Effect of Shari’ah supervisory board effectiveness and financial determinants of profitability of Islamic Banks in Kenya

Abstract

Demand for various Islamic finance products and services is growing because of increasing populations of Muslim within Kenya and the adoption of Islamic finance services by non-Muslims. Even though interest is strictly forbidden in Islamic Banking, Islamic banks have recorded relatively positive financial performance. This study explored the factors influencing the profitability of Islamic commercial banks in Kenya, with particular attention to the role of Shari’ah Supervisory Boards (SSBs). The research sought to evaluate how bank size, capital adequacy, liquidity, and macroeconomic conditions impact profitability, measured through return on assets (ROA) and return on equity (ROE). Using a causal research design, the study focused on Kenya's three fully Shari’ah-compliant commercial banks, analyzing secondary data through quantitative methods, including descriptive and inferential statistics. The regression analysis indicated a significant relationship between SSB effectiveness, key determinants, and bank profitability. Specifically, bank size had a positive and significant effect on ROE but only a marginally positive effect on ROA. Capital adequacy showed mixed results: while its earnings ratio had a negligible impact on ROE, it negatively and significantly affected ROA. Liquidity, however, exerted a negative and significant influence on both ROA and ROE. Macroeconomic variables—interest rates, inflation, and GDP—were found to have no statistically meaningful effect on profitability. Similarly, SSB effectiveness, as measured by the IFCI index, did not significantly influence ROA or ROE. These findings suggest that internal bank-specific factors, such as size and liquidity, play a more decisive role in shaping profitability than external macroeconomic conditions or SSB governance in Kenya's Islamic banking sector. The study recommends introduction of alternative policy measures in the country that will help to spur development of Islamic banking and support an improved health of the institutions. Bank managers need to pay more attention to their expansion plans by taking into consideration digital channels as a more cost-efficient method of increasing outreach of the banks which can improve their profitability. The research also calls for Islamic banks to reanalyze their portfolio holdings to reduce exposure of their capital in risky investments. The banks should focus on strengthening their capital base through a more robust control of their assets earning investments. The banks should further implement active management of short-term obligations which will help mitigate liquidity risks and any losses arising from the operations of the firm.

Key Words: profitability, Islamic banks, Shari’ah, bank size, capital adequacy, liquidity, macroeconomic factors