1.
Background of the study
Risk is highly multifaceted, complex and often interlinked making it necessary to manage,
rather than fear. The primary function of a commercial bank is to collect the public deposits
and invest them in to most profitable sectors and always face different types of risks. The
ability of comprehensive risk management has become the basic requirement of
commercial banks for running their operations smoothly. Among the various risks faced
by the banks, credit risk has the greatest impact on bank's performance and its profitability.
Credit risk is defined as possibility that a contractual party will fail to meet its obligation
in accordance with the agreed terms .Giesecke (2004) mentioned that credit risk is a
significant risk faced by bank by the nature of their activity and success of bank intern of
financial performance depends on efficient management of its any other type of risk that
bank faces .It is a risk of financial loss where by money invested by to their customers in
the form of loans are not repaid back.
Profitability is an important tool in financing sector. Malik (2011) explains that the
profitability is one of the most important objectives of financial management because one
goal of financial management is to maximize the owner`s wealth and profitability is very
important determinants of performance. Banks cannot run without profitability.
Profitability is required for the survival of the banking business. So, measuring profitability
is very important. Credit risk has the major impact on bank's profitability as huge amount
of bank's revenue are accrues from loans from which the interest is derived. To maintain
the profitability credit risk management plays a vital role.
Giesecke (2004) mentioned that, it is a risk of financial loss where by money invested by
to their customers in the form of loans are not repaid back. Credit risk is a significant risk
faced by bank by the nature of their activity and success of bank intern of financial
performance depends on efficient management of its any other type of risk that bank faces.
Likewise, Khan, Nazir & Abdullah (2012), asserted credit risk is a kind of misfortune
because of the default of loan of the bank.
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Credit risk management should be at the centre of banks operations in order to maintain
financial sustainability and reaching more clients. In order to minimize credit risk, there is
essential of financial systems that have a well capitalized bank, provide service to wide
range of customers, share information regarding borrowers, have a stable interest rate,
increase bank deposit and credit to borrowers, and reduce non-performing loan. In order to
avoid financial difficulties, credit risk management is more important and essential for
achieving long-term success in the bank.
The credit policy should set out the bank’s lending philosophy and specific procedures
and means of monitoring the lending activity. The guiding principle in credit appraisal is
to ensure that only those borrowers who require credit and are able to meet repayment
obligations can access credit.
Manandhar (2015) found that credit risk has negative relationship with return on equity,
capital adequacy ratio, gross domestic product and bank branch but positive relationship
with inflation and capital to total deposit. A strong credit risk management avoids
significant drawbacks and increase banks financial performance. Good financial
performance rewards shareholders for their investments. This will then encourage
additional investment and bring economic growth. In contrast, poor banking performance
can lead to banking failure and crisis which may have a negative consequence on economic
growth.
2. Statement of the Problem
There are new trends of expansion, operations and establishments of banking and financial
institutions that helps to grow the banking industries in Nepal. Recently, the regulator has
added some changes in policies to grow the financial sectors that concerns of merger and
acquisition, upgrade, opening branches in remote areas. There are some unique
environments and activities of banks in daily operations. Some of banks are busy to lunch
new deposit products in high interest rate, some of them are trying to catch attention of
customers by reducing interest rate on loan. So, there is tough competition in the entire
banking industries in Nepal.
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Most of the banking business is so delicate because more than 85% of their liability is
deposits form customers. Bank creates loan from those deposits that deposited by
customers and those loans are the major income generating source of bank. However, the
action is associated with enormous risk to both banks and customers. With the aim of
increasing revenue and gaining a large portion of the market share, bank provides loan and
advance which could not be recovered lending by huge growing non-performing loan. This
has become stress situation for bank and other stakeholders. In order to control such type
of condition, the regulatory body of the bank and financial institution (Nepal Rastra Bank)
has directed of the credit loss provision.
3. Objectives of the Study
The general objective of this study is the assessment of credit risk management of Nepalese
commercial banks. This study analyzed the overall credit risk management of sample
banks. To achieve the general objective, the study also includes specific objectives
• To assess the impact of capital adequacy on profitability of Standard Chartered Bank.
• To identify the credit risk management of Standard Chartered Bank.
• To examine the impact of credit risk on profitability of Standard Chartered Bank.
4. Literature Review
Khan and Ali (2016) aim at investigating the relationship between liquidity and
profitability of commercial banks in Pakistan. The main objective of the study was to find
the nature of relationship and the strength of relationship exists between the variables.
Correlation and regression are used respectively to find the nature of the relationship and
extent of relationship between dependent and independent variables. Secondary data was
used for analysis that was extracted from the annual accounts of Habib Bank Limited. After
conducting correlation and regression analysis it was found that there as significant positive
relationship between liquidity with profitability of the banks. Since, the data of the banking
sector was used; hence the results cannot be generalized to other sectors.
Soyemi, Ogunleye, and Ashogbon (2014) observed that the greater the risk, the higher the
return, hence, the business must strike a trade-off between the two. In addition, risk
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management in banking impacts significantly on economic growth of the nation and
business development. Inefficient management of risk by banks may not only prevent
banks from achieving its objectives but can also lead to bankruptcy. Therefore, banking
activities are always involved with various kinds of risk. Risks are considered warranted
when they are understandable, measurable, controllable and within a banks capacity to
willingly resist its adverse effect..
Boahene et al. (2012) published an article "Credit risk and Profitability of selected banks
in Ghana", utilized regression analysis in an attempt to reveal the connection between credit
risk and profitability of selected banks, and established that credit risk components. One of
the components is non-performing loan rate and identified that there is a positive and
significant relationship with bank profitability in Ghana. This shows that banks in Ghana
enjoy high profitability regardless of high credit risk, an opposing view to other views
expressed in many studies that credit risk indicators are negatively related to profitability.
Noman et al. (2015) conducted an empirical study with the aims to find the effect of credit
risk on profitability of the banking sectors of Bangladesh. The study used an unbalanced
panel data and 172 observations from 18 private commercial banks from 2003 to 2013. The
study found a negative and significant effect of credit risk on profitability. The analysis
also found a negative and significant effect of capital adequacy ratio on profitability.
Poudel (2018) has published a research article titled "Assessment of credit risk in Nepali
commercial banks". The objective of this article is to identify the major indicators of credit
risk among the Nepali commercial banks. In this article, 15 Nepalese commercial banks
were used as a sample. All the data were collected through secondary data collection
method. All the data in this study were obtained from the database of World Bank for
macroeconomic variables for the period from 2002/03 to 2014/15 and database of Nepal
Rastra Bank for bank specific variables. One way Fixed Effect Model (FEM) of panel data
analysis was used as a major tool of analysis.
Konovalova, Kristovska, and Kudinska (2016) projected a model of credit risk assessment
on the basis of factor analysis of retail clients / borrowers in order to ensure predictive
control of the level of risk posed by potential clients in commercial banks engaged in
consumer lending. It demonstrated the creation of a model of borrowers’ internal credit
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ratings and the development of the methods of improving credit risk management in
commercial banks.
This report clearly explains that bank size has a positive and statistically insignificant
impact of Bank Size on bank profitability. It has shown that there is a huge difference
between the biggest bank and the small bank. Those private commercial banks which have
a big size have an advantages of absorbing some credit risks. Based on this finding, bank
size is not affect bank performance. Bank’s size appears to have a positive relationship
with performance. It has concluded that bank can increase profitability if its size gets big.
This report has clearly explained about how bank size impact on profitability.
By reviewing the literature, it reveals that there are not enough effort given to study about
the impact of credit risk on the profitability of commercial banks in Nepal. It discloses that
there is lacking conclusion of relationship between credit risk management and profitability
of commercial banks of Nepal.
5. Theoretical Framework
In this project there are two types of variables i.e. dependent and independent. Dependent
variables are those, which are affected by the change in independent variables. Profitability
is dependent variable for this project. The variable influence the dependent variable in
positive or negative way is said to be independent variable. Non-performing loan, Bank
size and net interest income is taken as the independent variable. If these variable changes
there will be change in profitability.
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Non- performing loan
Bank size Profitability
Net interest income
Figure 1.1: Theoretical framework of the study
Source: MS & N (2016), Olalere et al. (2015), Poudel (2018) and Abera (2018)
[
6. Research Hypothesis
The broad objectives of this study are to explore the relationship between the uses of credit
risk management on profitability. Its objective is also to identify various factors affecting
profitability at commercial banks in Nepal as well as major obstacles for credit risk
management being faced by them. Based on above objectives and relation, the following
hypotheses are explored:
Hypothesis I: Non-performing loan ratio has a significant and negative effect on
profitability.
Hypothesis II: Bank size has a significant and positive effect on profitability.
Hypothesis III: Net interest income has significant impact on profitability.
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7. Significance of the study
The research itself is very important because it aims to convert theory and knowledge into
practical way. The main purpose of this research is to access the credit risk management
and its impact on profitability of Nepalese commercial banks. It is important for the
following sectors.
• The research is important for Nepalese banking industry to insure that the effective
strategies are being implemented to minimize risk for expanding markets and financial
returns.
• This study is important to the entire stakeholder that includes customers, employees,
shareholders, society Investors, depositors, borrowers and the regulars to know the
credit risks condition of Nepalese commercial banks.
• It also helps the regulators to make policy provisions.
• This research provides an insight into the organizational credit risk management
patterns within the standards set by NRB.
8. Research Methodology
Research methods that are used for the study are discussed on the following headings.
8.1 Research design
The research designed adopted in this study consists of causal comparative research design
to analysis the various issues are raised. The comparative analysis is used for the purpose
of fact-finding, conceptualization, description, and operation searching for adequate
information in the context of RHM practices and employee and organizational performance
in Nepal.
8.2 Population and sample
Among different organization of Nepal, Nepalese Insurance Companies and commercial
banks are taken for the present study. Financial statements of at least 5 years (2016/17 to
2019/20) have been taken as sample for comparative analysis of impact of human resources
management practices on employee commitment.
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8.3 Data collection methods
This research is completely based on secondary data. In this study, websites of
organization, online publications articles and journal papers have been use to analyze the
data.
8.4 Data analysis methods
In this project, statistical tools are used to analyze the data. The statistical tools that are
used are as follows:
Mean
The arithmetic mean, also called the mathematical expectation or or average, is the central
value of a discrete set of numbers: specifically, the sum of the values divided by the number
of values. It is the most commonly used and readily understood measure of central
tendency. In this study, mean is calculated to find out the average of different variables i.e.
non-performing loan, bank size and net interest income. Mathematically,
∑𝑋
Mean =
𝑁
Where, X= Amount of variables,
N= Number of variable
Standard deviation
Standard deviation often represented by Greek letter sigma, is the measure of a spread of
data around the mean. It is the statistical measure of dispersion or deviation of possible
outcomes around an expected or mean value. In this study, we use it to measure the risk.
Mathematically,
√∑(𝑥−𝑥̅ )2
Standard Deviation (ϭ) =
𝑛
Where, X= Amount of variables,
N = Number of variables
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Coefficient of variation
Coefficient of variation is the standardized measure of risk per unit of return. It is calculated
as the standard deviation divided by the expected return or average return. It is the relative
measure of risk. In this study it is use to relatively evaluate the risk caused by non-
performing loan, bank size and interest income.
Regression
Literal meaning of regression is stepping back or returning to the average value. It is use
to identify the impact of one variable on another. In this report, regression is used to study
the impact of credit risk indicators such as, non-performing loan, bank size and interest
income on profitability.
9. Limitation of the Study
The limitations of the study are as follows:
• There are many commercial banks in Nepal this research is based on only one
commercial bank.
• This research only includes data of Standard Chartered Bank for the period 2016/17 to
2019/20, which is 5 years’ financial period.
• This study has only applied limited number of statistical tools to analyze data.
• This research is limited only to the study of commercial banks of Nepal and ignores
the other types of financial institutions.
• The evaluation is made through the analysis of financial statement published and
presented by the banks
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References
Boahene, S.H., Dasah, J. and Agyei, S.K. (2012). Credit Risk and Profitability of Selected
Banks in Ghana, Research Journal of Finance and Accounting, 3 (7)
Gieseche, K. 2004. "Credit Risk Modeling and Valuation: An Introduction." Credit Risk:
Models and Management, 2: 1-40.
Khan, R.A., and Ali, M. (2016). Impact of Liquidity on Profitability of Commercial Banks
in Pakistan: An Analysis on Banking Sector in Pakistan. Global Journal of
Management and Business Research: C Finance, 16(1)
Khan, W. A., and Sattar, A. (2014). Impact of Interest Rate Changes on the Profitability of
four Major Commercial Banks in Pakistan. International Journal of Accounting and
Financial Reporting, 4(1), 142.
Konovalova, N., Kristovska, I., & Kudinska, M. (2016). Credit risk management in
commercial banks. Polish Journal of Management Studies, 13(2), 90-100.
Malik, H. (2011). Determinants of Insurance Companies Profitability : an Analysis of
Insurance Sector of Pakistan. Academic Research International
Manandar, A. (2015). Credit Risk Management in Indian Commercial Banks.
International Journal of Marketing, Financial Services and Management Research, 2(7),
47-51.
Noman, A.H.M., Pervin, P., Chowdhury, M.M., and Banna, H. (2015). The effect of Credit
Risk on the Banking Profitability: A Case of Bangladesh. Global Journal of Management
and Business Research: C Finance, 15(3).
Poudel, S.R. (2018). Assessment of Credit Risk in Nepali Commercial Banks. Journal of
Applied and Advanced Research, 3(3), 65-72.
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