Bank Characteristics and Profitability of Tier Three Commercial Banks in Kenya
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Date
2025-11
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Kenyatta University
Abstract
In recent years, the profitability of tier three Kenyan commercial banks has encountered difficulties, as financial reports reveal a progressive drop in performance. The CBK (2024) reported that the tier three banking sector's profitability growth slowed down in 2023, with some banks reporting reduced net earnings due to escalating operational costs. Many of these banks are also experiencing a rise in non-performing loans (NPLs), further constraining their profitability margins. This study aimed to identify key factors influencing profitability among Kenya’s tier three commercial banks. It specifically assessed the impact of market share, asset quality, capital adequacy, and central bank rates. Anchored in Market Power and Capital Buffer theories, the research explored how central bank rates relate to bank performance. A descriptive design was applied, focusing on all 22 licensed tier three banks in the country. The research applied secondary data comprising panel data of audited financial statements submitted to the CBK by the twenty-two commercial banks over the last ten years. The gathered data was encoded and entered into SPSS software and Excel spreadsheets for analysis, interpretation, and presentation of results. Descriptive statistics—frequencies, means, and percentages, were used to process quantitative data. To predict the dependent variable, multiple regression was employed with independent factors. A panel data model, suitable for tracking changes across banks and time, was adopted. Diagnostic checks were run to manage error risks. Results were displayed through tables, charts, and graphs. All three variables were statistically significant (Market Share: p = 0.003; Asset Quality: p = 0.019; Capital Adequacy: p = 0.001), demonstrating their joint explanatory power (F(3, 382) = 2.22, p < 0.001, R-squared = 0.2694). The final moderated model was also statistically significant (F (7, 376) = 3.18, p < 0.001), affirming the combined influence of internal and external factors on bank profitability. Findings showed that profitability in Kenya’s tier three banks was positively shaped by market share, asset quality, and capital adequacy. Stronger market positions boosted earnings, sound assets reduced default rates, and robust capital improved financial stability. While market share and asset quality also reinforced one another, capital adequacy appeared less connected to loan quality, suggesting different underlying drivers. The central bank rate had a weaker and less consistent influence, though modest increases could enhance profitability through interest margins; however, its overall direct effect in the panel model was negative, indicating that higher rates generally dampen returns. When monetary policy context was considered, the explanatory power of the model improved, with larger banks and well-capitalized institutions showing greater ability to withstand tighter policy conditions. Asset quality’s interaction with monetary policy was not significant, but it still trended positively, hinting at potential benefits under certain conditions. Profitability in Kenya’s tier three banks is shaped by internal elements—capital strength, asset quality, and market share, as well as external forces like central bank rates. To improve performance, banks are advised to grow their market footprint, strengthen credit controls, use capital efficiently, and adapt to economic shifts. Embracing digital tools and adhering to regulations are also key to sustaining growth and stability.
Description
A Research Project Submitted to the School of Business, Economics and Tourism in Partial Fulfilment of the Requirements for the Award of Degree in Master of Business Administration (Finance Option) of Kenyatta University, November 2025.
Supervisor
1. Moses Odhiambo Aluoch