The relationship between inflation and financial performance of commercial banks in Kenya

Abstract

Inflation is a sustained rise in the general level of prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services; consequently, inflation is also erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. Financial performance is how well a firm can use assets from its primary mode of business and generate revenues. This term is also used as a general measure of a firm's overall financial health over a given period of time. Line items such as revenue from operations, operating income or cash flow from operations can be used, as well as total unit sales. The objective of this study is to establish the relationship between inflation and financial performance of commercial banks in Kenya. Secondary data was used for the study. The data that is inflation rates and financial performance (profits assets and cash flows) was collected from banks‘ annual reports for all the 44 commercial banks for the 10 year period 2000-2009. Data analysis of the relationship between inflation and financial performance of commercial banks was done using correlation coefficient and coefficient of determination to establish the nature and the strength of relationship while the test of significance was undertaken to analyze the magnitude of the relationship. The analysis of quantitative data was carried out using SPSS version17 (statistical package for social Science) and presented in form of tables, graphs and pie charts while contextual data was analyzed qualitatively. On the relationship between inflation and financial performance, profits indicate a negative relationship. As inflation decrease, profits increase. The relationship between inflation and total assets indicate no clear pattern therefore a weak relationship. The total cash flows do not indicate a clear pattern in relation to inflation indicating a weak relationship. In conclusion, banks profits have the strongest clear pattern in relation to inflation indicating that profits increase as inflation decreases. This means that the independent variable, inflation, has a significant association with the dependent variable, financial performance.