Fundamental Risk Factors and Profitability of Commercial Banks in Kenya

Abstract

Commercial banks are vital to the financial sector in any country more so in developing economies where capital markets are not well developed and strong. Commercial Banks’ profitability is important because the soundness of an industry is closely connected to soundness of the whole economy. Profitability of the banking sector is also central as the well-being of the industry is closely associated with the wellness of the whole economy in general. Thus, a proficient and productive banking sector is able and better placed to endure negative economic shocks. This study investigated the fundamental risk factors and profitability of Kenyan commercial banks. The study systematically reviewed past studies undertaken on the area of interest. Attention was given on the study findings and the methodology. Conclusions on the relationship that exist between the variables were drawn for the study from the findings of the past studies. Recommendations were made based on the study findings and conclusions. price level fluctuation had a significant positive effect on profitability of commercial banks in Kenya based on return on assets and net interest margin while an insignificant positive effect on return on equity. Exchange rate fluctuation had a significant negative effect on profitability of commercial banks in Kenya based on return on assets and an insignificant negative effect based on return on equity and net interest margin. Interest rate fluctuation on profitability of commercial banks in Kenya. The study found that interest rate fluctuation had a significant positive effect on profitability (return on assets, return on equity and net interest margin) of commercial banks in Kenya. The study recommends that the managers of commercial banks in Kenya should always be in the know of the prevailing economic conditions of the country and that of other countries which they have operational branches. The study found that exchange rate fluctuation is a major predictor of profitability of commercial banks in Kenya (based on return on assets). As such, the managers of commercial banks can engage in foreign exchange hedging practices where the fixed forward exchange rates can be used. The effect of interest rate fluctuation on profitability of commercial banks in Kenya was found to be significant for all the three measures. The study therefore recommends that in periods of high demand for loans, bank managers can take advantage of such periods by charging higher interest rates on loans, however moderately.