The determinants of banks profitability: the case of Commercial Banks in Kenya

Abstract

A large portion of Kenyan financial institutions revenue is generated from credit extended to various individuals and organizations. This revenue is in the form of interest earned and charges on the preparation and management of the credit process. Interest rates therefore form an integral part of a commercial bank's determinants of profit. Other sources of income for banks are service charges and commissions, income on foreign exchange dealings among others. It is nevertheless important for commercial banks to manage their non-interest revenues so as to provide diversification and greater ability for its profits. Not much is known about factors that determine profitability for unquoted commercial banks in Kenya. Thus, an explicit analysis of the determinants of quoted and unquoted commercial banks profitability in Kenya was necessary. This study was to fill this gap and is an attempt to answer the questions: "What factors determine profitability of the Kenyan commercial banks? Do the factors differ between the quoted and unquoted commercial banks?" The study's objectives were to determine the factors that affect profitability of quoted and unquoted commercial banks in Kenya, the extent to which these factors affect profitability and profitability performance between the quoted and unquoted commercial banks. This study was based on a sample of thirty-six commercial banks. Seven were quoted on the Nairobi Stock Exchange (NSE) and twenty-nine were unquoted. The period of study spans seven years from 1998 to 2004. Secondary data from the financial statements of individual commercial banks on the profit before taxation, interest income from loans and advances to customers, interest expense on customers' deposits, non-interest income, non-interest expenses, provision for bad and doubtful debts, loans and advances to customers net of provision for doubtful, customers' deposits, non-performing loans, market share in percentage measured by total deposits, total assets net of loans and advances to customers, shareholders' funds, liquid assets and loans to deposits ratios were used. Using Statistical Package for Social Sciences (SPSS), multiple regression analysis was set out between Profitability as the dependent variable and the independent variables on all the banks combined, quoted and unquoted commercial banks separately.

The study found out that the most critical variables affecting commercial banks profitability are nonperforming loans and advances, loans and advances to customers net of provision for doubtful, interest expense on customers' deposits, interest income from loans and advances to customers, operating expenses, customers' deposits, provision for bad and doubtful debts, shareholders funds, loans to deposits ratio and total assets net of loans and advances to customers. Among the quoted banks, provision for bad and doubtful debts, non-performing loans and advances, loans and advances to customers net of provision for doubtful and customers' deposits were the variables that affected profitability significantly. In the unquoted banks, operating expenses, non-performing loans, provision for bad and doubtful debts, shareholders funds, market share and loans and advances to customers net of provision for doubtful were the variables that affected profitability significantly.