The Effect of Financial Derivatives on the Financial Performance of Commercial Banks in Kenya

Abstract

The increasing propensity of commercial banks to take part in derivative activities is one of the notable developments in the present day financial markets. Latterly, the financial innovation improvements, deregulation and development of the financial markets,and banks‟ margins decreases, due to low-quality loan applicants, motivate the commercial banks to provide advanced services and products to expand their profits. Profits from traditional banking activities has been decresing whilst the competitiveness of markets have been increasing thus forcing banks to undertake derivative activities.The objective of this study was to establish the effect of financial derivatives on the financial performance of commercial banks in Kenya. The study involved an in depth analysis of financial derivatives and its effects on the financial performance of commercial banks and thus descriptive research design was found to be appropriate. Secondary data about the commercial banks‟ notional amount of derivatives, total assets, liquidity ratio and total shareholders‟ equity was collected from the Central Bank of Kenya bank supervision annual reports (2011-2015) and analyzed using multiple regression. Statistical Package for Social Sciences (SPSS version 18) was used obtain the regression output. Return on Assets (ROA) was used as the proxy for financial performance while financial derivatives, liquidity ratio and shareholders‟ equity ratio were the predictor variables.The findings of the study indicated that there is an insignificant relationship between the financial performance (ROA) of commercial banks in Kenya and financial derivatives. Additionally, the negative nature of the relationship means that a unit change(increase) in financial derivatives will result to a decrease in financial perfomance of commecial banks in Kenya.Consequently, therefore,financial derivatives should be properly used in a manner that is instrumental to the goal of a sound and safe banking system in kenya