Effectiveness of Credit Risk Management on the Financial Performance of

Philippine Universal Banks

Marylet H. Ilagan
Master in Business Administration
Lyceum of the Philippines University-Batangas

Effectiveness of Credit Risk Management on the Financial Performance of

Philippine Universal Banks

Banks are considered to be in the business to safeguard money and other

valuable of the clients; provide loans, credit and payment services; and even
offer investment and insurance products. This financial institution is also critical in
handling and surviving different types of risks. The issue on credit risk has
greater concern on the level of perceived risk from business conditions, since this
risk most likely prompts bankruptcy.

The turmoil in the banking industry

highlights the effectiveness of credit risk management.

Credit risk management is a structured approach to managing
uncertainties through risk assessment, developing strategies to manage it, and
mitigation of risk using managerial resources (Achou & Tenguh, 2008). Its quality
is the main indicator of the banks financial soundness. Boahene et all (2012)
stressed that default of loans and advances shows serious setbacks not only for
borrowers and lenders but also to the entire economy of a country. Studies of
banking crises all over the world have shown that poor loans (asset quality) are
the key factor of bank failures.
In one of the published report of Asian Banker Research (2011), Philippine
banks are considered to have high consumer risk and slow loan demand. It only
means that most of the Philippine banks are still slow on the growth level of their
lending portfolio because of the gradual improvement in risk management and
collection abilities. This relates on the poor and ineffective credit risk

management emphasizing the increasing level of non-performing loan (NPL)

rates, poor loan processing, and undue interference in the loan granting process,
inadequate or absences of loan collaterals among other things, which can be
linked with that negative impact on banks profitability. As of record, retail banking
itself only generates 27% of profits. The industry is beset by high operational cost
and credit risk.
In the most recent article from The Asian Banker (2014), year 2013 is
marked as the toughest year for banks performance since 2008. Philippines, as
represented by BDO Unibank ranked at fifteenth place among the top 500 banks
in the Asia Pacific Region. Although marked as one of the strongest and has
achieved the highest balance sheet growth, with assets, loans and deposits up
by 31%, 25% and 38%, respectively, it is still relatively had a slower pace of
growth in 2013. Philippine banks are not even represented in the ranking among
the banks with largest profit and lowest gross NPL ratio. This only shows that
Philippine banks have increased in non-performing loans which signals weaker
credit condition and signals worsening credit quality.
Effectiveness of credit risk management on the profitability growth or
financial performance of banks shall be observed. In the recently concluded
study by Abdelrahim (2013), it shows that liquidity has significant strong positive
impact on bank size which has significant strong negative impact on
effectiveness of credit risk management. Analyzing the effectiveness of CRM has
been essential in identifying its characteristics, determinants, challenges and
developments. While another study made by Kurawa (2014) assessed the effect

of credit risk management on the profitability of Nigerian banks using the default
rate, cost per loan asset and capital adequacy ratio for the period of ten years to
evaluate the relationship between the two variables.
It is deemed important to undertake the research on the effectiveness of
Credit Risk Management (CRM) on the financial performance in this critical time
when most of the banks from Asia Pacific region recorded to have slower pace of
growth over the years. The subject of the analysis is to determine the variation in
performance brought about by changing CRM approaches among the banks and
how such practices affected the financial health of the sector as a whole. It also
attempts to unfold the use of some risk management, evaluation and assessment
tools, models, and techniques.
Objectives of the research
The study will determine the Effectiveness of Credit Risk Management on
the Financial Performance of Philippine Universal Banks.
More specifically, it will present profile of the various Philippine universal
banks, number of years of operation, capital adequacy, asset quality,
management soundness, banks earning, liquidity, bank size, and different risk
management in banking. It will also identify the benefits of credit risk
management strategy and characteristics of credit risk management of Philippine
universal banks through a quantitative research design survey method. It will also
investigate the challenges on the effectiveness of credit risk management on the
financial performance of these universal banks. Moreover, it will identify the

development methods of credit risk management effectiveness. It will also test

the relationship between the effectiveness of credit risk management and the
financial determinants of these universal banks such as capital adequacy, asset
quality, management soundness, banks earning, liquidity and bank size.
Hypothesis
Based on the research objectives, the research hypotheses are:
1. There is no significant relation between credit risk management and
profitability of banks.
2. There is no significant relation between the effectiveness of credit risk
management and financial determinants (capital adequacy, asset quality,
management soundness, banks earning, liquidity and bank size).
Methods
Research design
The research will follow a descriptive-quantitative analysis of data using a
questionnaire to collect the primary data and correlational analysis approaches
for the secondary data to be gathered from the annual reports and researches of
Bangko Sentral ng Pilipinas (BSP) and other references.
The descriptive-quantitative analysis is the numerical description such as
frequency and mean and as it is defined, it is used to measure things as they are.
On the other hand, the correlational/regression analysis is the quantitative

analysis of the strength of relationship between two or more variables.

(www.serve.org)
The research model will be adopted from the study made by Abdelrahim
(2013). The research model is "CAMEL" which indicates the relationship between
the independent variables of capital adequacy, asset quality, management
soundness, earning, and liquidity, and the dependent variable of Effectiveness of
credit risk management as shown in figure (1).
Independent Variables

Dependent Variable

1.Capital Adequacy Ratio (C)

2.Assets Quality (A)
3.Management Soundness (M)
4. Earnings of Credit Facility (E)
5. Liquidity (L)
6.Bank Size(S)

Effectiveness Of Credit Risk

Management

Fig. 1. Model of Determining Factors of Effectiveness of Credit Risk Management

Source: Dr. Khalil Elian Abdelrahim Research Design (2013)

The specifics of the variables used by CAMEL Model are:(1) Capital

Adequacy refers to the ratio that measures the total capital of banks articulated
as a percentage of its risk weighted credit coverage (Kurawa, 2014); (2) Asset
Quality is measured by the growth of total loans as a proxy for the quality of
bank's asset; (3) Management Soundness is a qualitative variable that expresses
the control of board of directors over the resources of the bank to protect
shareholders interests. Management soundness could be measured by the asset
turnover ratio, which is a proxy of management soundness that denotes bank
efficiency in using assets in generating revenue; (4) Earning in terms of credit
facilities can be measured by return on credit as reflected by interest rate; (5)

Liquidity refers to a situation where institutions can obtain sufficient funds, either
by increasing liabilities or by converting its assets quickly to cash at a reasonable
cost; and (6) Bank Size is measured in term of value of total assets. (Abdelrahim,
2013).
Respondents of the Study
Due to some limitations on the published lists of bank managers and credit
officers and due to limited time and resources, the researcher will select a
purposive sample of 50 respondents to have their points of views on the
challenges and developing methods of credit risk management of Philippine
universal banks. The purposive samplings will include bank managers and
credit/lending officers of the top five largest banks in the country based from the
records of Bangko Sentral ng Pilipinas. These are BDO Unibank, Bank of the
Philippine Islands, Metropolitan Bank, Landbank of the Philippines and Philippine
National Bank. Other universal banks are excluded because of the lack of time
and resources and they are left for other researchers future study.
Data Gathering Instrument
The questionnaire is adopted from the research survey conducted by the
students of Heriot Watt University and from the study of Abdelrahim (2013). It will
be used to collect the primary data on the awareness of credit risk management
and on the challenges and developing methods on the effectiveness of credit risk
management practiced by the bank managers and credit officers of Philippine
Universal banks.

The first part of the survey questionnaire is personal information of the

respondents; and to check the general awareness of bank managers and credit
officers on credit risk management; and the internal and external factors affecting
their credit judgment. The second part relates on the challenges facing the
effectiveness of credit risk management and methods of developing the
effectiveness of credit risk management among the Philippine universal banks.
Data Gathering Procedure
In checking the validity and accuracy of the questionnaire, the researcher
will distribute the questionnaire then tests the reliability of the questionnaire using
Cronbach Alpha Coefficient.
Data Analysis
Distributed questionnaires will be analysed using SPSS. The tools of
analysis are: frequency distribution, mean, standard deviation for descriptive
analysis, besides the use of regression analysis to test research hypotheses and
the use of t-statistics to detect differences in the answers of respondents.