Assessing the relationship between credit risk indicators and financial performance of Tanzanian commercial banks

Abstract

The study examines the effects of credit risks on the financial performance of commercial banks in Tanzania. Secondary data, which were obtained from the audited financial statements of twenty-eight commercial banks in Tanzania from 2010 to 2022, were employed in this study. The data were collected from the websites of the Bank of Tanzania and the commercial banks. Return on assets (ROA) or return on equity (ROE) were used as financial performance measures, while the Non-Performing Loans (NPLs) to Gross Loan Loss Reserve (LLR) to Gross Loans (GL) and Loss Reserve (LLR) to Gross Loans (GL) were used to measure credit risk. Since there were no audited financial statements available for some banks, we had to leave out 12 banks from this study. This study used balanced panel data regression to explore how credit risks affect the financial performance of commercial banks in Tanzania. A balanced panel helped to make sure that each bank is observed within the same time frame, which improves the consistency and comparability of estimates. This method works well since it controls for differences between banks and changes over time. It also accounts for unobserved differences and lowers bias when measuring the impact of credit risk factors on bank performance. The panel regression assumption such as normality test, multicollinearity test, heteroscedasticity test and serial correlation test were used. The study also used the Hausman test to select the appropriate model between the fixed effect and random effect model where the fixed effect mode was appropriate. The Prais-Winsten regression, correlated panels and corrected standard errors (PCSEs) were used to handle multicollinearity, heteroscedasticity and serial correlation which existed in the study. The study found that the Non-Performing Loans (NPLs) to Gross Loans (GL) ratio had significant negative effects on both Return on Assets (ROA) and Return on Equity (ROE). On the other hand, the study found that Non-Performing Loans to Net Provisions had positive effects on ROA and ROE. The study also found a non-significant positive effect of ROE from the Loan Loss Reserve (LLR) on Gross Loans (GL) and that Loans and Advances to Total Assets had non-significant effect on ROA or ROE. The study concludes that the credit risk has an effect on financial performance of commercial banks in Tanzania. To cut down on non-performing loans and raise profits, the banks should tighten their assessment of credit risks, set aside reserves, and recoup loans. Regulators should watch provisioning policies to keep the bank profits stable. Future research should examine other bank-specific and macroeconomic factors that affect the financial performance of the banks in Tanzania and determine if similar trends exist in other emerging markets.