International Journal of Management (IJM)

Volume 12, Issue 3, March 2021, pp.148-154, Article ID: IJM_12_03_013

Available online at http://iaeme.com/Home/issue/IJM?Volume=12&Issue=3
ISSN Print: 0976-6502 and ISSN Online: 0976-6510
DOI: 10.34218/IJM.12.3.2021.013

© IAEME Publication Scopus Indexed

EFFECT OF RISK MANAGEMENT ON BANKS’

FINANCIAL PERFORMANCE: EVIDENCES
FROM ETHIOPIAN COMMERCIAL BANKS
Lemaa Belay Zeleke
Ph D -Scholar at School of Management Studies,
Jawaharlal Nehru Technological University Hyderabad (JNTUH), Telangana, India

Dr. Sindhu
Professor and Director at School of Management Studies,
Jawaharlal Nehru Technological University Hyderabad (JNTUH), Telangana, India

ABSTRACT
The purpose of this study was to examine the effect of risk Management aspects such
as, managing credit risk, managing operational risk, managing Liquidly risk and
managing Market risk on Financial performance (Return on asset and Return on equity)
of banking sectors in Ethiopia. The data of five years from 17 Ethiopian commercial
banks was taken and the regression result showed that non performing loan ratio and
Loan Loss Provision Ratio (Managing Credit risk) has significantly impact both Return
On Asset and Return On Equity but Capital adequacy ratio has significance only if
financial performance is measured by ROA. Loan to deposit ratio, exchange rate and
inflation rate didn’t indicated significance effect on Ethiopian commercial banks.
Key words: Risk, Risk Management, Financial Performance, Commercial banks
Cite this Article: Lemaa Belay Zeleke and Sindhu, Effect of Risk Management on
Banks’ Financial Performance: Evidences from Ethiopian Commercial Banks,
International Journal of Management (IJM), 12(3), 2021, pp. 148-154.
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1. INTRODUCTION
Regardless of its size under the poor risk Management situation, the prosperity of every bank
could be affected which could result low profit margin of the bank and make it be more
irrelevant in highly aggressive market. Hence that profitability to be attained, bank must stick
on its financial operations with different regulations and guidelines (Olalere & Dr. Wan, 2016).
Banks Performance is not only depends on having more total (assets, equity and operating fixed
assets), so it does not show that having higher total (assets, operating fixed assets and equity)
could have superior efficiency (Abbas, Tahir, & Mutee-ur, 2012). In Ethiopia the banking
industries showed a persistent increase throughout the study periods(2004 to 2010) with a
tremendous improvement in profitability based upon size of deposits, disbursement of loan and

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 Lemaa Belay Zeleke and Sindhu

ownership of assets, however, after this period there was an increase with decreasing rate
compare to other neighbor countries in Africa (Habtamu, 2015) that raised from the failure of
managing risk and unable to mobilizing people toward saving habit, as well as collection of
disbursed loan in banking sector

2. LITERATURE
Study in Ethiopia (Tesfaye, 2014 ) on Commercial Banks found that the capacity of handling
credit risk, diversification the sources of their revenue and handling capacity of different
operating cost showed the significance role for return on asset of the banks. In addition to this
he also prove that initial start up money and amount of liquidity of the bank, Gross Domestic
Product growth rates of the country, and bank size didn’t significantly affect return on asset of
the bank , however, inflation rate is significant factor for the change of banks’ return on asset.
Using the Combination of panel data and crossectional design (Melaku, 2016) conducted
the study on Determinants of Bank Profitability in Ethiopia, Case Study of Private Commercial
Banks and concluded that Bank size, Capital of the bank, productivity, and liquidity has positive
and significant relationship with return on asset. However, loan loss Provision is significantly
and inverse relationship with return on asset that has high contribution. A study result on banks
in Ethiopia, (Moges, 2017) point out that there were positive and significant effect of bank size
; Gross Domestic Product growth rate but interest rate of the bank have a opposite sign and
importantly connected with return on asset but LTDR is inversely significant. However, no
significant effect on Return on equity. Also his study result showed, Inflation at 10% has
significant relation with return on asset but, it has no effect on return on equity. In addition to
this, loan consideration index has positive and significant impact on return on equity of the
banks. A study made by (Michael, 2011) found that , Bank size is negative and significant,
equity over asset gave significant in all models, the loan to asset ratio has positive and
significant, The relationship of economic environment, interest rate, allowance for loan loss
ratio and ratio of liquidity with total risk is statistically significant.
Research reviewed by (Fentaw & Dr. Dhiraj, 2017) revealed that macroeconomic factors,
such as real Gross Domestic Product growth rate and inflation rate, are found paramount
important factors affecting directly or indirectly the profitability of commercial banks. Study
made in Ethiopia by (Tadele, 2016), identified several factors like liquidity and deposit as
important factors that improve bank efficiency, while quality of loan, expenses, profitability,
bank’s size and diversification were statistically insignificant. Banks should work hard to
collect more deposits by design different strategies like convenience of location and quality of
customer services to become efficient because it has a positive significance effect on efficiency.
Liquidity has also an important role to improve bank’s efficiency, so banks should improve
their lending capacity based on critically analyses strategies. Ethiopian Commercial banks’
Panel data analysis was made by (Kokobe & Birhanu, 2015), and regression result showed that,
all bank and industry related variables and other macroeconomic elements affect ROA of the
bank significantly. However, the fluctuation of inflation rate was not influenced ROA
significantly. The result of Study in Indonesia (Eddy Winarso, 2017) showed that NPL and
OEOI significantly and negatively related to ROA banking sector, CAR, LDR, and the NIM
has non-significant impact on ROA in banking sector.
Study made in Indonesian banking industries by (Erna Sari and etal,2018) found Risk
management and profitability has positive relationship with performance but tier 1 has no
relationship with performance; has positive with risk management and negative with
profitability. Profitability negatively and performance positively affect tier 1 capital but risk
management doesn’t has an effect on profitability. Employing financial ratios and descriptive
statistical tools (Mengistu, 2015 ) Conducted a study on Zemen bank in Ethiopia, found that

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 Effect of Risk Management on Banks’ Financial Performance: Evidences from
Ethiopian Commercial Banks

financial performance of zemen bank during study period (2009 to 2014 years) showed stable
improvement that was not fluctuating over time. He measured the Profitability of the Bank by
employing return on asset, return on equity, and net income margin and the result of the ratios
revealed that zemen bank had scored growth pattern of those ratios in the first few years.
However, it has consistently changing in the others years of the study.

Hypothesis
• Ho: There is no significance effect of managing risk on Return on asset (ROA)
Sub hypothesis:
HO1: There is no significance effect of managing credit risk (NPLR, LLPR) on Return
on asset (ROA)
HO2: There is no significance effect of managing Operational risk (CAR) on Return on
asset (ROA)
HO3: There is no significance effect of managing Liquidity risk (LTDR) on Return on
asset (ROA)
HO4: There is no significance effect of managing Market risk (EXR, IFR) on Return on
asset (ROA)
• Ho: There is no significance effect of managing risk on Return on equity ( ROE)
Sub hypothesis:
HO5: There is no significance effect of managing credit risk (NPLR, LLPR) on Return
on equity (ROE)
HO6: There is no significance effect of managing Operational risk (CAR) on Return on
equity (ROE)
HO7: There is no significance effect of managing Liquidity risk (LTDR) on Return on
equity (ROE)
HO8: There is no significance effect of managing Market risk (EXR, IFR) on Return on
equity (ROE)
Resaerch Concepual Frame Work- After reviewing literature the following conceptual
frame work was developed.This frame work incorporate Managing varios risks and its relation
with bank performances (according to Basel III on risk management in banks).
Managing Credit Risk (Loan loss
provision and Non performing Loan
Ratio)

Managing Operational risk (Capital

Adequacy Ratio)
Financial Performance
of the bank
Managing Liquidity Risk (Loan to
deposit ratio) (ROA and ROE

Managing Market Risk (Inflation and

Ex. rate)

Figure 1 Concepual Frame Work

Source: developed based on literature and Basel- III accord

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 Lemaa Belay Zeleke and Sindhu

3. RESEARCH METHOD
The nature of current research is empirical and this study adopts deductive reasoning. The
research process of this study starts with an exhaustive review of literature in order to
understand the background of research. Based upon this contextual understanding, research
hypotheses are developed. This study was conducted through Time series research design in
which a five year data from 17 Ethiopian commercial has been taken, using secondary data
from annual reports (2013/14-2017/18 years) of banks in Ethiopia. The study population is all
registered commercial banks under National Bank of Ethiopia. In Ethiopia there are 17
commercial banks; and, using census means all banks was selected. For measurement of risk
management, financial ratio analysis (NPLR, LLPR, CAR, LTDR, EXR and IR) was computed
as proxy of risk management and ROA and ROE have taken as measurement of bank financial
performance. Multiple linear regressions were utilized to explore the relationship between risk
management and the financial performance of selected banks. Research Model Specification,
the regression model estimate has been specified in line with the objectives of the study. Model
shows all the independent variables in the framework for the study to examine the effect of
these variables on Financial Performance of the bank
Model: BANKFINPERFCE nt= β0 +β1BSIZE nt + β2 CARnt + β3NPLRnt +β4LLPRnt + β5
LTDR nt + β 6EXRnt +β7INFRnt + β8DUMI.PUBnt +β9DUMIPVTnt + 𝑒 nt………………. (1)
Where, BANKFINPERFCE nt = Financial Performance of nth bank has at time t, BSIZE nt=
Size of the n th bank has at time t, CARnt = Capital adequacy ratio which nth bank has at time t,
NPLRnt= Non-performing loans ratio which n th bank has at time t , LLPR nt= Loan loss
provision ratio which nth bank has at time t , LTDR nt =Loan to deposit ratio which nth bank has
at time t , EXRn=Exchange Rate which n th bank has at time t, INFRnt= Inflation rate which nth
bank has at time t, 𝑒nt = Error term which n th bank has at time t, β1,β2,β3,β4,β5,β6,β7 , β8 and
β9 are the coefficients that measured by employing the Multiple linear regression model.

4. RESULT
Under the circumstance of measuring the performance of the banks by Return on Assets (ROA),
Multiple regression result showed that (R2 = O.756), indicated 75.6% of variation on ROA is
explained by independent variables such as: Capital adequacy ratio, Exchange rate, Non
Performing Loan Ratio, Loan Loss Provision Ratio, Loan to Deposit Ratio, Net Interest Margin,
Bank size, and Inflation rate and the Simultaneous effect of these variables have significance
impact (F= 21.333, p = .000) on Return on Assets (ROA). Since, (F=21.333, P=0.000) is
significance at 1% significance level, there is significance effect of managing risk on return on
asset (ROA) of Ethiopian commercial banks. Loan loss provision ratio (LLPR), is significance
at 1 significance level and Non performing loan ratio also significance at 5% significance level,
hence that there is significance effect of managing credit risk on ROA. From table, Capital
adequacy ratio (CAR) is significant which favor alternative hypothesis. Therefore, there is
significance relationship of Managing operational Risk and financial performance (ROA) of
Ethiopian banks. Loan to Deposit Ratio (LTDR) is insignificant and, there is no evidence to
reject HO, hence that loan to deposit ratio has no significance effect on financial performance
(ROA) of Ethiopian banks. Both exchange rate and inflation rate showed insignificance result,
which means that there is no evidence that exchange rate and Inflation rate has significant effect
on ROA of Ethiopian commercial banks. Therefore, H O is accepted which means that there is
no significance effect of Managing Market Risk on financial performance (ROA) of Ethiopian
commercial banks.

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 Effect of Risk Management on Banks’ Financial Performance: Evidences from
Ethiopian Commercial Banks

Table 1 regression analysis results, if Bank performance is measured by ROA

Independent Coefficients t Sig. Collinearity Statistics
Variables Toleranc
B Std. Error e VIF
CAR .130 .015 8.739 .000 .533 1.875
LLPR .049 .012 4.173 .000 .910 1.099
NPLR .367 .342 1.073 .03 .930 1.075
LTD .000 .000 .893 .375 .841 1.189
NIM .091 .027 3.334 .001 .729 1.372
INFR -.005 .020 -.273 .786 .255 3.919
BNKSIZE -2.508E-010 .000 -5.363 .000 .479 2.088
EXR .047 .036 1.312 .194 .220 4.541

R2= 0.756, F= 21.333, P<5%

Using Return on Equity (ROE) as Proxy measure of bank performance, Loan Loss provision
ratio, Non performance loan ratio and net interest margin are positive and significant, whereas
Bank size is inversely significant effect on ROE. From ANOVA table, (F=33.632, P=0.000)
revealed the significance at 1% significance level and Ho is rejected. Therefore, there is
significance effect of managing risk on return on equity (ROE) of Ethiopian commercial banks.
Loan loss provision ratio (LLPR), is significance at 1 significance level and Non performance
loan ratio also significance at 5% significance level, so that there is evidence to reject HO, in
other, there is significance effect of managing credit risk(NPLR, LLPR) on ROE.
Capital adequacy ratio (CAR) is insignificant which favor null hypothesis. Therefore, there
is no significance relationship of Managing operational Risk and ROE of Ethiopian banks. Loan
to Deposit Ratio (LTDR) is insignificant. Therefore, there is no evidence to reject HO, hence
that loan to deposit ratio has no significance effect on financial performance (ROE) of
Ethiopian banks. Both exchange rate and inflation rate showed insignificance result, which
means that there is no evidence that exchange rate and Inflation rate has significant effect on
ROE of Ethiopian commercial banks. Therefore, H O is accepted which means that there is no
significance effect of Managing Market Risk on financial performance (ROE) of Ethiopian
banks.

Table 2 Regression results, if Bank performance is measured by ROE

Independent Coefficients t Sig. Collinearity Statistics
Variables Toleranc
B Std. Error e VIF
CAR -.144 .094 -1.539 .128 .533 1.875
LLPR .393 .074 5.296 .000 .910 1.099
NPLR 1.552 2.167 .716 .04 .930 1.075
LTD .002 .002 .759 .450 .841 1.189
EXR .345 .229 1.508 .136 .220 4.541
INFR -.001 .125 -.011 .991 .255 3.919
NIM .445 .174 2.563 .013 .729 1.372
BNKSIZE -1.552E-009 .000 -5.239 .000 .479 2.088

R 2= 0.83, F=33.632, P=0.000

The hypothesis of this study and the decision made on null hypothesis based on regression
result was summarized on table 3.

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 Lemaa Belay Zeleke and Sindhu

Table 3 Summary of hypothesis test result and decision

Null Hypothesis ( H O ) Result Decision
A There is no significance effect of managing risk on Return on asset (ROA) Significant Rejected
1 There is no significance effect of managing credit risk (NPLR) on Return on asset (ROA): Significant Rejected
2 There is no significance effect of managing credit risk (LLPR) on Return on asset (ROA): Significant Rejected
3 There is no significance effect of managing operational risk (CAR) on Return on asset (ROA) Significant Rejected
4 There is no significance effect of managing liquidity risk (LTDR) on Return on asset (ROA) insignificant accepted
5 There is no significance effect of managing Market risk (EXR) on Return on asset (ROA). insignificant accepted
6 There is no significance effect of managing Market risk (IFR) on Return on asset (ROA). insignificant accepted
B There is no significance effect of managing risk on ROE Significant Rejected
7 There is no significance effect of managing credit risk (NPLR) on Return on equity (ROE) Significant Rejected
8 There is no significance effect of managing credit risk (LLPR) on Return on equity (ROE) Significant Rejected
9 There is no significance effect of managing operational risk (CAR) on Return on equity (ROE) insignificant accepted
10 There is no significance effect of managing liquidity risk (LTDR) on Return on equity (ROE) insignificant accepted
11 There is no significance effect of managing Market risk (EXR) on Return on equity (ROE). insignificant accepted
12 There is no significance effect of managing Market risk (IFR) on Return on equity (ROE). insignificant accepted

5. DISCUSSION
Risk of banks could be measured having adequate capital, expecting credit default bank,s
provision for loan loss and management of nonperforming loan which is the significance factor
for ROA, especially credit management is main factor for variation on both return on asset and
equity. Similar to study found by (Meleku, 2016, Eddy Winarso, 2017) Bank size, LLP ratio or
managing Credit risk has significant impact on ROA and also in line with (Moges 2017,
Michael 2011 and Meleku, 2016) LTDR/managing liquidity risk and LLPR/ managing credit
risk indicated significance influence on financial performance in banking sectors, but study by
(Tesfaye,2014) contradicting to this found that LTDR indicated insignificance result. The same
as found by (Meleku 2016, moges 2017, Michael 2011 )Bank size significance effect but study
found by( Tesfaye ,2014 )contradict with this results.

6. CONCLUSSION
Establishment of banking business with adequete size and Managing operational risk (keeping
Capital adequecy ) has high influence with ROA in banking sector in Ethiopian Commercial
banks.Managing credit risk through having loan loss provision ratio and Non performance loan
ratio has significance influence on financial performance of the banks. Loan to deposit ratio,
exchange rate and inflation rate (managing market risk) didn’t indicated significance effect on
Ethiopian commercial banks.

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