Author(s): Ephias Munangi, Athenia Bongani Sibindi
The banking sector is an important industry that needs to be safeguarded, as its failure is bound to have negative knock-on effects on the economy at large. In this article we examine the impact of credit risk on the financial performance of 18 South African banks for the period 2008 to 2018. Panel data techniques, namely the pooled ordinary least squares (pooled OLS), fixed effects and random effects estimators were employed to test the relationship between credit risk and financial performance (proxied by non-performing loans (NPLs) and by return on assets (ROA) or return on equity (ROE) respectively). The results of the study documented that credit risk was negatively related to financial performance. Thus, the higher the incidence of non-performing loans, the lower the profitability of the bank. Secondly, the study documented that growth had a positive effect on financial performance. This indicates that productivity capacity is ameliorated through bank development. Thirdly, it was found that capital adequacy was positively related to financial performance. While a greater capital adequacy ratio may instil confidence of stakeholders in a bank, making it competitive, to the contrary a high capital base may be perceived as lack of initiative and tying up resources which could have yielded better returns in alternative investments. Fourthly, the study did not find any conclusive relationship between size and financial performance. Lastly, the study found that bank leverage and financial performance were negatively related. The implications of the findings are that at a micro-level, banks should observe prudent and stringent credit policies in-order to limit the incidence of non-performing loans. At a macro-level, regulators must enhance supervision in order to ensure that banks manage their credit risk according to the regulations thereby minimising the risk of bank failure.