the factors influencing the profitability of kenyan banks in the 21st [PDF]

THE FACTORS INFLUENCING THE PROFITABILITY OF KENYAN BANKS IN THE 21ST CENTURY

BY

JORAM AREBA ONSARE

UNITED STATES INTERNATIONAL UNIVERSITY AFRICA

SPRING 2017

THE FACTORS INFLUENCING THE PROFITABILITY OF KENYAN BANKS IN THE 21ST CENTURY

BY JORAM AREBA ONSARE

A Project Report Submitted to Chandaria School of Business in Partial Fulfillment of the Requirement for the Degree of Global Executive Master of Business Administration (GeMBA)

UNITED STATES INTERNATIONAL UNIVERSITY AFRICA

SPRING 2016

STUDENT’S DECLARATION

I, the undersigned, declare that this is my original work and has not been submitted to any other college, institution or university other than the United States International University in Nairobi for academic credit.

Signed: ____________________

Date: ___________________

Joram Areba Onsare (ID 650047)

This project has been presented for examination with my approval as the appointed supervisor.

Signed: ____________________

Date: ___________________

Dr. Peter N. Kiriri

Signed: ____________________

Date: ___________________

Dean, Chandaria School of Business

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ACKNOWLEDGEMENT

The completion of this research is owed to the cooperation and support of faculty, friends and family who played a key role in guiding and navigating me towards completion of the paper. I take this opportunity to express my sincere appreciation to all the people who have helped me and to make special mention of the following: My sincere gratitude to my project supervisor, Dr. Peter N. Kiriri, Lecturer, Associate Professor of Marketing for his continuous guidance, availability and encouragement through the development and completion of this paper. I also wish to acknowledge the contribution of my family, for their full support and assistance that enabled me complete my studies.

Most important, my humble gratitude to the Almighty for granting me strength, good health and knowledge that enabled me complete this paper.

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ABSTRACT

The study sought to assess the factors that affected profitability of banks in Kenya in the 21st Century. The main focus was on the recent developments and changes in the financial sector that have impacted banks and expected to impact banks further. The purpose of the study was to assess the factors that determine profitability of banks in Kenyan Industry in the 21st Century. The specific objectives guiding the study were; What are the effects of regulations on bank profitability? What are the effects of technology on bank profitability? What are the effects of macroeconomics on bank profitability?

The research methodology used was quantitative explanatory research and the sampling design was stratified random sampling. The sample for the study involved 10 banks with the participants being 59 employees working in the finance department of the sampled banks. Questionnaires were the chosen tool used to collect data that was later analyzed using Microsoft excel.

The study concluded that regulations are key to the operations of banks and hence profitability for banks. Regulations were found to lead to strategy changes and the reorganization of a banks’ balance sheet lines to meet the required ratios or regulations. The study found that core capital regulations led to banks adjusting their focus to lines with most impact on core capital rations. The bank mostly adjusted their loan book, fixed assets and other investments to meet the regulations. The impact of new corporate governance regulations have focused on the management structures and operation policies. The credit quality regulation were found to be critical in the enhancement of loan book quality and also shielding the bank against losses. The study found out that the new regulations have increased efficiency of operations, speed of decision making and increased the influence of the board of directors.

The study established that technology was key and the impact of technological innovations are critical to operations of banks and their profitability. Technology was found to reduce the costs of transactions and also improve the access to solutions by the various customers. The study looked at internet and mobile banking at depth and established that the impact iv

on transactions and access to customer was greatly improved. The study found that technology had been accepted as a game changer in the new banking and it greatly reduced operational costs and thus profitability of banks.

The study found out that macroeconomic factors affected operations and profits. Macroeconomic factors are external determinants of profitability of banks and impact both the bank and the bank’s customer. The study looked at GDP and Inflation and established that they affected business level in the economy and product prices, the business level changes meant more business for banks while the product price changes affected the operational costs. The impact of these factors was found to be on both income and expense lines of a bank hence a direct impact on profitability. The study concluded that all the factors were integral to profitability of banks and recommended that the understanding and factoring the key factors stated above in the strategy formulations and forecasting was needed to enhance and stabilize profitability of banks. The conclusion on the impact of regulations is that they are inevitable and banks should always opt for changes which are of minimal cost, that are easy to implement and also meet required minimum condition. The study concluded that corporate governance regulations led to a better managed institutions and smoothened operations. The credit quality regulations were found to improve stability of a bank. The conclusion of the study on technology was that it was next frontier in the provision of banking services and the pioneering banks in the field would benefit form a vast clientele and provision of affordable services. The study recommends that banks incorporate the impact of regulations, macroeconomic factors and technology in their strategic plans. This factors generally tend to shift the course of banks in disruptive way by reducing performance and or change the mode of operations. The recommends that banks should invest in understanding the factors and forecasting the expected changes hence ensuring they are to withstand any changes. The impact of the factors is minimized with proper planning and implementation of key mitigants like price adjustments and capital investments in line with the predicted changes.

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TABLE OF CONTENTS STUDENT’S DECLARATION ........................................................................................ii ACKNOWLEDGEMENT ................................................................................................iii ABSTRACT ....................................................................................................................... iv CHAPTER ONE ................................................................................................................ 1 1.

INTRODUCTION ...................................................................................................... 1

1.1.

Background of the Problem ...................................................................................... 1

1.2.

Statement of the Problem .......................................................................................... 5

1.3.

General Objective ..................................................................................................... 6

1.4.

Specific Objectives ................................................................................................... 6

1.5.

Importance of the Study ............................................................................................ 6

1.6.

Scope of Study .......................................................................................................... 7

1.7.

Definition of Terms................................................................................................... 7

1.8.

Chapter Summary ..................................................................................................... 8

CHAPTER TWO ............................................................................................................... 9 2. LITERATURE REVIEW ............................................................................................ 9 2.1.

Introduction ............................................................................................................... 9

2.2.

The Effects of Regulations on Profitability .............................................................. 9

2.3.

The Effects of Technology on Profitability ............................................................ 13

2.4.

The Effects of Macroeconomics on Profitability .................................................... 17

2.5.

Chapter Summary ................................................................................................... 20

CHAPTER THREE ......................................................................................................... 21 3. RESEARCH METHODOLOGY ............................................................................... 21 3.1.

Introduction ............................................................................................................. 21

3.2.

Research Design...................................................................................................... 21

3.3.

Population and Sampling Design ............................................................................ 21

3.4.

Data Collection Methods ........................................................................................ 23

3.5.

Research Procedures ............................................................................................... 24

3.6.

Data Analysis Methods ........................................................................................... 25

3.7.

Chapter Summary ................................................................................................... 25

CHAPTER FOUR ............................................................................................................ 26 4.0

RESULTS AND FINDINGS ................................................................................ 26 vi

4.1

Introduction ............................................................................................................. 26

4.2

General Information ................................................................................................ 26

4.3

Impact of Regulations on Profitability.................................................................... 28

4.4

Impact of Technology on Profitability.................................................................... 37

4.5

Impact of Macroeconomics on Profitability ........................................................... 42

4.6

Chapter Summary ................................................................................................... 43

CHAPTER FIVE ............................................................................................................. 44 5.0

DISCUSSIONS, CONCLUSIONS AND RECOMMENDATIONS ................. 44

5.1

Introduction ............................................................................................................. 44

5.2

Summary ................................................................................................................. 44

5.3

Discussions ............................................................................................................. 45

5.4

Conclusion .............................................................................................................. 51

5.5

Recommendations ................................................................................................... 52

REFERENCES ................................................................................................................. 53 APPENDIX ....................................................................................................................... 59 Research Questionnaire ..................................................................................................... 59

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TABLE OF CONTENTS Table 4. 1 Response Rate ................................................................................................... 26 Table 4. 2 Gender ............................................................................................................... 27 Table 4. 3 Age Groups ....................................................................................................... 27 Table 4. 4 Level of Education ............................................................................................ 27 Table 4. 5 Work Experience .............................................................................................. 28 Table 4. 6 Impact of Capital Adequacy Regulations on Balance Sheet Items .................. 29 Table 4. 7 Changes to Balance Sheet Items due to Capital Adequacy Regulations .......... 31 Table 4. 8 Presence of a Written Corporate Governance Manual ..................................... 32 Table 4. 9 Impact of Corporate Governance Regulations on Operations .......................... 33 Table 4. 10 Impact on Strategy Implementation as a result Corporate Governance Regulations ........................................................................................................................ 34 Table 4. 11 Presence of a Written Credit Policy................................................................ 35 Table 4. 12 Loan Regulations that have led to Reduction of Profits ................................. 36 Table 4. 13 Impact of Loan Regulations on Loan Disbursements ..................................... 37 Table 4. 14 Banking Transactions provided on the Online Platforms ............................... 38 Table 4. 15 Usage of Banking Transactions on Online Platforms ..................................... 40 Table 4. 16 Usage of Mobile Banking and Internet Banking ............................................ 41 Table 4. 17 Impact of Technological Changes on Operations ........................................... 41 Table 4. 18 Effect of Macroeconomics on Operations of the Bank................................... 42 Table 4. 19 The Key Macroeconomic Factors for Bank Operations ................................. 42 Table 4. 20 Impact of Macroeconomic Changes on Bank Operations .............................. 43

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CHAPTER ONE 1.

INTRODUCTION

1.1.

Background of the Problem

The global financial sector has been facing a number of challenges with the financial risks in the sector have been on the increase since 2015. The outlook in the sector has been on the decline in advanced economies due to heightened uncertainty and setbacks to growth and confidence, the decline in oil and commodity prices and reduced growth rate have kept risks elevated in emerging markets (IMF, 2016). The financial sector in Africa has also not been spared by the global shocks facing the global economy and it has been further complicated by political challenges via coups and regime changes. The financial sector in Kenya has been undergoing numerous changes in recent times the sector very competitive and moving its focus from banks. The changes made to the sector in recent times include; incorporation of credit sharing structures, growth of micro finance institutions , provision of financial services by non-banks, implementation of new regulations on financial services and changes in technology.

The changes have created a tough environment for banks but have not negated the key role that banks play; banks have been forced to change how they operate in order to remain profitable in light of the new dynamics. Modern-day banking originate from practices in the Medieval Italian cities of Florence, Venice, and Genoa. The Italian bankers made loans to princes, both to finance wars and their lavish lifestyles, and to merchants engaged in international trade. In fact, these early banks were inclined to be set up by trading families as a part of their more general business activities (Italian et al., 1994). The Banks have continued to play a key role to the economy to date and Allen & Carletti, (2008) identified the following as the roles: banks ameliorate the information problems between investors and borrowers by monitoring the latter and ensuring a proper use of the depositors’ funds, banks provide inter-temporal smoothing of risk that cannot be diversified at a given point in time as well as insurance to depositors against unexpected consumption shocks, banks contribute to the growth of the economy and they also perform an important role in corporate governance when solving the agency problem between parties in a transaction. The need to 1

assess determinants of profitability of banks will help understand the key risks faced by such a paramount player in the economy in pursuit of the key business goal of being profitable. The factors that determine profitability of banks can be divided into internal and external factors. The internal factors are bank specific while external factors consist of industry and macroeconomic factors.

The key sources of income for banks during early times were divided into interest income and non-interest income. The traditional source of income for banks has always been interest income but in recent times banks have been shifting to non-traditional sources of income. Gamra & Plihon (1997) noted that the 1997 financial crisis in emerging market economies had important implications for the feasibility of different banking models. The crisis clearly exposed the dangers of a bank’s excessive reliance on the traditional business activities in a context of capital account liberalization. Many analysts have particularly advanced the lack of proper diversification of the loan portfolio as a key catalyst of bank distress after financial deregulation. The banking industry experienced a strong recovery after the worst of the financial crisis, but continued to be weighed down due to the ongoing Eurozone crisis and concerns of sluggish growth in the United States. An evolving banking landscape in emerging economies (especially China and Latin America) is expected to transform the banking industry in the future. Meanwhile, regulations continue to evolve and create an ever-tightening regulatory environment for the banking industry (Deloitte, 2013). The trend worldwide is of concern, for example the banking industry in the United States closed 1,614 branches over the 12 months ending in June 2014, the largest decline in more than two decades (Deloitte, 2015). The indication is that banks need to change how they do banking in order to adapt to changing times. The African banking sector is seen to be full of opportunity as it’s considered to be shallow and less penetrated due to the large numbers of an unbanked population. While overall, 23% of adults in the Africa region have a bank account. Within Africa, there is a large variation in account ownership: 24% of adults in Sub- Saharan Africa report having an account at a formal financial institution, though this ranges from 51% in Southern Africa 2

to 11% in Central Africa In the Democratic Republic of Congo and Central African Republic, more than 95% of adults are unbanked (i.e. do not have an account at a formal financial institution). In North Africa 20% of adults have an account at a formal financial institution ranging from 39% in Morocco to 10% in Egypt (Calleo, 2014). One of the main reasons for this large unbanked population in Africa is geographical inaccessibility and poor infrastructure, with many of the unbanked living in remote rural areas. This, combined with the high cost of banking services and a lack of financial education and understanding, creates very high barriers to banking for poor rural populations (Calleo, 2014). It is this need for banking services that has created an opportunity for non-banks to participate in the field of financial services. The Non-banks have since created competition to banks and hence they have become a key threat to the profitability of banks. The most obvious example of this is M-Pesa, the mobile money transfer service in Kenya. Launched in 2007 by Safaricom, the country’s largest mobile network operator, it is now used by over 17 million Kenyans, approximately two-thirds of the adult population, and around 25% of the country’s gross national product flows through it (Calleo, 2014). According to Nyantakyi et. al, (2015), the banking system has five key features: the depth and penetration of banking and banking services, innovation and technology in the banking industry, banking efficiency, competition and ownership in the banking sector and the banking sector regulations and supervision. The depth and penetration of banking and banking services in sub-Saharan Africa is 24%, domestic credit to the private sector is about half the average ratio for North Africa and Latin America & Caribbean and less than a quarter of that of OECD (Organization for Economic Cooperation and Development) countries. Within the sub-regions, West and East Africa record the lowest ratios of 20% and 21% respectively, while Southern Africa records a relatively high ratio of 43%, driven mainly by the high financial depth of South Africa. The low penetration creates opportunities for non-banks to eat into the profitability of banks. Innovation and technology, has not only allowed domestic banks to efficiently reach higher number of clients and compete with large foreign competitors, but also improved banks’ margins by reducing operations cost. The mobile banking technology has allowed the unbanked to enjoy personal banking services without having a bank account; in Africa 3

specifically the use of mobile banking has had great effect on banking. Africa currently has a mobile penetration of 67% (Adepetun, 2016). Cost controls and effective utilization of resources are central to the success of financial intermediaries operating in a competitive environment (Nyantakyi et al., 2015). In Africa, there is evidence that, foreign and private owned banks are more efficient than their public counterparts and that banks could save between 20% to 30% of their total cost if they were operating efficiently. Operating expenses account for 5.4% of total assets in sub-Saharan Africa, whereas in North Africa, they account for 1.7%, close to the overhead cost of OECD countries of 1.5% (Nyantakyi et al., 2015). Most other African regions are still far from most OECD countries, though they face different operating conditions this shows that there is room for improvement. The African banking system has also benefited from the growing presence and participation of foreign banks across the continent; they have helped bolster competitive pressure in the industry and allowed banking techniques such as good corporate governance and innovations to spillover to domestic banks. This may however create unfair competition where foreign banks disproportionally dominate the banking industry in terms of assets and branches. Foreign banks with the capacity to obtain both hard and soft information about borrowers and businesses can embark on anticompetitive schemes by “cherry picking” borrowers, while worsening the remaining credit pool for small domestic banks (Beck & Brown, 2010). During the quarter ended 30th September 2015, the sector comprised 42 commercial banks, 1 mortgage finance company, 12 microfinance banks, 8 representative offices of foreign banks, 86 foreign exchange bureaus, 14 money remittance providers and 3 credit reference bureaus. (CBK,” 2015). The Kenyan banks face the same determinants of profitability like any other banks; Financial Statements variables, Non-financial statement variable, Regulations, Impact on competitive conditions ,Concentration, Market Share, Interest Rate on profitability, Ownership, Scarcity of Capital and Inflation (Rasiah,2008). Kenya is also set to adopt Basel III in 2018; the country currently operates under Basel II and the adoption of Basel III is expected to have stricter rules of operation for banks and by extension impact on profitability of banks. The relevance of bank regulations in the 4

developing world has always been questioned, Nyantakyi et al., (2015) note that the lack of a large market for derivatives, the high liquidity of banks, and the recent improvement in governance seem to be sufficient to ensure the stability of the banking system in Africa and their implementation may just be very complicated due to the lack of human resource capacity and deficiencies in information technology. A review of the factors that determine profitability is necessary to ensure that the banks operating in the country continue to play a key role. The social impact of banks is very key in terms of their contribution to economy both financially and socially, by understanding the factors affecting profitability, banks will be able to remodel their strategies to ensure their success. 1.2.

Statement of the Problem

The research aims to provide more information on the determinants of profitability in a specific country and in the recent times. Researches mostly carried out about profitability are normally done at a regional scale. An example is Staikouras, (1996) who looked at the determinants of profitability of European banks and Flamini, Mcdonald, & Schumacher, (2009) focused on Sub Saharan Africa. There are number of studies which are country specific, an example is Sufian & Chong, (2008) who focused on the Philippines. The studies done by local researches have also focused on particular components of the factors that affect profitability and also a sample of the certain banks, Matano (2016) focused on strategic planning and had the sample of the study as one bank. Murerwa (2015) focused mostly on internal factors performance of local banks and briefly on the key uncontrollable external factors. Kamau (2016) focused on the effect of financial innovation on performance of banks and the study used data from 2008-2012. This study aims to assist scholars assess the impact of the current changes and how they have affected banks in recent times. The aim of the study will be to investigate the impact new regulations being implemented for the first time in the country thus no lack of studies on effect and also provide an updated view of the impact current global changes. The study was based on a sample from banks in Kenya and will refer to particular banks when explaining different factors. The study is based on the 21st

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Century hence will provide an up to date understanding of banking in light of new changes facing the sector.

1.3.

General Objective

The general objective of this study was to assess the factors that determine profitability of banks in Kenyan Industry in the 21st Century.

1.4.

Specific Objectives

The following were the specific objectives: 1.4.1. To determine the effects of regulations on bank profitability 1.4.2. To determine the effects of technology on bank profitability 1.4.3. To determine the effects of macroeconomics on bank profitability

1.5.

Importance of the Study

The key challenges faced by banks in Kenya are in the creation and implementation of strategies which have clear impact on profitability. The research assessed the factors that are key to determination of profit hence improving the way businesses formulate goals which will have an impact on a company’s key goal of being profitable. This study if implemented would be of great benefit to the shareholders of the company, the management, the employees and Researchers and Academicians

1.5.1. The Shareholders The owners of the company will be empowered to assess management goals and provide relevant input that would drive company performance. The information will provide more input to new factors affecting banks and how manage them.

1.5.2. The Management The strategy formulation and implementation process of the company will be structured to impact profitability since management will be more informed by the findings of this study 6

on the key determinants of profits. The findings will help the bank management develop key strategy and policies to remedy existing challenges of maintaining profitability in banks. The findings will be crucial in assisting the management plan and implement relevant strategies.

1.5.3. The Employees The bank’s employees will be able to use the findings to understand how they can affect a bank’s performance and also how to focus their contributions to ensure maximum benefit to the organization.

1.5.4. Researchers and Academicians The research aims at contributing significantly to the body of knowledge in regards to how banks work and how they achieve profitability. The study will contribute to the efforts of scholars to understand the field of banking.

1.6.

Scope of Study

The study covered a demographic of Kenyan banks focusing on Nairobi branches. This study used stratified random sampling to identify 59 finance department employees. The data collection was done within a timeframe of 3 months beginning September 2016 to November 2016. The challenge was identifying people with the required in depth understanding of factors affecting bank operations and up to date knowledge on the new changes in the banking sector. The data collection process utilized the existing bankers association and established networks in the sector to assist identifying the right participants for the study.

1.7.

Definition of Terms

1.7.1. Smoothing of risk This is the process of financing risk in such a way that the financial impact of incurred losses is distributed between members of the risk pool over more than one financial reporting or policy period. (Institute, 2016) 7

1.7.2. Basel Regulations Basel regulations are set by the Basel Committee (Members are central banks of different countries) the primary global standard-setter for the prudential regulations of banks operations ((BIS), 2016)

1.7.3. Profitability Profitability is taken to mean the net surplus and it’s expressed as the excess of revenues less all expenses including exchange rate effect. This is expressed as a net surplus.

1.7.4. Macroeconomics A factor that is pertinent to a broad economy at the regional or national level and affects a large population rather than a few select individuals organisation. 1.7.5. Technology The purposeful application of information in the design, production, and utilization of goods and services, and in the organization of human activities.

1.7.6. Profitability This refers to the net surplus and it’s expressed as the excess of revenues less all expenses including exchange rate effect. This is expressed as a net surplus. 1.8.

Chapter Summary

This chapter has introduced the factors that the study will explain and provide key information. The second chapter covers the literature review in relation to the specific objectives while chapter three provides details of the study methodology. Chapter four elaborates the methods applied to analyze, present and interpret data collected using the questionnaires. Chapter five summarizes the study, discusses conclusions and study recommendations. 8

CHAPTER TWO 2. LITERATURE REVIEW 2.1.

Introduction

This chapter reviews the various studies, research and concepts that exist in regards to profitability of banks. The review will aim to assess how the various key factors impact profitability with a key focus on Kenyan banks. The review is divided into three sections based on the specific objectives; the impact of banking sector regulations, macro-economic factors and the ever changing technology on profitability of Kenyan banks.

2.2.

The Effects of Regulations on Profitability

Before 1980s, prudential regulation and supervision in banking was mostly based on the following parameters; reserve requirements, liquidity constraints, portfolio requirements, and interest rate controls. Until early 1980s, high capital seemed enough for soundness to meet the obligations and main emphasis was put on a minimum level of (Caprio, 2013). Basel I focused on credit risk only by means of skipping other risks such as market risk and operational risk. In 1996, capital accord took into consideration some dimensions of market risk in capital adequacy regulations. Basel II was based on three pillars: minimum capital requirements, supervisory review, and market discipline. In addition, the latest and more complex accord, Basel III, agreed upon in 2010, redefined the capital adequacy measurements and set higher capital, liquidity, and leverage requirements (Caprio, 2013). The regulations have imposed strict operating rules for banks and hence creating a tough environment for profit maximization. The Kenyan banking sector is regulated by the Central Bank of Kenya (CBK) and the regulator is currently in the process of adopting components Basel II regulations. 2.2.1. The Effect of Capital Requirements on Profitability of Banks The regulator of the banking sector is normally tasked with setting the minimum capital those banks to hold and the measurement of the capital is normally compared as parameter of other factors like deposits and assets. The Basel committee is in the process of implementing Basel 9

III regulations, which have a philosophy stronger rules on capital requirements: the aim is to maintain the spirit of Basel II, requiring more capital for the banking activities that entail greater risk (Gual, 2011). In assessing the impact of capital requirements on bank lending, spreads and cost of capital, Kashyap, Stein, & Hanson, (2010) reached two main conclusions: a) in the short-run, increased capital requirements might prompt lead to a reduction in lending significantly, rather than issuing equity or increasing retained earnings and b) in the long-run the effects are difficult to assess as banks will find a way to meet the capital requirements and manage impact on business. The short run negative impact of capital requirement is shown by Shekhar & Aiyar, (2011) in their analysis of UK banks found that an increase in capital requirements of one percentage point reduces the growth rate in real lending by 4.6 percent and credit growth by 6.5-7.2 percent, the same documented when the European Banking Authority (EBA), increased capital requirements to more than the expected changes of Basel III. Impact in the Long Term: Gradually, as banks build up capital reserves in accordance with regulatory requirements and reduce high-risk-weighted assets, they would see a lowering of their cost of capital due to improved portfolio risk and a lower risk premium for high-quality assets. This would improve credit margins in the long run. Undercapitalized banks stand to gain as loan growth usually recovers in the long run on the back of an improved economy (Yadav, Druten, Hellawell & Sawan, 2014).

Capital requirements put restrictions on the abilities of banks to lend by increasing the capital requirements hence raising the cost of funds. The cost of funds increases especially when the bank decides to raise equity to match the requirements of the regulator, the urgency limits ability to negotiate on better terms on the equity hence increases the cost of funds. The spread (Interest – Cost of funds) will decrease due to the increase in cost of funds (Ikeda, 2013).

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2.2.2. The Effect of Corporate Governance Regulations on Profitability of Banks Adams & Mehran, (2003) defines corporate governance as "the mechanism through which stakeholders (shareholders, creditors, employees, clients, suppliers, the government and the society, in general) monitor the management and insiders to safeguard their own interests."

Two key differences distinguish the governance of banks from that of nonfinancial firms. The first is that banks have many more stakeholders than nonfinancial firms. The second is that the business of banks is opaque and complex and can shift rather quickly. Banks, which consist of more than 90 percent debt (as opposed to an average of 40 percent for nonfinancial firms), have more stakeholders than nonfinancial firms (Mehran, 2011). Corporate governance essentially involves balancing the interests of a company's many stakeholders, such as shareholders who may be domestic or foreign. Some Efficiency studies that were conducted in developed nations suggest that foreign institutions are less efficient on average.

The effect of strong government ownership in institutions in some studies has also been found to have negative influence on the performance of banks and financial systems. La Porta, Lopez-De-Silanes, & Shleifer, (2002) find that countries with high levels of government ownership in 1970 were associated with lower levels of bank development and slower economic growth. The need for regulation on corporate governance to monitor how banks operate is of paramount importance. Banks are the corner stone of the financial system and the role they play has tremendous ripples to the financial system if trust in the service they offer is lost. Academics throughout time have debated on how opaque banks truly are reviewed the disagreement by rating agencies on the bonds issued by banks as compared to those issued by non-financial institutions (Mehran, 2011). Opacity and complexity play a role in governance in both the interaction between the board and management and the relationship between the bank and its regulators. The important role that corporate governance regulations play thus can only be achieved if the structures and units in place to support implementation are strong and fulfill their obligations. The Board of directors is key to the success of corporate governance; 11

performance of organizations is dependent on the realization of the roles of BODs, (Mokaya & Jagongo, 2015). The roles performed by BODs are both important and numerous, they are critical to the implementation of checks and balance to safe guard stakeholders. 2.2.3. The Effect of Loan Quality Regulations on Profitability of Banks The loan portfolio quality has a direct impact on the profits that a bank makes. The biggest risk facing a bank is the loss derived from non-performing loans which reduce the interest income that a bank earns. It is the major concern for all commercial banks to keep the amount of nonperforming loans at a low level. This is so because high nonperforming loan affects the profitability of the bank. The lower the ratio the better the banks’ performance. Hallunovi & Kume, (2008) observed that high profitability could be indicate market power, especially by large banks. This reduces competition as banks with market power offer lower returns on deposit but charge high interest rates on loans. The regulations surrounding loan quality assist the regulators supervise and monitor banks so as to have an alert system that would predict if a bank is under stress. The regulations monitor loans which compromise between 50-75% of a banks’ asset hence very critical to the survival of the bank. The conditions in place vary from lending qualifications to provisioning to ensure that a bank is secure in case a loan becomes non-performing (Awuor, 2015) A study of determinants of banks’ profitability in developing countries between 1980 and 2010 Ikpesu, (2016), indicates that credit risk and liquidity capital adequacy are significant drivers of bank profitability. The quality of loans or credit is considered a proxy of operational performance and financial procedures of banks. The risk with credit is that the borrower will not repay and the bank will lose the loan and the expected interest on the same. Credit is largely sourced from deposits which come from the economy hence the need for regulators to monitor the credit system. The emphasis is that the health of the financial sector chiefly depends on a sound banking system which is its cornerstone.

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2.3.

The Effects of Technology on Profitability

Information technology (IT) broadly refers to the use of computers and peripheral equipment, which have been on the rise in service industries in the recent past. In the banking industry, this has been evidenced by the introduction of IT products such as internet banking, electronic payments, security investments, information exchanges (Berger et al., 2003). This technologies have enabled banks provide much more services with less manpower and more efficiently.

Schlich, Baggs, Bellens, & Lewis (2015) found that banks in recent times have been forced banks to grapple with a low-growth environment across most areas of the developed world and the continual slowing growth in the emerging world and thus to remain profitable and survive the new times they have to transform, become simpler and more efficient. The transformation can be aided by technology.

The rapidly changing technology sector has necessitated the preparation for the next wave of reinvention factoring new ways of doing things. Banks have been forced to understand the need to change product offering and pursue investment programmes so to embrace new market changes and compete, the solution to reinvention is technology innovation and trends (Kimber, Angwin, Miles-Khan, & Backeberg, 2015). The new age way of thinking will enable banks develop a new pool skills required for staff, develop better management strategies and regulatory and compliance frameworks, that are needed to leverage future technologies.

2.3.1. The Effects of Mobile Banking on Profitability of Banks Mobile banking (m-banking) is a term used for performing banking transactions via mobile device such as mobile phones (Agarwal, 2017). Tiwari et al., (2006) define mobile banking as any transaction, involving the transfer of ownership or rights to use goods and services, which are initiated and/or completed by using mobile access to computer- mediated networks with the help of an electronic device.

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Gupta,( 2013) notes that Governments see mobile technology to be an opportunity to increase the financial inclusion, especially among the people living in the rural areas and the poor, the penetration of the mobile phone is so high that it is expected to reduce the high levels of the unbanked and increase the reach of financial services. Sanou, (2015) noted that in 2015 there were more than 7 billion mobile cellular subscriptions worldwide, an increase of over 6 billion from the year 2000, the world population in 2015 stood slightly above 7 billion and thus this represented penetration rate of 97%. Mobile phones have thus created a new atmosphere and potential clientele for the various businesses including banks which have seen the need to target customers both new and old via the gadget.

The use of mobile banking has benefits on both the provider and user of the service. Kumar, (2010) noted that banks can reduce several costs when they provide mobile banking services; the use of text messages to remind customers of obligations and new products saves the bank marketing costs and loan officers or loan collectors time. The customers on the other hand are getting savings from reduced transport cost and even service costs as mobile services are cheaper. The reduced costs translate into increased profits.

The use of mobile banking services is critical in recent times as it enables banks to move away from the traditional brick and mortar system. The use of this technology enables banks access a wider market within the shortest time possible. Lee et. al, (2007) identify the provision of mobile banking services as an important avenue for banks to quickly impose their services and the same time increase market share.

The use of mobile banking has forced banks to move from their traditional way of providing banking services in order to compete. In Kenya, convenience, affordability, security and ease of operation have come along with the introduction of m-banking concept and have forced the commercial banks to change from their traditional way of doing business to integrate the mobile transactions in their business (Mbiti 2011).

The ability of mobile phones to provide financial services has both brought opportunities for banks to make more profits but at the same time presented an opportunity for non-banks to 14

participate in financial services (Deloitte, 2013). At the same time, note that banks must prepare to defend their franchises against threats from not only other financial institutions, but also mobile carriers, credit card processors, and other nonbank competitors that want to help consumers conduct financial transactions wherever they are through their mobile devices. This new competitors have a strong advantage over banks as they are not regulated hence operate with a lot of freedom.

Dilemma, & Yal, (2015) find that the speed of penetration of new players in the provision of financial means that banks have to think about new ways of utilizing the mobile banking platform to enhance profitability. The key success story of a non-bank successfully providing financial services is Safaricom’s M-PESA since 2007, a mobile phone-based solution that provides money transfer, payment and banking services. The statistics as at June 2015, Safaricom had more than 22 million M-PESA subscribers served by over 90,000 M-PESA agents. The factors that have contributed to M-PESA's success, include; Kenya's political and economic context, demographics, telecommunications sector structure, lack of affordable consumer options, and enabling regulatory policies. The successful usage of mobile banking would thus be the utilization of strategic partnership to maximize on the untapped customer base.

2.3.2. The Effects of Online Banking on Profitability of Banks Online banking is the adoption of electronic means in the delivery of banking services to clients mainly through the internet. Online banking avails convenience to the clients by being able to access their financial information and carry out financial transactions from the comfort of their location and timing through the internet. In addition to this, the bank also benefits from cost savings by eliminating the cost implication to be incurred in terms of labor through the face-to-face interaction between a teller and a customer as well as minimizing the cost of stationery used such as paper for printing receipts (Kaur & Pathak, 2015).

For banks to continue generating market value they are likely to undergo a radical transformation in their image and marketing in aim of shifting focus from day-today transactions to increasing the sales. A compelling market value for a successive uptake would 15

necessitate a customer interface that is fast in accessibility, simple to use and secure from internet banking frauds. The value proposition would need to achieve competitive pricing in such ways as curbing fees for self-service and be innovative by keeping up with the developing technologies such as the use of virtual banking from which customers can deliberate with the customer service team by use of the web camera (Garbois, Ardill, Pock, Gourp, & Massa, 2013).

Banks would benefit from new revenues from transactions and user fees from online banking. These fees, such as per wire transfer, would allow banks counterbalance the expense incurred in providing the online service. Other cost savings may be experienced in the back and front office operations. The dependency on manual operations such as loans processing would be reduced with improved efficiencies through online processing and handling. Cross-selling is a phenomena where a bank receives new account relationships from clients from the promising service offered in online banking. For banks that already operate an online platform, it would be seamless to leverage on existing internet infrastructure when introducing new modules such as online loan application. Streamlining of operations would facilitate the ability of the bank to track and analyze customer usage and promote the broadcasting of informed marketing. Customer retention rates would appreciate with existing customers expressing loyalty in maintaining relationship with the bank (Marenzi, Hickman, & Dehler, 2000).On the other hand, the implementation of online banking can have hefty costs at the inception stages.

These costs are identifiable in the purchase of the hardware, software, technical manpower and organizational restructuring for integration with pre-existing systems. Consequentially, other costs mature at production stage where the hardware requires maintenance, repairs and technical support. These costs have a ripple effect on the client and are dependent on the bank in the form of monthly subscription fees and commissions for banking online. The learning curve would require the client to accumulate some orientation hours in getting accustomed to how to use the online service. In the event of technical challenges or for matters that are insoluble by use of the internet, this will prevent the client from accessing their banking interface at the risk of cultivating customer dissatisfaction (Gjino, 2015). 16

2.4.

The Effects of Macroeconomics on Profitability

The effects of macroeconomics factors on the economy are normally broad based and cut across all areas of the economy. This factors are key to the success of any sector in the economy, Flamini, Mcdonald, & Schumacher, (2009) identifies macroeconomics as one of the key determinants of profitability of banks. The study focuses on understanding the impact of inflation and GDP on profitability of banks

The impact of macroeconomics on profitability does not have a direct causality or predictable impact to specific components of a bank’s profitability. The effects of these factors have multiple impacts on the various lines of the financials. Combey & Togbenou, (2017) establish that there is indeed a relationship between the bank sector performance and macroeconomic environment depending on the factor, the effect can be positive or negative.

2.4.1. The Effects of Inflation on Profitability Benabou & Gertner, (1993) show that increase in inflationary pressures leads to consumers to seek more information before making decisions on purchase of services or assets, in equilibrium, information is available and decision making on trade is much faster. Benabou & Gertner, (1993) note that inflationary pressures impact to markets depends on ability of buyers or consumers to get information on pricing, if the process of getting market pricing is high, market efficiency will be affected by inflationary pressures. The same applies to banking as inflation affects prices, profitability of institutions and by extension ability to repay loans. The impact of inflation is nevertheless majorly dependent on whether a bank had anticipated the change and put in place strategies to cushion or counter the change or if the same was unanticipated. In cases where the change is anticipated the impact on profitability is insignificant as the bank would have adjusted its key revenue lines to ensure less of an impact to profitability

Frederick, (2015) looks at inflation as measured by the consumer price index (CPI) and concludes that the same has a significant impact on the performance of a bank. The study 17

noted that the parameter affected by the CPI was return on equity (ROE) and the results suggested that the bank income increased more than costs hence improved profitability, the change in the CPI that lead to an increase in profit was seen to be a positive change that lead to relative positive change in profits.

Friedman, (1977) further argues in support of inflation uncertainty and its distortion of relative prices. The uncertainty of inflation thus tends to have an impact on profitability of banks and other institution. Inflationary pressures leads to the adjustment of prices which have an adverse effect on the customer and the bank. The pressures will lead to banks adjusting interest rate and make money in the short run but run the risk of default by borrower in the long run due to high interest rates. Further studies have found a nonlinear relationship between inflation and the banking sector performance. A study done by Boyd et. al, (2001) found a nonlinear significant negative relationship between inflation and banking sector performance. They confirmed that there is a rapid diminishing trend on banking lending activities as inflation increase; this is normally driven by the increase in cost of credit. Banks would adjust the price of loans and this would normally decrease uptake of the facilities and thus in the long run result in slowing down of lending.

Namazi et al, (2010) in their study found that there exists a direct correlation between inflation and decrease of absorbed deposit and loans given capacities of banks. The reduction in deposits is caused by the fact that banks would increase interest rates on loans and pay less for deposits thus reducing the deposits they have and hence by extension their ability to create credit. The study thus showed that inflation affects the two cornerstones of bank; deposits and loans; this fact means that inflation has a strong impact on the performance of the banking sector. Umar et al, (2014) concluded in their study on impact of inflation to banks that even though banks are normally able to withstand the effects of inflation at its initial stages, the impact of inflation can nevertheless be major. The banking system mostly operates with reference to interest rate and maturity of financial instruments ignoring the purchasing power of money 18

but when the rate of inflation becomes stronger, the banking system cannot absorb the shock. Their study concluded that inflation has a detrimental impact on the banking sector and that the effects can easily spillover and have an even bigger impact on the overall economy. 2.4.2. The Effects of GDP Growth on Profitability The gross domestic product (GDP) is a common macroeconomic indicator used to measure a country total economic activity. GDP affects a number of factors that relate to supply and demand of loans and deposits. When the growth in GDP slows down studies have shown that at the same time credit quality reduces and defaults increase. The increase in defaults results in a reduction of interest income and thus profitability of the bank. (Sufian et al., 2008) Combey & Togbenou, (2017) notes there are multiple linkages of real GDP growth to a number of bank performance indicators which are positively affected by its increase; net interest income, loan losses improving, and operating costs. The study finds that the profitability of banks tend to increase during periods of expansion, decrease during recession, high GDP growth leads to; increase in loans and deposits, net interest income as it normally implies a higher disposable income, a reduction in unemployment and loan default levels. The study concludes that Net interest income and loan losses are therefore pro-cyclical with GDP growth. Khasawneh & Kornreich, (2016) studied real GDP, they established that the performance of banks was linked to the movement of GDP. The study noted that during a crisis period the key factors that would explain the performance of banks are; operational efficiency, yearly growth of deposits, GDP growth and inflation. Their study went on further to established which factors had the most significant impact on banks’ profitability, they identified three factors that are 1% significant which means they have a 99% probability of impacting profitability; the factors identified were size, leverage and GDP. The study concluded that even though the most key issues that are pertinent to a bank’s profitability are normally internal the role played by external factors such as GDP should not be ignored as the impact may be major and have significant impact. GDP was considered to be problematic factor due to its unpredictability.

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GDP has been rarely used as a parameter to assess or measure different variables in the economy. However, Hoggarth et. al. (1998) studied real GDP and arrived at the conclusion it fails to explain the greater variability of banking sector profits in the UK than in Germany. The conclusion nevertheless did not explain the impact of GDP on profit but rather its impact on bank performance was evident. If this variable is not statistically significant in explaining profitability, then the conclusions of the authors are reinforced. Otherwise, the expected sign should be positive since higher growth implies both lower probabilities of individual and corporate default and an easiest access to credit. Some studies have linked the change in money supply to changes in the nominal GDP and the price levels. The money supply in the economy is a central bank function and its impact on GDP is not direct. Money supply may be affected by the behavior of households and banks, when this two units decide to spend there is increase in money supply in the economy. Kosmidou, (2008) related the change in money supply to changes in nominal GDP and thus a link to performance of banks. Mamatzakis et al, (2003) used the money supply as a measure of market size and find that the variable significantly affects bank profitability. Pasiouras et. al. (2007) in his study of UK banks found that the GDP growth rate has an impact on the profitability of banks. They conducted their study trying to monitor the changes in GDP and the impact of the same to bank profits. GDP simply measures the growth of economic activity in the country and thus its increase means improvement in activities and trade. Trade requires a financial system to prosper and thus when GDP increases and trade increases this leads to more business for banks and hence profits. 2.5.

Chapter Summary

This chapter discusses the factors that affect profitability of banks in depth form, by reviewing the existing literature on the same. The population definition, sampling technique, data collection and analysis is discussed in the research methodology that is covered in Chapter three.

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CHAPTER THREE 3. RESEARCH METHODOLOGY 3.1. Introduction This chapter focuses on the methodology was employed on this research. A discussion on the opted research design will provide guide on how this research will be conducted with specification on the target population that would be sampled for data collection. Further to this, an elaborate research procedure will be provided in articulation of the steps that will be carried out during this research for the specified duration. The tools to be pursued data analysis and manipulation would be identified. 3.2. Research Design Research design is the approach used and procedures of inquiry garnered while studying a given topic for data collection, analysis and reporting (Creswell, 2013). This study assumed the quantitative explanatory research design. The quantitative approach signifies that numerical data would be collected from a sample which is representative of the target population from which generalizations would be made of the population in study. Explanatory research would facilitate the examination of the cause and effect relationships between the independent and dependent variables (Realtor University Library, 2015). The independent variables for the research are; capital regulations, loan regulations, corporate governance, inflation, GDP, mobile banking and online banking. The dependent variable in the study is profitability 3.3. Population and Sampling Design 3.3.1. Population A research population is described as the collective elements of analysis for a particular study. These elements would have similar characteristics (Ross, 1978). The population size for this study comprised of 59 finance department employees from 10 banks within Nairobi

21

County. The population covered people who deal with financial reporting and or accounting functions and have good understanding financials of banks. 3.3.2. Sampling Design A sample is the representative group of subjects that are selected from a larger target population for the purpose of studying and making generalized inferences about the broader population. The process of selecting this sub set from the population is known as sampling. The sampling design is a plan used to derive the samples from the population (Prasad, 2015). 3.3.2.1. Sampling Frame A sampling frame is the list of the individuals in the target population from which the sample is selected. Sampling frames are ideal for providing the means for selecting the respective individuals of the target population that data will be collected from (Turner, 2003). The study required the collection of data from staff with intricate knowledge on how banks function and factors that influence profitability. The sampling frame strives to identify a sample that may provide required data. The sampling frame for this study was a list of 59 Finance department employees working in 10 commercials banks. The list was obtained from the respective finance departmental heads of the banks in the study. 3.3.2.2. Sampling Technique The probability sampling design was used for this research. This design ensured that each sample has the same chance of being selected, in addition to this, it allows the calculation of bias and likelihood of error in the data that would be collected. A multi stage sampling procedure was borrowed, where the researcher identifies the various groups from which the samples would be drawn followed by the process of obtaining names of the respondents in the group and then sample within it (Creswell, 2013). The random stratified technique was adopted where the population was be broken down into categories known as strata. The characteristics of this population would be pre-determined in appropriateness for the specific objectives. The essence of stratification would be to reduce the sample variance and ensure representation of the samples (Realtor University Library, 22

2015). The strata chosen was the relevant departments to be used for data collection as stated in the sampling frame. The questionnaire was then distributed to the departments to facilitate data collection. 3.3.2.3. Sample Size Determining the sample size for this study required consideration of the below critical factors; degree of accuracy and confidence level. The degree of accuracy denotes the expected difference between the true population and a sample estimate of the same parameter. Confidence level is the percentage of all possible samples that can be expected to include the true population. The formula based on the Central Limit Theorem in use to calculate the sample size is; S=

X2NP(1-P) D2(N -1)+X2P(1-P)

where; S = Sample size X2 = Z score value of 1.96 for 95% confidence level N = Population Size P = Population proportion (50%) D = Degree of accuracy (5%) The above formula therefore resulted to a sample size of 59 for this study. 3.4. Data Collection Methods The instrument for the collection of primary data was a questionnaire. A questionnaire is an instrument structured in a set of questions and is used for gathering and documenting of information from individuals about an area of interest (Department of Health and Human Services, 2008).

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The relevance of this instrument for this research was to facilitate the collection information from a large pool of individuals through the wide dissemination within a significantly minimal period of time. In addition to this, the questionnaires maintained the privacy of the respondents with the aim of anonymity especially as the study involved sensitive information. The nature of the questionnaire, given that it catered for both closed-ended and open-ended design of questions, allowed for the collection of data for both statistical analysis and expression of position from which opinions were given. The sequence of questions in this instrument was thematic with regards to the respective specific objectives defined in Chapter 1. Section A of the questionnaire captured the general information about the respondents while section B, C and D captured information about the specific objectives and their impact on the operations of the bank. The last section was E which structured with questions that wanted to find out the impact of all the factors on the profitability of the bank 3.5. Research Procedures The research procedure comprised of a set of activities that were carried out over the course of August and January 2017. The research proposal was submitted to the University for Approval before proceeding and modifications to be made on receipt of feedback.

The Questionnaire was designed under the guidance of the project supervisor and later piloted to 5 accountants working in banks to ensure clarity of questions and modification to be made to achieve exhaustiveness and precision to the areas of study. The feedback gathered from the pilot was used to amend the questionnaire and perfect the same before rollout. Once the successful pilot and modification was complete, a request for an introductory letter from the University was made and the letter facilitated the seamless acceptance of the questionnaire and participation into the study. The sample size enabled the researcher engage the respondent banks directly for drop off and pick up of the questionnaires which was the preferred tool for the study.

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The utilization of the existing networks in the banking sector and the bankers association to assist in follow ups and setting up of introductory meetings enabled the research achieve a high response rate. 3.6. Data Analysis Methods The data entry and cleaning was done using Microsoft excel and all the data that appeared to be incomplete or dubious was cleared from the rest to minimize on errors during analysis. The data was analyzed using of Microsoft Excel software package for inferential and descriptive statistical analysis. Inferential statistics deals with interpretations about the population based on the findings gathered from the samples. The concept is to determine the likelihood for the results achieved from a sample being similar to the results anticipated from the target population. Descriptive statistics would enable the description of the distribution of scores using given statistics that are used in dependence of the variables in study. (Mugenda, 2003).

The descriptive analysis was in the form of means which were the average of a set of measurements and standard deviation being the extent to which scores within a distribution deviate from the average, variances and distribution frequencies. All the variables were calculated using Microsoft excel tool. The analyzed data was presented by use of tables. 3.7. Chapter Summary This chapter explains in detail the research process and the methodology that was used in the research. The population for the study was 70 accounting and finance department staff of Kenyan banks and the sample for the study was 59. The data was collected via questionnaires and the analysis was done using Microsoft excel and inferential statistics were used in the analysis. The next chapter will present the results and findings.

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CHAPTER FOUR 4.0 RESULTS AND FINDINGS 4.1 Introduction This chapter addresses the analysis and presentation of the data collected from the questionnaires on the factors influencing the profitability of Kenyan banks in the 21st century. The results and findings relate to the following specific objectives guiding this study; to determine the effects of regulations on bank profitability, to determine the effects of technology on bank profitability and to determine the effects of macroeconomics on bank profitability. The findings are presented via tables. 4.2 General Information The study had targeted 59 respondents out of whom 50 correctly completed and returned their questionnaires for analysis. The questionnaires that we considered unusable were 12 in number and they contained errors in terms of; incomplete sections and some had one response for all sections. The return rate achieved was 81% which is above the average mark and it allows for the views of the sample population to be considered to be the views of the whole population. Table 4. 1 Response Rate Response Rate Response Non- Response Total

Frequency 50 12 62

Percentage 81% 19% 100%

4.2.1. Gender of Respondents On the demographics information of the population, the study asked a question to the respondents in regards to their gender in order to establish the distribution. The study established that 72% of the respondents were male while 28% were female. The table below presents the findings;

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Table 4. 2 Gender Gender Male Female Total

Frequency 36 14 50

Percentage 72% 28% 100%

4.2.2. Age Groups The study also sought to identify the age distribution of the respondents. From the results, 66% of the respondents were between 25 – 29 years, 32% were between the ages of 30 – 35 years while only 2% of the respondents were above 35 of age. The results of the various age groups are indicated in table 4.3 below; Table 4. 3 Age Groups Age – Group (Years) 20 - 24 25 - 29 30 - 35 > 35 Total

Frequency 0 33 16 1 50

% 0% 66% 32% 2% 100%

4.2.3. Level of Education The study also wanted to establish the education of the respondents, 98% of the respondents had bachelor’s degrees while only 2% had Masters Level of education, and the results are shown in table 4.4 below; Table 4. 4 Level of Education Level of Education Degree Masters Total

Frequency 48 2 50

% 98% 2% 100%

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4.2.4. Work Experience The table below seeks to show the work experience of the respondents of the study; 42% of the respondents had work experience had 0 – 4 years, 50% of had experience of between 5 – 9 years and 8% had 10 – 15 years, and the results are shown in table 4.5 below;

Table 4. 5 Work Experience Level of Education 0 – 4 Years 5 – 9 Years 10 – 15 Years Total

Frequency 21 25 4 50

% 42% 50% 8% 100%

4.3 Impact of Regulations on Profitability The study sought to determine the impact of regulations on the profitability of banks. The study focused on the impact of regulations on the cornerstone elements of banks i.e. assets and how regulations impacted assets and what adjustments were made. 4.3.1. Impact of Capital Adequacy Regulations on Balance Sheet Items The study reviewed assets as classified by the prudential guidelines and sought to establish the type of balance sheet items that are affected by regulations in the banking sector. The study looked at the impact of capital adequacy ratios on balance sheet items and later took a deeper focus on the impact of loan regulations on a bank. The respondents were asked to rank the balance sheet items that were affected by capital adequacy regulations in terms of change in policy and strategy on a scale of 1 – 4 (where 1 = strongly agree while 4 = strongly disagree). The study looked at the balance sheet items as classified by the prudential guidelines with the aim of understanding the changes to the said assets due to the new rules. The table 4.6 below shows the results; Core capital had a mean of 1.54, standard deviation of 0.5035 with a variance of 0.2535, Deposits from local institutions had a mean of 1.5, standard deviation of 0.5047 with a variance 0.2547, Deposits from foreign institutions had a mean of 2.22, 28

standard deviation of 0.8154 with a variance of 0.6649, Foreign treasury bills and bonds had a mean of 2.1, standard deviation of 0.7354 with a variance 0.5408, Claims guaranteed by multi-lateral banks Loans had a mean of 2.32, standard deviation of 0.8676 with a variance 0.7527, Loans and advances secured by residential property had a mean of 1.92, standard deviation of 0.8533 with a variance 0.7282, Other loans and advances had a mean of 1.80, standard deviation of 0.5714 with a variance 0.3265, Other Investments had a mean of 1.92, standard deviation of 0.5657 with a variance 0.32, Fixed assets had a mean of 1.96, standard deviation of 0.6688 with a variance 0.4473, Amounts due from other companies had a mean of 2.18, standard deviation of 0.7743 with a variance 0.5996. Table 4. 6 Impact of Capital Adequacy Regulations on Balance Sheet Items

Mean

Standard Deviation Variance

Core Capital

1.540

0.5035

0.2535

Deposits from local institutions

1.520

0.5047

0.2547

Deposits from foreign institutions

2.220

0.8154

0.6649

Foreign treasury bills and bonds

2.100

0.7354

0.5408

Claims guaranteed by multi-lateral banks

2.320

0.8676

0.7527

Loans and advances secured by residential property

1.920

0.8533

0.7282

Other loans and advances

1.800

0.5714

0.3265

Other Investments

1.920

0.5657

0.3200

Fixed assets

1.960

0.6688

0.4473

Amounts due from other companies

2.180

0.7743

0.5996

The study also looked into the strategy most banks implemented in regards to the position they had in relation to the balance sheet items. The respondents were asked to state the measures their banks took in regards to the balance sheet items that were affected by capital adequacy regulations in terms of change in policy and strategy with a rating of 1 – 3 (where 1 = Increase position, 2 = Decrease position while 3 = No Impact). The table 4.7 below shows the results; Core capital had a response of 82% for an increase position, 14% for a decrease in the positions while 4% noted that the regulations had no 29

impact on the positions, Deposits from local institutions had a response of 16% for an increase position, 18% for a decrease in the positions while 66% noted that the regulations had no impact on the positions, Deposits from foreign institutions had a response of 22% for an increase position, 42% for a decrease in the positions while 36% noted that the regulations had no impact on the positions, Foreign treasury bills and bonds had a response of 18% for an increase position, 2% for a decrease in the positions while 80% noted that the regulations had no impact on the positions, Claims guaranteed by multi-lateral banks Loans had a response of 20% for an increase position, 26% for a decrease in the positions while 54% noted that the regulations had no impact on the positions, Loans and advances secured by residential property had a response of 30% for an increase position, 66% for a decrease in the positions while 4% noted that the regulations had no impact on the positions, Other loans and advances had a response of 8% for an increase position, 64% for a decrease in the positions while 28% noted that the regulations had no impact on the positions, Other Investments had a response of 12% for an increase position, 54% for a decrease in the positions while 34% noted that the regulations had no impact on the positions, Fixed assets had a response of 2% for an increase position, 62% for a decrease in the positions while 36% noted that the regulations had no impact on the positions, Amounts due from other companies had a response of 0% for an increase position, 42% for a decrease in the positions while 58% noted that the regulations had no impact on the positions.

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Table 4. 7 Changes to Balance Sheet Items due to Capital Adequacy Regulations

Core Capital

Frequency % Deposits from local institutions Frequency % Deposits from foreign Frequency institutions % Foreign treasury bills and bonds Frequency % Claims guaranteed by multiFrequency lateral banks % Loans and advances secured by Frequency residential property % Other loans and advances Frequency % Other Investments Frequency % Fixed assets Frequency % Amounts due from other Frequency companies %

No Increase Decrease Impact 41 7 2 82% 14% 4% 8 9 33 16% 18% 66% 11 21 18 22% 42% 36% 9 1 40 18% 2% 80% 10 13 27 20% 26% 54% 15 33 2 30% 66% 4% 4 32 14 8% 64% 28% 6 27 17 12% 54% 34% 1 31 18 2% 62% 36% 0 21 29 0% 42% 58%

Total 50 100% 50 100% 50 100% 50 100% 50 100% 50 100% 50 100% 50 100% 50 100% 50 100%

4.3.2. Impact of Corporate Governance Regulations on Operations 4.3.2.1. Importance of a Written Code of Governance Manual The study sought to establish the importance of a guiding document on the structure and policies of corporate governance so as to assist with implementation. The respondents were asked on their respective banks having a written code of governance manual, the table 4.8 below shows the results; 72% of the respondents confirmed having known of the existence of a manual while 28% had no knowledge of the existence of a manual.

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Table 4. 8 Presence of a Written Corporate Governance Manual Presence of a written corporate governance manual

Frequency

%

YES

36

72%

NO

14

28%

TOTAL

50

100%

4.3.2.2. Impact of Corporate Governance Regulations on Operations The study looked at the impact of corporate governance regulations on the operations of banks. The respondent were asked on the impact via a rating scale and also via a strategic actions taken by a bank due to the regulations. The respondents were asked to rank the impact of certain new corporate governance regulations on the smooth operations of the bank, the scale of 1 – 4 (where 1 = strongly agree while 4 = strongly disagree). The table 4.9 below shows the results;

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Table 4. 9 Impact of Corporate Governance Regulations on Operations Standard Deviation

Variance

3.260

0.751

0.564

3.380

0.725

0.526

The regulation that central Bank of Kenya has to approve acquisition of more than 5% of the share capital of an institution where there is fresh capital injection, or from existing shareholders has affected the smooth operations and effective management of your bank.

3.420

0.609

0.371

The regulation that the Board of Directors have regular meetings has affected the smooth operations and effective management of your bank.

3.220

0.840

0.706

The regulation that the Board of Directors is responsible for vision, mission & Strategic plan has affected the smooth operations and effective management of your bank.

3.140

0.881

0.776

The regulation that the policies & procedures on corporate governance are extensively applied in the bank has affected the smooth operations and effective management of your bank.

2.320

0.978

0.957

Regulation

Mean

The regulation that no shareholder with more than five percentage (5%) shareholding in a banking institution shall be an executive director has affected the smooth operations and effective management of your bank. The regulation that no shareholder with more than five percentage (5%) shareholding in a banking institution shall form part of the management of the institution has affected the smooth operations and effective management of your bank.

The respondents were asked to state the how the new regulations affected the speed of strategy implementation in the bank via a rating of 1 – 3 (where 1 = Increase position, 2 = Decrease position while 3 = No Impact).

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Table 4. 10 Impact on Strategy Implementation as a result Corporate Governance Regulations No Increase Decrease Impact Total

REGULATION The regulation that no shareholder with more than five percentage (5%) shareholding in a banking institution shall be an executive director has affected the smooth operations and effective management of your bank. The regulation that no shareholder with more than five percentage (5%) shareholding in a banking institution shall form part of the management of the institution has affected the smooth operations and effective management of your bank. The regulation that central Bank of Kenya has to approve acquisition of more than 5% of the share capital of an institution where there is fresh capital injection, or from existing shareholders has affected the smooth operations and effective management of your bank. The regulation that the Board of Directors have regular meetings has affected the smooth operations and effective management of your bank. The regulation that the Board of Directors is responsible for vision, mission & Strategic plan has affected the smooth operations and effective management of your bank. The regulation that the policies & procedures on corporate governance are extensively applied in the bank has affected the smooth operations and effective management of your bank.

Frequency

%

Frequency

%

Frequency

% Frequency %

Frequency

% Frequency

% 34

7

26

14%

52%

7

23

14%

46%

7

31

14%

62%

36

9

72%

18%

29

3

58%

6%

37

9

74%

18%

17

50

34% 100%

20

50

40% 100%

12

50

24% 100% 5

50

10% 100%

18

50

36% 100% 4

50

8% 100%

4.3.3. Impact of Loan Regulations on Operations The study looked at the impact of regulation in regards to loans specifically, the aim for the focus was to assess how regulations affected the key revenue driver loans. 4.3.4.1.

Importance of a Written Credit Policy

The study sought to establish the importance of a guiding document on the structure and policies of credit so as to assist with implementation. The respondents were asked on their respective banks having a written credit policy, the table 4.11 below shows the results; 72% of the respondents confirmed having known of the existence of a manual while 28% had no knowledge of the existence of a manual. Table 4. 11 Presence of a Written Credit Policy Presence of a written credit policy

Frequency

%

YES

50

100%

NO

0

0%

TOTAL

50

100%

4.3.4.2.

Impact of Loan Regulation on Profitability

The study looked at the impact of loan regulations on the profitability of banks. The respondent were asked on the impact via a rating scale and also via strategic actions taken by a bank due to the regulations. The respondents were asked to rank the impact of certain new loan regulations that have led to a reduction in the profitability of banks, respondents were asked to use the scale of 1 – 4 (where 1 = strongly agree while 4 = strongly disagree) . The table 4.12 below shows the results;

35

Table 4. 12 Loan Regulations that have led to Reduction of Profits

Mean Central bank’s lending guidelines have led to the reduction of profits that banks make from loans The regulation requiring classification of multiple loans from a single borrower as non-performing due to one loan not performing has led to the reduction of profits that banks make from loans

Standard Deviation Variance

2.200

0.670

0.449

2.260

0.694

0.482

2.100

0.614

0.378

1.380

0.667

0.444

1.780

0.954

0.910

1.340

0.626

0.392

The regulation requiring consumer protection guidelines affecting the disposal of collateral security have led to the reduction of profits that banks make from loans The regulations introducing the use of credit reference bureau have led to the reduction of profits that banks make from loans Future appreciation in value should not affect the discounted value of collaterals that will be deducted from the loan balance before making provisions have led to the reduction of profits that banks make from loans The loan loss provisioning regulations have led to the reduction of profits that banks make from loans

The respondents were asked to state the how the new loan regulations affected the growth in the number of loans issued in the bank via a rating of 1 – 3 (where 1 = Increase position, 2 = Decrease position while 3 = No Impact).

36

Table 4. 13 Impact of Loan Regulations on Loan Disbursements No Increase Decrease Impact Central bank’s lending guidelines have led to the reduction of profits that banks make from loans The regulation requiring classification of multiple loans from a single borrower as nonperforming due to one loan not performing has led to the reduction of profits that banks make from loans The regulation requiring consumer protection guidelines affecting the disposal of collateral security have led to the reduction of profits that banks make from loans The regulations introducing the use of credit reference bureau have led to the reduction of profits that banks make from loans Future appreciation in value should not affect the discounted value of collaterals that will be deducted from the loan balance before making provisions have led to the reduction of profits that banks make from loans The loan loss provisioning regulations have led to the reduction of profits that banks make from loans

Frequency % Frequency

% Frequency

% Frequency %

Frequency

% Frequency %

Total

0

50

0

50

0%

100%

0%

100%

5

28

17

50

10%

56%

34%

100%

11

13

26

50

22%

26%

52%

100%

12

29

9

50

24%

58%

18%

100%

0

16

34

50

0%

32%

68%

100%

0

31

19

50

0%

62%

38%

100%

4.4 Impact of Technology on Profitability The study sought to determine the impact of technology on the profitability of banks. The study focused on the impact of technological innovations on how banks operate and how the same has changed. All the banks that were covered in the study provided online and mobile banking to their customers. 37

4.4.1. Bank Transactions available on Online Platforms The study sought to establish the importance of technology in improving the access to bank services in a quicker and efficient way. The respondents provided information on the various services that were available on the online platform, the table 4.14 below shows the results; Loan application processes were not available on the platform as confirmed by 100% of the respondents, Local funds transfer processes were available on the online platforms as confirmed by 100% of the respondents, International funds transfer services were provided by 46% of the banks while 56% did not have the service, Customer service/feedback services were provided by 60% of the banks while 40% did not have the service, Credit card services were provided by 44% of the banks while 66% did not have the service, Utility payment were provided by 42% of the banks while 58% did not have the service while Client Account opening services were provided by 46% of the banks while 52% did not have the service. Table 4. 14 Banking Transactions provided on the Online Platforms Transaction Personal loan application

Frequency % Frequency % Frequency % Frequency % Frequency % Frequency % Frequency %

Local funds transfer International funds transfer Customer service / feedback Credit card services Utility payment Client Account opening

38

Availability YES NO 0 50 0% 100% 50 0 100% 0% 23 27 46% 54% 30 20 60% 40% 22 28 44% 56% 21 29 42% 58% 23 26 46% 52%

4.4.2.

Bank Transactions frequently used by clients

The study sought to establish the services that clients used the most on the various technology platforms. The respondents were asked to rate the use of the various services in terms of frequency of usage in terms of rating of 1 – 3 (where 1 = Never, 2 = Occasionally & 3 = frequently) The table 4.15 below shows the results of the study; Personal loan application processes had 100% of the respondents saying they never used this transaction and this related to fact that most banks had not automated this service, Local funds transfer processes were utilized occasionally by 18% of the respondents and frequently by 82% of the respondents, International funds transfer services were never utilized by 54%, occasionally by 32% of the respondents and frequently by 14 % of the respondents. Customer service/feedback services were never utilized by 40%, occasionally by 38% of the respondents and frequently by 22% of the respondents, Credit card services were never utilized by 56%, occasionally by 28% of the respondents and frequently by 16% of the respondents, Utility payment were never utilized by 58%, occasionally by 24% of the respondents and frequently by 18% of the respondents while Client Account opening services were never utilized by 52%, occasionally by 28% of the respondents and frequently by 20% of the respondents.

39

Table 4. 15 Usage of Banking Transactions on Online Platforms

Personal loan application

Frequency % Local funds transfer Frequency % International funds Frequency transfer % Customer service / Frequency feedback % Credit card services Frequency % Utility payment Frequency % Client Account opening Frequency %

4.4.3.

Never 50 100% 0 0% 27 54% 20 40% 28 56% 29 58% 26 52%

Usage Occasionally Frequently 0 0 0% 0% 9 41 18% 82% 16 7 32% 14% 19 11 38% 22% 14 8 28% 16% 12 9 24% 18% 14 10 28% 20%

Total 50 100% 50 100% 50 100% 50 100% 50 100% 50 100% 50 100%

Usage of Mobile Banking vs Internet Banking

The study sought to find out usage of mobile banking and internet banking from the respondents. The respondent were requested to rate the technology platforms that they preferred to interact with banking services. The scale used was 1 – 3 (where 1 = Frequently Used, 2 = Rarely Used & 3 = Never Used) The table 4.16 below shows the results; all the respondents confirmed using the both internet and mobile banking platforms, mobile banking was frequently used by 46% of the respondent and 54% rarely used the platform, internet banking was frequently used by 56% of the respondent and 44% rarely used the platform.

40

Table 4. 16 Usage of Mobile Banking and Internet Banking

Mobile Banking Internet Banking

4.4.4.

Frequency % Frequency %

Frequently Used 23 46% 28 56%

Usage Rarely Used 27 54% 22 44%

Never Used

Total 0 0% 0 0%

50 100% 50 100%

Impact of Technology on Banks Operations

The study sought to assess the impact of technology on operations and hence profitability via asking a particular set of questions in regards to the technological changes. The respondents were asked to rank the impact of some technological issues on the profitability and or operations of banks, respondents were asked to use the scale of 1 – 4 (where 1 = strongly agree while 4 = strongly disagree). The table 4.17 below shows the results; Table 4. 17 Impact of Technological Changes on Operations

Mean From the customer satisfaction surveys, the use of online banking has improved customer service The use of mobile and online banking is fundamental to the success of the bank The inception & maintenance of technology has been costly to the organization Mobile banking has increased the non-funded income lines for the bank The use of mobile and online banking services have led to the increase in the amount of transactions performed by the bank

41

Standard Deviation

Variance

1.580

0.499

0.249

1.440

0.501

0.251

1.880

0.328

0.108

1.560

0.541

0.292

1.640

0.525

0.276

4.5

Impact of Macroeconomics on Profitability

The study sought to determine the impact of macroeconomics on the profitability of banks. The focus was on the impact of key macroeconomic factors i.e. GDP and Inflation, and how they impact banks operations and profitability. 4.5.1.

Impact of Macroeconomic Factors on Bank Operations

The study focused on inflation and GDP with the aim of understanding how the factors affected banks at macro level. The study sought to ascertain if macroeconomic factors had a role to play in the operations of banks and also by extension the profitability of the banking sector. The respondents were asked if the macroeconomic factors greatly impacted the operations of their bank. The table 4.18 below shows the results; Table 4. 18 Effect of Macroeconomics on Operations of the Bank

Macroeconomic factors (Inflation, GDP) Frequency have greatly affected operations at the bank % 4.5.2.

YES

NO

TOTAL

50

0

50

100%

0%

100%

The Key Macroeconomic Factors for Bank Operations

The study looked at the two macroeconomic factors with the aim of establishing which factor between inflation and GDP was more critical to a banks operation. The respondents were asked which of the two factors was considered critical to banks operations. The table 4.19 below shows the results; Table 4. 19 The Key Macroeconomic Factors for Bank Operations Inflation GDP Both Which Macroeconomic factor (Inflation, GDP) has greatly affected operations at the bank

Frequency %

42

Total

20

19

11

50

40%

38%

22%

100%

4.5.3.

Impact of Changes in Macroeconomics on Bank Operations

The study sought to assess the impact of macroeconomics on operations and hence profitability via asking a particular set of questions in regards to the changes in macroeconomics. The respondents were asked to rank the impact of some macroeconomics changes on the profitability and or operations of banks, respondents were given a set questions describing certain changes and then were asked to rank this changes using a scale of 1 – 4 (where 1 = strongly agree while 4 = strongly disagree). The table 4.20 below shows the results; Table 4. 20 Impact of Macroeconomic Changes on Bank Operations

Mean

Standard Deviation Variance

The changes in macroeconomic factors greatly impact the banks strategy

1.340

0.479

0.229

Inflationary changes have a strong impact on operations and business plans greatly affected profitability

1.820

0.774

0.600

Higher inflation implies less long-run financial activity and thus a reduction in demand for loans

2.040

0.807

0.651

Higher GDP implies more long-run financial activity and thus an increase in demand for loans

1.500

0.544

0.296

High inflation rates lead to stringent lending policies for banks

2.100

0.735

0.541

4.6

Chapter Summary

This chapter presented the findings of the research paper, it detailed the methods applied to analyze, present and interpret data collected using the questionnaires. The chapter elaborates the descriptive statistics techniques used when analyzing the data collected and calculates the frequency, mean, standard deviation and variance in order to interpret the results. The chapter presented the results in percentages and number with the structure being based on the specific objectives the study aimed to address. The next chapter presents the discussions of the findings of this chapter, the summary of the study, conclusions and the recommendations for the study. 43

CHAPTER FIVE 5.0 DISCUSSIONS, CONCLUSIONS AND RECOMMENDATIONS 5.1 Introduction This chapter presents the summary of this study; the sections that follow have broader discussions, recommendations and conclusions made from the evaluation of the stated research questions of the study. 5.2 Summary The purpose of this study was to investigate the factors influencing the profitability of Kenyan banks in the 21st century. The study was guided by the following specific objectives: to determine the effects of regulations on bank profitability, to determine the effects of technology on bank profitability and to determine the effects of macroeconomics on bank profitability. This research adopted a descriptive research design. The research population was 70 which consisted of employees from 10 banks in Nairobi who specifically dealt with finance and or strategy in the bank, using a confidence level of 95%, the sample size was 59 employees. The banks to be selected focused on serving the key client classifications in the Kenyan market; Retail, Corporate and SME. The data collection method was via questionnaires and the analysis tool for the information was MS Excel. The findings on the impact of regulations on profitability indicated that regulations played a big role on how banks performed. The study looked at three types’ regulations; capital adequacy regulations, corporate governance regulations and loan regulations. Capital adequacy regulations led to the need for banks to reconstitute most of their balance sheet items in order to satisfy regulations while corporate governance was found to have little or no impact to the smooth operations of the bank. Loan regulations were found to have led to reduction of profitability by tightening the minimum lending rules and also by putting more controls on reporting practices by banks.

44

The study revealed that technology had changed the operations of banks by allowing provision of most banking services via several platforms. The banks in the study had automated most of their services hence improving access by consumers to their services. The impact of embracing technology was found to be far reaching from the improvement of service provision to efficiency. The study looked at two key macroeconomic factors and the impact they had on profitability of banks. Inflation and GDP were the factors looked at and it was found that they both played a key role in the financial activities in the economy and they had an impact on the policies implemented in the banking sector. 5.3 Discussions 5.3.1.

Determine the Effects of Regulations on Bank Profitability

The study found that regulations had impact on a banks’ operations and hence profit by affecting the changes in strategy and or policy brought about by the new rules. The impact of core capital regulations on balance sheet items was found to be more on core capital that banks hold. The respondents overwhelmingly noted that these regulations led to increase in the core capital amounts held by banks. The core capital regulations were found by more than half of the respondents to lead banks to decrease their positions in certain balance sheet items; Loans and advances secured by residential property, other loans and advances, Other Investments and Fixed assets. The regulations had little or no impact on; Deposits from local institutions, foreign treasury bills and bonds and claims guaranteed by multi-lateral banks. The findings were similar with Martinez-Miera & Suarez, (2014) who affirms that capital requirements reduce cost of credit and output in calm times but lead to certain trade-offs by banks of non-trivial items. The intended impact of core capital regulations is normally to induce weakly capitalized banks to rebuild their capital reserves in a rapid way and in the process improve their position. The study affirms that this purpose was achieved as the respondents noted that the banks were indeed forced to shore up their core capital positions. The study in affirms this conclusion as most of the banks in the study adjusted core capital upwards improving their 45

stability. The impact of core capital regulations though varies with many banks with the choice of which position to be adjusted normally being guided by the cost of the adjustment. The increase of Tier 1 capital for example is an expensive option as compared to Tier 2 capital or the adjustment of risk weighted assets which are used in the calculation of core capital ratios. The study affirms that banks adjust various positions so as to meet core capital regulation and at times this may involve the reduction of loans similar Jackson, Furfine, Yoneyama, & Hancock, (1999) and their conclusion on impact of the regulations. The other type of regulations looked in the study was corporate governance regulations that have forced banks in the Kenyan banking sector to change various modalities from the operation systems to their management structure. The study found that most participants had a written corporate governance manual which had been shared to staff hence showing commitment of banks to the implementation. Corporate governance is key to the success of an organization and the communication followed by implementation of the same to an organization helps an entity achieve accountability, transparency and ethical values (Mohammed, 2012) The study further established that the impact some selected new corporate governance regulations have led to better conditions of operation and enhance effective management structures. The research thus affirms the findings of Espiritu, (2005) that the issuance of corporate governance regulations results in better governance of an institution as it provide key assistance to the Board. One of the key regulations that is being implemented in recent times in Kenya is the requirement that shareholders owning more than 5% shareholding in a banking institution shall not be in the management of the bank. The respondents overwhelming noted that the regulations have not affected smooth operations which is in line with the separation of roles as advocated by corporate governance regulations. The impact of loan regulations on profitability was found to be negative as the regulations imposed more controls and rules in regards to the issuance of loans hence they resulted in the reduction of income earned by the bank. The recent regulatory reforms in the banking sector have created new reporting structures, leverage ratios and new norms of industry practice. The reforms have led to regulatory and in the process hampered credit growth thus leading to reduced income generating potential of the banks this shown by the study and it 46

affirms the conclusions of Yadav et. al., (2014) as to the effects of regulation. The study agreed with the conclusions on the regulations as the respondents showed that new reporting structures had an impact on the performance of their banks, the requirements on qualification for facilities led to reporting of more provisions which had an impact on profitability. Further new conditions on qualifications for facilities led to a decrease on the number of facilities issued hence a direct impact on profitability. 5.3.2.

Determine the Effects of Technology on Bank Profitability

The study found that banks have gone a long way in automating most of the revenue earning services in order to improve access of their services to their clients. The study sought to establish and compare the services that were available on the online platform. It was clear that all services that were clear revenue earners had already been automated while the slow and sensitive revenue services were yet to be automated. Loan application services were yet to be automated by the banks which were surveyed in the study. The use of technology in the banking sector has improved reach and facilitated faster operation and distribution services without much investment Berger et al., (2003) a conclusion affirmed by the study. The study found out that the use of technology was not platform based but rather more on the availability and convenience of the platform to access the banking services. The study looked at the use of mobile banking and internet banking services and established the fact that both were prevalent in use by the customers in the various banks. The respondents noted that the usage of the platforms was of a high frequency as both were of convenience and served to improve access to services. This supported the notion that e-banking activities are gaining a significance importance in the banking sector and its drive was to enhance service quality and efficiency Ho, (2006) a conclusion affirmed by the study. The study found out that the use of technology has improved customer satisfaction in the banks that participated in the study. The respondents further agreed that technology had become a key determinant in the success of banks as it is now the key separator in service delivery and efficiency. The speedy acceptance of technology bay banks has been necessitates by the fact that banks have been forced to innovate in order to survive and increase the customer base available. The number of banks is on the increase and the target 47

pool of customers is also on the rise, product differentiation and quality of service have become key differentiators that improve customer’s satisfaction. Thulani et. al., (2009) conclude that technology is transforming the banking and financial industry in general by changing how products and services are packaged, proposed, delivered and consumed as affirmed by the study. The study also found that the cost of technology for banks has been high as it involves a steep purchase and implementation cost. The general cost of technology is high due to other reasons; this include the cost of strategic, operational and organizational changes which at a cost. The cost of acquisition of the best technologies is still on the rise as most IT solutions providers aim to provide up to date solutions with numerous functionalities and abilities so as to compete with other providers. The cost of technology innovations and solutions available to banks has not stopped the acceptance or implementation of the solutions as the solution have a become a necessity rather an option, Vater, Cho, & Sidebottom, (2012) conclude this and further explain that the technology revolution is not limited to the banking sector and companies like Kodak and Blockbuster resisted change and this led to their collapse. The study found that technology impacted profitability via increase in the non-funded income lines and also by the number of transactions that customers would do due to convenient access to bank services. Non-funded income is considered to be critical income to a bank’s profitability; this is an income source that is earned with no cost of funds hence it has a straight through impact to a banks bottom line. Smith et. al., (2003) explain the importance of non-funded income in their study and note that non-interest income is more important than interest income as it plays a key role in stabilizing the total operating income of a bank. The importance of this source of income gives a bank strategic reliance in the source of income and solutions that advance the stability of this revenue source are at the core of a bank’s profitability. The improvement of number of transactions was evidenced by the finding in the study as the respondents noted that online banking services led to an increase in transactions performed by the customers of the bank. The convenience of the platforms and access of services at a touch of button have been a game changer for banks in enabling them access their clients in 48

a cost efficient way hence improving service provision thus increasing the total number of transactions. 5.3.3.

Determine the Effects of Macroeconomics on Bank Profitability

The study focused on two key macroeconomics factors (GDP and inflation) among the many and found out that both factors have a great impact on the operations of banks. The study wanted to establish the role that macroeconomics factors play in the operations of banks and thus the impact they have on profitability. Boyd et. al., (2001) concluded the same in their study about the impact of inflation but went on further to explain that the effect of inflation on profitability related to the effect on costs of the banks and lending. They stated when inflation is high the operating costs increase while the lending reduces hence a negative impact on profitability of banks. The study wanted to establish which of the two identified macroeconomic factors had the most impact on the operations of the bank and the response indicated that the impact of both GDP and Inflation was considerable. The role of GDP in the economy and Inflation work in tandem on the impact on the economy and hence the operations of banks. The study established that the changes in these macroeconomic factors led to a change in the bank’s strategy, operations and business plans. The two factors; inflation and GDP were found to have a significant impact on profitability. The impact of GDP on banking performance was shown by the study to impact three key lines; net interest income, losses from loans and operating costs. The study affirmed the findings of Boyd et. al., (2001) that during periods of high GDP which is associated with economic expansion the impact on profitability will be positive and the profitability of the institutions including banks will increase. The lower the GDP rates the most likely occurrence is that there would be a decrease in the deposits and loans for banks plus the increase in management costs. The study affirms this conclusion by demonstrating that high GDP rates lead to an increase in demand for loans which would lead to increase in interest income and thus profits. The impact on inflation also led to changes in the bank’s core activity of lending, high inflation means and increase in prices with reduced profitability margins as agreed prices 49

may not be adjusted as materials cost increase. The immediate adjustment of costs and a sluggish adjustment in revenue drivers would in most cases lead to defaults as the strain on the borrower would increase thus leading to defaults. Flamini, Mcdonald, & Schumacher, (2009) affirm this conclusion in their study by stating that the impact of these macroeconomics factors is indeed cross-cutting from the revenue to expenses with adjustments being forced on an institution in order for good performance to be sustained. The study also found that GDP had a role to play in the profitability achieved by banks, the respondents noted that there was indeed a relationship between the two. GDP is a factor used to explain or measure economic growth in an economy. The role GDP thus is seen to be critical to the success of banks, growth in the economy is associated with an increase in mobility of funds in the economy hence a chance for financial institutions to benefit from provision of their services. Rumler & Waschiczek, (2010) affirm in their study that the impact on the profitability of banks can indeed be established from studies in different financial markets and that there is indeed a positive correlation between financial performance and GDP growth. The study found out that the two macroeconomics were key to banks operations and success as they incorporated in the formulation of bank policy, strategy and costing of banks products. The factors were seen to be a predictor of economic activity in the future hence a key component in the generation of future plans of strategy. The study established that high GDP was a strong indication of increased economic activity in the banking sector and this meant an increase in the demand for loans to finance the various economic activities in the country. Inflation on the other hand was seen to affect a number of factors from; operations due to the increase in costs, change in the lending policies as the shift inflation increases general costs in the economy and reduces the loans disbursed due to an increase in default rate. The study showed that both factors were critical to decision making n banks and they had impact on the operations of banks in the generation of revenue 0and later the conversion of the same into profits.

50

5.4 5.4.1.

Conclusion Determine the Effects of Regulations on Bank Profitability

The study concludes that regulations play a key role in the operations of banks and affect key lines of profitability for banks. Regulations lead to a change in the strategy that a bank is implementing as it involves the re-organization of various balance sheet lines to meet the required ratios or regulations. The impact of regulations to banks is major as it has both cost implications and operational implication; new regulation may affect the number of process required in the provision of a service and hence reduce efficiency or force manpower changes as is the case with corporate governance regulations. The impact of regulations is normally meant to be positive but in most cases results in negative scenarios due to the nature of the regulations. In Kenyan context, the country is implementing banking regulations that applicable in the developed in an economy that is still developing. The regulations should work regardless the market but generally fail due to the lack of understanding of the local context and scenarios. Regulations thus if developed in consultation with banks would result in a free and fair environment and also have a less distractive 5.4.2.

Determine the Effects of Technology on Bank Profitability

The study established that technology is key to profitability of banks in the 21st century. The impact of technological innovations have played a big role in the operations of banks and their profitability by reducing the costs of transactions and also improving the access to solutions by the various customers. Technology was found to be a key differentiator in competitor advantage and it was seen to lead to improved efficiency and customer satisfaction. 5.4.3.

Determine the Effects of Macroeconomics on Bank Profitability

The study found out that macroeconomic factors affect different facets of how banks operate and make profits. Macroeconomic are external determinants of profitability of banks and impact on both the bank and the bank’s customer hence the impact cannot ignored. The

51

factors result in cost changes and policy modification to ensure business continuity and also sustained profitability. 5.5 5.5.1.

Recommendations Recommendations for Improvement

5.5.1.1. Determine the Effects of Regulations on Bank Profitability The study recommends that banks and regulators work together in the development and implementation of regulations to ensure minimal interruptions to business. The regulations normally result in disruptions due to the lack having input from the users and hence they fail or result in negative effects in the economy. The recommendation is that the bank ensures that implementation is properly planned in advance and structures are put in place to avoid undue inconveniences. 5.5.1.2. Determine the Effects of Technology on Bank Profitability The study recommends that banks embrace technology but also ensure that they still use as part of their products and not the product. Technology can have value ads so that it becomes a differentiator between the providers of the various services, banks need to ensure their various platform are unique and they meet the needs of the customers. 5.5.1.3. Determine the Effects of Macroeconomics on Bank Profitability The study recommends that the impact of macroeconomics on profitability is unavoidable and hence proper planning and forecasting may be of help to cushion a bank from the impact. The diversification of revenue sources and focus on stable income sources like non-funded income may enable a bank further increase it cushion from macroeconomic factors. 5.5.2.

Recommendations for Further Studies

The current study investigated three factors and how they individually impacted profitability of banks with a key focus on respondents view on the impact. The study recommends that future studies should look at the combination of factors and their impact on profitability. The interlinkage of the factors would be critical as the factors do not individually occur but rather they normally impact the bank at the same time. 52

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APPENDIX Research Questionnaire

RESEARCH QUESTIONNAIRE – GLOBAL EXECUTIVE MBA This questionnaire is intended to facilitate the study on, “The Factors Influencing Profitability of Kenyan Banks in the 21st Century” The information you provide will be used for academic purposes only and will therefore be kept private and confidential. This activity will take at least 10minutes to complete. Your cooperation is highly appreciated. Section A: Background information 1.

What is the name of the bank where you are employed? _____________________________________________________________________

2.

What is your age? 20 – 24 Years

25 – 29 Years

3.

What is your Gender?

4.

Male Female What is your position in the bank?

30 – 35 Years

Over 35 Years

___________________________________________ 5.

Which one of the following department do you work in?

6.

Finance Strategy Others (Please Specify) ________________ For how many years have you worked in the banking sector? 0 – 4 Years

7.

5 – 9 Years

10 – 15 Years

What level of the organization do you fall under? Operations

Junior Manager

Senior Manager

Others (Please Specify) 8.

Over 15 Years

What is the highest level of your education? Certificate

Diploma

Degree 59

Masters

Others (Please Specify) ________________________________________________ Section B: Impact of Capital Adequacy Regulations on the Bank 1.

On a scale of 1 to 4 (where 1 = Strongly Agree and 4 = Strongly Disagree), The new capital adequacy regulations have necessitated a great change in policy and strategy

STRONGLY DO NOT AGREE

DO NOT AGREE

1.1. Capital adequacy regulations have had an

AGREE

STRONGLY AGREE

in regards to the following balance sheet lines.

1

2

3

4

1

2

3

4

1

2

3

4

1

2

3

4

1

2

3

4

1

2

3

4

1

2

3

4

1

2

3

4

1

2

3

4

effect core capital 1.2. Capital adequacy regulations have had an effect deposits from local institutions 1.3. Capital adequacy regulations have had an effect deposits from foreign institutions 1.4. Capital adequacy regulations have had an effect foreign treasury bills and bonds 1.5. Capital adequacy regulations have had an effect claims guaranteed

by multi-lateral

development banks 1.6. Capital adequacy regulations have had an effect

loans

&

advances

secured

by

residential property 1.7. Capital adequacy regulations have had an effect Other loans & advances 1.8. Capital adequacy regulations have had an effect Other investments 1.9. Capital adequacy regulations have had an effect Fixed assets

60

1.10. Capital adequacy regulations have had an

1

2

3

4

effect Amounts due from other group companies 2.

How did the bank adjust the value positions of the following balance sheet items to align itself to the updated CBK capital adequacy ratio regulations? Rate from 1 to 3

1

2

3

1

2

3

1

2

3

1

2

3

1

2

3

1

2

3

1

2

3

1

2

3

1

2

3

NO IMPACT

DECREASE

2.1. How have core capital value positions been changed due to

INCREASE

where 1 = Increase, 2 = Decrease & 3 = No Impact

the new capital adequacy regulations 2.2. How have deposits from local institutions value positions been changed due to the new capital adequacy regulations 2.3. How have deposits from foreign institutions value positions been changed due to the new capital adequacy regulations 2.4. How have foreign treasury bills and bonds value positions been changed due to the new capital adequacy regulations 2.5. How have claims guaranteed by multi-lateral development banks value positions been changed due to the new capital adequacy regulations 2.6. How have loans & advances secured by residential property value positions been changed due to the new capital adequacy regulations 2.7. How have other loans & advances value positions been changed due to the new capital adequacy regulations 2.8. How have other investments value positions been changed due to the new capital adequacy regulations 2.9. How have fixed assets value positions been changed due to the new capital adequacy regulations 61

2.10. How have amounts due from other group companies value

1

2

3

positions been changed due to the new capital adequacy regulations

Section C: The Impact of Corporate Governance on the Bank 1. Does the bank have a written code of governance manual? Yes

No

2. The below corporate governance regulations have negatively impacted the smooth operations and the effective management of your bank. On a scale of 1 to 4 (where 1 =

DO NOT AGREE

STRONGLY DO NOT AGREE

AGREE

2.1. The regulation that no shareholder with more than five

STRONGLY AGREE

Strongly Agree and 4 = Strongly Disagree)

1

2

3

4

1

2

3

4

1

2

3

4

percentage (5%) shareholding in a banking institution shall be an executive director has affected the smooth operations and effective management of your bank. 2.2.The regulation that no shareholder with more than five percentage (5%) shareholding in a banking institution shall form part of the management of the institution has affected the smooth operations and effective management of your bank. 2.3. The regulation that central Bank of Kenya has to approve acquisition of more than 5% of the share capital of an institution where there is fresh capital injection, or from existing shareholders has affected the smooth operations and effective management of your bank.

62

2.4. The regulation that the Board of Directors have regular

1

2

3

4

1

2

3

4

1

2

3

4

meetings has affected the smooth operations and effective management of your bank. 2.5. The regulation that the Board of Directors is responsible for vision, mission & Strategic plan has affected the smooth operations and effective management of your bank. 2.6. The regulation that the policies & procedures on corporate governance are extensively applied in the bank has affected the smooth operations and effective management of your bank. 3. How have the following factors affected the speed of strategy implementation in your

DECREASE

NO IMPACT

3.1.How has the regulation that no shareholder with more than five

INCREASE

bank? Rate this from a scale of 1 to 3 where 1 = Increase, 2 = Decrease & 3 = No Impact

1

2

3

1

2

3

1

2

3

1

2

3

percentage (5%) shareholding in a banking institution shall be an executive director affected the speed of strategy implementation 3.2. How has the regulation that no shareholder with more than five percentage (5%) shareholding in a banking institution shall form part of the management of the institution affected the speed of strategy implementation 3.3. How has the regulation that Central Bank of Kenya has to approve acquisition of more than 5% of the share capital of an institution where there is fresh capital injection, or from existing shareholders affected the speed of strategy implementation 3.4. How has the regulation that the Board of Directors have regular meetings affected the speed of strategy implementation 63

3.5. How has the regulation that the Board of Directors is responsible

1

2

3

1

2

3

for vision, mission and Strategic plan affected the speed of strategy implementation 3.6. How has the regulation that the policies and procedures on corporate governance are extensively applied in the bank affected the speed of strategy implementation Section D: Impact of Loan Regulations on the Bank 1. Does the bank have a written credit policy? Yes

No

2. What classes of customers have taken the most loans in the bank? Corporate

Retail

On a scale of 1 to 4 (where 1 = Strongly Agree and 4 = Strongly Disagree) The following

STRONGLY DO NOT AGREE

DO NOT AGREE

3.1. Central bank’s lending guidelines have led to the

AGREE

regulations have reduced the profits that banks make from loans.

STRONGLY AGREE

3.

SME

1

2

3

4

1

2

3

4

1

2

3

4

reduction of profits that banks make from loans 3.2.The regulation requiring classification of multiple loans from a single borrower as non-performing due to one loan not performing has led to the reduction of profits that banks make from loans 3.3.The regulation requiring consumer protection guidelines affecting the disposal of collateral security have led to the reduction of profits that banks make from loans

64

3.4.The regulations introducing the use of credit reference

1

2

3

4

1

2

3

4

1

2

3

4

bureau have led to the reduction of profits that banks make from loans 3.5.Future appreciation in value should not affect the discounted value of collaterals that will be deducted from the loan balance before making provisions have led to the reduction of profits that banks make from loans 3.6.The loan loss provisioning regulations have led to the reduction of profits that banks make from loans 4. How have the following factors affected the number of loans disbursed by your bank?

DECREASE

NO IMPACT

4.1.How have Central bank’s lending guidelines affected the number of

INCREASE

Rate this from a scale of 1 to 3 where 1 = Increase, 2 = Decrease & 3 = No Impact

1

2

3

1

2

3

1

2

3

1

2

3

1

2

3

1

2

3

loans disbursed 4.2.How has the classification of multiple loans from a single borrower as non-performing due to one loan not performing affected the number of loans disbursed 4.3.How have the consumer protection guidelines affecting the disposal of collateral security affected the number of loans disbursed 4.4.How have the regulations introducing the use of credit reference bureau affected the number of loans disbursed 4.5.How has the regulation requiring that future appreciation in value should not affect the discounted value of collaterals that will be deducted from the loan balance before making provisions affected the number of loans disbursed 4.6.How have the loss provisioning regulations affected the number of loans disbursed 65

Section E: Impact of Macroeconomics factors on the Bank 1. Macroeconomic factors (Inflation, GDP) have greatly affected operations at the bank Yes No 2. Which type of factor has strongly affected how the bank operates? Inflation GDP Both 3. On a scale of 1 to 4 (where 1 = Strongly Agree and 4 = Strongly Disagree) rank the

AGREE

DO NOT AGREE

STRONGLY DO NOT AGREE

3.1. The changes in macro-economic factors greatly impact

STRONGLY AGREE

following statements

1

2

3

4

1

2

3

4

1

2

3

4

1

2

3

4

1

2

3

4

the banks strategy 3.2. Inflationary changes have a strong impact on operations and business plans greatly affected profitability 3.3. Higher inflation implies less long-run financial activity and thus a reduction in demand for loans 3.4. Higher GDP implies more long-run financial activity and thus an increase in demand for loans 3.5. High inflation rates lead to stringent lending policies for banks Section F: Adaptation of Technology at the Bank 1. Does the bank have an online platform for the clients to transact on? Yes

No

66

2. If yes, are the below transactions available on the online platform? 1=Available, 2 =

AVAILABLE

UNAVAILABLE

Unavailable

2.1. Personal loan application

1

2

2.2. Local funds transfer

1

2

2.3. International funds transfer

1

2

2.4. Customer service / feedback

1

2

2.5. Credit card services

1

2

2.6. Utility payment

1

2

2.7. Client Account opening

1

2

3. Which of the below services are most used by the clients? Rank from 1-3 where 1 =

OCCASIO NALLY

3.1. Personal loan application

1

2

3

3.2. Local funds transfer

1

2

3

3.3. International funds transfer

1

2

3

3.4. Customer service / feedback

1

2

3

3.5. Credit card services

1

2

3

3.6. Utility payment

1

2

3

3.7. Client Account opening

1

2

3

4. Does the bank offer mobile banking as a viable means of transaction for the client? Yes

No

67

FREQUE NTLY

NEVER

Never, 2 = Occasionally & 3 = Frequently

5. From the hit-rate analysis, rank on a scale of 1 to 3 (where 1 = Frequently Used, 2 = Rarely Used & 3 = Never Used) which type of technology appears to be the most used

FREQUENTLY USED

RARELY USED

NEVER USED

by the clients?

5.1. Mobile banking

1

2

3

5.2. Internet banking

1

2

3

6. Rank from 1 to 4 (where 1 = Strongly Agree, 2 = Agree, 3 = Disagree, 4 = Strongly

DISAGREE

STRONGLY DO NOT AGREE

6.1.From the customer satisfaction surveys, the use of online

AGREE

STRONGLY AGREE

Disagree) on the below factors;

1

2

3

4

1

2

3

4

1

2

3

4

1

2

3

4

1

2

3

4

banking has improved customer service 6.2. The use of mobile and online banking is fundamental to the success of the bank 6.3. The inception & maintenance of technology has been costly to the organization 6.4. Mobile banking has increased the non-funded income lines for the bank 6.5. The use of mobile and online banking services have led to the increase in the amount of transactions performed by the bank

68