Current Volume 8
Effect of Adverse Selection On Non Performing Loans and Financial Health of Commercial Banks in Kenya
Abstract
This study uses hypothetical data to investigate the impact of adverse selection on non-performing loans (NPLs) and how they influence the financial health of commercial banks in Kenya. Grounded in the theory of asymmetric information it explains how imperfect borrower screening and limited credit information increase credit risk, leading to a rise in defaulted loans. This study utilizes a conceptual framework linking adverse selection, NPLs, and financial performance, and employs two Ordinary Least Squares (OLS) regression models. The results reveal a strong and statistically significant positive relationship between adverse selection and NPLs, indicating that poor credit risk assessment substantially elevates the proportion of defaulted loans. Furthermore, the second model demonstrates that higher NPL ratios significantly reduces bank profitability, as measured by Return on Assets (ROA), while capital adequacy and liquidity ratios positively influence financial performance. These findings suggest that adverse selection do not only deteriorates asset quality but also undermines long-term financial resilience. The study demonstrates that strengthening credit information systems, enhancing borrower screening mechanisms, and reinforcing prudential regulation are vital policy priorities. By mitigating the effects of adverse selection, commercial banks can better manage credit risk and preserve financial stability. The research offers valuable insights for policymakers, regulators, and bank managers seeking to build a more robust and transparent credit market in Kenya’s banking sector.
Keywords
Adverse Selection, Commercial banks, Financial Health and Non-Performing Loans
Citations
IRE Journals:
Patience Petronila Oduori , Dr. Yasin Ghabon
"Effect of Adverse Selection On Non Performing Loans and Financial Health of Commercial Banks in Kenya" Iconic Research And Engineering Journals Volume 8 Issue 12 2025 Page 975-981
IEEE:
Patience Petronila Oduori , Dr. Yasin Ghabon
"Effect of Adverse Selection On Non Performing Loans and Financial Health of Commercial Banks in Kenya" Iconic Research And Engineering Journals, 8(12)
About IRE Journals
IRE Journals is an open access online journals established with an aim to publish high quality of research work in various diciplines. We have more than 6 years in publications. Over 2500+ papers already published.
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