RELATIONSHIP BETWEEN ECONOMIC RISK AND FINANCIAL, PERFORMANCE OF COMMERCIAL BANKS IN KENYA

Abstract

Financial institutions play a key role in spurring the growth of the economy. Commercial banks operate in a highly volatile environment which threatens their ability to achieve their desired goals. The purpose of this study was to establish the relationship between economic risk and the financial performance of commercial banks in Kenya. The study was anchored on agency and prospect theories. Longitudinal and cross-sectional research design was used. The study population was 42 commercial banks in Kenya. 32 purposively sampled commercial banks which had audited financial accounts for the years 2016 to 2021 were included in the study. Secondary panel data collected using an extraction tool validated by experts from banks and academia was analyzed using R statistical software version 4.3.2. Reliability of the data was ensured by using audited financial reports. Descriptive and inferential data analysis techniques were used. Inferential statistics used were linear mixed effects multiple regression allowing random effects to vary by banks. The study findings showed that economic risk significantly influence financial performance with high liquidity and credit risks associated with lower ROE (beta; -10.36; 95% Confidence Interval (CI): ( -18.45 to -2.27), p-value: 0.012) and (beta: -0.29; 95% CI (-0.46 to -0.13), p-value: 0.001.)The study concluded that there is a statistically significant relationship between economic risk and financial performance of commercial banks in Kenya. Based on the findings from this study, it is recommended that commercial banks may adopt a holistic approach to risk management by emphasizing economic risks. This study may significantly benefit the government, CBK and the commercial bank management in Kenya to inform policy framework as well as the academia and researchers as far as economic risk and financial performance of commercial banks is concerned.