The Effect of Asset Quality on Value of Commercial Banks Listed at the Nairobi Securities Exchange

Abstract

Low quality assets can reasonably be expected to enter default. All the losses arising from asset quality are summed up in the final financial performance of an entity. Carrying low quality assets on the statement of financial position places three distinct burdens on lenders. The non-payment of interest or principal reduces cash flow for the lender, which can disrupt budgets and decrease earnings. Loan loss provisions, which are funds set aside to cover potential losses, reduce the capital available to provide subsequent loans. Once the actual losses from defaulted loans are determined, they are written off against earnings which consequently sum up in the final firm value. This study sought to determine the effect of asset quality on value of commercial banks listed at the NSE. The study‟s population was all the 11 commercial banks listed at the NSE. Asset quality in this study was the dependent variable and was measured by the ratio of performing loans to total loans and advances. The control variables were capital adequacy, bank size, management efficiency, capital structure, age of the bank and interest rate spread. Value of the firm was the dependent variable which the study sought to explain and it was measured by the ratio of market value of equity to book value of equity. Secondary data was collected for a period of 5 years (January 2013 to December 2017) on an annual basis. The study employed a descriptive cross-sectional research design and a multiple linear regression model was used to analyze the association between the variables. Data analysis was undertaken using the Statistical Package for Social Sciences version 2.1. The results of the study produced R-square value of 0.508 which means that 50.8 percent of the variation in the listed commercial banks‟ value can be explained by the seven selected independent variables while 49.2 percent in the variation of value of quoted commercial banks at the NSE was associated with other factors not covered in this research. The study also found that the independent variables had a strong correlation with financial performance (R=0.713). ANOVA results show that the F statistic was significant at 5% level with a p=0.000. Therefore the model was fit to explain the relationship between the selected variables. The results further revealed that bank size, management efficiency and interest rate spread produced statistically significant values for this study. The study found that asset quality, capital adequacy, age of the banks and capital structure are statistically insignificant determinants of the value of commercial banks listed at the NSE. This study recommends that measures should be put in place to enhance bank size and management efficiency among commercial banks as this will improve their value.