The effect of credit risk management on the financial performance of commercial banks: evidence from Tanzania

Abstract

The vital role played by commercial banks in economic development calls for the stable and sustainable financial performance of banks for smooth financial intermediation. However, unhealthy credit has caused the collapse of many financial institutions all over the world. Therefore, this study examines how credit risk management practices affect the financial performance of commercial banks in Tanzania. While employing multiple linear regression techniques, the study analysed balanced panel data from 225 observations gathered from audited published annual reports of 15 commercial banks in Tanzania from 2006 to 2020. Credit risk approval and credit risk monitoring were used as proxies for credit risk management. The findings reveal that credit risk approval has a positive effect on banks’ capital adequacy, efficient utilisation of equity, asset quality, and liquidity. However, credit monitoring negatively affects the financial performance of banks through their earning ability, asset quality, and liquidity. The study recommends that incorporating credit risk management practices as a core aspect of bank operations is crucial, as it has a beneficial impact on financial performance. Nevertheless, it is advised to exercise caution and achieve a harmonious balance in the integration and concentration of all examined variables since credit approval could not exhibit a positive effect on banks’ earning ability. This has also been established on credit monitoring towards capital adequacy and efficient use of equity.