The determinants of credit risk of commercial banks in Botswana

Abstract

The study investigated the determinants of credit risk of commercial banks in Botswana from 2005 to 2017. The study used fixed effects model to meet the objectives. Commercial banks used in the study are Barclays Bank of Botswana, Standard Chartered Bank of Botswana and First National Bank of Botswana. Variables used are non-performing loan ratio as a proxy for credit risk and the dependent variable whereas the independent variables are management efficiency, capital adequacy ratio, return on asset, loan to deposit, inflation rate, unemployment rate and GDP growth rate. Bank specific factors were sourced from bank audited financial statements while macroeconomic variables are taken from the Bank of Botswana, Statistics Botswana and World Bank Group. Furthermore, fixed effects model was appropriate to examine the determinants of credit risk as per the Wald test undertaken. The study used lagged variables as the effect of the shock may not be transmitted immediately to other variables. The results from the regression showed that management efficiency, capital adequacy ratio, loan to deposit, return on asset, inflation rate and unemployment are statistically significant. Inflation, unemployment, management efficiency and capital adequacy ratio have negative relationship with credit risk whereas return on assets and loan to deposit have a positive relationship. Furthermore, only GDP growth rate is statistically insignificant in influencing credit risk. Based on the findings, the study suggest that banks should be focused on the key drivers of credit risk such as return on asset, inflation rate, unemployment, management efficiency, loan to deposit and capital adequacy ratio in order to reduce the probability of default in the Botswana commercial banks. Capitalized banks are good in absorbing more losses, which resulted from defaults. The study notes that poor credit evaluation; monitoring and wrong collateral evaluation can lead to future growth in non-performing loans. Additionally, banks should diversify their lending activities to productive sectors in the economy as a way to mitigate credit risk. Furthermore, banks should diversify their income stream from interest income to non-interest revenue.