Effects of prudential regulations on financial performance of commercial banks in Kenya

Abstract

Prudential regulation forms a critical part of operations in the banking sector. The aim of the regulations is to protect investors and consumers and ensure systemic stability. Consequently, commercial banks are required to maintain adequate level of capital, liquidity, asset quality, credit risk and management efficiency. This implies that new regulations have a direct impact on financial performance of banks. In Kenya, the Central bank of Kenya implemented the prudential regulations in 2013. However, there is no consensus from existing studies whether the new regulations have a positive or negative influence on bank performance. The main objective of this study was to determine the effect of prudential regulations on the financial performance of commercial banks in Kenya. The specific objectives of the study investigated whether the prudential regulations had significant influence on the profitability of commercial banks using capital adequacy, liquidity management, asset quality, management efficiency and credit risk management as the independent variables while return on assets (ROA) was used as the indicators of profitability. The sample comprised of all 43 commercial banks operating in Kenya, with data for the period, 2013-2017 used. Data was extracted from annual financial reports of the banks and Central bank of Kenya (CBK) annual regulatory reports, which reduced the sample to 36 banks and used to compute derivative ratios. The study adopted a correlation research design and examined the relationship between the independent variables and performance. Multiple regression model was used to determine the linear relationship to examine the effect of the prudential regulations of profitability of commercial banks. The linear regression model was statistically significant (p=0.006), with positive autocorrelation in the panel variables. Liquidity management, credit risk management and management efficiency had significant effect on the financial performance of commercial banks while capital adequacy and asset quality have no significant effect on the performance of commercial banks in Kenya. Consequently, reject the second, fourth and fifth hypotheses that the variables have no significant effect on profitability. However, we fail to reject first and third hypotheses that capital adequacy and asset quality have no significant effect on bank performance. The research findings are useful to scholars and the different stakeholders, as they demonstrate the extent to which new prudential regulations influence the financial performance. The study recommends strict implementation of the regulation to improve banks financial performance and achieve banking industry stability and reduce the growing trend of insolvency among Kenyan banks.