The effect of liquidity and solvency on the profitability of commercial banks in Kenya

Abstract

The primary function of banks is to convert liquid deposits (liabilities) to illiquid assets such as loans which make them inherently vulnerable to liquidity risk. Lack of liquidity in bank‟s statement of financial position is an indicator of a liquidity crisis in a banking system. On the other hand, illiquidity, unless remedied, will give rise to insolvency and eventually bankruptcy as the business‟s liabilities exceed its assets. The fact that it is impossible for banks to survive without making profits cannot be overemphasised. This study sought to examine the effect of liquidity and solvency on the profitability of Commercial Banks in Kenya. The study used a descriptive research design. The population of this study comprised the entire population of all the 43 Commercial Banks in Kenya (Appendix 1) and 42 out of the 43 Commercial Banks formed the sample. Five year secondary data was collected from 2010 to 2014 for the banks from their annual reports. Data was analysed using descriptive, correlation and regression analyses. The regression results showed that the model explained 42.4% of the variance in bank performance. The ANOVA results showed that the model was statistically significant at 1% level of significance. The study found that both liquidity and solvency had negative but insignificant effects on the performance of banks in Kenya. Further, the study found that asset quality had a negative but insignificant effect on bank performance while growth had a positive but insignificant effect on the bank performance in Kenya. The results showed that bank size had a positive and significant effect on bank performance. The study concludes that the performance of Commercial Banks in Kenya is not influenced by both liquidity and solvency. The study recommends that the management of Commercial Banks in Kenya should take note of the fact that while the liquidity and solvency levels of banks were not found to influence bank performance, it is important to keep them at manageable levels in relation to the industry. The study also recommends that bank managers should take note of the fact that the size of the banks influences their performance. As such, Commercial Banks should strive to have higher asset base in the industry in order to record better performance in terms of profitability. The study further recommends that since growth in bank revenues may have a positive impact on the performance of banks in Kenya, banks should focus on improving their revenue sources in order to record better performance