Financial Innovation and Its Effect on Financial Performance of Commercial Banks in Kenya

Abstract

The purpose of the study was to assess the effect of financial innovation on commercial bank’s financial performance as the key players in the banking sector over a period of 4 years. Kenya’s financial sector has undergone significant transformation in the last few years. Many new more efficient and real time financial systems have come into place. Despite the undeniable importance of financial innovation, its effect on financial performance is not always obvious since there are reported cases of reverse causality between innovation and performance. The causal research design was used to carry out this study. The population of study was all the 43 commercial banks in Kenya as at 30th June 2012. The study used secondary data from published central banks’ annual reports. The independent variable was financial innovations unique to commercial banks while dependent variable was consolidated financial performance of all banks. Study results indicated that financial innovation indeed contributes to and is positively correlated to profitability in the banking sector particularly that of commercial banks. This is further supported by high uptake of more efficient financial systems in substitution for the less efficient traditional systems. This is evidenced by the negative correlation between Real Time Gross Settlement and Automated Clearing House (Cheques & EFTs) throughput over time; as well as that of profitability and Automated Clearing House throughput. Development of more efficient payment systems, with adequate regulation, should therefore be encouraged for improved financial performance and faster economic growth.