The relationship between financing contracts and financial performance of Islamic banking in Kenya

Abstract

The objective of this research study was to establish whether a relationship exists between financing contracts and financial performance of Islamic banking in Kenya. The study targeted seven (7) commercial banks that operate Islamic banking in Kenya. It covered the period between 2010 and 2014. Specifically, the study sought to establish the relationship between Islamic financing contracts and banking financial performance. The return on Assets (ROA) was used to measure financial performance. The financing contracts discussed in the study include; Murabaha (cost plus mark up), Mudharaba (profit sharing), Musharaka (profit-loss sharing/joint venture), Ijara (leasing), and Tawaruq (reverse Murabaha). The data for this study was collected using questionnaires for primary data study and secondary data was obtained from the Central Bank of Kenya annual reports and individual bank statements for unlisted banks. Out of the seven banks targeted, six responded which represented a response rate of 85.7%. A regression analysis was performed. From the results it was noted that there is a relationship between the financing contracts and performance of Islamic banking. The key indicator supporting this theory is the p value being < 0.05. The analysis on the financing contracts produced a coefficient of determination of 85.9% which shows how well the model used fits the data available. This coefficient of determination also shows the percentage of variations in bank financial performance explained by financing contracts. Based on the summary of the findings, the study concluded that if Islamic banking is to have meaningful contribution to profits such banks should adopt a larger proportion of murabaha and musharaka in their financing portfolio. Given that the relationship of the model is positive, increasing proportion of financing contracts offered would affect a bank’s financial performance positively. Similarly, a decline would decrease a bank’s performance. The moderate relationship (moderate correlation) between financing contracts and financial performance implies that there are other factors which affect a bank’s financial performance and not only the financing contracts. The study recommended that banks offering Shariah compliant financial services should pay key attention to the contracts they offer and capitalize on those with greater yields. This would significantly improve financial performance.