Relationship between core capital and profitability of commercial banks in Kenya

Abstract

Capital adequacy has been the focus of many studies and regulator as it is considered to be one of the main drivers of any financial institution’s profitability. In Kenya, the government, through the Central Bank of Kenya has put requirements that all commercial banks should gradually increase their capital base to one billion Kenya shillings from the current 250 million Kenya shillings by 2012. This means that the level of capital has some implication on the performance and bankruptcy of a bank. Profitability is the primary goal of all business ventures. Without profitability the business will not survive in the long-run. So measuring current and past profitability is very important. The objective of the study was to establish the relationship between Core Capital and profitability of commercial banks in Kenya. The nature of the data collected necessitated the use of empirical research design. Secondary data were collected from the banks’ annual reports and financial statements for the period 2001-2010 obtained from the banks supervision department of the Central bank of Kenya. The data was analyzed using descriptive statistics, regression and correlation analysis. From the findings of the study, it can be concluded that core capital is linearly related with profitability as measured using Return on Equity (ROE) across all the three tiers of banks, tier group one, tier group two and tier group three used in the study. The study has also concluded that core capital is not a major determinant of profitability (ROE) across all the three tiers of the banks which is supported by the weak values of both correlation coefficient and coefficient of determination analyzed using simple linear regression and correlation analysis. Based on the study findings, it is recommended that a number of the independent variables be included and a multiple linear regression model be used. Similar studies need to be done in non commercial banks operating in the Kenyan banking industry and the results be compared to establish whether the models are consistent among the various categories of the banks.