Financial Innovation and Financial Performance of Commercial Banks in Kenya

Abstract

This research delves into the intersection of financial innovation and commercial bank performance within the competitive and innovative banking sector of Kenya, which comprises 38 commercial banks. During a period characterized by swift digital evolution, this research delves into how financial innovations affect financial performance of banks. This study is grounded in several theoretical frameworks: the Diffusion of Innovations Theory, which examines how new ideas are adopted and spread; Schumpeter's Theory of Economic Development, focusing on the role of innovation in economic progress; and the Constraint Induced Financial Innovation Theory, which looks at how financial innovations emerge in response to certain constraints. Together, these theories offer a comprehensive approach to understanding both the uptake and the effects of financial innovations. Employing a combination of descriptive and explanatory research designs, the study conducts a thorough investigation on all 38 licensed commercial banks in Kenya, utilizing a census sampling method. The research analyzes secondary panel data over a period of five years, from 2018 to 2022, leveraging descriptive statistics and inferential techniques such as correlation and regression analyses to distill the relationships between financial innovation and bank performance. Key findings from the regression analysis reveal that mobile banking and digital payment systems are significantly beneficial to banks' financial performance, highlighting their indispensable role in the modern financial ecosystem. In contrast, a high liquidity ratio is found to adversely affect profitability, pointing to the opportunity costs of maintaining liquid assets. The study also notes the non-significant impact of fintech adoption, bank size, and capital adequacy on the banks' financial performance, suggesting that these factors may have indirect effects. In conclusion, the study asserts the critical importance of mobile banking and digital payment systems in enhancing the financial performance of Kenya banking sector. It also highlights the negative influence that excessive liquidity can have on profitability, drawing attention to its potential drawbacks in the banking sector. Recommendations include a strategic review and adjustment of mobile banking policies to enhance service delivery, augmented security measures to protect clients, and a proactive approach to educating clients about the advantages of digital payment systems. Additionally, the study advocates for a reassessment of liquidity management practices to bolster financial returns. The conclusions and recommendations of this study offer actionable insights for banking executives and policymakers, indicating a path forward for the Kenyan banking industry to leverage financial innovation for optimal financial performance. This study serves as a call to action for banks to not only embrace the digital revolution but to strategically navigate its challenges to realize greater financial success.