Bank strategy, interest capping environment and bank performance in Kenya

Abstract

It is widely accepted that bank performance is profoundly affected by changes in interest rates. Besides impacting bank performance, the introduction of interest capping in Kenya resulted in changes in bank strategies encompassing product diversification, bank efficiency and risk management strategies. However, questions remained on the extent to which the aforementioned strategies affected bank performance and the efficacy of the strategies in an interest capping environment. The objective of the study was to determine the moderating effect of interest capping on the relationship between bank strategies and performance based on product diversification, bank efficiency and risk management strategies using Balance Scorecard model, Porters generic strategies and price theory. The study took a positivism approach and used explanatory research design while data analysis was conducted through hierarchical regression. The population of the study was 42 banks as per CBK database for the year ended 2019 and the research focused on 35 banks which met the inclusion and exclusion criteria of being consistently in operation during research period from 2013 to 2019. Secondary data was collected from banks annual financial statements with the assistance of CBK annual bank supervision reports and was analyzed using both descriptive and inferential statistics involving the use of mean and standard deviation. Inferential statistics involved the use of Pearson correlation coefficient to check for associations of variables while hierarchical regression analysis was conducted to test the hypotheses at a 0.05 significance level. Further, the study relied on Hausman’s test to decide between random and fixed effects. The model was significant as indicated by the changes in R2 by 0.369. The fixed effects regression results showed that Product diversification (β=-0.002, p<0.000) was significant with negative effect on bank performance while Bank Efficiency (β=0.433, p<0.000) and Risk Management (β=40.182, p<0.000) were significant with positive effect on bank performance. Further, the results revealed that Interest Rate (β= -2.459915, p<0.000) was significant with negative effect on bank performance. The interaction results revealed that the interaction between Product diversification and interest rate (β=0.102, p<0.000) was significant with Positive effect on bank performance while the interaction between Bank Efficiency and Interest Rate (β=-15.535, p<0.000) was significant with negative effect on bank performance. Further, the interaction between Risk Management and Interest Rate (β=-99.212.182, p<0.099) was insignificant with negative effect on bank performance. Therefore, the study moderation effects revealed that only two of the three observed strategies employed by banks during interest capping period, namely product diversification and bank efficiency strategies had significant effect on bank performance. Product diversification interaction results showed a positive and significant effect on bank financial performance while the interaction results on bank efficiency affirmed a negative and significant effect on bank financial performance. Conversely, risk management interaction had a weak or no significant effect on bank financial performance. Therefore, banks should pursue product diversification strategies to compensate for squeezed earnings caused by low interest rate environment. Furthermore, banks should take a long-term view when undertaking efficiency strategies to elude the mistake of scrambling for short term gains. It is therefore recommended that banks should adopt risk-based pricing strategies for loans since there is weak or no evidence to support the claim that risk management strategies increase performance.