Capital adequacy,income diversification,competition and liquidity creation of Commercial Banks in Kenya

Banks create liquidity which in turn improves capital allocation and accelerates economic growth. Liquidity creation is essential and critical as it may lead to a stable financial system and provide growth opportunities. Liquidity has been observed to be more unstable in developing countries than in developed nations. Despite the rise in minimum deposits, commercial banks in Kenya, a developing country, struggle to optimize their profits due to reduced liquidity creation capacity. This study aimed to evaluate how capital adequacy, income diversification and competition impacted Kenyan commercial banks' ability to create liquidity. From 2001 to 2020, the study employed unbalanced panel data from Kenya's 36 licensed commercial banks. Data was extracted from published financial statements and reports from banks. The two-step system generalized method of moments approach was used in the study. To increase the robustness and prevent erroneous conclusions, cross dependence, serial correlation and instrumental validity tests were carried out. Berger and Bouwman's method was used to determine the liquidity creation levels of commercial banks. The capital adequacy liquidity creation link of commercial banks was found to be significantly negative, supporting the financial fragility-crowding out hypothesis. The study found a positive linkage between income diversification and liquidity creation of commercial banks, implying that well-diversified banks have a high level of liquidity creation and vice versa. The study also found a significant negative effect of competition on liquidity creation, depicting competition's value-destroying effect. A tradeoff exists between capital adequacy and liquidity creation, which must be carefully evaluated as changes in capital requirements are considered. Due to this tradeoff, there is a need for an optimal level of capital. The findings suggest that reinforcement of the diversification drive in Kenyan commercial banks is necessary. The value-destroying effect on liquidity creation by competition presented a case for policymakers geared toward consolidating banks' operations through possible mergers and acquisitions. The study has important implications for Kenya's financial sector, as it guides managers and other stakeholders regarding measures that can be taken to increase commercial banks' liquidity creation through capital requirements, diversification, and consolidation of banks