Performance and financial ratios of commercial banks in Kenya from 2006-2010

Abstract

The objective of this study is to identify factors, in a ratio form that shape bank performance as measured through return on assets (ROA) and return on equity (ROE). To predict performance, selected indicators are used. The predictor variables include liquidity, credit risk, capital adequacy, size and macroeconomic variables that included GDP, interest rate and inflation. The population for this study comprises all commercial banks in Kenya, 49 licensed commercial banks in Kenya as of 31st. December 2010; and the data for the period between 2006 and 2010. Regression analysis was used to test the relationships. The findings are that liquidity, capital adequacy and the size of the bank explained variations in performance over the period of study. Furthermore, large banks earn superior returns compared to small banks. As liquidity decreases in large (size) banks there is improvement in performance improves. This suggests that bank size is desirable and that size could act as a buffer for liquidity risk. Additionally large banks with adequate capital post superior return on assets. In conclusion, some banks in Kenya appear to be earning much higher returns than their counterparts despite being in same macroeconomic environment. There is therefore a need to study and explain variations in both ROA and ROE. In addition, large banks earnings are higher than that of small banks. The implication is that small banks should merge. In terms of capital adequacy, the Central Bank of Kenya should reset the levels to impact positively on bank performance. Finally, low correlations between the ratios used in this study and profitability suggest monopoly in the banking industry, i.e. a market where banks are too powerful and thus take advantage of their customers. Therefore, regulators should develop market power to discipline errant banks. In fact, given the public complaints about the commercial banks and in light of the findings in this study that there is no visible modeling of profitability within the banks there is a need to reorganize the banking sector.