Understanding the Factors Affecting the Success of Credit Risk in Kuwait Finance House

Introduction
The banking business sector is enormously impacted by the perceptive and imperceptive factors in an intensely competitive environment. In recent times, this competition has stiffened all the more with the advancement of globalization. In each regard of their business operations, banks ought to take effective measures in order to diminish risk by pinpointing the prospective causes based on real-world circumstances. Imperatively, the banking sector is deemed to be a significant source of financing for several companies and entrepreneurs. In the past decade, there have been dramatic changes concerning the management of risk in the banking industry. Progressively more financial institutions and managers have augmented the focus on the significance of risk management. In delineation, risk management encompasses the practice of identifying, assessing and listing of risks followed by organized and cost-effective application of resources to curtail, supervise and control the probability and influence of disastrous events or to capitalize in the realization of prospects (Gizaw, Kebede, and Selvaraj, 2015).
The power and supremacy of financial establishments, particularly commercial banks, to generate money is of great significance in business operations. These banks operate as financial intermediaries within any economic setting and they are key providers of financial credit to both the corporate and household sectors. Credit risk is basically the likelihood that a borrower in a financial institution or a counterparty will end up failing to meet its obligations in line with the consented terms and conditions. In general, credit risk is linked to conventional lending activities of banking institutions and it basically delineated as a loan that has not repaid either partly or in full. Nonetheless, credit risk can also emanate from a financial establishment holding bonds and other financial securities. Imperatively, all banking institutions have their personal credit philosophy instituted in an official written loan policy that must be backed and conveyed with a suitable credit philosophy. A credit philosophy is deemed to be effective when all employees within the financial establishment are in alignment with the lending primacies of the management. Credit risks can emanate from ambiguity in financial markets, failures in projects, and legal obligations, credit problems, calamities, natural causes and adversities, in addition to intentional attacks from an opponent. Specifically, credit risk is the by a long way the most significant risk that is faced by banks and the success of their business operations are reliant upon precise measurement and efficacious management of this risk to a greater magnitude as compared to any other kind of financial risk. An increase in credit risk has the effect of increasing the financial institution’s marginal cost of debt and equity, which consequently brings about an increase in the cost of funds for the institution (Tefera, 2011).
Literature Review
Derelioglu and Gurgen (2011) defined credit risk as the prevailing or potential risk to earnings and capital emanating from the failure of an obligor to meet the terms of any agreement with the financial institution or in the event that the obligor otherwise fails to carry out the terms and agreements. Imperatively, credit risk is one of the fundamental risks in commercial risks and the capability to manager it efficaciously is a determining factor of the banking institution’s stability. When implementing financial decisions, banks employ a credit risk assessment instrument that facilitates the estimation of the likelihood that the prospective borrowers will end up defaulting in their loan obligations. In the course of this process, the analysis of credit risk is purpose to curtail the potential loss to the acceptable levels of risk (Derelioglu and Gurgen, 2011).
The fundamental income generating activity for banking institutions is credit creation. Nonetheless, this activity encompasses major risks to the lender as well as the borrower. The risk of a counterparty failing in not fulfilling his or her obligation in accordance to the contract or agreement can significantly endanger the functioning of the bank’s business operations. It is imperative to note that banks that have high credit risk also have high risk of experiencing bankruptcy and this puts the bank depositors in danger (Bhattarai, 2016). To sustain sufficient profit level in this intensely competitive setting, there is a high tendency of banks taking up excessive risks. Nonetheless, this exposes the institutions to credit risk. The greater the level of exposure of the banks to credit risk the greater the inclination of the banks in facing financial disaster and vice versa. Bank loans are the biggest and most apparent source of credit risk and therefore banks have to be prudent in this approach (Gizaw, Kebede, and Selvaraj, 2015; Bhattarai, 2016).
Whereas banking institutions have experience major challenges over the years for a wide range of reasons, the fundamental cause of severe banking issues continues to have a direct relation to the counterparties’ credit standards, inappropriate risk management, or failure to focus on changes in economic or other situations that can result in a worsening in the credit position of a financial institution’s counterparties. Taking into consideration that exposure to credit risk is a prevailing source of issues in banks across the globe, it is pivotal for banks and their managers to take in significant insight from past experiences. Presently, banks ought to have a profound cognizance of the need to ascertain measure, supervise and control fundamental credit risk factors (Asfaw and Veni, 2015).
In relation to existent literature, scholars have determined that the factors affecting the success of credit risk can be categorized into two groups including internal factors (micro-economic) and external factors (macro-economic). In accordance to Garr (2013), the different factors that influence credit risk can be classified into macroeconomic factors, industry-specific factors, and bank institution –specific factors.
Macro-economic Factors
These are factors that have an influence on the economy of a nation as a whole and comprise of different variables including the prevailing interest rates, the rate of inflation in the country, unemployment rates, the level of consumer consumption, and also gross domestic product (GDP). Research conducted by Vazquez et al. (2012) establishes that here is a negative correlation between the GDP of a nation and non-performing or defaulting loans. In contrast, the findings of the study established that there exists a positive correlation between non-performing loans and macro-economic variables including high rate of inflation, the rate of unemployment, and the interest rates. High inclinations of credit risk go in tandem with high rate of inflation, high interest rates, in addition to high unemployment rate. This is largely for the reason that they restrict the capacity of borrowing in addition to increasing the cost of borrowing (Sandada and Kanhukamwe, 2016).
Microeconomic Factors
The basis of micro-economic factors that give rise to credit risk comprise of restricted institutional capability, unsuitable credit policies, unpredictable interest rates, poor institutional management, inadequate rules and regulations, insufficient capital and liquidity levels, inappropriate underwriting of financial loans, negligence in credit evaluation, intrusion by the government, in addition to inadequate monitoring by the national monetary authority (Kithinki, 2010). Research conducted by Das and Ghosh (2007) extensively examined the factors affecting credit risk in the Indian banking sector. The findings of the study established that credit risk was largely impacted by different micro factors including the managerial competencies, institution capacity, institutional risk and also excessive loan growth.
Bank-Specific Factors
Research has indicated that different bank-specific factors have an influence on the success of credit risk within the financial institution. The research study conducted by Garr (2013) identified a number of variables including the ownership structure of the financial establishment, operating costs, proficiency and efficacy of the bank’s management, quality and composition of the bank deposits, quality of the bank assets, size and capital of the bank in addition to the reserve requirement for the bank.
Research conducted by Mwaurah (2013) established that a key determining factor of credit risk success is managerial efficiency. The study indicates that crises experienced by commercial banks come about largely owing to inadequate management competencies and that know-how and management responsibility play a pivotal role in ascertaining the risk appetite of a financial establishment. Furthermore, the author points out that poor credit management policy give rise to poor lending practices, which bring about a ballooned portfolio of defaulted and unpaid loans. Furthermore, a study conducted by Bashir (2000) makes the argument that the ownership structure of a financial institution is a key determining factor of credit risk. The study outcomes demonstrated that foreign-owned banking institutions are profitable and effective in managing credit risk as compared to their domestic rivals amongst Islamic banks.
Problem Definition
In the contemporary, banks in Kuwait are experiencing numerous challenges that have a likelihood of influencing their capacity to grow and develop in addition to operating within a more competitive business setting. Presently, the economy of the country continues to be largely dependent upon oil as its key driving force for growth. Statistics indicate that in Kuwait, oil signifies over 90 percent of its earnings generated from exports and also accounts for 80 percent of the national budget revenue. Owing to the economy being over-reliant on oil together with the public sectors, it has become daunting to develop numerous lucrative investment prospects outside the restrictive scope of trade, real estate and stock market activities. Consequently, this has resulted in credit becoming pivotal in Kuwait. There is a massive amount of bank lending towards consumer loans, construction sector, real estate, and also trade (Limam, 2001).
Banks take up credit risk when they operate as financial intermediaries of funds. In essence, the business of banking encompasses providing credit and such kind of credit consists of credit mitigation risk and default risk. Ugirase (2013) defines default risk as the risk that there might be defaulting by the counterparty on its obligations to the investor. With regard to this particular risk, the quality of credit ends up deteriorating. It is more daunting to measure credit risk owing to the reason that there is minimal data concerning defaulting and recovery rates, the returns on credit are significantly skewed and fat tailed, in addition to lengthier term time limit and greater confidence levels are utilized in measuring credit risks. Bearing this in mind, this study plans to understand the different factors that influence the success of credit risk in Kuwait Finance House.
Kuwait Finance House is one of the major financial institutions in the Kuwaiti banking industry. It was founded in the year 1977 becoming the very first banking institution in the State of Kuwait conducting its business operations in line with the Islamic Sharia law. Since then, the company has expanded coverage not only nationally but also regionally in nations such as Turkey, Malaysia and Bahrain. The bank also conducts investment activities in the United States, the Middle East and also in Europe.
To this end, the fundamental impetus of the researcher is to fill this existent gap in literature and to make an endeavor of bringing empirical evidence through the identification of the major factors affecting the success of credit risk of banks in Kuwait, with a case study on Kuwait Finance House. As a result, this study will make a contribution to the restricted literature on credit risk in banks and also make a contribution in the ascertainment of key determinate factors on its findings.
Research Objective
The main objective of this research study is to understand the factors affecting the success of credit risk in Kuwait Finance House.
The research study will be guided by the following research sub-objectives:
1. To determine the internal factors that impact the success of credit risk
2. To determine the external factors that impact the success of credit risk
3. To determine the risk management strategies effective for credit risk
Assumptions
The following assumptions will be made in regard to this research study:
1. The research instrument that will be employed will bring about reliable responses
2. The respondents included in the study will fully comprehend the questions they will be asked
3. The respondents included in the study will provide forthright and honest expressions of their know-how and proficiency
4. The primary assumption in this study is that micro-economic, macro-economic, and bank-specific factors are the most significant factors affecting credit risk
Limitations
Research methodology acts as the pillar of a research study. Each research methodology employed by a researcher comprises of two wide-ranging phases including planning and execution. As a result, it is perceptible that within these two stages, there is likelihood that there will arise limitations that are beyond the control of the researcher (Saunders, Lewis, and Thornhill, 2009). One of the key limitations of the study is that it will only employ the quantitative research method. Specifically, this study will employ structured questionnaires with close-ended questions. As a result, this will give rise to restricted results because they cannot always signify the actual occurrence, in a generalized manner. In addition, the respondents will have limited options in terms of the responses given, therefore limiting the comprehensiveness of the outcomes obtained. Secondly, quantitative research is daunting, costly and necessitates plenty of time to conduct the analysis. Usually, a massive proportion of respondents is suitable for the representation of the target population. In this case, this will be a limitation because of the restricted time and resources available to the researcher. Third, the study only employs the quantitative approach, which will limit the researcher. By employing both the qualitative and quantitative approaches, it could be possible to provide an improved and more wide-ranging understanding of the research topic so as to render more comprehensive answers to research questions, ascertain new research questions and provide recommendations for changes to ensuing research designs.
Research Questions
Based on the provided problem definition, the research study will attempt to answer the following basic research questions:
1. What are the internal factors that affect the success of credit risk?
2. What are the external factors that affect the success of credit risk?
3. What are the risk management techniques that can facilitate effective credit risk?
Hypotheses or Propositions
The hypotheses formulated for the study comprise of the following:
H1: There are internal factors impacting the success of credit risk in banks
H2: There are external factors impacting the success of credit risk in banks
Data Collection
This research study will make use of the quantitative research approach. Quantitative research utilizes a fixed design that arranges beforehand the research question and a comprehensive technique of data gathering and analysis. The quantitative facets of the research study are owing to the objective to attain the standpoints of experts towards the subject of the factors that affect success of credit risk in a bank.
The method adopted for identifying the respondent and collecting the data to be used for the study will be the random sampling approach. The participants of the study will be randomly selected and be deemed as a general representation of the population as a whole. This sampling technique will be selected owing to the reason that it facilitates impartiality in obtaining the research participants. A population can be delineated as the items and people, basically the unit of analysis that contains the features that the researcher endeavors to study. The population of the study will be the labor force for Kuwait Finance House. At the present moment, the company has a workforce of 15,000 employees. The sample size for the study will be 200 individuals. The main criterion for sample selection was that the employees have to have worked at Kuwait Finance House for more than one year. This is imperative to ensure that the participants had an extensive insight on the organization.
The data collection process will be undertaken using questionnaires as a research instrument. The key advantage of using this research instrument is that data can be gathered comparatively fast owing to the reason that the research would not have to be mandatory to be present when questionnaires are finished. This is convenient for huge populations such as this case when interviews would not be fully adequate (Johnson and Christensen, 2008). Questionnaires can be conducted by the researcher with minimal impact on its reliability and validity. Furthermore, questionnaires are practical and the outcomes from them can characteristically be rapidly and basically quantified by the researcher (Saunders, Lewis, and Thornhill, 2009).
The questionnaires will include both open-ended and closed-ended questions. Data will be collected via telephone, e-mail, or in person. The structure of the questionnaire will be split into different sections. The first section of the questionnaire will be designed to obtain information regarding the demographics of participants. The second section will be designed to facilitate the understanding of the factors that impact the success of credit risk, with a specific case study on Kuwait Finance House.
The Statistical Package for Social Sciences (SPSS) Version 24 will be used to analyze the data. Specifically, the data will be scrutinized using descriptive statistics to ascertain the frequency distributions. Furthermore, correlation analysis will be employed to ascertain the correlation amongst the factors and finally regression analysis will be utilized in determining the causal correlation between the factors incorporated in the study and credit risk.
Timeline
The time-scale Gantt chart below provides an extensive timeline that places all of the tasks and activities that will be carried out for the thesis study:
References
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