Impact of Prudential Regulations on Technical Efficiency of Deposit Taking Cooperative Societies in Kenya

Abstract

Savings and Cooperative Societies (Saccos) continue to be a key player in the Kenyan financial sector with a total asset base of over 393 Billion shillings by the end of the year 2017. In recognition of its important role and impact on the financial sector, prudential regulations were introduced in 2010, calling for major reforms in the operations of Deposit Taking Saccos (DTS) if they were to continue offering Front Office Services. In their effort to comply, DTSs were forced to carry out radical changes in their structure and operations with significant effects on key aspects of their performance. Analysis of how the regulations have had effects on their efficiency is nonexistence despite its critical importance as a key determinant of the sustainability of DTS. To bridge this critical gap, this study sought to examine the impact of capital adequacy, liquidity, investment, and asset provisioning prudential regulations on the technical efficiency of DTS in Kenya. The effect of size as a moderator between compliance and technical efficiency was also tested. A balanced panel data for 95 Deposit Taking Sacco’s covering a period between 2011 and 2016 was taken through a two-stage data analysis process. In the first stage, Data Envelopment Analysis was used to estimate bias-corrected technical efficiency scores using total deposits, core capital, and labor cost as inputs while total loans and financial investments were used as outputs. In the second stage, two models were tested using fixed-effect estimation. Un-moderated model to assess the influence of compliance status on liquidity, capital adequacy, asset provisioning and investment regulations on biased corrected technical efficiency scores and a moderated model where size measures by total assets was tested for its moderating effect between DTS compliance with prudential requirements and biased corrected technical efficiency. Despite the persistent increase in deposits, capital, labor costs, loans, and investments of DTS over the six years reviewed in the study, the underlying technical efficiency remain relatively unchanged. The study revealed that compliance with liquidity, asset quality ratios did not influence the DTS technical efficiency indicating that maintaining a liquidity ratio greater than the recommended 15% and holding financial assets less than 5% of the total loan loss provision does not influence DTS allocative efficiency. Maintaining a ratio of core capital to total assets greater than 10% and holding more than 5% in non-government backed securities to total assets were found to significantly impede the efficiency of DTSs. Size measured by the total assets did not significantly moderate between compliance and the technical efficiency of DTS in Kenya. The study recommends strengthening of existing prudential regulations and ratios in the interest of promoting allocative efficiency the sector.