Assessing the effect of liquidity on profitability of commercial banks in Kenya

Abstract

The financial sector in Kenya is dominated by commercial banks which have reported significant growth and improved financial performance. Despite the growth, the sector still faces many challenges including stiff competition from within, MFIS, mortgage firms and SACCOs and competition over the last few years resulting from increased innovations in the market. In order to survive and remain competitive they need to be profitable since a profitable banking sector is better able to withstand negative shocks. This study therefore was motivated by the fact that commercial banks need to understand the internal factors which they can manipulate to their advantage to maximize profits. The study will aid commercial banks to maintain a certain minimum balance of cash to enable them maximize the returns. The study determined the effect of internal factors on profitability of commercial banks in Kenya particularly the banks liquidity. The study employed a descriptive research design incorporating panel data. All the 43 Commercial banks in Kenya formed the population and a census was done over a period of 5 years from 2009 to 2013 due to availability of data. This study used secondary data obtained from the annual published financial statements which were analyzed using descriptive and inferential statistics. Internal factor was Liquidity, while Profitability was measured using ROA ratios. The findings of the study show that all the variables Liquidity, has statistically significant and positive relationship with banks’ profitability. This study recommends that banks should invest heavily in assets if substantial gains have to be realized, maintain adequate liquidity levels though in the form of short term marketable securities in order to realize profits and aggressively identify viable investment opportunities and link such opportunities to customer deposits.

Keywords: Liquidity, profitability, commercial banks, financial performance