Effects of Credit Risk on the Financial Performance of Nepalese

Commercial Banks

BY

Rubina Shrestha

Exam Roll No: 14488/14

T.U. Reg. No: 7-2-22-35-2014

A Summer Project Report

Submitted to

Faculty of Management, Tribhuvan University

In partial fulfillment of the requirements for the degree of

Bachelor of Business Administration

Patan Multiple Campus

Lalitpur

Tribhuvan University

April, 2018
 RECOMMENDATION BY SUPERVISOR

This is to certify that the summer project entitled “Effects of Credit Risk on the Financial
Performance of Nepalese Commercial Banks” is an academic work done by “Rubina
Shrestha” (T.U. Reg. No: 7-2-22-35-2014) submitted in the partial fulfillment of the
requirements for the degree of Bachelor of Business Administration at Faculty of
Management, Tribhuvan University under my guidance and supervision. To the best of my
knowledge, the information presented by her in the summer project report has not been
submitted earlier.

______________________
Signature of the Supervisor
Name:
Designation:
Date:

ii
 VIVA – VOCE SHEET

We have conducted the viva – voce sheet examination of the summer project

Submitted by:
Rubina Shrestha

Entitled:
Effect of Credit Risk on the Financial Performance of Nepalese Commercial Banks

and found the summer project to be the original work of the student and written according to
the prescribed format. We recommend the summer project to be accepted as partial fulfillment
of the requirements for
Bachelor’s degree in Business Administration (BBA)

Viva – Voce Committee

Head, Research Department: …………………………………

Member (Report Supervisor): …………………………….......

Member (External Expert): …………………………………..

Date: ……………………………………

iii
 DECLARATION

This is to declare that I have completed the Summer Project entitled "Effects of Credit Risk on
the Financial Performance of Nepalese Commercial Banks" under the guidance of “Dr. Yuga
Raj Bhattarai” in partial fulfillment of the requirements for the degree of Bachelor of
Business Administration at Faculty of Management, Tribhuvan University. This is my
original work and I have not submitted it earlier elsewhere.

Date: ………………………….. Signature…...........................

Rubina Shrestha

iv
 ACKNOWLEDGEMENT

This study is to examine the effects of credit risks on commercial bank‟s performance in the
context of Nepal. The success and final outcome of the project required a lot of guidance and
assistance from many people. So, first and foremost I would like to offer sincere gratitude to the
Faculty members of Patan Multiple Campus for providing advice and support while carrying out this
study.

I would like to take a privilege for offering my deep sense of gratitude and indebtedness
towards director of BBA program and my project supervisor, Dr. Yuga Raj Bhattarai, for
providing advice, ideas, suggestions and guidance throughout this project. I am very thankful
to Prof. Bijaya Gopal Shrestha, faculty member of Patan Multiple Campus, for facilitating
with necessary ideas, materials, and support that are required to complete this study.

My heartfelt thanks are also extended to the staff members of selected commercial banks for
providing me all the necessary data required for the study. I have taken considerable help from
several books, articles of Nepalese and foreign writers while preparing this study.

I would also like to thank my family, who supported me directly or indirectly in the course of
this study preparation.

v
 TABLE OF CONTENTS

Page
Recommendation by Supervisor ............................................................................................. ii
VIVA – VOCE Sheet ............................................................................................................ iii
Declaration .............................................................................................................................iv
Acknowledgement ...................................................................................................................v
Table of Contents ...................................................................................................................vi
References ............................................................................................................................ vii
Appendices........................................................................................................................... vii
List of Tables ...................................................................................................................... viii
List of Figures ........................................................................................................................ix
List of Abbreviations ...............................................................................................................x
Executive Summary ...............................................................................................................xi
Chapter I Introduction .........................................................................................................1
1.1 Context Information ..........................................................................................................1
1.2 Statement of the Problem ................................................................................................... 3
1.3 Purpose of the Study ..........................................................................................................3
1.4 Significance of the Study ................................................................................................... 4
1.5 Literature Review ..............................................................................................................4
1.5.1 Conceptual Review ................................................................................................... 5
1.5.2 Review of Related Studies ........................................................................................ 5
1.5.3 Concluding Remarks .................................................................................................7
1.6 Research Methodology ......................................................................................................8
1.6.1 Research Design .......................................................................................................9
1.6.2 Sources of Data .........................................................................................................9
1.6.3 Population and Sample .............................................................................................. 9
1.6.4 Techniques of Data Analysis ................................................................................... 10
1.6.4.1 Descriptive Statistics ................................................................................... 10
1.6.4.2 Correlation Analysis .................................................................................... 12
1.6.4.3 Regression Analysis .................................................................................... 13
1.6.5 Study Variables ....................................................................................................... 13
1.7 Limitation of the Study .................................................................................................... 15
1.8 Organization of the Study ................................................................................................ 16
vi
Chapter II Data Presentation and Analysis....................................................................... 18
2.1 Organization Profile ........................................................................................................ 18
2.2 Credit Risk and Profitability Position of Selected Commercial Banks .............................. 20
2.2.1 Analysis of Earning Per Share (EPS)....................................................................... 20
2.2.2 Analysis of Non-performing Loan (NPL) ................................................................ 22
2.2.3 Analysis of Capital Adequacy Ratio (CAR) ............................................................ 23
2.2.4 Analysis of Cash Reserve Ratio (CRR) ................................................................... 24
2.2.5 Analysis of Book Value per Share (BVPS) ............................................................. 26
2.3 Descriptive Statistics of Study Variables.......................................................................... 27
2.4 Relationship between Profitability and Credit Risk Indicators .......................................... 29
2.5 Effect of Credit Risk on the Profitability of Commercial Banks ....................................... 30
2.6 Findings and Discussion .................................................................................................. 31
Chapter III Conclusion and Action Implications .............................................................. 33
3.1 Conclusion ...................................................................................................................... 33
3.2 Action Implications ......................................................................................................... 34

References
Appendices

vii
 LIST OF TABLES

Page
Table 1.1 Banks Selected For the Study and Period Covered 10
Table 2.1 Data Analysis of Earning Per Share of HBL and NIBL 21
Table 2.2 Data Analysis of the Non-performing loan of HBL and NIBL 22
Table 2.3 Data Analysis of Capital Adequacy Ratio of HBL and NIBL 23
Table 2.4 Data Analysis of Cash Reserve Ratio of HBL and NIBL 25
Table 2.5 Data Analysis of Book Value per Share of HBL and NIBL 26
Table 2.6 Data and Descriptive Statistics of Study Variable -Both Banks 27
Table 2.7 Pearson Correlation Coefficients-Both Banks 29
Table 2.8 Regression Results of Effects of Credit Risk on Bank Performance 30

viii
 LIST OF FIGURES

Page
Figure 2.1 Earnings per Share Position of selected banks 21
Figure 2.2 Non-performing Loan Position of selected banks 23
Figure 2.3 Capital Adequacy Ratio Position of selected banks 24
Figure 2.4 Cash Reserve Ratio Position of selected banks 25
Figure 2.5 Book Value per Share Position of selected banks 27

ix
 LIST OF ABBREVIATION

HBL Himalayan Bank Limited

NIBL Nepal Investment Bank Limited

NPL Non-Performing Loan

NPLR Non-Performing Loan Ratio

CAR Capital Adequacy Ratio

CRR Cash Reserve Ratio

CLA Cost per Loan Assets

ROE Return on Equity

ROA Return on Assets

S.D Standard Deviation

C.V Coefficient of Variation

i.e. That is

x
 EXECUTIVE SUMMARY

The main objective of this study is to investigate the impact of credit risk on the performance
of Nepalese commercial banks. Credit risk refers to the risk that a borrower may not repay a
loan and that the lender may lose the principal of the loan or the interest associated with it.
Credit risk arises because borrowers expect to use future cash flows to pay current debts; it's
almost never possible to ensure that borrowers will definitely have the funds to repay their
debts.

This study has taken the non-performing loan (NPL), capital adequacy ratio (CAR), cash
reserve ratio (CRR) and book value per share (BVPS) as credit proxies whereas earning per
share (EPS) is proxy of profitability or bank performance. Among 28 commercial banks in
Nepal, two commercial banks, Himalayan Bank Ltd. and Nepal Investment Bank Ltd. with 20
observations. Secondary data are collected for the study from selected banks for the period of
2006 to 2016 which have been used for the analysis. These data are analyzed using regression
model. This study will be focusing on the effect of credit risk on the bank performance in the
context of Nepal‟s commercial banks only. It tries to minimize the research gap by
emphasizing the effects of credit risk on the financial performance of Nepalese commercial
banks.

The descriptive and analytical research design has been adopted for the study. The regression
model revealed that Non-performing loan (NPL) has a negative and statistically significant
impact on bank performance. Cash Reserve Ratio and Book Value per Share have a positive
and statistically significant impact on bank performance. Capital Adequacy Ratio is not
considered as the influencing variable on bank performance. This study concludes that there
exits significant relationship between bank performance and credit risk indicators.

xi
 CHAPTER-I
INTRODUCTION

1.1 Context Information

Credit risk is defined as a risk when the financial instrument issuer or debtor is unwilling or
unable to pay interest and the principal according to the terms specified in a credit agreement,
such failure has an adverse effect on the financial performance of the bank. 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 (Gieseche, 2004).

For most of the banks, loans are the largest and most obvious source of credit risk; however,
credit risk could stem from activities like both on and off balance sheet. Coyle (2000) defines
credit risk as losses from the refusal of credit customers to pay what is owed in full and on
time. It arises mainly from direct lending and certain off-balance sheet products i.e.
guarantees, letter of credits, foreign exchange, forward contracts & derivatives and also from
the bank‟s holding of assets in the form of debt securities. The management of credit risk is a
critical component of a comprehensive approach to risk management and is essential to the
long-term success of a commercial bank.

Credit risk doesn‟t occur in isolation. The same source that endangers credit risk for the bank
may also expose it to other risks. For instance, a bad portfolio may attract liquidity problem.
Credit risk management is necessary to minimize the risk and maximize financial institution‟s
risk-adjusted rate of return by assuming and maintaining credit risk exposure within the
acceptable parameters (Pandey, 2004).

Credit or default risk is the risk that the promised cash flows from loans and securities held by
financial institutions may not be paid in full. Should a borrower default, both the principal
loaned and the interest payments expected are at risk. The potential loss a financial institution
1
can experience suggests that financial institutions need to collect information about borrowers
whose assets are in their portfolios and to monitor those borrowers overtime (Saunders &
Cornett, 2003).

Credit risk is the uncertainty associated with borrowers‟ loan repayments. In general, when
borrowers‟ asset values exceed their indebtedness they repay loans but when borrowers‟ assets
values are less than loan values, they do not repay and they could, therefore, exercise their
option to default (Sinkey Jr, 2002).

Extra flexible credit rationing policy can also be a source high NPLs rate in the highly
competitive banking environment of today‟s world. Hence it is clear why banks need to
manage credit risk which is mainly from NPLs as it is very crucial for banks survival and
profitability (Juliana, 2017).

Therefore, it is a requirement for every bank worldwide to be aware of the need to identify
measure, monitor, and control credit risk and again determining how credit risks could be
lowered. More capital can compensate for risks taken; this means that a bank should hold
adequate capital against these risks (Sethi, Sahoo & Sucharita, 2003).

Credit risk may cause cash flow problems and affects banks liquidity. Credit risk is the most
important area in risk management. More than 80% of all banks balance sheet relates to credit.
All exposure to credit risk has led to many bank failures. Effective management of credit risk
can enhance banks‟ goodwill and depositors‟ confidence. Thus, good credit risk policy is an
important condition for banks‟ performance.

Every bank needs to identify measure, monitor, and control; credit risk and also determining
how credit risks could be lowered. The findings of this study may enable bank executives to
understand how credit risk affects the bank performance and they may adopt the appropriate
credit risk strategies.

2
1.2 Statement of the Problem
Banks use the deposits to generate credit for their borrowers, which is the main revenue
generating activity for most banks. With the increase of credit transactions and loan customers
in the nation‟s economy, credit expansion is inevitable. The trend in the sector shows growing
bank deposit-loan ratio as the economy grows and so does credit risk. The impact of credit risk
on financial performance has been a topic of interest to many scholars since credit risk has
been identified as one of the major factors known to impact the financial performance of
banks. Amongst others who have carried out extensive studies on the topic, their results have
not been in consensus. While some researcher found credit risk to impact positively on bank‟s
performance, other‟s found a negative relationship and other‟s emphasized other factors
instead of credit risks which impact on bank performance. The overall objective of the study is
to investigate the impact of credit risk on the financial performance of two commercial banks.
This study tries to answer the main question i.e. the effects of credit risk on the financial
performance of commercial banks of Nepal, by resolving the following issues:

 What is the profitability and credit risk position of selected banks of Nepal?
 Is there any relationship between profitability and credit risk?
 What is the effect of credit risk on the profitability of selected banks?

1.3 Purpose of the Study

The main objective of this study is to examine the impact of credit risk on the financial
performance of Nepalese Commercial Banks. The specific objectives are:

1. To evaluate the profitability and credit risk position of the selected commercial bank.
2. To examine the relationship among profitability, credit risk, capital adequacy, liquidity
` and book net worth.
3. To investigate the effect of credit risk on the profitability of the selected commercial
bank.

3
1.4 Significance of the Study
The main aim of this research project is to assess the impact of credit risk on the financial
performance of Nepalese Commercial Banks over a period of seven years (2009-2016). This
report is prepared for the fulfilling the partial requirement of bachelor degree of business
administration. The study is made because of the damaging effect of credit risk on bank
performance and would be of utmost relevance as it addresses how credit risk affects
commercial banks performance using a judgmental sampling and the findings would serve as
the basis for possible recommendations and provides policy measures to the various
stakeholders to tackle the effect of credit risk in order to enhance the quality of banks; risk
assets. Plus, it also provides insight into the local context by considering similar researches
made in different countries and hence help fill the gap in the literature. The results of this
research will have implications and importance to various stakeholders as follows:

 To regulator and policymakers, the research will provide the basis for the regulatory policy
framework to mitigate the financial system from the financial crisis and to better
appreciate and quantify those credit risks exposures.
 To investors, this study will help them to understand the factors that influence the returns
on their investments.
 To commercial banks, this study will provide an insight into the credit risk attributes which
may need to be incorporated in their investment decision processes. The study will
improve not only researcher‟s scope of understanding risk management but also entire
public hence gain exposure to the banking industry. These findings will be used as
reference material by future researchers interested in further research on credit risk
management and its effects on financial performance of Nepalese commercial banks.

1.5 Literature Review

Various researchers have made different studies on the effects of credit risk on the
performance of Nepalese commercial banks. Those researchers examined results are taken as a
base for this study. Reviewing literature is divided into three parts: conceptual review, review
of related studies and concluding remarks.

4
1.5.1 Conceptual Review
Credit risk is a financial exposure resulting from a Bank‟s dependence on another party
(counterparty) to perform an obligation as agreed (National Bank of Ethiopia 2010). The main
sources of credit risk include limited institutional capacity, inappropriate credit policies,
volatile interest rates, poor management, inappropriate laws, low capital and liquidity levels,
and directed lending, massive licensing of banks, poor credit assessment. Credit risk exposure
means the total amount of credit extended to a borrower by a lender.

The word „Performance‟ means „to do‟, „to carry out‟ or „to render‟. It refers the act of
performing; execution, accomplishment, fulfillment, etc. In border sense, performance refers
to the accomplishment of a given task measured against preset standards of accuracy,
completeness, cost, and speed. In other words, it refers to the degree to which an achievement
is being or has been accomplished. Bank profit is an appropriate measure of bank
performance. The primary focuses of financial reporting are information about an enterprise‟s
performance provided by measures of earnings and its components. The non–performing loan
ratio and capital adequacy ratio are the indicators of credit risk and earnings per share (EPS)
are the indicator of bank‟s performance. The most of the related studies reported that bank
performance is affected by capital adequacy ratio, non-performing loan etc. Banks‟
performance moreover may be affected by cash reserve ratio and book value per share.
Similarly, in this study, earning per share is a dependent variable which determines the bank‟s
performance whereas non-performing loan, capital adequacy ratio, cash reserve ratio, book
value per share are independent variables. This study shows the impact of credit risk on the
performance of Nepalese selected commercial banks.

1.5.2 Review of Related Studies

Credit risk plays an important role in banks‟ profitability since a large chunk of banks‟
revenue accrues from loans from which interest is derived. Therefore various researchers have
examined the impact of credit risk on banks in varying dimensions. The major studies related
to the issue of credit risk and bank performance have reviewed as follows:

5
Gizaw, Kebede, and Selvaraj (2013) examined the impact of credit risk on the profitability of
commercial banks in Ethiopia using pooled data of 8 commercial banks for the period of 2003
to 2014. The authors found that the credit risk measures: non-performing loan, loan loss
provisions, and capital adequacy have a significant impact on the profitability of commercial
banks in Ethiopia and also suggested a need for enhancing credit risk management to maintain
the prevailing profitability of commercial banks in Ethiopia.

Kithinji (2010) has analyzed the effect of credit risk management on the profitability of
commercial banks in Kenya and found out that bulk of the profits of commercial banks is not
influenced by the amount of credit and non performing loans, therefore suggesting that other
variables; other than credit and non performing loans impact on profits.

Poudel (2012) has studied the factors affecting commercial banks performance of Nepal of 31
commercial banks for the period of 2001 to 2012 and followed a linear regression analysis
technique. The study revealed a significant inverse relationship between commercial bank
performance measured by ROA and credit risk measured by default rate and capital adequacy
ratio.

Bhattarai (2016) has examined the effect of credit risk on the performance of Nepalese
Commercial Banks using pooled data of 14 commercial banks for the period of 2010 to 2015.
The author found that „non-performing loan ratio has a negative effect on bank performance
whereas „cost per assets‟ has a positive effect on bank performance. Moreover, the author
concluded that there is a significant relationship between bank performance and credit risk
indicators.

Kargi (2011) has evaluated the impact of credit on the profitability of Nigerian banks.
Financial ratios as a measure of bank performance and credit risk were collected from annual
reports of sampled banks from 2004-2008. The author found out that bank‟s profitability is
inversely influenced by the levels of loans and advances, non–performing loans and deposits

6
thereby exposing them to great risk of liquidity and distress. The findings revealed that credit
risk management has a significant impact on the profitability of Nigerian banks.

Kurawa and Garba (2014) have assessed the effect of credit risk management (CRM) on the
profitability of Nigerian banks with a view to discovering the extent to which default rate
(DR), cost per assets (CLA), and capital adequacy ratio (CAR) influence banks‟ profitability
(ROA). The secondary data from the annual reports and accounts of quoted banks during the
period of 2002 to 2011 were used for analysis. The author concluded that credit risk
management components have a significant positive effect on the profitability of Nigerian
banks.

Ugoani (2015) has examined the relationship of poor credit risk management and bank failure
in Nigeria using survey research design. The results from CHI- square statistics revealed that
weak corporate governance accelerates bank failures and the credit risk management functions
is to the greatest extent the most diverse and complex activity in the banking business. The
author, at last, concludes that poor credit risk management influences bank failures.

1.5.3 Concluding Remarks

The purpose of this study is to see what new contribution can be made and receive some
ideas, knowledge, and suggestions in relation to the impact of credit risk on the performance
of commercial banks. However, the previous studies cannot be ignored because they provide
the foundation for the present study. This study is continuity in research and is ensured by
linking the present study with the past research studies.

It is clear fact that new study cannot be found on that exact topic, i.e. effects of credit risk on
the performance of commercial banks. As many researchers emphasized the effects of credit
risk in own country context or with a variable like ROA, ROE etc. in their research. Hence,
there exists research gap. Therefore, to fulfill the gap, this study will be focusing on the effect
of credit risk on the bank performance in the context of Nepal‟s commercial banks only. The

7
research gap will be minimized by emphasizing the effects of credit risk on the financial
performance of Nepalese commercial banks with a variable like EPS.

This study tries to complete the research work as many journals, articles are followed as
guidelines to make the research easier and smooth. To achieve the main objectives, various
financial and statistical tools are used. Hence, this study is useful to the concerned bank as
well as stakeholders.

Based on theories and past empirical evidence, following conceptual model has been
developed.

Independent Variables Dependent Variable

Non Performing Loan

Ratio

Capital Adequacy Ratio

Earnings per share
(EPS)
Cash Reserve Ratio

Book Value per Share

Figure 1.1
Conceptual Framework

1.6 Research Methodology

Research methodology refers to the various sequential steps to be adopted by a researcher in
studying a problem with certain objectives. It tries to make a clear view of the method and
process applied in the entire subject of the study. It is also considered as the path from which
researcher can systematically solve the research problem.

8
1.6.1 Research Design
A research design is an overall framework for completing his/her work since beginning till the
end. It incorporates the blueprint for the collection, measurement, and analysis of data. It
generally presents works of research serially from the beginning to the end in a logical way. A
research design is the set of methods and procedure used in collecting and analyzing measures
of the variables specified in the research problem. The design of study defines the study type
(descriptive, correlation, experimental, historical, developmental, casual comparative) and
sub-type (descriptive- longitudinal growth study, case study).to achieve the objective of this
study, descriptive and analytical research design has been used.

1.6.2 Sources of Data

This study is mainly based on the secondary data that are available in the published form; the
required data for the study are collected from the concerned organizations. Following are the
sources of data used in the study:
 Annual reports, broacher etc. of selected banks.
 Articles, journals on the internet.
 Laws, NRB guidelines, NRB acts
 Banks websites and other relative websites.

1.6.3 Population and Sample

Population refers to the entire group of people or things of interest that the researcher wishes
to investigate. In the case of this study, listed commercial banks are the population. There are
altogether 28 commercial banks operating in Nepal at present. Data collection of these entire
commercial banks operating will so difficult and hard to manage. It will be very lengthy and
time-consuming and vague while taking all commercial banks into considerations for study.
Therefore, among 28 commercial banks, two banks namely Himalayan Bank Ltd. (HBL) and
Nepal Investment Bank Ltd. has been selected for the sample of the study. In this study,
convenience sampling has been used. The details of the banks selected have been depicted in
the table below:

9
Table 1.1
Banks selected for the study and period covered

S.N Name of Banks Period covered Observation

1. Himalayan Bank Ltd. 2006/07 to 2015/16 10

2. Nepal Investment Bank Ltd. 2006/07 to 2015/16 10

Total 20

1.6.4 Techniques of Data Analysis

Before analyzing the data, the data and information are shown in tables and graphs and later
on, they are analyzed and interpret. Various financial, accounting, and statistical tools have
been used to obtain the objectives of the study. The main analytical tools and techniques used
for analysis are:

1.6.4.1 Descriptive Statistics

Descriptive statistics is concerned with measures of central tendency and measures of
variability. Measures of central tendency include mean, median, and mode, while measures of
variability include standard deviation or variance, the minimum and maximum variables, and
kurtosis and skewness.

Arithmetic Mean (A.M.)

Arithmetic mean is the sum of all the numbers in the series divided by the count of all
numbers in the series. The arithmetic mean is also referred to as the average or simply as the
mean. Arithmetic mean is calculated by following formula:

𝑋̄̅
Mean (X̅) =
𝑛
Where,
∑x = sum of x series

10
 n = number of years

Standard Deviation (S.D)

Standard deviation is a measure of the dispersion of a set of data from its mean. It is a
calculated as the square root of variance by determining the variation between each data point
relative to the mean.

𝑑2
Standard Deviation (S.D) =
𝑁

Where,
d = (X-X̅̅̄)

Coefficient of Variation (C.V)

The coefficient of variance is the relative measure of dispersion, comparable across

distribution, which is defined as the ratio of the standard deviation to the mean expressed in
percent. It can be calculated as follows:

S.D.
Coefficient of Variation (C.V.) =
Mean

Skewness
Skewness is asymmetry in a statistical distribution, in which the curve appears distorted or
skewed either to the left or to the right. It defines the extent to which a distribution differs
from the normal distribution.

3(𝑀𝑒𝑎𝑛 −𝑀𝑒𝑑𝑖𝑎𝑛 )
Skewness =
𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝐷𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛

11
Kurtosis
Kurtosis is a measure of whether the data are heavy-tailed or light tailed relative to the normal
distribution. Data sets with high kurtosis tend to have heavy tails or outliers. Data sets with
low kurtosis tend to have light tails or lack of outliers. A uniform distribution would be the
extreme case.

1
( 𝑄3−𝑄1)
𝐾= 2
𝑃90−𝑃10

Where,
Q = Quartile
P = Percentile

1.6.4.2 Correlation Analysis

Correlation is a term that refers to the strength of the relationship between two variables.
Pearson r correlation is the most widely used correlation statistic to measure the degree of the
relationship between linearly related variables. It is developed by Karl Pearson.

The correlation coefficient can range from -1.00 to +1.00. A value of -1.00 indicates a perfect
negative correlation, which means that as the value of one variable increases, the other
decreases. While a value of +1.00 represents a perfect positive relationship, meaning that as
one variable increases in value, so does the other. As the correlation coefficient value goes
towards 0 that represents no relationship between variables being tested. The formula used to
calculate the Pearson r correlation:
𝑁 𝑥𝑦 − ( 𝑥)( 𝑦)
𝑟=
[𝑁 𝑥 2 − ( 𝑥)2 ][𝑁 𝑦 2 − ( 𝑦)2 ]
Where,
N = number of pairs of scores
∑xy =sum of the products of paired scores
∑x = sum of x scores

12
∑y = sum of y scores
∑x2 = sum of squared x scores
∑y2 =sum of squared y scores

1.6.4.3 Regression Analysis

A regression is a statistical analysis assessing the association between two variables. It is used
to find the relationship between two variables. It is a technique to discover a mathematical
relationship between two variables. The formula for regression is as follows:

Regression equation (𝒚) = 𝒂 + 𝒃𝒙

𝑵 𝑿𝒀−( 𝑿)( 𝒀)
Slope 𝒃 =
𝑵 𝑿𝟐 −( 𝑿)𝟐
𝒀−𝒃( 𝑿)
Intercept 𝒂 =
𝑵
Where,
X and Y are variables
b = slope of the regression line is also called regression coefficient
ɑ = intercept point of regression
N = number of values
∑X = sum of x scores
∑Y = sum of y scores
∑XY =sum of the products of paired scores
∑X2 = sum of squared x scores

1.6.5 Study Variables

Variables are anything that has a quantity or quality that varies. This study concerns following
dependent and independent variables.

13
 Dependent Variable
Dependent variables depend on other factors that are measured. These variables are expected
to change as a result of an experimental manipulation of the independent variable or variables.

Earnings per Share (EPS)

The dependent variables represent the profitability measured by Earnings per Share (EPS).
Earnings per share (EPS) are the portion of company‟s profit allocated to each outstanding
share of common stock. Earnings per Share (EPS) serve as an indicator of company‟s
profitability.EPS is calculated as:

(Net income – Dividends on Preferred Stock )

EPS=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑆ℎ𝑎𝑟𝑒𝑠

EPS is an important fundamental used in valuing a company because it breaks down a firm‟s
profits on a per share basis. This is especially important as the number of shares outstanding
could change, and the total earnings of a company might not be a real measure of profitability
for the investor.

 Independent Variable
The independent variables represent the credit risk management indicators. It includes Non-
Performing Loan Ratio (NPLR), Capital Adequacy Ratio (CAR), Cash Reserve Ratio (CRR)
and Book Value per Share (BVPS).

Non-Performing Loan Ratio (NPLR)

A non-performing loan (NPL) is the sum of borrowed money upon which the debtor has not
made his scheduled payments for at least 90 days. A non-performing loan is either in default
or close to being default. The non-performing loan ratio, better known as the NPL ratio, is the
ratio of the amount of non-performing loans in a bank‟s loan portfolio to the total amount of
outstanding loans the bank holds. The NPL ratio measures the effectiveness of bank in
receiving repayments on its loans.
14
Capital Adequacy Ratio (CAR)
Capital adequacy ratio (CAR) is used to describe or measure the bank's capital fund. It is
expressed as a percentage of a bank's risk-weighted credit exposures. This ratio plays a
significant role to protect depositors and promote the stability and efficiency of financial
system around the world and to examine the adequacy of the total capital fund and core
capital.

Cash Reserve Ratio (CRR)

Cash Reserve Ratio refers to a certain percentage of total deposits the commercial banks are
required to maintain in the form of cash reserve with the central bank. The main objective of
maintaining the cash reserve is to prevent the shortage of fund in meeting the demand by the
depositors.

Book Value per Share (BVPS)

Book value per share is a ratio that divides common equity value by the number of common
stock shares outstanding. The book value per share is one factor that investors can use to
determine whether a stock price is undervalued. If a business organization can increase its
BVPS, investors may view the stock as more valuable, and the stock price increases.

1.7 Limitation of the Study

This report is for the partial fulfillment of bachelor degree of business administration. The
efforts have been made to present and analyze the fact clearly and truly and within a specific
boundary. But the reliability of tools, lack of research experience, time limit and lack of data
are the primary limitation of this report.

 Only Nepalese commercial banks have been considered for the study and two joint venture
banks have been selected as samples for the study. Hence, the finding may not be
applicable to other banks i.e. Development Banks, Finance Companies and other
companies in Nepal.

15
 The whole study is based on secondary data, annual reports, and publication of respective
bank and also articles and journals of the respective topic, which may or may not provide
the exact vision of the field. So the reliability of this research will highly depend upon the
accuracy of information. If available data are not accurate, the whole findings of the study
will be meaningless.

 Past ten years secondary data from FY 2006/07 to FY 2015/16 are taken for study of two
joint venture banks, HBL and NIBL.

 The study is confined to limited bank considering time constraints. The findings should not
be generalized. Hence the study is just to fulfill the partial requirement of bachelors‟
degree of business administration.

1.8 Organization of the Study

According to the summer project guidelines for BBA 7th semester, the study should organize
into five chapters, each devoted to some aspects of Effects of Credit Risk on the Performance
of Nepalese Commercial Banks. The rationale behind this kind of study of organization is to
follow a simple research methodology approach.

Chapter one deals with major issues to be investigated along with the general background of
the study, statement of the problem, objective, significance, literature review, research
methodology, and limitation of the study. Literature review consists of conceptual review,
review of related studies and a conceptual model is developed by taking past and empirical
study as a base. Research methodology deals with research design, sources of data, and
methods of data collection, population and sample and techniques of data analysis.

Chapter two is devoted to data presentation and analysis, which includes organizational
profile, data presentation, and analysis of variables, findings, and discussion. Descriptive
statistical tools are used to analyze the data. Correlation and Regression analysis are carried

16
out with the help of Ms-Excel software 2007. Tables and trend chart are developed to present
data findings. Findings include the major evidence and major result derived from this study.

Chapter three includes conclusion and action implications of the study. The whole study is
briefly described with major findings and relevant ideas for better results. Action implications
deal with filling the defects to make the further study more relevant. Conclusions and action
implications concerns point started and the end and if conditions applied it could be better than
this.

17
 CHAPTER II
DATA PRESENTATION AND ANALYSIS

2.1 Organization Profile

Commercial banks is an institution that provides services such as accepting deposits, providing
loans, and offering basic investment products. There are 28 commercials banks in Nepal,
among them two joint ventures banks, Himalayan Bank Ltd (HBL) and Nepal Investment
Bank Ltd. (NIBL) are selected for the study. This report focuses on “Impact of Credit Risk on
the Financial Performance of Commercial Banks in Nepal.” including past 10 years data from
FY 2006/07 to FY 2015/16.

Himalayan Bank Ltd (HBL)

Himalayan Bank was established in 1993 in the joint venture with Habib Bank Limited in
Pakistan. Despite tough competition in the Nepalese Banking sector, Himalayan Bank has
been able to maintain a lead in the primary banking activities – loans and deposits. Himalayan
Bank is not only a bank, it is committed, Corporate Citizen. It holds a vision to become a
Leading Bank of the country. The bank‟s mission is to become the preferred provider of
quality financial services in the country.

The legacy of Himalayan lives on in an institution that‟s known throughout Nepal for its
innovative approaches to merchandising and customer service. Products such as PREMIUM
Savings Account, HBL Proprietary Card and Millionaire Deposit Scheme besides services
such as ATMs and Tele-banking were first introduced by HBL. Other financial institutions in
the country have been following HBL lead by introducing similar products and services.
Therefore HBL stands for innovation that it brings about in the country to help our customers
besides modernizing the banking sector. With the highest deposit base and loan portfolio
amongst private sector banks and extending guarantees to correspondent banks covering
exposure of other banks under our credit standing with foreign correspondent banks, HBL

18
believes it obviously leads the banking sector of Nepal. The most recent rating of HBL by
Bankers‟ Almanac as country‟s number 1 Bank easily confirms their claim.

All Branches of HBL are integrated into Globus (developed by Temenos), the single banking
software where the bank has made substantial investments. This helped the bank to provide
services like „Any Branch Banking Facility‟, Internet Banking and SMS banking. There are 18
branches inside valley and 31 outside the valley.

Nepal Investment Bank Ltd. (NIBL)

Nepal Investment Bank Ltd. (NIBL), previously Nepal Indosuez Bank Ltd., was established in
1986 as a joint venture between Nepalese and French partners. The French partner (holding
50% of the capital of NIBL) was Credit Agricole Indosuez, a subsidiary of one of the largest
banking group in the world.

Later, in 2002 a group of Nepalese companies comprising of bankers, professionals,

industrialists, and businessmen acquired the 50% shareholding of Credit Agricole Indosuez in
Nepal Indosuez Bank Ltd., and accordingly, the name of the Bank also changed to Nepal
Investment Bank Ltd. At present, the Bank's shareholding pattern is 69% by promoters and
31% by general public.

NIBL vision is to be the most preferred provider of Financial Services in Nepal. The Bank
fully complies with the provisions of Nepalese Money Laundering Prevention Act, 2008 and
regulations made there under and the Guidelines of our central bank viz. Nepal Rastra Bank
(NRB) regarding anti-money laundering. Bank's compliance with Anti-Money-Laundering
requirements and procedures is monitored by the NRB and by Bank's internal and external
auditors. NIBL, which is managed by a team of experienced bankers and professionals having
proven track record, can offer you what you're looking for. NIBL also provide ATM, debit
card, credit card, branchless banking, e-banking, SMS banking etc facilities to its customers.
There are 65 branches and four extension counter and information office.

19
2.2 Credit Risk and Profitability Position of Selected Commercial Banks
Data collected from various sources are processed and changed into the understandable
presentation using financial as well as statistical tools supported by diagrams and graphs.
Similarly, the process of transforming data is called analysis for the examination and
interpretation of the data to draw the conclusion. For the purpose of the study ten years data
from fiscal year 2006/07 to 2015/16 of two joint venture bank have been taken into
consideration i.e. Himalayan Bank Ltd. (HBL) and Nepal Investment Bank Ltd. (NIBL).

The detailed analysis carried out by comparing two joint venture commercial bank‟s (HBL and
NIBL) profitability and credit risk indicators in Nepal. Among two banks, whose performance
is better and degree of effects of credit risks.

2.2.1 Analysis of Earning Per Share (EPS)

Table 2.1 displays the mean value of HBL‟s EPS (44.539) is greater than of NIBL (42.42).
However, the standard deviation of HBL data over ten years shows more (SD=12.653) with
respect to the HBL than NIBL (SD=12.13). It indicates volatility and high earning risk with
respect to the HBL in absolute basis. Since the standard deviation measures absolute risk, a
coefficient of variation (CV) has also been calculated to analyze the relative earning risk.
Accordingly, the result shows the earning risk of NIBL is slightly greater than HBL (0.29
against 0.284). Hence, the NIBL EPS has a weak status than that of HBL.

20
Table 2.1
Data Analysis of Earning Per Share (EPS) of HBL and NIBL

Year HBL NIBL

2007 60.66 62.6
2008 62.74 57.9
2009 61.9 37.4
2010 31.8 52.5
2011 44.66 39.1
2012 39.94 27.6
2013 34.19 46.2
2014 33.1 40.7
2015 33.37 30.9
2016 43.03 29.3
Mean 44.539 42.42
S.D 12.653 12.13
CV 0.284 0.29
Source: Annual report of selected banks

The overview of the aforesaid analysis is illustrated in the trend chart. Figure 2.1 gives the
glimpse of the trend of Earning per share (EPS) of Himalayan Bank Ltd (HBL) and Nepal
Investment Bank Ltd (NIBL).

70
60
50
40
EPS (in rupees)

30 EPS of HBL
20
EPS of NIBL
10
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Year

Figure 2.1
Earnings per Share Position (EPS) of Selected Banks

21
2.2.2 Analysis of Non-performing Loan (NPL)
As depicted in Table 2.2, HBL‟s non-performing loan mean is 2.726 percent which is greater
than NIBL i.e. 1.46. The standard deviation of a non-performing loan of HBL is more than
NIBL (0.919 against 0.88) whereas CV of HBL is lesser than NIBL, which indicates relative
risk of NPL is greater in NIBL than HBL.

Table 2.2
Data Analysis of Non-performing loan of HBL and NIBL
Year HBL NIBL
2007 3.61 2.40
2008 2.36 1.10
2009 2.16 0.60
2010 3.52 0.70
2011 4.22 0.90
2012 2.09 3.30
2013 2.89 1.90
2014 1.96 1.80
2015 3.22 1.30
2016 1.23 0.70
Mean 2.726 1.46
S.D 0.919 0.88
CV 0.337 0.61
Source: Annual report of selected banks

The analysis above in table 2.2 is best described by the line graph below which gives the trend
of Nonperforming Loan (NPL) of both Himalayan Bank Ltd (HBL) and Nepal Investment
Bank Ltd (NIBL).

22
 4.5
NPL (in percentage) 4
3.5
3
2.5
2
NPL (%) of HBL
1.5
1 NPRL (%) OF NIBL
0.5
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Year

Figure 2.2
Non-performing Loan (NPL) Position of Selected Banks

2.2.3 Analysis of Capital Adequacy Ratio (CAR)

Table 2.3 indicates that the mean value of HBL and NIBL„s capital adequacy ratio is 11.175
and 11.68 percent respectively. As per NRB requirements, CAR must be ten percent as both
joint venture bank Himalayan Bank Ltd and Nepal Bank Limited has maintained more than
ten percent on average.

Table 2.3
Data Analysis of Capital Adequacy Ratio (CAR) of HBL and NIBL
Year HBL NIBL
2007 11.13 12.20
2008 12.42 11.30
2009 11.02 11.20
2010 10.72 10.60
2011 10.68 10.90
2012 11.02 11.10
2013 11.55 11.50
2014 11.23 11.30
2015 11.14 11.90
2016 10.84 14.90
Mean 11.175 11.68
S.D. 0.507 1.23
C.V. 0.045 0.11
Source: Annual report of selected banks.
23
Table 2.3 indicates that the mean value of HBL and NIBL„s capital adequacy ratio is 11.175
and 11.68 percent respectively. As per NRB requirements, CAR must be ten percent as both
joint venture bank Himalayan Bank Ltd and Nepal Bank Limited has maintained more than
ten percent on average. The absolute risk of CAR of HBL is 0.507 percent whereas NIBL has
1.23 percent. This indicates HBL‟s capital adequacy ratio has lesser absolute risk than NIBL.
Similarly, the C.V of capital adequacy of HBL is slightly less than C.V of NIBL i.e. (0.045
percent against 0.11 percent). Hence, the CAR of NIBL is riskier.

The analysis above in table 2.3 is best described by trend graph below which gives the trend of
Capital Adequacy Ratio (CAR) of both Himalayan Bank Ltd (HBL) and Nepal Investment
Bank Ltd (NIBL).

16
14
CAR (in percentage)

12
10
8
6 CAR (%)of HBL
4 CAR (%) OF NIBL
2
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Year

Figure 2.3
Capital Adequacy Ratio (CAR) Positions of Selected Banks

2.2.4 Analysis of Cash Reserve Ratio (CRR)

As depicted by Table 2.4 cash reserve ratio of NIBL seems strong. The mean value of NIBL‟s
CRR (11.52) is much greater than HBL (6.843). Similarly, the standard deviation (S.D) of
NIBL‟s CRR over ten years shows higher volatility and high risk than that of HBL (3.85
against 1.297). While coefficient of variation of NIBL is higher than HBL, it shows slightly
high risk in NIBL„s CRR in relative basis than that of HBL.C.V of NIBL‟s CRR is 0.33 and
HBL‟s CRR is 0.189.

24
Table 2.4
Data Analysis of Cash Reserve Ratio (CRR) of HBL and NIBL
Year HBL NIBL
2007 5.92 10.50
2008 5.13 10.90
2009 6.76 10.30
2010 6.76 7.80
2011 5.75 7.70
2012 8.72 13.60
2013 6.08 16.00
2014 8.72 19.20
2015 8.32 12.00
2016 6.27 7.20
Mean 6.843 11.52
S.D. 1.297 3.85
C.V. 0.189 0.33

The overview of analysis is illustrated in the trend chart. Figure 2.4 gives the trend of cash
reserve ratio (CRR) of both Himalayan Bank Ltd (HBL) and Nepal Investment Bank Ltd
(NIBL).
25
CRR ( in percentage)

20

15

10 HBL
5 NIBL

0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Year

Figure 2.4
Cash Reserve Ratio (CRR) Position of Selected Banks

25
2.2.5 Analysis of Book Value per Share (BVPS)
Table 2.5 displays book value per share of HBL seems strong. The mean value of HBL‟s CRR
(219.564) is much greater than NIBL (181.89). However, the standard deviation (S.D) of
HBL‟s BVPS (27.647) over ten years has slightly higher volatility and high risk than that of
NIBL (27.14) in absolute basis. While coefficient of variation of NIBL is higher than HBL, it
shows slightly high risk in NIBL„s BVPS in relative basis than that of HBL.C.V of NIBL‟s
BVPS is 0.15 and HBL‟s BVPS is 0.126.

Table 2.5
Data Analysis of Book Value per Share of HBL and NIBL
Year HBL NIBL
2007 264.74 234.40
2008 247.95 223.20
2009 256.52 162.40
2010 226.79 190.00
2011 199.77 171.00
2012 193.00 161.00
2013 192.02 169.00
2014 209.92 166.00
2015 208.81 155.00
2016 196.12 187.00
Mean 219.564 181.89
S.D. 27.647 27.14
C.V. 0.126 0.15

The data displayed in Table 2.5 is best described by trend graph below which gives the trend
of Book Value per Share of selected banks.

26
 300
BVPS (in rupees)
250
200
150
100 HBL

50 NIBL

0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Year

Figure 2.5
Book Value per Share (BVPS) Position of selected banks

2.3 Descriptive Statistics of Study Variables

Table 2.6 reports that there is single bank performance indicator earning per share (EPS) and
four independent variables. They are non-performing loan (NPL), capital adequacy ratio
(CAR), cash reserve ratio (CRR) and book value per share (BVPS).

Table 2.6
Data and Descriptive Statistics of Study Variable -Both Banks (n=20)
Variables Mean S.D. Kurtosis Skewness Range Minimum Maximum
EPS 43.48 12.11 -1.19 0.51 35.14 27.60 62.74
NPL 2.10 1.09 -0.93 0.31 3.64 0.58 4.22
CAR 11.43 0.95 9.88 2.86 4.37 10.55 14.92
CRR 9.18 3.69 1.73 1.40 14.07 5.13 19.20
BVPS 200.73 32.93 -0.73 0.47 109.74 155.00 264.74
Source: Annual report of selected banks

The result shows that the average value of the bank performance (EPS) is 43.48 during the
period of 2006-2016, that means on average per share of sample commercial banks in Nepal
earns 43.48. The standard deviation of earning per share is 12.11 which show the lack of
substantial variation.

27
Recognizing the role of the nature and shape of data distribution in further statistical analysis,
the skewness and kurtosis of EPS have been measured as a part of descriptive statistics.
Skewness reflects the asymmetry of distribution. As a result shows, the coefficient of
skewness regarding EPS data of sample commercial banks (0.51) seems the distribution is
moderately skewed. The general consensus of statistics states that coefficient of skewness
between -1 and -0.5 or between 0.5 and 1 considers as moderately skewed.

On the other hand, kurtosis is the degree of peakness of a distribution. A distribution with a
negative kurtosis value indicates that the distribution has shorter and thinner tails and lower
and broad central peak than the normal distribution. The non-performing loan ratio among the
sample commercial banks in Nepal is varied from 0.58 to4.22 percent with the mean and
standard deviation 2.10 percent and 1.09 percent respectively which indicates volatility among
the banks‟ ability in credit risk management.

The coefficient of skewness regarding NPL data of sample commercial bank (0.31) seems the
distribution is approximately symmetrical. The general consensus of statistics states that
coefficient of skewness between -0.5 to 0.5 considers as approximately symmetric. On the
other hand, a distribution with negative kurtosis value indicates that the distribution has
shorter and thinner tails and lower and broad central peak than a normal distribution. Hence,
non-performing loan of sample banks indicates such situation.

The minimum capital adequacy ratio is 10.55% that is higher than regulatory requirement of
10% which is the evidence of the compliance of sample banks regarding Nepal Rastra Bank‟s
Directives 2015 and Basel II requirements. The coefficient of skewness regarding CAR data of
sample commercial banks (2.86) seems the distribution is highly skewed. The general
consensus of statistics states that coefficient of skewness if less than -1 or greater than +1, the
distribution is highly skewed. The value of kurtosis is positive and kurtosis value is 9.88 called
leptokurtic. Compared to a normal distribution, its central peak is higher and sharper and its
tails are longer and flatter.

28
Table 2.6 shows that minimum observation of cash reserve ratio is 5.13% which is slightly
lower than regulatory requirement of 6% which can be taken as non compliance of banks
regarding Nepal Rastra Bank‟s Unified Directives. According to data above in Table 2.6, the
distribution of CRR is highly skewed (1.40) and the distribution has positive kurtosis 1.73, so
compared to a normal distribution, its central peak is higher and sharper, and its tails are
longer and flatter.

On average book value per share are 200.73 with the standard deviation of 32.93. The
minimum and maximum book values per share are 155.00 and 264.74 respectively. The
distribution of skewness (0.47) is approximately symmetric and has negative kurtosis called
platykurtic compared to the normal distribution, its central peak is lower and broader and its
tails are shorter and thinner.

2.4 Relationship between Profitability and Credit Risk Indicators

In an effort to analyze the nature of correlation between dependent and independent variables,
Pearson correlation analysis has been computed. Correlation indicates the relationship between
the variables.

Table 2.7
Pearson Correlation Coefficients-Both Banks (n=20)
Variable EPS NPL CAR CRR BVPS
EPS 1
NPRL 0.021858 1
CAR -0.10388 -0.29052 1
CRR -0.18792 -0.20709 -0.02478 1
BVPS 0.700222 0.402591 -0.01913 -0.56648 1

Results are drawn using Excel-2007 version

The correlation matrix that is shown in Table 2.7 indicates that non-performing loan is
positively associated with profitability but the magnitude of association is weak with the
correlation coefficient of 0.021858. However, capital adequacy ratio as well as cash reserve
29
ratio is negatively correlated with profitability but their magnitude of profitability seems weak.
The correlation coefficient between profitability and book value per share is positive but the
magnitude of relationship is high that can be evidenced by Pearson‟s correlation coefficient
(0.7). Since, the correlation coefficient among independent variables is less than 0.8, meaning
that the multicollinearity problem may not arise and the selected independent variables are
suitable to be used in the regression model.

2.5 Effect of Credit Risk on the Profitability of Commercial Banks

For analyzing the effect of credit risk on the profitability of commercial banks of Nepal,
regression analysis has been computed. Regression analysis is analysis using specified and
associated data for two or more variables such that one variable can be estimated from the
other variable.

Table 2.8
Regression Results of Effects of Credit Risk on Bank Performance
(EPSit = β0+ β1NPLit + β2CARit+ β3CRRit+ β4BVPSit+ eit)
Variable Dependent Variable: EPS
Coefficients Standard Error t Stat P-value
Constant -5.39363 28.70319 -0.18791 0.85347
NPRL -4.23298 1.88860 -2.24133 0.04056
CAR -2.38906 1.98704 -1.20232 0.24788
CRR 1.01649 0.59122 1.71932 0.10612
BVPS 0.37715 0.07087 5.32143 0.00009
R2 = 0.67099; Adjusted R2 = 0.58326; F-stat= 7.64799; F-sig=0.00144

Results are drawn using Excel-2007 version

Table 2.8 presents the regression results of the effect of credit risk on bank performance. The
value of R2 and adjusted R2 are 0.67099 and 0.58326 respectively. The overall explanatory
power of the regression model is fair with R2 of 0.67099. This indicates that 67.099% of the

30
variation in bank performance can be explained by the variation in the explanatory variables.
The p-value for F-statistics in the model represents model is fairly fitted well statistically since
p-value of F-statistics is less 0.01. The results from Table 2.8 indicate that the coefficient of
non-performing loan (a measure of default rate) is negative but statistically significant. The
finding of this study supports the hypothesis that non-performing loan has a significant effect
on bank performance. Moreover, the result indicates that increase in non-performing loan ratio
reduces the profitability (earning per share) of Nepalese commercial banks.

The coefficient of capital adequacy ratio is negative but statistically insignificant. So, the
finding of the study doesn‟t support the hypothesis that capital adequacy ratio has a significant
effect on bank performance.

Cash reserve ratio in the estimated regression model assumes that changes in cash reserve ratio
(CRR) have an inverse impact on banks‟ profitability. Contrary to prior expectation, the result
indicates that the coefficient of cash reserve ratio is positive and statistically insignificant. The
result of this study reveals that cash reserve ratio doesn‟t significantly affect the performance
of commercial banks in Nepal.

Book value per share has a significant positive association with bank performance. The result
of this study indicates that increase in book value per share significantly enhances the
performance of commercial banks in Nepal. The coefficient of capital adequacy ratio is
insignificant meaning that it cannot explain the variation of a dependent variable (EPS).
Likely, the coefficient of cash reserve ratio is also insignificant which indicates that cash
reserve ratio has a negligible effect on bank performance in Nepalese context.

2.6 Findings and Discussion

This study is carried out to identify the effects of credit risk on bank performance in Nepalese
context. The data of both independent and dependent variables over ten years are obtained
from selected bank‟s annual reports and they are used in this study using Excel Spreadsheet
Software. Major findings while analyzing the data are pointed out be

31
 The higher mean of EPS among two sample banks is of Himalayan Bank Ltd. (HBL) i.e.
44.539. Similarly, HBL also has the higher mean (2.726 percent) of Non-Performing Loan
(NPL).
 Both HBL and NIBL have maintained more than minimum Capital Adequacy Ratio (CAR)
as specified in NRB Directive i.e. 11.175 and 11.68 percent respectively. However, NIBL
has maintained slightly high Capital Adequacy Ratio (CAR).
 On average, Cash Reserve Ratio (CRR) of NIBL is greater than HBL (11.52 against 6.843).
However, both banks have maintained cash reserve ratio greater than specified by NRB
Directive.
 HBL has higher mean of Book Value per Share (BVPS) than NIBL (219.564 against
181.89).
 The Pearson‟s Correlation Coefficient result indicates the bank performance (EPS) is
positively correlated with non-performing loan ratio (NPLR) and book value per share
(BVPS), whereas the bank performance (EPS) is negatively correlated with capital
adequacy ratio (CAR). Likely, there is a negative relationship between cash reserve ratio
and earnings per share.
 The regression model revealed that Non-performing loan (NPL) has a negative and
statistically significant impact on bank performance. Cash Reserve Ratio and Book Value
per Share have a positive and statistically significant impact on bank performance. As the
regression model, the coefficient of capital adequacy ratio is a negative and statistically
insignificant impact on bank performance (EPS).

32
 CHAPTER III
CONCLUSION AND ACTION IMPLICATIONS

3.1 Conclusion
The main purpose of this study is to investigate the impact of credit risk on the performance of
Nepalese commercial banks. The data of two commercial banks with 20 observations for the
period of 2006 to 2016 have been used for the analysis. The regression model revealed that
Non-performing loan (NPL) has a negative and statistically significant impact on bank
performance. Cash Reserve Ratio and Book Value per Share have a positive and statistically
significant impact on bank performance.

The finding of this study indicates that the sampled commercial banks have poor credit risk
management practices. This is evidenced by the insignificant result of Capital Adequacy
Ratio. It indicates that capital adequacy ratio couldn‟t be regarded as the influencing variable
for bank performance. As the coefficient of capital adequacy ratio is negative and statistically
insignificant, the study rejects that Nepalese commercial banks with higher capital adequacy
ratio can advance more loans and absorbs credit losses whenever they crop up and record
better performance.

Moreover, the negative coefficient of Non-performing loan ratio confirms the negative effect
on bank performance.NPL ratio, in particular, indicates how banks manage their credit risk
because it defines the proportion of loan losses amount in relation to total loan amount in
relation to the total loan amount. All these evidences support that Nepalese commercial banks
have poor credit risk management.

This study has found the significant relationship between bank performance and credit risk
indicators. Hence, Nepalese commercial banks have poor credit risk management.

33
3.2 Action Implications
The study “Effects of credit risk on the financial performance of Nepalese Commercial Bank”
was based on the secondary data derived from respective banks (HBL and NIBL) annual
report from FY 2006/07 to 2015/16. The secondary data collected includes the proxy of
profitability (EPS) and proxies of credit risk i.e. non-performing loan ratio, capital adequacy
ratio, cash reserve ratio and book value per share. From the study, it could be taken into
consideration that there are effects of credit risk on the bank‟s performance.

Based on the analysis, interpretation and conclusions, some recommendations are made here.
This study was undertaken with two commercial joint venture banks only. A further study
should be undertaken to further explore the effects of credit risks by employing more samples
and carrying out detail analysis of banks. The study could be more interesting to include more
indicators to test the relationship. Meanwhile, it can help researchers to enhance the accuracy
of the research model with the most suitable variables.

For banking industry‟s development, diversified types of banks have built to satisfy the
demand of innovation of financial market. This study focus on commercial banks while credit
risk also affects development banks performance. Not only credit risk, liquidity risk, market
risk, operational risk can also be taken into consideration.

Banks need to place and devise strategies that will not only limit the bank‟s exposition to
credit risk but will develop performance and competitiveness of the banks, and banks should
establish a proper credit risk management strategies by conducting sound credit evaluation
before granting loans to customers.Based on findings from the data analysis part, the study
offers action implications that to improve credit risk management and to have an effective role
in achieving profitability. Nepalese commercial bank should take into consideration, the
indicators of credit risk i.e. non-performing loan ratio, cash reserve ratio and book value per
share that were found to have a statistically significant impact on bank performance
.

34
 REFERENCES

Bhattarai, Y. R. (2016). Effect of Credit Risk on the Performance of Nepalese Commercial

Banks. NRB Economic Review. 28(1), 42-64.

Coyle, B. (2000). Framework for Credit Risk Management, United Kingdom: Chartered
Institute of Bankers.

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 APPENDICES

Appendices –I

Data of the selected banks for study

NPRL CAR CRR

Year Bank EPS (%) (%) (%) BVPS
2006/7 HBL 60.66 3.61 11.13 5.92 264.74
2007/8 HBL 62.74 2.36 12.42 5.13 247.95
2008/9 HBL 61.90 2.16 11.02 6.76 256.52
2009/10 HBL 31.80 3.52 10.72 6.76 226.79
2010/11 HBL 44.66 4.22 10.68 5.75 199.77
2011/12 HBL 39.94 2.09 11.02 8.72 193.00
2012/13 HBL 34.19 2.89 11.55 6.08 192.02
2013/14 HBL 33.10 1.96 11.23 8.72 209.92
2014/15 HBL 33.37 3.22 11.14 8.32 208.81
2015/16 HBL 43.03 1.23 10.84 6.27 196.12
2006/7 NIBL 62.57 2.37 12.17 10.47 234.37
2007/8 NIBL 57.87 1.12 11.28 10.91 223.17
2008/9 NIBL 37.42 0.58 11.24 10.32 162.35
2009/10 NIBL 52.50 0.67 10.55 7.80 190.00
2010/11 NIBL 39.10 0.94 10.91 7.70 171.00
2011/12 NIBL 27.60 3.32 11.10 13.60 161.00
2012/13 NIBL 46.20 1.91 11.49 16.00 169.00
2013/14 NIBL 40.70 1.77 11.27 19.20 166.00
2014/15 NIBL 30.90 1.25 11.90 12.00 155.00
2015/16 NIBL 29.30 0.68 14.92 7.20 187.00
Source: Annual report of selected banks and data were analyzed using excel 2007.
 Appendices –II

Descriptive Statistics

NPRL CAR CRR

EPS BVPS
(%) (%) (%)

Mean 44.539 2.726 11.175 6.843 219.564

Standard Error 4.001 0.291 0.160 0.410 8.743

Median 41.485 2.625 11.075 6.515 209.365

Standard Deviation 12.653 0.919 0.507 1.297 27.647

Sample Variance 160.110 0.844 0.257 1.681 764.333

Kurtosis -1.452 -0.761 4.078 -1.190 -1.263

Skewness 0.637 0.066 1.840 0.554 0.680

Range 30.940 2.990 1.740 3.590 72.720

Minimum 31.800 1.230 10.680 5.130 192.020

Maximum 62.740 4.220 12.420 8.720 264.740

Sum 445.390 27.260 111.750 68.430 2195.640

Count 10.000 10.000 10.000 10.000 10.000

Source: Data are analyzed and extracted from Excel 2007
 Appendices –III

Regression Results

Model Summary

Regression Statistics
Multiple R 0.819143
R Square 0.670995
Adjusted R Square 0.58326
Standard Error 7.819364
Observations 20

ANOVA
df SS MS F Significance F
Regression 4 1870.467 467.6169 7.647989 0.001444
Residual 15 917.1369 61.14246
Total 19 2787.604

Independent variables: Non-Performing Loan, Capital Adequacy Ratio, Cash Reserve Ratio
and Book Value per Share.
Dependent variable: Earning per Share