Firm Characteristics And Financial Stability Of Commercial Banks In Kenya

ABSTRACT

A stable banking sector is significant in ensuring economic growth as well as sound, efficient and stable financial system. However, the banking sector has been considered fragile and this is evident from the increasing trend of non-performing loans, fluctuating deposit trend of some commercial banks and increasing trend of foreign liabilities held by commercial banks in Kenya which is associated with financial stability. Furthermore the collapsing of commercial banks and some being put under receivership is of great concern to the financial stability of the commercial banks in Kenya. The Central Bank of Kenya (CBK) uses the CAMEL model whose firm characteristics namely, capital adequacy, asset quality, management efficiency, earnings/profitability and liquidity are used as measures of ascertaining the financial stability of commercial banks in Kenya. Despite the CBK‟s adoption of the CAMEL model, the banking sector in Kenya has been considered fragile. It is the need to investigate the link between firm characteristics and financial stability of commercial banks in Kenya, which triggered the desire to undertake this study. The general objective of the study was to establish the effect of firm characteristics on financial stability in commercial banks, Kenya. The specific objectives of the study were to determine the effect of operational efficiency, capital adequacy, bank liquidity, profitability and asset quality on financial stability of commercial banks in Kenya. Exchange rate was utilized to ascertain the moderating effect between firm characteristics and financial stability of commercial banks in Kenya. The study has been underpinned on Agency Theory and supported by Efficiency Structure Theory, Buffer Capital Theory, Liquidity Shiftability Theory and Information Asymmetry Theory. Causal research design was employed. The study was carried out in 17 fragile commercial banks in Kenya, between years 2011 to 2018.The study carried out normality test, panel unit root test, autocorrelation, heteroscedasticity test and multicollinearity test. Generalized Method of Moments (GMM) model guided by dynamic panel regression results revealed that operating efficiency had a statistically significant positive effect on financial stability of commercial banks in Kenya. Capital adequacy had a statistically significant negative effect on financial stability of commercial banks in Kenya. The study further revealed that bank liquidity had a statistically insignificant negative effect on financial stability of commercial bank in Kenya. In addition, profitability had a statistically significant negative effect on financial stability. Asset quality had a statistically significant positive effect on financial stability. Exchange rate had a statistically significant negative effect on the relationship between firm characteristics and financial stability of commercial banks in Kenya. The study concludes that firm characteristics namely operating efficiency, capital adequacy, profitability and asset quality are strongly linked to financial stability of commercial banks in Kenya. The study recommends for mergers and acquisition among the fragile commercial banks as per the fragility index, adoption of internal economics of scale, limits on insider loans to be established, credit to borrowers should not exceed 15% of the capital and adoption of unified exchange rate. This would ensure a sound and vibrant economy towards achieving the Vision 2030 that advocates for well-functioning, efficient and stable financial system.