Effect of bank capitalization on liquidity of commercial banks in Kenya

Abstract

The relationship between a bank’s capitalization and liquidity position has important implications for regulatory policies. This is because banks as financial markets’ outlet are regarded as one of the important chains in the economy in performing the resource distribution function which exposes it to liquidity risk arising from different terms of assets and liabilities maturity. This study sought to establish the effect of bank capitalization on the liquidity of Commercial banks in Kenya using the annual data of 42 banks for the period 2010 to 2014. The results of panel data regression reveal that bank size, capital asset ratio and the asset quality are positively related to bank liquidity and are all significantly related to bank liquidity. The implication is that better capitalized banks tend to create more liquidity, which supports the ‘financial fragility-crowding out’ hypothesis. This finding has important policy implications for emerging countries like Kenya as it suggests that bank capital requirements, that is, recapitalization policy, implemented to support financial stability, may enhance the level of liquidity. The financial regulatory body needs to provide appropriate effective measures to adequately enhance transparent accountability in the capitalization process. The study also recommends that bank capitalization should be encouraged in all commercial banks and other financial institutions so that performance can be enhanced. Institutions should endeavor to retain earnings to boost up capital rather than paying exorbitant bonuses. Well-capitalized Institutions have lower financial risk and thus are more likely to survive financial crisis thus, a well capitalized banking system will ensure financial stability and make the industry more resilient against external shocks and risk.