The impact of credit and operational risks on financial performance of commercial banks in Rwanda: a partial least square structural equation model approach evidence from five selected commercial banks in Rwanda

Abstract

The aim of this study was to assess the effect of credit risk and operational risk on financial performance of selected Rwandan commercial banks that are registered at Rwanda Stock Exchange. The specific objectives were to assess the levels of credit risk, operational risks, and bank’s financial performance, and to examine the effects of both credit and operational risks on the financial performance of commercial banks operating in Rwanda. To achieve these objectives, this study used a partial least squares structural equation model (PLE-SEM) estimation technique with data sourced from banks’ financial statements and annual reports for the period of 2013 to 2018. Results in this study show that higher credit risks as proxied by non-performing loans (NPL) ratio significantly reduces banks’ return on assets (ROA) and moderately increases banks return on equity (ROE). In addition, higher operational risks significantly reduce banks’ return on assets but increases banks’ return on equity. In other findings, banks’ age significantly increases banks’ financial performance (both ROA & ROE). This study provides both academic and policy implications. It adds to the rare literature on the measures of credit and operational risks as required by Basel II & III financial requirements on Pillar II (Capital requirements). In addition, it uses a novel and rarely used estimation technique in measuring banks’ financial performance (PLE-SEM). This study also contributes to policy by recommending central bank to implement proficient credit risk and operational risk management measures in place to protect the financial performance of the commercial banks. This will not only protect the assets of the banks and safeguard investors’ interests but also harden to the business entities, individuals’ benefit and the entire economy at large. Regulators should also set policies that will reinforce the banking industry mainly policies that bothers around risk management.