The Effect of Capital Adequacy on the Financial Performance of Commercial Banks in Kenya

67 Pages·2017·0.72 MB·English

THE EFFECT OF CAPITAL ADEQUACY ON THE FINANCIAL
PERFORMANCE OF COMMERCIAL BANKS IN KENYA

BY
BONIFACE KIOKO MUSYOKA

A RESEARCH PROJECT SUBMITTED IN PARTIAL
FULFILLMENT OF THE REQUIREMENTS FOR THE AWARD
OF THE DEGREE OF MASTERS OF BUSINESS
ADMINISTRATION, SCHOOL OF BUSINESS, UNIVERSITY OF
NAIROBI

2017
DECLARATION
I hereby declare that this is my original work and has not been presented in any other
university or college for examination purpose.
Signature: …………………………… Date: ……………………………
Boniface Kioko Musyoka
D61/84044/2015

This project is presented for examination with our approval as university supervisors.
Signature: …………………………… Date: ……………………………
Dr. Winnie Nyamute
Lecturer, Department of Finance and Accounting
School of Business
University of Nairobi

Signature: …………………………… Date:…………………
Mr. Patrick Kiragu
Lecturer, Department of Finance and Accounting
School of Business
University of Nairobi

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ACKNOWLEDGEMENT
I wish to thank the Almighty God for the gift of life and good health to undertake and
complete the MBA programme. My most sincere acknowledgements goes to my
dedicated supervisors: DR. Winnie Nyamute and Mr. Patrick Kiragu for their
patience, constructive criticisms and guidance throughout the project.
My sincere gratitude to the commercial banks in Kenya for provision of necessary
data used in the completion of this study. I am most grateful to all writers referenced
on this document for providing me with important information to put together this
research project. I would like to thank my classmates for their kindness, friendship
and support.

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DEDICATION
This research project is dedicated to my parents and my brothers. You took upon
yourselves to encourage and support me spiritually, emotionally and materially.

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TABLE OF CONTENTS
DECLARATION ......................................................................................................... ii
ACKNOWLEDGEMENT ........................................................................................ iii
DEDICATION ............................................................................................................ iv
TABLE OF CONTENTS ............................................................................................ v
LIST OF TABLES ................................................................................................... viii
LIST OF FIGURES .................................................................................................... ix
ABBREVIATIONS AND ACRONYMS ................................................................... x
ABSTRACT ................................................................................................................ xi
CHAPTER ONE: INTRODUCTION ........................................................................ 1
1.1 Background of the Study ...................................................................................... 1
1.1.1 Capital Adequacy .......................................................................................... 2
1.1.2 Financial Performance .................................................................................. 3
1.1.3 Capital Adequacy and Financial Performance .............................................. 5
1.1.4 Commercial Banks in Kenya ........................................................................ 6
1.2 Research Problem ................................................................................................ 7
1.3 Research Objectives ............................................................................................. 9
1.4 Value of the Study ................................................................................................ 9
1.4.1 Value to Theories .......................................................................................... 9
1.4.2 Value to Practice ......................................................................................... 10
1.4.3 Value to Policy ............................................................................................ 10
CHAPTER TWO: LITERATURE REVIEW ........................................................ 11
2.1 Introduction ........................................................................................................ 11
2.2 Review of Theories ............................................................................................ 11
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2.2.1 The Theory of the Market Power ................................................................ 11
2.2.2 Buffer Theory of Capital Adequacy ............................................................ 12
2.2.3 The Trade-off Theory of Capital Structure ................................................. 13
2.3 Determinants of Financial Performance for Commercial Banks ....................... 14
2.3.1 Capital Adequacy ........................................................................................ 14
2.3.2 Asset Quality ............................................................................................... 15
2.3.3 Management Quality ................................................................................... 16
2.3.4 Liquidity ...................................................................................................... 17
2.3.5 Size of the Bank .......................................................................................... 18
2.4 Empirical Literature Review .............................................................................. 19
2.5 Conceptual Framework ...................................................................................... 23
2.6 Summary of Literature Review .......................................................................... 24
CHAPTER THREE: RESEARCH METHODOLOGY ........................................ 25
3.1 Introduction ........................................................................................................ 25
3.2 Research Design ................................................................................................. 25
3.3 Population and Sample ....................................................................................... 25
3.4 Data Collection .................................................................................................. 25
3.5 Data Analysis and Reporting ............................................................................. 26
3.5.1 Diagnostic Test ........................................................................................... 27
3.5.2 Test of Significance .................................................................................... 27
CHAPTER FOUR: DATA ANALYSIS, RESULTS AND DISCUSSION .......... 28
4.1 Introduction ........................................................................................................ 28
4.2 Descriptive Statistics .......................................................................................... 28
4.3 Correlation Analysis .......................................................................................... 29
4.4 Regression Analysis ........................................................................................... 30
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4.4.1 Model Summary .......................................................................................... 30
4.4.2 Analysis of Variance ................................................................................... 31
4.4.3 Regression Coefficients .............................................................................. 32
4.5 Interpretation of the Findings ............................................................................. 33
CHAPTERFIVE:SUMMARY,CONCLUSION AND RECOMMENDATIONS 35
5.1 Introduction ........................................................................................................ 35
5.2 Summary ............................................................................................................ 35
5.3 Conclusions ........................................................................................................ 36
5.4 Recommendations .............................................................................................. 37
5.5 Limitations of the Study ..................................................................................... 38
5.6 Suggestion for Further Research ........................................................................ 39
REFERENCES .......................................................................................................... 40
APPENDICES ............................................................................................................ 47
Appendix I: List of Commercial Banks in Kenya at 31 December 2016 ................ 47
Appendix II: Research Data ..................................................................................... 49

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LIST OF TABLES
Table 4.1 Descriptive Statistics .................................................................................... 28
Table 4.2 Correlations .................................................................................................. 29
Table 4.3 Model Summary ........................................................................................... 30
Table 4.4 Analysis of Variance .................................................................................... 31
Table 4.5 Coefficients .................................................................................................. 32

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LIST OF FIGURES
Figure 2.1 Conceptual Framework ............................................................................... 23

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ABBREVIATIONS AND ACRONYMS
BCBS Basel Committee on Banking Supervision
CAMEL Capital adequacy, Asset quality, Management quality, Earnings and
Profitability and Liquidity
CAR Capital Adequacy Ratio
CBK Central Bank of Kenya
GLS Generalized Least Squares
ICAAP Internal Capital Adequacy Assessment Process
NIM Net Interest Margin
NPL Non-performing loans
NSE Nairobi Stock Exchange
ROA Return on Assets

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