Interest Rate Spread, Credit Risk, Bank Size, Ownership and Financial Performance of Commercial Banks in Kenya

Abstract

The country's commercial banks have been confronted with a plethora of difficulties that are connected to several essential FP data. Some of the problems that continue to plague the banking industry include expanding interest rate spreads (IRSs), declining asset quality, worries over capital sufficiency, and liquidity issues. This research investigates the links between credit risk and FP, and it considers the expected influence of the IRS as an ex-ante variable. Bank size and ownership were moderating factors in this investigation. The major objective of this study was to examine the links between IRS, credit risk, company size, ownership structure, and FP. The study used a positivist research ethic and used a longitudinal research approach to analyze data from 41 authorized financial institutions to determine correlations between variables. The investigation is based on secondary data, which was subjected to multiple regression analysis in STATA. Normality, multicollinearity, Heteroscedasticity, Stationarity, autocorrelation and Hausman tests were some of the diagnostic examinations carried out to assess the compliance of the model to the key regression assumptions. The study is built on six hypotheses. The first hypothesis postulated that interest rate spread does not affect credit risk and was rejected. The second theory proposed that credit risk had no bearing on financial results; this too was debunked. The third and fourth hypothesis state that bank ownership and size do not regulate the relationship between credit risk and financial performance. The assumption made in the sixth hypothesis, which was that IRS does not influence FP, was similarly disproved. In conclusion, the research came to the conclusion that size and ownership both have a considerable impact on FP. Further, it also confirmed that interest rate spread, credit risk, bank ownership, and size have a joint effect on FP. It recommends that policy makers and the regulators need to have a keen interest in the IRSs and develop credible and robust policy frameworks that will guide the determination of interest rates. The interest rate caps introduced in 2016 were blamed of being reactionary and therefore well-thought-out frameworks that are not necessarily restrictive would be helpful. In many Sub-Saharan Africa countries, the challenges of widening interest rates spreads persist, and the financial systems end up with discontented borrowers that are likely to default in credit repayments and this negatively impacts the bank returns. To reduce credit risk, commercial banks in conjunction with the regulator should be able to adopt or invest in very robust credit risk management systems that will help stem out the increasing levels of non-performing loans. Recovery and collections efforts that will help in the management and reduction of NPLs need to be in place and regulators should insist on more aggressive and stringent NPLs management policies and procedures if the banks’ financial performance is to be improved. Central bank of Kenya should also encourage mergers and consolidations to ensure that there are fewer but financially strong commercial banks which serves to strengthen the financial system. Ownership structure is also an important factor, and this study establishes that an ultra-expanded structure is beneficial in increasing a bank’s FP. The study contributed to the four theories including the loanable funds theory, modern portfolio theory, arbitrage portfolio theory and agency theory. The results of this research corroborate the connections proposed by the theoretical frameworks' central concepts, particularly with regard to the importance of interest rates in establishing the pricing of loans and, by extension, the amount of money that may be borrowed. The study provides a unique conceptual approach or model in examining the liaison between credit risk and FP. Ex-ante evaluation of IRS and credit risk and FP backed up with two moderating variables provides an enriched study which in not very common based on review of past studies. Areas that future research could consider include interrogating the impact of the additional stringent standards such as IFRS 9 or Basel II & III Accords. The impact of massive adoption of technology in banking operations presents an aspect that should be studied on how it has impacted on the main relationship. These additional dimensions to research would be very practical and beneficial not only to researchers but also to banks and policy makers.