The Relationship Between Liquidity Risk and Financial Performance of Commercial Banks in Kenya

Abstract

Liquidity risk is considered as one of the serious concern and challenge for the modern era banks. A bank having good asset quality, strong earnings and sufficient capital may fail if it is not maintaining adequate liquidity. Towards this end, the research sought to establish the relationship between liquidity risk and financial performance of commercial banks in Kenya. The study adopted correlation research design where data was retrieved from the balance sheets, income statements and notes of 33 Kenyan banks during 2008-2012. Multiple regressions was applied to assess the impact of liquidity risk on banks’ profitability. The findings of the study were that profitability of the commercial bank in Kenya is negatively affected due to increase in the liquidity gap and leverage. With a significant liquidity gap, the banks may have to borrow from the repo market even at a higher rate thereby pushing up the cost of banks. The level of customer deposit was also found to positively affect the bank’s profitability and it will therefore be encouraged for banks to open more branches in the country. The period studied in this paper is 2008-2012, due to availability of the data. However, the sample period does not impair the findings since the sample includes 14 banks, which constitute the main part of the Kenyan banking system. Only profitability was considered in the study and there is need to consider other variables such as the economic condition prevailing in a given period.