ABSTRACT
A stable banking sector is significant in ensuring economic growth as well as sound, efficient and stable financial system. However, the banking sector has been considered fragile and this is evident from the increasing trend of non-performing loans, fluctuating deposit trend of some commercial banks and increasing trend of foreign liabilities held by commercial banks in Kenya which is associated with financial stability. Furthermore the collapsing of commercial banks and some being put under receivership is of great concern to the financial stability of the commercial banks in Kenya. The Central Bank of Kenya (CBK) uses the CAMEL model whose firm characteristics namely, capital adequacy, asset quality, management efficiency, earnings/profitability and liquidity are used as measures of ascertaining the financial stability of commercial banks in Kenya. Despite the CBK‟s adoption of the CAMEL model, the banking sector in Kenya has been considered fragile. It is the need to investigate the link between firm characteristics and financial stability of commercial banks in Kenya, which triggered the desire to undertake this study. The general objective of the study was to establish the effect of firm characteristics on financial stability in commercial banks, Kenya. The specific objectives of the study were to determine the effect of operational efficiency, capital adequacy, bank liquidity, profitability and asset quality on financial stability of commercial banks in Kenya. Exchange rate was utilized to ascertain the moderating effect between firm characteristics and financial stability of commercial banks in Kenya. The study has been underpinned on Agency Theory and supported by Efficiency Structure Theory, Buffer Capital Theory, Liquidity Shiftability Theory and Information Asymmetry Theory. Causal research design was employed. The study was carried out in 17 fragile commercial banks in Kenya, between years 2011 to 2018.The study carried out normality test, panel unit root test, autocorrelation, heteroscedasticity test and multicollinearity test. Generalized Method of Moments (GMM) model guided by dynamic panel regression results revealed that operating efficiency had a statistically significant positive effect on financial stability of commercial banks in Kenya. Capital adequacy had a statistically significant negative effect on financial stability of commercial banks in Kenya. The study further revealed that bank liquidity had a statistically insignificant negative effect on financial stability of commercial bank in Kenya. In addition, profitability had a statistically significant negative effect on financial stability. Asset quality had a statistically significant positive effect on financial stability. Exchange rate had a statistically significant negative effect on the relationship between firm characteristics and financial stability of commercial banks in Kenya. The study concludes that firm characteristics namely operating efficiency, capital adequacy, profitability and asset quality are strongly linked to financial stability of commercial banks in Kenya. The study recommends for mergers and acquisition among the fragile commercial banks as per the fragility index, adoption of internal economics of scale, limits on insider loans to be established, credit to borrowers should not exceed 15% of the capital and adoption of unified exchange rate. This would ensure a sound and vibrant economy towards achieving the Vision 2030 that advocates for well-functioning, efficient and stable financial system.
CHAPTER ONE INTRODUCTION
Background of the Study
Financial stability of a commercial bank is the backbone of the whole financial system as banks assume a focal role in the economic growth (Hussein, 2010). Commercial banks contribute to a larger percentage of the counties GDP of 43.22% (Plecher, 2020). In evaluating the financial stability of a commercial bank, special consideration should provide for recognizing exogenous factors and endogenous elements that rely upon the functioning of the bank and to decide the degree of their effect on the state and activities of the commercial banks (Brauers, Ginevicius & Podviezko, 2014). Exogenous elements include political, social and economic factors while endogenous variables comprises of bank‟s capital adequacy, liquidity, level of profitability, asset quality, management efficiency and the solvency of the bank. These variables are common to all commercial banks; they have a huge effect on the accomplishment of the financial stability state (Dovhal & Chamara, 2015). Hence, the financial stability of the banking sector needs to be established to ensure steadiness in the financial system.
Internal factors (endogenous variables) and external shocks (exogenous variable) largely can collectively hamper the financial stability of a financial institution (Alexandru & Romanescu, 2008). Shocks may emanate from economic policies, macroeconomic conditions and external environments (Azam & Siddiqoui, 2012). When a financial institution system is weak, any externalities can lead to its collapse, however strong the institution, thus halting the financial intermediation process (Lumpkin, 2008). In the outrageous case, it might even prompt a financial crisis with unfriendly ramifications for a given economy (Vento & Ganga, 2010). Internal
(endogenous) variables can be classified as firm characteristics while the external (exogenous) variables can be classified as the external operating environment (Azam & Siddiqoui, 2012).
Globally financial stability among financial institutions has been of major concern since the genesis of banking crises that have adversely affected the economies of developed, emerging and developing countries (Timoumi, Mohamed & Zeitun, 2015). The world at large has experienced five major devastating banking crises of modern times. First, was the Credit Crisis of 1772 which was precipitated by the failure of banks in London and Scotland. Second, was the Banking Crisis of 1933 triggered by the Great Depression of 1929-1933 which began after the stock market crash of October 1929. Third, was the Secondary Banking Crisis of 1973-75 which coincided with the first global oil crisis of 1973 triggered by Organization of the Petroleum Exporting Countries – OPEC (Reid & Kynaston, 2003). Fourth, was the Asian Financial Crisis of 1997 originating from Thailand and engulfing the whole Sub-Asian continent (Zhuang & Dowling, 2002). Lastly, was the Global Financial Crisis of 2007- 2009 originating from the United States of America (USA); is classified as the most severe crisis, triggered by the breakdown of the Lehman Brothers which was among the largest venture banks worldwide (White, 2010).
Financial stability has been a critical point of concern with regards to policy makers internationally since the Financial Crisis of 2007-2009 (Beck, 2009). The 2007-2009 Financial Crisis was engineered by the breakdown of an asset price bubble in the housing market in the US (Zywicki & Okloski, 2009). The collapse of the Lehman Brothers investment bank was immediately followed by a credit crunch that translated into liquidity and solvency crises, resulting into a global recession (Mutuku, 2010).
Developed countries were greatly affected by the fundamental banking financial crisis in the U.S and Europe. Capital streams, cross border financial linkages and exchange rates were the main avenues through which the other markets were affected and yet they had a well-developed financial systems (Sin, 2016). The developing countries were drawn into the global financial crisis because of the portfolio outflows that hit hard the developing countries to the extent that some economies took time to recover from the shock (Diery, 2010).
Due to the recurring financial crisis, this triggered the G10 governors to come up with a methodology that would ensure financial stability around the globe and thus the formation of Camel Model in 1974 in Switzerland at Basel City hence the name Basel Committee. The Basel Committee on Banking Supervision (BCBS) has been on the forefront in ensuring financial stability in all financial institutions globally (Kouser, Aamir, Mehvish, &Azeem, 2011). The Basel Committee in 1998 further established Basel Capital Accord I to strength the Camel Model. In June 2004, the Basel Capital Accord II was formulated to strengthen Basel I; in 2010, Basel III was formulated to strengthen Basel II, a risk based approach after the global financial crisis of 2007-2009 (Savluk, 2015). The common narrative among the three accords is the emphasis to strengthen the key internal factors within the financial system, all geared towards attaining financial stability of the sector through establishing minimum requirements of the key internal factors that banks should comply to (BCBS, 2012).
