Effect of Liquidity and Credit Risk on Bank Financial Performance: A Case of Afghanistan’s Commercial Banks

Abstract

Aim: The aim of this study was to examine the impacts of liquidity risk and credit risk on financial performance of commercial banks in Afghanistan. Methods: Panel data from six commercial banks was collected from their official website for the period 2010 – 2014. The data was analyzed by Gretel software using Ordinary Least Square (OLS) model. Dependent variable (financial performance) was measured by return on assets (ROA) while independent variables liquidity and credit risks were measured by current and leverage ratios respectively. Results: It was found that liquidity risk and credit risk have negative impact on financial performance of selected commercial banks in Afghanistan. The impact of credit risk on financial performance was less than the impact of the liquidity risk on financial performance. The correlation between return on asset and leverage ratio was weak (23 percent) and the correlation of current ratio with leverage ratio and return on asset is as low as minus 6 percent and minus 37 percent respectively. Conclusion: This study detected the negative relationship between commercial banks’ financial performance and liquidity and credit risks. So there is a negative significant impact of liquidity and credit risks on selected commercial banks’ financial performance in Afghanistan Recommendations: The Study recommend that CBs in Afghanistan should not unnecessarily keep cash amount in idle form because it decrease return in asset. Cash is a valuable asset which should be invested for fruitful investment results. In addition, CBs should not refrain from advancing loans since it has minor effects on return on asset and reduces unfavorable liquidity.