The Effect of Real Estate Finance on Financial Performance of Commercial Banks Listed on the Nairobi Securities Exchange

Abstract

It is generally observed that commercial banks’ lending criteria are pro-cyclical in nature. This means that their lending criteria are not very strict in a real estate boom while during the bust they are very strict. As a result of this,commercial banks are more likely to underestimate the default risk of real estate loans during a real estate boom. Such a situation leads to real estate price inflation and this increases the banks’ credit risk exposure to the real estate. When there is a sharp drop in real estate prices, commercial banks that have a high proportion of real estate loans in their portfolios or loans to other financial institutions that specialize in real estate lending suddenly find themselves faced by a high exposure to real estate risk. This therefore affects their financial performance in a significant manner. As a result, the country's financial system becomes at risk and exposed. The study sought to evaluate the effects of real estate finance on the financial performance of listed commercial banks in Kenya. This study adopted a descriptive research design.The population of this study was all the 11 listed commercial banks in Kenya. For the purposes of this study, only secondary data was used. The secondary data was sourced from the annual reports that are available from their websites, the NSE and the Central bank of Kenya website. Data was collected for a period of 5 years from 2009-2013 since most of the other studies have used a similar period. Then, the study used descriptive statistics and inferential statistics to establish the relationship between the variables and financial performance of commercial. The results showed that the model explained 59% of the variance in financial performance as given by the value of R2. The model was also fit to explain the relationship as the F-statistic of 5.598 was significant at 5% level, p = 0.000. The major finding of the study was that mortgage finance had a strong negative effect on the financial performance of listed commercial banks in Kenya, β = -2.147, p = 0.054. Further, liquidity and cost of operations also had a strong effect on the financial performance of commercial banks. The study concludes that real estate finance influence the financial performance of listed commercial banks in Kenya. The study recommends that commercial banks be wary of the way mortgage financing affects their financial performance. The current levels of mortgage finance have not improved the financial performance of banks and it may therefore be necessary to examine how mortgage finance can be used to improve the financial performance of banks in Kenya.