Financial Performance of the Banking Sector :the Case of Kenyan Banks and Financial Institutions (1986 to 1990)

Abstract

This study sought to do

cument the financial performance of the banking sector for the period 1986 to 1990 and to develop a model to predict bank failure using financial ratios derived from annual published financial statements. Ratios cannot be evaluated in isolation and they carry some meaning only if related to some standard, hence the need for development of industrial or sector benchmarks. Return on assets (ROA) and return on equity (ROE) for the banking sector lS 2% and 24.9% respectively, these can be considered as the sector's performance benchmark or norm and can be used for comparative analysis with other sectors or industries. These norms were developed from a sample of 30 banks who have been in operation for at least 6 years prior to the period of interest (1986-1990).

The Kenya Banking authorities specify statutory ratios that must be complied with by the sector in an attempt to ensure that prudent management practices are employed 'but banks continue to fail. Bank failure is no doubt very costly to investors, depositors, and society at large and the benefits of being able to predict it before it occurs cannot be over emphasised. To develop a discriminant function a sample of 6 failed and 27 non­

failed (unmatched) banks were used. A set of 6 failed and 6 non­ failed (matched) was also considered in an attempt to control for ex)

difference in characteristic of size and age, but the results In the two sets (matched and unmatched) confirmed that financial ratios can perfectly discriminate between failed and non-failed banks. The discriminant functions developed showed that profi tabili ty and

liquidity ratios were the best in predicting failure. Each of the fourteen (14) ratios that were considered contributed to the discrimination function but the best ten (10) were net profit/total equity, net profit/total assets, quick ratio, current ratio, net profit/paid up or assigned capital, equity/total deposits, equity/total assets, equity/total loans, current ratio and asset growth rate. The other four ratios had insignificant contribution and were in fact excluded in the matched sample function. These were; total loan/total deposit, deposit growth rate, deposits/total liabilities and net loans/total assets.