The Effect of Financial Distress on Financial Performance of Commercial Banks in Kenya

Abstract

The Kenyan banking sector is one of the fastest rising in the economy today. It plays major roles in the country contributing immensely to the GDP of the country. However, there are also a number of challenges facing the industry. Financial distress is one of these challenges and if left unchecked it can lead to failure of the banks crippling the economy. Thus it is very important that this industry is carefully watched to ensure such occurrences are dealt with immediately to avoid negative consequences. This study therefore was designed to identify the impact of financial distress on commercial banks performance in Kenya. Due to the high number of banks that have collapsed in Kenya due to financial distress, there was need to establish or find out how financial distress affects the financial position of a bank. There have been numerous studies on ways of predicting financial distress but few on how it affects the financial performance of a firm. This study thus would be vital in helping banks establish if they are in distress and if so, how their performance is affected and how to rectify the situation. From a population of forty four banks, a sample of twenty two banks was selected. The sample included eleven listed banks at the NSE and eleven non listed banks. Data was obtained from the financial statements of the banks and the Central bank of Kenya. Altman’s Z score model was used to measure financial distress while return on assets ratio was used to measure financial performance. Data was then analyzed using Microsoft excel. Regression analysis was used to establish the effect of financial distress on financial performance. The period under study was from 2008 to 2012. The study found out that most of the banks under study had financial distress. The non listed banks suffered more from financial distress as compared to the listed banks. The study also showed that financial distress had a significant effect on financial performance of banks where performance was negatively affected. A rise in financial distress led to a decrease in financial performance and vice versa. The study established the need to reduce financial distress by ensuring financial stability in banks to ensure shareholders confidence.