Effect of Regulation on Financial Performance of Commercial Banks in Kenya

Abstract

The Kenyan government, through the Central Bank of Kenya (CBK) which is its governing body, has come up with financial regulations to guide banks while in operation while inculcating a fair competition culture industry wide. The practical guidelines introduction depict the continued efforts employed by Kenya with an aim of underpinning its environment of banking so as to achieve its Vision 2030 goal of being a financially stable country internationally. The study’s aim was determining how financial regulations impact performance of Kenyan banks. All the 42 banks in operation were the study’s population. The independent variable for the study was financial regulation with three measures; capital adequacy given by the ratio of core capital to risk weighted assets, asset quality given by non-performing loans to total loans and liquidity given by liquid assets to total assets on an annual basis. The control variables were management efficiency given by total revenue to total assets and bank size given by natural log of total assets per year. Financial performance was the dependent variable given by ROA and efficiency. Secondary data for 5 years (January 2015 to December 2019) was obtained annually. A descriptive cross-sectional design together with a multiple linear regression model was employed in analyzing how the variables relate. A profitability-efficiency matrix was developed which revealed that majority of the banks (38.5%) were ‘dogs’ having high efficiency and low profitability followed by ‘stars’ with (35.9%) having high profitability and high efficiency and thirdly the ‘sleepers’ with (17.9%) having a high profitability and low efficiency and finally the ‘question marks’ were the least with only 7.7% banks having low profitability and low efficiency. Data analysis was performed using SPSS version 23. Findings revealed an R-square value of 0.312 when financial performance was measured by ROA which meant that 31.2 percent variations in performance resulted from variations in the five selected independent variables. The study further revealed that the independent variables explain 36.7% of variations in performance of banks given by efficiency. ANOVA revealed an F statistic which was significant for both models at 5% level since p<0.05. hence the models were sufficient in explaining the relation between the variables. Additionally, capital adequacy, liquidity and bank size had a positive substantial influence on ROA while asset quality had a negative and significant impact on ROA. Management efficiency was not statistically significant. When financial performance was measured using efficiency, liquidity was found not to be statistically significant but the effect of the other variables remained unchanged. The investigation recommends the implementation of measures to enhance capital adequacy and liquidity and to minimize credit risk as these financial regulations have a significant influence on performance. The study also recommends that future studies should focus on other determinants of financial performance of Kenyan banks.