Effect of buffer capital provision on the relationship between loan portfolio quality and financial performance of Commercial Banks in Kenya

Abstract

Financial performance and its sustainability in commercial banks and its relationship with loan portfolio quality has remained a subject of interest to most scholars. Though non-performing loans in relation to financial performance of commercial banks has been evaluated by a number of scholars, a long-lasting solution has not been identified yet. The main objective of this study was to examine the effect of buffer capital provision on the relationship between loan portfolio quality and financial performance of commercial banks in Kenya. The specific objectives included; establishing the effect of delinquency rate on financial performance; to determine the effect of leverage ratio on financial performance; to evaluate the influence of portfolio at risk ratio on financial performance of commercial banks in Kenya and to evaluate the moderating effect of buffer capital provision on the relationship between loan portfolio quality and financial performance of commercial banks in Kenya. This study was guided by Portfolio theory, Information Asymmetry theory, and Financial Intermediation theory. The study employed explanatory research design and data was obtained from published financial reports. The population of this study was all 45 commercial banks operating in Nairobi City; and thus, the study adopted census. In regard to data, this study used secondary data from financial reports for period of five years. To prove that the practice of the concept of buffer capital and loan portfolio quality concepts, a cross-tabular analysis of certain questions was performed, where the coefficient of correlation, linear and hierarchical regression were calculated. The findings revealed that that delinquency rate negatively impacts RoA (β=-0.2134, p=0.000), leading to the rejection of H 01 . Leverage ratio positively affects RoA (β=0.0234, p=0.020), rejecting H 02 , while portfolio ratio improves RoA (β=0.1452, p=0.023), rejecting H 03 . Buffer capital moderates these relationships, mitigating risks from leverage (β=-0.034567, p=0.007, rejecting H 04 ), delinquency rate (β=0.045678, p=0.005, rejecting H 05 ), and portfolio ratio (β=- 0.056789, p=0.004, rejecting H 06 ). Based on these results, it can be concluded that delinquency rates negatively impact profitability, while leverage and portfolio ratios enhance performance. Firm size and buffer capital were crucial in stabilizing these relationships, underscoring the need for effective risk management and strategic planning. This study provides actionable recommendations for bank managers aimed at enhancing financial performance. By focusing on effective credit risk management, balanced leverage strategies, strategic portfolio management, and maintaining adequate buffer capital, managers can navigate the complexities of the banking sector and position their institutions for long-term success. The study offers practical insights for banking executives and policymakers on improving profitability and ensuring long- term stability in the competitive financial sector.