The most important challenge faced by the banking industry today is the challenge of understanding and managing the risk in the banking business where a threat of risk is imbibed in it. A well-functioning financial system facilitates efficient intermediation of financial resources to the economy. The more efficient the financial system in resource generation and allocation is the greater in its contribution to economic growth and sustainability (Mohan, 2005). Financial institutions play a key role in economic growth and development because they supply money for individuals, business sectors, lend government organizations etc. Moreover, financial institutions help the government in assessing and bearing out the monetary and economic policies, and provide a wide variety of economic services such as money transfer, foreign exchange, facilitate international trade, market stabilization and other related activities.
To investigate the status of risk management practice in Ethiopian commercial banks a survey were conducted on November 2009. Questionnaires were distributed for a sample of 15 Ethiopian banks. The report revealed that credit, liquidity and operational risks were key bank risks over the last two years and would continue to be so over the next five years. But, the study did not identify the factors that affect risk management efficiency of Ethiopian banks. Therefore, identifying the factors that affect risk management efficiency of Ethiopian banks is open for empirical analysis.
In Ethiopia, private commercial banking system has been witnessing a significant expansion over the past ten years than before even though the Ethiopian banking industry was still Underdeveloped. A survey made by National Bank of Ethiopia (NBE) (2010), believes that such growth should be matched with strong risk management practices. This is because with the fastest economic growth of the country, societal demand of various banking service also increase and this situation may increase level of risks on the banks unless and otherwise banks have introduced effective risk management program.
A number of relevant studies regarding risk management in banks were made across the world. A study by Piyananda et al (2015) were made considering capital adequacy as a dependant variable and aims to identify the significant bank specific determinants of risk management efficiency of the listed commercial banks in Sri Lanka. The study revealed that the credit risk, liquidity risk, ROA, operational efficiency and banks’ size are the important factors of determining the degree of (CAR) capital adequacy ratio of commercial banks in Sri Lanka. Capital adequacy ratio (CAR) generally represents the safety moderate which can understand any unexpected loss that banks might face when operating in a highly uncertain environment. It represents the solidarity and stability of financial institutions.
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The issue of risk management was concern of researchers such as Emira(2013) that have conducted research on Comparative Analysis of Risk Management in Conventional and Islamic Banks (The Case of Bosnia and Herzegovina). This research paper tries to determine the dependence of banks’ financial performance on the risk management. The results of this research reveal that still practices of risk management are developing worldwide. Anas & Fauziah (2014) also studied the impact of financial risk on Islamic banks’ profitability. However, their findings found to be different across country, bank nature and ownership structure.
Determinants of the risk management efficiency can be two fold; mainly internal and external. Internal factors are the bank specific factors whereas the external determinants are macroeconomic factors, which can be the growth rate of Gross Domestic Product (GDP), changes in interest rates and inflation rates etc.
In Ethiopia a number of risk management related studies were undertaken in commercial banks ignoring the issue of determinants of risk management efficiency and trying to study points like the relationship between risk management and profitability; credit risk issues and risk management practices. In this regard a study by Eneyew(2013) examines the impact of financial risk on profitability of commercial banks in Ethiopia. Fasika(2012) has investigated selected Ethiopian commercial banks operational risk management and Tibebu (2011) has studied on the impact level of credit risk management towards the profitability of commercial banks in Ethiopia. Emawayih(2017) assesses the determinants of financial risks in private commercial banks using credit risk and liquidity risk indictors. Endawek (2015) deals with the impact of risk management on performance of banks. Yalemzewd(2013), Girma(2010), conducted on credit risk and performance of banks and Fikremariam(2018) conducts a research on factors affecting credit risk management practices in private commercial banks. In all the available research works there is no specific study on risk management efficiency of commercial banks in Ethiopia which shows as there is a knowledge gap to show clear cut determinants of risk management efficiency in Ethiopian commercial banks. This initiates the researcher to investigate on the problem.
In this regard a study by Tilahun Amiro & Dugasa Afisa (2014) on the bank specific determinants of credit risk in Ethiopian commercial banks, only bank specific determinant variables such as bank size, profitability, capital adequacy, liquidity, credit growth, operating efficiency and ownership were used. This study differs from the previous studies in that it is addressing the problem for the first time in Ethiopian Commercial banks and considers bank specific and macroeconomic variables in the study. The dependant variable of this study is Capital adequacy ratio (CAR) as a proxy to risk management efficiency in banks and the bank specific variables were credit risk, liquidity risk, profitability, bank size, operation efficiency and market risk. The macroeconomic variables used in this study were GDP growth, inflation, lending interest rate and foreign exchange rate.
The main purpose of the study is to follow a comprehensive approach towards identifying determinant factors of risk management efficiency taking into account some private commercial banks in the country. In the context of this study, the risk management efficiency, as indicated above, was measured through the CAR while investigating the internal and external factors that may affect risk management efficiency in private commercial banks in Ethiopia.
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