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DETERMINANTS OF BANKS’ FINANCIAL PERFORMANCE IN DEVELOPING
ECONOMIES: EVIDENCE FROM KENYAN COMMERCIAL BANKS
BY
CHARLES B. MURERWA
UNITED STATES INTERNATIONAL UNIVERSITY - AFRICA
SUMMER 2015
DETERMINANTS OF BANKS’ FINANCIAL PERFORMANCE IN DEVELOPING
ECONOMIES: EVIDENCE FROM KENYAN COMMERCIAL BANKS
BY
CHARLES B. MURERWA
A Research Project Report Submitted to Chandaria School of Business in Partial
Fulfillment of the Requirement for the Degree of Masters in Business Administration
(MBA)
UNITED STATES INTERNATIONAL UNIVERSITY - AFRICA
SUMMER 2015
i
STUDENT’S DECLARATION
I, the undersigned, declare that this is my original work and has not been submitted to any
other college, institution or university other than the United States International University in
Nairobi for academic credit.
Signed: ________________________ Date: _____________________
Charles Murerwa (ID 639920)
This project has been presented for examination with my approval as the appointed
supervisor.
Signed: ________________________ Date: _____________________
Mr.Samuel Wainaina
Signed: _______________________ Date: ____________________
Dean, Chandaria School of Business
ii
COPYRIGHT
Copyright © 2015 by Charles Bundi Murerwa
All rights reserved.
No part of this publication may be reproduced, distributed, or transmitted in any form or by
any means, including photocopying, recording, or other electronic or mechanical methods,
without the prior written permission of the publisher, except in the case of brief quotations
embodied in critical reviews and certain other noncommercial uses permitted by copyright
law.
iii
ABSTRACT
The purpose of this study was to evaluate the determinants of banks’ financial performance in
developing economies with a focus on Kenyan commercial banks. This research strived to
give an understanding into the determinants of financial performance in Kenya. The study
answered three research questions which were; what are the industry specific factors that
influence the financial performance of commercial banks in Kenya? In this case, the research
reviewed how the industry affects the financial performance of the banks. The second
research question was; what are the firm specific factors which influence the financial
performance of the commercial banks? The last research question was; what are the
macroeconomic which influence the financial performance of the commercial banks?
The research methodology adopted by the study was descriptive research design. The
population of study was all the 44 commercial bank licensed to operate in Kenya as at 31st
December 2013. A census study was carried out where primary data from the banks and
secondary data from relevant central bank data was used. Data was analyzed using
descriptive and inferential analysis and presented using charts and tables.
The key findings were as follows; on industry specific factors influencing bank performance,
the study found out that industry factors relating to competition, product innovation and the
development of mobile banking mostly affected the profitability of the banks. Findings
showed that 58% of the respondents strongly agreed on competition as having a key impact.
On the other hand, 63% and 40% agreed on innovation and mobile as having a key impact on
profits.
On firm specific factors influencing bank performance, the distribution networks, information
systems and strategic positioning were regarded as key bank specific determinants of
profitability. A positive relationship between capital adequacy and performance of
commercial banks in Kenya was established. A similar relationship was seen between
performance of commercial banks and management efficiency.
In relation to the macro-economic factors, the study reviewed that they had least impact on
profitability because they have been relatively stable. However, volatility in interest and
exchange rates had some considerable impact on profitability.
The conclusion drawn was that bank specific factors that are under the control of the
management and owners affect the performance of commercial banks in Kenya and in
developing countries generally. These factors have a deep and direct impact on the bank’s
iv
profitability. This is in line with the efficiency structure theory, which states that enhanced
managerial efficiency leads to higher performance of institutions. Competition is the
strongest industry specific determinants while macro-economic factors did not have
significant impact on profitability.
The study recommends that banks put a lot of focus on their own internal processes since
bank specific factors have the biggest impact on their profitability. Most importantly, Kenyan
commercial banks should invest in modern technology and also upscale their innovation
leading to products attractive to consumers. Competition, which is the main industry specific
factor affecting profitability, should be handled through well designed marketing strategy.
Macro economic factors do not have a major impact on profitability and therefore more
emphasis should be on internal and industry specific factors.
In conclusion, it’s clear that firm specific, industry specific and macroeconomic factors all
have an impact on the profitability of the commercial banks in Kenya. The industry is one of
the most profitable in Kenya because of the country’s emerging middle class. Therefore, as
the banks endeavor to maximize their profitability, its critical to establish which factors have
the most impact on their bottom line and how well to manage them.
v
ACKNOWLEDGEMENT
I am using this opportunity to express my gratitude to everyone who supported me
throughout the course of this MBA project. I am thankful for the aspiring guidance,
invaluably constructive criticism and friendly advice during the project work. I am sincerely
grateful to those who shared their truthful and illuminating views on a number of issues
related to the project.
I express my warm thanks to my supervisor Mr. Samuel Wainaina for his unwavering
support and guidance throughout the project
Thank you,
Charles B.Murerwa
vi
TABLE OF CONTENTS
STUDENT’S DECLARATION ................................................................................................. i
COPYRIGHT ............................................................................................................................. ii
ABSTRACT ............................................................................................................................. iii
ACKNOWLEDGEMENT ......................................................................................................... v
CHAPTER ONE ........................................................................................................................ 1
1.0 INTRODUCTION .......................................................................................................... 1
1.1 Background of the Study ................................................................................................ 1
1.2 Statement of the Problem ................................................................................................ 4
1.3 Purpose of the study ........................................................................................................ 6
1.4 Research Questions ......................................................................................................... 6
1.6 Scope of the study ........................................................................................................... 7
1.7 Definition of Terms......................................................................................................... 8
1.8 Summary of Chapter ....................................................................................................... 9
CHAPTER TWO ..................................................................................................................... 10
2.0 LITERATURE REVIEW ............................................................................................. 10
2.1 Introduction ................................................................................................................... 10
2.2 Industry Specific Determinants of Performance ........................................................... 10
2.3 Firm Specific Determinants of Performance ................................................................ 17
2.4 Macro Economic Determinants of Performance ........................................................... 25
2.5 Summary of Chapter ..................................................................................................... 31
CHAPTER THREE ................................................................................................................. 32
3.0 RESEARCH METHODOLOGY.................................................................................. 32
3.1 Introduction ................................................................................................................... 32
3.2 Research Design............................................................................................................ 32
3.3 Population and Sampling Design .................................................................................. 32
vii
3.4 Data Collection Methods .............................................................................................. 34
3.5 Research Procedures ..................................................................................................... 34
3.6 Data Analysis Methods ................................................................................................. 35
3.7 Chapter Summary ......................................................................................................... 37
CHAPTER FOUR .................................................................................................................... 38
4.0 RESULTS AND FINDINGS ........................................................................................ 38
4.1 Introduction ..................................................................................................................... 38
4.2 General Information ........................................................................................................ 38
4.3 Industry Specific Factors ................................................................................................ 38
4.4 Bank specific factors ....................................................................................................... 57
4.5 Macroeconomic Factors .................................................................................................. 58
4.6 Chapter Summary ........................................................................................................... 60
CHAPTER FIVE ..................................................................................................................... 62
5.0 DISCUSSION, CONCLUSIONS AND RECOMMENDATIONS .............................. 62
5.1 Introduction ...................................................................................................................... 43
5.2 Summary .......................................................................................................................... 62
5.3 Discussion ........................................................................................................................ 65
5.4 Conclusions ...................................................................................................................... 68
5.5 Recommendation ............................................................................................................. 69
REFERENCES ........................................................................................................................ 71
APPENDICES ......................................................................................................................... 77
viii
LIST OF TABLES
Table 4.1: Number of years worked ........................................................................................ 38
Table. 4.2: Level of Education ................................................................................................. 39
Table 4.3: Position in the bank ................................................................................................ 40
Table 4.4:Industry Specific Factors ......................................................................................... 43
Table 4.5: Capital Adequacy Report ........................................................................................ 46
Table 4.6: Trends in Asset Quality .......................................................................................... 47
Table 4.7: Trends in Liquidity of Commercial Banks of Kenya ............................................. 48
Table 4.8: Commercial banks’ profitability 2008 to 2013 ....................................................... 49
Table 4.9: The trends in return on assets and return on equity ................................................ 49
Table 4.10: Summary of Responses on Firm Specific Factors ................................................ 52
Table 4.11: Tabulation of macroeconomic factors .................................................................. 54
ix
LIST OF FIGURES
Fig.4.1: Years of experience worked ....................................................................................... 39
Fig. 4.2: Level of Education .................................................................................................... 40
Fig. 4.3: Position in the bank ................................................................................................... 41
Fig.4.4:The top industry specific factors ................................................................................. 44
Figure 4.5: Summary of Financial Performance of Commercial Banks in Kenya 2001-2010 50
Figure 4.6: Key bank specific factors which were found to affect profitability ...................... 53
Fig. 4.7: The top macroeconomic factors affecting profitability ............................................. 55
1
CHAPTER ONE
1.0 INTRODUCTION
1.1 Background of the Study
The Banking sector all over the world acts as the life blood of modern trade and economic
development and through being a major source of finance to the economy (Ongore and Kusa,
2013). The concept of profitability is very important both for the non-financial institutions as
well as financial institutions and commercial banks are considered to be the major
constituents of the financial institutions. The success and growth of commercial banks is
mainly dependent on the competitive marketing strategy that their marketing department
adopts to help them compete with others in the market (Swarnapali, 2014). Over the last
decade, it is clear from banking literature that the performance of commercial banks is one
research area that has been of main concern to management experts, investors, and economic
analysts across the entire world and has a lot of researchers have focused on the factors that
influence the performance (Sufian and Chong, 2008). This concern is closely related to the
significant impact of the profitability of these commercial on the potential growth of the
economy of the country. This has resulted in a lot of changes in the banking environment in
terms of operations in order to improve their financial performance (Hussain and Bhatti,
2010).
It is clear from research that commercial banks play a very crucial role in the allocation of
economic resource of countries by basically helping to channel funds from depositors to
investors in a continuous manner (Ongore and Kusa, 2013). Handley-Schachler, Juleff and
Paton (2007) notes that “these commercial banks offer the all-important services of providing
deposit and credit facilities for personal and corporate customers, making credit and liquidity
available in adverse market conditions, and providing access to the nation’s payments
systems”. It is also noted that commercial banks are also the channels used to transmit
effective monetary policy of the central bank of the economy thus it is considered that they
also share the responsibility of stabilizing economy of their country (Siddiqui and Shoaib,
2011). The soundness of the banking sector in a country is very critical to the health of the
country’s economy (Sufian and Chong, 2008). Further agreeing to this statement, Katrodia
(2012) argues that the banking sector and the economy of a country are closely related. On
the other hand, it is important to note that the soundness of the commercial banks is largely
2
dependent on their financial performance which is normally used to indicate the strengths and
the weaknesses of such a commercial bank (Makkar and Singh, 2013). The financial
performance of any business organization is normally evaluated by determining their
profitability.
Generally, researchers note that the sustainability of a commercial bank is largely determined
by its level of profitability. This is due to the fact that these commercial banks must generate
the necessary income in order to be able to cover their costs of operations which are incurred
as they go about their work (Ongore and Kusa, 2013). It is also noted that it is out of these
profits that the shareholders of the banks get their dividends from their investment and this
leads to a situation where they are encouraged to invest more in the bank thus ensuring a
steady flow of investment funds for the bank and thus securing the future in terms of
sustainability of operations (Ongore and Kusa, 2013). It is important to note that business
entities normally remain in operation sue to the fact that they expect to make profits from
their operations; therefore in case the management confirms that they cannot achieve this
goal, the only option that they remain with is to close shop and exit the business in order to
avoid a situation of loss making (Ayanda, Christopher and Mudashiru, 2013). Ongore and
Kusa (2013) asserted, “Profit is the ultimate goal of commercial banks, thus all the strategies
designed and activities performed are meant to realize this grand objective”. They however,
clarified that this does not mean that commercial banks or any other business entities are not
guided by any other additional goals and objectives and that they are also guided by goals
such as social benefits as well as economic benefits.
According to Ayanda (2013) profitability is defined as the “the ability of the business
organization to maintain its profit year after year”. Further, according to Podder (2012), the
profitability of a commercial bank “is the efficiency of a bank at generating earnings”. Others
also further that apart from ensuring that the commercial banks’ operations are sustainable,
profitability also has far much wider implications on the economy of the country as a whole.
Researchers note that the profitability of any commercial organization normally contributes
to the economic development of a country through the fact that the profits can be reinvested
back into the business and thus offer additional employment to the citizens of the country and
thus increased revenue for the country through taxation (income tax and corporate tax)
(Ayanda et al. 2013). It is also noted that the profitability of any commercial organization
leads to increased wealth of the investors through the higher dividends that are paid which in
turn leads to improved quality and standards of living of the people of the country. As it can
3
be seen from the discussion above, the profitability of commercial banks is very critical and
therefore, poor financial performance of the banking industry of a country can result in
serious negative impacts on the growth and development of a country as well as the
wellbeing of the citizens of that country (Ongore and Kusa, 2013).
A lot of researchers in the banking sector and in the academic world have given their
attention to the issue of performance of commercial banks due to the fact that the banking
industry is a major player in the economic development of a country (Ayele, 2012). These
studies have shown that the performance of commercial banks can be expressed or measured
in various terms and these include competition, productivity, profitability, efficiency as well
as concentration (Macit, 2011). Commercial banks that have better financial performance are
considered to have better ability to resist any negative shocks from the external environment
and thus be able to contribute to the stability of a country’s financial system (Athanasoglou et
al., 2008).
The banking sector in Kenya is governed by various Acts such as The Companies Act, the
Banking Act, the Central Bank of Kenya Act and various other prudential guidelines that
have been issued by the Central Bank of Kenya (CBK) over the years. The banking sector in
Kenya was liberalised in 1995 which led to the removal of exchange controls. The CBK is
normally responsible for formulating and implementing the monetary policy adopted by the
Kenyan government and ensuring there is liquidity, solvency and proper functioning of the
financial system in the country. The entity also publishes valuable information related to the
banking industry in Kenya and the non-banking financial institutions, as well as information
about the interest rates prevalent in the country and other publications and guidelines. The
Kenyan commercial banks have come together under an umbrella body referred to as the
Kenya Bankers Association (KBA), which serves as a lobby body for the members’ interests
and addresses issues affecting the registered commercial banks in the country (CBK, 2013).
In Kenya, the performance of commercial banks has been influenced by various factors such
as the prevailing economic conditions and the ownership structure. These determinants have
influenced the performance in negative as well as positive ways depending on the
management skills of the executives of the commercial banks (Ongore and Kusa, 2013).
1.2 Statement of the Problem
Understanding the factors that influence the performance of commercial banks is critical not
only to the management of these commercial banks but also to other stakeholders and interest
4
groups such as the country’s Central Bank, the government as a whole, the banker’s
association as well as other financial authorities in the country (Ayele, 2012). Studies carried
out to evaluate the determinants of the financial performance of commercial banks have
revealed various factors such as the internal bank specific factors, industry specific factors
and external macro-economic factors (Sufian and Chong, 2008). It is however important to
note that countries differ in terms of the macro-economic conditions, the financial systems as
well as the operating environment of these banks (Ongore and Kusa, 2013). This shows that
factors that influence performance in one country may not be the same as those in another
country (Lipunga, 2014).
A search for literature in this area shows that there are various studies that have been carried
out both on the international arena, in the African context as well as locally. Obamuyi (2013)
evaluated the determinants of a bank’s profitability in a developing economy and focused on
the banking industry in Nigeria. The study found that bank specific factors such as efficient
management of expenses and increased interest income and macro environment factors such
as favorable economic conditions lead to improved profitability of commercial banks. This
study did not evaluate the influence of industry specific factors on the performance of the
commercial banks and this will be a focus of the current study. Lipunga (2014) also carried
out a similar study and focused on the banking industry in Malawi. The results of the study
found that the size of the bank, the efficiency of the bank’s management and the liquidity of
the bank influenced its profitability measured by ROA. This study only focused on internal
factors or firm specific factors only and did not consider the influence of external factors such
as the GDP or interest rates as will be used in the current study.
Most studies conducted in relation to bank performance focused on sector specific factors
which affected the entire banking sector performance.For instance, Comparative Studies of
Foreign and local banks in Thailand by Chantapong (2005) and The profitability of European
banks: a cross- sectional and dynamic panel analysis by Goddard et al. (2004). Also, Ongore
and Kusa (2013) studied the effects of various factors in banking sector performance in
Kenya. The results of the study showed that board and management decisions influence the
performance of commercial banks in Kenya and also that macro-economic factors have
insignificant influence on their performance. This study however omitted the effects of
industry specific factors on the performance of commercial banks. Literature has not
specifically focused on the identifying the specific factors that influence bank performance in
developing countries but the available literature shows determinants in all economies
5
(Karasulu, 2001). Macro- economic factors that influence the performance of commercial
banks have also not been evaluated in the Kenyan context despite their importance in
determining the performance of any industry in the economy. It is clear therefore that in
Kenya, no study has been done on the determinants of bank performance using the industry
specific factors, the bank specific factors and the macro-economic factors. This is the gap this
study will seek to fill.
1.3 Purpose of the study
The purpose of this study was to examine the determinants of bank’s financial performance in
the developing countries with a specific focus on Kenya. The specific objectives of the study
are:
1. To determine whether industry specific factors affect the performance of commercial
banks in Kenya
2. To examine the effect of firm specific factors on the performance of commercial
banks in Kenya
3. To evaluate the macroeconomic factors which influence the financial performance of
the commercial banks in Kenya
1.4 Research Questions
This study will be guided by the following research questions
1. What are the industry specific factors that influence the financial performance of
commercial banks in Kenya?
2. What are the firm specific factors that influence the financial performance of
commercial banks in Kenya
3. What are the macroeconomic factors that influence the financial performance of
commercial banks in Kenya
1.5 Significance of the Study
1.5.1 Bank Management
This study will be beneficial to Commercial Bank managers as it will help them better
understand the determinant factors of their financial performance and thus be able to focus on
improving these factors to ensure that their financial performance keeps improving.
6
1.5.2 Policy Makers
This study will also guide policy makers in the banking sector especially the Central Bank of
Kenya and the Treasury in coming up with policies which will ensure favorable macro-
economic indicators to spur growth and profitability in this sector.
1.5.3 Researchers and Academicians
Researchers and academicians in the field of finance, economics and banking will find this
study a useful guide for carrying out further studies in the area.
1.6 Scope of the study
This study focused on evaluating the determinants of the financial performance of
commercial banks and emphasized on industry specific factors, firm specific factors and
macro-economic specific factors. The study adopted a descriptive survey design of the entire
banking industry in Kenya and therefore surveyed all the registered commercial banks in the
country. The study focused on the performance of these commercial banks for a period of the
last five years from 2009-2013.
The target population for this study was all the registered commercial banks in Kenya.
According to the Central Bank of Kenya, which is, the body charged with the supervision of
commercial banks in Kenya, there were 44 registered commercial banks in Kenya as of 30
June 2014 (CBK, 2014)
The limitations of the study were that different factors had different impacts on the various
banks. Also, the secondary data collected from the central banks could not be verified
independently and hence future research should give much more focus on primary data.
Finally, the study relied on publicly available data since banks could not disclose a lot of
information due to sensitivity issues.
1.7 Definition of Terms
1.7.1 Financial Performance
Financial performance is the level of performance of a firm over a specific period of time and
expressed in terms of the overall profits or losses incurred over the specific period under
evaluation (Bodie, Kane and Marcus, 2005).
7
1.7.2 Industry Concentration
Industry concentration is the structural characteristics of a business sector such as the number
of firms operating in it and their respective share of the industry production (Walter and
Brock, 2005).
1.7.3 Liquidity
Liquidity refers to the degree with which an asset or security can be easily sold in the market
without the sale affecting its price (Bodie, et al 2005).
1.7.4 Developing Countries
These are countries that have lower living standards, low human development index and
under developed industrial base in comparison to other countries (Sullivan and Sheffrin,
2003).
1.7.5 Commercial banks
This is a type of bank that is involved in the provision of services such as deposit taking,
offering basic investment products and extending both business and personal loans
(Khambata, 1996).
8
CHAPTER TWO
2.0 LITERATURE REVIEW
2.1 Introduction
This chapter will present the literature review related to the determinants of the financial
performance of commercial banks and will try to focus on the developing countries like
Kenya. The chapter will be organized such that each of the research questions presented in
the previous chapter will be discussed separately under a subsection and empirical literature
on the determinants presented under each of the subsections. The empirical review will focus
on the studies that have previously focused on the various determinants of the financial
performance of commercial banks and will try to narrow down the situation to the developing
countries like Kenya.
2.2 Industry Specific Determinants of Performance
One of the main strands of literature on the determinants of the financial performance of
commercial banks has focused on the influence of industry specific factors such as the market
structure and bank specific variables to explain the differences in the financial performance
of commercial banks across the various countries. A lot of studies in the area of banking
literature have focused on investigating whether the structure of the financial sector, which
has been defined as the relative importance of commercial banks has any major role in
influencing the financial performance of commercial banks. These studies have shown that
generally, a high bank asset-to-GDP ratio shows that financial development plays a very
critical role in the economy in the economy of a country. This relative importance may be an
indication of a higher demand for banking services, which in turn, leads to a situation where
more competitors are attracted to enter the market. Increased competitiveness in the banking
sector leads to a situation where these commercial banks are required to adopt different
competitive strategies in order to ensure that they sustain their financial performance levels
(Karasulu, 2001).
2.2.1 Structure of Financial Sector
The results of the study show that commercial banks in countries that have more competitive
banking sectors, where the bank assets make up a large part of the GDP of the country,
generally tend to have smaller profit margins and are therefore less profitable. They also note
that countries that have underdeveloped or poorly developed financial systems tend to exhibit
9
lower efficiency in their operations and also tend to adopt less-than-competitive pricing
behaviours which lead to poor financial performance. It is clear that for such countries, an
improvement in financial development would lead to an improvement in the efficiency levels
of the banking sector which is a clear indication that the market structure of the banking
industry has a significant influence on the financial performance of the commercial banks in
the industry (Khrawish, 2011).
The structure of the financial sector also determines its ability to attract more customers and
gain more customer deposits and thus improve their chances of increasing revenues through
interest earning from loans. Commercial banks that are able to offer investment products are
also able to make more money since they earn more from the fees and commissions from the
investments. The structure also makes it possible for customers to trust the banking industry
and therefore take more of their business transactions and thus make more profits (Ayele,
2012). The structure of the banking industry also allows the government to channel some of
its development funds through the commercial banks and this means more business for the
commercial banks and thus more revenues. This in turn leads to improved profitability
(Siddiqui, 2011). An optimally structured financial industry in general ensures that the
various industries in the economy are well linked and that the commercial banks are able to
play their financial intermediary roles in a successful and beneficial manner to the economy
as well as to the commercial banks themselves through improved profitability.
2.2.2 Industry Concentration
Another study by Staikouras and Wood (2003) suggests that “industry concentration has a
positive impact on the financial performance of commercial banks”. The study notes that as
the industry gets more concentrated, the commercial banks tend to gain more monopolistic
power which has the result of increasing the profit margins of the commercial banks. It is
however important to note that there are studies that have posted conflicting results with
researchers such as Naceur (2003) reporting that there is a negative coefficient between
industry concentration and the financial performance of commercial banks in Tunisia.
Further, the results of Karasulu (2001) in Korea show that the increasing industry
concentration is not a guarantee that there will be improved financial performance of
commercial banks.
The SCP hypotheses have been applied in different studies by various researchers and the
results of these studies have clearly shown that there is a positive relationship between market
10
concentration (measured by concentration ratio) and financial performance (measured by
profits) of commercial banks. Furthermore, the hypotheses showed that the competitiveness
of small banks (small market share) with large banks (large market share) is weak due to the
positive relationship between market concentration and the financial performance
(profitability) of these large banks (Goddard et al., 2004). It is therefore clear that market
concentration has a significant influence on the financial performance of commercial banks
due to the reduction in competition between smaller banks and larger banks in the industry.
A high industry concentration means that the banking industry in the country is made up of
many commercial banks which are competing for the same customers. The level of
competition in such an industry is very high and only the most competitive banks in terms of
price and quality of products and services will remain in operations. Commercial banks that
are able to acquire various forms of competitive advantage will therefore be able to attract
more customers while those that are unable to attain competitive advantage will tend to lose
customers to the competitors (Hussain and Bhatti, 2010). Larger banks tend to have more
resources at their disposal and therefore adopt strategies that ensure they acquire competitive
advantage easily. This leads to a situation where they are able to attract and retain more
customers due to their quality of services as well as the lower costs they charge. Such banks
will further be able to use the large pool of customer deposits to issue more loans to
borrowers and thus increase their ability to earn interest. Highly competitive banks will
therefore make more profits while the lesser competitive ones will have reduced profit
margins or even losses. A highly concentrated banking industry can therefore have positive
effects or negative effects on the profitability of commercial banks depending on their size
and their ability of compete favorably (Khrawish, 2011).
A study by Podder (2012) provided evidence that concentration of commercial banks in the
industry has a positive impact on the performance of commercial banks. According to the
study, high concentration in the banking industry allows for a high monopolistic power of the
banks and this means the banks can charge higher prices for their products. This leads to
higher margins and therefore better performance. Another study by Beck, Cull and Afeikhena
(2005) supports this by arguing that there is a positive relationship between industry
concentration and profitability of commercial banks. This is in line with the structure-
conduct-performance hypothesis which suggests that higher market power leads to higher
profit margins due to monopoly and vice versa. There are however other studies that suggest
11
that there exists an inverse relationship between bank concentration and bank profitability.
These studies are however not popular.
2.2.3 Maturity of Banking System
Another industry specific determinant of the financial performance of commercial banks is
the maturity of the banking system. Some of the researchers who have evaluated this
relationship between the financial performance of commercial banks as measured by size or
level of development and the maturity of the banking sector are Delis et al (2008) who
concluded that there was a negative relationship between the financial performance of the
commercial banks and the size of the banking industry in the country. They further explain
that the greater the size of the banking sector, the greater the number of commercial banks
and this leads to a situation where the competition of the banks is very fierce. This leads to a
situation where the maximum performance of each commercial bank is reduced and thus
clearly showing that a greater banking sector may lead to poor financial performance of the
commercial banks in the country. In 2001, they carried out another study which aimed to
evaluate the relationship between the financial performance of commercial banks and the
development of the financial market and the level of complexity of its structure. The results
of the study clearly showed that there is a significant relationship between the variables
which shows that a more developed banking industry leads to a reduction in the financial
performance of commercial banks in that country (Sufian and Chong, 2008).
Maturity of the banking industry also influences the number of services that commercial
banks are able to offer to their consumers as well as the coverage of the market. The more
mature the banking industry is, the more it is expected to be large and to accommodate large
volumes of transactions thus better performance. A mature banking industry is characterized
by various products to satisfy the needs of most customers and therefore it is able to attract
more customers. When more citizens rely on the banking industry to conduct their businesses
as well as make payments and transfer money, commercial banks tend to earn more from the
banking charges and fees and therefore they are able to increase their revenues. The ability of
a commercial bank to increase its revenues while at the same time lowering its costs of
operations result in improved financial performance and profitability (Dietrich and
Wanzenried, 2008).
A study by Ali, Akhatar and Ahmed (2011) on the maturity of financial system in a country
showed that a small banking system allows for high margins and profits. This study explores
12
banking systems of 80 countries between 1988 and 1995. Another study involving a larger
sample of banking systems for both developed and developing countries conducted by
Iannotta, Nocera and Sironi (2007) between 1990 and 1997 concluded that less profitable
banks were those operating in mature or more developed banking systems characterized by
high asset-to-GDP ratio. This is because such developed or mature systems allow for lower
margins hence lower profitability. Dietrich and Wanzenried (2011) on their part argue that
the maturity of a financial system does not affect the performance of commercial banks.
Their argument is that maturity of banking system does not necessarily lead to improved
efficiency and profitability. Other studies by Nacaeur and Goaied (2010) on the determinants
of performance of commercial banks in Greece concluded that maturity of the industry has a
positive but insignificant effect on bank performance.
Another study by Khrawish (2011) on the determinants of commercial banks in Tunisia
concluded that maturity of banking industry is negatively associated with profitability. This is
because it was observed that under the mature banking industry, the institutional and
regulatory variables were controlled. The same study showed that there is a negative and
significant relationship between bank assets to GDP ratio and return on equity and return on
assets. The conclusion from this study was that in countries where the banking assets were
large contributor to the total GDP, the banks were less profitable.
2.2.4 Competitive Forces in the Industry
Research in marketing has shown that there are certain competitive forces that influence the
performance of players in every industry (Khrawish, 2011). Porter (1980) refers to these
forces as “the drivers of competition and profitability in every industry, which as well include
banking industries around the world. He further stressed that it is difficult for firms which
operates in highly competitive industries to earn favorable returns on investment”. Based on
this statement, it is very clear that the financial performance and profitability of commercial
banks is influenced by certain competitive forces in the industry and even some studies in this
area have shown that fierce competition in the commercial banking industry tends to lead to a
situation where there are decreased profits (Smith, 1984).
It is therefore clear that some competitive forces in the banking industry have an influence on
the financial performance of those commercial banks. This is the case in both developed
countries and in developing countries. Increased competition in the banking industry leads to
lower levels of financial performance and profitability due to the increased number of players
13
and the lower market share (Podder, 2012). Highly competitive firms are able to offer better
services to their clients and therefore tend to attract and retain more clients. In the banking
industry, highly competitive commercial banks are able to operate at a lower cost than their
competitors and therefore charge lower fees for their services as well as interest rates for their
loans. This tends to attract more customers to such commercial banks and therefore more
funds to loan out to customers. These commercial banks are therefore able to make more
revenues and thus more profitability in the long run (Ayele, 2012).
Competition in the banking industry today is being driven by technology advancements and
the commercial banks that have enough assets to invest in technological innovations are
emerging as major players in the industry and this translates to increased profitability. The
emergence of mobile banking and mobile money transfer services has changed the
competitive scope of the banking industry and this has influenced their performance in a
significant manner. Research shows that commercial banks that are able to get into
partnership with telecommunication companies to develop mobile money transfer platforms
are able to tap into the large unbanked population particularly in developing countries and
therefore increase their customer base. Such services have ensured that the commercial banks
continue to increase their cash reserves and therefore issue more loans to consumers and thus
improved financial performance (Ongore and Kusa, 2013).
2.2.5 Ownership Structure
Ownership structure is both a firm specific as well as an industry specific determinant of
bank performance. According to Podder (2012), the relationship between bank performance
and ownership structure in the industry exists because of spillover effects from superior
performance of privately owned banks compared to publicly owned banks. This is based on
the general assumption that publicly owned banks do not always aim at profit maximization
and are marred by inefficiencies. There is no clear empirical evidence supporting the
relationship between ownership and bank performance in industry level. It is however a
determinant worth investigating (Podder, 2012).
2.3 Firm Specific Determinants of Performance
Firm specific factors that influence the financial performance of commercial banks have been
studied by various researchers in different settings. This is attributed to the fact that internal
factors such as management efficiency are some of the major determinants of the
performance of an organization. Firms that perform well are normally characterized by good
14
management of internal factors and these are the factors that can be manipulated by the
management of the firm for better and improved performance. This has resulted in the
identification of the various internal factors that influence the performance.
2.3.1 Cost of Operations
One of the major firm specific factors that influence the financial performance of commercial
banks is the cost of operations. The operating costs of a bank are normally expressed as a
percentage of the profits and they are normally expected to influence the financial
performance of the bank in a negative manner (Swarnapali, 2014). In the literature in
financial performance, the level of operating expenses is normally looked at as a way of
measuring the efficiency of a firm’s management. Memmel and Raupach (2010) in their
study of several European countries conclude that “operating costs have a negative effect on
profit measures despite their positive effect on net interest margins”. Another dimension of
operating costs is that the bank expenses are considered to influence the financial
performance of commercial banks and this is supported by Rasiah (2010) whose study
showed that there is a negative relationship between the financial performance of commercial
banks and the management of their expenses. Efficiency in cost management is normally
measured as a ratio (operating costs to assets). This is due to the fact that only operating
expenses can be directly associated to the outcome of bank management (Athanasoglou,
Brissimis and Delis, 2008). This has resulted in a negative relationship due to the fact that
improved management of bank expenses lead to improved efficiency and thus improved
profitability ratios.
In general performance management of organizations, high cost of operations lead to lower
profit margins since it means that the organization is spending more in order to get output. It
is important to note that due to competition and market regulations, a bank that is faced by
high cost of operations cannot pass the whole burden to the customers through increasing the
bank fees and charges and therefore this means that the bank has to shoulder it. Increased
costs affect the left side of the profit and loss statement and this means that the profits
realized will be lower than in a case where the costs of operations are lower. Commercial
banks that are interested in achieving high financial performance or profitability need to
develop ways of ensuring that their costs of operations are maintained at an acceptable level.
Firms that are able to minimize their costs of operations are considered to be more efficient
and it is also expected that they post higher profits margins than their counterparts that have
higher costs of operations (Athanasoglou, et al., 2008).
15
2.3.2 Ownership Status
Ownership status of the bank is another firm specific factor that has in the recent past drawn a
lot of attention from researchers in financial management who are interested in the evaluating
the determinants of the financial performance of commercial banks (Bonin, Hasan and
Wachtel, 2004). The literature on this has mainly focused on the influence of foreign
ownership on financial performance as compared to the influence of domestic ownership on
the financial performance of commercial banks (Amare, 2012). In developing countries like
Kenya, literature shows that foreign ownership brings in several advantages to the
performance of commercial banks such as improved technology, risk management expertise,
improved knowledge on corporate governance as well as increased competitiveness. All these
advantages lead to the improved performance of the commercial banks in terms of improved
efficiency in cost management which results in improved financial performance
(Athanasoglou, Brissimis and Delis, 2008). It is therefore clear that foreign ownership leads
to better financial performance of commercial banks in developing countries.
Researchers have also evaluated the influence of government or private ownership on the
financial performance of commercial banks and the results from the various studies have
been contradictory. Some of the empirical studies show that there is no significant negative
effect of either government or private ownership on the financial performance of commercial
banks (Bonin, Hasan and Wachtel, 2005). Some studies on the other hand show that privately
owned commercial banks post better financial results than government owned banks due to
the improved efficiency associated with the private sector (Dietrich and Wanzenried, 2008).
This means that the ownership of a commercial bank particularly in the developing countries
like Kenya influences their financial performance in one way or another.
Studies have further attempted to establish the main theoretical explanation that can be used
to explain the relationship between the ownership structure of commercial banks and their
financial performance. The main theory that has been used is the agency theory as explained
by Jensen and Meckling (1976). It is indicated that managers of commercial banks that have
different capital structures tend to choose different activities or investment decisions. The
relationship is such that due to capital market discipline, owners of the commercial banks
may have more control over the management and this would lead to a situation where the
management of the commercial bank is inclined to be more efficient and profitable. The
studies therefore suggest that ownership structure of commercial banks and the corporate
governance of the same influence their financial performance. Commercial banks that are
16
owned by value based owners who are stringent in terms of management control are expected
to be more profitable than commercial banks that are owned by the state or co-operatives.
The agency theory therefore clearly shows that the ownership structure of a commercial bank
influences its profitability in a significant manner due to the influence that the owners have
on the management (Swarnapali, 2014).
2.3.3 Size of Bank
Another factor that researchers have evaluated in relation to the financial performance of
commercial banks is the size of the bank which is normally measured in terms of assets. The
results of these studies have also been conflicting since researchers have not been able to
agree on whether size actually influences performance of commercial banks. Goddard et al.
(2004) identified only slight relationship between the size of a bank and their financial
performance. Another study by Goddard, et al. (2004) showed that there is a significant and
positive relationship between the bank’s size and its financial performance. This is associated
with the fact that the bigger the size of the bank the lower the cost of raising capital for that
bank and thus the higher the profitability ratios. Other studies by Bikker and Hu (2002) and
Goddard et al. (2004) agree with the previous study and they note that an increase in the
bank’s size has a positive influence on the financial performance of that bank due to the fact
that the cost of seeking capital for that bank is reduced significantly. It is however important
to note that researchers have had no consensus on whether an increase in the size of the bank
through increased assets provide economies of scale to commercial banks which eventually
leads to the improved financial performance. This is therefore an issue that needs to be
evaluated further through more studies.
The size of the commercial bank or any other business entity in terms of the assets is a very
significant determinant of profitability due to various issues. Commercial banks that have a
large asset size are able to expand their operations geographically to regions where
competition is not very high or to regions where the market is largely untapped. Such a move
would increase the customer base of the bank in a significant manner and this would also lead
to increased customer deposits (Goddard, et al., 2004). It is important to remember that most
of the profits of commercial banks come from the reinvestment of the customer deposits as
well as through lending to borrowers. Increased customer deposits mean that the bank has a
higher lending capacity. Such a high lending capacity will result in the bank making more
money from the loans and thus recording higher profit margins than those commercial banks
17
that have a smaller asset size. It is therefore clear that there is a relationship between the size
of the bank and its level of financial performance or profitability (Ongore and Kusa, 2013).
Another dimension related to the relationship between the size of the bank and its
profitability that has been focused on by researchers is the idea that a bank with more assets
is able to make huge investments in technology and other input factors which increase the
firm’s efficiency as well as its customer base. Investments in technological innovations as
well as engaging in joint ventures with technological companies such as companies providing
mobile money transfer services is one way of improving the performance of the commercial
banks. In Kenya for example, one of the largest commercial banks in terms of assets (Kenya
Commercial Bank) has entered into various partnerships with Safaricom and other mobile
networks to develop a mobile money transfer platform which has enabled to increase its
revenues in a significant manner and thus its profitability (Ongore and Kusa, 2013). The fact
that larger banks are able to enter into more strategic partnerships and engage in more
investments clearly indicates that there is potential for improvement of financial performance
or profitability in the long term (Amare, 2012).
2.3.4 Capital Adequacy and Liquidity
Capital and liquidity are other firm specific factors that researchers have found to have an
influence on the financial performance of commercial banks both in the developing world
and in the developed world. The studies argue that commercial banks that have higher levels
of capital post better financial results than their counterparts who have less capital at their
disposal. Staikouras and Wood (2003) claim that “there exists a positive link between a
greater equity and financial performance among EU commercial banks”. Abreu and Mendes
(2001) also show that there is a positive impact of the equity level of a commercial bank on
the financial performance of that bank. Goddard et al. (2004) supports the prior finding of a
“positive relationship between capital/asset ratio and bank’s earnings”.
Capital adequacy for commercial banks is measured by different variables including the log
of total assets (LTA), Loan Loss provisions to total loans, loans to assets, tax to operating
profit before tax, overhead expenses to total assets, non interest income to total assets , total
revenue to number of employees and shareholders’ equity to total assets. All these measures
aim to measure capital adequacy of commercial banks from different perspectives. The aidea
behind the measures is to determine the level of capital held compared to equity and other
balance sheet activities. For instance, capitalization which is regarded as the principal
18
measure of capital adequacy, is a measure ratio of shareholders equity to total assets. The
lower the capitalization or capital ratio is the risky the banking institution is and vice versa.
Liquidity of the commercial bank is also considered to have an influence on the financial
performance of the bank. Researchers note that insufficient liquidity of commercial banks is
considered to be one of the major reasons why they fail. It is however important to note that
when a commercial bank holds a lot of liquid assets, then it incurs an opportunity cost of
getting higher returns from investing with those assets. It is noted from the various studies
that there is a positive relationship between liquidity and the performance of commercial
banks although it is also noted that during times of instability in the business environment,
commercial banks will tend to increase their cash reserves (holdings) as a way of mitigating
themselves against risks. It is therefore clear that there is a negative correlation between the
level of liquidity and the financial performance of commercial banks (Memmel and Raupach,
2010).
Other researchers adopt a different perspective where they note that a commercial bank that
has high liquidity (high amounts of cash reserves) is able to carry out its basic functions
smoothly. These functions include to offer cash for withdrawals as well as to lend to
borrowers. Such basic functions ensure that the commercial bank is earning more money in
terms of fees charged on withdrawals as well as other bank charges and also in terms of the
interest earned on the loans extended to customers. A bank with high liquidity is therefore
preferable due to its ability to execute these functions and thus make more money
(Athanasoglou, et al., 2008). Commercial banks however have to establish a limit for the
lowest cash reserves they can hold in order to ensure that customers are served smoothly. The
Central Bank of Kenya, which is the institution charged with the responsibility of regulating
commercial banks in Kenya normally requires that commercial banks keep a certain amount
of cash reserves as a way of protecting the interests of the depositors (customers) against
losses since this is essentially their money (Central Bank of Kenya, 2013).
2.3.5. Credit Risk
Existing theory on the bank exposure suggests that increased credit risk is associated with a
decrease in bank profitability. Credit risk is negatively related to Return on Assets (ROA) and
Return on Equity (ROE). Credit risk is defined as the loan-loss provisions to loans ratio.
Therefore, banks can improve their performance by reducing the credit exposure. According
to Podder (2012), this can be achieved by improving on screening and monitoring of credit
19
risk policies and adopting current strategies to forecast future levels of risk. In most countries,
the central banks and other regulatory authorities that regulate the banking and financial
institutions set us specific standards to address the level of loan loss provisions in order to
enhance good performance of banking institutions and safeguard the economy. In line with
these provisions, most banking institutions adjust their provisions held for loan losses to a
predetermined level set at the end of each period. Therefore, credit risk is a predetermined
determinant of bank performance that is depended on risk attitude and philosophy of
management as well as on other decisions taken by the management.
2.3.5. Productivity
Over the recent decades, there has been increased competition in the banking sector in both
the developed and developing countries. This has been brought by the reduction of barriers to
entry into the industry and also globalization of banking institutions. This has forced banks to
reorganize their operations in order to cope with the competition. Part of the reorganization
strategy is to focus on the most productive operations and pursuing growth in productivity by
keeping a lean and steady labour force while putting measures in place to increase the overall
output. In most cases, productivity in banks is measured as the percentage of change in labour
productivity. This measure, which is the ratio of gross total revenue to the number employees
in the organization, shows the efficiency in the bank in making use of the available resources
to generate revenue. The higher the productivity of a bank is, the better the performance of
the bank and vice versa.
All the above factors measure the financial strength of a bank including the liquidity,
efficiency, profitability, capital adequacy, risk and liquidity. Although these are important
determinants of bank performance, they tend to be justifications because of much emphasis
on past data. An effective study on determinants of bank performance must therefore consider
both the bank specific factors and external factors.
2.4 Macro Economic Determinants of Performance
Another group of variables that researchers have evaluated in order to determine the factors
that influence the financial performance of commercial banks are the macro-economic
factors. Macro-economic factors influence the performance of the business entities in an
economy in a significant manner since they determine the kind of operating environment
available. Commercial banks do not operate in a vacuum and this therefore means they are
influenced by the conditions of the external environment. An economy with favorable macro-
20
economic conditions will give room for business to thrive and this also means that
commercial banks will benefit from the increased business activities and thus improved
profitability (Bodie, et al., 2005).
2.4.1 Gross Domestic Product
One of the major measures of the performance of the entire economy is the gross domestic
product (GDP) and is used to measure the total economic activity within a particular country.
The growth in GDP has been linked with increased economic activity in a country. Increased
economic activity means there are more people with improved standards of living and who
can be able to engage in banking activities. This will mean more business for the commercial
banks as they are the intermediaries in of money exchange in such economies and this will
lead to improved financial performance and profitability (Bikker and Hu, 2002). Literature
further shows that a growth in GDP has a significant and positive effect on the financial
performance of the financial sector of that country. This means that it is expected that growth
in GDP will have a positive influence on the financial performance of individual commercial
banks.
Macroeconomic conditions may affect the financial performance of commercial banks in a
number of ways. Firstly, when the economy of a country is going through a boom period, the
public will have a higher demand for bank loans thus driving the earnings of these
commercial banks. During times of recession this trend is reversed. It is noted that a high
aggregate growth rate of the economy will be beneficial due to the fact that it improves the
ability of local borrowers to service their debts and thus contribute to a lower credit risk for
commercial banks in that country. On the contrary, poor macro-economic conditions lead to
an increase in the amount of non-performing loans and thus increase the credit risk of
commercial banks. It is therefore clear that an increase in the economic growth rate of a
country will lead to improved financial performance of commercial banks in that particular
country (Gerlach, et al., 2004). Guru et al (2002), presents evidence that “economic growth, if
particularly, associated with entry barriers to the banking market, would potentially lift the
financial performance of commercial banks”.
The gross domestic product of a country indicates the level of economic activity in the
country. Countries with high levels of GDP are characterized by an economic climate which
promotes the growth and development of businesses and this means that the consumers are
able to afford basic needs and their living standards are improved. Once the citizens are
21
satisfied with meeting their consumption needs, the rest of the money is used for investments
and savings. Most of the savings are done through commercial banks in the country. A high
level of GDP therefore means that citizens make more investments as well as savings and this
means more cash reserves available to commercial banks to engage in their loaning activities.
When banks loan out more money, they earn more interest from the loans and thus more
profitability (Podder, 2012).
2.4.2 Interest Rates
It is also believed that an increase in interest rates should lead to an increase in the financial
performance of commercial banks since this leads to an increase in the spread between the
interest rates for savings and the interest rates for borrowing. Podder (2012) evaluated this
relationship and found that “this relationship is particularly apparent for smaller banks in the
USA”. They further noted that a reduction in the interest rates during a recession period
results in a slower growth in bank loans while at the same time increasing the amount of non-
performing loans and thus increased loan losses. This therefore means that commercial banks,
particularly the smaller ones may have a lot of difficulties in maintaining their financial
performance when the market rates are on a decreasing trend. More studies have been carried
out to evaluate this relationship and results have clearly shown that there is a positive
relationship between interest rates and the financial performance of commercial banks
(Podder, 2012).
Interest rates affect both the commercial banks and their customers in two major ways. When
the interest rates rise, customers are unable to service their existing loans which leads to
losses to the commercial banks since if the situation continues that way, they are forced to
write off their debts. This eats into the profits of the company since it means that the
commercial bank is not able to recover both the principal amounts loaned as well as the
expected interest from the customers (Makkar and Singh, 2013). When the interest rates are
too low, the interest earned from the loaned out amounts is negligible and thus contributes
little to the profitability of the commercial bank. There is therefore need for a balance in the
interest rates in order to ensure the banks benefit (Lipunga, 2014).
Customers on the other hand avoid the consumption of bank loans when the interest rates are
too high since they can ether not afford to take up loans or the interest rates are too high that
they just prefer to seek other cheaper alternatives such as micro finance institutions and other
cheaper lending institutions. This affects negatively the ability of the commercial banks to
22
earn interest from their customer deposits since they cannot loan them out to borrowers. This
therefore leads to poor performance of the commercial bank as well as its profitability. It is
important to note that this is the case that happened when the financial crisis of 2008
occurred. Macit, (2011) analysed the bank specific and macro-economic determinants of the
profitability of commercial banks and found that interest rates are a major determinant.
2.4.3 Inflation rates
The inflation rate in a country is also another macro-economic factor that has been associated
with the performance of commercial banks and a number of researchers have focused on
establishing this relationship. It is noted that generally, high inflation rates lead to high
interest rates on loans and thus lead to higher income to commercial banks. Swarnapali
(2014), however, asserts that “the effect of inflation on banking performance depends on
whether inflation is anticipated or unanticipated”. In an event where an increase in the
inflation rates is fully anticipated and an adjustment is made to the interest rates accordingly,
then this leads to a positive influence on the financial performance of commercial banks. On
the other hand, when an increase in the inflation rates is not anticipated, it results in a
situation where the local borrowers are faced with cash flow difficulties and this can result in
the termination of bank loan agreements in a premature fashion thus causing loan losses for
the issuing commercial bank. The general observation is that when commercial banks take a
lot of time to adjust their interest rates after changes in the inflation rates, it leads to a
situation where the bank’s operating costs may rise faster than the revenues of the bank.
Siddiqui and Shoaib (2011) even conclude that “high and variable inflation may cause
difficulties in planning and in negotiation of loans”.
Other researchers have also evaluated the influence of macro-economic indicators on the
financial performance of commercial banks in various countries. For example, Dietrich and
Wanzenried (2008) applied a multivariate logit model to evaluate the influence of macro-
economic indicators on the financial performance of the commercial banks in those countries.
The results of the study suggested that macro-economic indicators have a significant
influence on the performance of commercial banks. Delis et al (2008) on the other hand used
a linear regression model to evaluate the data collected from commercial banks in 80
countries. The empirical results of the study showed that there was a positive but insignificant
influence of macro-economic factors on the financial performance of commercial banks in all
the sampled countries.
23
Another researcher, Naceur (2003) evaluated the financial performance of commercial banks
in Tunisia in an effort to identify the macro-economic factors that influences their
performance. The study used balanced panel data collected from 10 major deposit
commercial banks for the years from 1980 to 2000. The results of the study showed that the
annual growth rate of the economy and the inflation rates had no or insignificant influence on
the financial performance of commercial banks in Tunisia. Mamatzakis and Remoundos
(2003) evaluated the same relationship with a “sample of 17 commercial banks from Greece
and used the structure-conduct-performance framework to derive results of 1989-2000-year
bank level data”. The findings of their study indicated no significant relationship between the
Consumer Price Index (CPI) and Real interest rate with the Return on Assets (ROA) and the
Return on Equity (ROE) of the commercial banks that were subjected to the study. Another
study by Athanasoglou, Brissimis, and Delis (2005) used GMM estimator approach to
evaluate the relationship and the results showed that that there was a significant and positive
relationship between the inflation rates and the real interest rate on the financial performance
of commercial banks in Greece.
High inflation rates also lead to a situation where consumers find themselves at a position of
low purchasing power and they therefore tend to use most of their money for consumption.
This means that the money that would have been used for investments or savings in
commercial banks is redirected to consumption. Such a situation therefore reduces the
amount of money being deposited in commercial banks as savings by the consumers and this
in turn reduces their cash reserves as well as their ability to issue loans to borrowers (Rasiah,
2010). Consumers will also tend to withdraw their savings from commercial banks at such
times since there is not enough money to spend due to the low purchasing power. Banks
therefore find themselves in a situation where they have less funds available to them to offer
as loans to borrowers. The fact that most of the profits of commercial banks is derived from
interest earned on loans means that a bank that cannot offer loans to its customers makes less
money. This will then affect its profitability in a negative manner. It is therefore clear that
inflation rates as well as other macro-economic indicators influence the profitability of
commercial banks (Sufian and Chong, 2008).
2.5 Summary of Chapter
This chapter has reviewed literature relating to the determinants of the financial performance
of commercial banks. The chapter has presented the various determinants and is structured in
a manner to show that there are three major categories of the determinants. These are the
24
bank specific factors, the industry specific factors and the macro-economic indicators.
Various studies have been presented to show the previous work of other researchers on the
same in order to identify the various issues that have been discussed and thus lead to a better
understanding of the relationship between the various variables.
25
CHAPTER THREE
3.0 RESEARCH METHODOLOGY
3.1 Introduction
This chapter explains the methodology that the researcher employed in the process of data
collection and analysis. It describes the research design, population and sampling design, data
collection and analysis techniques.
3.2 Research Design
In this study, the researcher used descriptive research survey design. According to Greener
(2008), descriptive research design is a design that is used when the researcher wants to
describe specific behavior as it occurs in the environment. Researchers posit that the main
purpose of using a descriptive study design is in order to help the researcher to establish how
things are currently in the field of study and to report them as they are without any attempt to
manipulate them or change their status. It is therefore clear that the study design helps the
researcher to report situations as observed (Mugenda and Mugenda, 2003). On the other
hand, Saunders, Lewis and Thornhill (2009) note that descriptive survey research is intended
to produce statistical information about aspects of a study that interest policy makers in order
to help them make more informed decisions.
3.3 Population and Sampling Design
3.3.1 Population
According to Kothari (2006), the population of a study is simply the entire set of individuals
or items that are described in the study as being the area of study and which the researcher is
trying to observe their characteristics or behavior. The population constitutes of all the items
that fit the study area and it should be noted that this is the area the researcher selects an
appropriate sample to subject to the study. The target population for this study was all the
registered commercial banks in Kenya. According to the Central Bank of Kenya which is the
body charged with the supervision of commercial banks in Kenya, currently, there are 44
registered commercial banks in Kenya as of 30 June 2014 (CBK, 2014).
26
3.3.2 Sampling Design
3.3.3.1 Sampling Frame
According to Cooper and Schindler, (2006) a sampling frame is defined as a list of elements
from which the sample is actually drawn and is closely related to the population. It is a
complete and correct list of population members only. There is agreement on this definition
by Saunders (2007), who define a sample frame as the complete list of all the cases in the
population from which the sample is drawn. Since this study was a survey of the entire
banking industry, the sampling frame was the 44 commercial banks operating as at 30 June
2014 as included in appendix 1. This is the entire population of the study.
3.3.2.2 Sampling Technique
A sampling technique is the method used to select an appropriate sample of respondents from
the population. This study targeted the entire banking industry. Since Kenya constitutes of
only 44 banks, a census was done in order to provide a true measure of population. As result
no sampling technique was necessary because the research utilized the entire population.
3.3.3.3 Sample Size
A sample is the appropriate number of individuals or items that the researcher selects from
the population and subject to data collection through the use of the appropriate sampling
methods and designs. This study was a survey of the entire banking industry in Kenya. This
therefore meant that all the registered commercial banks in Kenya would be subjected to the
study. This is due to the fact that the study aimed to investigate the determinants of the
financial performance of commercial banks in the entire banking industry in Kenya. The
sample of this study was therefore the 44 commercial banks since all of them were surveyed.
The period of study was three years 2011, 2012 and 2013.
Table 3.1: Sample Size Distribution Table
Population Sample % Sampled
44 Banks 44 100%
3.4 Data Collection Methods
Due to the nature of this study, the researcher used both primary and secondary data sources.
Primary data was collected through the use of properly structured questionnaires based on the
27
objectives of the study. The questionnaires contained both structured and unstructured
questions. Secondary data is defined by researchers as data that is not original in terms of the
fact that it had already been collected by another individual or researcher for use in another
study or for any other purpose other than the one the current researcher intends to use it for
(Greener, 2008). The researcher distributed questionnaires to 44 banks in Kenya. Three
questionnaires were sent to each bank giving a total of 132. The rationale for this was so that
the researcher could get a representative number of respondents that could increase the
objectivity of the research being undertaken. However, this research was able to collect 97
valid questionnaires from the respondents.
Secondary data was sourced from statistics maintained by the central bank of Kenya which is
the regulatory body which supervises the banking industry in Kenya. Financial measures of
profitability such as return on assets, revenue, return on investment, profitability growth,
banking sector growth are some of the key data which was sourced from CBK and analyzed
in order to examine how they affect the profitability of the commercial banks in Kenya over
the period of study.
3.5 Research Procedures
Research procedures involved the procedures that the researcher used to collect the type of
data identified as crucial for the study. The questionnaires were developed based on the
research questions set out earlier.
Questionnaires were administered to all 44 commercial banks through a drop and pick later
method where the researcher gave a two week duration for the respondents to fill them and
then go back to collect them. The secondary data was to be collected from central bank of
Kenya statistics, the body which monitors and supervises the commercial banks in Kenya.
The data on the financial performance of the banks, the size of the banks in terms of assets,
the liquidity level of banks and their capital adequacy was collected from CBK website. Data
on the banking industry concentration was also collected from the website of the Central
Bank of Kenya. These sources provided the researcher with enough secondary data, which
was reliable enough to be used in this study and thus help in solving the research problem and
arriving at the expected conclusions
3.6 Data Analysis Methods
After the data was collected from the various secondary sources, the researcher edited the
data to fit analysis of this study. The data analysis in this study involved the use of descriptive
28
and inferential statistics in order to help the researcher to establish the relationship between
the various independent variables (determinants of financial performance of commercial
banks) and financial performance of commercial banks in Kenya. Descriptive measures such
as mean, standard deviation and the inferential technique were used as well. Data was also
analyzed and expressed in terms of charts and tables for quick references. In relation to
inferential statistics, the linear regression model was utilized to further give inferences to the
data obtained.
3.7 Chapter Summary
This chapter has presented the research methodology and the methods the researcher will use
to collect the data and analyze it. The chapter shows that the study will use a descriptive
study design since this is considered to be the most appropriate design based on the research
problem and the study objectives that the study seeks to address. The study then shows the
target population and shows that it will be a survey of the entire banking industry in Kenya.
The next chapter will focus on data analysis and review of the findings.
29
CHAPTER FOUR
4.0 RESULTS AND FINDINGS
4.1 Introduction
The previous chapter has explained the research methodology that was used to meet the
objectives of the study. A descriptive study design was used incorporating both primary data
and secondary data. The secondary data used in the analysis is sourced from statistics on
commercial banks in Kenya as compiled by the Central Bank of Kenya.
4.2 Demographic Information
The general information described in this section stems from the primary data that was
collected from 97 valid respondents. This reflects 73.5% response rate.
4.2.1 Years of Experience
The study sought to understand the number of years the interviewees had worked for their
respective banks. The table below shows the distribution of the results; 23.7% of respondents
had 0-3 years of experience; 36.1% had 3-6 years of experience; 27.8% had 6-9 years of
experience and 12.4% had over 9 years of experience.
Table 4.1: Number of years worked
Years old 0-3yrs 3-6 yrs 6-9 yrs Over 9 yrs. Total
Frequency
%
23 35
36.1%
27
27.8%
12
12.4%
97
100% 23.7%
4.2.2 Level of Education
The study collected information about the level of education of the interviewees. The table
and chart below tabulates the results; 12.4% respondents had certificate; 3.1% respondents
diploma; 41.2% respondents degree; 39.2% respondents had masters and 4.1% respondents
were apprentice.
30
Table 4.2: Level of Education
Qualification Certificate Diploma Degree Masters Apprentice Total
Frequency 12 3 40 38 4 97
% 12.4% 3.1% 41.2% 39.2% 4.1% 100.0%
Most of the people interviewed had a degree or masters as the highest level of education. This
represented 80.4% of the bank employees.. This is mainly because degree has been
considered as the minimum entry requirement in the modern Kenyan banking industry.
4.2.3 Position of the respondent in the bank
The study also requested information on the position of the people interviewed. The results
are as per below; 10.3% respondents subordinate; 10.3% respondents lower levels; 41.2%
respondents middle level; 38.1% respondents senior manager. This is as summarized in the
table below;
Table 4.3: Position of the respondents in the bank
Position Subordinate Lower
Level
Middle
Level
Senior
Manager
Total
Frequency 10 10 40 37 97
% 10.3% 10.3% 41.2% 38.1% 100.0%
Majority of the employees of the bank were middle level as this was represnted by 41.2% of
the employees being in the middle level category. Most of the interviewees were middle and
seniour managers and that was deliberate because the study targeted these employees because
of their experience and knowledge in the banks.
4.3 Industry Specific Factors That Influence the Financial Performance of Commercial
Banks in Kenya
4.3.1 Analysis of the Findings
This part required the respondents to indicate whether various industry specific factors
influenced financial performance of commercial banks and to what extent. The industry
31
specific factors listed were competition, concentration of banking industry, the upward trend
of the banking industry, central bank regulations, the relative period the bank has been in
operation, development of the financial sector, turnover of key staff, growth of mobile money
transfer services, innovations in product content and bank ownership. Below are the results:
32
Table 4.4: Industry Specific Factors
33
Table 4.4 above summarizes the respondent’s views on industry specific determinants of
bank performance. The main factor affecting the profitability of the banks is competition.
Majority of the respondents agreed that competition was a key factor with 58% strongly
agreeing and 34% agreeing. This is in line with literature review on profitability of
commercial banks, which showed that competition in the industry leads to high advertising
expenditures hence reducing profitability. Also, as the banks seek to differentiate their
business from competitors they incur huge costs. Concentration of the banks in the industry
was also a major factor with 18% strongly agreeing.
The results also indicated that the respondents are comfortable with the regulation of the
commercial banks by the Central Bank of Kenya. The statement sought the respondents’
views on whether the regulations by the Central Bank of Kenya affect profitability of the
commercial banks negatively. Majority of the respondents, 63% strongly disagreed that
regulation significantly affects their profit. This therefore indicates that the commercial banks
in Kenya have confidence with the regulators and the regulatory framework does not affect
their profitability adversely. Ownership, whether local or foreign was not found to have a
major impact as the respondents felt that both types have equal chances of operating
profitably. Other factors like relative period in operation and employee turnover also did not
have a significant effect on the profits.
One of the main strands of literature on the determinants of the financial performance of
commercial banks has focused on the influence of industry specific factors such as the market
structure and bank specific variables to explain the differences in the financial performance
of commercial banks across the various countries. This study aligned with most of the
previous studies which indicated that bank specific variables tend to have a wider implication
on the bank’s financial performance as compared to the industry and macroeconomic
variables. However, there are some specific industry specific variables which the respondents
of this study felt that they have a significant impact on the financial performance. Increased
competitiveness in the banking sector leads to a situation where these commercial banks are
required to adopt different competitive strategies in order to ensure that they sustain their
financial performance levels (Karasulu, 2001).
34
4.4 Firm Specific Factors That Influence the Financial Performance of Commercial
Banks in Kenya
4.4.1 Profitability Measures
A key measure of the financial performance of commercial banks in Kenya used was the
Return on Assets (ROA), Return on Equity (ROE) and Net Interest Margin (NIM). The
financial sector in Kenya has grown significantly with the country becoming a more
integrated in the overall economy, regionally and internationally. This section shows the
highlights of the commercial banks in Kenya. The profitability of the sector has been growing
tremendously over the years. The net assets increased by 16.6% between 2012 and 2013 to
Ksh 2,703.4 Billion in December 2013. This was on account of loans and advances. Loans
and advances, government securities and placements have become key components of the
balance sheet of commercial banks in Kenya. They account for 56.7%, 21.6% and 6.5% of
the total balance sheet items respectively. Net loans and advances increased by 18.2% while
placements increased by 42.6%. The total deposits held by the commercial banks increased
from Ksh 1,707.8 billion in 2012 to Ksh 1,935.7 billion, an increase of 13.3%. This was
explained by branch expansion, growth in agency banking, remittances, and exports receipts
(CBK, 2013).
4.4.2 Capital Adequacy
The central bank of Kenya (CBK) has issued new guidelines on prudential capital adequacy
ratios for the commercial banks in Kenya. A capital buffer of 2.5% above the traditional
ratios has been proposed and it will be effective from January 2015. Although the
commercial banks have the freedom to choose their levels of capital adequacy, there is a
minimum regulatory capital adequacy requirement which is 8% for ratio of core capital to
total risk weighted assets (Tier I) and 12% for total capital to total risk weighted assets (Tier
II). The table below summarizes the trends in capital adequacy ratios for three years.
Table 4.5: Capital Adequacy Report
35
Source: CBK Financial Stability Report 3013
From Table 4.5 above, the ratio of core capital to total deposits increased from 17% in 2012
to 19% in 2013. Retained earnings and injection of fresh capital because of the increase in the
capital base funded this. According to the report, most of the banks met the minimum core
capital base of sh. 1.0 billion. The Tier II ratios and I declined from 20% and 23% in 2012 to
18% and 21% in 2013 respectively. This was because of the larger increase in total risk
weighted assets, which grew by 17.3% and 18.5% respectively.
4.4.3 Asset Quality
The commercial banks in Kenya recorded a low proportion of loans and advances in 2013
due to the subdued economic activities associated with uncertainty around the 2013 general
elections in the country. The stabilization and realignment of government operations as well
as the implementation of the devolved governments system under the new constitutional
dispensation saw the delays in payments of services rendered. Below table shows the trends
in assets quality.
Table 4.6: Trends in Asset Quality
Source: CBK Financial Stability Report 2013
From Table 4.6 above, the Kenyan commercial banks had the net assets growing steadily
between 2010 and 2013. This shows that the current assets grew ahead of current liabilities,
which demonstrate a strong balance sheet position. The net loans also grew modestly by
above 10% per year. This reflects the growing customer base for the banks and attractive
economic outlook for the banking sector. Notably, the gross loans to net asset ratio grew
modestly from 54.52% in 2010 to 58.4% in 2013.
36
4.4.4 Liquidity
The statutory liquidity level for commercial banks in Kenya is 20%. The reason for the
minimum liquidity level is to ensure that the banks are able to fund increase in assets and
meet the obligations as they fall due. Liquidity is one of the keenly checked factor be the
CBK since its deterioration can trigger panic leading to a system crisis in the banking sector
and spillover to the rest of the economy. The table below summarizes the trends in liquidity
of commercial banks
Table 4.7: Trends in Liquidity of Commercial Banks of Kenya
Source: CBK Financial Stability Report 3013
From the table 4.7 above, the average liquidity for the commercial banks in Kenya exceeded
the statutory minimum requirements of 20%. The average of the liquidity was 38.6% in 2013
compared to 41.9% in 2012. The decline of 3.3% was due to the increase in lending in 2013
as evidenced by the increase in loans to deposits from 77.9% to 81.6%.
4.4.5 Profitability
The profitability of commercial banks in Kenya remained strong over the last six years. This
is because of growth in credit portfolio, investment in government securities, commissions
and earnings from foreign exchange trading. Below is a summary of profitability of the
commercial banks in Kenya.
Table 4.8: Commercial banks’ profitability 2008 to 2013
37
Source: CBK Financial Stability Report 2013
The profitability of the commercial banks increased from Ksh 107.9 billion in 2012 to Ksh
125.8 billion in 2013. This represented a 16.6% increase. The interest income declined to
58.4% from 60.8% in 2013 and 2012 respectively. The performance of the commercial banks
remains uneven despite the strong profitability, asset base, return on assets and return on
equity.
Table 4.9: The trends in return on assets and return on equity
Source: CBK Bank Supervision Annual Reports 2013
The following figure 4.5 summarizes the financial performance of commercial banks in
Kenya between 2001 and 2010.
Figure 4.5: Summary of Financial Performance of Commercial Banks in Kenya 2001-2010
Source: Central Bank of Kenya 2013 priceless
Figure 4.5 above shows an erratic trend of performance of commercial banks in Kenya. In
2001, the average ROA, ROE and NIM was 1.63, 18.20 and 6.15 respective. This reduced to
1.05, 7.18 and 5.34 respectively in 2003. According to Khrawish (2011), one of the possible
reasons for this decline in performance of commercial banks in Kenya was the liquidation of
a bank in 2003. In 2007, the performance of the banks improved mainly because of the
decrease in non-performing loans from 5% to 3.4%. In 2009, there was a decline in the
performance of the banks as shown in the graph. This was probably due to the global
38
economic crisis, which as felt far and wide. In 2010, the banks recorded improved
performance as the world started its recovery path from the economic crisis. Generally, the
financial performance of commercial banks in Kenya has been in an upward trend. Compared
to most countries, the commercial banks in Kenya recorded a better performance between
2001 and 2010. Therefore, investments in the banking industry in Kenya is profitable hence
an avenue of attracting Foreign Direct Investment (FDI).
4.3.5 Description of Independent Variables
Most studies on performance of banks have categorized the determinants of performance into
internal and external factors. Some of the studies refer to the internal factors as the bank
specific determinants of bank performance while the external factors are referred to as the
macroeconomic determinants of profitability. The internal factors include capital, asset
quality, management efficiency, and liquidity. The capital ratio ensure of the funds available
to the bank to support the business and act as a safety net during times of adverse
development. The capital ratio is calculated as a ratio of equity to total assets. The asset
quality measures the availability of resources to the bank such as networks, goodwill and
others that can be used to generate revenue. Management efficiency relates to the quality of
decisions made by the management relating to the deployment of the resources available to
the bank for use in revenue generation. Liquidity is a short term measure of the ability of the
bank to meet its short term obligations as they fall due.
Table 6: The correlation coefficients between variables
CAPITAL
RATIO
ASSET
QUALITY
MANAGEMENT
EFFICIENCY
LIQUIDITY
Capital Ratio 1.00000
Asset Quality 0.5476 1.0000
Management
Efficiency
0.3122 0.1921 1.0000
Liquidity 0.6979 0.6112 0.2910 1.000
From the table above, the correlation coefficient between asset quality and capital ratio is
0.55, while the correlation coefficient between management efficiency and capital ratio is
0.31. The correlation coefficient between liquidity and capital ratio is 0.69, and 0.61 and 0.29
39
between asset quality and management efficiency respectively. The correlation coefficients
for all the independent variables were less than 0.8 hence there is no multicollinearity.
Table: 4.10: Summary of Responses on Firm Specific Factors
Based on the table 4.10 above, out of the 97 respondents, 65% respondents strongly agreed
that state of the art information systems play a key role in driving profits for the banks. 33%
respondents agreed with the statement while only one respondent disagreed. Information
systems are critical for banks as they affect the quality and speed of service to the customers.
40
State of the art systems enhance efficiency, increase customer satisfaction and significantly
reduce costs hence increasing profits.
Strategic positioning is another key determinant with 53% respondents and 44% respondents
strongly agreed and agreed respectively with the statement that strategic positioning of bank
branches. Customers require flexibility and convenience hence the reason why respondents
thought that strategic positioning of branches impacts profits positively. Top management
changes also affected profitability because of the nature of instability it causes to the
businesses with 74% of the respondents agreeing to this position. Product range and
distribution networks were other key determinants affecting profitability. This shows that
most banks in Kenya deal with retail banking and therefore access to customers and improved
service through branch networks improves bank performance. Other factors like partnerships
with other institutions and bank ownership were not found to have a huge impact on
profitability.
4.5 : Macroeconomic Factors That Influence the Financial Performance of Commercial
Banks in Keny
This section sought the views of the respondents on the impact of macro-economic factors on
bank performance. The macro-economic factors include government policies such as
increasing or decreasing expenditure, change in consumption behaviors, economic growth,
volatility of exchange rates, depreciation and appreciation of Kenyan currency,
unemployment rate, consumer purchasing power, trade balances, stability of inflation rates
and saving culture of Kenyans.
41
Table 4.11: Tabulation of macroeconomic factors
On the macro-economic policies by the government, 41% respondents were neutral, 23%
agreed and 35% strongly agreed that decreasing or increasing government expenditure affects
profits of banks. This is because the expenditure by the government has a multiplier effect on
the economy. On consumption behavior of the customers, 34% respondents agreed that it
affects profits of banks and 65% strongly agreed. This indicates that the higher the
consumption, the lower the profits because of low savings and low demand for banks’
products. On the other hand, the lower the consumption, the higher the demand for products
offered by the bank hence high profits.
Economic growth affects bank performance as shown in the table. 65% respondents strongly
agreed while 34% respondents agreed that economic growth lowers the cost of production
and increases demand for banking services. This shows that the respondents unanimously
agreed that the volatility of exchange rates directly affects the profitability of commercial
banks in Kenya since it dictates the pricing of the banking services. Apart from the economic
growths, Stability of inflation rates and saving culture of Kenyans were found to affect the
42
profitability of commercial banks. Around 45% respondents agreed that saving culture of
Kenyans affects profitability of banks while 53% respondents strongly agreed. Saving culture
increases the demand for banking services hence increasing profitability of commercial
banks. Volatility in exchange and inflation rates also have a significant role in the
profitability of the banks.
4.6 Chapter Summary
This chapter has presented the data which has been analyzed both from primary and
secondary data sources. The data has been tabulated, discussed and explained including
through the use of graphs. Also, the study evaluated the moderating effect of ownership
identity on the performance of commercial banks in Kenya. It has showed that ownership
identity does not have a significant moderating effect on the relationship between
performance of commercial banks and the determinants. The next chapter will summarize,
discuss the findings and give recommendations for this study.
43
CHAPTER 5
5.0 DISCUSSION, CONCLUSIONS AND RECOMMENDATIONS
5.1 Introduction
This chapter seeks to focus on the findings in chapter 4 whilst also arriving at certain
conclusions. In addition, based on the conclusions made, recommendations will be made in
order to assist the Kenyan commercial banks have a stable financial performance.
5.2 Summary
The purpose of this study was to evaluate the determinants of bank’s financial performance in
developing economies with a focus on Kenyan commercial banks.
This research strived to give an understanding into the determinants of financial performance
in developing but with a focus on Kenya. In order to achieve this, the following research
questions guided the study. What are the industry specific factors that influence the financial
performance of commercial banks in Kenya? What are the firm specific factors that influence
the financial performance of commercial banks in Kenya? What are the macro economic
factors that influence the financial performance of commercial banks in Kenya
The research adopted methodology was descriptive research design. A survey was done
where all the 44 commercial bank licensed to operate in Kenya as at 31st December 2013
were considered. Primary data was collected from the banks using a structured questionnaire
while the secondary data was collected from the banks’ financial statements as well as from
the Central Bank of Kenya database. Thereafter, data was analyzed using descriptive and
inferential analysis and presented using charts and tables.
The first research question sought to find the industry specific factors that influence the
financial performance of commercial banks in Kenya. The research findings regarding the
industry specific factors that influence the financial performance of commercial banks in
Kenya suggested that in most case, these factors did not have significant impact on
profitability. Nevertheless, competition amongst banks within the industry had the most
impact on the financial performance of the commercial banks. The reason why majority of
the banks felt that competition was the most significant factor was because the cost of
substitution of one bank to another bank had greatly decreased resulting in the ease of
44
customer movement from one bank to another. Therefore, banks that had a large number of
customers had a higher probability of having a high financial performance whilst banks that
had a smaller number of customers could only manage a lower financial performance. In
addition, the general growth trajectory of the Kenyan banking industry had also been a
significant determinant of the financial performance of the Kenyan banks.
The second research question sought to establish the effects of bank specific factors on
profitability. The research findings suggest that capital adequacy, management efficiency and
asset quality will have a strong impact on Return on Assets, Return on Equity and Net
interest margins. These findings were generated after posing the question of which factors
that the banks considered were likely to affect their financial performance in the Kenyan
banking sector. In addition, the records from the Central Bank of Kenya complemented the
findings that indeed, the aspects of return on assets, return on equity and net interest margins
impacted upon the financial performance of the commercial banks. From the study, it was
determined that the relationship between liquidity and the performance of commercial banks
was not significant. Nevertheless, there existed a positive relationship between capital
adequacy and the performance of the commercial banks. However, aspects such as asset
quality that were determined by the ratio of non-performing bank loans contributed to the
poor performance experienced by the banks.
On the last research question, the research findings on the impact of macroeconomic factors
on the financial performance of commercial banks in Kenya suggested that macroeconomic
variable had little impact on the performance of commercial banks in the developing
countries. Nevertheless, changes in consumer consumption behavior, economic growth,
depreciation and appreciation of the Kenyan currency, inflation and saving culture of
Kenyans indeed impacted upon the financial performance of the Kenyan commercial banks.
This can be attributed to the fact that the above mentioned factors affect the money supply in
the Kenyan economy to a great extent. With money supply to the economy being greatly
affected, the financial performance of the Kenyan commercial banks is also affected
adversely.
45
5.3 Discussion
5.3.1 Industry Specific Factors That Influence the Financial Performance of
Commercial Banks in Kenya
Competition has been cited as the most significant industry specific factor that affects the
performance of the Kenyan commercial banks. This is because 58% of the banks that were
interviewed acknowledged that indeed the competitive forces that exist in the Kenyan
banking scene had been instrumental for the changes in the financial performance of the
Kenyan commercial banks. In addition, the upward growth of the Kenyan banking sector and
the concentration of the banking industry in Kenya have also affected the profitability of the
Kenyan commercial banks. On the basis of the above factors it is evident that the primary
data findings suggest that industry specific factors tend to have minimal effect on the Kenyan
commercial bank’s financial performance. These primary findings are consistent with the
viewpoints of Khrawish (2011) and Ayele (2012) viewpoint that an improvement in the
financial development would result in an improvement in the level of efficiency experienced
in the Kenyan banking sector. On this basis, it can be concluded that the external market
structure ideed affects the financial performance of the Kenyan banks. It can be argued that
the authors were of the opinion that aspects such as maturity of the banks and industrial
concentration could easily affect the profitability of the Kenyan commercial banks.
Therefore, with this effect being experienced by the Kenyan commercial banks profitability is
regarded as a critical pointer of the financial performance of the Kenyan commercial banks.
In this regard, any aspect that has an ability of eating into the profits of the Kenyan
commercial banks is regarded to have an impact on the financial performance. The
implication of the above findings for this research is that it informs the fact that industry
specific factors impact upon the performance of the Kenyan commercial banks.
5.3.2 Firm Specific Factors That Influence the Financial Performance of Commercial
Banks in Kenya
Firm specific factors have been considered to have an impact on the financial performance of
the Kenyan commercial banks based on the secondary research findings. This has been
attributed to the fact that the firm specific factors have a direct impact on the profitability of
the Kenyan commercial banks. The secondary data findings mainly focused on the aspects of
capital adequacy ratio, asset quality, liquidity, profitability and description of independent
46
variables. The focus placed on these items has suggested that indeed firm specific factors
have an ability to influence the financial performance that the Kenyan commercial banks are
able to achieve. These findings appear consistent with the findings of Swarnapali, (2014),
Memmel and Raupach (2010) and Rasia (2010) that the firm specific factors such as
operating costs charged by the Kenyan commercial banks are normally expressed in the form
of percentages of profits and therefore influence the financial performance of banks. In this
regard, it appears evident that profitability that is a major function of firm profitability and
financial performance is adversely affected by the firm specific factors such as capital
adequacy, liquidity and asset quality. Therefore, with Rasiah (2010) identifying a negative
relationship between financial performance and the management of the commercial bank
expenses, it further solidifies the argument that firm specific factors have the ability to
influence the financial performance of a firm. Hence, the local commercial banks should be
concerned with the effect that firm specific factors have on the financial performance of the
Kenyan commercial banks. The implication of these findings is that the Kenyan commercial
banks should focus on how their firm specific factors are likely to impact upon their
performance and initiate the corrective measures to prevent the poor financial performance of
the banks.
5.3.3 Macroeconomic Factors That Influence the Financial Performance of Commercial
Banks in Kenya
The findings on the impact of macroeconomic variables on the financial performance of the
Kenyan commercial banks resulted in the findings that they have minimal impact. This
implies that the primary research findings suggested that the effect posed by fluctuations in
the macroeconomic environment poses limited challenge to the financial performance of the
Kenyan commercial banks. Nevertheless, the macroeconomic factors of changing
consumption behaviors, economic growth and the volatility of the exchange rate was
considered to have significant impact on the financial performance of the Kenyan commercial
banks. However, based on the fact that other macroeconomic variables that were under
analysis yielded significantly lesser findings, implies that the general impact of
macroeconomic fluctuations on the financial performance of the Kenyan commercial banks is
minimal. This finding is consistent with the viewpoints by Bodie et al (2005) and Gerlack et
al (2004) positing that macroeconomic factors can affect the financial performance of the
Kenyan commercial banks in a number of ways. Some of the ways that have cited include;
47
the changes in consumer behavior, low economic growth and exchange rate volatility.
Drawing on the above aspects, it is evident that indeed macroeconomic factors have an
impact on the financial performance of the Kenyan commercial banks. Nevertheless, the fact
that they are not the only macroeconomic factors that can affect the financial performance of
the Kenyan commercial banks implies that they cannot be wholly used as basis for
determining the effect of the financial performance of the Kenyan commercial banks. With
evidence from the other findings suggesting minimal impact on the Kenyan banking sector
financial performance, it can be argued that the impact posed macroeconomic factors on the
financial performance is minimal.
5.4 Conclusions
5.4.1 Industry Specific Factors
Though to a small extent, industry specific factors affect the financial performance of the
Kenyan commercial banks. An improvement in the financial development would result in an
improvement in the level of efficiency experienced in the Kenyan banking sector. On this
basis, it can be concluded that the external market structure indeed affects the financial
performance of the Kenyan banks. It can be argued that the authors were of the opinion that
aspects such as maturity of the banks and industrial concentration could easily affect the
profitability of the Kenyan commercial banks. Therefore, with this effect being experienced
by the Kenyan commercial banks profitability is regarded as a critical pointer of the financial
performance of the Kenyan commercial banks. In this regard, any aspect that has an ability of
eating into the profits of the Kenyan commercial banks is regarded to have an impact on the
financial performance.
5.4.2 Firm Specific Factors
Firm specific factors indeed have a significant impact on the financial performance of the
firms. Firm specific factors such as operating costs charged by the Kenyan commercial banks
are normally expressed in the form of percentages of profits and therefore influence the
financial performance of banks. In this regard, it appears evident that profitability that is a
major function of firm profitability and financial performance is adversely affected by the
firm specific factors such as capital adequacy, liquidity and asset quality. Therefore, there is a
negative relationship between financial performance and the management of the commercial
bank expenses, it further solidifies the argument that firm specific factors have the ability to
influence the financial performance of a firm. Hence, the local commercial banks should be
48
concerned with the effect that firm specific factors have on the financial performance of the
Kenyan commercial banks.
5.4.3 Macroeconomic Factors
Macroeconomic factors have little impact on the financial performance of the Kenyan
commercial banks. Macroeconomic factors can affect the financial performance of the
Kenyan commercial banks in a number of ways. Some of the ways that have cited include;
the changes in consumer behavior, low economic growth and exchange rate volatility.
Drawing on the above aspects, it is evident that indeed macroeconomic factors have an
impact on the financial performance of the Kenyan commercial banks. Nevertheless, the fact
that they are not the only macroeconomic factors that can affect the financial performance of
the Kenyan commercial banks implies that they cannot be wholly used as basis for
determining the effect of the financial performance of the Kenyan commercial banks. With
evidence from the other findings suggesting minimal impact on the Kenyan banking sector
financial performance, it can be argued that the impact posed macroeconomic factors on the
financial performance is minimal.
5.5 Recommendation
5.5.1 Recommendation for Improvement
5.5.1.1 Industry Specific Factors
In seeking the evidence on the industry specific factors that affect the financial performance
of commercial banks, this report could have improved its objectivity by leveraging on the use
of in-depth interviews for the research process. This is because using the in-depth interview,
the researcher could have taken advantage of face to face interview to cross-examine the
interviewees and determine the accuracy and truthfulness of their answers regarding the
industry specific factors that affect the financial performance of the Kenyan commercial
banks. Therefore, the adoption of a focus on specific factors is expected to yield a more
focused and useful research study.
5.5.1.2 Firm Specific Factors
In seeking the findings for the second research question, there was a great overreliance on the
secondary data that was provided by the Central Bank of Kenya archives. The limitation in
this is that the firm specific factors that affect the financial performance of commercial banks
49
though they may exist could have changed the intensities in which they affect the banks. This
implies that the archived data from the central bank may not be effective in painting a clear
picture of the modern day firm specific factors that affect the performance of the commercial
banks. Therefore, future research should leverage on primary research in developing a more
current analysis of the firm specific factors affecting the financial performance of Kenyan
commercial banks.
5.5.1.3 Macroeconomic
Future researches on the macroeconomic factors that affect the performance of the local
commercial banks should follow the direction of focusing a single or a few aspects and to
what extent they actually affect the financial performance of the Kenyan commercial banks.
The rationale for this proposal is based on the fact that this research focuses on a number of
aspects and therefore compromises on the breadth of the research that could otherwise have
been achieved. Therefore, focusing on one or two aspects will be useful in leveraging on the
depth of the analysis and achieving a sounder analysis that also entails a detailed plan on how
to mitigate on the macroeconomic challenges that the Kenyan commercial banks could face.
5.5.2 Recommendation for Further Studies
Based on the findings, discussions and conclusions made in this research, it appears evident
that this research could have improved its objectivity by also utilizing a qualitative research
approach. This is because the interview process represents an opportunity for the researcher
to cross examine the interviewee and ensure on the validity of the information provided by
checking vital non-communication cues that are provided by the interviewee. Therefore,
future studies on this topic should seek to leverage on mixed research approaches that utilize
both quantitative and qualitative research studies.
50
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APPENDICES
List of Commercial Banks in Kenya
1. African Banking Corporation Ltd.
2. Chase Bank (K) Ltd
3. Commercial Bank of Africa Ltd
4. Consolidated Bank of Kenya Ltd
5. Co-operative Bank of Kenya Ltd
6. Credit Bank Ltd
7. Development Bank of Kenya Ltd
8. Diamond Trust Bank Kenya Ltd
9. Equatorial Commercial Bank Ltd
10. Equity Bank Ltd
11. Family Bank Limited
12. Fidelity Commercial Bank Ltd
13. Fina Bank Ltd
14. First community Bank Limited
15. Giro Commercial Bank Ltd
16. Guardian Bank Ltd
17. I and M Bank Ltd
18. Jamii Bora Bank Limited
19. Kenya Commercial Bank Ltd
20. K-Rep Bank Ltd
21. National Bank of Kenya Ltd
22. NIC Bank Ltd
23. Oriental Commercial Bank Ltd
56
24. Paramount Universal Bank Ltd
25. Prime Bank Ltd
26. Victoria Commercial Bank Ltd
27. Trans-National Bank Ltd
28. Imperial Bank Ltd
29. Bank of Africa Kenya Ltd
30. Bank of Baroda (K) Ltd
31. Bank of India
32. Barclays Bank of Kenya Ltd
33. CFC Stanbic Bank Ltd
34. Charter House bank Ltd (Under Statutory Management)
35. Citibank N.A Kenya
36. Dubai Bank Kenya Ltd
37. Ecobank Kenya Ltd
38. Gulf African Bank Limited
39. Habib Bank A.G Zurich
40. Habib Bank Ltd
41. Middle East Bank (K) Ltd
42. Standard Chartered Bank Kenya Ltd
43. UBA Kenya Bank Limited
44. Kenya Women Finance Trust (KWFT) Bank
Source: Central Bank of Kenya 2013.
57
Questionnaire for Kenyan Banks Key Personnel
A STUDY ON ‘DETERMINANTS OF BANK’S FINANCIAL PERFORMANCE IN
DEVELOPING ECONOMIES: EVIDENCE FROM KENYAN COMMERCIAL BANKS’
(The information you provide here will be kept CONFIDENTIAL)
INSTRUCTION
I. Do not write your name or any other personal identification information anywhere in
this questionnaire.
II. Tick where appropriate in the spaces provided and provide descriptive answers where
requested.
III. Please answer ALL the questions in the spaces provided.
IV. Use the scoring guide where applicable.
PART A: General Information
1. For how long have you been working with the Bank?
2 Level of Education
3 What is your position in this bank?
Years
old
0-3yrs
(1)
3-6 yrs
(2)
6-9 yrs
(3)
Over 9 yrs
(4)
Tick
Qualification Certificate
(1)
Diploma
(2)
Degree
(3)
Masters
(4)
Other
(5)
Tick
Subordinate Lower Level Middle Level Senior Manager
58
PART A: Industry Specific Determinants of Financial Performance
Please tick as appropriate;
Statement
Str
ongly
Dis
agre
e
Dis
agre
e
Neu
tral
Agre
e
Str
ongly
Agre
e
1 Competition affects my bank
Profitability
2 Concentration of banking industry
in Kenya affects profitability
3 The Kenyan Banking Industry has
been on upward trend in the last 5
years
4 Central Bank of Kenya regulations
negatively impacts our profits
5 The relative time Period the bank
has been in operation affects the
profit levels
6 The development of financial sector
in Kenya has an impact on profits
7 Turnover of key staff in Kenyan
banks affects the profitability
8 Growth of mobile money transfer
had directly affected our profits
9 Innovations in product contents is a
key driver of profitability in the
industry
10 Bank ownership, whether local or
foreign has a role to play on
profitability
a) Kindly mention any other industry specific factor which affects the profitability of
your bank
59
b) Please state how you feel industry specific factors do affect the profitability of your
bank
PART C: Firm Specific Determinants of Financial Performance
Please tick as appropriate;
Statement
Str
ongly
Dis
agre
e
Dis
agre
e
Neu
tral
Agre
e
Str
ongly
Agre
e
1 There is a positive relationship
between Capital Ratio and bank
performance
2 There is a strong relationship
between Asset Quality and bank
performance
3 There is a positive relationship
between Management Efficiency
and bank performance
4 There is a negative relationship
between Liquidity and bank
performance
5 Restructuring of top management
improves the profitability
6 Continuous training improves
financial performance
7 Deeper distribution in terms of
more branches leads to higher
profits
8 Partnering with other related
institutions improves the
profitability
9 State of art information systems
60
plays a key role in driving profits
for the bank
10 Hiring of top talents in our bank
has led to better financial
performance
11 Offering of a wide range of
products contributes to more profits
12 The level of debt held by the bank
will affect its profitability
13 The nature of ownership, whether
private or public, plays a role in our
profits
14 The strategic positioning of our
bank branches directly impacts our
profits
a) Kindly mention any other firm specific factor which affects the profitability of your
bank
b) What other internal business practices do your bank have which you feel plays a key
role in your profitability?
PART D: Macro-Economic Determinants of Performance
Please tick as appropriate;
Statement
Str
ongly
Dis
agre
e
Dis
agre
e
Neu
tral
Agre
e
Str
ongly
Agre
e
1 Macro-economic policies by the
government such increasing or
decreasing its expenditure affects
our profits
61
2 Change in consumption behaviors
affects the profits we make
3 The economic growths has a key
role on our profitability
4 The volatility of exchange rates
affects our financial performances
5 Depreciation and appreciation of
the Kenyan currencies is a key
determinant of our profitability
6 The unemployment rate in Kenya
has a huge impact on our
profitability
7 The consumer purchasing power
has plays a role in our financial
performance
8 Imbalance of trade, which the gap
between imports and exports in
Kenya affects our profits
9 Stability of inflation rates plays a
role in the profits we make
10 The saving culture and practices of
Kenyans has an impact on our
financial performance
a) Kindly mention any other macro-economic factor which affects the profitability of
your bank
b) Please state as to what extent you feel that macro-economic factors affects your
profitability
THANK YOU FOR COMPLETING THE SURVEY.
