International Journal of Business and Social Science

ISSN 2219-1933 (Print), 2219-6021 (Online)

The Relationship between Capital Requirement and Financial Performance of Commercial Banks in Kenya
Mwai E.Nyawira, Jagongo Ambrose (PhD), Fredrick W. Ndede (PhD)

Financial regulation imposes requirements on banks to hold certain amounts of capital. When the financial crisis began in 2007, the capital banks held fell significantly. Regulators tended to maintain their rules, so that if banks capital had fallen below the regulatory thresholds they were required to raise additional capital. Spurred by stronger regulatory requirement, banks steadily increased their capital ratios since the financial crisis as required by the Central Bank of Kenya. This study sought to evaluate the relationship that exists between capital requirement set by the Central Bank of Kenya and the financial performance for the Kenyan banking sector. The study was guided by the, Economic theory of regulation, the liquidity theory and agency theory. The specific objective of the study was to evaluate the relationship between capital requirement and financial performance of commercial banks in Kenya. The research design adopted by the study was descriptive to examine the relationship between the variables. The target population was a total of forty-three (43) commercial banks operating in Kenya. All the banks were considered in the study since the number of banks in Kenya is small and manageable for a census study. The study used secondary data which was collected from bank supervision and banking sector reports which are released on an annual and quarterly basis by the Central Bank of Kenya and the Commercial Banks.Data was analyzed using descriptive statistics, correlation analysis, and regression analysis. The study found that capital requirements have positive linear relationship with financial performance of commercial banks in Kenya. These results were significant for Return on Assets and Return on Equity but insignificant for Net Interest Margin. This meant that when capital requirements increase, financial performance increases as well. The study also found that ownership percentage did not have any significant moderating effect on financial performance of Kenyan banks. The study recommended that CBK should strengthen the capital requirements for commercial banks even more to ensure optimal performance and industry growth. The study also recommended that the objective of the regulator should not be to set minimum capital requirements in a way that eliminates the likelihood of bank failure, but rather to balance the benefits and costs of alternative policies while leveraging on other tools at regulators disposal to ensure stable banks performance. Banks should comply with capital requirements since apart from increasing on its financial performance, increased capital provides a measure of assurance to the public that an institution will continue to provide financial services even when losses have been incurred, thereby helping to maintain confidence in the banking system and minimize liquidity concerns. This study was limited to capital adequacy ratios only and it neglected many other variables that influence performance of banks. Therefore, other researches can include such variables as liquidity ratios, management efficiency ratios, asset quality measures and variables that encompass sensitivity to market conditions.

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