Credit risk management and Its effect on profitability of microfinance companies in Nepal

Abstract

The main purpose of the study is to examine the credit risk management and its effects on profitability of Microfinance companies in Nepal during the period of 2013/14-2022/23. Correlation and multiple regression analysis are used to analyze the data. This study shows that the Microfinance company have low credit risk and lending policy of banks is sound and effective as it is acceptable up to a certain limit or below five percent. Profitability position in terms of ROA and ROE, Microfinance could manage their overall operations due to highest ratio as well as good financial performance. The correlation analysis reveals that cash reserve ratio and non-performing loan has insignificant positive relation with ROA and insignificant negative relation with ROE. Likewise, there is insignificant negative correlation between loan to deposit ratio and ROA and significant positive relationship between credit to deposit ratio and ROE. Moreover, there is significant negative relationship between bank size and ROA but there is insignificant positive relationship between bank size and ROE of the banks. The multiple regression shows that cash reserve ratio has insignificant impact on profitability (ROA and ROE) of the Microfinance companies. Then, credit to deposit ratio has significant positive impact on ROA and it has insignificant positive impact on ROE. However, non-performing loan ratio has negative impact on profitability of the sample banks and microfinance. At the same time, Capital adequacy has insignificant positive impact on ROA and significant positive impact on ROE. Finally, bank size has significant negative impact on profitability on ROA but insignificant negative impact on ROE of Microfinance in Nepal. Hence it can be concluded that credit to deposit ratio, non-performing loan, Capital adequacy ratio, cash reserve ratio and banks size are the major indicators of credit risk and its effects on profitability of Microfinance companies in Nepal. Keywords: Profitability, cash reserve ratio, loan to deposit ratio, capital adequacy ratio and non-performing loan.