Financial soundness and performance: evidence from commercial banks in Kenya

Abstract

PurposeThe study aims to analyze the effect of financial soundness on financial performance of commercial banks in Kenya.Design/methodology/approachThe study used dynamic panel model to analyze data from commercial banks for the period 2009 to 2020. The study was modeled on the concept of CAMEL approach using five CAMEL variables as financial soundness indicators. Four indicators that is, net interest margin (NIM), earnings per share (EPS), return on assets (ROA) and return on equity (ROE) were used as measures of financial performance.FindingsGeneralized method of moments results established that financial soundness had a statistically significant effect on NIM, ROA and ROE. It was also found that asset quality and earning quality had a statistically significant effect on net interest margin. In addition management efficiency had significant effect on ROE. However, the study established that capital adequacy, asset quality, earning quality and liquidity had a statistically insignificant effect on ROA and ROE respectively while capital adequacy, management efficiency and liquidity had statistically insignificant effect on NIM.Practical implicationsBank managers should put into place effective financial policies to govern changes in CAMEL variables to ensure optimal banks' financial soundness to facilitate positive growth in banks' financial performance.Originality/valueThe current study is modeled on the concept of the CAMEL approach by employing the five CAMEL variables as financial soundness indicators. In addition, the study contributes to local literature by examining banks in a developing economy to provide reliable and relevant information on their differences to monitor their dynamics in financial soundness and financial performance which could not be provided by regional or global studies.

Influence of Financial Soundness on Financial Performance in the Banking Sector Listed on the IDX

“…According to Kirimi et al (2022) in the banking sector, financial performance is a subjective measure which assesses how much the bank can generate income from using its assets properly. If the bank can generate large profits, it can provide large rewards from its investment, so the bank will continue to improve its performance to ensure its value increases.…”

“…Based on the description and previous research above, the first hypothesis is as follows: H1: There is an effect of CAR on financial performance Asset Quality Asset quality at commercial banks is determined by the level of non-performing loans to total loans and advances to bank customers. Asset quality not only affects financial performance in commercial banks, but also in the context of global aspects (Kirimi et al, 2022). The company's financial performance can also be seen from the level of earning quality.…”

“…Management efficiency has a big influences on bank operations on internal and external policies in regulating banking operations. Bank profits are generally influenced by internal factors such as efficiency management, CAR, and asset quality (Kirimi et al, 2022). If management of financial efficiency is good, it can improve financial performance, and vice versa if management of financial efficiency is bad, it can make financial performance decrease (Nasution, 2018).…”

“…To be able to obtain a strong financial system, banks need to have healthy finances which are obtained from utilizing various financial instruments to provide funds for borrowers. Commercial banks act as financial intermediaries between savers and borrowers by mobilizing savings and providing credit (loans) to potential investors (Kirimi et al, 2022).…”

“…This tool can also assess how a bank implements risk management by focusing on significant risks, and compliance with applicable regulations and the application of the precautionary principle (Jaelani & Purwanti, 2022). Just like previous research, this study adopted the CAMEL variable as an indicator of financial soundness, in which the variables are Capital Adequacy (CA), Asset Quality (AQ), Management Efficiency (ME), Earning Quality (EQ), and Liquidity (L) (Kirimi et al, 2022).…”