Determinants of commercial bank profitability in Kenya
Kabuuri, George Ndegwa
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This study explores internal and external factors that influence profitability of commercial banks in Kenya. Like other firms, banks seek to maximise profit by controlling internal factors while managing the impact of external factors on their operations. To maximise profitability and improve stability of the banking sector; managers, policymakers and other banking industry stakeholders need to understand how bank profits are swayed by various factors. Using a panel data set of commercial bank’s financial ratios and selected macroeconomic variables, this study applies the generalised least squares regression technique in exploring relationships between selected variables and profitability, drawing from conceptual and empirical literature for insights into the determinants of bank profitability. An inverse relationship between cost to income ratio and bank profitability is detected, which supports attention towards lowering operating costs by Kenyan bank managers in an effort to increase profitability. Even though Kenyan banks continue to embrace innovations such as agent banking, mobile-banking, internet-banking, credit bureau referencing and adoption of new payment systems to improve their operating efficiency, these efficiency gains are yet to transform into lower interest spreads for Kenyans, demonstrating the value of this study from a policy perspective, although spreads are beyond the scope of this study. Another interesting finding is the revelation of a negative relationship between deposits to total assets ratio and return on assets (ROA), this relationship could be a result of the costs banks incur collecting and maintaining deposits such costs include; maintenance of sizable branch networks, interest payment to depositors and costs of raising capital to cover deposits (core capital to total deposits should exceed 8 percent for banks in Kenya). A poor loan portfolio is found to have a significant negative impact on bank profitability while banks with diversified income streams are found to be more profitable. Evidence on macroeconomic determinants is mixed with inflation found to negatively affect bank profitability while change in real gross domestic product (GDP) had no significant impact on bank profitability over the period 1998 to 2009.