Influence of Loan Portfolio on Financial Performance of Commercial Banks in Kenya

Abstract

Financial performance and its sustainability in commercial banks and its relationship with loan portfolio has remained a subject of interest to most scholars, Though non-performing loans in relation to financial performance of commercial banks has been evaluated by a number of scholars, a long lasting solution has not been identified yet. This study evaluates on how each loan component influences financial performance of commercial banks in Kenya. Commercial banks do lend to different sectors of the economy and are well known for spurring the economic growth, in the process the intention is to generate enough funds for their growth and for the benefit of the stakeholders. The bulk of lending is in the form of personal loans, for real estate development, to SMEs and insider lending, however the problem for most of these commercial banks is to determine of how much influence these loans have towards their financial performance, can a strong or weak financial performance be attributed to a loan portfolio?. For a strong and sustainable financial performance, banks depends so much on the quality of loan portfolio they hold at one particular time. The objectives of the study were to determine how the various types of loans contribute to financial performance ranging from personal loans, real estate loans, SME loans, and insider loans besides banks size as a moderating variable, a joint influence were established to determine whether the entire loan portfolio significantly influences the financial performance. Various theories were used to explain the independent and dependent variables used in the study that includes asymmetric information theory, lifecycle theory, multiple lending theory, modern portfolio theory and CAMEL model. The components that have been selected to represent the loan portfolio were measured in terms of loan deposit ratio, value of loans advanced, percentage of total loan portfolio, default rate, maturity period, and value of security and size of the loan. Financial performance was measured by the use of return on assets, return on equity and current ratio for liquidity purposes. Bank size as a moderating variable was measured by the use of market share and number of branches that is likely to conform to the tier classification system by Central Bank. A census of 42 commercial banks in Kenya was done for a period of ten years between 2006-2015. The study used an explanatory cross-sectional design and panel data design. Secondary data was collected from audited financial statements and other relevant financial sources using data analysis sheet. Inferential statistics that is correlation and regression were used with STATA version 14 used to analyze secondary data. Hypotheses H1, H2, H3 and H4 were examined using multiple regression analysis, which is a form of multivariate regression analysis. Hypothesis H5 was tested using Baron and Kenny’s steps for testing moderating effect. The results showed that personal loans, real estate loans, SME loans, and insider loans has an influence in the financial performance of commercial banks as evidenced by the P-values. When bank size as a moderating variable was introduced to the model, the predictability of the model improved signifying the moderating influence. Findings revealed that loan portfolio influenced the commercial banks’ financial performance in Kenya. Overall, there exist a strong influence of loan portfolio on ROA, ROE and current ratio. These influences are important at 5% level of significance. The Recommendations therefore are two fold, at managerial and policy level, Potential contracts, relationship lending and restructuring of loans involved in this loan portfolio stands out as areas that deserves much attention and should be taken into account to improve financial performance and on theoretical application, information theory will require ascertainment of additional information on loan borrowers in order to minimize on defaults associated with issuance of loans.