The Effects of Capital Requirements on Operating Efficiency of Commercial Banks in Kenya

Abstract

The objective of this study was to analyze effects of capital requirements on operating efficiency of commercial banks in Kenya. The study was carried out over the period 2011-2015, taking advantage of the profound regulatory changes in capital requirements that occurred during this period to measure the exogenous impact of an increase in the capital ratios on banks‟ operating efficiency. The study adopted a descriptive research design. The population of interest in this study consisted of all 41 commercial banks operating in Kenya as at 31.12.2015. Data was analyzed using fixed effects regression model to attain the best regression equation. Statistical significance was checked by an F- test of the overall fit and t- tests of individual parameters. The study found that operating efficiency is positively related to core capital to total risk weighted assets ratio (tier 1 risk-based capital ratio). This implies that an increase in capital reduces the costs of financial distress, including bankruptcy. The study also establishes that there is a negative relationship between the equity capital to total assets ratio and operating efficiency. Therefore, the study provides evidence that supports the Central bank of Kenya‟s move to increase bank‟s core capital from Kshs.250 million to Kshs.1 billion.