Cost Efficiency and Default Risk in Commercial Banks in Kenya

Abstract

The purpose of this study was to evaluate effect of cost efficiency on default risk in commercial banks in Kenya. Many literature show that there have been an increased number of significant bank problems in USA, Brazil, India, Pakistan Indonesia, Ghana and even Kenya. In Kenya, the ratio of gross non-performing loans to gross loans increased from 6.8 percent in December 2015 to 9.2 percent in December 2016, subsequently increasing the default risk. The banking sector in Kenya has undergone several changes from the early 1990’s that was characterized by high level of bank failures, non-performing loans and inefficiencies to the current period that exhibits high levels of profitability, innovations like mobile and internet banking, agency banking, unsecured lending and the introduction of credit reference bureaus. The National treasury had hinted at introducing regulations to curb the high interest rate regime after commercial banks recorded huge profit margins in a high interest rate environment, even though depositors had been left dry. According to the bank supervisory report, the interest rate spread widened to 13 per cent at the end of December 2011 from 10.3 per cent by December 2010 which the CBK Governor termed as a sign of inefficiency in the banking sector. Secondary data was used in the study and descriptive survey design was applied. The target population was 42 Commercial Banks in Kenya out of which 2 were under receivership and 1 was under statutory management. Panel data for 39 commercial banks for the six years period from 2014 to 2019 were obtained from the CBK and individual bank websites. The study was guided by Agency theory, Moral hazard theory and Stakeholders theory. Descriptive statistics, correlation analysis and random and fixed effects were used for secondary data using E-views software. The findings indicated that cost efficiency highly reduces loan defaults. It was recommended that cost efficiency be improved in all commercial banks to reduce loan defaults.

Keywords: Cost efficiency, Default Risk

DOI: 10.7176/RJFA/12-22-06

Publication date: November 30th 2021