Financial Innovations and Cost Efficiency of Commercial Banks in Kenya
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Date
2025-12
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Kenyatta University
Abstract
The banking sector in Kenya has experienced fluctuating cost efficiency amid rapid financial innovations, raising concerns among regulators and practitioners about sustainable operational performance. Persistent high cost-to-income ratios, averaging 48% from 2020-2023, imply elevated operational risks and reduced profitability, which undermine financial intermediation and economic growth. It is therefore critical to enhance cost efficiency to bolster sector resilience and investor confidence. Kenyan commercial banks have adopted various innovations, yet challenges in optimizing costs under inflationary pressures persist. This study examined the effect of financial innovations on the cost efficiency of commercial banks in Kenya. The specific objectives were: to determine the effect of product innovation on cost efficiency of commercial banks in Kenya; to establish the effect of system innovations on cost efficiency of commercial banks in Kenya; to analyze the effect of process innovations on cost efficiency of commercial banks in Kenya; and to evaluate the moderating effect of inflation on the relationship between financial innovations and cost efficiency of commercial banks in Kenya. The investigation was anchored in the Efficiency Structure Theory, Transaction Cost Theory, Resource-Based View Theory, and Innovation Diffusion Theory. The study targeted a census of all 39 commercial banks licensed by the Central Bank of Kenya and employed a descriptive research design with an explanatory approach. Secondary data were extracted from CBK reports and bank financial statements spanning 2020 to 2024, supplemented by primary data from structured questionnaires administered to 68 respondents. Inferential analysis utilized multiple linear regression models alongside Pearson’s product-moment correlation coefficients, while means and standard deviations supported descriptive evaluation. Correlation outcomes reflected moderate negative relationships with cost efficiency: system innovations displayed the strongest link, followed by process innovations, and product innovations. The GLS regression findings showed that product innovations had a negative influence on cost efficiency, system innovations a stronger negative effect, and process innovations a significant negative effect. Moreover, results from the Whisman moderation test revealed that inflation positively moderated the association between financial innovations and cost efficiency, amplifying cost pressures annually. In conclusion, adopting product, system, and process innovations enhanced cost efficiency in commercial banks, though inflation eroded these gains, particularly for system and product innovations. Consequently, the study recommends that banks prioritize system and process innovations while implementing inflation-hedging strategies, such as dynamic pricing and fintech partnerships, to maximize operational efficiency
Description
A Project Report Submitted to the School of Business, Economics and Tourism in Partial Fulfilment of the Requirements for the Award of the Degree of Master of Business Administration (Finance), Kenyatta University. December, 2025
Supervisor
Francis K. Gitagia