Influence of Credit Risk on Intermediation Efficiency of Commercial Banks in Kenya

The banking sector in Kenya demonstrates a low intermediation efficiency of 67.5%, which limits its capacity to effectively perform its essential function in fostering economic growth. This study aimed to explore the effect of credit risk on the intermediation efficiency of commercial banks in Kenya. The study was anchored on agency theory and employed an explanatory sequential design, incorporating both secondary and primary data across two distinct phases. The focus of this study encompassed 39 commercial banks that were operational in Kenya throughout the period spanning from 2014 to 2023. A two-phase examination was implemented. Initially, efficiency scores were derived through the application of the Data Envelopment Analysis (DEA) methodology, with the calculated efficiency scores subsequently serving as dependent variables within the efficiency equation. Subsequently, a Tobit regression analysis model was employed to examine the relationship between the computed DEA efficiency scores and credit risk. The research additionally collected qualitative data through interviews, which were subsequently analyzed using thematic summary analysis. The research revealed that credit risk has a significant and negative influence on intermediation efficiency in commercial banks in Kenya (β = -0.2113, z = -3.01, p = 0.003). This study contributes new country specific evidence by quantifying how credit risk shapes intermediation efficiency, addressing a significant gap in the literature on African emerging markets. The findings underscore the criticality of robust credit risk management not only for bank stability but for the overall efficiency of the financial intermediation process in developing economies.