Effect of capital structure choice on financial performance of commercial banks in Kenya

Abstract

A firm‘s capital structure consists of both debt (bonds) and equity (stock) and has been an issue of great interest in the corporate finance literature. This is due to the fact that the mix of funds (leverage ratio) affects the cost and availability of capital thus, firms‘ investment source. Several theories from various scholars have been championed to explain the corporate capital phenomena but somehow all seem unreasonable in the real world. The most notable theory was that of Modigliani and Miller in the 1958‘s Capital irrelevancy paper, ―under the perfect capital market assumption that if there is no bankrupt cost and capital markets are frictionless, if without taxes, the firm‘s value is independent with the structure of the capital‖. It is from the arguments of this paper that the researcher decided to extend by examining the impact of capital structure choice on performance of commercial banks in Kenya, covering five years from 2009 to 2013 by utilizing data of banks from their annual financial reports. Multiple regression models was applied to estimate the relationship between the capital structure and banking performance. Performance was measured by returns on assets (ROA) and return on equity (ROE) while determinants of capital structure which also served as independent variables included reserve fund, long-term debt, short-term debt and customer deposits. The study revealed that amongst the determinants of capital structure, capital reserve and long-term debts had a strong positive relationship with ROE and ROA. Therefore, the researcher concluded that there is no specific and perfect structure that would apply for all the commercial banks in a uniform manner. This is because banks are at all-time at different levels of what they hold as customer deposits, short-term debt, long-term debt and total capital reserves.