The Effect of Liquidity on Profitability of Commercial Banks in Kenya

Abstract

The essence of the research is to affirm the effect of liquidity on profitability of commercial banks in Kenya. Financial managers find themselves in a predicament of whether to invest in high liquidity risk assets which are long term in nature and have a high return or invest in short term assets with low liquidity risks and low earnings. The population study is composed of 43 banks operating from the period 2011 to 2016.Banks that have operated for the whole period will qualify to be included in the population study. Banks that merged or were not in operation for the whole period of study will not be included. The research used audited financial statements of Kenyan commercial banks as secondary data. Liquidity ratio, deposit to asset ratio and capital ratio are the factors that measured liquidity while the profitability variable was measured by return on assets. The research used regression analysis and descriptive statistics to demonstrate the relationship between the two variables. Response rate was 79% which represents a total of 35 banks out of a total of 43 that satisfied the data criterion. The research results showed that the association linking liquidity and profitability variables in commercial banks of Kenya was positive over the six years period of study. Recommendations from the study are that bank finance managers must have an efficient level between the levels of liquid assets and long-term assets to strengthen each other and maintain sufficient liquidity and ensure profitability in the short and long term period of the bank. The regulator, CBK, should maintain the liquidity requirement and place strong mechanisms to ensure that it is adhered to by the banks.