Abstract
This study sought to establish the relationship between liquidity risk and failure of commercial banks in Kenya in the years 2013 to 2016. Additionally, the study endeavoured to establish the effect of capital adequacy, asset quality, management quality, earnings, sensitivity to market and size on the failure of banks in Kenya. To achieve this goal, secondary data was collected from the websites of operational banks while data for failed banks was collected from reports published by the central bank of Kenya, corroborated with publications in past years newspapers. Panel logit regression was used to analyze the data using Eviews 9.5 student version. The results of the regression revealed that there was a positive and significant relationship between liquidity risk and bank failure, implying that liquidity increased the likelihood of failure. The study also found a positive and significant relationship between bank failure and asset quality and earnings indicating that they increased the likelihood of failure. The study found a negative and significant relationship between bank failure and management quality and sensitivity to market implying that they decreased the likelihood of bank failure. Capital adequacy and bank size were found to have insignificant relationship with the failure of commercial banks in Kenya. These findings are valuable to managers in understanding how the variables of the study increase or decrease the likelihood of failure so that they may come up with appropriate strategies for managing the various risks facing their banks
Highlights
Banks play an indispensable function in a country’s financial system and economy as a whole through offering intermediary and liquidity services (Heffernan, [1])
Capital adequacy has a correlation of -0.151, -0.132, -0.12, 0.185 and -0.199 with asset quality (AQ), management quality (MQ), earnings (ROA), sensitivity to market (SM), and size (ASSETS) respectively
There exists a positive correlation between bank failure and liquidity risk, capital adequacy, asset quality, and earnings
Summary
Banks play an indispensable function in a country’s financial system and economy as a whole through offering intermediary and liquidity services (Heffernan, [1]). The function of financial intermediation inherently exposes banks to liquidity risk through the activity of transforming the maturity of short-term liabilities and demand deposits into long term maturity assets in form of loans. According to Kaufman [3] a bank is deemed to be a failure if the market price of its assets is diminished to an extent that it is less than the market price of its liabilities. Minamihashi [5] consider a bank to be a failure if it suspends issuance of new loans or credit to its clients. According to Bennett and Unal [6] liquidity, undercapitalization, safety, soundness, and fraud are some of the causes of bank failure
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