The Effect of Credit Risk on Financial Performance of Nepalese Commercial Banks

This study examines the impact of credit risk on the financial performance of commercial banks in Nepal. The sample selection for this study is based on a purposive sampling method. Out of the 20 commercial banks in Nepal, 13 were selected as the sample for analysis. This study examines the published, audited annual reports specifically the financial statements, income statements, and cash flow statements of these 13 commercial banks over a 10-year period, from 2014 to 2023. The total number of observations in this study is 130, and involving of three dependent variables ROA, ROE, and NPM and six independent variables i.e. NPLR, CAR, LR, LDR, CFR, and AWISR for analysis. This selection is aimed at effectively justifying and addressing the core objectives of the research. Further, this study used unbalance panel data for the period of 2014 to 2023. Breusch and Pagan Lagrangian multiplieer test found that panel model is more appropriate and Husman test concluded that random effect model is more appropriate for ROA, ROE and Fixed effect model is more appropriate for NPM in this study. The findings highlight that higher Non-Performing Loan Ratios (NPLR) significantly reduce profitability across these indicators, emphasizing the need for robust credit risk management. The Cost of Funds (CFR) also plays a critical role, with higher CFR lead to lower ROA, ROE, and NPM. In contrast, a higher Average Weighted Interest Spread Rate (AWISR) positively influences ROA and ROE, though its effect on NPM is less clear. Liquidity management, indicated by the Liquidity Ratio (LR), positively affects ROE and NPM but has a less significant impact on ROA. The Capital Adequacy Ratio (CAR) shows a positive effect on ROA but a mixed impact on ROE and NPM. Lastly, the Loan-to-Deposit Ratio (LDR) generally negatively impact on financial performance, particularly ROA and ROE, while its effect on NPM is negligible. The study concludes that Nepalese commercial banks should prioritize effective credit risk management, control funding costs, optimize interest rate strategies to enhance profitability and financial performance. This study provides deeper insights into improving the financial performance of Nepalese commercial banks. Key Words: Credit risk, financial performance, Return of Assets, Return of Equity, Net Profit Margin, Nepalese Commercial Bank, Panel data.