Effect of Firm Characteristics on Non-performing Loans of Commercial Banks in Kenya

Abstract

The banking sector is crucial to the economic stability and growth of a country. In recent years, the rise of non-performing loans in commercial banks has become a significant concern in Kenya, posing threats to the financial system's stability. There is a pressing need to investigate the underlying factors influencing this surge, which can inform interventions and policies geared towards a more resilient banking environment. This study sought to ascertain the effects of specific firm characteristics, namely profitability, bank size, liquidity, and capital adequacy, on the level of NPLs in commercial banks in Kenya. The study was anchored on information asymmetry theory, financial intermediation theory, and trade-off theory. A quantitative research design was employed, leaning on secondary data spanning a period of five years (2018-2022). The data were sourced from the Central Bank of Kenya (CBK) and individual banks' annual reports. A total of 35 banks provided a complete data set and were utilized in the study. The research utilized descriptive statistics, correlation, and regression analysis techniques to establish patterns and relationships among the study variables. The study findings revealed that profitability and liquidity had a significant negative correlation with NPLs at (r= -0.326, p=000) and (r= -0.382, p=000) respectively. On the other hand, bank size and capital adequacy demonstrated a weaker correlation. The regression results shed further light on these relationships, with the model accounting for approximately 21.6% of the variation in NPLs. Profitability variable emerged as the most influential predictor (β = -1.286, p = 001), followed by liquidity (β = -0.320, p = 000). Bank size and capital adequacy displayed no significant impact on NPLs in the regression model. The study concludes that within the Kenyan context, a bank's profitability and liquidity play pivotal roles in determining the level of NPLs. Contrarily, metrics like bank size and capital adequacy were found to be less influential in predicting the quality of loan portfolios, underlining the unique dynamics of the Kenyan banking landscape. The study recommends that institutions and policymakers are advised to emphasize strategies that enhance profitability and liquidity management given their pronounced influence on NPLs. Future studies could expand on the scope, incorporating additional determinants like governance, technological adoption, and customer relations. A broader longitudinal analysis covering extended periods might also offer richer insights into NPL cyclic trends