Factors Affecting Default Risk of Commercial Banks: Evidence from Ethiopian Banking Industry

Abstract

The primary aim of banking industry is collecting funds from the community and extending credit to encourage business development and support a growing economy.  While default risk is one of the main risks of banks and affects the development of the financial system. This  study  was  conducted  to  investigate  the  factors that  affect default  risk  of  Ethiopian Commercial banks.To achieve this research objective quantitative research design was used and data was collected mainly through secondary sources. The study applied a balanced fixed effect panel data of eight Ethiopian commercial banks for six years (2005- 2011). The audited annual reports (Balance sheet and income statements) of Ethiopian commercial bank were obtained from National Bank of Ethiopia (NBE). Both macroeconomic and bank specific default risk factors were investigated using fixed effect panel data model.The study reveals that  leverage, operating  inefficiency  and  loan  growth  have  a  positive  statistically  significant  relationship  with  default risk.  Whereas  loan  to  deposit  ratio  has  a  significant  negative  relationship  with  default risk.  In terms of ownership, government owned banks are more risky than private banks. Accordingly, leverage, operating inefficiency, loan growth, ownership  and  loan  to  deposit  ratio  are  significant  determinants of  default risk of  Ethiopian  commercial  banks  in  the  study  period.  Generally, in this study bank specific variables have more significant effect than macroeconomic variables. So, the result of the study is of value to policy making, practice and further research.

Keywords: Default Risk, Commercial Banking Industry, Macroeconomic and Bank Specific Variable and Ethiopia