Firm Characteristics and Financial Intermediation Efficiency of Deposit Taking Saving and Credit Co-operative Societies in Kenya

Abstract

There has been growing concerns over the financial soundness of a number of SACCOs with a few having collapsed in the recent past. Empirical evidence indicates that there exists a strong association between efficiency and stability of financial institutions and that efficient banking sector is better able to withstand negative shocks incase of financial crises. Recent developments in the subsector may point to intermediation inefficiency; this includes a sustained increase in SACCO lending rates accompanied by a loss of customer base. The study first sought to evaluate the financial intermediation efficiency of DTSs and subsequently determine the relationship between firm characteristics and efficiency. Specifically, the relationship between capital adequacy, asset quality, liquidity, diversification, profitability & size and financial intermediation efficiency was assessed. A balanced panel data for 103 DTSs over the period 2011-2014 was collected and analyzed using a two staged methodology. In the first stage, efficiency scores were generated using data envelopment analysis (DEA). DEA Computer Program Version 2.1 was used to generate the efficiency scores. The results showed that on average, there had been a sustained increase in intermediation efficiency over the years from a low of 0.646 in year 2011 to a high of 0.707 in 2014. This was attributed to regulatory compliance indicating that as more and more DTSs met regulatory requirements, they improved in their financial intermediation efficiency. Over the period; the scale efficiency was higher than pure technical efficiency implying that inefficiencies were due to managerial underperformance rather than suboptimal size. Malmquist total factor Productivity Index (MPI) was used to assess the changes in productivity over the period. The results indicated that, technical efficiency increased by 5.7% which could largely be attributed to increase in pure technical efficiency by 3.8% and increase in scale efficiency by 1.5%. In the second stage, firm characteristics were regressed on the efficiency scores using fixed effects panel regression model. The bias corrected efficiency score were used instead of conventional DEA scores and xx incorporated into EViews version 8 and STATA for regression analysis. The study used forward selection approach to select the most significant measure for each independent variable. The study revealed an insignificant relationship between capital adequacy, liquidity and financial intermediation efficiency. This was attributed to the fact that most DTSs maintained the minimum ratio set by the regulator. This effectively rendered capital adequacy and liquidity non firm specific. In case of asset quality, the relation was found to be direct implying that as the asset quality improves, efficiency of a DTS increases. Diversification was found to be hurting efficiency. As non-interest income increases, the level of efficiency was found to decline. More profitable DTSs were found to be more efficient indicating that profitability is efficiency enhancing. The results also revealed a positive relationship between size and efficiency. The study recommends that managers and policy makers should concentrate on how to improve the managerial efficiency and also increase the size of SACCOs. Policy framework should also be directed towards encouraging DTSs to consolidate their operations and limit their diversification into non-interest income. Additionally, sufficient resources should be directed towards improving quality of asset held by SACCOs through increased monitoring of the credit process.