Effects of camel variables on bank efficiency: a panel analysis of Kenyan Commercial Banks

Abstract

Financial intermediation theory posits that information asymmetry arises in financial markets between borrowers and lenders because borrowers generally know more about their investment projects than lenders do. This intermediation function when carried out efficiently reflects a sound intermediation process and hence the banks’ due contribution to economic growth through offering more affordable banking services like loans and deposit taking at better interest rate margins. Our problem statement is informed by the changing structure of the banking industry that calls for the adoption of a broader based set of performance measures like the CAMEL framework that go beyond the traditional measurements like Return on Assets and Return on Equity. Further the impact of the market power and efficiency theories on whether profitability is determined by bank market power or bank efficiency also calls for us to go deeper and establish whether, based on market power, inefficient banks can simply translate their higher costs to higher prices and still earn positive profits or whether profitability is simply a result of efficiency. The objective of the study therefore, was to establish the effects of CAMEL variables on bank Efficiency as measured by the efficiency ratio of Kenyan commercial banks. The study adopted a panel data design and descriptive approach to meet its objectives. Annual financial statements of 37 Kenyan commercial banks from 2007 to 2011 were obtained from the CBK. The data comprising a sample of 185 study units was analyzed using multiple linear regressions method. Our findings suggest that Capital Adequacy, Earnings and Liquidity ratio have a negative relationship to efficiency ratio while Management quality and Asset Quality have a positive relationship. The policy implication therefore is that, banks and the regulatory authorities should find an optimal point on regulatory capital adequacy ratio and liquidity ratio whereby banks would not be holding on too much capital and liquidity without compromising on their efficiency. Further, the findings also indicate that banks should strive to be more efficient by managing their asset book well and invest in credit risk management systems and recruit and pay well, the best human resource to derive efficiency benefits.