The impact of liberalization on the financial performance of the Kenyan banking industry.

Abstract

Financial Sector reforms in Kenya began in 1989, as a continuation of structural adjustment programmes sponsored by the International Monetary Fund and World Bank. Prior to liberalization, the financial system was highly repressed, with heavy government intervention in the banking sector through credit and interest rate controls. Financial sector reforms led to the removal of credit ceilings and interest rate controls and opened the banking system to new competition. A sound banking system is necessary for the conduct of monetary policy and for the operation of the payment system. The financial system facilitates and encourages intermediation by mobilizing the transfer of funds between lenders and borrowers transmitted through money and capital markets and indirectly through financial institutions. The study presents a methodology which can be used to measure financial performance of the Kenyan commercial banks. The study focused on profitability ratios and the findings of the study indicate that counting market perception, the profitability of the Kenyan commercial banks has been low with an average ROA far below 2 (Yo in most cases .The results further indicate that smaller banks in peer-group four continued to be less profitable compared to bigger banks in peer-group one. In addition the study established that government owned banks recorded the lowest profitability in terms of ROA and ROE during the study period. Operating expenses continues to undermine the profits of the banks and that foreign owned banks were more efficient in the utilization of resources thereby posting the lowest managerial efficiency ratio. The study however. could not solely attribute the poor performance of the commercial banks to the implementation of the financial liberalization programme, but rather to the weak management of the financial sector and inadequate supervision and regulatory mechanism together with an inconsistent macroeconomic framework. The study examines, the effect of financial sector reforms on bank profitability as measured by capital adequacy, asset quality, earnings, liquidity and managerial efficiency ratios. The evidence in this study show that some signs of financial repression still exist, although some positive developments have taken place. The results show that, financial liberalization has not significantly increased financial performance of the banking industry. Furthermore it revealed the existence of excess liquidity in the local banking industry due to low demand for loans by individuals and businesses and scarcity of profitable investment opportunities. Government owned banks were found to be less profitable compared to private banks. - The study finds a significant positive relationship .between management quality and commercial bank profitability. The study recognizes the dualistic nature of the financial system in Kenya and proposes as a policy recommendation the linkages of the formal banking system with the informal components of the financial sector as one way of enhancing financial intermediation and encouraging optimal sectoral credit allocation in order to promote economic growth. Various policy implications are drawn from the results of the study. The study recommends government divestiture in Kenya commercial bank, national bank of Kenya, Industrial Development Bank, Consolidated Bank of Kenya and the recapitalization of Co-operative bank. The study also recommends that to solve the excess liquidity, the government should refrain from giving large amounts of money to the development banks through CBK and instead should be encouraged to mobilize their own funds at the prevailing market price.