Abstract:
Commercial banks play a significant role in economic development and support
economic growth in any nation through their role as financial intermediaries and
providers of financial services to communities and international organizations. With the
help of the financing facilities they provide, both private investors and institutional
investors can explore and widen their options for profitable investment. Considered a
stand-in for a bank's financial stability is the credit quality. The risk of default and non-
performing loans, which increases the likelihood that assets and loans would no longer
be recovered, is known as the credit risk. Despite the fact that numerous research on
credit risk have been done in the past, the issue is still up for debate. Therefore, this
study sought to examine whether capital adequacy ratio moderates the relationship
between credit risk and financial performance of commercial banks in Kenya. The
specific objectives were to examine the effect of non-performing loan rate, net charge-
off rate and pre-provision profit/ loss rate on financial performance of commercial
banks. The study further examined whether capital adequacy moderated the relationship
between non-performing loan rate, net charge-off rate, pre-provision profit/ loss rate
and financial performance of commercial banks in Kenya. The study was grounded on
the stakeholder theory and the agency theory of firms. The target population was forty-
two commercial banks in Kenya over the period between 2011 and 2021. After the
application of an inclusion and exclusion criteria the final sample was 35 banks that
yield 385 firm-year observations. The secondary data and was extracted from the
Central bank of Kenya and the individual bank’s financial statements. The data was
analyzed through descriptive and inferential statistics with the aid of STATA. The study
employed hierarchical multiple regression to test the hypotheses. The results of
Hausman guided the choice of either the random effect or the fixed effect regression
models. The finding revealed that non-performing loan rate (β = -0.1802 and ρ-
value<0.05), net charge-off rate (β = -0.0704 and ρ-value<0.05); and pre-provision
profit/ loss rate (β= 0.141 and ρ-value<0.05); on financial performance had a significant
effect on financial performance of commercial banks in Kenya. Additionally, the
regression results confirmed that capital adequacy moderated the association between
non-performing loan rate (β = 0.222 and ρ-value<0.05), net charge-off rate (β = 0.357
and ρ-value<0.05), and pre-provision profit/ loss rate (β = 0.295 and ρ-value<0.05); on
financial performance. In light of this, the study concluded that credit risk significantly
contributes to Kenyan banks' profitability and that capital sufficiency has an impact on
this relationship. This study advises banks to strengthen their credit management
strategies as a way of improving their profitability. Additionally, in an effort to enhance
bank performance, bank management and the regulator should comprehend the critical
balance between credit risk and bank capital. Future research might take into account
additional aspects of bank financial performance and investigate how they relate to each
other in rations with various regulatory capital requirements and credit exposure.