Effect of Bank Specific Factors on Capital Adequacy of Commercial Banks in Kenya

Abstract

The research evaluated the causal effect relationship between bank specific factors and capital adequacy of licensed commercial banks operating in Kenya. The research was based on suitability theory of liquidity, Information Asymmetry and Buffer capital theories.” The research was based on descriptive survey design. The study targeted 43 commercial banks licensed to operate between 2016 and 2021. The research did not carry out sampling because of the small size of population hence it was a census. The research sourced annual secondary data spanning from 2016 to 2021 from audited financial statements of the banks. The collected data was recorded on data collection sheet. The data collected was keyed into Excel sheet and the variables were generated before being exported to STATA version that aided in generation of descriptive and inferential statistics. Regarding descriptive analysis, standard deviation, mean, minimum, maximum and standard deviation were adopted. Panel correlated standard errors (PCSEs) regression model was adopted in analysis to correct for serial correlation and heteroskedasticity problem. The regression analysis revealed that 59.1% of the variation in capital adequacy was explained by explanatory variables in the model. Moreover, the study revealed a statistically significant direct effect of return on assets management quality and bank liquidity on capital adequacy. Further, asset quality and bank size had a major inverse effect on capital. Overall, the research concluded that bank specific factors studied had a major effect on capital adequacy of CBK’s licensed commercial banks. Given that ROA had direct and major causal effect relationship with capital adequacy, the study suggested to commercial banks’ top executives to seek to increase their profitability via interest based and non-interest-based revenue sources. The CBK to continue tightening supervision of commercial banks to ensure the reported ROA in the audited financial statements reflect the true and fair view of the banks as regards the profitability. The study also suggests to executives of commercial banks to strengthen their liquidity position. The banks should have adequate liquidity to settle maturing obligations including fixed and demand deposits. Increasing liquidity in terms of cash and cash equivalents leads to increased credit worthiness and trust in the bank by customers and investors hence increased capital adequacy through attraction of more share capital to the bank. The CBK should also continue exercising close and stringent supervision of the commercial banks liquidity to ensure it is within acceptable level especially strong or satisfactory level. The study suggests to management of commercial banks ought not increase their assets size without proportionate increase in total capital. The bank should therefore increase their capital to match increase in assets size to avoid reduction in capital adequacy ratio. The study also suggests to management of commercial banks to improve their credit analysis and implement stringent loan application screening to weed out prospective loan defaulters. The CBK should also continue monitoring the quality of asset of commercial banks to ensure that the banking system does not suffer from widespread increasing loan losses.