Effect of Financial Distress Factors on Performance of Commercial Banks in Kenya

Abstract

Commercial banks have continued using various financial models for determining financial distress. However, commercial banks have not identified all the factors influencing financial performance and to which extent they influence financial performance of commercial banks in Kenya. This study focused on the effect of financial distress factors on financial performance for commercial banks regulated by Central Bank of Kenya (CBK) since they provide an important contribution to the economy. The study was prompted by the increased number of commercial banks in the recent past facing financial difficulties. These difficulties resulted into low returns to the investors and in some cases commercial banks put under statutory management thus threatening the wellbeing of the country’s economy. Research done relating to financial distress on performance do not show directly the effect of financial distress factors on financial performance of commercial banks. Specifically, the study sought to achieve the following objectives; whether liquidity has an effect on financial performance of commercial banks in Kenya, to establish whether leverage has an effect on financial performance of commercial banks in Kenya. To examine the extent to which operational efficiency has an effect on financial performance of commercial banks in Kenya, to establish the extent to which asset quality affects the performance of commercial banks in Kenya and the extent to which capital adequacy as a financial distress factor has an effect on financial performance of commercial banks in Kenya. The study adopted a descriptive research design where a census of 43 commercial banks regulated by CBK was carried out due to the small size of the units of analysis. Secondary data was used. Panel data was analyzed using STATA software version 13 or regression analysis and model specification tests. Correlation and multivariate panel regression approaches were used to test five hypotheses. Frequency tables were used to present the findings of the study. The study first sought to evaluate the financial distress factors in the performance of commercial banks in Kenya and subsequently determine the relationship between financial distress factors and financial performance of commercial banks. A balanced panel data for 43 out of the possible 44 commercial banks over the period 2005-2015 xxi was collected, banks with more than 10% missing data were expunged to remain with 38 commercial banks that were then analyzed using STATA. The study used confirmatory factor analysis approach to select the suitable latent variable. Financial distress factors were regressed on financial performance using panel regression models. Feasible Generalized Least Squares method, random effect for models and fixed effect based on Hausman specification test were used. The study revealed a significant relationship between liquidity, leverage, operational efficiency, asset quality and capital adequacy as financial distress factors on financial performance with operational efficiency being the most significant determinant of financial distress on financial performance of commercial banks in Kenya. The study recommends that managers and regulatory bodies should concentrate on how to improve financial performance of commercial banks and how to put proper controls to mitigate the effects of financial distress factors on financial performance. Regulatory bodies should ensure that there is routine revision of their policies for the purpose of ensuring a level playing field for all commercial banks regardless of their size. Further, constant monitoring by regulatory bodies should be in place.