The effect of risk management on financial performance: the case of commercial banks in ethiopia

Abstract

In the aftermath of the global financial crisis, risk management became a major area of focus for stakeholders in the financial sector. This study was aimed to examine the effect of risk management on commercial banks’ financial performance in the context of Ethiopia. Return on assets was used as indicator of financial performance indicators while credit risk, liquidity risk, solvency risk, operational risk, interest rate risk, and foreign exchange rate risk were used as proxies for risk management. The study target population was all 18 commercial banks in Ethiopia and the study covered a period of 10 years from 2010 to 2019. To this end, the study adopts a mixed research approach by combining documentary analysis and in-depth unstructured interviews. The data was obtained from published annual financial statements of thirteen (13) commercial banks in Ethiopia. Descriptive statistics, correlation, and regression analyses were applied to analyze Time-Series Cross-Sectional balanced secondary data. The results of regression analysis showed that credit risk, liquidity risk, solvency risk, operational risks have a negative and significant effect on financial performance, while foreign exchange rate risk has a statistically significant and positive influence on the financial performance of the Commercial banks in Ethiopia. Based on the panel regression approach, the study concluded that the risk management variables considered in this study were a key factor in affecting the financial performance of commercial banks in Ethiopia. Thus, the study suggested that Commercial banks in Ethiopia should maintain a proper balance between risk management practices and financial performance by engaging in appropriate credit, liquidity operational, and market risk management that will ensure safety for their banks and yield positive profits.