Effect of Financial Risk on Financial Performance of Commercial Banks in Kenya

Abstract

Central in the field of finance is financial performance. The need to explain how two firms operating within the same environment perform differently is a concern and several research works in finance have been devoted towards understanding this mystery. It is theoretically hypothesized that an increase in financial risks like liquidity, credit, interest rate risks among others leads to a reduction in FP. The general objective of this research was to investigate how financial risk impacts the financial performance Kenyan commercial banks. The independent variables in this study were; credit risk, liquidity risk, interest rate risk and operating risk while the dependent variable was financial performance. The control variables were capital adequacy and bank size. The research targeted a population of all the 42 banks in Kenya. Data was from 37 out of the 42 which was a response rate of 88.1% which was considered adequate for the study. The study was conducted for 5 years, 2015-2019. The research design used during the study was descriptive cross-sectional. Secondary data was gathered from published bank’s financial statements and annual reports. Analysis was made using the descriptive, correlation and multiple regression models. The analyzed data was illustrated in tables, charts, percentages, mean and standard deviation. From the results of regression, it was found that the selected independent variables (credit risk, liquidity risk, interest rate risk, operating risk, capital adequacy and bank size) combined explain 32.9% of changes in performance of the banks. The overall model was also found to be statistically significant with a p<0.05. The study further revealed that individually, credit risk and interest rate risk are negatively statistically significant to financial performance while capital adequacy is positively and statistically significant to performance. The rest of the variables (liquidity risk, operating risk and bank size) had a statistically insignificant impact on performance. The study recommends the need for banks to come up with measures aimed at reducing credit risk as this will go a long way in improving their performance. The study further recommended the need for banks to enhance their capital adequacy and interest income as this will have a significant influence on financial performance.