determinants of operating efficiency for commercial banks in kenya: a market share index position analysis

Abstract

Commercial banks play an important role as financial intermediaries for savers and borrowers in an economy. All sectors of the economy depend on the banking sector for their survival and growth. Operational efficiency is the ability to deliver products and services without sacrificing quality. Operating efficiency for banks is essential for a well- functioning economy. Banks operate efficiently by directing society‘s savings toward those enterprises with highest expected social returns and monitoring them carefully after lending society‘s scarce resources. The banking sector in Kenya has grown tremendously over years in terms of numbers, size and profitability. Despite growth in the sector, challenges still remain, market risk, credit and operational risk posses a major challenge. Kenyan commercial banking is not the largest supplier of credit yet the largest in terms of assets in the financial services industry. Banks are yet to adopt a model that managers and any interested party may use to determine the level of operating efficiency. Guided by the efficiency theory, this study endeavored to examine the determinants of operating efficiency for commercial banks in Kenya. In particular, the study investigated the effect of bank-specific performance indicators capital adequacy, credit risk, liquidity, profitability and asset quality on operating efficiency of banks. The study further examined the existence of statistically significant difference between low and high market share banks in relation to their operational efficiency. The study adopted an explanatory research design using panel data. Secondary data was obtained from annual financial statements and reports of 43 commercial banks operating in Kenya for seven- year period 2005 - 2011. Data was analyzed using fixed effects regression model to attain the best regression equation. Statistical significance was checked by an F- test of the overall fit and t- tests of individual parameters. The results indicate that previous year’s operating efficiency together with equity capital to total assets as proxy for capital adequacy, loan loss provision to total assets as proxy for credit risk, recurring earning power as proxy for Profitability and loan loss provision to net interest revenue as proxy for asset quality were significant in explaining operating efficiency. Interbank ratio as proxy for liquidity was insignificant in explaining bank operating efficiency. The results also indicate that there exists significant difference between low market share banks and high market share banks. The study contributes to the available strategies that managers may apply in managing risk and efficiencies in their organizations. The study recommends that bank regulators and managers should put more emphasis and control on variables that affect bank operating efficiency in order for them to remain competitive in the market. Further research using non-bank specific performance indicators and using different samples may provide further insights on the concept of operating efficiency for commercial banks.