Effect of Capital Structure on the Profitability of Fully Fledged Islamic Banks in Kenya

Abstract

Capital structure is very significant aspect for any business sustainability. It is usually challenging for different organizations to establish the right mix of Debt and Equity. Many organizations prefer to utilize debt financing in the capital structure plans in order to increase their levels of performance. The purpose of this project was to investigate the effect of capital structure on the profitability of fully fledged Islamic banks in Kenya. The project specifically sought to examine how financial leverage; debts ratio capital adequacy; customer deposit leverage retained earning leverage and size affected profitability of fully fledged Islamic banks in Kenya. The project adopted descriptive research design. The target population was three Gulf of African Bank, First Community Bank and Dubai Islamic Bank) fully fledged Islamic Banks in Kenya. The project used a census approach. Secondary data was used in the project and it was collected using data extraction excel sheet. The collected data was coded into SPSS and the analysis was done using descriptive and inferential statistics. Descriptive statistics included use of Means, Standard deviations, Skewness and Kurtosis. Inferential statistics involved correlation and regression analysis. The analyzed data was presented using tables and charts. The project established that when Return on Assets (ROA) was used as a measure of profitability of full-fledged Islamic banks in Kenya, correlation results indicated an retained earnings to total assets had significant influence on profitability of fully fledged Islamic banks in Kenya measured by ROA (r=.715, P=0.000<0.05). Using ROE as a measure of profitability of fully fledged Islamic banks in Kenya, correlation analysis results showed that retained earnings to total assets had significant influence on profitability of fully fledged Islamic banks in Kenya measured by ROA (r=.683, p=0.000<0.05). From regression analysis results, when ROA was used a measure of profitability and before controlling for size, the effect of customer deposit leverage (p=0.041<0.05) and retained earnings leverage (p=0.000<0.05) was significant. After controlling for size and ROA as dependent variable, only customer deposit leverage was significant in explaining the effect of capital structure and ROA as a measure of profitability of full-fledged Islamic banks in Kenya p=0.000<0.05. Before controlling for size and ROE as a measure of profitability, both customer deposit leverage p=0.019<0.05 and retained earnings leverage p=0.000<0.05 had significant effect on return on equity as a measure of profitability of full-fledged Islamic banks in Kenya. When the relationship between independent variables and ROE was controlled by size, only retained earning leverage had significant effect on ROE as a measure of profitability of fully fledged Islamic banks in Kenya. In conclusion, return on asset was an efficient measure of profitability of profitability of full-fledged Islamic banks in Kenya R2=58.6% than ROE whose R2=49.2%. The study concludes that retained earnings leverage had strong direct relationship with ROA as a measure of profitability of fully fledged Islamic banks in Kenya; Customer deposit leverage and Retained earnings leverage had significant effect on ROA as a measured of profitability of full-fledged Islamic banks in Kenya before the controlling effect of size. In addition, return on asset was an efficient measure of profitability of profitability of full-fledged Islamic banks in Kenya. However, size has a significant controlling effect in assessment of profitability of fully fledged Islamic banks in Kenya. The study recommends that top management of the Islamic banks in Kenya should enhance their retained earning leverage by expanding their investment strategy that increases profits which transpires into increased retained earnings.