Financial Risks and Financial Performance of Commercial Banks in Kenya
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Date
2019-04
Authors
Omondi, Nicholas Odhiambo
Journal Title
Journal ISSN
Volume Title
Publisher
Kenyatta University
Abstract
Banking industry in Kenya has experienced a major transition in the last two decades. The industry being a mixed one, comprises of both local private and foreign commercial banks which have lately been characterized by poor performance. This has led to the collapse of a number of banks including Dubai Bank, Chase Bank and imperial Bank. The Kenyan banking sector is vulnerable to risks originating both from their micro and macro environment. This threatens the banks long term sustainability and consequently their financial viability. Some of the risks that pose a major challenge to the financial sector growth include; credit, liquidity, foreign exchange rate and interest rate risks. This study therefore, sought to investigate the effect of financial risk on the Kenya’s commercial banks financial performance. Specific objectives for the study were to examine the effect of, credit risk, liquidity risk, foreign exchange rate and interest rate risk on performance of commercial banks in Kenya. The study adopted Liquidity preference theory, International Fisher effect theory, Interest rate parity theory, and the Agency theory to support relationship between the study variables. A causal research design was adopted in this study in which the population targeted included 42 commercial banks that had been in operation in Kenya from the year 2013 to 2017. The study used secondary panel data that was analyzed through descriptive and inferential statistics within the framework of panel regression model with the aid of STATA (vs14). However some banks had been put under receivership and another under statutory management. Therefore complete data was only available for 34 commercial banks. Diagnostic test were conducted for normality, multicollinearity and heteroscedasticity. Ethical considerations were adhered to in every stage of the study. From the analysis of the data, R-square (R2) for the regression was 0.7386 implying that credit risk, liquidity risk, interest rate risk and foreign exchange risk, jointly explain 73.86 percent of the variations in commercial banks’ financial performance (ROE) in Kenya at 0.05 level of significance. From the study findings it can be substantively concluded that interest rate risk have a positive and significant effect on the banks’ financial performance with a coefficient of β=0.2465312 while, credit risk and foreign exchange risk have a negative and significant effect on financial performance of commercial banks in Kenya with coefficients of β= -0.1307926 and β=-0.3395534 respectively. Liquidity risk on the other hand indicated an insignificant positive effect on financial performance of commercial banks in Kenya. In overall, exchange rate risk was found to have the greatest effect on financial performance of commercial banks in Kenya. Based on the study findings, commercial banks can be able to improve their financial performance (ROE) through efficient and effective management of exchange rate risk which poses the greatest effect on the commercial banks financial performance. The study would recommend the use of swaps, options, spot markets and forward markets when dealing with operations abroad so as to minimize the exchange rate risk. The use of restrictive covenants and thorough scrutiny of the banks customers before advancing any loans/ facilities would assist to reduce credit risk.
Description
A Research Project Submitted to the School of Business in Partial Fulfillment of the Requirement for the Award of the Degree of Master of Business Administration (Finance Option) Of Kenyatta University