DETERMINANTS OF EFFECTIVNESS OF RISK MANAGEMENT in PRIVATE COMMERCIAL BANKS IN ETHIOPIA.

Abstract

Banks and other financial institutions usually play a significant intermediary role between borrowers and lenders for the progress of a stable and healthy economy of a nation. In Ethiopian banking industry Commercial banks are the most dominant banks categorized as public and private banks. This study was designed to examine the relationship between risk management effectiveness and its determinants in private commercial banks. Capital adequacy was used as a proxy for risk management effectiveness in commercial banks. Ten explanatory variables namely bank specific factors (credit risk, liquidity risk, profitability, bank size, operating effectiveness, market risk) and Macroeconomic factors (GDP growth, inflation, lending interest rate and exchange rate) were used as independent variables. From the total population of 16 private commercial banks purposive sampling technique was used to select eight private commercial banks in Ethiopia. Secondary data were used to estimate the relationship between independent variables and capital adequacy ratio of banks. Balanced panel data set of ten fiscal years was collected from the audited financial statements of selected private banks in Ethiopia for the period of 2012 – 2022. Both descriptive statistics and econometric model was employed where descriptive statistics were used to describe the variables. In a panel regression analysis random effect model was used to determine the effect of bank specific and macroeconomic variables on risk management effectiveness of banks. The regression result shows that credit risk has negative impact where Bank size and profitability has a positive effect on risk management effectiveness in private commercial banks. The macroeconomic factors have positive effect on risk management effectiveness of private banks where exchange rate has a significant effect. The study concludes that risk management effectiveness of banks is highly determined by bank specific and macroeconomic factors and private commercial banks are recommended to introduce risk based control systems in overall banking system operations and Businesses.