International Journal of Research in Business, Economics ...ijrbem.com/doc/161.pdf · Vol.3 Issue 6...

International Journal of Research in Business, Economics and Management

Vol.3 Issue 6 Nov-Dec. 2019

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Bank Characteristics and Profitability of Commercial Banks in Kenya

ANTHONY MAINA WAMBUGU

MBA Student, Kenyatta University

DR. JEREMIAH KOORI

Lecturer, Department of Accounting and Finance

School of Business, Kenyatta University

ABSTRACT

The profitability of commercial banks in Kenya has generally been on a declining trend from 20

percent in 2012, to 16percent in 2013, to 12.1 percent in 2014, to negative 5.3 percent in 2015,

with the profitability being 10 percent in 2016. Beyond the intermediation role performed by

commercial banks, the profitability of commercial banks has critical implications for growth and

economic well-being of a nation. The research work reviewed did not consider inflation and its

controlling impact on the conducted studies the characteristics of bank on commercial banks

performance. This research study filled these gaps by determining the relationship between bank

characteristics and commercial bank’s profitability in Kenya. Specific objectives of the study were

to establish the effect of characteristics namely; size of the bank, quality of the asset and capital

adequacy on profitability of the commercial banks in Kenya and the moderating/regulating effects

of inflation on the bank characteristics relationship with profitability of commercial banks in

Kenya. Market power theory and efficiency structure Theory were used to explain the

interrelationship between variables. The study adopted a census sampling design where causal

research design was used. The study made use of panel data and panel regression model was

utilized. Diagnostic tests for multi-collinearity and normality was carried out before making

inferences. The study obtained complete financial data from 35 commercial banks. This accounted

for 81.3 per cent of the targeted population. The descriptive results presented that the average

capital adequacy was 22.35 per cent for the year 2013 to 2017. The descriptive findings indicated

that the average asset quality was 0.1094. The findings on bank size indicated that average bank

size (natural logarithm of total assets) was 10.6042. The banks average net income was 0.98166

billion for period 2013 to 2017. The multicollinearity test indicated that there was no possibility

of multi-collinearity between variables thus regression analysis could be done to show the

relationships between the dependent and independent variables. The results on analysis of variance

established that the regression analysis equation was significant in explaining the relationship

between the variables. The results on regression coefficients indicated that indicated that the

relationship between capital adequacy and net income was not significant and was negative. The

findings indicated that the correlation between asset quality and profitability of the bank was

insignificant abut positive. However, the relationship between size of the bank and profitability of

commercial banks was found to be positive and significant. The moderating effect of inflation was

tested and the results showed that its effects was insignificant on bank characteristics effect on

profitability of commercial banks in Kenya. The study concluded that the moderating effect of

inflation on bank characteristics effect on profitability of commercial banks in Kenya was

insignificant. The study recommended that, commercial banks in Kenya increase total assets which

will help in increasing the level of revenue. The study period was five years hence further research

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can be done on longer periods to examine the effect of bank characteristics on profitability of

commercial banks in Kenya. The study used total capital to total risk weight as a measure of capital

adequacy hence it recommends for further study use of other measures of capital adequacy to

examine their relationship with profitability.

INTRODUCTION

Globally, commercial banks perform a very vital economic role in developing the nations for they

widely control the supply of money in circulation and greatly are the major economic progress

stimuli (Mohana&Tekeste, 2012).The banking system is a vital part of a nation’s financial system.

The financial intermediation role of commercial banks cannot be overemphasized. They link

surplus unit’s agents (depositors) and deficit unit agents (borrowers) together for the purpose of

productive activities which in turn enhances the economic growth of a country (Olweny & Shipho,

2011). Therefore, the health of a country’s economy is directly related to the stability of its banking

system.

In Kenya, commercial banks largely dominated the financial sector which implies that any at large

any failure of the financial institutions in Kenya has got an enormous effects on the survival of the

country’s economy. This is attributed to the reasoning that any insolvency that may occur in the

banking sector a domino and multiplier effect which can lead to problem in the economy, bank

runs and overall economic and financial crisis (Meshak & Nyamute, 2016).

The profitability of banks is of vital importance for all stakeholders, these stakeholders are

investors, owners of the banks, managers of various banks, government agents, regulators,

depositors and the public in general (Podder, 2012). This is because banks’ profitability gives a

snapshot of the commercial banks performance which are the backbone in giving directions to the

stakeholder’s thus enabling them make important decisions. It also a source of direction to the

investors and debtors on whether to or not invest in a particular bank. It gives proper directions to

the managers of the banks whether make improvements or retain a certain strategy and regulatory

bodies are also interested in the profitability financialperformance for the regulation purposes

(Ongore, 2013).

The profitability of financial institutions especially the banks is mostly affected by factors from

within the banks for instance internal factors (bank characteristics) and factors outside the banks

also known as external factors (macroeconomic). The internal factors are bank characteristics

specific to a particular bank that impacts on its profitability. Bank characteristics are influenced

by internal decision made by banks’ management and its board. On the other hand, the external

factors are country or sector wide factors which affect profitability and are beyond the control of

bank management (Ognore, 2013). This study aims to determine the effects of bank characteristics

(internal factors) on the commercial bank profitability and effects of inflation (external factor)

moderator on bank characteristics relationships with commercial bank profitability in Kenya.

Bank Characteristics




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Internal factor considered i.e bank characteristics, bank characteristics are specific to a bank with

bank management control within it (Kajuju, 2016). Bank characteristics include size of the bank,

capital adequacy and quality of assets. Bank size is a bank specific variable that accounts for

diseconomies and economies of scale. There are two views concerning the relationship between

bank size and profitability. The “too big to fail” hypothesis is the first view advocates a negative

relationship between bank size and profitability. Conversely, the second hypothesis supports a

positive relationship between bank size and profitability (Kajuju, 2016). In this study, bank size

was measured using bank total asset.

The quality of asset in a bank is another bank characteristic that impacts on banks’ profitability.

The main source of income of commercial banks is interests charged on loans (Dietrich &

Wanzenried, 2011). Therefore, loans are the major assets of commercial banks from which income

is generated. The profitability of banks is determined by the quality of these loan portfolios. There

is a direct bearing of loan portfolio quality on profitability of banks. The losses derived from

delinquent loans constitute the highest risk faced by banks (Dang & Uyen, 2011). Therefore, the

current study adopted ratio of loans not performing to total bank loans as a proxy for asset quality.

Hence, low non-performing loans to total loans ratio indicates a good quality of the bank asset as

the lower the ratio the better the profitability of banks (Sangmi & Tabassum, 2010).

Inflation

A continual increase in price level of all goods and services over a certain period of time in the

market is known as the inflation. This was measured using the inflation rate, which is defined as

the percentage change in the monthly consumer price index (CPI) (Buyinza, 2010). A rise in

general price level signals a fall in the purchasing power of the currency. Implying that there is a

rise the general price level, a given money unit can afford lesser and lesser goods and services.

The inflation effects may not be distributed evenly which may result in costs which are hidden to

some and benefits to some others from the decline in the power of purchasing.

Profitability

One way to determine the performance of banks is by determining their profitability. Profitability

is the financial institutions’ ability to generate income by earning more money that exceeds the

yearly expenses and taxes incurred in every financial year (Kwakwa, 2014). Banks generate profits

from the interests levied on assets and the fees charged for services offered. Conversely, the main

expense incurred by financial institutions lies on the paid interest every financial year on their

liabilities. Therefore, the profitability of the commercial bank is represented by the positive

differences between increased earnings and the reduced expenses. The only asset of the

commercial banks that attract more revenue are bank loans which may be advanced to persons,

entities and other institutions.

The indicator of commercial banks profitability is gross profit margin, profit before tax, net profit

margin, and profits attributable to shareholders. The current study adopt net income as a measure

of profitability. Commercial banks profitability in Kenya is on a declining trend in years 2012 to

2016.




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Table 1.1 Trends in Profitability of Commercial Banks in Kenya

Figure 1.1 presents the trend in profitability of commercial banks in Kenya as indicated by their

profit before tax.

Year 2012 2013 2014 2015 2016

Profitability(PBT change in percent ) 20.1 16

12.1 (5.3) 10

Source: World Bank (2017)

The trend depicted in Table 1.1 indicates a generally declining pattern of commercial banks’

profitability as shown by their profit before tax (PBT). The PBT stood at 20.1 percent as at

2012which declined to 16 percent in 2013. Furthermore, the decline extended to 12.1 percent in

2014, negative 5.3 percent in 2015 and 10 percent in 2016. Kenyan banks’ total profit before tax

in 2018 clocked a record high of 152.3 billion shillings which surpassed the 2016 profit before tax

peak which was reported before the introduction of controls on interest rate. The trend has not been

consisted since the pre-tax profit for 2017 was Kshs. 136 billion and that of 2016 was Kshs. 150

billion. Over the profit that the banks made in the year 2017 the lenders earnings increased by

12.3% (Central Bank of Kenya report, 2018).

Commercial Banks in Kenya

Currently in Kenya there are 43commercial banks which comprise of both locally and foreign

owned and are regulated by the Central Bank of Kenya. 7 of the commercial banks are listed at

NSE while 36 are non-listed. These banks offer services which range from retail services, corporate

services to investment banking (Meshak & Nyamute, 2017).

Table 1.1: Classification of Commercial Banks in Kenya

Peer Group (Size) Market share No. of institutions

Large 49.90percent 6

Medium 41.70percent 16

Small 8.40percent 21

Total 100percent 43

Source: CBK (2017)

The large banks category comprise of 6 bank which account for 49.90percent of the market share,

the medium banks category comprise of 16 banks which account for 41.70percent of the market

share and while the small size banks category is made up of 21 banks accounting for 8.40percent

of the market share.

According to Kenya Deposit Insurance Corporation (KDIC) forensic audit report 2015, two banks

Dubai Bank and Imperial Bank were indicted for Loans frauds, bad loans provision inadequacy




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and omissions, low cash ratio and capital inadequacy. This led to the banks being put under

receivership. Further the CBK noted that non-performing loans trend was increasing and there is

need to curtail loopholes that would result to further collapse. Therefore, one of the objectives of

the research work was establish the effects of asset quality on commercial bank profitability in

Kenya.

Statement of the Problem

The profitability of Kenyan banks has experienced a deteriorating trend as indicated by the

declining profit before tax. The PBT stood at 20.1 percent as at 2012 which declined to 16 percent

in 2013. Furthermore, the decline extended to 12.1 percent in 2014, negative 5.3 percent in 2015

and 10 percent in 2016. This in turn has generated debates by scholars and professionals. This is

because Kenya is a bank driven economy and therefore the failure of the banking sector will have

a multiplier effect on the economy as a whole. Understanding the bank characteristics and their

effect on profitability of banks remains crucial to the banks’ management and other stakeholders

who include the CBK, the government among others (Kimande, 2017).

Empirical studies on bank characteristics and profitability were mostly focused on developed

countries and other countries other than Kenya. Furthermore, these studies are characterized by

mixed results.

For instance, studies by Liu (2011); Olweny and Shipho (2011); Ogilo (2012); Ezra (2013);

Macharia (2013),Ongore and Kusa (2013); Echeboka et al., (2014);Uzhegova (2015); investigated

the effect of bank size, asset quality and capital adequacy on financial performance. Some of these

scholars found a significant effect of these bank characteristics on performance of bank while the

others found insignificant effect of these bank characteristics of performance.

Additionally, all the above empirical studies conducted never considered moderating effects of

inflation on bank characteristics relationship with performance of commercial banks. Therefore,

this study aimed at bridging the gap on the effects of bank characteristics namely; size of the bank,

quality of the asset and capital adequacy on Commercial Bank’s profitability in Kenya and the

moderating/regulating effect of inflation on the bank characteristics effects on profitability of

commercial banks in Kenya.

Objectives of the Study

General Objective

The main purpose the study was to find out the effect of bank characteristics on commercial’

bank’s profitability in Kenya.

Specific Objectives

The study determined the following the specific objectives.




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i) To establish the relationship between size of the bank and commercial bank’s

profitability in Kenya.

ii) To determine the relationship between asset quality and commercial bank’s


iii) To establish the Capital adequacy relationship with commercial bank’s profitability in

Kenya.

iv) To ascertain the moderating effect of inflation on the relationship between bank

characteristics and commercial bank profitability in Kenya.

Research Hypotheses

The study sought to test the following hypotheses:

H01: There is no significant relationship between bank size and commercial bank’s


H02: There is no significant relationship between asset quality and commercial bank’s


H03: There is no significant relationship between capital adequacy andcommercial bank’s


H04: There is no significant moderating effect of inflation in determining the relations

between bank characteristics and commercial bank’s profitability in Kenya.

Significance of the Study

The study findings helped the management of commercial banks in carrying out operations that

enhanced profitability in the banking sector. The findings will help the managers understand the

interrelationship between the reviewed bank’s characteristics on profitability. The findings also

helped the Kenyan government on commercial banks and financial institutions on policy

formulations. Furthermore, the study educated the members of public in general on the effect

commercial banks characteristics on profitability. The study was of importance to academicians

as it provided important insight on effects of bank characteristics on bank’s profitability and helped

researchers who wish to embark on a related study topic.

Limitations of the Study

The study used secondary data which was sourced from the internet. The secondary data had a

limitations in that different sources in the internet have numerous and different data. The researcher

reduced this challenge by comparing data from different sources and getting the averages from the

credible sources such as Central Bank of Kenya and Cynton investment reports.

Project Organisation

The following is the proposal organization; the first Chapter (Chapter one) presented the

background information, the motivation problem, measurable study objectives, study’s




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significances, limitation’s and the study’s scope covered. The next chapter, Chapter two includes

the reviews on empirical and theoretical literature. The third chapter includes the research study

methodologies to be used. The fourth chapter presents the findings, presentation and data

interpretations. The summary of the study, conclusions and recommendations based on the specific

objectives were presented in chapter five.

LITERATURE REVIEW

Theoretical literature review, review on empirical, literature review summary and the conceptual

framework was presented in this chapter.

Theoretical Review

In carrying out the study, Market Power Theory and Efficiency Structure Theory was used to

underpin the study.

Market Power Theory

This theory was proposed by Bhagwati in 1965. The market power theory proposes that a

firm/institution can influence the market prices of goods and services by demand or supply control

exercise or both. A zero market power can only be experienced under perfect competition, thus all

the firms must accept the prevailing market price without the ability to control or change over it

(Kamande, 2017). According to Bhagwati, the increase in market external forces will result to

improved financial performance. Additionally, the theory hypotheses that only institutions with

well differentiated assets and large market share was able to win against their competitors and earn

monopolistic incomes (Flamini et al., 2009).

In support of the current study, market power theory argues that the size of banks can positively

impact on their profitability. This can be through various channels, bearing in mind that banks

larger in size enjoy the economies of scale benefits and powers to control the market share which

will facilitate in generating profits which are abnormal. The size of the bank may be used to arrest

the economies of scale or banking sector diseconomies of scale (Karkrah & Ameyaw, 2010).

Mostly large banks have shown improved profitability and the incomes has been positive,

however, due to the bureaucratic and agency costs, the effects could be negative especially for

large banks with the reported enormous asset base (big size) (Goddard, Molyneux& Wilson, 2004).

Hence, the banks’ size results to the economies of scale and hence the market power. The current

study supports the asset quality and capital adequacy who are the indicators of bank characteristics

in explaining their relationship with profitability of commercial banks in Kenya.

Efficiency Structure Theory

The propositions of Efficiency Structure Theory are that improved efficient managerial scale

results to improved concentration and then to improved incomes. Efficiency in itself indicates the

desirable improved profitability of financial institutions more so the commercial banks. The theory

on the efficiency structure presents that firm’s performance is positively correlated to firm’s

efficiency. According to Ayano (2016) the improved profits are as a results of increased efficiency.




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The two hypotheses that is X efficiency and scale efficiency are also included in efficiency

structure theory. The first hypothesis (X efficiency) posits that commercial banks with good

managers practices cost controls and raises the level of incomes, moves the commercial banks

closer to the best customer care practices and lowers the bound cost curve. On the other hand the

scale efficiency posits that many of the commercial banks attain improved operation scale thus

lowering costs (Kimande, 2017).

Empirical Review

This section comprises of the review of empirical review relating to bank characteristics and

profitability.

Bank Size and Profitability

Musyoka (2017) studied the bank size effects on performance of commercial banks in Kenya. The

study adopted a descriptive analysis and data was collected from 42 banks in Kenya. The study

found bank size relationship with commercial banks returns on asset was negative and and

significant. Babalola (2013) findings concurred with Musyoka findings on a study on the effects

of bank size in determining revenue levels. The study found that banks size is very key in

determining its relationship with both internal and external environment and larger banks are stable

and have capability to generate huge revenues due to different products they offer as well as the

market coverage.

Asset Quality and Profitability

Shipho and Olweny (2011) studied the impact of commercial bank’s specific contributors on

commerrcial bank’s financial performance in Kenya. Explanatory method was employed by the

use of panel research design. The study was interested in the periods 2002 to 2008 where financial

statements of 38 commercial banks in Kenya were obtained from the CBK and commercial bank

survey data for 2009. A method on multiple regression was employed to present the correlation

between variables and to show the direction of change of dependent variable as a result of change

of independent variables. The study found asset quality has got a very significant negative effects

on commercial bank’s financial performance in Kenya. However, the study did not conduct

diagnostics tests before carrying out inferential analysis. In addition, the above study failed to

include the moderating effects of inflation in the relationships between the variables sought.

Musyoka (2017) studied the bank size effects on performance of commercial banks in Kenya. The

results revealed that there is a negative and insignificant relationship between assets quality and

commercial banks in Kenya financial performance. This is an indication that there is no significant

relationship between commercial banks in Kenya financial performance and assets quality. Jeanne

and Svensson (2014) however suggest that asset quality is a key determinant of future earnings

and, therefore, capital generation or erosion. The author argued that bank’s asset is loans and they

determine a greater percentage of the firms income hence the quality of the loans is key.




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Capital Adequacy and Profitability

Musyoka (2017) studied the bank size effects on performance of commercial banks in Kenya.

.indicated that the average capital adequacy for the banks was 23.16% which above the regulatory

value of 14.5%. The study found that on average the asset quality was 0.09909 whereas the average

liquidity was 0.40795 while the average value of management quality was 4.03326. The study

found that capital adequacy relationship with the returns on assets in commercial banks was

negative and significant.

A study was done to assess the impact of camel models variables that is capital adequacy liquidity

management earnings and sensitivity on profitability of commercial banks in Chinese (Liu, 2011).

The focus of the study was periods 2008 to 2011. The study was interested in 13 banks quoted in

stock exchange of Shangai, China. Multiple linear regression methods predicted the relationship

between variables of the study. The inferential statistics indicated that capital adequacy and strong

and significant effect on Commercial Bank financial performance. The focus of this study was on

Commercial banks in Chinese something financial performance while the current study will focus

on banks in Kenya and all Factor the inflation rate is the moderating effect on the relationship

between the profitability of commercial banks and the capital adequacy.

Inflation and Profitability

Buyinza (2010) assessed the effects of bank characteristics on commercial bank’s profitability in

Sub-Saharan African countries. The scope of the study considered 23 commercial banks. The

periods of interests was 1999 to 2006 and the study captured the profitability for these periods in

Sub-Saharan Africa. The analysis was done with the help of panel regression model. The finding

of the study presented there is a significant positive effects of inflation on commercial banks

profitability. Buyinza’s study was a cross country analysis study while this study focused on

Kenyan commercial banks thus specific findings affecting the local banks.

Ajayi and Atanda (2012) studied the effects of instruments of controlling money supply on

Commercial bank’s financial performance in Nigeria. The study periods of interest were years

1980 to 2008. The study utilized Engle-granger two step co-integration method. The study found

that the rate of inflation had a positive in-significant effects on Nigerian. The study revealed th

banks financial performance. However, the study did not conduct diagnostic tests in Nigeria before

carrying out inferential analysis. The current study conducted diagnostics tests for panel regression

before conducting inferential analysis and conclusions.

Assessment of the effect of global crisis and profitability of commercial banks in Kenya was done

by Macharia (2013). The study was interested in banks’ (commercial) that offer secured loans

financing. The effect of inflation was found to be strongly and negatively correlated to the bank's

profitability. The study by Macharia concentrated on inflation’s direct effects profitability levels

of the banks. This research paper will focus on Kenyan 43 banks’ profitability and also factored in

the inflation’s moderating effects on the relationships between bank characteristics and

commercial bank’s profitability.




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Kiganda (2014) analysed the effects of macro-economic factors on commercial bank’s profitability

in Kenya. The study employed a case study and Equity’ Bank in Kenya was considered. The

independent considered included GDP, rate of exchange and rate of inflation while the dependent

variable was the bank’s profitability. The periods of interest was years 2008 and 2012 and data for

the period was collected. A multiple regression model was utilized to determine the relationship

between variables. The paper found that the rate of inflation effects on profitability of commercial

banks (Equity Bank) were positive and insignificant. The study focused on a single bank in Kenya

out of the 43 commercial banks and therefore such analytical findings may not be generalized to

the remaining 42 banks (commercial). This research paper focused on Kenyan 43 banks’

profitability and also factored in the inflation’s moderating effects on the relationships between

bank characteristics and commercial bank’s profitability.

Profitability of Commercial Banks

A Study in Ethiopia before the period of ten years that is 2002 to 2013 was examined by Alemu

(2015) on Commercial banks profitability. To analyse data the study used a linear regression and

a fixed effect regression models. The study found that capital adequacy bank size and gross

domestic product is a significant positive relationship with the bank's profitability the findings of

this study indicated that the operational efficiency bank sector development funding costs and

liquidity had negative statistical significance with the bank’s profitability. The study found that

relationship between efficiency of employees’ management efficiency and inflation and rate of

exchange ad are insignificant statistical relationship with the performance of commercial Banks.

A study by Abebe (2014) on the effect of internal external factors on profitability of commercial

banks in Ethiopia. The study collected data which were panel data for the period of 2002 to period

of 2013. The study also used the fixed effects regression models the results of the inferential

statistics indicated that diversification of income structure of the capital cost of operations and

negative significant correlations with the performance of the banks. The study also indicated that

the size of the bank and profitability had significant and positive relationship. This study also

established that microeconomic variables and insignificant correlations with the return on assets

of commercial banks considered in Ethiopia. The study used the return on asset is the indicator of

the financial performance. The study was done in Ethiopia while the current study will be carried

out in Kenya

Summary of Literature Review and Research Gap

The following is the reviewed research gaps from the above empirical literature.




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Table : Summary of Empirical Review and Research Gap

Authors

Context and

Focus

Major Findings Gaps Identified Current study

Focus

Musyoka

(2017)

Bank size and

financial

performance of

commercial banks

The relationship

between bank size

and return on

assets was

negative and

significant.

Descriptive

analysis was

used.

Both descriptive

and exploratory

was used.

Musyoka

(2017)

Asset and financial

performance of

commercial banks

The relationship

between asset

quality and return

on assets was

positive and

significant.

Descriptive

analysis was

used.

Both descriptive

and exploratory

was used.

Ifeacho

and

Ngalawa

(2014)

The

macroeconomic

variables and bank

specific variables

and their effects on

financial

performance of

South Africa’s

banking sector.

The study found

that asset quality

has a significant

negative effects

on ROE.

The study made

use of annual data

on the four largest

banks in South

Africa which are

ABSA, Nedbank,

First National

Bank and

Standard Bank for

the period 1994

and 2011.

The current

proposed research

problem seeks to

fill the gap

(contextual gap)

as it focused on

commercial

bank’s financial

performance in

Kenya.

Kwakwa

(2014)

Contributors of

Ghana’s

commercial bank

financial

performance.

The study found

that inflation had

a positive

insignificant

effects on

commercial

bank’s financial

performance

Cross country

analysis was

used.

The current

proposed research

study sought to

fill the gap

(contextual gap)

as it focused on

commercial

bank’s financial

performance in

Kenya.

Kiganda

(2014)

Analysed the

effects of macro-

economic factors

on commercial

bank’s profitability

in Kenya.

The paper found

that the rate of

inflation effects

on profitability of

commercial banks

(Equity Bank)

Study focused on

a single bank in

Kenya out of the

43 commercial

banks and

therefore such

This research

paper focused on

Kenyan 43 banks’

profitability and

also factored in

the inflation’s




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were positive and

insignificant.

analytical

findings may not

be generalized to

the remaining 42

banks

(commercial).

moderating

effects on the

relationships

between bank

characteristics and

commercial

bank’s

profitability.

Ezra

(2013)

The contributors of

profitability of

commercial banks

in sub-Sahara

Africa

Bank size had a

negative

significant effects

on commercial

bank profitability.

Capital Adequacy

has a positive

significant effects

on commercial

bank’s

profitability.

Cross country

analysis was

used.

This study

focused on local

analysis hence the

results was

Kenyan specific

findings.

Okoth and

Gemechu

(2013)

Contributors of

financial

performance of of

commercial banks

in Kenya.

Capital adequacy

had a positive

significant effects

on commercial

banks financial

performance.

The study did not

conduct

investigative tests

to establish the

correctness of

data before

conducting

inferential

analysis.

The current study

conducted

investigative tests

to establish the

correctness of

data before

conducting

inferential

analysis.

Jha and

Hui (2012)

Financial

characteristics

relationship

performance of

different

ownership

structured

commercial banks

in Nepal

Capital adequacy

ratio has a

positive

significant effects

on Nepal’s

commercial banks

financial

performance

The banks

considered were

from Napal

Kenyan

commercial banks

were considered

in the current

study.

Buyinza

(2010)

Sub-saharan

countries

Commercial

bank’s profitability

Size of the bank

has a positive

significant effects

on bank’s

profitability.

Cross country

analysis was

used.

This study

focused on local

analysis hence the

results was

Kenyan specific

findings.




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Source: Researcher’s Literature Review (2018)

Conceptual Framework

The framework provided a visual relationship of the study variables. The independent variables of

the study were bank characteristics while the dependent variable constitutes the profitability of

commercial banks as measured by PBT. The bank characteristics (bank size, asset quality and

capital adequacy) were proposed to predict the profitability of banks. Similarly, the moderating

variable of the study was inflation which was proposed to affect the relationship between bank

characteristics and profitability.

Independent Variables

Dependent Variable

Figure 2.1: Conceptual Framework

Source: Researcher (2019)

Ho4

Moderating variable

Ho3

Ho2

Ho1

Bank Characteristics

Bank Size

Log of total assets

Capital Adequacy

CAR = Equity/

Total assets.

Asset Quality

Non-Performing

Loans / total

loans

Inflation

Inflation Rate

Profitability

PBT




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RESEARCH METHODOLOGY

Chapter three presented the study methodologies. It presented the study research design,

units/elements targeted by the researcher, instruments used to collect data and methods of

analysing data.

Research Design

A study research design presents the outline for gathering data, measurement used and data

estimation by the researcher (Cooper & Schindler, 2009). The current study adopted causal

research design. The current focuses on the causal effects of bank characteristics on commercial

bank’s profitability in Kenya hence causal design was appropriate.

Target Population

A target population refers to a collection of units or elements LED videos in which the researcher

will use to make various influences. The 43 Commercial banks in Kenya will be considered as the

target population. The banks considered worthy commercial banks which were in operation for the

period of consequently, the unit of observation of the study comprised of the published financial

statements of the 43 commercial banks.

Empirical Model

In conducting the analysis of the study, panel regression model based on a panel data was adopted.

Therefore, profitability (PBT) was expressed as a function of bank size, asset quality and capital

adequacy.

Yit = β0 + β1X1it + β2X2it + β3X3it + єit……………………………………………………….3.1

Where:

Y it - Profitability

β0 - Constant

X1it – Bank Size

X2it – Asset Quality

X3it – Capital Adequacy

β1 – β3 are co-efficients of the multiple variables and indicate the changes of the dependent

variable as a result of changes in the independent variables.

Єit= The model Error Term, It presents any uncaptured variable in the model

The two models presented below tested the moderator (inflation) and its contribution on the effects

of commercial bank characteristics on level of profitability.

Yit = β0 + β1Xit+ ε……............................................................................................................3.2

Yit = β0 + β1Xit + β2M0it + β3 Xit * M0it + ε......................................................................3.3




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Where; Yit = Profitability

Xit = Bank Characteristics

M0it = Inflation (The moderator)

Xit * M0it = Interaction term

β1, β2, and β3 = Beta coefficients

ε = Error term

According to Whisman and McClelland (2005) in the case of the overall effects moderation, the

test moderation effect focused specifically on determining whether the interaction term co-

effecients was empirically be different from zero.

Operationalisation and Measurement of Variables

The independent variables of the study were bank characteristics (bank size, asset quality and

capital adequacy). Consequently, the dependent variable of the study was profitability which was

measured in terms of profit after tax. Furthermore, the moderating variable of the study was

inflation which was measured using inflation rate in percentage. The Operationalization and

measurement of the study variables were presented in the table below (Table 3.1)

Table 3.1: Operationalisations and Variable Measurement

Variable Type Operationalisation Measurements

Profitability

Dependent

Variable

Return on

shareholders’ wealth

PAT in billions

Inflation Moderating

Variable

Inflation Rate

Percentage inflation rate

Bank Size Independent

Variable

Total Assets Log of total assets

Asset Quality Independent

Variable

Non-Performing Loans Non-Performing

Loans/total loans in

percentage

Capital Adequacy Independent Variable Level of capital

required

Capital Adequacy Ratio

= Core capital/ Total

assets

Source: (Researcher, 2019)




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Sampling Design

The 43 commercial bank’s data was included in this study and therefore a census sampling study

was appropriate. The data was collected from the banks who existed in years 2013 to 2017.

According to Mugenda and Mugenda census sampling design can be applied when the population

is of manageable size or when it desirable to incorporate the total target population. In addition,

Kothari (2011) put forward that the use of census sampling eliminates type I and type II errors in

the study.

Data Analysis and Presentation

Data analysis was conducted in every empirical research to enable making of inferences and

conclusions. Therefore, inferential analysis and descriptive statistics was used to analyse the

findings. After the collection of research data, the data was analyzed. The annual panel data was

analysed by the use of panel’ regression’ analysis. Descriptive analysis provided the descriptions

of the study variables presented. The descriptions included parameters such as the mean,

minimum, maximum observations and standard deviations. The data was presented in tables which

aided in the analysis.

Diagnostic Tests

These tests are important as they show whether stochastic properties are met. The study will test

multicollinearity using Variance inflation factor (V.I.F) test. The test for Heteroscedasticity was

Breusch Pagan Godfrey test, and normality was tested using Skewness and kurtosis tests.

Multicollinearity Test

Multicollinearity occurs when independent variables are correlated either moderately or highly.

The Variance inflation factor (V.I.F) was used to test this aspect. The V.I.F should not exceed 10

for it to be tolerated.

Normality Test

These are tests used to determine whether the data is normally distributed, with some tolerance

level. Tests on kurtosis and skewness are very appropriate when using descriptive statistics as they

show the distribution of a variable from normal distribution, (Jeeshim, 2013).

RESEARCH FINDINGS AND DISCUSSIONS

The chapter presented the findings on the effects of bank characteristics on profitability of

commercial banks in Kenya. The study targeted all the 43 commercial banks in Kenya and data on

their capital adequacy, asset quality, bank size and net income were presented.

4.2 Descriptive Statistics




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The target population was 43 commercial banks in Kenya as at 31st December 2017. The study

obtained complete financial data from 35 commercial banks. This accounted for 81.3 per cent of

the targeted population. This according to Mugenda and Mugenda (2009) was sufficient to carry

out the study.

Table. Descriptive Statistics

Capital Adequacy Asset Quality Bank Size Net Income

N 175 175 175 175

Mean 0.2235 0.1094 10.6042 .9817

Max 0.73 0.62 11.77 19.704

Min 0.024 0.00 9.30 (1.153)

Std Deviation 0.0909 0.1016 0.5945 23.7838

Skewness 0.361 0.5685 (1.541) 1.7881

Kurtosis 0.699 1.543 1.611 1.9231

The study used mean, maximum, minimum, skewness, kurtosis and standard deviation to analyse

the findings. The variables considered were capital adequacy, asset quality, bank size and net

income. Capital adequacy was measured by ratio of shareholders’ funds to total assets. Asset

quality was the ratio of gross non-performing loans to the total loans. Bank size was measured by

the log of total assets of the commercial banks while net income was measure in billions of Kenyan

shillings. The study obtained data for the years 2013 to 2017 on the commercial banks net income,

capital adequacy, asset quality and net income and the results summary presented in the table 4.1.

The total number of observations (N) were 135 (5 years * 35 banks)

Correlation Analysis

The study sought to establish the correlation between variables. Table 4.2 presented the results

obtained.




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Table.Correlation Matrix

Capital

adequacy Net Income

Asset

Quality

Log of Total

assets

Capital adequacy Pearson

Correlation 1 -.

Sig. (2-tailed)

N 175

Net Income Pearson

Correlation .092 1

Sig. (2-tailed) .225

N 175 175

Asset Quality Pearson

Correlation -.211** -.122 1

Sig. (2-tailed) .005 .109

N 175 175 175

Bank Size Pearson

Correlation -.193* .227** -.249** 1

Sig. (2-tailed) .010 .002 .001

N 175 175 175 175

**. Correlation is significant at the 0.01 level (2-

tailed).

*. Correlation is significant at the 0.05 level (2-

tailed).

The findings indicate that the correlation between capital adequacy and net income was weak and

positive (r= 0.092 p=0.225). The correlation between asset quality and capital adequacy and the

correlation between asset quality and net income were found to be weak and negative(r= -0.211,

p=0.005) and (r= -0.122, p=0.109) respectively. The study also found that the correlation between

log of total assets and capital adequacy was weak and negative (r= -0.193, p= 0.010), the

correlation between log of total assets and net income was weak and positive (r=0.227, p=0.002)

while the correlation between log of total assets and asset quality was negative and weak (r= -

0.249, p= 0.001). The findings concurred with Ifeacho and Ngalawa (2014) on assessment of the

effects of macroeconomic variables and specific variables of the bank on South Africa’s banking

sector performance. The study considered the following independent variables: asset quality,

earnings, capital adequacy and liquidity. Financial performance of commercial banks was the

dependent variable. The indicator of financial performance was ROE. The findings showed that

capital adequacy and bank size had a positive significant effect on ROE.




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Testing Multicollinearity

The study sought to investigate whether two or more independent variables have a high correlation

with each other. The findings were presented in Table 4.4

Table. Multi-Collinearity Coefficientsa

Model

Collinearity Statistics

Tolerance VIF

1 Asset Quality .822 1.217

Log of Total assets .789 1.267

Inflation Rate .980 1.020

Capital adequacy .823 1.215

a. Dependent Variable: Net Income

Source: Research Data (2019)

Testing the Moderating Effects of Inflation Rate

The study sought to investigate the moderating effects of inflation rate on bank characteristics

effects on profitability.

Moderated Model Summary

Table. Moderated Model Summary

Model R

R

Square

Adjusted

R Square

Std. Error of

the Estimate

Change Statistics

R

Square

Change

F

Change df1 df2 Sig.

1 .155a .024 .007 23.6997138 .024 1.412 3 171 .241

a. Predictors: (Constant), BSMO, AQMO, CAMO

Moderated Coefficients




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Table. Moderated Coefficientsa

Model

Unstandardized

Coefficients

Standardized

Coefficients

t Sig. B Std. Error Beta

1 (Constant) 2.138 14.343 .149 .882

CAMO 236.467 300.642 .061 .787 .433

AQMO -445.033 256.747 -.133 -1.733 .085

BSMO -1.960 19.563 -.008 -.100 .920

a. Dependent Variable: Net Income

The findings in table 4.8 show a change in R2 by -0.044 indicating that the moderating effects

decreased by 4.4 per cent. The change of adjusted R2 from 0.051 to 0.007 indicating a decrease in

profitability was as a results on inflation rate which was insignificant (P=0.241). The effects of

inflation moderating the effect of bank characteristics (Capital adequacy, asset quality and Bank

size) was insignificant (all the P- values are greater than 0.05). Therefore the study accepted the

fourth hypothesis (H04) that there is no significant moderating effects of inflation in determining

the relations between bank characteristics and commercial bank’s profitability in Kenya.

The study findings showed that there was a negative and insignificant relationship between capital

adequacy and profitability of commercial banks in Kenya. This indicates that the relationship

between profitability and capital adequacy of commercial banks was not significant and that capital

adequacy change does not significantly explain the changes in profitability of commercial banks

in Kenya. According to Olalekan (2013) adequate capital is one of the important parameter used

by the CBK and other stakeholders to evaluate the stability of the commercial banks in Kenya.

The study found that there was a significant and positive relationship between the size of the bank

and profitability of commercial banks in Kenya. This an indication that a positive change in bank

size will result to a positive change in the profitability of commercial banks in Kenya and that

negative change in bank size will result to a negative change in the profitability of commercial

banks in Kenya. The findings concurs with Babalola (2013) finding that bank size is key in

determining the relationship between internal and external environment factors and that majority

of larger banks have the capability of generating huge profits due to the market coverage level and

ability to offer and support more products.

The study indicated that there was insignificant and negative relationship between the quality of

the assets and profitability of Kenyan commercial Banks. This indicates that the relationship

between asset quality and profitability of commercial banks is not significant and that asset quality

change does not significantly explain the changes in profitability of commercial banks in Kenya.

However, according to Jeanne and Svensson (2014) asset quality or the bank loans quality is a

greater determinant of the firms’ income. The moderating effect of inflation was tested and the




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results showed that its effects was insignificant on bank characteristics effect on profitability of

commercial banks in Kenya.

CONCLUSIONS, SUMMARY AND RECOMMENDATIONS

The chapter provides the summary on the study findings, conclusions and recommendations based

on the findings in chapter four. The chapter presents also the limitations and suggestions for further

studies.

Summary of the Study

The study sought to determine the effect of bank characteristics on profitability of commercial

banks in Kenya. The independent variables of the study were bank size, asset quality and capital

adequacy. The moderating variable was inflation rate and the dependent variable was profitability

of commercial banks measured by the net income. The study targeted all the Kenyan 43

commercial banks. Secondary data on net income, capital adequacy, asset quality, and bank size

and inflation rate was collected for periods 2013 to 2017. The Multicollinearity test indicated that

there was no possibility of Multi-collinearity between variables thus regression analysis could be

done to show the relationships between the dependent and independent variables.

The descriptive results presented that the average capital adequacy for the studied commercial

banks was above the regulatory requirements for the period under consideration. The correlation

findings indicated that the correlation between capital adequacy and net income was weak and

positive. The results on regression coefficients indicated that indicated that the relationship

between capital adequacy and net income was negative and insignificant.

The descriptive findings indicated that the average asset quality was ratio was low an indication

that there was a low non-performing loans in the commercial banks for period 2013 to 2017. The

correlation between asset quality and capital adequacy and the correlation between asset quality

and net income were found to be weak and negative. The results also showed the relationship

between asset quality and profitability of the bank was positive and insignificant.

The findings on bank size was presented and indicated that there was a high variation on average

bank size (natural logarithm of total assets).The correlation between size of the bank and capital

adequacy was weak and negative. The correlation between bank size and net income was weak

and positive while the correlation between size of the bank and asset quality was negative and

weak. The banks average net income generally increased for the period under study. However, the

relationship between bank size and profitability of commercial banks was found to be positive and

significant.

Conclusions

Based on the findings, the study concluded that capital adequacy relationship with net income was

negative and insignificant. The study concluded that relationship between asset quality and

profitability of the bank was positive and insignificant. The study concluded that the relationship




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55

between bank size and profitability of commercial banks was positive and significant. The study

concluded that the moderating effect of inflation on bank characteristics effect on profitability of

commercial banks in Kenya was insignificant.

5.4 Recommendations

Based on the conclusion that the there was a positive and significant relationship size of the bank

and profitability of commercial banks, the study recommended that commercial banks in Kenya

should invest on more asset for the size in terms of increased bank total assets will help in

increasing the level of revenue generation.

Based on the conclusion that the relationship between capital adequacy and net income was

negative and insignificant. The study recommended that commercial bank in Kenya should ensure

that regulatory requirements on capital adequacy is met and that much effort be concentrated in

increasing the bank size in terms of total assets.

Based on the conclusions that there was positive and insignificant relationship between

profitability of banks and quality of assets, the study recommended commercial banks should keep

an average low ratio between non-performing loans and total loans and finally based on the

conclusion that the moderating effect of inflation on bank characteristics effect on profitability of

commercial banks in Kenya was insignificant, commercial banks should advance loans, increase

their investment on total assets and improve their capital adequacy despite the levels of inflation

rate.

REFERENCES

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Cooper, D. & Schindler, P. (2009).Business Research Methods.9th edition. McGraw Hill

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Dang,&Uyen. (2011). The CAMEL Rating System in Banking Supervision: a Case Study of

Arcada University of Applied Sciences, International Business.

Dietrich, A., &Wanzenried, G. (2011). Determinants of bank profitability before and during the

Crisis: Evidence from Switzerland. Journal of International Financial Markets,

Institutions and Money, 21, 307ı327.

Ifeacho C. & Ngalana, H., (2014). Performance of the South African Banking Sector since 1994.

Journal of Economic and Sustainable Development, 5(2):46-56

Kiganda E. O. (2014). Effects of macroeconomic factors on Commercial Banks, profitability in

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Kimande, E.G (2017). The Effect of Bank Specific Factors on Financial Performance of

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Kwakwa, O. M (2014) Determinants of Performance of Commercial Banks In Ghana. A Thesis

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Mugenda, O. &Mugenda, P (2011).Qualitative and Quantitative Research Methods. Kenya.

Okoth,V, & Gemechu,B. (2013). Determinants of Financial Performance of Commercial Banks in

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