EFFECTS OF FINANCIAL REGULATIONS ON THE FINANCIAL PERFORMANCE OF COMMERCIAL BANKS IN KENYA.
A PROPOSAL SUBMITTED TO THE DEPARTMENT OF COMMERCE AND ECONOMICS IN THE SCHOOL FOR HUMAN RESOURCE DEVELOPMENT IN PARTIAL FULFILMENT FOR THE AWARD OF THE DEGREE OF MASTER OF BUSINESS ADMINISTRATION OF THE JOMO KENYATTA UNIVERSITY OF AGRICULTURE AND TECHNOLOGY
DECLARATIONThis research proposal is my Original work and has not been presented for a degree in any other university
Signature: …………………………… Date: ……………………………
This proposal has been submitted for examination with my approval as the university supervisor
Signature ………………………… Date: ……………………………
Dr. Joshua Matanda
DEDICATIONSTo my beloved dad John Ng’eny,
You laid a foundation upon which I build.
To my dear mum Emily Ng’eny,
You prayed and God opened the doors.
To my dear siblings- Allan and Gillian,
You encouraged me and lit my darkest moments.
Many of us have dreams or ambitions we hope to fulfill someday. My own to write a book to be read by masses might never have succeeded had it not for my Almighty God for giving me the love, wisdom, confidence and grace which has been sufficient for me throughout my education and this research.
I owe a lot of gratitude to my supervisor Dr. Joshua Matanda who has worked tirelessly and sacrificed her time from commencement to denouncement of my research. I note with appreciation all my lectures who tutored me in all my coursework. I thank all my friends who believed in me and encouraged me to keep on going.
God made it all.
Table of Contents
TOC o “1-3” h z u DECLARATION PAGEREF _Toc526852473 h iDEDICATIONS PAGEREF _Toc526852474 h iiACKNOWLEDGEMENT PAGEREF _Toc526852475 h iiiLIST OF FIGURES PAGEREF _Toc526852476 h vLIST OF ABBREVIATIONS AND ACRONYMS PAGEREF _Toc526852477 h viABSTRACT PAGEREF _Toc526852478 h viiiCHAPTER ONE: INTRODUCTION PAGEREF _Toc526852479 h 11.1 Background of the Study PAGEREF _Toc526852480 h 11.1.1 Global Perspective PAGEREF _Toc526852481 h 21.1.2 Regional Perspective PAGEREF _Toc526852482 h 31.1.3 Local Perspective PAGEREF _Toc526852483 h 41.1.4 Commercial Banks in Kenya PAGEREF _Toc526852484 h 51.2 Statement of the Problem PAGEREF _Toc526852485 h 71.3 Objective of the study PAGEREF _Toc526852486 h 91.3.1 General Objective of the Study PAGEREF _Toc526852487 h 91.3.2 Specific Objectives of the Study PAGEREF _Toc526852488 h 91.4 Research Questions PAGEREF _Toc526852489 h 91.5 Significance of the Study PAGEREF _Toc526852490 h 101.5.1 Banking sector PAGEREF _Toc526852491 h 101.5.2 Government PAGEREF _Toc526852492 h 101.5.3 Policy Makers PAGEREF _Toc526852493 h 101.5.4 Researchers and Academician PAGEREF _Toc526852494 h 111.6 Scope of the Study PAGEREF _Toc526852495 h 11CHAPTER TWO: LITERATURE REVIEW PAGEREF _Toc526852496 h 112.1 Introduction PAGEREF _Toc526852497 h 112.2 Theoretical Framework PAGEREF _Toc526852498 h 122.2.1 Agency theory PAGEREF _Toc526852499 h 122.2.2 Liquidity theory PAGEREF _Toc526852500 h 132.2.3 Financial Reporting Quality view (FRQ) PAGEREF _Toc526852501 h 142.2.4 Foreign exchange exposure theory PAGEREF _Toc526852502 h 152.3 Conceptual framework PAGEREF _Toc526852503 h 162.3.1 Capital adequacy PAGEREF _Toc526852504 h 172.3.2 Interest rates limits PAGEREF _Toc526852505 h 192.3.3 Foreign exchange exposure PAGEREF _Toc526852506 h 212.3.4 Financial reporting and disclosure PAGEREF _Toc526852507 h 222.4 Empirical review PAGEREF _Toc526852508 h 232.5 Critique of Existing Literature PAGEREF _Toc526852509 h 282.6 Research Gaps PAGEREF _Toc526852510 h 292.7 Summary PAGEREF _Toc526852511 h 31CHAPTER THREE: RESEARCH METHODOLOGY PAGEREF _Toc526852512 h 323.1 Introduction PAGEREF _Toc526852513 h 323.2 Research design PAGEREF _Toc526852514 h 333.3 Target population PAGEREF _Toc526852515 h 333.4 Sampling frame PAGEREF _Toc526852516 h 333.5 Sample and sampling techniques PAGEREF _Toc526852517 h 333.6 Research instruments PAGEREF _Toc526852518 h 343.7 Data collection procedures PAGEREF _Toc526852519 h 343.8 Pilot testing PAGEREF _Toc526852520 h 343.9 Data analysis and presentation PAGEREF _Toc526852521 h 35REFERENCES PAGEREF _Toc526852522 h 36
LIST OF FIGURES
LIST OF ABBREVIATIONS AND ACRONYMS
FRQ Financial Reporting Quality
SPSS Statistical Package for Social Sciences
CBN Central Bank of Nigeria
CBK Central Bank of Kenya
CBR Central Bank Rate
KNBS The Kenya National Bureau of Statistics
IMF International Monetary Fund
M&A Mergers and Acquisitions
CAR Capital adequacy ratio
ROA Return on Assets
IFRS International Financial Reporting Standards
NSE Nairobi Security Exchange
CMA Capital Markets Authority
DTMs Deposit Taking Microfinance Institutions
RER Real Exchange Rate
NPL Non-performing loans
RWA Risk Weighted Assets
EBIT Earnings Before Interest and Tax
ABSTRACTThe general objective of this study is to establish the effects of financial regulations on the financial performance of commercial banks in Kenya. The investigation will be guided by the accompanying goals; to determine effect of capital adequacy on the financial performance of business banks in Kenya, to examine the effect of interest rates limits on the financial performance of commercial banks in Kenya, to find out the effect of foreign exchange exposure on the financial performance of commercial banks in Kenya, and to establish the effect of financial reporting and disclosure on the financial performance of commercial banks in Kenya. This study will be anchored on Agency theory, liquidity theory, financial reporting quality view (FRQ) and foreign exchange exposure theory. The population of the study will be the 43 licensed commercial banks in Kenya and the period of study will be between 2007 and 2017. Six years before the reviewed prudential guidelines for banks of 2013 came into effect and four years after. This will enable the study to analyse the effects of regulations on the financial performance of commercial banks under the current and former prudential guidelines. The study will adopt a descriptive research design. The study will use secondary data. Data will be collected from the Central Bank of Kenya, the financial statements of the commercial banks and from other sources where the banks’ books of accounts have been recorded. The test will be carried out on each of the independent variables. Multiple regression analysis will be used to establish the relations between the independent and dependent variables. Chi-square test of independence will be used to analyse the relationship between the two variables. Data will be analyzed using the Statistical Package for Social Sciences (SPSS Version 24.0)
CHAPTER ONE: INTRODUCTION1.1 Background of the StudyRecent economic crises have revealed that banks regulations are a form of hedging strategy that can be used to reduce the high risks that are normally attributed to fluctuations in the bank’s financial performance. In spite of that, excessive regulations may have adverse effects but on the other hand, it serves as a prudential measure that alleviates the effects of economic crisis on the stability of the banking system subsequent accompanying macroeconomic results. Excessive regulations, on the other hand, may result to increase in the cost of matching lenders to borrowers and thus reducing the profitability of the banking industry. As banks become more constrained, their ability to expand in terms of credit creation and there contribute to economic growth will be slowed down.
According to the micro-prudential and the macro-prudential theories, there is a correlation between regulations and financial performance in financial institutions. These theories state that regulations must be put in place and enforced even though this may cause a bank to shrink its assets or seek fresh capital from the stock market. The theories aim at achieving economic stability and protecting taxpayers’ interests. This may have the effect of slowing down the financial performance of commercial banks (Hanson et al, 2011).
Banks usually finance themselves using government-insured deposits. This helps the banks to shield themselves against banks runs but on the other hand, it created a moral hazard. The management will be geared towards undertaking risky projects since they know that the government will cover up for any losses. In order to safeguard the economy, banks are required to take immediate actions to restore their capital ratio if losses occur. Banks may resolve towards selling their assets in order to cover up for their losses. The economy of the country will be affected in the event where several banks decided to sell their assets at the same time. This, therefore, brings the need for regulations to control the activities of all banks and other financial institutions. The aim of regulations is to control the effects and reduce the impact of banks activities on the economy of the country.
In recent decades, we have experienced the collapse of both the banking and savings-and-loan industries, which has resulted in a huge cost burden to the taxpayers and the economy. The fact that this happened to heavily regulated industries, and never happens in the absence of regulations, raises a question as to whether regulation does more harm than good. In modern financial history, there have been just two cases in which entire industries suffered a wholesale collapse and those involved the banking and savings-and-loan industries in the 1980s and early 1990s.
The banking and savings-and-loan industries, which seems to be the most regulated industry experienced the highest form of instability even when the economic conditions of the country were deemed to be favorable. Although there is clearly a political consensus that regulation is necessary, researchers of the financial system should examine whether that consensus will survive in the absence of a compelling policy rationale. This study will therefore seeks to examine whether that consensus will survive in the absence of a compelling policy rationale through establish the effect of regulations on the financial performance and the extent to which the regulations will affect the financial performance of the banking sector.
1.1.1 Global PerspectiveThe growing divergence in regulatory standards is a reversal of previous post-crisis trends. Since 2009, banking regulators around the world have generally been committed to strengthening the capital, liquidity, and leverage standards for banks. Those efforts led to an equally strong commitment to address the unevenness and complexity of the global capital framework for internationally active banks, with regulatory convergence initiatives such as Basel III focus on resolution regimes setting the tone for an increasingly consistent banking rulebook in most jurisdictions.
Charles W. Calomiris, (2000) stated that the principal cause of bank instability was unit banking. This entailed laws and regulations that limited branch banking thus the geographical diversification of banks. The laws made financial institutions unduly subject to local economic conditions. Banks with fewer restrictions on diversification failed less often than banks that were confined to small geographical areas or that were unit banks that did not have authority to branch at all. In states that permitted branch banking, failure rates for branching banks were negligible less than 0.02 percent.
The Canadian economy and the U.S. economy are more or less similar in terms of economy and climatic conditions. However Canadian banks have never suffered any kinds of failures and panics in its banking industry as opposed to the United States that has suffered banks failure and panic over the last two centuries. The Canadian banking system is widely diversified. This therefore confirms the association between diversification and financial soundness in that diversifications has a positive impact on the financial soundness. On the other hand the failure and panic in the United States banking industry and instability of the economy at large is caused by weaknesses in the regulatory policies. This is because merely all businesses in the US suffered losses and some become insolvent but only the regulated depository institutions recorded simultaneous failure in wholesale number.
1.1.2 Regional PerspectiveThere was a period in Nigeria when the banking industry was operation in a free and unregulated setup. The establishment of banks was faced with a high rate of failure. This was because there were no regulations to guide the operations and activities of the banks. Most of the banks had little capital base that could not cover them against the effect of any shock that could arise in the ordinary course of their banking business. The emergence of the first Banking Law however did not bring to a stop the series of bank failure. In the year 1959, the Central Bank of Nigeria commenced its operations and brought banking examination and supervision under its umbrella.
The global financial crisis of 2008 is said to have affected the economy of Nigeria. The financial crash that later affected the Nigeria financial sector is said to have resulted from ripple effects of the global financial crisis. Anis Chowdbury stated that the financial and economic crisis of 2007 was the result of regulatory failure. He categorized financial regulation is in two categories, each with its distinct objective. The first was Economic Regulation which had control over interest rates and credit allocation. Its objective was to mitigate market failures in the allocation of resources. The second was prudential regulation, whose aim was to protect the stability of the financial system and to protect depositors.
The remote cause of the banking crisis in Nigeria was fraudulent acts in bank lending practice. Following the banking consolidation directive of the CBN that stipulated minimum paid-up share capital as twenty-five billion nairas, the banks increased their authorized share capital and sold shares in the primary market of the Nigerian Stock Exchange to raise funds in their effort to comply with the re-capitalization directive. This, coupled with poor risk management practices, ultimately led to a concentration of assets in margin lending. There was excess cash in the banking system and banks were increasingly under pressure to create risk assets. The excess cash in the banking system was used to induce and stimulate transactions in the stock exchange and the result was a bubble in the stock market.
1.1.3 Local PerspectiveFor the year ended 31st December 2016, CBK famous that 12 banks were in infringement of the Banking Act and CBK Prudential Rules by up to three times compared to four banks within the previous year. The increment within the number of banks in infringement was primarily with regard to encroachment of liquidity proportion necessity after Chase Bank was put into receivership. Agreeing to CBK, seven institutions were in infringement of the Banking Act and CBK Prudential Rule on Liquidity Administration, which needs institutions to have a least liquidity proportion of 20 percent.
After the little and medium-sized customers-centered Chase Bank was put into receivership on April 2016, certainty levels within the division dropped, activating freeze withdrawal of stores in little and medium-sized banks. In December 2016, the sector’s year-on-year client stores expanded by 5.3 percent to Sh2.62 trillion, with expansive banks taking the lion’s share of stores taking after the banking crisis.
For Family Bank, it ended the year with a fluidity proportion of 14.4 percent being 5.6 percent points underneath the CBK’s threshold, having misplaced Sh21.3 billion in deposit. This was activated by social media reports that the depository financial institution was about to fold after it was involved in the National Youth service scandal. The malevolent social media assault in November 2016 had an unfavorable effect on liquidity at the close of the year. Since then the bank has recouped completely taking after its declaration of its full-year results. Completely State-owned Advancement Bank of Kenya too saw its liquidity proportion recoil from 43.1 percent to 1.7 percent.
1.1.4 Commercial Banks in KenyaA commercial bank is a type of bank that provides services such as accepting deposits, offer loans and basic investment products. They are licensed and regulated pursuant to the provisions of the Banking Act and the Regulations and Prudential Guidelines. They are the dominant players in the Kenyan Banking system. There are 43 licensed commercial banks. Out of these, 40 commercial banks are Private where 3 are public financial institutions. (Central Bank of Kenya, 2013). Of the 40 private banks, 27 are local financial institution and 13 have foreign ownership and. Kenya’s commercial banks like any other organization are open systems operating in a turbulent environment. Their continued survival depends on the ability to secure a “fit” with the environment (Mohamed, 2016).
The Monthly Economic Review of November 2015 prepared by the CBK shows that the banking sector had grown in its financial performance. Gross loans grew from Ksh 1,948.4 to Ksh 2,260.2 billion between November 2014 and November 2015, representing 16 percent growth. The deposit base increased from Ksh 2,279.8 billion to Ksh 2,553.8 billion in the same period of time, representing 12 percent growth. Deposits were the main components of the balance sheet making up 70.4 percent of the total liabilities. Core capital increased from 402.5 billion to 460.3 billion while total capital increased from 473.2 billion to 552.1 billion in November 2015. Profitability grew by 14.4% in pretax profits from Ksh 20.1 billion to Ksh 23.0 billion in the period between February 2014 and February 2015.
On 20 March 2017, the Central Bank of Kenya (CBK) held the Central Bank Rate (CBR) rate at 10% in order to grapple winning vulnerabilities, for example, rising swelling and the effect of the loan fee tops on the viability of fiscal approach. The Banking (Amendment) Act, 2016, that came into power in September 2016, topped financing costs charged by loaning organizations to 4% over the overall CBR set by the CBK. The Act likewise set the base loan fee conceded on a store held in an enthusiasm procuring account in Kenya to something like 70% of the base rate. The usage of this Act prompted the development in the normal reserve funds rates given by business banks by 262% between August 2016 and October 2016 and an abatement in the normal loaning rates offered by business banks by 23% in a similar period.
The Kenya National Bureau of Statistics announced that expansion expanded from 7 percent in January 2017 to 9 percent in February 2017 by virtue of rising nourishment and power costs. Inflation averaged 6.3 percent in 2016 as a result of repressed oil costs, reduced power taxes and low nourishment costs because of enhanced precipitation. As indicated by the KNBS, the Kenya Shilling fortified by 0.1%, 16.7% and 3.1% against the United States Dollar, the Great British Pound and the Euro individually between December 2015 and December 2016. The International Monetary Fund (IMF) ascribes this to an expansion in remote money named capital inflows, increment in gathering tourism receipts and the vote by Great Britain to exit from the European Union which destabilized Western economies.
In 2016 the Kenyan banking sector experienced shifting degrees of basic and administrative choppiness. Following the receivership of Imperial Bank and Dubai Bank in 2015, the year began off with the fall of Chase Bank, a mid-tire lender, following liquidity challenges because of a bank run. This prompted credit tightening in the inter-bank market, with smaller banks bolted out. Furthermore, a large number of banking sector players kept on reporting decreased levels of benefit book quality. The banking sector income in the third quarter of 2016 showed moderate low profitability growth, for the most part owing to bigger misfortune provisioning occasioned by a stricter administrative condition with respect to non-performing resource acknowledgment and divulgence. The year ended with some movement in the mergers and acquisitions (M;A) field. SBM Holdings of Mauritius entered the Kenyan banking field with the securing of Fidelity Bank, and I;M Holdings purchased out Giro Commercial Bank in June 2016.
The vast majority of the extensive banks are very well capitalised, with only a few looking for Tier-2 financing to shore up their capital proportions and increase there lending capacity. There was no prominent value capital raising by the listed banking institutions at the end of 2016. A few banks raised Tier-2 capital. KCB Bank had before demonstrated an aim to raise KSh10 billion in Tier-1 capital through a rights issue to shore up its capital sufficiency proportions however has since retired these plans. To help boost its Tier-2 capital position, KCB got a capital infusion of KSh7.5 billion following chats with the International Finance Corporation in the final quarter of 2016.
1.2 Statement of the ProblemOver the last two decades of the twentieth century, nations worldwide have had to confront a phenomenal number of business bank disappointments. Therefore, consideration is swinging to the requirement for more suitable approaches to enhance the execution of national budgetary frameworks. For sure, a generous writing is as of now rising on the causes and outcomes of monetary for the most part saving money emergencies, and on different changes that may help avert future emergencies. The exceptional job that banks play in the financial framework infers that banks ought to be controlled and administered not exclusively to secure speculators and customers yet additionally to guarantee foundational solidness (Llewellyn, 1999). It is detectable that at whatever point regulation is actualized with the point of confining or constraining the banking sector. The banks’ lead of business and the proficiency with which they work will be influenced. This, thus, could actuate banks to participate in more dangerous exercises and/or to put resources into approaches which could influence financial development. (Jalilian et al., 2007). Progressively stringent banking regulations are changing how financial institutions work together. Today, the money related markets are more regulated than any time in recent memory. While expanded oversight has been important to reestablish and improve trust in the part, there is a barely recognizable difference between reestablishing trust and choking opportunity through high consistence costs, expanded capital prerequisites and unbalanced punishments
Implementing financial regulations is a major challenge for many countries but in the long run, they contribute to the strengthening of banking systems (Sinha, Kumar & Dhal 2011). Some aspects of regulation can be oriented towards these countries achieving their development objectives without having to sacrifice prudent regulation and financial sector stability considerations. Sinha et al. (2011) state that there is a lack of unanimity among economists on how relevant finance is to the growth of an economy. However, the financial crisis of 2008 proved that it is necessary to have a stable financial system as it will have a positive impact on equity and growth. Typically, one would expect regulations to improve efficiency and lower any risk of a financial crisis. Many critics have argued that regulations interfere with the efficiency of the market while those advocating for regulation. Sinha et al (2011) argued that if regulations are well designed and managed then they can make markets more efficient and equitable in terms of their outcomes. When we analyze the history of the banking sector in Kenya for example, we find that government interference has been present. This study will determine what effect it has had on the financial growth of the commercial banks.
KPMG prepared a report in 2014 based on a survey that had been conducted by Forbes Insights between June and July 2013 in the United States after the financial crisis of 2008 and they observed that financial institutions were finding it very difficult to comply with new regulations that had been imposed. The survey showed that there was a reduction in profits as a result of regulations. Chiarella et al. (2011) in a survey conducted by Mckinsey and Company observed that new regulation on corporate banking businesses in Europe had resulted in significant reductions in credit costs and profits had decreased remaining well below the 2007 peaks. Brownbridge (1996) conducted a study in Nigeria in which he investigated the effects of deregulation which had started in 1986. He concluded that it increased the financial fragility of even the well-managed banks. Vianney (2013) carried out a study in Rwanda. He observed that there was no relationship between regulations and the financial performance of commercial banks in Rwanda.
Previous related local studies include; Mureithi (2012) who did a study to establish the effect of financial regulation on financial performance of deposit-taking microfinance institutions in Kenya, Okwachi, (2008) who did a study to examine the effectiveness of state regulation of the insurance industry in Kenya, Mwega (2014) who carried out a case study in the Kenyan financial sector to investigate the potential tradeoff between regulation and stability of Kenya’s financial sector, Wakiriba (2014) who carried out a study on the effects of financial controls On Financial management In Kenya’s Public Sector: A Case Of National Government Departments In Mirangine Sub-County, Nyandarua County. The studies reviewed generally focused on regulations and financial performance of deposit-taking microfinance institutions, insurance companies, Kenyan financial sector and Kenya’s Public Sector.
Most of the studies done on the effects of financial regulations on the financial performance of commercial banks have concentrated in the developed countries. Most of the local studies generally focused on insurance sectors and microfinance institutions. Those that focused on the banking sector have majorly focused on the minimum capital requirement. Less has been done on interest rate limits, foreign exchange exposure and financial reporting and disclosure. Therefore this study seeks to establish the effect of financial regulations on the financial performance of commercial banks in Kenya.1.3 Objective of the study1.3.1 General Objective of the StudyThe general objective of this study is to determine the effects of financial regulations on the financial performance of commercial banks in Kenya.
1.3.2 Specific Objectives of the StudyThe study will be guided by the following objectives;
To determine the effect of capital adequacy on the financial performance of commercial banks in Kenya.
To examine the effect of interest rates limits on the financial performance of commercial banks in Kenya.
To find out the effect of foreign exchange exposure on the financial performance of commercial banks in Kenya.
To establish the effect of financial reporting and disclosure on the financial performance of commercial banks in Kenya.
1.4 Research QuestionsThe study will be guided by the following research questions;
How does capital adequacy on the financial performance of commercial banks in Kenya?
What is the effect of interest rates limits on the financial performance of commercial banks in Kenya?
To what extent does foreign exchange exposure affect the financial performance of commercial banks in Kenya?
What effect does financial reporting and disclosure have on the financial performance of commercial banks in Kenya?
1.5 Significance of the Study1.5.1 Banking sectorThe discoveries and suggestions of the investigation will help the Central bank of Kenya to think of the coveted administrative rules to administer the tasks and exercises of Commercial Banks in Kenya. It will likewise assist the CBK with improving the present controls in the business to coordinate the condition of the economy. The investigation will help the saving money area to increase understanding in the examples of the bank controls and its impacts on budgetary execution. This investigation will furnish Commercial banks with information of how to keep up and maintain monetary execution by following the standards of the business.
1.5.2 GovernmentFindings for this study will help the Government of Kenya in reforming banking regulation that pertains to the running of the banking industry. The study will provide solutions that will foster the attainment of the Kenya Vision 2030. The government will use this study to help the public and private sectors in policy implementation.
1.5.3 Policy MakersPolicy makers in private and public companies will use this study to explore opportunities that arise out of the effects of regulations on performance. The findings of this study will help in identifying gaps within the systems of financial controls in banking sector as well as give recommendations on how to address the issues and fill the gap. The findings will also aid the management and the regulators to streamline the systems of financial controls. Ultimately, the findings will ensure improved financial management and also attainment of the banking sector organizations’ objectives.
1.5.4 Researchers and AcademicianThe study will advance the literature on bank regulation and is a basis for further research. Very few research and studies have been done assessing the regulation of banks in Kenya. The findings will contribute to the professional extension of existing knowledge regarding financial controls and financial management, particularly in the banking sector. The study will generate knowledge to link financial controls and financial management which may guide policy makers in the planning for the public resources. The findings of the study will be helpful to all academicians in finance and accounting and other pertinent fields.
1.6 Scope of the StudyThis examination looks to set up the impacts of financial regulations on the financial performance of commercial banks in Kenya. The investigation will center on all the 43 enlisted business banks in Kenya. This will give a sufficient populace and test for the investigation and accordingly it will give solid outcomes and discoveries. The time of study will be somewhere in the range of 2007 and 2017. Six years previously the checked on prudential rules for banks of 2013 became effective and four years after. The investigation will be a completed in a time of three months.
CHAPTER TWO: LITERATURE REVIEW2.1 Introduction
The specific areas that will be covered under the literature review will be theoretical review, conceptual framework, empirical review, critique of existing literature, summary and research gap. The literature will be reviewed from journals, published books and related documents, periodicals, reports etc.
2.2 Theoretical FrameworkThis section will analyse the theories, assumptions and related studies which will be supported by data and evidences that will explain the phenomenon being studied. The sections will majorly look into the theories underpinning the study. The study will review the following theories; Agency theory, liquidity theory, financial reporting quality view (FRQ) and foreign exchange exposure theory.
2.2.1 Agency theoryAgency theory by Jensen and Meckling (1976), brings up that larger amounts of administrative proprietorship structure increases a ?rms execution because of a motivating force e?ect. Shlefer and Vishny 1986 and Zeckhauser and Pound 1990) recommended that huge outside proprietors have a task to carry out as screens of the administration and consequently improve execution. Then again, the private bene?ts writing (Barclay and Holderness 1989 and Bebchuk 1999) proposes that high proprietorship focus may prompt the extraction of the ?rm’s assets by the predominant proprietors to the detriment of different investors.
Agency theory manages two issues in agency relationship (Jensen and Mecling 1976). The first is the agency issue that emerges when the objectives of the principle and the agent are in struggle. The second is the point at which it is troublesome for the principle to check what the agent is doing. Principal-agent theory addresses issues of information asymmetry, which with regards to utility direction for the most part implies that the administrator find out about its capacities and exertion and about the utility market than does the controller. In this writing, the administration is the principle and the administrator is the specialist, regardless of whether the administrator is government possessed or exclusive.
In the general finance framework and in the bank regulations specifically, data asymmetry issues are greater than in different divisions. Howels and Bain (2004) expressed that the explanation behind bank control begins from the presence of asymmetric information the fact that clients of banks are less educated and along these lines more off guard about the issues of the banks than the bank itself. The government is keen on defeating data asymmetries with the administrator and in adjusting the administrator’s enthusiasm to the administration’s advantage, clients want security from market control when rivalry is non-existent or insufficient, administrators want insurance from opponents, or administrators want assurance from government advantage.
2.2.2 Liquidity theoryHolmstom and Tirole (1998) gave a hypothesis of liquidity in a model in which intermediaries have obtaining grindings. In their Model, an administration has favorable position over private markets since it can implement reimbursement of acquired assets while the private markets can’t. They demonstrate that the accessibility of government-povided liquidity prompts a Pareto change where there is total vulnerability. They additionally contend that the job of the legislature is accordingly to rectify any wasteful aspects emerging from externalities and private data and plausibility of concealed exchanges.
H.G. Moulton brings up the move capacity of banks liquidity. He expresses that if the business banks keep up a considerable measure of assets that can be moved on to alternate banks for trade without material misfortune, at that point there is no compelling reason to depend on developments. As per this view, for an asset to be perfectly moveable it must be instantly transferable without capital misfortune when the requirement for liquidity emerges. This is especially appropriate to short term market ventures, which can be promptly sold at whatever point it is important for the banks to raise funds.
The anticipated income theory was developed by H.V. Prochanow in 1944 on the basis of the practice of extending term loans by the US commercial banks. According to this theory, regardless of the nature and character of a borrower’s business, the bank plans the liquidation of the term-loan from the anticipated income of the borrower.
The liquidity management theory (1960) states that there is no need for banks to grant self- liquidating loans and keep liquid assets because they can borrow reserve money in the money market in case of need. A bank can acquire reserves by creating additional liabilities against itself from different sources. These sources include the issuing of time certificates of deposit, borrowing from other commercial banks, borrowing from the central banks, raising of capital funds by issuing shares, and by ploughing back of profits.
The real bills doctrine or the business credit hypothesis expresses that a business bank should progress only short term self-selling gainful advances to business firms. Self-exchanging credits are those which are intended to fund the creation, and development of merchandise through the progressive phases of generation, stockpiling, transportation, and circulation. The hypothesis expresses that when business banks make only short term self-exchanging gainful advances, then the central bank should just lend to the banks on the security of such short term loans. This guideline would guarantee the best possible level of liquidity for each bank and the correct cash supply for the entire economy.
2.2.3 Financial Reporting Quality view (FRQ)Jonas and Blanchet (2000), states that financial reporting is not only a final output; the quality of this process depends on each of its parts, including disclosure of the company’s transactions, information about the selection and application of accounting policies and knowledge of the judgments made. However, even though companies may generate financial statements in accordance with generally accepted accounting principles, these statements may present different levels of quality (Choi and Pae, 2011)
According to the leading authorities on the evaluation of financial reporting, (for example, the FASB, the SEC or the Jenkins panel), the primary attributes required are importance, unwavering quality, straightforwardness and clearness (Jonas and Blanchet, 2000; Lu et al., 2011). It has been declared that brilliant accounting information is a significant methods for neutralizing data asymmetry (Chen et al., 2011). Lambert et al. (2007) got experimental proof that the nature of accounting information can impact the expense of capital, both specifically, by influencing market members’ discernments about the circulation of future money streams, and in a roundabout way, by influencing genuine choices that modify the dissemination of future money streams. Chen et al. (2011) found that FRQ emphatically influences private firms’ speculation productivity in developing markets and that this impact upgrades bank financing and abatements impetuses to limit profit for assessment shirking purposes.
FRQ has been studied in various areas, and a few creators have alluded to its preferences, for example, its constructive outcomes from the financial perspective, by adding to lessening information hazard and improving liquidity (Lambert et al., 2007). Then again, data in budgetary articulations is especially essential under debt contracting (Costello and Wittenberg-Moerman, 2011). This exploration centers around building up the impact of financial related detailing and divulgence on the budgetary execution regarding benefit, liquidity and market share of the overall industry particularly for business banks in Kenya.
2.2.4 Foreign exchange exposure theoryAmong the risks inherent in international business operations, the exchange rate risk represents one of the important considerations for the managers of multinational companies. Foreign Exchange Exposure Management has become in increasingly important to companies operating internationally due to a series of recent exchange crises. Sizable fortunes have been made and lost due to the whimsical behavior of the foreign exchange markets.Among the risks inherent in international business operations, the exchange rate risk represents one of the important considerations for the managers of multinational companies. Foreign Exchange Exposure Management has become in increasingly important to companies operating internationally due to a series of recent exchange crises. Sizable fortunes have been made and lost due to the whimsical behavior of the foreign exchange markets.Among the risks inherent in international business operations, the exchange rate risk represents one of the important considerations for the managers of multinational companies. Foreign Exchange Exposure Management has become in increasingly important to companies operating internationally due to a series of recent exchange crises. Sizable fortunes have been made and lost due to the whimsical behavior of the foreign exchange markets.Among the risks inherent in international business operations, the exchange rate risk represents one of the important considerations for the managers of multinational companies. Foreign Exchange Exposure Management has become in increasingly important to companies operating internationally due to a series of recent exchange crises. Sizable fortunes have been made and lost due to the whimsical behavior of the foreign exchange markets. Among the risks inherent in international business operations, the exchange rate risk represents one of the important considerations for the managers of multinational companies. Foreign Exchange Exposure Management has become in increasingly important to companies operating internationally due to a series of recent exchange crises. Sizable fortunes have been made and lost due to the whimsical behavior of the foreign exchange markets.The measurement of a firm’s economic exposure to foreign exchange risk is the sensitivity of the firm’s economic value, or share price, to exchange rate changes. A firm’s financial exposure will depend on the extent to which financial hedges such as debt service on foreign currency debt and forward foreign exchange contracts reduce foreign exchange exposure. The firm’s total natural exposure will depend on the extent to which a devaluation is commensurate with foreign relative inflation and on the extent to which net foreign currency cash flows can be immediately and fully adjusted to inflation.
(L. A. Soenen 1979) destinations the exchange rate hazard as one of the dangers inborn in universal business tasks, which speaks to one of the imperative contemplations for the supervisors of multinational organizations. Remote Exchange Exposure Management has turned out to be progressively vital to organizations working globally because of a progression of ongoing trade emergencies. Sizable fortunes have been made and lost because of the unusual conduct of the outside trade markets.
Contemporary foreign exchange hypothesis (Buckley, 2000; Levi, 1996; Shapiro, 2003) is of the assessment that exchange rate variances should influence the estimation of a multinational organizations fundamentally by means of foreign deals and foreign (net) resources, which must be designated in the domestic money of the parent organization. In spite of that, the earliest experimental investigations on the theme (Levi, 2009; Amihud, 2009; Jorion, 2010.), despite the fact that it concentrates on organizations with impressive activities abroad, fail to demonstrate a huge effect of variances in return rates on the stock cost of multinational organizations.
Most resent examinations (Jongen et al., 2006; Gao, 2000; Bartov et al. 1996; Bodnar and Gentry, 1993), notwithstanding, are steadier with money related hypothesis and find that conversion scale developments, through their impact on sales and net resources esteems, are a critical factor in deciding firm esteem.
2.3 Conceptual framework
The conceptual framework is a schematic diagram representing the relationship between the dependent and independent variables. In this study, the dependent variable is the financial performance of commercial banks while the independent variables are Capital adequacy, Minimum capital requirement, Foreign exchange exposure and financial reporting and disclosure. This is displayed in the figure underneath.Capital adequacy
Interest rates limits
Foreign exchange exposure
Financial reporting and disclosure
Interest rates limits
Foreign exchange exposure
Financial reporting and disclosure
2.3.1 Capital adequacyThe Banking Act of 2013 gave the prudential rules that administer organizations authorized under the Banking Act. One of the prudential prerequisite is capital adequacy. Segment 18 of the Banking Act engages the Central Bank of Kenya to endorse the base proportions that will be kept up by organizations as between their core capital and aggregate capital from one perspective and their hazard weighted resources and off balance sheet items on the other, and for that reason, may likewise decide the strategy for classifying and assessing resources.
CBK reviewed the prudential rules for banks stipulated in the Banking Act of 2006. The new rules took effect on first of January 2013. Capital adequacy was evaluated under section 33 (4) of the Banking Act which offers specialist to the CBK to issue rules to be clung to by institutions to maintain a productive and stable saving money and budgetary framework. The reason for the rule is to guarantee that institutions keep up a level of capital that is sufficient to secure its investors and banks. The base core capital under the 2006 rule was 250 million shillings while under the 2013 rule it is 1 billion shillings.
The 2006 guideline provided that institutions shall at all times maintain a core capital to total risk weighted assets of not less than 8 per cent. It also stated that the core capital to total deposit liabilities ratio shall not be less than 8 per cent. It also stated that the total capital to total risk weighted assets shall not be less than 12 per cent. The 2013 guidelines state that institutions shall at all times maintain a minimum ratio of 8 per cent for core capital to total risk weighted assets ratio and core capital to total deposit liabilities ratio, and 12 percent for the total capital to total risk weighted assets ratio. In addition to this, institutions are required to hold a capital conservation buffer of 2.5 per cent over and above the minimum ratios. This buffer should consist of high quality capital which should mainly be made up of, premium reserves, retained earnings and common equity, (CBK, 2013).
At the point when the Central Bank confirms that an institution has deficient funding to shield against the dangers emerging from its group relationship, according to Section 18 of the Act and the Capital Adequacy Guideline, the Central Bank will require higher minimum capital proportions for the organization. Individuals from the banking group are required to keep up the capital sufficiency proportions endorsed by their particular controllers and ensure minimum capital necessities are conformed to on a solo and consolidated basis. In the event of any setback in the capital sufficiency proportion of any of the subsidiaries, the parent ought to keep up capital notwithstanding its own regulatory prerequisites to cover the deficit.
The ampleness of capital is determined based on capital sufficiency proportion. It is the measure of capital a bank or other money related establishment needs to hold as required by its budgetary controller. Capital ampleness proportion demonstrates the inward quality of the bank to withstand misfortunes amid emergency. Capital ampleness proportion is specifically corresponding to the flexibility of the bank to emergency circumstances. It has additionally an immediate impact on the productivity of banks by deciding its venture into unsafe however gainful endeavors or territories (Sangmi and Nazir, 2010).
For capital adequacy prerequisite, literature propels two contentions. From one viewpoint, capital sufficiency is viewed as an instrument constraining exorbitant hazard taking of bank proprietors with restricted obligation and, subsequently, advancing ideal hazard sharing between bank proprietors and contributors. Then again, capital sufficiency regulations is regularly seen as a support against indebtedness emergencies, constraining the expenses of money related trouble by decreasing the likelihood of bankruptcy of banks (Barrell et al., 2009; Miles et al., 2011; Caggiano and Calice. 2011).
As indicated by the 1988 Basel Accord, there were two primary objectives behind the adoption of the minimum base capital necessity for universally dynamic banks; first, higher capital would help fortify the soundness and solidness of the global banking framework by urging worldwide saving money associations to support their capital positions. Second, it’s trusted that higher capital would lessen aggressive disparities. What’s more, capital lessens restricted obligation driven motivating forces of bank investors to go out on a limb by expanding their potential misfortune if there should be an occurrence of bank disappointment (Holmstrom and Tirole, 1997; Perotti, 2011).
2.3.2 Interest rates limits
Interest rate is defined as the price a borrower pays for the use of money they borrow from a lender/financial institutions or fee paid on borrowed assets. They are expressed as a percentage rate over the period of one year. Interest rates reflect market information regarding the expected change in the purchasing power of money or future inflation.
Interest rate unpredictability is expected to influence monetary execution of business banks whose job in an economy is the financial asset distribution where they channel assets from contributors to speculators. In spite of the fact that it is hard to demonstrate the course of the connection between loan fees and productivity, loan fees precariousness has an impact on monetary execution of business Banks. High financing costs will prompt expanded business banks interest income yet additionally prompt low interest for the loans and subsequently swarming out the expanded interest income
Kenya has been portrayed by interest rate unpredictability over the last five years whose impact on business banks stays obscure. The shakiness on macroeconomic factors was seen in the year 2011 where loan fees rose to more than 30%, inflation rate to 13.97 percent contrasted with 3.9 percent in 2010 and Kenya shilling incredibly debilitated against real world monetary forms. Against the US dollar, the shilling found the middle value of 101.270 in October 2011 from 81.029 in January 2011.
The Banking Act Amendment of 2016 cleared path for interest rate capping which set limits on lending and deposit rates. It sets the most extreme loaning rate at close to four for each penny over the Central Bank base rate and the base financing cost conceded on a deposit held in interest earning account with business banks to something like 70% of a similar rate. In accordance with the Central Bank of Kenya (CBK) Act (Section 36(4), the CBK set the Central Bank Rate (CBR) as the base rate.
Since the initiation of the interest rate capping law in September 2016, the quantity of loan records declined fundamentally between October 2016 and June 2017, in this manner bringing about rising normal credit estimate by 36.7 percent over the period. The rising estimation of loan size against decreased quantity of loan records mirrored a lower access to small borrowers and bigger credits to more settled firms. Following interest rate caps, the income of the commercial banks moved their income sources in favour of non-interest income. The share on non-interest income remained at 12.4 percent in September 2016 yet it expanded slowly to 15.2 percent in June 2017. The move to non- interest income was seen across all the classifications of business banks.
Tier III (small size) banks recorded the biggest capital disintegration after interest capping. This was manly credited to decreased profit that affected on the ability to develop capital. Tier I banks (large size) kept up high capital develop levels. Tier II (medium size) banks seemed to have been influenced by unsteadiness in late 2015 and ‘new typical’ necessities. Profitability of the banking sector declined since the commencement of interest rate caps. The return on equity (ROE) contacted the most reduced level of 19.8 percent in February 2017 with return on assets (ROA) achieving the least level of 2.3 percent in January 2017.
2.3.3 Foreign exchange exposureSection 33(4) of the Banking Act, gives guidelines on foreign exchange exposure limits which enables the Central Bank of Kenya (CBK) to issue rules to be clung to by institutions with a specific end goal to keep up a steady and efficient banking and financial system. It characterizes foreign currency as a methods a cash other than legal tender of Kenya. It characterizes foreign trade business as office offered, business attempted or exchange executed with any individual including a foreign currency comprehensive of any account, credit expansion, loaning, issuance of certification, counter-assurance, buy or deal by methods for money, cheque, draft, exchange or some other instrument designated in an foreign currency.
The Banking Act places the following limits on each type of foreign exposure that business banks participate in; the overall foreign exchange risk exposure as estimated utilizing spot mid-rates and shorthand strategy will not surpass 10% of the organization’s core capital The foreign exchange hazard exposure in any single currency, regardless of short or long position, will be controlled by the individual establishment gave it stays within the general presentation point of confinement of 10% of its center capital. Intra-day foreign exchange hazard exposures, both in single monetary forms and generally speaking, will be kept up within reasonable points of confinement as built up by a bank’s top managerial staff in a composed strategy covering foreign trade chance risk exposure.
Among the factors that affect foreign exchange are; inflation rate, interest rate, public debt and political stability among others. If inflation rises in one country it can make their currency value fall with respect to currencies in other countries that do not experience the same increase in inflation. If interest rates are high in a certain country, it tends to increase the demand for their currency and increase the currency’s value. If the foreign nation decides to reduce interest rates, it can cause demand for the currency to fall resulting in a declining currency value. Countries with long-standing, stable governments are likely to enjoy relatively stable currency values. Nations with long-standing, stable governments are probably going to appreciate generally stable currency esteems. Then again, nations that experience political strife may encounter more prominent vacillations in the estimation of their currency. A nation with government obligation is more averse to gain foreign capital, leading to inflation. To oversee remote trade hazard, business banks need to receive supporting methodologies to moderate the hedging strategies. The supporting methodologies received are; forwards, futures options and swaps.
Any unhedged position in a specific currency gives rise to foreign exchange hazard and such a position is said to be vacant position in that specific currency. On the off chance that a bank has sold more foreign cash than it has bought, it is said to be net short in that money, on the other hand in the event that it has obtained more foreign cash than it has acquired than it is in net long position. Both of these positions are presented to chance as the foreign cash may fall in value when contrasted with neighborhood or home currency and turns into a purpose behind significant misfortune for the bank.
According to the statutory prerequisites, all the banks working in Kenya including business banks need to specify in the notes to money related articulations the net foreign cash presentation in Kenyan shillings. On the off chance that a bank has zero net foreign currency exposure, it implies it has the majority of its assets and liabilities supported and balance against different monetary forms or in a similar currency. It may be investigated either in respect to total assets or net assets of the bank, anyway it is more proper to dissect it with its comparability to net resources.
2.3.4 Financial reporting and disclosureSection 33(4) of the Banking Act requires all institutions licensed under the Banking Act to conform to the financial reporting and disclosure requirements. Amongst the requirements are; to present a statement of financial position and statement of comprehensive income, to publish Audited financial statements in a newspaper of nationwide circulation within three months of the end of every financial year and to publish quarterly un-audited financial statements in a newspaper of nationwide circulation. The institutions are also required to ensure continuous access to institutions’ financial statements and other disclosures by the public. In the event where an institution fails to comply with this guideline, the Central Bank may pursue any or all corrective actions as which include; prohibition from declaring or paying dividends, establishing new places of business, engaging in new activities or expanding existing activities and prohibition from declaring or paying bonuses, salary incentives, or other discretionary compensation to directors or officers.
Firms all over the world are currently facing a challenge to expand and enlarge their profits as well as to engage in social activities to improve the environment. Balancing the two major objectives raises concern about sustainability accounting especially in the face of the adoption of International Financial Reporting Standards (IFRS) which emphasizes a lot on disclosure. Sustainability accounting can be defined as the integration of reporting and accounting for social, environmental and economic issues in corporate reporting or simply the ‘Tipple bottom line reporting (Elkington, 2004).
A major concern to financial and social critiques is that most business and economic activities of firms often results in social, ecological and humanitarian problems. Firms are required to take care of these problems as well as contribute towards improving their environment. Firms are also often challenged to increase their shareholders stake which is often achieved through profiteering. In view of this, accounting, as well as financial scholars who advocate sustainability reporting, have argued that firms that have entrenched and availed the public of their sustainability activities have positive performance indices well and above those who have not integrated sustainability reporting.
2.4 Empirical reviewBerger and Bouwman (2013) carried out a study on how capital affects a bank’s performance (survival and market share), and how this effect varies across banking crises, market crises, and normal times that occurred in the U.S. The study found a direct association and considerable impact of capital adequacy on international bank profitability. They concluded that capital helps small banks to increase their probability of survival and market share at all time (banking crises, market crises, and normal times). Capital enhances the performance of medium and large banks during the banking crisis. Berger and Bouwman note that while operating at international level, banking regulators demand a high level of capital to make sure that the banks are more capable to take extra risks associated with global trading.
Ogboi and Unuafe (2013), carried out a study on the impact of capital adequacy on banks’ financial performance in Nigeria. Their research was based on a time series and cross-sectional data from 2004-2009 obtained from selected banks annual reports and accounts in Nigeria. Data for the study were obtained from the published financial statement of six out of twenty-one banks operating in Nigeria as of December 2009. Panel data model was used to estimate the relationship that exists among loan loss provisions (LLP), loans and advances (LA), non-performing loans (NPL), capital adequacy (CA) and return on asset (ROA). Results showed that capital adequacy influenced positively on the bank’s financial performance with the exception of loans and advances that was found to have a negative impact on banks’ profitability in the period under study.
Marion Nekesa Otwani (2017) carried out an investigation on the impact of capital adequacy on the financial performance of the companies listed on the Nairobi Securities Exchange in Kenya. The research design used in this study was mixed research designs in both qualitative and quantitative design. Secondary data was extracted from the NSE database, Capital Markets Authority (CMA) database, journals and other publications. Primary data was acquired through administering questionnaires and interviews. Data analysis was by descriptive statistics and inferential statistics. The study found out that capital adequacy contributes positively to the companies listed on the NSE in Kenya and therefore it is paramount for companies to have a sound capital base in order to remain competitive and maintain the confidence of its customers.
Tough Chinada (2015) carried out an investigation on the impact of minimum capital requirements on the performance of commercial banks in Zimbabwe and to analyze the relationship between minimum capital requirements and bank performance. The study used the triangulation of a quantitative and qualitative research design where both primary and secondary data were used. Questionnaires and documentary analysis were used. The study found out that Minimum capital requirement enable banks to make profits since meeting the minimum capital reduces the chances of bank distress as banks will not be pressured by short-term borrowing which is usually at a high cost. The study concluded that there is a positive relationship between a bank’s capital, its competitiveness as well as strength and the overall performance of the bank. The research findings indicated that a bank which is adequately capitalized will be more competitive as it has the ability to offer more products than its peers and this will result in a larger market share.
Samy Ben Naceur (2009) carried out an investigation on the Impact of Capital Requirements on Banks’ Cost of Intermediation and Performance: The Case of Egypt. The results provide a clear illustration of the effects of capital regulations on the cost of intermediation and banks’ profits. It concluded that the capital adequacy ratio internalizes the risk for shareholders, banks increase the cost of intermediation, which supports a higher return on assets and equity. These effects appear to increase progressively over time, starting in the period in which capital regulations are introduced and continuing two years after the implementation. Nonetheless, the evidence does not support the hypothesis of a sustained effect of capital regulations over time or variation in the effects with the size of capital across banks.
Rosymary J Murkomen (2013) carried out an investigation on the effects of capital requirements on operating efficiency of commercial banks in Kenya. The study found out that core capital to total risk weighted assets ratio has a strong positive relationship with operating efficiency of commercial banks in Kenya. Total capital to total risk-weighted assets and equity capital to total assets ratio have a negative relationship with efficiency. Therefore, banks need to build up the level of capital requirement ratios and more so on core capital to total risk-weighted assets ratio so as to be able to improve their operating efficiency.
Waseem Ahmad Khan (2014) carried out a study on the impact of interest rate changes on the profitability of four major commercial banks in Pakistan. The study carried out an examination on the financial statements of four major banks from 2008 to 2012. The study used Pearson correlation technique to analyze the findings. The study found out that there was a strong and positive correlation between interest rate and commercial banks profitability. The study recommended that; the state bank of Pakistan should play its significant role in regulating the interest spread. For the betterment of economy management of bank should concentrate on their profitability by charging lower interest rate and providing a handsome return to depositors. About the unexpected variation in the interest rate and capital adequacy ratio bank must take conscious steps.
Newman Enyioko (2012) carried out a study on the impact of interest rate policy and performance of deposit money banks in Nigeria. The study attempted to examine the performances of banks and macro-economic performance in Nigeria based on the interest rate policies of the banks. The study analyzed published audited accounts of twenty (20) out of twenty-five (25) banks that emerged from the consolidation exercise and data from the Central Banks of Nigeria (CBN). The study denoted the year 2004 as the pre-consolidation and 2005 and 2006 as post-consolidation periods for the analysis. The study found out that the interest rate policies had not improved the overall performances of banks significantly. The study concluded that banking the sector was becoming competitive and market forces were creating an atmosphere where many banks simply could not afford to have weak balance sheets and inadequate corporate governance. The study recommended that bank interest rate in the financial market must be market driven to allow for an efficient process.
Mburu Ngure (2014) carried out a study on the effect of interest rates on the financial performance of commercial banks in Kenya. The study used descriptive research design using secondary data obtained from Central Bank of Kenya for the period of five years from 2009 to 2013. The study found that interest rates have a significant positive effect on the financial performance of commercial banks in Kenya at 95% confidence level. The relationship between interest rates and financial performance was also found to be linear with increase in interest rates leading to higher profitability. The study also concluded that bank size and interest rate volatility had an effect on the profitability of commercial banks.
Aksu and Kosedag (2005) carried out a study on the relationship between transparency and disclosure and firm performance in the Istanbul stock exchange. The study was based on a sample of large capitalization and liquid ISE firms and their transparency and disclosure (T&D) scores. The study found out that the companies with higher scores, especially in the category of board and management structures, have higher returns and accounting measures of profitability. The firms that also use IFRS in the preparation of financial statements have higher T&D scores and commitment to better disclosure (CBD) scores. As such, IFRS adoption seems to be a credible signal of commitment to transparency and more accurate disclosure. Finally, the study found out that there is a stronger relationship between our parsimonious index of CBD scores and performance and a dummy variable for early IFRS adoption improves the weak relationship between TDS and performance measures.
Hossain, Mohammed, Peter J Taylor, (2007) carried out a study on the empirical evidence of the voluntary information disclosure in the annual reports of banking companies: The case of Bangladesh. The study set out to investigate the relationship between firm-specific characteristics and the extent of voluntary disclosure of a sample of banking companies in Bangladesh. The results indicated that size and audit firm were significant in determining the disclosure levels of the banks. The profitability variable was not significant. The results suggested that voluntary disclosure by banking companies in Bangladesh systematically differ depending upon the firm size and characteristics of its audit market (whether it is audited by Big Five audit firms or not) and thus discharging the corporate accountability to the various stakeholders of the society.
Mugo Naomi Wangari (2014) carried out a study on the effect of voluntary disclosure on the financial performance of commercial banks in Kenya. The study examined general and strategic disclosure, financial disclosure, forward-looking disclosure and social and board disclosure and how they affect the financial performance of commercial banks in Kenya. The study found a positive relationship between financial, forward-looking and board and social disclosure and return on equity. On the other hand, the study found a negative relationship between general & strategic disclosure and return on equity. The study concluded that firms should lean towards disclosure of financial and social and board disclosure to increase their performance.
Deniz Parlak (2016) carried out a study on foreign exchange risk and financial performance: The case of Turkey. The purpose of the study was to investigate the magnitude of foreign exchange open positions of manufacturing and service sector companies, to determine the effect of open positions on companies’ financial performance and to find out the factors that contribute to the firms’ tendency of keeping short foreign exchange position. The results demonstrated that the magnitude of foreign exchange risk was positively associated with liquidity, asset efficiency and negatively associated with total profitability. Firms with lower operating profitability relied on open positions and were able to recover their low profitability in times of currency undervaluation. However, profitability for such firms remained low in sub-periods of currency overvaluation compared to firms that carry long position.
Ani W.U (2013) carried out a study on the Effect of Foreign Exchange Reforms on Financial Deepening: Evidence from Nigeria. The time series data used to determine the effect of foreign exchange reforms on financial deepening were generated from the Central Bank of Nigeria statistical bulletin. According to Ani W.U the evidence from the non-spurious regression results suggest that foreign exchange reforms in Nigeria have not had the desired positive effect on the depth of the Nigerian financial sector. Generally, the findings suggest that reforms in the financial services sector generate tremendous financial booms and busts in the short-run, but these booms and busts have not intensified in the long-run.
Leyla Ahmed (2015) carried out a study on the Effect of Foreign Exchange Exposure on the Financial Performance of Commercial Banks in Kenya. The research used both secondary and primary data. The study utilized a descriptive design. Data were analyzed using Statistical Package for Social Sciences (SPSS). The study found that first; interest rates have an insignificant positive effect on commercial bank performance, secondly, foreign exchange exposure has a negative effect on the performance of listed commercial banks in Kenya and finally, inflation has a negative effect on bank performance. It is therefore concluded that foreign exchange affects banks, companies, imports and accounts payables and export sales and accounts receivables thus with the net effect on the Net Income of multinational companies through the income statement or the owners’ equity reserves.
2.5 Critique of Existing LiteraturePreviously, research has been conducted on regulations and performance of commercial banks in Kenya. Although various studies have been done on the effect of stand-alone components of banks financial regulations and its determinants on performance, none has looked at how these determinants of financial regulations affect the financial performance of commercial banks. This study, therefore, will seek to determine how various forms of financial regulations affect the financial performance of commercial banks in Kenya.
Mureithi, (2012) carried out an investigation on how financial regulations affected the financial performance of deposit-taking microfinance institutions in Kenya. The study found out that the regulations lead to an increase in the value of loans outstanding, total assets of DTMs, the profit and shareholders’ equity of DTMs. The study only focused on deposit-taking microfinance institutions in Kenya. This study will enlarge the scope by focusing on commercial banks in Kenya.
Nekesa, (2017) carried out an investigation on the impact of capital adequacy on the financial performance of the companies listed on the Nairobi Securities Exchange in Kenya. The study found out that capital adequacy contributed positively to the companies listed on the NSE in Kenya. The study focused on a capital adequacy of firms listed in the Nairobi Security Exchange. This study will expand its scope to include other forms of regulations which include; interest rate limits, financial reporting and disclosure and foreign exchange exposure. It will narrow down on its effects on commercial banks in Kenya.
Okwachi, (2008) carried out a study to examine the effectiveness of state regulation of the insurance industry in Kenya. The research found out that the state had succeeded to address Autonomy to a great extent and supervisory intervention to a significant extent. The research concentrated on the extent to which the state has succeeded in regulating the insurance industry in Kenya and establishing the factors that affect effective regulation of the insurance industry in Kenya. This study will analyze the effects of various forms of financial regulations and its effects on financial performance in the banking sector.
2.6 Research GapsThe banking industry in Kenya operates in a competitive but regulated setup. As a result, banks have to embrace different strategies to enhance their public presentation. Banks today find themselves increasingly challenged by having to manage unpredictable and continually changing regulatory environment. Forecast become unworkable and success is dependent on an ability to respond rapidly and flexibly to regulatory essentials to modify the organization in these new opportunities on a constant basis.
Exchange rate movement in Kenya has been quickly changing because of deterioration of the domestic currency of Kenya Shilling, which unfavorably influence the Kenyan economy. Despite the fact that reviews have been directed on the trade rates and the suggestions for macroeconomic administration and also overseeing foreign exchange risk, little been done on crafted by the firm defenselessness to trade risk in Kenya. For instance, Musyoki, Pokhariyal and Pundo (2012) examined the impact of real exchange rate excitability on economic growth of Kenyan. The study found that RER was very volatility for the whole study period and it reflected a negative impact on economic growth of Kenya. It is in this setting that this research will evaluate the effects exchange rate exposure has on the financial performance of the commercial banks in Kenya.
Performance of business banks has been fluctuating over the previous years. The literature survey has demonstrated that the estimation of bank performance especially business banks is well looked into and has gotten increased consideration over the previous years in Kenya as well as all over the world. In an examination led among worldwide banks, Berger and Bouwman (2013) found an immediate affiliation and significant effect of capital ampleness on universal bank productivity. Notwithstanding research contemplates being directed, there existed logical, reasonable, and methodological holes that have been seen from a few examinations. For example, kipruto, (2017) inspected the impact of capital ampleness proportion on the money related execution of second-level business banks in Kenya. The investigation was done on just second-level business banks, in this way, restricting the appropriateness of the exploration discoveries in level one and level three business banks. It is in this setting this examination will assess the impacts capital ampleness has on the monetary execution of the business banks in Kenya.
Firms all over the world are progressively being tested to develop and extend their monetary reportage to incorporate both those focused at profiteering and in addition social endeavors being made to enhance the environment. There has been an expansion of firm-particular research on the impact of consistence with high corporate administration models on the expense of capital and money related execution. Naemeka (2017) did an assessment on the impact of sustainability accounting on the financial performance of listed manufacturing firms in Nigeria. The investigation uncovered that manageability detailing had a positive and critical impact on the money related execution of firms considered. The examination concentrated on assembling firms in Nigeria consequently the exploration discoveries are not appropriate to the banking sector in Kenya.
The micro prudential regulation theory states that financial institutions are funded by government insured fund which presents a moral hazard problem for managers. The security provided by the government entices them to engage in risky investments. Micro prudential regulation ensures that the financial institutions are able to raise funds by either shrinking their assets or seeking fresh capital from the stock market to cater for the losses. The critique of this theory is that if a large number of financial institutions are in the same situation and they decide to shrink their assets at the same time, then this would have a negative impact on the economy. The macro prudential regulation theory does not rely on the existence of insured deposit. Regulators therefore, need to pay attention to all operations and activities through which financial institutions can cause damage, insured or not.
Studies have been done in different nations. In the developed nations in Europe and USA regulations have unfavorably influenced the money related execution of financial organizations. In Nigeria, the process of deregulation that started in 1986 led to an increase in the risk of financial fragility for even the well managed banks. In Rwanda there seems to be no relationship between the two variables while in Kenya regulations seem to be contributing positively to the financial performance of financial institutions according the case studies discussed above, in spite of the fact that the regulations may not be exceptionally strict in Kenya.
There is no literature that shows a concise relationship between regulations and growth in financial institutions. It is not clear whether regulations bring about growth in the financial sector or not. For instance, the American example shows a negative correlation between regulations and growth of financial institutions while in Kenya there seems to be a positive correlation between the two variables. This project seeks to clarify what the relationship is between financial regulations and the growth of financial institutions.
CHAPTER THREE: RESEARCH METHODOLOGY
3.1 IntroductionThis part displays the philosophy that will be received in the operationalization of the examination and accomplishment of the investigation goals. This segment of the examination recognizes the methods and procedures that will be utilized in the collection, preparing and investigation of information. In particular, the accompanying subsections will be incorporated;; research design, target population and sampling, data collection instruments, data collection procedures and finally data analysis.
3.2 Research designThis study will analyze the impact regulations have on the financial performance of commercial banks in Kenya. This study will therefore have a descriptive design. A descriptive design is concerned with determining the frequency with which something occurs or the relationship between variables (Sekaran, 2011). It will be analyzing the major bank regulations that have been introduced in Kenya in the recent years. It will explain what regulations these are and what effect they have had on the financial performance of the 43 commercial banks in Kenya. It will also explain why these regulations have the effect they do on the banks.
3.3 Target populationA target population is referred to as the specific group that data will be collected from (Touliatos & Compton, 1988). It is classified as all the members of a given group to which the investigation is related, whereas the accessible population is looked at in terms of those elements in the target population within the reach of the study. The population of interest is the 43 registered commercial banks in Kenya. The study will use secondary data.
3.4 Sampling frame
The examining outline depicts the rundown of all populace units from which the example is chosen (Cooper and Schindler, 2008). It is a physical portrayal of the objective populace and contains every one of the units that are potential individuals from an example (Kothari, 2008). All the 43 banks comprised the investigation test. A census design will be conducted where all the 43 business banks will be subjected to the investigation.
3.5 Sample and sampling techniquesThe study will use census as a means of sampling. A census is a collection of information from all units in the population or a complete enumeration of the population. A census design is used where the population is small and manageable (Mugenda & Mugenda, 2003). This type of sampling will be suitable because the entire population of study consist of 43 commercial banks. The study will therefore be carried out on the entire population since the population is small and manageable.
3.6 Research instrumentsSecondary data will be obtained from both audited and unaudited financial statements and from any other source where banks record and publish their accounts i.e. from the CBK reports and publications in the media.
3.7 Data collection proceduresThis examination will utilize auxiliary information. Information will be gathered from the Central Bank of Kenya, the evaluated and unaudited money related articulations of the business banks and from different sources where the banks’ books of records have been recorded. The information will be assembled and dissected utilizing both time series and cross sectional investigation.
3.8 Pilot testing
The reason for the pilot testing will be to set up the legitimacy and unwavering quality of the examination instrumentation and to upgrade confront legitimacy (Joppe, 2009). From the pilot results unwavering quality and legitimacy will be tried. Unwavering quality is the consistency of an arrangement of estimation things while legitimacy shows that the instrument is testing what it should. Dependability is the consistency of the estimation, or how much an instrument estimates a similar way each time it is utilized under a similar condition with similar subjects. It is the likelihood of your estimation. A measure is viewed as dependable if a man’s score on a similar test given twice is comparable. Unwavering quality isn’t estimated yet it is evaluated and does not imply validity because while a scale may be measuring something consistently, it may not necessarily be what it is supposed to be measuring. To guarantee that information legitimacy and dependability, information examined was acquired from Central Bank of Kenya productions.
3.9 Data analysis and presentationMultiple regression analysis will be utilized to set up the relations between the independent and dependent factors. Multiple regression tool will be utilized on the grounds that the strategy utilizes at least two autonomous factors to anticipate a reliant variable. The investigation will utilize various relapses examination to break down the gathered information to quantify the impact of budgetary controls on the money related execution of business banks in Kenya. Multiple regression attempts to decide if a gathering of factors together foresee a given ward variable (Babbie, 2010). Since there are four autonomous factors in this investigation the multiple regression model will be generally assume as the following equation;
Y= ?0 + ?1X1 + ?2X2 + ?3X3 + ?4X4 + ?
Y= Financial performance of Commercial Banks
?1, ?2, ?3 and ?4, = Beta coefficients
X1= Capital adequacy
X2= Interest rate limits
X3= Exchange rate exposure
X4= Financial reporting and disclosure
? = Error term
Ratio analysis will be used to analyze the independent variables. The ratios shall be computed as follows:
Core capital to total deposit liabilities = Core capital/total deposit liabilities x 100
Core capital to RWA = (Core capital/total risk weighted assets x 100) + 2.5%
Total capital to RWA = (Total capital/total risk weighted assets x 100) + 2.5%
The minimum core capital for each bank will be evaluated in addition to the above ratios. The mean for each year will then be established and a test of difference will be carried out. Mean will be calculated as follows:
The following investment ratios will also be used to determine the financial performance and they will be computed as follows:
Return on Equity = Net Income/ Shareholders Equity
Return on Assets = Net Income/Average Total Assets
Return on Capital ratio = Earnings before Interest and Tax/ Capital Employed
The mean will be established for each year and a test of difference will be carried out to determine if the changes in profitability are significant. The analysis of variance (ANOVA) will be used to test the significance of the overall model at 95% level of significance. Coefficient of correlation (R) will be used to determine the strength of the relationship between the dependent and independent variables. Coefficient of determination (R2) will also be used to show the percentage for which each independent variable and all independent variables combined will explain the change in the dependent variable. This analysis will be done using SPSS software and the findings presented using pie charts, graphs and tables.
REFERENCESCentral Bank of Kenya (2013). Prudential Guidelines for Institutions Licensed Under the Banking Act. 70-92
Central Bank of Kenya (2010). Bank Supervision Annual Report 2010, 38-45.
Central Bank of Kenya (2011). Bank Supervision Annual Report 2011, 53-62.
Central Bank of Kenya (2012). Bank Supervision Annual Report 2012, 65-74.
Central Bank of Kenya (2013). Bank Supervision Annual Report 2013, 68-78.
Central Bank of Kenya (2014). Bank Supervision Annual Report 2014, 57-67.
Central Bank of Kenya (2015). Bank Supervision Annual Report 2015, 50-60.
Barth, J. R., Caprio, G., ; Levine, R. (2002). Bank Regulation and Supervision: What Works Best? National Bureau of Economic Research Working Paper No. 9323, 1-10.