The Relationship Between Profitability and Capital Adequacy of Commercial Banks in Kenya

Abstract

This study set out to establish the relationship between profitability and capital adequacy of commercial banks in Kenya. The population of the study included all the licensed commercial banks in Kenya that have been in operation over the last 6 years from 2004 to 2009. The end year measures used for profitability were Return on Equity (ROE) and Return on Assets (ROA) while the end year measure for capital adequacy was Capital Asset Ratio (CAR). An empirical analysis was done and a regression model was used to establish whether the independent variables including CAR, have a significant relationship with the dependent variables, ROE and ROA. The regression model was then further modified and control variables included in the model to investigate further this relationship between the dependent and independent variables. The control variables included have been identified to have an effect on bank profitability and are credit risk, market power, operating efficiency, activity mix and size. The findings of the study indicated that there is an insignificant relationship between ROE and capital. Even with the inclusion of control variables, the relationship remained insignificant. On the other hand, the study found that there was a significant negative relationship between ROA and capital. On inclusion of control variables, the relationship between the two variables remained significant.