Financial Distress And Profitability Of Tier Three Commercial Banks In Kenya

ABSTRACT

The financial system in Kenya has seen tremendous growth over the years. This growth has spurred growth in all the other sectors in the economy enabling Kenya’s economy to emerge as East Africa’s largest economy. The growth in the financial sector has been driven by the innovation and dynamism of the banking sector. As compared to the other banks in the region, Kenya’s banking sector shows significant depth, diversity, and sophistication. Despite the impressive growth, dynamism, sophistication and depth, the banking sector in Kenya has faced numerous challenges. The most significant challenge facing this sector in the recent past is financial distress. During the period 2015 - 2016 three commercial banks faced financial distress which resulted in financial closure. Amongst the banks were Dubai bank which was closed in August 2015, Imperial bank which collapsed in October 2015 and Chase bank which closed down in April 2016. Of the three commercial banks that faced financial distress, two are in the tier three category of commercial banks. These closures point to the susceptibility of this category to financial distress. This study aimed at analysing the effect of financial distress on the profitability of tier three commercial banks in Kenya. The specific objectives of the study were to establish the effect of non-performing loans on the profitability of tier three commercial banks in Kenya; to determine the effect of liquidity on the profitability of tier three commercial banks in Kenya; and to evaluate the effect of leverage on the profitability of commercial banks in Kenya. The study was anchored on the financial accelerator theory, capital irrelevance theory, and Keynesian theory of money. The study sampled twenty commercial banks and used the casual research design. The study used secondary data collected from the audited financial statements and reports published by the individual commercial banks and the Central Bank of Kenya. The study estimated a multiple regression linear model. The study established that non-performing loans have a negative and statistically significant effect on the financial performance of tier three commercial banks in Kenya. The study found that leverage had a positive and statistically significant effect on the profitability of tier three commercial banks. The study determined that liquidity had a positive and statistically insignificant effect on the profitability of tier three commercial banks in Kenya. The study concluded that financial distress in tier three commercial banks is most likely to be caused by non-performing loans. The study recommends that tier three commercial banks should review their loan procedures and criteria in order to reduce the cases of default. The study also recommends that tier three commercial banks should increase the amount of leverage as leverage is positively associated with profitability. Further, the study recommends that the government should review the liquidity requirements of banks as the liquidity does not help in generating income.