Impact of economic performance and monetary policies on credit risk in Kenya’s banking sector

Abstract

The paper investigates the influence of Economic performance and monetary policies on Credit risk in Kenya’s banking sector. By employing a panel data regression spanning from 2007 to 2024, this research assesses the nature of the relationship between the set of macroeconomic indicators and monetary policy tools against measures of credit risk. Specifically, GDP growth rate, unemployment, and core inflation as macroeconomic variables, while Kenya Central Bank's rate (CBR) and money supply growth rate stand in for the monetary policy actions. Nonperforming loans serve as a proxy for credit risk. Bank-specific factors have been included in the regression as they play a role in the credit risk of banks, these include Capital Adequacy Ratio (CAR) and Loan to Deposit Ratio (LDR). The study finds that stronger GDP growth is associated with lower credit risk, while higher unemployment levels significantly increase the likelihood of non-performing loans. In contrast, core inflation and changes in the CBR show no significant direct impact on credit risk. An expansion in the money supply, though negatively related to credit risk, does not have a statistically significant effect, suggesting its influence is indirect and may depend on broader economic conditions.