Journal of International Business Research and

Marketing
Volume 2, Issue 3, 2017
journal homepage: www.researchleap.com

The Impact of Credit Risk on the Financial Performance of Chinese Banks

Juliana Stanley Isanzu
School of Management, Wuhan University of Technology, China

ABSTRACT
2017 Research Leap/Inovatus Services Ltd. The study aim was to empirically examine the impact of credit risk on the financial
All rights reserved. performance of Chinese banks. Secondary data was collected from five largest commercial
banks in the country for the period of 7 years from 2008 to 2014. The study used
DOI: 10.18775/jibrm.1849-8558.2015.23.3002
nonperforming loans, capital adequacy ratio, impaired loan reserve, and loan impairment
URL: http://dx.doi.org/10.18775/jibrm.1849-
8558.2015.23.3002
charges as measures of credit risk and for a measure of financial performance return on asset
was used. Data analysis was done using a balanced panel data regression model, and the study
Keywords: findings reveal nonperforming loan and Capital adequacy have a significant impact of on
China; financial performance of Chinese commercial banks; therefore, the need to control credit risk
Credit risk;
is crucial for bank financial performance.
Financial performance;
Banks.

1. Introduction Committee on Banking Supervision- BCBS (1999) defined credit risk as

The Management of the risk-return tradeoff is imperative for the banks to the potential that a bank borrower or counterparty will fail to meet its
maintain their profitability. Since their core activity is credit creation, this obligations in accordance with agreed terms.
renders credit risks inevitable. As a result, credit risk is among the core
risks related to the bank main income generation activity. According to a Banks generate income mainly through credit creation, which also results
Feb. 13 China Banking Regulatory Commission report, credit risks has in huge risks to the lender and the borrower. The smooth functioning of
been observed to continue to increase for Chinese banks through 2014, the bank can be greatly jeopardized by a failure of the trading partner to
with nonperforming loans of the country's commercial banks increasing fulfill their contractual obligation in due date. A bank with a high credit
from 250.6 billion Yuan to 842.6 billion Yuan from the previous year. risk has high bankruptcy risk that puts the depositors in jeopardy. Interest
However, the regulator still assures the public that banks' asset quality rates charged by banks are fast overtaken by inflation and borrowers find
was still under control. it difficult to repay loans in unstable economic environments because real
income falls, leading to increased insider loans and over-concentration in
It should be noted that it is an established fact in many literature of certain types portfolios giving rise to credit risk. But in a bid to survive
banking that the losses of many banks are a result of the Non-Performing and maintain profits in this highly competitive environment, banks have
Loans. Increases in NPLs rate are often associated with the failure of the the tendency to take unnecessary risks. In 1994, many bank failures
bank's credit policy. It is also evident that the financial crisis which occurred in Mexico, 1980s banking crises in Kenya and 1990s in Spain
occurred in the US in the late 2000s and spread in most parts of the world were attributed to lack of experience, improper lending practices,
was indeed a result of default on loans and mortgages. Although, the increasing the tendency for greater risk taking and organization, and lack
major causes of bad debts are the failure of borrowers to pay back, which of information systems to adequately assess credit risk in the falling
is often caused by the uneconomic use of loans, high-interest rate and low economy.
per capita income. Extra flexible credit rationing policy can also be a
source high NPLs rate in the midst of the high competitive banking 2. Literature review
environment of today's world. Hence, it is clear why banks need to Noman. A et al (2015) Study was to find the effect of credit risk on the
manage credit risk which is mainly from NPLs as it is very crucial for profitability of Bangladesh banks. The study used an unbalanced panel
banks survival and profitability. data and 172 observations from 18 private commercial banks from 2003
to 2013. The study uses NPLGL, LLRGL, LLRNPL and CAR as credit
Credit risk according to Basel Committee of Banking Supervision BCBS risk indicators and ROAA and ROAE and NIM as profitability indicators.
(2001) is the possibility of losing the outstanding loan partially or totally, Using OLS random effect model, GLS and system GMM the study finds
due to credit events (default risk). Credit events usually include events a robust negative and significant effect of NPLGL, LLRGL on all
such as bankruptcy, failure to pay a due obligation, profitability indicators. The results showed a negative and significant
repudiation/moratorium or credit rating change and restructure. Basel effect of CAR on ROAE. The results also revealed that the effect of the

14 Journal of International Business Research and Marketing, vol. 2, issue 3, pp. 14-17, March 2017
 15 Journal of International Business Research and Marketing

implementation of Basel II is significantly positive on NIM but financial status, business sustainability, reputation, and liquidity, but the
significantly negative on ROAE. unpredictable market situations make it difficult for banks to rely on these
Kipngetich and Muturi (2015) study focused on assessing the effect of determinants. Business conditions are often unpredictable and can lead to
credit risk management on the financial performance of SACCOs with changes in the borrower's financial position thus affecting their ability the
specific reference to SACCOs in Bomet County. SACCOS remain the repay the loans.
most important players in the provision of financial services and have
deeper and extensive outreach than any other type of financial institution. The impact of Credit risk on financial performance has been a topic of
They provide savings, credit and insurance services to a large portion of interest to many scholars since credit risk has been identified as one of
the Kenyan population. SACCOs have contributed to a large extent to the the major factors known to impact the financial performance of banks.
continuous economic development in Kenya, by offering financial Amongst others who have carried out extensive studies on the topic, their
services to the poor and small scale businesses. However, the growth of results have not been in consensus. While others found credit risk to
SACCOs has been inhibited by several challenges relating to effective impact positively on bank's financial performance, others found a
credit risk management strategies. The dependent variable used was a negative relationship and others asserted that other factors apart from
financial performance of the SACCOs while the independent variables credit risks which impact on bank's performance because they did not find
were comprised of Capital adequacy and Management efficiency. The convincing evidence otherwise. The overall objective of the study is to
sample size for 18 SACCOs was selected to participate in the study. All investigate the impact of credit risk on the financial performance of five
the predictor variables (CAR, and ME) had a positive relationship with major Chinese banks which aims to provide managerial and policy
financial performance. The CAR coefficient of the predictor variables implications but also a contribution to existing literature on the subject
was significant at 5% level of significance except for ME. The findings matter. The study will answer the specific research questions:
confirm that there is a statistically significant influence of CAR on the
financial performance of SACCOs. Is there a significant relationship between Non-Performing Loans and
financial performance of Chinese banks?
Raad M.L (2015) The study aimed at adding knowledge on how CRM Is there a significant relationship between Capital Adequacy and financial
practices help to increase profitability and long-term sustainability of performance of Chinese banks?
commercial banks. Credit risk management covers identification, Is there a significant relationship between Impaired Loan Reserves and
measurement, matching mitigation, monitoring and control of the credit financial performance of Chinese banks?
risk exposures. The researcher used secondary data relating to the Is there a significant relationship between Loan Impairment Charges and
financial status of Basic Bank Ltd and did a comprehensive overview financial performance of Chinese banks?
about CRM in a different phase of the report. First a description of CRM
practice and performance of BBL. Then analyzed the impact of CRM on 4. Data and Methodology
the financial performance of the bank. The researcher used MS Excel as The study adopted a similar model as used by Gizaw et al 2015 where
well as SPSS software to establish a relationship between CRM and banks ROA will be used as a measure of financial performance the dependent
profitability. Findings revealed that credit risk management for banking variable, the independent variable credit risk will be measured by Non-
is vital since banks make a profit from their credit disbursement. Effective performing loan ratio, Capital Adequacy ratio, impaired loan reserve, and
CRM proved to help increase the present and future financial loan impairment charges, which were found to be suitable for the country
performance of the bank. The relationship between CRM and Banks of study and also data availability according to the reporting standards.
profitability was found to be positive thus effective CRM contributes to Bank financial statement for the time period of 2008-2014 from the
Banks financial performance. bank’s website was be used to obtain the data for the variables.

Perhaps the most compelling rationale for the researcher to pursue credit The model: ROA = β0 + β1NPL+ β2CAR+ β3IMPLR+ β4LIMPC + e
risk is because it causes variability of profits which leads to a reduction Where β0 is a constant term, β1 - β4 coefficients of independent variables
in the bank's earnings. Significant loss of earnings can lead to ROA is a dependent variable net income / total asset
stakeholders losing confidence in the bank's operations, it also reduces NPL is Non-performing loan ratio
credit available for prospective loan applicants, compromises the bank's CAR is Capital Adequacy ratio
liquidity and causes failure to meet its obligations and subsequent loss of IMPLR is impaired loan reserve ratio
the strategic bank position in the industry. Sometimes it can cause the LIMPC is loan impairment charges
withdrawal of license or charter and even bankruptcy. It is for this reason
that the study aims to investigate the impact of credit risk on bank's Return on Assets is the measure of efficiency; it determines how well the
financial performance to help understand the effect, solidify the need for bank uses its scarce resources to generate profits. It is the ratio of net
allocating time and resources for effective credit risk management. income to the total asset. The higher the ratio is an indication of a better
financial performance. It was also used in similar studies by Francis 2013,
3. Research problem and objectives Athanasoglou et al. (2008); Perera et al. (2013).
It is not doubted that innovation and in general research and the nature of
the banking business is very sensitive because more than 85% of their Nonperforming loans to gross loan (NPL) as credit risk indicators as used
liabilities are customer's deposits (Saunders, Cornett, 2005). Banks then by Kolapo et al., 2012; Rajan & Dhal, 2003; Samad, 2004. It measures
use these deposits to generate credit for their borrowers, which is the main the percentage of gross loans that are nonperforming or doubtful in banks'
revenue generating activity for most banks. With the increase of credit loan portfolio. It is considered as one of the most important indicators of
transactions and loan customers in the nation's economy, credit expansion credit risk and loan quality the bank. Lower the ratio is the indication of
is inevitable. The trend in the sector shows growing bank deposit-loan better asset quality and lowers doubtful loan, therefore, lower credit risk
ratio as the economy grows but unfortunately so is credit risk growth. and the better the financial performance.
Traditionally, credit was made available in association with one's
 16 Journal of International Business Research and Marketing

Capital adequacy ratio (CAR) also used by Francis (2013); Masood and Table 2: Results of the Regression Analysis
Ashraf (2012); Perera et al. (2013) is recommended by Basel accord for
judging asset quality and prudent credit risk management. It is the ratio Variable Coefficient Std. Error t-Statistic Prob.
of total capital to risk adjusted assets of the bank. The higher the ratio is C 0.951014 0.110405 8.613838 0.0000
the indication of adequacy of the bank’s capital and better assets quality, NPL -0.100689 0.020561 -4.897053 0.0000
therefore, low credit risk. This is also an independent variable and is CAR 0.061692 0.020931 2.947407 0.0067
chosen because it is the core measure of a bank's financial strength from IPLRESERV -0.005743 0.028358 -0.202512 0.8411
a regulator's point of view. It consists of the types of financial capital LICHARGE 0.031600 0.086913 0.363583 0.7191
considered the most reliable and liquid, primarily shareholders' equity. Weighted Statistics
Banks with good Capital Adequacy Ratio have good financial R-squared 0.903090 Mean dependent var 1.474038
performance.
Adjusted R-
squared 0.873272 S.D. dependent var 0.708524
Impaired loan reserve ratio to gross loan (IMPLR) as credit risk indicators
S.E. of
as used by Boahene et al. (2012); Kolapo et al. (2012); Samad (2004).
regression 0.066985 Sum squared resid 0.116661
This ratio measures the percentage of gross loan which has been set side
but not yet charged off. Historically higher the ratio is the indication of
Adjusted R-squared is coefficient is used to tell us the amount of variation
weak loan portfolio management quality and high credit risk.
in the dependent variable which is due to changes in the independent
variable. From the findings in the table above the value of adjusted R-
Loan Impairment Charge to gross loan (LIMPC) as a measure of credit
squared is 0.873, indicating that there was variation of 87.3 percent on the
risk shows the percentage of loans which have been charging off as
financial performance of Chinese banks due to changes in nonperforming
impaired loans thus has an impact on the financial performance as it
loans, capital adequacy, Impaired loan reserve ratio and Loan Impairment
reduces the profitability of the bank. The ratio shows the irrecoverable
Charge at a 95 percent confidence interval. R is the correlation coefficient
impaired loans and the higher ratios shows inefficiency and high credit
which shows the strength of the relationship between the study variables
risk faced by the bank.
which in our case is 0.90 which shows a strong relationship between the
study variables.
5. Findings and Discussion
Table 1 presents the descriptive statistics of the variables used in the
As expected relationship between nonperforming loan ratio and financial
study, the four measures of credit risk indicator which are the ratio of
NPL, CAR, IMPLR, LIMPC and the measure of financial performance performance is found to be negative and significant indicating that high
ROA. nonperforming loan reduces the bank's ROA. Keeping other repressors
constant, the results show that one unit rise in nonperforming loan
Table 1: Descriptive Statistics decreases returns on assets by 0.10 units. Other researchers who also
found a negative impact includes Kolapo et al. (2012) and Ruziqa (2013).
N Min. Max. Mean Std. Deviation
roa 35 .8200 1.4600 1.1931 .16820 Capital adequacy is said to increase the strength of the bank which
npl 35 .8500 4.3200 1.4511 .72112 improves the capacity of the bank to buffer or absorb impaired loan losses
car 35 3.8600 7.5600 6.2248 .87218 and ensure the bank can continue to run efficiently as a going concern.
implr 35 2.0500 4.4600 2.7117 .67143 The results show that capital adequacy was found to have a positive and
lichgl 35 .2900 1.2200 0.6262 .26092 significant effect on return on assets. Keeping other repressors constant,
Valid N 35 the results show that one unit rise in capital adequacy increases returns on
(listwise) assets by 0.06 units. Similar results were also found by Kosmidou, et al
2005 and Gizaw, 2015. The findings reveal that Chinese commercial
All commercial banks are required to follow regulations of central bank banks depend on the equity capital as the source of funding and it is used
regarding different statutory issues of risk management. It is evident from to enhance profitability which is evident by the increase in financial
the low standard deviations that credit risk management quality is similar performance.
among the used banks. The nonperforming loan ratio has a maximum
value of 4.3 to minimum of 0.85 percent with the mean and standard The effect of impaired loan reserve to gross loan on return on asset was
deviation 1.45 and 0.72 respectively which indicates there is low also found to be negative as by Kolapo et al., 2012 and Sufian, 2009
volatility among the ability of banks to manage credit risk. The minimum because as banks use more profit as a buffer against their impaired loans
capital adequacy ratio is 3.86 percent with is lower than regulatory the profitability will also reduce. The beta coefficients of impaired loans
requirement of 10 percent which means there are some banks which are reserve ratio indicate that keeping other variables constant a unit increase
noncompliance as they have not been reaching the required level of Basel in the ratio decreases return on assets by 0.006 unit.
II standards. The Impaired loan reserve ratio has a minim of 2.05 and a
maximum of 4.46 with a standard deviation of 0.671 which is also low. The effect of the ratio of loan impairment charges on ROA is found to be
The Loan impairment charges are very low which is desirable since it positive. The results reveal that a unit increase in loan impairment charges
represents the actual loan charge-off, as it is evident with the minimum of leads to an increase in financial performance by 0.03 units while keeping
0.29 and a maximum value of 1.2 with a low standard deviation of 0.6 other variables constant. This means that Chinese banks have been able
signifying a low variation among banks. The measure of financial to find a way to keep the impaired loans charges to gross loan ratio within
performance ROA has a minimum value of 0.82 and a maximum of 1.4 a rate that is enhancing its profitability. Some of the impaired loans
with a very low standard deviation of 0.168 which is evident that the actually get recovered before they are written off as bad debts which
performance among banks is nearly similar.
 17 Journal of International Business Research and Marketing

increase financial performance. This was evident from the low levels  Perera, S., Skully, M., & Chaudhry, Z. (2013). Determinants of
found in the banks of this ratio. Commercial Bank Profitability: South Asian Evidence: Asian
Journal of Finance & Accounting, 5(1), 365-380.
6. Conclusion and Suggestions  Raad Mozib Lalon (2015). Credit Risk Management (CRM)
Credit creation being the main activity of the bank is inevitable, and it Practices in Commercial Banks of Bangladesh: A Study On Basic
also exposes the bank to credit risk. By employing panel data regression Bank Ltd.: International Journal of Economics, Finance and
analysis, the study aimed to find the impact of credit risk on the financial
performance of major Chinese banks for eight years. The results revealed Management Sciences Vol 3(2): 78-90, CrossRef
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