Determinants of profitability of Islamic Financial Institutions in Kenya

Abstract

Compared with their conventional counterparts, majority of the Islamic financial institutions do encounter challenges with their profitability. Such challenges are characterized by a relatively higher proportion of operating expenses relative to their net income. Hence, the motivation of this study is to seek and establish the determinants of profitability of these Islamic financial institutions in Kenya. The study adopted descriptive survey design targeting 7 Islamic financial institutions in Kenya. Census was used and thus all the 7 firms were covered. Primary and secondary data was collected covering a period of 2010-2019. Descriptive statistics covering means and standard deviations helped to summarize the data. For drawing of relevant inferences, factor analysis was used. The study noted that majority of the Islamic financial institutions are posting financial losses and this is attributed to the following six factors: firm specific factors; regulatory factors & competition; size, religiosity & regulations; nature of market; investment framework; and tax regime against zakat. The study concluded that firm specific factors had the largest contribution towards profitability of the Islamic financial institutions while tax regime had the least effect. The study recommended that policy makers at the Central Bank of Kenya should establish regulations and guidelines for Islamic financial institutions that are separate from the other conversional institutions. In designing investment regulations and policies, the Capital Market Authority (CMA) should consider the fact that interest (riba) is forbidden Islamic financial institutions. The Kenya Revenue Authority should give special consideration to these Islamic financial institutions in regard to taxation since they pay Zakat (which is compulsory) besides the normal tax that is paid to the government resulting into an incident of double taxation of their incomes. The various practitioners including Islamic banking scholars should establish a lobby for representation on the boards of the regulatory bodies in the financial sector in Kenya. The senior management team of the Islamic financial institutions should capitalize on firms’ specific factors to enhance profitability of their institutions. The management of the Islamic financial institutions should work to improve on their firm specific factors like the level of management efficiency and the amount of Nonperforming loans. The study was limited to a smaller sample size of 7 firms which were the Islamic financial institutions. The study recommended further studies to be undertaken focusing on the variables covered but in relation to financial performance unlike profitability.