Effect of Financial Leverage on the Financial Performance of Commercial Banks in Kenya

Abstract

Despite the growth in the Kenyan banking sector, financial leverage remains a major factor of financial performance. The choice of debt financing by commercial banks can be advantageous or can lead to financial distress depending on how the finances are utilized by the finance managers. Prudent allocation and use of the borrowed funds lead to improved financial performance. The study sought to assess the effect of financial leverage on the financial performance of commercial banks in Kenya. The study covered the period between year 2013 and 2017. Financial leverage includes debt and equity financing by firms to back their assets. Financial leverage was estimated by level of debt proportion, firm size and liquidity while returns on assets was used to estimate financial performance. Central Bank of Kenya financial statements and annual reports for individual commercial banks were the key data sources. Descriptive statistics and correlations between the factors were done. Analysis of variance (ANOVA) and F-test at 5% criticalness level was utilized to decide the regression model significance while adjusted R-square, was utilized to establish the degree of variability in financial performance explained by debt proportion, firm size and liquidity. The study results revealed financial performance of commercial banks is significantly influenced by financial leverage on financial performance of commercial banks in Kenya. Therefore, commercial banks should select a composition of debt and equity finances so as to balance the cost and benefit of debt. This is because at disequilibrium a levered firm may appear to have a higher value which will not persist for long at this firm and the levered firm is overvalued and therefore the investors in this company will attempt to make switch from a levered firm to unlevered firm.