The Effect Of Asset Quality On Profitability Of Commercial Banks In Kenya

Abstract

Asset quality is an aspect of bank management that involves examination of the assets of a bank so as to so establish the level and size of credit risk associate with its operation. This study aimed at determining the effect of asset quality on profitability of Commercial Banks in Kenya and was guided by the following theories; Capital asset pricing model, Modern portfolio theory and the Signaling theory. The study employed a descriptive research design which enabled the researcher to describe the characteristics of the research variables. There are 43 commercial banks in Kenya (CBK, 2014). The study focused on all the 43 commercial banks. Secondary data was collected from audited annual financial reports for individual banks found on the banks website and at the Central Bank of Kenya website and library. Annual audited financial reports were used in the study due to ease of availability and the fact that they are credible. The quantitative data generated were analyzed with the help of Statistical Package for Social Sciences (SPSS) version 20. The findings were presented using tables, frequencies and percentages. Descriptive statistics was used to quantitatively describe the important features of the variables using: frequency, mean, maximum, minimum and standard deviation. Multiple regressions were also used to measure the quantitative data which was analyzed using the SPSS. Regression was used in determining the effect of asset quality on profitability of banks. The study concluded that there is a great positive relationship between asset quality and profitability of Commercial Banks in Kenya. This is because when the ratio of Non-performing asset to net assets is lower, asset quality of Commercial Banks in Kenya it means that the trade-off between assets quality and profitability is positive. In addition, the research concludes that proper management of expenditure of Commercial Banks in Kenya contributes to increased profitability. On the other hand, the study concluded that there is a great positive relationship between capital adequacy and profitability of Commercial Banks in Kenya. Higher levels of equity would decrease the cost of capital, leading to a positive impact on profitability. Similarly, on liquidity management, the study concluded that there is a great positive influence of liquidity management on profitability of Commercial Banks in Kenya. This shows that adequate level of liquidity of Commercial Banks in Kenya is positively related to bank profitability. On the bank size the study concluded that there is a great positive influence of bank size on profitability of Commercial Banks in Kenya. The positive relationship between size and bank profitability means there are significant economies of scale. The study recommends that at the bank level, the improvement of the profitability of Kenyan commercial banks needs to be conducted by a reinforcement of the capitalization of banks through national regulation programs, because higher levels of equity would decrease the cost of capital, leading to a positive impact on profitability. The management of Commercial Banks in Kenya should adopt policies that will ensure that expenses management is well conducted thus higher profitability expected. The study findings were applicable to Commercial Banks in Kenya only. The findings can therefore not be generalized to other firms. The study focused on establishing the effect of asset quality on profitability of Commercial Banks in Kenya. The study proposed that similar study should be carried out on the influence of asset quality on profitability of Banks listed in Nairobi Securities Exchange. There is need for further studies to carry out similar study for a longer time period.