (Cebenoyan, 2004).

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Banks credit risk management practices can be affected by internal and external factors. Government policy,
infrastructure facilities, inflation, global economic crises, credit culture of the society and economic level of the
countries are among external factors that can affect credit risk management practice of commercial banks, on the
other hand, Poor credit assessment technique, poor credit approval process, lack of credit management tools, lack
of supervisory monitoring and evaluating, lack of effective credit guideline and inadequate employee are some of
the internal factors that determine credit risk management practice of commercial banks (Yuqi Li, 2006).

Since exposure to credit risk continues to be the leading source of problems in banks World-wide, banks and their
supervisors should be able to draw useful lessons from past experiences. Banks should now have a keen awareness
of the need to identify measure, monitor and control major credit risk factors before the bank incurred to risks
(Atakelt, 2015).

Developing a strong credit risk management framework can help commercial banks to minimize exposures to risks
and to improve the competitive ability within the market.

Private banks in Ethiopia provide several types of credit facilities such as, overdraft credit service, merchandise loan
facilities, pre-shipment export facilities, revolving credit facilities, special truck loan financing, short term loan,
medium and long term loan agricultural input loans, etc.,.

According to the survey National Bank of Ethiopia (NBE) (2010), the private commercial banking system in
Ethiopia has been witnessing a significant expansion over the past ten years than before eventhough the Ethiopian
banking industry was still Underdeveloped. The survey believes that such growth should be matched with strong
credit risk management practices. This is because with the fastest economic growth of the country, societal demand
of credit service also increase and this situation may increse credit risk on the banks unless and otherwise banks
have effective credit risk management program. Accordingly, this research believes that to come up with a more
advanced form of credit risk management practice of private banks an academic study should focus first of all, on
identifying factors that affect credit risk management practice of private banks. Based on this, the study focused on
identifying major factors that determine credit risk management of private banks.

With related to credit risk issues the study tried to assess different published and unpublished research results to
reduce similarities with other researches. Accordingly, there are a number of studies provided on issues related to
credit risk management in Ethiopia: majority of the studies done in the banking sector of Ethiopia has been focused
on the impact of credit management on financial performance, tools of credit management, liquidity risk and bank
performance determinants. To mention just a few among the studies by different postgraduate students and
researchers such as, Yalemzewd (2013) assess credit management practice of Bunna International Bank S.C and
analyzed the process of accessing credit, credit control process and credit collection strategy against non-performing
loan of the bank.

Tibebu (2011) assesses credit risk management practice of Nib International Bank S.C and find out that risk which
emanates from credit is due to high degree of credit concentration in few sector and borrowers, and Girma (2010) in
his study of tools used to credit management in Wegagen Bank deal only focusing on the tools used by the bank to
manage risk. However, in Ethiopia none of the studies addresses in examining factor affecting credit risk
management practice of private banks. The main purpose of the study is to follow a comprehensive approach
towards identifying credit risk determinant factors taking into account some private banks in the country.

To this end, the underlying motivation of the researcher is to fill this gap on literature and to make an effort to bring
empirical evidence by identifying major factors affecting credit risk management practice of private commercial
banks in Ethiopia. Thus, this study contributes to the limited literature on credit risk management practice of banks
in Ethiopia and it contributes in identifying major determinate factors on it‟s findings.

Research Question:-
Based on the provided statement of the problem the study tried to answer the following basic research questions:-

1. How establishing Credit risk environments affect credit risk of the banks?
2. How Credit Granting processes affect the Banks Credit risk management Practice?
3. How Credit Measurement and Monitoring process Affect Credit risk management Practice?

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4. How Market Risk Affect the banks Credit risk management Practice?
5. How Operational Risk affect credit risk of the banks?
6. How Legality risk affect Risk management practice of the banks?

Objective of the Study:-

The major objective of the study is to assess factor affecting credit risk management practice of private commercial
banks in Ethiopia

Specific Objective of the Study:-

The specific objectives of the study are:-
1. To examine the effect of establishing Credit risk environments on credit risk management practice of the Banks
2. To assess credit granting processes of the banks and its effect on credit risk management practice of the banks
3. To examine the effect of Credit Measurement and Monitoring process of the banks in credit risk management
practice
4. To examine the effect of Market risk on the credit risk management practice of the banks
5. To examine the effect of operational challenges on the credit risk management practice of the banks
6. To examine the effect of legality risk on credit management practice of the banks

Significance of the Study:-

The study‟s findings and recommendations could be important for management of the banks and it can draw
attention to some of the points where corrective actions are necessary and enables them to make such corrections.
Furthermore, this study would serve as an input and basis for other researchers, academicians, consultants and some
associations who are in penchant of conducting further researches on related issues.

Scope of the Study:-

This study is delimited only to assess, factors affecting credit risk management practice of commercial private banks
of Ethiopia. The study is also delimited to four selected private banks. The banks were selected considering their
experience in the market. Accordingly, the study selected four relatively less experienced private banks. This is
because they are not well equipped and less experienced, the challenges of credit risk may pronounced in these
banks. And assessing of similar areas may help to indicate their common challenges in aggregate. The study also
delimited it self on the primary data that were gathered using questionnaires.

Organization of the Study:-

This research was organized in to five chapters. The first chapter deals with introduction of the study, statement of
the problem, objective of the study, significance of the study, delimitation (scope of the study). The second chapter
introduces review of related literature in the area. The third chapter deals with the research design and methodology.
The forth chapter presents the analysis and the fifth chapter contains summary of the major findings, conclusion and
recommendation of the study. Finally list of references and appendices are annexed at the end of the page.

Literature Review Of The Study:-

Introduction:-
This chapter presents what other scholars have written about the factors affecting credit risk management practice of
commercial banks, the variables and methodology they used as well as their findings and recommendations.
Therefore, this study tried to indicate some of the theoretical and empirical related literatures which defined and
elaborates the theories about each dependent and independent variables including the measurements of banks credit
risk.

Theoretical Literature:-
The theoretical part of the review provides theoretical literatures related to factors affecting credit risk management
practices of commercial banks.

Definition of Credit Risk:-

Credit risk is most simply defined as the potential that a bank borrower or counterparty will fail to meet its
obligations in accordance with agreed terms. The goal of credit risk management is to maximize a bank‟s risk-
adjusted rate of return by maintaining credit risk exposure within acceptable parameters (Yuqi Li, 2006). Banks
need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credits or transactions.

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Banks should also consider the relationships between credit risk and other risks. The effective management of credit
risk is a critical component of a comprehensive approach to risk management and essential to the long-term success
of any banking organization (Edward, 2006).

Credit risk, as defined by the Basel Committee on Banking Supervision (2003), is also the possibility of losing the
outstanding loan partially or totally, due to credit events (default risk). It can also be defined as the potential that a
contractual party will fail to meet its obligations in accordance with the agreed terms.

Credit risk is also variously referred to as default risk, performance risk or counterparty risk. A Bank exists not only
to accept deposits but also to grant credit facilities, therefore inevitably exposed to credit risk. Credit risk is by far
the most significant risk faced by Banks and the success of their business depends on accurate measurement and
efficient management of this risk to a greater extent than any other risks (Cebenoyan, 2004).

According to Davide and Thangavel, (2008), credit risk is the degree of value fluctuations in debt instruments and
derivatives due to changes in the underlying credit quality of borrowers and counterparties. Koehn and Santomero
(2006) defines credit risk as losses from the refusal or inability of credit customers to pay what is owed in full and
on time. Credit risk is the exposure faced by Banks when a borrower (customer) defaults in honoring debt
obligations on due date or at maturity. This risk interchangeably called „counterparty risk‟ is capable of putting the
Bank in distress if not adequately managed. Credit risk management maximizes Bank‟s risk adjusted rate of return
by maintaining credit risk exposure within acceptable limit in order to provide framework for understanding the
impact of credit risk management on Banks‟ profitability (Edwad, 2006).

Concept of Credit Risk Management:-

According to Tseganesh (2012) credit risk management includes all management function such as identification,
measurement, monitoring and control of the credit risk exposure. The writer further indicated that for long term
achievement of banking sector effective credit risk management practice is a vital issue in the current business
environment and poor credit risk management policy will create serious source of crisis in the banking industry.

According to Atakelt (2015) Credit risk management practice define as the process of analyzing and renewing
Credit risk management documents and apply constantly in actual Credit granting process, Credit administration and
monitoring and risk controlling process with suitable Credit risk environment, understanding and identification of
risk so as to minimize the unfavorable effect of risk taking activities and the effectiveness of credit risk management
process is dependent on different variables such as proper application of best Risk management documents, Staff
quality, Credit culture, devoted top management bodies, sufficient training program, proper organizational structure,
ample level of internal Control and Performance of intermediation function. This indicates that credit risk
management includes different issues such as developing and implementing suitable credit risk strategy, policy and
procedure, accurate identifications of risk, best credit granting process, credit administration, monitoring and
reporting process determining and controlling the frequency and methods of reviewing credit policy and procedure
and setting authority and responsibility clearly. Besides he mentioned that by establishing suitable credit risk
environment, acceptable level of credit limit, best credit granting process, proper monitoring and controlling credit
risk and optimizing risk return of a bank credit risk management develop credit performance.

Main Source of Credit Risk:-

The main source of credit risk include, limited institutional capacity, inappropriate credit policies, volatile interest
rates, poor management, inappropriate laws, low capital and liquidity levels, direct lending, massive licensing of
Banks, poor loan underwriting, laxity in credit assessment, poor lending practices, government interference and
inadequate supervision by the central Bank (Davide and Thangavel, 2008).Credit risk is critical since the default of a
small number of important customers can cause large losses, which can lead to insolvency (Basel Commute, 2003).

An increase in Bank credit risk gradually leads to liquidity and solvency problems. Credit risk may increase if the
Bank lends to borrowers it does not have adequate knowledge about. Richard (2011) state that the most obvious
characteristics of failed Banks is poor operating efficiency.

Cebenoyan (2004), suggest that Bank risk taking has pervasive effects on Bank profits and safety. Edward (2006)
asserts that the profitability of a Bank depends on its ability to foresee, avoid and monitor risks, possible to cover

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losses brought about by risk arisen. This has the net effect of increasing the ratio of substandard credits in the
Bank‟s credit portfolio and decreasing the Bank‟s profitability.

According to NBE (2010), Revised Risk Management Guidelines, credit risk arises any time bank funds are
extended, committed, invested, or otherwise exposed, whether reflected on or off the balance sheet as a result of lax
exposure management, poor economic conditions, or a variety of other factors. However, generally the risk is
assumed to be a rise from transaction (default) risk, operation risk, lack of supervision and portfolio risk. These
signify the role of credit risk management and therefore it forms the basis of present research analysis.

Credit Assessment:-
A thorough credit and risk assessment should be conducted prior to the granting of loans, it should also focuses on
the credit risk assessment of other determinate factors. The results of this assessment should be presented in a Credit
Application that originates from the relationship manager/account officer (RM‖), and is approved by Credit Risk
Management (CRM). The RM should be the owner of the customer relationship, and must be held responsible to
ensure the accuracy of the entire credit application (Yong, 2003)

According to Ayalew (2011) Credit Applications should summaries the results of the RMs risk assessment and
include, as a minimum, the following details:

Borrower Analysis:-
The majority shareholders, management team and group or affiliate companies should be assessed. Any issues
regarding lack of management depth, complicated ownership structures or inter group transactions should be
addressed, and risks mitigated.

Industry Analysis:-
The key risk factors of the borrower„s industry should be assessed.
Any issues regarding the borrower„s position in the industry, overall industry concerns or competitive forces should
be addressed and the strengths and weaknesses of the borrower relative to its competition should be identified.

Supplier/Buyer Analysis:-
Any customer or supplier concentration should be addressed, as these could have a significant impact on the future
viability of the borrower.

Historical Financial Analysis:-

An analysis of a minimum of 3 years historical financial statements of the borrower should be presented. Where
reliance is placed on a corporate guarantor, guarantor financial statements should also be analyzed. The analysis
should address the quality and sustainability of earnings, cash flow and the strength of the borrower„s balance sheet.
Specifically, cash flow, leverage and profitability must be analyzed.

Projected Financial Performance:-

Where term facilities (tenor > 1 year) are being proposed, a projection of the borrower„s future financial
performance should be provided, indicating an analysis of the sufficiency of cash flow to service debt repayments.
Loans should not be granted if projected cash flow is insufficient to repay debts.

Account Conduct:-
For existing borrowers, the historic performance in meeting repayment obligations (trade payments, cheques,
interest and principal payments, etc) should be assessed.

Adherence to Lending Guidelines:-

Credit Applications should clearly state whether or not the proposed application is in compliance with the bank„s
Lending Guidelines. The Bank„s Head of Credit or Managing Director/CEO should approve Credit Applications
that do not adhere to the bank„s Lending Guidelines.

Mitigating Factors:-
Mitigating factors for risks identified in the credit assessment should be identified. Possible risks include, but are not
limited to: margin sustainability and/or volatility, high debt load (leverage/gearing), overstocking or debtor issues;

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rapid growth, acquisition or expansion; New business line/product expansion; management changes or succession
issues; customer or supplier concentrations; and lack of transparency or industry issues.

Loan Structure:-
The amounts and tenors of financing proposed should be justified based on the projected repayment ability and loan
purpose. Excessive tenor or amount relative to business needs increases the risk of fund diversion and may adversely
impact the borrower„s repayment ability.

Security:-
A current valuation of collateral should be obtained and the quality and priority of security being proposed should
be assessed. Loans should not be granted based solely on security. Adequacy and the extent of the insurance
coverage should be assessed.

Credit Risk Enhancement:-

Credit enhancement is the technique of risk-sharing and mitigation to facilitate commercial performances and
operations in line with the institute‟s objectives and goals. The fundamental tasks include customers or client
development operations, credit-based financial transactions efficiency and effectiveness, transactions performance,
innovations, transparency, and risk awareness and others (Basel Committee, 2003). Client development is basic and
integral part of the commercial success and profitability. It is a demand-driven operation that grounded into the
financial institutes‟ strategies and interests‟ frameworks towards the economic developments (Richard, 2004).
Efficiency and effectiveness is a key to the commercial sectors in terms of their development and impacts it focusing
on healthy and operable financial transactions and its comparative advantages (in consideration of their long-term
and/or sovereign risk) while letting its financing clients focus on their comparative advantages (such as short-term,
medium-term, and/or commercial risks) (Cebenoyan, 2004).

Lending Process:-
Process and Work Analysis of Bank Lending Activity:-
Koch and Macdonald (2000) pointed out that the activities in the process of commercial and industrial (C&I) loans
follow eight steps. These steps are application, credit analysis, decision, document preparation, closing, recording,
servicing and administration, and collection.

Internal Measures before Lending Decision:-

According to Menkhoff, Neuberger and Suwanaporn (2006), the factors for evaluation generally used in this
situation are in line with the 6C principles of basic lending. These 6C's are Character, Capacity, Capital, Collateral,
Conditions and Control, which are also important reference indexes for banks when making a credit analysis to
decide whether or not a borrower is worthy of a loan. Viewed overall, according to the principles, the internal
measure for measuring the value or quality of the output at this stage, regarding the visiting report, can be
determined by whether the collection of information by the loan officer concerning the is accurate and complete, or
not (Haider and Birley, 2001).

By analyzing a borrower's situation using the 6C principles, the comparatively more difficult situations encountered
by a loan officer become capacity and condition because in addition to the understanding and analysis of the
information about capacity and condition, it is also necessary to determine whether any future changes will affect
the financial situation and the loan repaying ability of an enterprise. Therefore, if an excellent, professional loan
officer can accurately and completely collect information in these capacity and condition, the value of the visiting
report will be high (Koch and Macdonald, 2000).

Tools of Credit Risk Management:-

Credit Risk Control Tools:-
Tools like covenants, collateral, credit rationing, loan securitization and loan syndication have been used by banks in
developing the world in controlling credit losses (Hugh, 2001). Marphatia and Tiwari (2004) argued that risk
management is primarily about people – how they think and how they interact with one another. Technology is just
a tool; in the wrong hands it is useless. This stresses further the critical importance of qualified staff in managing
CR. Figure 2.1 presents a summary of the CRM system as explained in the literature. It is established in the financial
economics literature that the CRM system of a CB is made up of credit policy and strategies that provide general

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and detailed operational guidelines. It also includes the facilitating factors such as quality of staff and technology.
According to Davide and Thangavel (2008) „) the tools through which credit risk management is carried out are:

Exposure Ceilings:-
Prudential Limit is linked to Capital Funds - say 15% for individual borrower entity, 40% for a group with
additional 10% for infrastructure projects undertaken by the group, Threshold limit is fixed at a level lower than
Prudential Exposure; Substantial Exposure, which is the sum total of the exposures beyond threshold limit should
not exceed 600% to 800% of the Capital Funds of the bank (i.e. six to eight times).

Review/Renewal:-
Multi-tier Credit Approving Authority, constitution wise delegation of powers, Higher delegated powers for better-
rated customers; discriminatory time schedule for review/renewal, Hurdle rates and Bench marks for fresh exposures
and periodicity for renewal based on risk rating, etc are formulated.

Risk Rating Model:-

Set up comprehensive risk scoring system on a six to nine point scale. Clearly define rating thresholds and review
the ratings periodically preferably at half yearly intervals. Rating migration is to be mapped to estimate the expected
loss.

Risk based scientific pricing:-

Link loan pricing to expected loss. High-risk category borrowers are to be priced high. Build historical data on
default losses. Allocate capital to absorb the unexpected loss.

Portfolio Management:-
The need for credit portfolio management emanates from the necessity to optimize the benefits associated with
diversification and to reduce the potential adverse impact of concentration of exposures to a particular borrower,
sector or industry. Stipulate quantitative ceiling on aggregate exposure on specific rating categories, distribution of
borrowers in various industry, business group and conduct rapid portfolio reviews.

Loan Review Mechanism:-

This should be done independent of credit operations. It is also referred as Credit Audit covering review of sanction
process, compliance status, and review of risk rating, pickup of warning signals and recommendation of corrective
action with the objective of improving credit quality. It should target all loans above certain cutoff limit ensuring
that at least 30% to 40% of the portfolio is subjected to LRM in a year so as to ensure that all major credit risks
embedded in the balance sheet have been tracked

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Figure 2.1:-Research model for the CRM System of a commercial bank.

Source:-Berger and Udell (2002).

The two Dimensions of Credit Risk Management:-

According to Yalemzewd (2013) credit risk management practice can classified in to two distinct dimensions as
preventive measures and curatives measures. Preventive measures include risk assessment, risk measurement and
risk pricing, early warning system to pick early signals of future defaults and better credit portfolio diversification.
The curative measures, on the other hand, aim at minimizing post sanction loan losses through such steps as
securitization, risk sharing, legal enforcement etc. It is widely believed that an ounce of prevention is worth a pound
of cure.

Factors Influencing Effectiveness of Credit Risk Management Practices:-

Loans that constitute a large proportion of the assets in most banks' portfolios are relatively illiquid and exhibit the
highest. The theory of asymmetric information argues that it may be impossible to distinguish good borrowers from
bad borrowers, which may result in adverse selection and moral hazards problems. Adverse selection and moral
hazards have led to substantial accumulation of non-performing accounts in banks. The very existence of banks is
often interpreted in terms of its superior ability to overcome three basic problems of information asymmetry, namely
ex ante, interim and ex post (Uyemura and Deventer, 2000).

Credit Risk Management Process:-

According to Basel (2004), the management of CR in banking industry follows the process of risk identification,
measurement, assessment, monitoring and control. It involves identification of potential risk factors, estimate their
consequences, monitor activities exposed to the identified risk factors and put in place control measures to prevent
or reduce the undesirable effects. This process is applied within the strategic and operational framework of the bank.

Risk – Adjusted Performance Measures:-

Several risk-adjusted performance measures have been proposed (Heffernan, 2002; Kealhofer, 2003). The measures,
however, focus on risk-return trade-off, which include measuring the risk inherent in each activity or product and

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charge it accordingly for the capital required to support it. This does not solve the issue of recovering loanable
amount. Effective system that ensures repayment of loans by borrowers is critical in dealing with asymmetric
information problems and in reducing the level of loan losses, thus the long-term success of any banking
organization (Basel, 2003).

Credit Risk Management Practices:-

Effective CRM involves establishing an appropriate CR environment; operating under a sound credit granting
process; maintaining an appropriate credit administration that involves monitoring process as well as adequate
ensure that there are proper and clear guidelines in managing CR, that is, all guidelines are properly communicated
throughout the organization; and that everybody involved in CRM understand them. Considerations that form the
basis for sound CRM system include: policy and strategies (guidelines) that clearly outline the scope and allocation
of a bank credit facilities and the manner in which a credit portfolio is managed, that is, how loans are originated,
appraised, supervised and collected The recommendation has been widely put to use in the banking sector in the
form of credit assessment. According to the asymmetric information theory, a collection of reliable information from
prospective borrowers becomes critical in accomplishing effective screening (Basel, 2004).

Assessment of Borrowers:-
The assessment of borrowers can be performed through the use of qualitative as well as quantitative techniques. One
major challenge of using qualitative models is their subjective nature. However, borrowers attributes assessed
through qualitative models can be assigned numbers with the sum of the values compared to a threshold. This
technique is termed as “credit scoring”. The technique cannot only minimize processing costs but also reduce
subjective judgments and possible biases. The rating systems if meaningful should signal changes in expected level
of loan loss concluded that quantitative models make it possible to, among others, numerically establish which
factors are important in explaining default risk, evaluate the relative degree of importance of the factors, improve the
pricing of default risk, be more able to screen out bad loan applicants and be in a better position to calculate any
reserve needed to meet expected future loan losses (Uyemura and Deventer, 2000).

Clearly Established Credit Approval Process:-

Clearly established process for approving new credits and extending the existing credits has been observed to be
very important while managing. Further, monitoring of borrowers important as current and potential exposures
change with both the passage of time and the movements in the underlying variables, and are also very important in
dealing with moral hazard problem Monitoring involves, among others, frequent contact with borrowers, creating an
environment that the bank can be seen as a solver of problems and trusted adviser; develop the culture of being
supportive to borrowers whenever they are recognized to be in difficulties and are striving to deal with the situation;
monitoring the flow of borrower's business through the bank's account; regular review of the borrower's reports as
well as an on-site visit; updating borrowers credit files and periodically reviewing the borrowers rating assigned at
the time the credit was granted (Donaldson, 2000; Tummala and Burchett, 2000; Mwisho, 2001; Basel, 2004;
Treacy and Carey, 2004;).

Internal Performance Measures of Bank Lending:-

A. Basel II Criteria:-
Banks are learning to review their risk portfolios using the criteria laid down by Basel II. Greenspan has indicated
that Basel's goal is to induce bankers to improve their risk management capability, including how the institutions
price products, reserve for loss, and control their operations (Rehm, 2002). This research is in line with the purpose
of Basel II, that is, to reduce a bank's operational risk during the lending process through a better monitoring of the
employees in the lending department. According to Basel Committee on Banking Supervision (2006), the Basel II
guidelines establish capital adequacy requirements and supervisory standards for banks to be implemented by 2007.
The main objective of Basel II is: to develop a framework that would further strengthen the soundness and stability
of the international banking system, while maintaining sufficient consistency that capital adequacy regulation will
not be a significant source of competitive inequality among internationally active banks. The Committee believes
that the revised framework will promote the adoption of stronger risk management practices by the banking
industry, and views this as one of its major benefits (Basel Committee on Banking Supervision, 2006).

Ferguson (2003) observed that Basel II Accord provides a roadmap for the improved regulation and supervision of
global banking. Basel II will provide strong incentives for banks to continue improving their internal risk-
management capabilities as well as the tools for supervisors to focus on emerging problems and issues more rapidly

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than ever before. Basel II is intended to align capital adequacy assessment more closely with the key elements of
banking risks and to provide incentives for banks to enhance their risk measurement (Basel Committee on Banking
Supervision, 2006). Particularly, the risk adjusted backing of credit exposures with recourse equity (regulatory
capital) is one of the key issues in the New Basel Capital Accord. Basel II will affect banks and customers equally.
Significant changes include: (i) the introduction of ratings as the basis for risk assessment and calculation of
regulatory capital; and (ii) the assessment of credit costs based on the degree of risk. The Basel II Accord proposes,
among other things, more detailed criteria for the treatment of credit risk, and for the first time introduces criteria for
the regulatory treatment of operational risk. Beyond merely measuring the capital requirements for the risk
categories, it also puts strong emphasis on criteria for supervisory review and increased public disclosure (Rowe,
Jovic and Reeves, 2004).

The First Pillar – Minimum Capital Requirements:-

The comprehensive version of the Basel II Accord provides improved risk sensitivity in the way capital
requirements are calculated for three major components of risk that a bank faces; credit risk, operational risk and
market risk. The capital ratio is calculated using the definition of regulatory capital and risk-weighted assets (RWA)
(Basel Committee on Banking Supervision, 2006). The total capital ratio must be no lower than 8 per cent. Tier 2
capitals are limited to 100 per cent of tier 1 capital. While market risk assessment has not been changed – a
standardized approach or value at risk (VaR) is retained – credit risk assessment has been changed and operational
risk has been introduced for the first time. For credit risk, Basel II provides three approaches to calculate credit risk-
based capital (Leippold and Vanini, 2003). The first approach is the standardized approach, which relies on external
ratings. Based on this approach, banks‟ activities are divided into eight business lines: corporate finance, trading and
sales, retail banking, commercial banking, payment and settlement, agency services, asset management, and retail
brokerage. For the purpose of calculating capital for operational risk, each of these lines is a percentage of the
bank‟s gross income from that particular line of business.

The second approach is the foundation internal ratings-based (IRB) approach which allows banks to calculate their
credit risk-based capital on the basis of their internal assessment of the probability that the counterparty will default
(Basel Committee on Banking Supervision, 2006). The third and most sophisticated approach is the advanced IRB
approach, which allows banks to use their own internal assessment not only of the probability of default (PD), but
also the percentage loss suffered if the counterparty defaults and the quantification of the exposure to the
counterparty. For the IRB there are four parameters to consider: VaR; (i) loss function, PD of a borrower; loss given
default (LGD), the estimate of loss severity; (ii) exposure at default, the amount at risk in the event of default and
the facility‟s remaining maturity (M) (Kealhofer, 2003). Calculation of these components requires advanced data
collection and sophisticated risk management techniques (Allen, 2004).

The Second Pillar – Supervisory Review Process:-

Basel II emphasizes that financial institutions should fulfill their self-responsibility for appropriately assessing and
managing the various risks they face, and maintaining sufficient capital according to such risks including those not
covered within the first pillar (minimum capital requirements). It also mentions that supervisors should review and
evaluate risk management methods which are adopted by individual financial institutions on their own initiative, and
take appropriate supervisory actions as necessary. For this Implementing Basel II purpose the Basel II Accord sets
four key principles of supervisory review (Basel Committee on Banking Supervision, 2006), as follows: (i) Banks
should have a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for
maintaining their capital levels; (ii) Supervisors should review and evaluate banks‟ internal capital adequacy
assessments and strategies, as well as their ability to monitor and ensure their compliance with regulatory capital
ratios. Supervisors should take appropriate supervisory action if they are not satisfied with the results of this process;
(iii) Supervisors should expect banks to operate above the minimum regulatory capital ratios and should have the
ability to require banks to hold capital in excess of the minimum; (iv) Supervisors should seek to intervene at an
early stage to prevent capital from falling below the minimum levels required to support the risk characteristics of a
particular bank and should require rapid remedial action if capital is not maintained or restored (Dutta and Perry,
2006).

The Third Pillar – Market Discipline:-

The aim of this pillar is to strengthen market discipline through increased disclosure. Market discipline imposes
strong incentives on banks to conduct their business in a safe, sound and efficient manner, including an incentive to

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maintain a strong capital base as a cushion against potential future losses arising from risk exposures (Fatemi and
Glaum, 2000).

The market discipline proposed greatly increases the disclosures that the bank must make. This is designed to allow
the market to have a better picture of the overall risk position of the bank and to allow the counterparties of the bank
to price and deal appropriately (Allen, 2004). The Basel II Accord indicates in this regard: Supervisors have an array
of measures that they can use to require banks to make such disclosures. Some of these disclosures will be
qualifying criteria for the use of particular methodologies or the recognition of particular instruments and
transactions (Basel Committee on Banking Supervision, 2006).

Risk management Process:-

Risk management is a process which involves an interlinked of sequence of function which should be performed in
order to measure, manage and control risk. Different methodologies for identifying capture, analyzing and reporting
credit market, liquidity and operational risks are at the disposal of financial institutions (Bonnevie, 2003). According
to Bennevie, credit risk management process as a methodology of identifying, capturing and containing risk has
eight different phases. These phases are shown on appendices 5 and 6 are also explained below:

The first phase involves position and market analysis. According to Bonnevie (2003), this phase is marked by the
following: first there is need for the financial institution to understand the market environment in which it operates.
In this case the financial institution should analyze its position in the market, the intensity of competition in the
market, the price elasticity of demand for its product and customers‟ needs having identified its position and own
share in the market, the financial institution should also identify the sources of data after which an information
management structure is established. Finally, there is need to understand the legal aspect of the risk to be taken.

The second phase is concerned with developing the knowledge about the risk awareness and identification of tools
to be used to manage risk. In this phase, there is need to evaluate the degree of risk awareness, risk incentives, risk
reward, perceptions and the risk acceptance limits. In this phase, the institution should evaluate the risk in terms of
volatilities and probabilities or occurrence. The institution should also priorities the risk areas in relation to
organizational goals and risk appetite.

According to Bonnevie (2003) and Vanden (2004), risk appetite is the degree to which an organization links its
objectives and goals to risk finally, this phase is characterized with the identification and deciding of the tools to be
used in measuring monitoring and controlling risk and how to integrate them into other organizational processes.

The next phase is the decision making phase. This involves deciding and agreeing on strategies and tactics that
should be used to link the risk appetite to business activities. Such strategies and tactics may include the top-down or
bottom techniques of measuring, evaluating and reporting risks.

The fourth phase is concerned with the defining and deciding on the limits to steer the risk management process.
There is need to define and expose the stop-loss limits for each credit risk. The institution should also decide on the
corrective measure to be taken, the channels of responsibility and the decision process to be followed.

Phase five involves communication of plans and decisions. In this phase, there is need to establish a communication
process among working groups between reporting lines and to decide on the periodicity and means of
communication. There is also a need to ensure that the risk culture is widespread in the entire organizations‟ staff.

Phase six is the implementation of plans and decisions. According to Bonnevie (2003) and BIS (2004), this phase
requires senior management sponsorship, a clear vision of what is to done and to ensure commitment to the
organization‟s objectives.

The next phase is monitoring of results and events. It involves the linking of the assessed risk to the established risk
limits, aggregating of risk, diversification of risk and reporting of risk. In this monitoring phase the top-down or
bottom-up reporting method may be adopted.

The last phase in the management process has to do with management of the risk data in order to meet
organizational goals and expectations.

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In conclusion, there are eight phases that constitute the requisites of measuring, managing and controlling risk. In a
commercial bank, the most dominant risk to measure and contain is the credit risk.

Although credit risk is not the only risk faced by a commercial bank, it is the risk that has caused financial
devastation in Uganda Commercial Banks for example; Green land bank, (Ssewagudde, 2000).

According to Sewagudde (2000), the business of banking is measuring and accepting risk. Because the major risk
faced by commercial banks is the credit risk. Credit risk can be interchangeable called loan default risk. Guidelines
and procedures to measure and contain default risk are explained in the next subsection as part of commercial bank
credit policy, procedures and guidelines.

Credit Policy in Commercial Banks:-

Credit policy is a frame work which provides the guidelines, procedures and responsibilities involved in measuring,
monitoring and controlling loan default risk. According to Ssewagudde (2000), a credit policy should provide
parameters define responsibilities and establish a system of checks and balances. It should include general policies,
specific loan strategies, miscellaneous loan policies and quality control committees whose role is to guide the credit
decision taken by the bank. A credit policy should be specific, clear, concise, relevant and should be supported by
credit procedures. It should also define the bank‟s acceptable and un acceptable risks. A good number of authors
BIS (2003), Sinkey (1998), Santomero (1996) and Ssewagudde (2000) agree that since taking is central to banking,
it is profitable for banks to take risks that are reasonable, controllable and with in their financial resources and
competences

According to these authors, banks need not engage in businesses in a manner that necessarily impose risks on them.
Similarly, they should not absorb risks that can adversely affect their clients.

In their strategic planning, there is need for the banker to clearly specify and if need be quality the risk factors and
level of risk for each market target, target customer segments and loan concentration. According to Sunkey (1998)
and Ssewagudde (2000), the lender must weigh the pros and cons of specialization and concentration of lending to
industry sector, groups and individuals borrowers to establish limits on their overall exposure to risk. If the loans in
the portfolio are highly concentrated and correlated with existing loans, then the lender is also concentrating loans
on loan default risks. If loans portfolio risk becomes excessive, it manifests itself in the form of bad loans. High bad
loans provisions and loan losses destroy the bank value (Ssewagudde, 2000).

Credit procedures are steps clarifying the techniques used by the bank to execute its credit policy. Credit directives
on the other hand are those to address credit policy issues in response to the market and economic changes. Credit
directives provide general parameters for the type of clients and market the bank is willing to serve, the loan
concentration levels and the acceptable risk in each market and industry.

According to Ssewagudde (2000), when a bank strategy, credit policy procedures and directives have been carefully
formulated and administered from the top and well understood all organizational levels, it enables the bank to
maintain proper credit standards, avoid excess risk and evaluate business opportunities properly.

Identification and prioritization of Market Targets:-

The formation of bank‟s strategic plan by top management is a very important aspect for the success of the business.
For banks, this strategy should, be outlines in terms of risk concentration, commitment to market segment, the
acceptable asset/liability exposure and the need to hedge against systematic risk of a particular type (Sentomero,
1996). In the strategic plan, management should meticulously design credit policies, credit directives and procedures
that are consistent with the desired credit risk in each market target

Various authors (MC Naughton et al 1996, Merton at el 1999, Sinkey, 1998 ad Santomero, 1996) agree that risk is
central to banking. For a bank to accept a risk, the bankers must fully comprehend and if possible qualify the risks
so taken. Banking institutions need not engage in business that will unnecessarily impose risks upon them and also
upon other stakeholders. Because the major risk faced by commercial banks is the default risk, it also follows that
major risks must measure, accept and manage in each market target is the default risk.

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When a bank strategic plan and credit policies are properly formulated by top management and well-understood at
all organizational levels, it enables the bank to maintain risk properly. It also enables that bank to operate
consistently and to adhere to uniform and sound bank practices.

Credit Initiation/ Analysis Process:-

Credit analysis is a process which involves procedures which a commercial has to follow in assessing whether a
prospective loan applicant should qualify for the loan. These procedures include credit origination, credit evaluation,
credit negotiation and approval. Each of these is an important element of credit risk management and are examined
under the following subheadings.

Credit origination:-
When a client applies for credit, bank officers should identify whether this customer‟s compatible with the bank‟s
credit policy. Credit origination involves the collection of sufficient and relevant information about the credit. So,
the bankers are capable to assess the compatibility of his/her need for cash and the bank‟s credit, procedures and
directives. Credit staff in the bank is expected to visit the potential client‟s business premises to access the
prevailing situation.

This initial step of physical visit and data collection is an important element of credit initiation as it gives the banker
the basis for decision-making. It helps the banker to decide whether to grant credit or deny it. It paves the way for
the next element of credit management. Credit origination is followed by credit evaluation.

Credit evaluation:-
Credit evaluation involves assessing whether the client is credit worthy. In credit evaluating, the banker is able to
assess the purpose of the loan, the business and the financial position of the potential customer. In credit principles
of lending, the 5C‟s of credit. These 5C‟s are discussed by Kakuru (2003), and Horne (1998), Pandeny 1997) and
Sinkey (1998). They refer to the customer‟s conditions or business cash flow and net worth, collateral securities and
economic conditions or business fluctuations. There is a need for the banker to evaluate the customer‟s capacity to
pay persistently. There is always information asymmetry between the bankers and their clients due to the ever-
changing economic conditions. Ideally sensitivity analysis on the client‟s ability should be carefully conducted by
the banker to minimize risks.

Credit negotiation and approval:-

This is the last step of the credit initiation process. It involves negotiating with the credit worthy customer on the
terms of the credit; the loan interest rate, the loan amortization schedule, agreement. Negotiation process should
ensure that the credit advanced by the bank is beneficial to the client and the payment will be orderly and favorable.
It should result into a good qualify loan portfolio. Once the process of negotiation is concluded, then the loan is
approved. The bank‟s loan committee should ensure that all term and procedures have been adhered to.

Credit evaluation is a very important element of credit initiation and credit risk management process. If it is carried
out properly and in accordance to the bank‟s credit policy and procedures, the resulting performance of the loan
advanced becomes good. It greatly reduces the loan default risk. A proper credit evaluation management. This
relationship between the client and the bank management. This relationship management of ten leads to lifetime
client management, constant renewal of contacts all of which culminate client-customer loyalty.

In credit evaluation, there is a need to apply a rating scheme to all investment alternatives before the bank makes a
decision. According to Harrison (2003), a credit-scoring scheme ought to be used by the banker to predict whether
the potential client is worth the credit. A common credit risk rating system for all bank loan portfolios is likely to
achieve lower loan defaults than the traditional method of credit awarding by experienced bank managers. Once the
credit evaluation procedures are accomplished and the decision to advance credit is made, then the process of credit
negotiation takes place.

A proper negotiation process will also result in a better quality loan portfolio. It ensures that the banker gives to the
customer a credit product that is profitable and credit product that will be paid timely. According to Sinkey (1996),
Chester (2003), banks need not involve in deal that will neither involve them in losses, nor involve their clients in
loss making venture. Once credit negotiation is completed, then the process of credit approval follows.

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Credit Approval
Credit approval is the last step in the credit initiation and analysis process. In this stage, the bank‟s credit. The
bank‟s credit committee should be composed of approving the credit impartial committee members. They should
devote sufficient amount of time in receiving analysis and approving or disapproving several loan application
presented to them at the same time. The committed ensures that all the procedures, guidelines and directives in the
credit; policy has been followed.

Credit Documentation and Disbursement

Credit documentation is the fourth element of the credit management process. It includes the taking of all security
and precautionary measures are obtained and documented before the funds are disbursed. It ensures that
modification on all approved credit have been compatible with the credit policy. It also involves the maintenance of
orderly and up-to-date credit files. It includes the imposition of the relevant fees, updating of relevant records and
prompt modification of the credit review and renewal dates (MC Naughton et al (1996). Credit documentation also
ensure that the loan covenants are also made before the loan is checks and document review to ensure that the bank
fully protected. According to Day et al (1996), if weakness and problems for the bank particularly in the area of
protection because they leave the bank unprotected if the clients run into difficulties. When the process of credit
disbursement must ensure that funds are not paid out; the procedure guidelines in the credit policy are met. If the
process of disbursing the funds is weak, the entire credit risk management process can easily be jeopardized.

Credit risk measurement, monitoring and control

This is the last step of credit risk management and measurement of risks guidelines and procedures of minimizing
them. It also involves the following administrative aspects: monitoring of the portfolio performance, classification of
the portfolio according to performance, ensuring that the credit is orderly and fully repaid, conducting of ob site
visits and regular contact with clients, conducting of credit audit or risk asset review to assess portfolio quality and
management and review clients files and documents as well as collated securities. It should also involve
quantification of the risk in each market to measure the magnitude of the risk and to monitor whether the bank credit
is being properly implemented.

All these aspects of credit administration are vital in monitoring change in behaviour and noncompliance. In this
way bankers are able to detect early warning signals of deterioration or non or non-compliance and timely effect
corrective measures to avoid losses. Another important aspect of credit administration is, collecting, processing and
analyzing of up to date and accurate information on portfolio performance. RMA (2004), Sinkey. (1998) and
Greuining et al (1999) agree that best ways to detect the flaws and weaknesses in the qualify of banker‟s portfolio is
through gathering processing, and analyzing quality information. Because of changing economic conditions and
customer‟s behaviour (moral hazards) and the failure to give timely data, there is information asymmetry and the
bank must constantly update its management information system and the database. Thus good quality portfolio
management and administration should contain risks in market segments.

Control and Management of Credit Risks

The Basel Committee on Banking Supervision (1999; 2000; 2001) having surveyed the difficulties connected with
banks management of credit globally, issued a few rules that have come to be viewed as benchmark credit risk
management rehearses keeping in mind the end goal to loan sound practices for overseeing credit risk (Nsiah-
Agyeman, 2010). The report of the Basel Committee on Banking Supervision (2000 refered to in Nsiah-Agyeman,
2010) on lay away risk concentrated around four fundamental zones as basic in each credit management process.
These areas are:
1. Establishing a suitable credit environment.
2. Operating a sound credit granting process.
3. Ensuring satisfactory controls over credit risk.
4. Evaluation and implementation of protective covenants

Establishing a suitable credit environment

The controlling and working spine of each organization is the top managerial staff as per (Wheehem & Hunger,
2008). As for every other area of a bank's dealings, the governing body has a genuine part to play in administering
the credit granting and credit risk management elements of the bank. The governing body, as indicated by the report
of the Basel Panel (2000) ought to have obligation regarding endorsing and intermittently (in any event every year)
investigating the credit risk technique and critical credit risk strategies of the bank. Every bank ought to build up a

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credit risk methodology or arrangement that sets up the goals controlling its credit-giving activities and embrace the
important strategies and techniques for directing such activities (Machiraju, 2004). The board needs to perceive that
the system and strategies must cover the numerous activities of the bank in which credit introduction is a critical
risk. Saunders (2007) likewise places that, these methods ought to mirror the bank's resilience for risk and the level
of benefit the bank hopes to accomplish for bringing about different credit risks.

The technique ought to incorporate a bank's announcement readiness to allow credit taking into account exposure
type (for instance, commercial, consumer, real estate) monetary part, geological area, currency, development and
foreseen productivity (Matyszak, 2007). This may additionally incorporate the distinguishing proof of target markets
and the general qualities that the bank would need to accomplish in its credit portfolio (including levels of
enhancement and resistances).

The top managerial staff ought to occasionally survey the monetary consequences of the bank and, in light of these
outcomes, figure out whether changes should be made to the system. The board should likewise focus the bank's
level capital ampleness (Boateng, 2004).

Wilson (1998) is additionally of the perspective that, the credit risk method of any bank ought to give progression in
methodology. Henceforth, the system should contemplate the intermittent parts of the economy and the resultant
changes in the structure and estimation of the aggregate credit portfolio. In spite of the fact that the procedure ought
to be occasionally assessed and adjusted, it ought to be doable over the long haul and through different monetary
cycles (Machiraju, 2004).

Fotoh (2005) upheld that the credit risk arrangements and methods ought to be successfully imparted all through the
organization. All noteworthy faculty ought to be obviously made to comprehend the bank's way to deal with
allowing and overseeing credit and ought to be considered responsible for agreeing to built-up approaches and
methodology. The board ought to guarantee that senior management is completely fit for dealing with the credit
activities directed by the bank and that those activities are done inside of the risk procedure, approaches and
resistances endorsed by the board (Basel Council, 2001). The board ought to additionally frequently (i.e. in any
event yearly), either inside of the credit risk system or inside of an announcement of credit strategy, favor the bank's
general credit-allowing criteria (counting general terms and conditions). Furthermore, it ought to affirm the way in
which the bank will sort out its credit-giving capacities, including autonomous audit of the credit granting and
management capacity and the general portfolio (Nsiah-Agyeman, 2010).

Operating a sound credit granting process

The Basel Board of trustees (2000; 2001) underlined that with a specific end goal to keep up a sound credit
portfolio, it is fundamental a bank have set up and built up formal exchange assessment and support process for the
conceding of credits. Regards ought to be made as per the bank's composed rules and conceded by the suitable level
of management. There ought to be an unmistakable review trail reporting that the regard procedure was consented to
and distinguishing the individual(s) and/or committee(s) giving data and also settling on the credit choice (Boateng,
2004). As per Wilson (1998), banks frequently profit by the foundation of expert credit gatherings to examine and
sanction credits identified with noteworthy product offerings, sorts of credit offices and modern and geographic
parts. Banks ought to put resources into sufficient credit choice making assets so they find themselves able to settle
on sound acknowledge choices reliable for their credit procedure and meet aggressive time, estimating and
organizing weights.

Every credit proposition ought to be subjected to cautious examination by a skillful acknowledge examiner for the
ability comparing to the size and complexity of the exchange. In the expressions of Boateng (2004), a successful
credit evaluation process builds up least prerequisites for the data on which the examination is based. There ought to
be arrangements set up with respect to the data and documentation expected

An exploration by Machiraju (2008) uncovered that, one of the management rules that banks have utilized in their
client data get-together process is screening. Screening as indicated by the researcher includes the procedure of
recognizing just solid and trustworthy clients from a pool of various candidates for money related help. Banks
screen "good" credit risk from "bad" ones in order to make productive loans. Screening is typically done before a
credit is conceded. Successful screening obliges banks to gather precise and dependable data from potential
borrowers. The point is to assess the default risk of their clients. The potential borrower is regularly needed to

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supply the loan officer with data about their experience, salary and total assets. Distinctive credit risk models
extending from subjective to quantitative ones may be utilized to encourage the screening procedure to land at an
educated choice.

Ensuring adequate controls over credit risk:-

As per Ganesan (2000), there must be credit points of confinement set for every officer whose expected set of
responsibilities has a relationship with credit granting to guarantee sufficient controls over credit. Material
exchanges with related gatherings ought to be liable to the board's endorsement of executives (barring board
individuals with irreconcilable situations), and in specific circumstances (e.g. an extensive credit to a noteworthy
shareholder) answered to the saving money supervisory powers.

Banks should likewise consider the time span for conceding credit since time is of specific significance to borrowers
(Nsiah-Agyeman, 2010). Borrowers for the most part oblige credit inside of a given time, and for such credits to be
significant they must be conceded inside of the period the office is needed. As indicated by Hubbard (2000), if a
borrower obliges a credit inside of, say, one month, the giving bank must meet such time period without undue
deferrals. This implies that lending institutions must make known in unequivocal terms to the borrowers the terms
and conditions to allowing the credit. Having allowed credit there is the requirement for keeping up a proper credit
organization, estimation and checking procedure. Once more, banks must build up an arrangement of autonomous,
nonstop evaluation of customers' operational results, paying special mind to ahead of schedule cautioning
indications of operational troubles.

Empirical Review
This part of the study summarizes various studies conducted in different countries which are related with factor
affecting credit risk management practice of commercial banks.

Risk Identification
Risk identification is vital for effective risk management. In order to manage risks effectively, management of bank
have to know what types of risks the bank face. The important thing during risk identification is not to miss any
risks out. There are a number of different techniques that can be used in risk identification The first step in
organizing the implementation of the risk management function is to establish the crucial observation areas inside
and outside the corporation (Edward, 2006). Then, the departments and the employees must be assigned with
responsibilities to identify specific risks.

For instance, interest rate risks or foreign exchange risks are the main domain of the financial department in relation
to commercial banks‟ practice of risk management, as study by Machiraju,(2003), found that the UAE commercial
banks were mainly facing credit risk. The study also found that inspection by branch managers and financial
statement analysis are the main methods used in risk identification. The main techniques used in risk management
are establishing standards, credit score, credit worthiness analysis, risk rating and collateral. The recent study by
Richard (2012) was conducted on banks‟ risk management of Kenya‟s national and foreign banks. Their findings
reveal that the three most important types of risks encountered by Kenya‟s commercial banks are foreign exchange
risk, followed by credit risk, then operating risk.

Impact of Bank Size on Credit Risk Management

The empirical evidence relating to the impact of bank size on credit risk appears to be mixed. For instance, some
studies report a negative association between credit risk and bank size, Koehn and Santomero (2006) according to
these studies, the inverse relationship means that large banks have better risk management strategies that usually
translate into more superior loan portfolios vis-a-vis their smaller counterparts. There are also studies which provide
evidence of a positive association between NPLs and bank size (Rajan and Dhal, 2003). In this study the size
variable is constructed by computing the relative market share of the asset of each commercial bank.

Theoretical arguments suggest a negative relationship between these two variables. Such a relationship is justified
by the most natural argument that is diversification by size. Indeed, larger banks are expected to have lower risks
because they have the capability of holding more diversifiable portfolios. Natural logarithm of total assets has been
used as a proxy for measuring bank size in most prior research (Basel Committee, 2003).
The empirical evidence relating to the impact of bank size on credit risk appears to be mixed. For instance, some
studies report a negative association between credit risk and bank size Cebenoyan (2004) and Edward (2006).

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According to these studies, the inverse relationship means that large banks have better risk management strategies
that usually translate into more superior loan portfolios vis-a-vis their smaller counterparts. There are also studies
which provide evidence of a positive association between NPLs and bank size (Rajan and Dhal, 2003). In this study
the size variable is constructed by computing the relative market share of the asset of each commercial bank.

Theoretical arguments suggest a negative relationship between these two variables. Such a relationship is justified
by the most natural argument that is diversification by size. Indeed, larger banks are expected to have lower risks
because they have the capability of holding more diversifiable portfolios (Girma, 2001).

The relation between Regulatory Capital and Credit Risk Management

The literature on regulatory capital and bank credit risk shows an inverse relationship. For example, Richard (2004),
in the context of 11 developing countries have shown a negative relationship between capital ratio and portfolio risk.
Davide, and Thangavel, (2008) have presented a comparative study of all factors contributing to the credit risks of
commercial banks in a multi-country setting: Australia, France, Japan and the U.S. represent developed economy
banking systems while emerging ones are represented by India, Korea, Malaysia, Mexico and Thailand. They have
found that the regulatory capital is an important factor influencing the credit risk of any banking system that offers a
range of services. This study also highlights that the credit risk in emerging economy banks is higher than that in
developed economies and that risk is formed by a larger number of bank specific factors in emerging economies
compared to their counterparts in developed economies. In the context of emerging countries, Basel committee
(2011) has found that the regulation of capital and risk are negatively related.

The Effect of Loan Growth on Credit Risk Management Practice

Credit growth sometimes called loan growth implies credit expansions by banks. Excessive rapid loan growth, as
well as sharp declines in bank capital levels are useful pointers to the deterioration in the financial health of banks
and can be employed as early warning indicators of future problem loans (Richard, 2011). A study by Tibebu (2011)
shows growth in loan is a cause for credit risk. A strong loan growth translates into significantly higher credit losses
with a lag of 2-4 years (Basel Committee, 2011).

Impact of Operating Inefficiency on Credit Risk Management

Regarding operating efficiency, Richard (2011) found a negative but insignificant relationship with credit risk of
Pakistan commercial banks. Inefficient managers will not cope successfully with the process of granting and
monitoring loans that will lower the banks‟ credit quality and bring about a growth in problem loans. Inefficient
banks hold riskier portfolio (Lis, Pages and Saurina, 2000). As studied by Berger and De Young (1997), poor
management in the banking institutions results in bad quality loans, and therefore, escalates the level of non-
performing loans. They argue that bad management of the banking firms will result in banks inefficiency and affects
the process of granting loans.

Methodology:-
Research Design:-
The study used dependent and independent variables. The Independent part is that the researcher used to assess how
they affect the dependent variable. The dependent variable is the variable that changes when the independent
variable changes. The dependent variable will depend on the outcome of the independent variable.The study
employeed descriptive as well as explanatory survey method for it is efficient to evaluate and determine the
adequacy of a program under existing condition against the established standards (Best and Kohn, 1999). The
descriptive method is of special importance for this particular study to portray how several factors affect the
activities of credit risk management practice of the selected banks. On the other hand, using explanatory research
design the study tested the causal relationship between dependent and independent variables.

Study Population:-
A population study is a study of a group of individuals taken from the general population who share a common
characteristic. Accordingly, the target population of this study grouped in to two; the first target population of the
study focus on the total number of commercial private banks in the country while the second group of target
population focuses on employee respondents of the banks. Accordingly, there are sixteen private commercial banks
in Ethiopia namely: Dashin Bank, Awash International Bank, Bank of Abyssinia, Wegagen Bank, United Bank,
Lion International Bank, Cooperative Bank of Oromia, Nib International Bank, Zemen Bank, Oromia International

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Bank, Bunna Bank, Birhan International Bank, Abay Bank, Addis International Bank, Debub Global Bank and Enat
Bank.

Sampling Technique of the Study:-

The study used non – probability sampling technique. From the given non – probability sampling frame purposive
sampling technique were applied. This is because the researcher wanted to select relatively four medium
experienced banks for the comparative purpose. Accordingly respondents were selected from the respective banks
who have been working in credit risk management process area.

Sample size of the Study:-

It would be impractical and unmanageable to include all population in the study, but it shall be advisable to come up
with representative samples and generate the findings of the study. Accordingly, the private banks were selected
based on their experience. In this regard the study prefers to select medium experienced private banks. This is
because, as they are not well equipped and relatively long stayed on the markets challenges‟ of credit risk
management may pronounced to them. In addition assessing similar areas subjects may help to indicate their
common challenges‟ in aggregate. Accordingly, the study selected the following medium experienced private banks
these are: Birhan International S.C Bank, Oromia International Bank S.C, Anbesa International S.C Bank and
Debub Global International S.C Bank.

The second level of sampling size determination focused on view of respondents. The choice of employee
respondents from the given banks only focused on employees working related to credit analysis and appraisal; credit
monitoring, risk management. The total staffs involved in credit management of the sampled banks were 224 in head
office and main branches. Therefore, the sample size that was selected out of 224 total population based up on
sampling technique of Belcourt and Saks (2000). The formula is large enough to allow for precision and confidence
in general ability of the research. Based on the method, formula for the calculation of sample size is presented as
follows:
𝑁
𝑛=
1 + 𝑁e2
Where n = sample size
N= Number of population
e = standard error used (0.1) or 90% confidence interval.
224
𝑛 = 224 (0.1)2
224
= 2.12
224
= = 105.6
2.12
Based on the above sampling technique nearly 106 sample respondents were presented in the study. Sample
proportion allocation among the four banks selected based on their staffs whose work is related to credit area. So to
have appropriate representative total sample size (106) divided to staffs employee on the credit area.

Table 3.1:-Distribution of sample size.

Types Population Sample
Of Banks Population
Birhan Bank 80 38
Oromia Bank 88 42
Anbesa Bank 24 12
Debub Global Bank 32 14
Total 224 106
Source:-Each banks human resource department (2017)

Method of Data Collection

The quantitative and qualitative data collection tools were applied to collect data from the concerned bodies.
Accordingly, questionnaire and interview used as instrument of data collection.

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To collect the primary data the study developed structured questionnaire based on the Basel‟s Credit risk
management principles/activities of 1999 and NBE‟s Credit risk management guideline of 2009. Accordingly the
study provided a five scale Likert questioner to measure respondent‟s level of agreement and disagreement.

Method of Data Analysis:-

The study employed both descriptive and inferential tools for analyzing the data. After data collected through
questionnaires they were edited and categorized according to their dimensions. Based on this the study were
analyzed using descriptive and explanatory data analysis method; in the descriptive analysis method the study
describes respondents response using table, frequency, graph, percentage, mean and standard deviation. On the other
hand, in the explanatory part the data analyzed the cause – effect relation between the dependent and independent
variables using correlation and regression analysis. Based on this analysis, the cause effect relation ship in this
study developed the following model;
Yᵢ= (b₀+b₁ACREᵢ₁+ b₂SCGPᵢ₂+ b₃CAMMPᵢ₃+ b₄ MRMi4 + b5 ORAi5 + b6 + ALRᵢ6) +ɛᵢ

Y is the outcome variable (dependent variable), b₁is the coefficient of the first predictor (ACRE₁), b₂is the
coefficient of the second predictor (SCGP₂), b₃is the coefficient of the third predictor (CAMM₃), b₄is the coefficient
of the fourth predictor (b₄ MRMi4), b5 is the coefficient of the fifth predictor (ORA i5), b6 is the coefficient of the
sixth predictor(ALRᵢ6) and εᵢ is the difference between the predicted and the observed value of Y for the i the
participant.
CR=ƒ (ACRE, SCGP, CAMMP, MRM, ORA, ALR,).
Where:
ACRE = Establishing an Appropriate Credit risk environment:
SCGP = Operating under a sound Credit granting process
CAMMP=Maintaining an Appropriate Credit Administration, Measurement and Monitoring process
MRM= Ensuring Adequate Market Risk management
ORA = Appropriate Operational Risk assessment
ALR= Assessment of Legality of Credit Risk

Ethical Consideration
During the course of administering the questionnaires, names and any identifying remarks were not used. The
confidentiality of the respondents is kept and any data received for the study kept at the hands of the researcher and
the advisor. The data's were used based on the questionnaires and interview of respondents rather than using the
researcher opinion and input. The researcher stayed truth full to responses of the respondents and was free from any
personal assessment. Results depicted were only from out puts of truth full inputs.

Data Analysis And Interpretation

Introduction
As indicated in the methodology part the study basically conducted using questionnaires filled by respondents. The
study totally distribute 106 questionnaires however, the analysis were done based on 98 (96%) the rest 8 questioners
were not returned back.

Background of Respondents
Analyzing background of respondents is very necessary to associate how employee educational level, work
experience, and demographic factors effect on credit risk management practice of the given banks. Accordingly,
below table 4.1 indicate demographic characteristics of respondents.

Table 4.1:-Characteristic of respondents.

Character Category Frequency Percentage (%)
Male 65 66.3
Gender Female 33 33.7
Total 98 100
20-25 Years 13 13.3
26-35 Years 24 24.5
Age 36 - 45 Years 44 44.9
Above 46 17 17.3

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Total 98 100
College diploma 20 20.4
First Degree (BSc, BA) 66 67.3
Education Second Degree (MSc, MA) 12 12.2
Total 98 100
Less than 3 years 16 16.3
Experience 3 - 6 years 40 40.8
6 - 10 years 36 36.7
Above 10 years 6 6.1
Total 98 100.0
Branch manager 15 15.3
Senior manager 21 21.5
Authorized body to Internal Auditor 10 10.7
assess risk External Auditor 7 7.5
Board of director 40 40.8
Risk management department 5 5.3
Total 98 100.0
Source :-Questionnaire 2017

Based on the above table from 98 total respondents whose work is related to risk management area of the banks
63.3% of them were male while the rest, 33.3% of them were female.

With regards to the age condition of the respondents, the distribution of frequency and percentage shows that, 13%
of respondents found between the age groups of 25 – 28, about 14.5% of them found between the age groups of 26 -
35 on the other hand 49.5%) of them found between the age group of 36 – 45, the rest 17.3% were above 46 years.
According to the age distribution of the respondent‟s majority of them found at the adult age group.

With regards to educational level of the respondents, majority of the respondents accounted for 67.3% hold their
first degree, while the rest 20. 4 % and 12% of them hold College Diploma and master degree respectively.
Regarding with the educational level the study implied that, as the area of risk management need well educated
person, there is still a gap covering the area through advanced education.

Regarding with, respondent‟s service years most of the employee fall in the range service years of 3 – 6 years
accounted for 40.8% and 6 – 10 years (36.7%) and the rest 16.3% and 6.1% respectively served less than 3 years
and
above 10 years.

For the Risk assessing body, the result in the above table shows highest percentage for board of director (40.8%) and
senior manager (21.5%). Similarly, the NBE‟s risk management guideline of (2009) indicates that in all banks top
management and board of directors have the authority to assess risk in their organization because the top-level
management has the authority to establish risk management and decides the objectives and strategies for
organizational risk management activities.

Risk Identification Methods

Credit Risk identification is the process of identifying an organization risks and vulnerabilities and raising awareness
of these risks in the organization. It is the starting point for understanding and managing Credit risks – activities
central to effective management of financial institutions. There are different types of techniques that can be applied
to identify a credit risks identification technique, such as, financial statement analysis, Audit and physical
inspection, inspection by the bank risk manager, and internal communication. Based on these respondents were
asked optional types of questions to indicate widely used techniques of credit risk identification in their banking
business. Table 4.2 indicates the participant‟s response on Risk identification methods.

Table 4.2:-Risk identification practice of the Banks

Basic Methods of Credit Risk identification Frequency Percent
Financial statement analysis 38 38.8
Audit and physical inspection 23 23.5

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Inspection by the bank risk managers and other staffs 27 27.6
Internal communication 10 10.2
Total 98 100.0
Sources:-Survey Data (2017)

It can be clearly seen from the table 4.2 that Financial Statement Analysis is the widely used method with total score
of 38.8% and followed by Inspection by the bank risk managers and other staffs with the score 27.6 % and then
audit and physical inspection total score of 23.5%. Overall, these results indicate that majority of the private banks
used the above major three methods of risk identification (Financial Statement Analysis, audit and physical
inspection and inspection by the risk manager as the most important and widely used method in Ethiopian private
commercial banks.

Factors Affecting Credit Risk Handling Techniques

Its known that the biggest risk faced by the banks today remains to be the credit risk. As a result, the banks are now
more equipped in handling credit risk, in the allocation of its on-going credit allocation activities. But, the analysis
of credit risk was limited to reviews of individual loans, which the banks kept in their books to maturity. Similarly,
as indicated in NBE‟s 2009 survey report, credit risk is the highest and most important risk than other type of risks
in Ethiopian banks. It is known that for most banks, loans are the largest and most obvious sources of credit risk.
Credit Risk can‟t be avoided but has to be managed by applying various risk mitigating processes. Banks can reduce
its credit risk as it can get vital information of the inherent weaknesses of the accounted by applying a regular
evaluation and rating system of all investment opportunities. Related to this idea, the researcher asked respondents,
which credit handling system of their bank mostly affected the banks effective credit handling and assessment
system such as, collateral risk, risk of payment collection or risk of credit rationing, accordingly, below in table 4.3
their respective response were presented as follows:

Table 4.3:-Credit risk more affected the bank Credit risk handling techniques
Credit Risk Handling Techniques Frequency Percent
Collateral risk 51 52.0
Credit payment risk 26 26.5
Credit rationing risk 21 21.4
Total 98 100.0
Sources, Survey Data (2017)

The above table indicates respondents view on credit handling techniques which frequently faced in their bank risk
handling practice. Accordingly respondents implied that, the main reason for which the banks are taking Collateral
is credit default reduction, especially during the time of the debt default. The above table shows that the average
collateral risks faced by banks were very high as implied by 52% of the respondents.

The other type of credit risk that challenged credit risk handling practice of the banks was payment collection risk,
as implied by 26.5 % respondents, this loss is generated from loss of principal from a borrower's failure to repay a
loan or meet a contractual obligation. Finally, the above table indicates challenges of credit rationing risks as
indicated by 21.4% respondent even though the challenging is lower than the collateral risk and credit payment risk
but still the problem is faced on the banks credit risk handling process. To reduce one of the risk area the study
asked respondents what methods where applied to reduce one of the challenges. Accordingly, respondents implied
their respective answer below in fig 4.1

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70
60
50
40
30
20
10
0
Collateral Risk Payment CollectionCredit Rationing Risk
risk

Figure 1:-Credit risk handling techniques frequency and percentages Source: Questionnaire survey, 2017

To handle specifically each type of credit risk, different techniques have been used by the banks. For collateral risks,
reduction is the most suggestible technique as 56% respondents suggested and followed by transfer 39 % of
respondents retention indicated by 5% respondent. Similarly, for payment collection risk, risk reduction and
retention is suggestible by respondents to handle it. 60% of the respondents respond that risk reduction is the
suitable risk controlling tool for payment collection. While 29% of them said transfer payment collection risk is
suitable and a small percentage suggests accounted for 10% refers retention. Respondent also indicate their view
regarding to rationing credit risk minimization techniques, accordingly, 40% and 34% of them respectively
indicated using reduction and transfer is available technique while the rest, 25% implied retention. The result of
open ended question stated that there are a number of techniques banks used in the mitigation of credit risk. Among
them the most commonly used are Collateral and guarantees. In credit risk, all collateral risks, payment collection
risks and limiting borrower‟s risks are handled through risk reduction, since it is not possible for the banks to avoid
businesses in this area and unprofitable to transfer all risks to another parties which takes premium. Next to
reduction, accepting and financing credit risk is advisable depends on finding of this study. Generally, in order to
reduce credit risk, Banks should assess the credit worthiness of the borrower before sanctioning loan and fix
prudential limits on various aspects of credit. There should be maximum limit exposure for single/ group borrower.

As stated in NBE 2011 Annual report, in monitoring credit risk exposure, consideration is given to trading
instruments with a positive fair value and to the volatility of the fair value of trading instruments. To manage the
level of credit risk, the Group deals with counter-parties of good credit standing, enters into master agreements
whenever possible, and when appropriate, obtains collateral. The Group also monitors concentrations of credit risk
by industry and type of customer in relation to the Group loans and advances to customers by carrying a balanced
portfolio. The Group has a significant exposure to individual customers or counter parties.

Descriptive Result using Mean and Standard Deviation

The descriptive part of this study was analyzed based on using a descriptive statistics of mean and standard
deviation. Accordingly, the composite mean value shows the average of all respondents‟ perceptions on a certain
related questions of credit risk determinate factors. While, standard deviation shows how diverse are the perceptions
of respondents for a given questions.

For instance, high standard deviation means that the data are wide spread, which implies respondents give variety of
opinion while, low standard deviation implies respondents closeness of opinions whether positively or negatively.
Based on these, the result mean score value and standard deviation of the study represented referring rule of thumb
that pertaining to the intervals for breaking the range in measuring variables that are captured with five point scale
(that ranges from strongly disagree to strongly agree) is 0.8, which is actually found by dividing the difference
between the maximum and minimum scores to the maximum score (Thumb, 2012). Hence, a calculated composite
mean value that ranges from 1 to 1.80 implies strong disagreement, whereas the remaining ranges of 1.81 to 2.6,
2.61 to 3.4, 3.41 to 4.2 and 4.21 to 5.00 representing respondents‟ perceptions of disagreement, neutrality,
agreement and strong agreement respectively. Therefore, composite scores of mean and standard deviation were
calculated for each of the variables as follow:

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Factor Affecting Establishment of Appropriate Credit Risk Environment
Establishing Appropriate Credit risk environment is preliminary activities of Credit risk management process. To
assess the banks whether they established appropriate credit risk environment or not the study had developed a five
scale Likert types of questions and respondents were invited to indicate their views for each of the questions. The
results mean score value and standard deviation implied below in the table.

Table 4.4:-Respondents View on establishing credit risk environment

Facilities to establish better credit risk environment N Mean Std. Deviation
The existing organizational culture helps to know how to 98 3.4286 1.20137
assess and handle risks
Risks are assessed regularly and its changes handled properly 98 2.9592 1.27561
The reported hazards been effectively controlled 98 3.0306 1.17932
There is an effective strategy established according to size of 98 2.5551 1.30866
the bank
Adequate resources are allocated for assessing risk 98 2.1020 0.24759
Banks have strong group risk and internal audit functions 98 2.9388 1.22530
which report directly to the Center
There is experienced staff, which recognizes potential 98 2.1796 0.13046
problems, and brings them to the attention of their supervisors
Banks should assess the credit worthiness of the borrower 98 4.1327 0.18093
before sanctioning loan
The bank offer training for employees on credit risk 98 2.1469 1.25470
management

Sources, Survey Data (2017)

As indicated from the above table the study asked whether the studied banks credit risk management practice
affected by the existing organizational culture or not, hence, the majority of the respondents implied at a mean score
value of 3.4286 with a standard deviation of 1.20137 there is a good organizational culture which helps to
understand credit risks of the studied banks. In Ethiopian banking environment there is similar rules and guidelines
developed at the Head Office for each bank, which helps to understand the risks that affect the bank. In addition, the
interview held with branch managers state that the banks followed policies and guidelines of National Bank of
Ethiopia (NBE), which may help to control risks, especially external risks like interest rate risk, foreign exchange
risk, and risks that came from countries economic and monetary policy.

With related to the question assessed whether credit risks assessed regularly and its changes handled properly or not,
respondents implied, at a mean score 2.9592 and Std. Deviation 1.27561 frequent assessment of risks were not done
regularly and the risks handled properly.

Similarly, the study were assessed whether the observed hazards of risk controlled effectively or not, respondents
implied at a mean score value of 3.0306 indicates the banks tried to tackle the observed hazards of risks, however,
the result implied by a respondents at a standard deviation at 1.17932 implied still there is some challenges in
effectively tackling the reported hazards. The interview result also indicates that the risks found and reported to the
center have been controlled by head office Board of Directors (BoD) and senior management by informing branches
through reports, meeting and direct contacts.

Regarding with the bank size the study assessed the size of the Bank in terms of its asset position. Large Banks are
expected to have low credit risk that emanate from their capacity to establish sound credit risk management
framework. In this regard the result mean value and Std. Deviation at 2.2245 and 1.30866 respectively implied
respondent‟s negative response on the challenge of the bank size in managing or controlling the credit risk easily.

With regard to allocation of resources for assessing credit risk, the mean score is lowest indicated at 2.1020 with a
Standard deviation 0.24759 this show respondents disagreement or the studied banks have a problem with allocating

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adequate resources to handle risks effectively. Therefore, from the result the study deduced that, lack of budget to
asses credit risk of the banks are one of the major cause that affect credit risk management practice of private banks.

With related to whether banks have strong group risk and internal audit functions which report directly to the Center
or not, the study implied at average mean score value of 2.9388 indicated that there were moderate group risk and
internal audit functions which directly report to the Head Office because internal auditors of banks do not
independently review effectiveness of banks‟ risk management functions and also the authority to deal with risk
management is given to risk management department at the Head Office.

The result presented regarding employee potentials and experience in identifying potential credit risks of their
respective banks respondents at lowest means core value of 2.1796 shows that for the variable of there is no that
much experienced staff, which recognizes potential problems and brings them to the attention of their supervisors in
the studied banks. In Ethiopia the banking sector is one of the institutions with experienced and educated staff,
however, most of the competent employee, after they serve some years, leave to other organizations such as local
and international NGOs and other well paid organization.
Finally, the study assessed whether the banks provide their employee credit risk training or not, however the mean
score value of the respondent at 2.1469 implied there was no adequate training program for employee.

Generally, the study analyzed that, understanding credit risk strategy, policy and procedures as well as identifying
risks are the cornerstone for Credit risk management process. Lack of Common understanding on Credit risk
strategy, policies and procedures across the banks may cause inconsistent interpretation and application of Credit
policy and procedures across the banks and finally lead to lack of common code of conducting Credit risk
management activities. In this regard some of the challenges observed in providing and implementing the
appropriate policy, procedures, and other necessary facilities that can reduce the problems were affected by some of
the problems such as, inadequate allocation of budget, lack of employee training on the areas and lack of well
experienced employees.

Credit Granting Process of the Study Area

Operating under a Sound Credit granting process is the Basis for an effective Credit risk management process under
which feasible and creditworthy client is identified. In this regard the study provided related questions to assess
credit granting processes of the study area. The table indicates credit granting process of the study banks.

Table 4.5:-Respondents View on Credit granting Process

Credit Granting and Management related questions N Mean Std.
Deviation
The Bank uses well defined Credit-granting Criteria for assessing 98 3.3163 1.18057
credibility of each loan applicants.
Banks should assess the credit worthiness of the borrower before 98 3.5007 0.26817
sanctioning loan
Adequacy, marketability and enforceability of collateral requirement is 98 2.2796 0.25163
properly evaluated and measured by professional personnel or
expertise
The bank critically follows Sound Credit granting process for 98 2.9592 1.21772
approving new credits as well as amending, renewing and re-financing
existing credits
The bank has established comprehensive Credit limit for the main 98 2.3163 1.17181
categories of risk factors in all types of credit facilities
Sources, Survey Data (2017)

As indicated on the above table the study respondents forward their view for each of the questions asked,
accordingly, the mean score value 3.3163 implied respondents response was neutral whether their bank uses well
defined Credit-granting Criteria for assessing credibility of each loan applicants or not, this implied that, still
respondents are not confident on their banks criteria credibility in providing loan for each applicant. Based on the
banks credit criteria the study forwarded a question whether the bank assess credit worthiness of borrower or not

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before sanctioning loan; in this regard respondents implied their agreement at a mean score value of 3.5007 with
smaller variation of std. deviation at 0.26817 which implies commercial banks assess credit worthiness of borrower
before sanctioning of a loan.

Regarding with adequacy, marketability and enforceability of collateral requirement, evaluation practice the study
forwarded a questions for the selected respondents of each banks accordingly, respondents implied their
disagreement at a mean value of 2.2796 with smaller indicated std. deviation 0.25163. in this regard some of the
employee implied that, the banks asked borrowers equivalent collateral for the money they lend, however,
collaterals marketability were not studied in detail.

Regarding the questions asked whether the bank critically follows Sound Credit granting process for approving new
credits as well as amending, renewing and re-financing, respondents implied at a mean score vale of 2.9592 and Std.
1.21772 there is some challenges specially, new borrowers are not treated based on several encouraging criteria.
Finally the study assessed whether the bank has established comprehensive credit limit for the main categories of
risk factors in all types of credit facilities or not in this regarding the mean value of 2.3161 with a std. deviation
value of 1.17181 implied their disagreement which means the banks didn‟t established well organized and
comprehensive credit limit for main categories of risk factors.

Maintaining an Appropriate Credit Administration, Measurement and Monitoring Process

Proper administration of Credit documentation as well as monitoring the status of borrowers, loan term and
conditions and collateral coverage periodically as well as keeping Credit file up to date and repayments continuously
are the basic post Credit approval activities of Credit risk management process that help to discover mistake at early
stage while management information system and internal risk rating are the main ingredient for monitoring,
reporting and controlling risks. With related to this questions the study were forwarded related questions for
respondents to assess the study banks appropriateness in measuring, monitoring as well as documenting the credit
file. The response indicated below in the table:

Table 4.6:-Respondents View on credit measurement and monitoring practice of the banks
Practice of credit measurement, monitoring related N Mean Std.
questions Deviation
The bank strictly monitors loan terms and conditions that have 98 3.1531 1.25470
been stipulated at the time of loan approval
The bank regularly reviews and monitors the performance of 98 3.1327 1.24053
Credit quality at individual and portfolio level
There is a complete, neatly organized and regularly updated 98 2.6143 1.24354
credit file in our bank
The bank has developed its own internal risk rating system and 98 3.4673 1.12505
applying in credit risk management process effectively
Sources, Survey Data (2017)

As indicated by respondents the bank strictness in monitoring loan terms that have conditions stipulated at the time
of loan approval the average mean score value at 3.1531 implied respondents neutrality, which implies there is
moderate strict monitoring of loan terms. Similarly the average mean score value 3.1327 with a std. 1.24053 implied
that, even though the bank follow up and monitor the performance of credit quality at individual level, however,
respondents response implied still the banks are not effectively assessing individuals portfolio after granting credits.

The study also asked respondents whether there is a complete, organized and regularly updated credit file in the
studied banks or not, in this regard respondents at a lowest mean value of 2.6143 implied their negative response or
disagreement which implies, still the banks are weak in providing updated credit file.

With regards to the banks internal risk rating system and applying in credit risk management process the highest
mean value of 3.4673 implied positive response of employee which means the banks use their own internal credit
risk rating system.

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Generally, In the the studied banks, establishing effective management information system, Communication and
reporting risk related data and quantifying credit risk both at individual and portfolio level are some issues that
require great attention of top management and regulatory bodies respectively. It indicates that appropriate Credit
administration, Measurement and Monitoring process are maintained somewhat in line with the guideline of NBE
and Basel (1999). However, there are challenges in continuously monitoring, measuring, filing and reporting credit
risk on time.

The Effect of market Risk on Credit Risk Management

The study assessed how the banks manage the marketing strategy and what is it‟s effect on credit risk management
practice. This is because, Poor reaction in the market leads to negative reactions from investors to the banks poor
earnings declarations which rocked the Credit risk management practice. In this regard, the study provided a related
questions and respondents were forwarded their respective view on the provided questions below in the table.

Table 4.7:-Respondent view on the effect of market risk of the bank on credit risk management
Questions related to market strategy on credit risk N Mean Std. Deviation
The bank applied an effective marketing reaction 98 2.4571 1.49914
There is lack of benchmarking against competitors 98 3.1837 1.47381
The bank critically assess commercial locations 98 3.5000 1.05762
The bank effectively work to fulfill customer demand and 98 2.8469 1.25470
expectation
The bank manage interest rate instability 98 4.9694 1.27185
Sources, Survey Data (2017)

As the above table indicates, the studied banks didn‟t applied an effective marketing reaction this was implied by
the lowest mean value at 2.4571 which indicates high risk of poor market reaction and high variation between
respondents which implied at std. deviation 1.49914. The result of this study also showed, there is moderate
exposure related to lack of benchmarking against competitors as indicated at a mean score value of 3.1837. The
other credit risk which affects Ethiopian banks is declining of commercial location. As the above table shows,
declining commercial location affects more private banks as its mean shows high risk of 3.5000.

The study also asked whether the banks effectively work to fulfill customer demand expectation or not; however the
result mean value at 2.8469 implied the banks moderately fulfill customer expectation on the demand of loan.

Finally, in Ethiopia the interest rate risk did not bring high loss, since the interest rate is constant for a long period of
time and no competition between Ethiopian banks on interest rate. In Ethiopia, bank deposits and lending held for a
fixed interest rate, which is determined by national bank of Ethiopia. The benchmark interest rate in Ethiopia was
last recorded at 7% percent. Similarly, regarding the result from the above table the risks of interest rate fluctuation
shows less than the average amount of risks at a mean score value of 4.9694.

Operational Risk Analysis’s

In modern flexible world there is no single working process continued ever. When banks change the existing process
and implement the new one, they may face different risks. Currently Operational risk becomes another source of
danger in managing and controlling credit risk, with related to these activities the study provided related assessment
questions to assess the problems on the area. In this regard, below in the table respondents implied their view as
follows:

Table 4.8:-Respondents view on the effect of operational risk on the effectiveness of credit risk management
Questions related to operational risk N Mean Std. Deviation

There is a problems when Risk of transition from the existing 98 3.1531 1.15189
process to the new one
worker‟s skill, experience and training risk challenges 98 3.9041 1.26784
frequently affect
There is frequent Systems failure 98 3.5918 1.04375

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There is failure of transaction risk 98 3.2245 1.16239
Failure to communicate with each other 98 3.1939 1.19844
There is failure whether Internal or external risk reporting 98 3.0204 1.25984
There is failure in an electronic transfer of payments 98 3.0510 1.26306
Sources, Survey Data (2017)
Related to the problem of financial transaction, respondents implied at a mean value score of 3.1531 even though
the banks are well done and reduced credit risk of in the process of financial transaction, however, some of the
respondents at a std. deviation of 1.15189 implied there are still problems, some of the interview related to this idea
implied that, even if one side of transaction is settled however, the other may fail.

Lack of workers skill, experience and training are another exposure that leads banks to a loss. The banks should
improve the worker‟s skill by providing appropriate training through establishing best practices for professional
development. In relation to this the above result indicated at highest mean value score of 3.9041 is with std.
deviation of 1.26784 implied that, lack of skilled and experienced professionals on the operation of credit risk affect
the bank effectiveness in reducing credit risk.

The risk of system failure which includes, network failure, hardware failure, software failure, interdependency risk,
and so on leads the banks to loss. The above table shows a mean and standard deviation of 3.5918 and 1.043753
respectively, implied that, the studied banks have faced frequent system failure, as some of the respondents implied
as the problem of system failing is countrywide. It is difficult to solve the challenges only in an effort of private
commercial banks.

Transaction risks such as execution error, booking error, settlement error, commodity delivery risk and etc. Have
another exposure which leads banks to loss. Most of the banks do not rely entirely on external sources of
information for transactional risks, but the smaller banks are more inclined to rely more heavily on such sources due
to lack of resources. The result of this study on transactional risk shows a mean of 3.2245 and std. deviation of
1.16239 implied the problem is still affects the bank credit risk management practice.

Failure to communicate with each other brings risks related to misunderstanding of information. Accordingly the
mean value at 3.1939 and std. deviation 1.19844the of the study banks implied even though the problem is not
widely exposed the banks to loss, however, some of the problem related to the area is still affects the banks
performance.

Banks have internal and external reporting requirements regarding the different kinds of risks and impacts associated
with its portfolio. There are some risks related to this Internal/external reporting which includes not reporting
Overall exposure to banks and performance at the branch level. The values from the table indicates a mean and
standard deviation of 3.0204 and 1.25984 respectively shows moderate risk are observed in the studied banks.

Legal Risk Analysis and Handling Techniques

The legal exposures of any particular bank which includes the risk of collateral damage, misinterpretation of law and
whether the documentation is relatively easy to understand or difficult to understand were depends on the
independence of judge and the sophistication of contract associated with risks. In this regard the study provided a
related question to assess the challenges of legality risk on credit risk management practice of the banks. Based on
these the study assessed the area, if misinterpretation of law and legislation problem faced in the banks, criminal
activities as well as documentation process of the contracts. In this regard respondents forwarded their respected
view below in the table.

Table 4.9:-Respondents view on the effect of legality risk on the effectiveness of credit risk management
Questions related to legality risk N Mean Std. Deviation
There is Misinterpretation of law and legislation problem faced in the 98 3.0000 1.18409
bank
Criminal activities (fraud, theft, and property damage) affected the 98 2.3878 1.17212
bank risk management practice
Documentation/contract risk affected the bank risk management 98 3.2653 1.23147
practice

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Sources, Survey Data (2017)

To analyze the result from the table above, the risks related to misinterpretation of law is moderate which was
implied by 3.0000 and 1.18409 mean value and std. deviation respectively.This is because the laws and the
legislation of the credit risk management program as a whole governed by NBE, policies and legislations; however,
some specific rules mandate are given for individual‟s banks to develop internal rules and regulation to control their
bank credit risk management.

As indicated by lowest mean value of 2.3878 criminal activist are rare case in commercial private banks of Ethiopia,
so that the effect of Criminal activities (fraud, theft, and property damage) didn‟t that much affect the bank risk
management practice.
Finally the study assessed the studied banks contract documentation practices, accordingly, resulted at a mean value
of 3.2653 implied still there is a moderate problem observed on the area, in this regards the NBE‟s survey report
(2009), implied that majority of banks having strategies, policies, programs and procedures related to credit risk
management, have also secured approvals on the documents from relevant authorities so that the problem on the
area is less.

Correlation Analysis on the Determinants of Credit Risk

To find out the relationship the dependent and independent variables Pearson‟s correlation coefficient (r) which
measures the strength and direction of a linear relationship between two variables were used. Values of Pearson‟s
correlation coefficient are always between -1 and +1. A correlation coefficient of +1 indicates that two variables are
perfectly related in a positive sense; a correlation coefficient of -1 indicates that two variables are perfectly related in
a negative sense, and a correlation coefficient of 0 indicates that there is no linear relationship between the two
variables. A low correlation coefficient; 0.1 - 0.29 suggests that the relationship between two items is weak or non-
existent. If r is between 0.3 and 0.49 the relationship is moderate. A high correlation coefficient i.e. >0.5 indicates a
strong relationship between variables. The direction of the dependent variable's change depends on the sign of the
coefficient. If the coefficient is a positive number, then the dependent variable will move in the same direction as the
independent variable; if the coefficient is negative, then the dependent variable will move in the opposite direction
of the independent variable. The table below presents the result of the correlation analysis.

Table 4.10:-Correlation coefficient analysis of the respondents

Correlations
Variables ACRE SCGP CAMMP MRA ORA ALR CR
N 98 98 98 98 98 98 98
ACRE 1 .303** .900** .904** .876** .797** .922**
SCGP 1 .454** .358** .525** .597** .726**
CAMMP 1 .894** .975** .909** .820**
Pearson MRA 1 .902** .778** .799**
Correlation ORA 1 .922** .790**
Sig. (2-tailed) N ALR 1 -.721

CR 1
**Correlation is significant at the 0.01 level (2-tailed).
*Correlation is significant at the 0.05 level (2-tailed).

The result of correlation coefficient shows that all variables are statistically significant and positively correlated with
the credit risk. Accordingly, the bank‟s credit risk management is more affected by lack of establishing appropriate
credit environment which represented by a sign (ACRE) at ( r = 0.922), followed by challenges of credit
administration, measurement and monitoring (CAMMP) at (r = .820**) , Lack of Market risk analyses (MRA), at (r
= 799**), Operational risk (ORA) at (r= .790**) and challenges sound Credit granting process (SCGP) at (r = 726),
however, Legality risk assessment has a negative relation with credit risk management at (r = - 721). The
correlation between the dependent and independent variables implies that, change made in one of the independent
variables can change organization performance and efficiency. Thus from this result the study confirmed that, all of

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the independent factors that are provided in the questioner affect credit risk management practice of the studied
private banks except little impact on the challenges of legality risk.

Regression Analysis
Regression analysis was employed to examine the effect independent variable over the dependent one; the result
also helps us to understand which variables affect more credit risk management practice of private commercial
banks in Ethiopia. Based on these below the regression analysis of the study summarized as follow:

Table 4.11:-Model Summary of the study

Model R R Square Adjusted R Square Std. Error of the Estimate
1 .936a .876 .868 .37891
a. Predictors: (Constant), ALR, SCGP, MRA, ACRE, CAMMP, ORA
As it can be depicted from the table there is a positive and statistically significant Relationship between the
independent variables and the dependent variable. In overall, the results revealed that all independent variables
accounted for 87.6% of the variance (R2 = 0.876). Thus, 87.6 % of the study assessed the studied banks factors
affecting credit risk management practice on the provided questionnaires, however, 12.4% unexplored or not
addressed in this study.

Table 4.12:-ANOVA Result of the study

Model Sum of Squares Df Mean Square F Sig.
1 Regression 92.608 6 15.435 107.503 .000b
Residual 13.065 91 .144
Total 105.673 97
a. Dependent Variable: CR
b. Predictors: (Constant), ALR, SCGP, MRA, ACRE, CAMMP, ORA

The result in the ANOVA table confirmed the significance of the overall model by p- value of 0.000 which is below
the alpha level, i.e. 0.05, which means, the independent variables taken together have statistically significant
relationship with the dependent variable under study. Accordingly, among the major factors which affect credit risk
management practice of private commercial banks were, establishment of credit environment, appropriate
measurement and monitoring of credit, operational challenges, challenges of credit granting, market challenges as
well as legality challenges are the most important factors that affect effective credit risk management of private
banks.

Table 4.13:-Coefficients Analysis of the study

Model Unstandardized Coefficients Standardized t Sig.
Coefficients
B Std. Error Beta
1 (Constant) 1.146 .149 7.666 .000
ACRE .863 .090 .993 9.612 .000
SCGP .172 .046 .195 -3.776 .000
CAMMP .591 .160 .610 -.571 .569
MRA .154 .076 .222 -2.025 .046
ORA .693 .192 .713 1.003 .318
ALR .11 .097 .-.43 1.150 .253
Dependent Variable: CR

In the table- above, coefficients indicated how much the dependent variable varies with an independent variable,
when all other independent variables are held constant. The beta coefficients indicated that how and to what extent
the independent variables influence the dependent variable. Accordingly the result coefficient value of regression
analysis indicated that, ACRE, (beta = .993, t = 9.612, p = < .000), ORA (beta = .713, t =1.003, p = .318) and
CAMMP (beta =.610, t= -571, p < .569) has the highest influence or significant impact on credit management
practice of the studied private banks.

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Discussion of the Results:-
According to Sullivan, & Drecnik (2002) commercial banks used several types of method to control credit risk such
as, credit rationing, loan syndication, loan securitization, and collateral. However, the finding of this study indicated
most of the studied private banks in Ethiopia used a tools to control credit risks that are collateral and credit
rationing. Tools like covenants, collateral, credit rationing, loan securitization and loan syndication have been used
by banks in developing world in controlling credit losses (Benveniste and Berger, 2001; Greenbaum and Thakor,
2000).

Yuqi Li,(2006) the findings also show that the respondent commercial banks undertook various activities with
respect to monitoring borrowers. These included the following: Frequent contact with borrowers, creating an
environment that the bank can be seen as a solver of problems and trusted advisor, development good organizational
culture of the banks, Similarly this study also indicated that, management practice of the private banks in Ethiopia
affected by the existing organizational culture this were indicated by the majority of respondents at a mean score
value of 3.4286 with a standard deviation of 1.20137 implied there is a good organizational culture which helps to
understand credit risks of the studied banks. This is because in Ethiopia‟s banking environment there is similar rules
and guidelines developed at the Head Office for each bank, which helps to understand the risks that affect the banks
credit risk.

The study‟s finding also indicated that credit growth of the banks negatively affected credit risk management
practices of the banks, however most of a similar studies implied a result in reverse to this study, such as a study
results of Das & Ghosh, (2007), Jimenez & Saurina (2006), Thiagarajan, S., et al (2011), Ahmad & Bashir (2013)
who found a positive influence of Credit growth on credit risk. This is due to the reason that the banks may develop
the best experience of dealing with borrowers (build the capacity of solving the borrower‟s problem by giving
consultant and other service to improve their loan repayment), developing strong credit risk culture as well as
develop sound Credit risk management system whenever a problem arise due to credit growth .

Regarding with the banks size and credit risk management most of the similar studies such as Yong (2003) implied
that, large banks are expected to develop better credit risk management practice than small size banks. It is due to
the fact that large banks have ability to deal with credit risk by formulating sound and effective Credit risk
management system, introducing modern risk management instruments and adopt new technology as well as a better
portfolio diversification opportunity and gaining competitive advantage on economies of scale so that it contributes
to the minimization of problems related to loan.

The result of correlation coefficient shows that all variables are statistically significant and positively correlated with
the credit risk management practice of the studied banks. Accordingly, the bank‟s credit risk management is more
affected by lack of establishing appropriate credit environment which represented, followed by challenges of credit
appraisal measurement and monitoring, Lack of Market risk analyses, Operational risk and challenges sound Credit
granting process, however, Legality risk assessment has a negative relation with credit risk management.

Summary, Conclusion and Recommendation:-

Summary of Findings
The study‟s analysis was dissected into two parts; in the first part the study analyzed variables using descriptive
approach and in the second part the study tried to analyze using inferential statistics such as, testing correlation
between dependent and independent variables as well as regression analysis. Based on these, major findings are
discussed as follows:

With regards to the study area risk assessing body, the result, the finding implied that, in the highest percentage of
risk assessing body were board of director (40.8%), followed by, senior manager (21.5%).

In relation to the banks credit risk identification processes the finding showed that, most of the studied banks used
Financial Statement Analysis method with total score of 38.8% and followed by Inspection by the bank risk
managers and other staffs with the score 27.6 % and then audit and physical inspection total score of 23.5%.
With related to challenges of credit risk handling, collateral risks faced by banks were very high as implied by 52%
of the respondents, followed by payment collection risk, this loss is generated from loss of principal from a
borrower's failure to repay a loan or meet a contractual obligation.

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In relation to the study‟s assessment of whether there is regular assessment of the bank credit management system
or not the study implied at average mean score of 2.9592 and Std. Deviation of 1.27561, even though some of the
branch banks are weak in proper assessment of practice of credit risk and handled the assessed report properly,
however, most of the studied banks were efficient in their practice. Similarly, the average score of the respondents
with regard to controlling the reported hazards at a mean score 3.0306 indicates their agreement with little difference
among some respondents of banks represented by 1.17932 St. Deviation is good.

Regarding the relation between the bank size and credit risk management practice, the study implied that, the banks
size affect credit risk management, this is because large size banks need huge resources to control the banks credit
effectively
Related to credit granting process of the study, the mean score value 3.3163 implied respondents response was
neutral whether their bank uses well defined Credit-granting Criteria for assessing credibility of each loan applicants
or not, the study‟s assessment on credit worthiness of borrower before sanctioning loan respondents implied their
agreement at a mean score value of 3.5007 with smaller variation of std. deviation at 0.26817 which means the
banks assess credit or worthiness before credit. Similarly the studied banks also assess the collateral of the borrower
marketability before granting the loan.

Regarding the banks Maintaining an appropriate Credit administration, Measurement and Monitoring process, the
banks perform very well in some area, however there were also a challenges in some areas such as, bank strictness
in monitoring loan terms that have been conditions stipulated at the time of loan approval the average mean score
value at 3.1531 implied respondents good. The average means score value 3.1327 with a std. 1.24053 implied the
banks are not effectively assessing individual‟s portfolio after granting credits.

With Related to Market Risk and credit risk of the studied banks the result implied that, there is high exposure
related to lack of benchmarking against competitors. The other credit risk which affects the studied banks was
declining of commercial location. The average score mean value at 2.4571 implied that, the studied banks were not
used an effective marketing reaction to minimize credit risk.

The banks credit risk management practice were also affected by operational challenges such as, risk transaction,
frequent Systems failure, failure to communicate with each other, failure whether Internal or external risk reporting
and failure of electronic transfer.

The assessment of the study with the relation between legality risk and credit risk, the studied banks were not that
much affected by a legality risk. This is because majority of banks having strategies, policies, programs and
procedures related to credit risk management, have also secured approvals on the documents from relevant
authorities so that the problem of legality was not significant.

In overall, the results of the correlation and regression revealed that, except tangibility all independent variables
(service quality dimension) are significant with customer satisfaction at the level p < .05. Furthermore, multiple
regressions identify the relative contribution of each variable and determine the best predictor variables among a set
of variables. The results demonstrate that all variables contributed significantly to credit risk.

The result of correlation coefficient shows that all variables are statistically significant and positively correlated with
the credit risk management practice of the studied banks. Accordingly, the bank‟s credit risk management is more
affected by lack of establishing appropriate credit environment which represented, followed by challenges of credit
appraisal measurement and monitoring, Lack of Market risk analyses, Operational risk and challenges sound Credit
granting process, however, Legality risk assessment has a negative relation and insignificant impact on credit risk
management practices of the study banks.

The Result regression coefficients also implied that, to what extent the independent variables influence the
dependent variables. Accordingly the result coefficient value of regression analysis indicated that, ACRE, (beta =
.993, t = 9.612, p = < .000), ORA (beta = .713, t =1.003, p = .318) and CAMMP (beta =.610, t= -571, p < .569)
respectively and significantly affect credit risk management practice of the studied private banks.

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Conclusion of the Study
The study investigated factors affecting credit risk management practice of selected private banks in Ethiopia, to
assess the credit risk area of each banks the study identified some of related areas that can affect the activities of the
banks such as, banks establishment of credit risk environment, credit granting process, credit monitoring process,
market assessment, operational risk analysis, legal risk analysis. To test the effect of such variables on banks
profitability, the study used both descriptive and inferential statistics. Accordingly the major fining‟s of the study
includes the following:
1. Regarding Credit Risk Environment management of the studied banks the result implied that, even though, the
boards and higher officials of the banks tried to establish an appropriate credit risk management producers
based on NBE guidelines and others well developed principles, the criteria‟s and polices affected in each
branches of the banks during their implementations. Related to this, the finding implied that, the existing
organizational culture helps to know how to assess and handle risks, however, when it is implemented at several
level of the banks management there were a problems such as, lack of assessing risks regularly, lack of adequate
resources allocation assessing credit risks, lack of experienced staff on the areas of credit risk, and lack of
training and development program on credit risk handling and management program. Therefore, In relation to
effect of the establishment of credit risk environment on credit risk management practices, the study implied
that, credit risk management practice of the studied banks were not affected by the establishment on the
policies, procedures and criteria‟s, however, risk management of the banks were affected when the established
rules implemented at different levels of the bank management.
2. Related to the banks credit granting process and the bank risk management practices the study found that, in
some of the credit granting processes the banks perform well such as, the Banks use well defined Credit-
granting Criteria for assessing credibility of each loan applicants, and banks assess the credit worthiness of the
borrower before sanctioning loan, however, there were also a challenges in some of the areas that the banks
were not performed well such as, lack of professionals evaluation and measurements of marketability
collaterals, lack of renewing and re-financing existing credits, lack of establishing comprehensive Credit limit
for the main categories of risk factors in all types of credit facilities.
3. Regarding with credit administration, Measurement and Monitoring process, the study implied that, appropriate
Credit administration, Measurement and Monitoring process are maintained somewhat in line with guideline of
NBE and Basel (1999). However, there are challenges in continuously monitoring, measuring, filing and
reporting credit risk on time.
4. The result of the finding also implied that, credit risk management practice of each banks were affected by
operational challenges such as, risk transaction, frequent Systems failure, Failure to communicate with each
other, failure whether Internal or external risk reporting and failure of electronic transfer.
5. Finally the study implied that, effect of legality risk on credit risk of the studied banks were not as such
significant compared to the others variables. This is because majority of banks having strategies, policies,
programs and procedures related to credit risk management, have also secured approvals on the documents from
relevant authorities so that the problem of legality was not significant.

Recommendation
1. As indicated on the findings one of the major challenges faced by the studied banks were, implementing the
established credit risk strategy provided by the higher officials of the banks, to solve and minimize these
problem the study advises that, the board of directors may need to have responsibility for approving and
periodically (at least annually) reviewing the credit risk strategy and significant credit risk policies of the bank.
The strategy may need to reflect the bank‟s tolerance for risk and the level of profitability the bank expects to
achieve for incurring various credit risks. In addition, senior management should have responsibility for
implementing the credit risk strategy approved by the board of directors and for developing policies and
procedures for identifying, measuring, monitoring and controlling credit risk. Such policies and procedures
should address credit risk in all of the bank‟s activities and at both the individual credit and portfolio levels.
2. With related to credit granting criteria and process the banks were also affected in some areas, to minimize the
challenges‟ the study suggests that, Banks must operate within sound, well-defined credit-granting criteria.
These criteria should include a clear indication of the bank‟s target market and a thorough understanding of the
borrower or counterparty, as well as the purpose and structure of the credit, and its source of repayment. There
also need that, banks should have a clearly-established process in place for approving new credits as well as the
amendment, renewal and re-financing of existing credits.
3. There are risks which specifically faced by branch level, therefore the bank management should establish risk
management department at branch level or regional level.

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4. Hence, improving performance requires to institute a strong credit risk management system that can efficiently
identify bankable borrowers and a system that can monitor their performance after the loan is granted.
5. A well-structured internal risk rating system is a good means of differentiating the degree of credit risk in the
different credit exposures of a bank. This will allow more accurate determination of the overall characteristics
of the credit portfolio, concentrations, problem credits, and the adequacy of loan loss reserves. Thus, all banks
are encouraged to develop and utilize an internal risk rating system to manage credit risk.
6. The Bank‟s operational risk management includes defining, assessing, monitoring, mitigating and controlling
risk. Every unit in the Bank is directly responsible for managing its operational risk and for establishing
measures to mitigate and control risk to the designated level by allocating appropriate resources and
establishing an organizational culture for managing operational risk.

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Appendix
Questionnaire
Dear respondents,
I‟m a lecturer at Wolaita Sodo University in the Department of Accounting and finance. Currently, I‟m conducting
a research entitled ‘ Factors affecting Credit risk Management Practices, The case of selected Private

Commercial banks in Ethiopia’.

The purpose of this questionnaire is to gather data for the proposed study, and hence you are kindly requested to
assist the successful completion of the study by providing the necessary information. Your participation is entirely
voluntary and the questionnaire is completely anonymous. I confirm you that the information you share will stay
confidential and only used for the aforementioned academic purpose. So, your genuine, frank and timely response is
vital for the success of the study. I want to thank you in advance for your kind cooperation and dedication of your
precious time to fill this questionnaire.
Sincerely,

Please Note:
1. No need of writing your name.
2. Indicate your answer with a check mark (√) on the appropriate block/cell for all questions.

Part One: Biographical Information (please use the right (√) mark to show your choice)
1. Indicate a bank name you belong
2.
3. – – > 46 years
4.
If other Specify
5. Work Esperance
– –
6. Authorized body to assess risk in the bank

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Senior manager
Internal Auditor

Board of director
Risk management department
The following table hold risk identification practice of banks, based on the type of risk identification system of your
bank indicate using (√) marks
Financial statement analysis
Audit and physical inspection
Inspection by the bank risk managers and other staffs
Internal communication
Survey analysis
Others
7. Which one of the following credit risk more affected your bank Credit risk handling techniques?
A. Collateral risk
B. Credit payment risk
C. Credit rationing risk
D. If any others please explain
8. Based on the question number 8 which one of the following techniques applied in your bank to reduced
credit risk Handling
Reduction Transfer Retention
Collateral risk
Credit payment risk
Credit rationing risk

Section II: Main Questionnaire

Please indicate your choice by putting the tick mark (√) on the appropriate cell.
Where, 1 = strongly disagree, 2 = disagree, 3 = neutral, 4 = agree, 5 = strongly agree.
Please indicate the degree to which you agree with the following statements regarding the factor affecting credit risk
management practice of your bank
S.N. Statement Score Values

Disagree(2
Disagree(1

Neutral(3)

Agree(4)

Strongly
Strongly

Agree
(5)
Establishing Appropriate Credit risk environment
1 The existing organizational culture helps to know how to assess and handle
risks
2 Risks are assessed regularly and its changes handled properly
3 There is an effective strategy established according to size of the bank
4 The reported hazards been effectively controlled
5 Adequate resources are allocated for assessing risk
6 Banks have strong group risk and internal audit functions which report
directly to the Center
7 There is experienced staff, which recognizes potential problems, and brings
them to the attention of their supervisors
8 Banks should assess the credit worthiness of the borrower before
sanctioning loan
9 The bank offer training for employees on credit risk management

Operating under a Sound Credit granting process

1 The Bank uses well defined Credit-granting Criteria for assessing
credibility of each loan applicants.

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2 Banks should assess the credit worthiness of the borrower before
sanctioning loan
3 Adequacy, marketability and enforceability of collateral requirement is
properly evaluated and measured by professional personnel or expertise
4 The Bank conducts comprehensive Credit worthiness analysis properly
before granting loan.
5 The bank critically follows Sound Credit granting process for approving
new credits as well as amending, renewing and re-financing existing credits
6 The bank has established comprehensive Credit limit for the main
categories of risk factors in all types of credit facilities.
Maintaining an appropriate Credit administration, Measurement
and Monitoring process
1 The bank strictly monitors loan terms and conditions that have been
stipulated at the time of loan approval
2 The bank regularly reviews and monitors the performance of Credit quality
at individual and portfolio level
3 There is a complete, neatly organized and regularly updated credit file in
our bank.
4 The bank has developed its own internal risk rating system and applying in
credit risk management process effectively
Market risk
1 The bank applied an effective marketing reaction
2 There is lack of benchmarking against competitors
3 The bank critically assess commercial locations
4 The bank effectively work to fulfill customer demand and expectation
5 The bank manage interest rate instability

Operational Risk Analysis

1 There is a problems when Risk of transition from the existing process to
the new one
2 worker‟s skill, experience and training risk challenges frequently affect
3 There is frequent Systems failure
4 There is failure of transaction risk
5 Failure to communicate with each other
6 There is failure whether Internal or external risk reporting
7 There is failure an electronic transfer of payments
Legality risk
1 There is Misinterpretation of law and legislation problem faced in the bank
2 Criminal activities (fraud, theft, and property damage) affected the bank
risk management practice
3 Documentation/contract risk affected the bank risk management practice

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