Academic journal article European Journal of Sustainable Development

The Impact of Credit Risk Management in the Profitability of Albanian Commercial Banks during the Period 2005-2015

Academic journal article European Journal of Sustainable Development

The Impact of Credit Risk Management in the Profitability of Albanian Commercial Banks during the Period 2005-2015

Article excerpt

1.Introduction

Today risk plays an important role in the activity of fanancial and non-financial institutions. Almost for each decision managers and executives should calculate the expected risk and return. The effective risk management is essential for the success and continuity of business activity. In the banking system, the risk management plays an important role and regulators are responsible for controling banks risk taking in order to avoiding financial and economic crises. Among other risk, such as market risk, operational risk and legal risk etc, the major cause of banks problems are related to the credit risk.

Due to the role of credit risk on the profitability of commercial banks the main purpose of this research is to study if it exist a relationship between credit risk management and profitability of commercial banks in Albania.

In order to analyze the impact of credit risk management on the profability of commercial banks in Albania the following research questions and hypotheses are made:

Research question:

What is the relationship between credit risk management and profitability of commercial banks in Albania during the period 2005-2015?

Hypotheses:

Hypothesis 1: NPLR (non-performing loan ratio) and CAR (capital adequancy ratio) have an impac on the ROE (return on equity) of commercial banks in Albania.

Hypothesis 2: NPLR and CAR have an impact on the ROA (return on assets) of commercial banks in Albania.

1.1 Limitations

Initially our study intended to analyze the data of the period 2005-2015 in order to have a larger number of observations. Indeed we collected the data from March 2007 to December 2015 because the data used for this study were available only starting from March 2007. Also we used quarterly data and not monthly data given that CAR is published by Bank of Albania every 3 months.

2.Theorical framework

2.1 Definition of credit risk

The main risk faced by the banks today is credit risk, which is defined as: "The potential that a borrower will fail to meet its obligations (principal, interests, commissions), on time or in accordance with the agreed terms "1. Banks are required by law to maintain Loan Loss Reserves2 in order to cover the losses caused by theloans. Credit risk arises from a debtor being unlikely to pay its obligations or its financial capacity deteriorated resulting in an economic loss for the bank. The loss could be equal to the entire amount of the loan or a part of the loan granted to the borrower.

The loss results from a reduction of loan portfolio value resulting from the deterioration of actual or perceived loans quality. The real credit risk is the deviation of portfolio performance from the expected value. Credit risk is also the risk of deterioration of the financial position of the issuer of securities (stocks, bonds). Credit risk rise from loan agreements signed between a bank and individuals, corporations, financial institutions or state. For the majority of banks loans are the most important and most visible source of credit risk, however, credit risk derives from other banking activities such as on and off balance sheet activities 3. Banks are facing credit risk also when they trade various financial instruments including: bank receipts, interbank transactions, exchange rate transactions, future, swaps and options contracts.

The credit risk can be categorized according to the reasons of the failure. For example the failure may be due to the countyr in which the bank has the exposure or as a result of problems in the performance and completion of the transactions. The bank should identify, measure, monitor and control the credit risk related to its activities and determine capital adequacy ratio.

The main objective of the Credit Risk Management is to maximize bank return adjusted to the risk and keeping an acceptable level of exposure to credit risk. The risk must be managed on "Related Parties"4 level. …

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