The Effect of Financial Risk Management on the Financial Performance of Commercial Banks in Kenya

Abstract

In the last two decades, the financial risk management has gained an important role for financial institutions. Risk management is one of the most important practices to be used especially in banks in order to get higher returns. In today’s dynamic environment, nothing is constant but risk. Banks are exposed to a variety of risks including credit risk, liquidity risk, foreign exchange risk, market risk and interest rate risk. An efficient risk management system is the need of time. Managing risk is one of the basic tasks to be done, once it has been identified and known. The risk and return are directly related to each other, which means that increasing one will subsequently increase the other and vice versa. The purpose of this study was to analyze the effect of financial risk management on the financial performance of commercial banks in Kenya. In achieving this objective, the study assessed the current risk management practices of the commercial banks and linked them with the banks’ financial performance. Return on Assets (ROA) was averaged for five years (2008-2012) to proxy the banks’ financial performance. To assess the financial risk management practices, a self-administered survey questionnaire was used across the banks. The study used multiple regression analysis in the analysis of data and the findings were presented in the form of tables and regression equations. The study found out that majority of the Kenyan banks were practicing good financial risk management and as a result the financial risk management practices mentioned herein have a positive correlation to the financial performance of commercial banks in Kenya. Although there was a general understanding about risk and its management among the banks, the study recommends that banks should devise modern risk measurement techniques such as value at risk, simulation techniques and Risk-Adjusted Return on Capital. The study also recommends use of derivatives to mitigate financial risk as well as develop training courses tailored to the needs of banking personnel in risk management.