Risk Reward: Unveiling Credit Risk and Performance of Commercial Banks in Nepal

Abstract

Recent structural change, regulatory capital requirement related adjustment by Nepal Rastra bank, and rising assets quality concern of lending portfolio have shaped bank profitability. In this regard, there is great concern with credit management and performance of banks. Applying descriptive and causal research design and utilizing the annual reports data of ten commercial banks in Nepal for the fiscal year of 2076/77 to 2080/81 B.S., the aim of this study is to establish the dynamic relationship between credit risk and performance of commercial banks in Nepal. The study used panel data regression techniques. The appropriate model is selected on the basis of Redundant Fixed Effects Tests, Correlated Random Effects - Hausman Test and omitted Fixed Effect model. The findings of this study reveal that credit risk negatively impacts the financial performance of commercial banks in Nepal. Non-Performing Loans (NPL) and total Loan Loss Provisions (LLP) have a negative impact on both Return on Assets (ROA) and Return on Equity (ROE), implying that low-quality assets can pose serious risks to banks' financial performance. Likewise, Capital Adequacy Ratio (CAR) has a positive impact on the financial performance of the bank, implying that well-capitalized banks tend to achieve high performance levels. An increase in the Loan-to-Deposit Ratio (LDR) reduces ROA due to increased credit risk, and LLP has the most adverse effect on the profitability indicator ROE. Therefore, the study concludes that effective credit risk management is crucial for enhancing the financial performance of commercial banks in Nepal. The results provide valuable insights for bank management, policymakers, and regulators to formulate strategies that balance risk and return for sustainable banking performance.