Liquidity Risk and Financial Performance of Commercial Banks in Kenya

Abstract

Commercial banks are essential entities in providing financial services among people, governments and business entities. Commercial banks contribute to the economy of the country via the tax revenue it remits to the government. The incapability of commercial banks to hold the right balance of the liquid assets for effective and efficient operations threatens their financial performance. Global financial crisis of the year 2007-2008 was a depiction of the importance of liquidity. Liquidity risks arise from failure to balance cash inflows against cash outflows. However, commercial banks fall short of the liquidity money to support their operations and also to lend to prospective borrowers undermining their financial performance. This study investigated how liquidity risks influence financial performance of commercial banks. The study was guided by specific objectives that include; effect of bank size, asset quality, operational efficiency and capital adequacy on financial performance commercial banks. The effect of money supply on the relationship between liquidity risks and financial performance of commercial banks was also determined. Causal research design was adopted in the study targeting 42 commercial banks operating in Kenya. Secondary data were extracted from financial books from individual commercial banks and CBK reports. Data analysis was undertaken by use of Stata 14.0 where descriptive results and panel models were generated. Results revealed that bank size is positively and significantly related to financial performance of commercial banks. It was also found that asset quality is negatively and significantly related to commercial banks’ financial performance. Capital adequacy is positively but insignificantly related to commercial banks’ financial performance. The operational efficiency of the bank was positively and significantly related commercial banks’ financial performance. Money supply moderates the relationship between liquidity risks and performance of commercial banks since the coefficient of determination increased. The study recommended that commercial banks need to consider diversifying their product portfolio with aim of expanding their income revenue. Commercial banks need also to review their credit evaluation methods to ensure that only worthy borrowers borrow their funds with aim of reducing high cases of nonperforming loans. Award of loans should go hand in hand with some form of financial training, guidance ad advice for borrowers on how to allocate the funds borrowed. Adequate capital needs to be held by commercial banks as stipulated by banks operational regulations. There is need to improve capacity development among bank employees with aim of enhancing operational efficiency in the bank.