Effect of Macroeconomic Factors on Commercial Banks Profitability in Kenya: Case of Equity Bank Limited

Abstract

Commercial banks appear very profitable in Sub-Saharan Africa (SSA), average returns on assets were about 2 percent over the last 10 years, significantly higher than bank returns in other parts of the world. In order to survive in the long run, it is important for a bank to find out what are the determinants of profitability so that it can take initiatives to increase its profitability. However, owing to the fact that there are few studies on the determinants of bank profitability, various studies indicate divergent views on the effect of macroeconomic factors on bank profitability. For these reasons, it is not clear whether or not macroeconomic factors affect bank profitability in Kenya. The main purpose of this study was to establish effect of macroeconomic factors on bank profitability in Kenya with Equity bank in focus to understand country and bank specific characteristics. Specific objectives were to determine, examine and evaluate effect of; economic growth (real GDP), inflation and exchange rate on bank profitability in Kenya with Equity bank in focus respectively. This study was modeled on the theory of production and based on correlation research design. Sample size consisted annual data spanning 5 years from 2008- 2012. Data was obtained from the World Development Indicators, published Equity bank documents (annual reports, investor briefings and financial statements). To accomplish this task the study used Cobb-Douglas production function transformed into natural logarithm. This study employed OLS to establish the relationship between macroeconomic factors and bank profitability. The results indicated that macroeconomic factors (real GDP, inflation and exchange rate) have insignificant effect on bank profitability in Kenya with Equity bank in focus at 5% level of significance. We concluded that macroeconomic factors do not affect bank profitability in Kenya. In view of this, it is clear that internal factors which relate to bank management significantly determine bank profitability in Kenya. The study therefore recommends that banks to adopt policies that enhance managerial efficiency for higher profits to be realized.

Keywords: Macroeconomic factors, Commercial bank Profitability