Effect of Increasing Core Capital on the Kenyan Banking Sector Performance

Strathmore University SU+ @ Strathmore University Library Electronic Theses and Dissertations 2018 Effect of increasing core capital on the Kenyan banking sector performance Anne W. Mwangi Strathmore Business School (SBS) Strathmore University Follow this and additional works at https://su-plus.strathmore.edu/handle/11071/5971 Recommended Citation Mwangi, A. W. (2018). Effect of increasing core capital on the Kenyan banking sector performance (Thesis). Strathmore University. Retrieved from http://su- plus.strathmore.edu/handle/11071/5971 This Thesis - Open Access is brought to you for free and open access by DSpace @Strathmore University. It has been accepted for inclusion in Electronic Theses and Dissertations by an authorized administrator of DSpace @Strathmore University. For more information, please contact [email protected] EFFECT OF INCREASING CORE CAPITAL ON THE KENYAN BANKING SECTOR PERFORMANCE MWANGI ANNE WANGUI – MBA/6971/15 Submitted in Partial Fulfilment of the Requirements for the Master of Business Administration at the Strathmore Business School Strathmore Business School Nairobi, Kenya 2018 This thesis is available for Library use on the understanding that it is copyright material and that no quotation from the thesis may be published without proper acknowledgement. i DECLARATION I declare that this work has not been previously submitted and approved for the award of a degree by this or any other University. To the best of my knowledge and belief, the report contains no material previously published or written by another person except where due reference is made in the thesis itself. No part of this thesis may be reproduced without the permission of the author and Strathmore University. Mwangi Anne Wangui MBA/6971/15 APPROVAL The proposal of Mwangi Anne Wangui was reviewed and approved by the following: Dr. Thomas Kibua Strathmore Institute of Public Policy and Governance Dr George Njenga Dean Strathmore School of Business Prof Ruth Kiraka Dean of Graduate Studies ii ABSTRACT The Kenya Vision 2030 envisions a globally competitive financial sector and proposes transforming the banking sector to have fewer, stronger and larger scale banks. In this regard, the National Treasury proposed and implemented an increase in the minimum core capital requirement in 2008 and proposed a further increase in 2015 and 2016 to improve competition in the banking sector, increase the level of savings in the economy and strengthen banks. This study sought to find out the effect of the 2008 increase in the minimum core capital requirement from Kshs.250 million to Kshs.1 billion on bank performance in the Kenyan banking sector. The specific variables that were studied to evaluate their impact on bank performance following an increase in core capital were competition and profitability. The study focused on the Kenyan banking sector from 2003 to 2016 and adopted an exploratory study approach. The research relied on secondary data from CBK and therefore took a quantitative approach. The entire population of 39 banks as provided by the CBK as at 31st December 2016 was studied. The study was conducted according to the three peer group classification provided by CBK as presented in Appendix B. The paired t-test was used to evaluate whether there was a change in competition and profitability pre and post increase in the minimum core capital requirement. Regression models were further included to assess the strength of the relationship between the dependent variables competition and profitability and the independent variable core capital and control variables total deposits, profits before tax, inflation and GDP. Results indicate that the regulatory increase in the core capital requirement had an inconsistent effect on profitability and competition in the three banking peer groups. In particular, as indicated by the paired t-test, there was no statistically inferred difference for both competition and profitability in all the three peer groups except for competition in peer group one. The policy recommendation arising from this study is for the regulator to have similar policies for the entire industry as well as different policies tailored for each peer group to increase the attainment of desired outcome of regulation. iii TABLE OF CONTENTS DECLARATION ii ABSTRACT iii LIST OF TABLES vi LIST OF FIGURES vii LIST OF ABBREVIATIONS viii ACKNOWLEDGEMENT ix CHAPTER ONE: INTRODUCTION 1 1.1 Introduction 1 1.2 Background of the Study 1 1.3 Overview of the Kenyan Banking Sector 2 1.4 Policy, Legal and Institutional Reforms in the Kenyan Banking Sector 4 1.5 Statement of Problem 6 1.6 Research Objectives 7 1.7 Research Questions 7 1.8 Scope 8 1.9 Significance 8 CHAPTER TWO: LITERATURE REVIEW 10 2.1 Introduction 10 2.2 Theoretical Framework 10 2.2.1. The Modigliani-Miller Theorem 10 2.2.2. Neo Classical Theory of Markets 11 2.2.3. Structure Conduct Performance Paradigm 12 2.3 Empirical Framework 12 2.3.1. Core Capital and Competition 12 2.3.2. Core Capital and Profitability 18 iv 2.4 Literature Review Summary and Research Gap 24 2.5 Conceptual Framework 26 CHAPTER THREE: RESEARCH METHODOLOGY 29 3.1 Introduction 29 3.2 Research Design 29 3.3 Data Collection Methods 29 3.4 Data Analysis and Presentation 30 3.5 Measurement of Variables 34 3.6 Research Quality 34 3.7 Ethical Considerations 35 CHAPTER 4: PRESENTATION OF FINDINGS 36 4.1 Introduction 36 4.2 Descriptive Statistics 36 4.3 Inferential Statistics 44 4.4 Regression Analysis 46 CHAPTER FIVE: DISCUSSION, CONCLUSION AND RECOMMENDATIONS 51 5.1 Introduction 51 5.2 Discussion 51 5.3 Conclusion 53 5.4 Recommendations 54 5.5 Limitations and Areas for Further Study 54 REFERENCES 55 Appendix A: 2016 and 2003 Commercial Banks Market Shares 59 Appendix B: List of Commercial Banks as at 31st December 2016 61 Appendix C: Standard Multiple Linear Regression Coefficients 62 v LIST OF TABLES Table 4.1 Objective One Paired Samples T-test ................................................................................. 45 Table 4.2 Objective Two Paired Samples T-test ................................................................................ 46 Table 4.3 Banking Metrics Regression Coefficients - Competition ................................................... 48 Table 4.4 Macroeconomic Metrics Regression Coefficients - Competition ....................................... 48 Table 4.5 Banking Metrics Regression Coefficients - Profitability .................................................... 49 Table 4.5 Macroeconomic Metrics Regression Coefficients - Profitability ....................................... 50 vi LIST OF FIGURES Figure 2.1: Conceptual Framework .................................................................................................... 26 Figure 4.1 lnHHI Peer Group One ...................................................................................................... 36 Figure 4.2 Pre-Regulation Peer Group One ........................................................................................ 37 Figure 4.3 Post Regulation Peer Group One ....................................................................................... 37 Figure 4.4 InHHI Peer Group Two ..................................................................................................... 38 Figure 4.5 Pre-Regulation Peer Group Two ....................................................................................... 38 Figure 4.6 Post-Regulation Peer Group Two ...................................................................................... 39 Figure 4.7 InHHI Peer Group Three ................................................................................................... 40 Figure 4.8 Pre-Regulation Peer Group Three ..................................................................................... 40 Figure 4.9 Post-Regulation Peer Group Three .................................................................................... 41 Figure 4.10 Pre-Regulation Peer Group One ...................................................................................... 42 Figure 4.11 Post-Regulation Peer Group One .................................................................................... 42 Figure 4.12 Pre-Regulation Peer Group Two ..................................................................................... 43 Figure 4.13 Post-Regulation Peer Group Two .................................................................................... 43 Figure 4.14 Pre-Regulation Peer Group Three ................................................................................... 44 Figure 4.15 Post-Regulation Peer Group Three .................................................................................. 44 vii LIST OF ABBREVIATIONS CAR Capital Adequacy Ratio CBK Central Bank of Kenya CIR Cost to Income Ratio GDP Gross Domestic Product HHI Herfindahl Hirschman Index NIM Net Interest Margin NPL Non-Performing Loans PBT Profit Before Tax SCP Structural Conduct Performance ROA Return on Assets ROE Return on Equity viii ACKNOWLEDGEMENT I thank the Almighty God for His grace throughout this journey and acknowledge my family and classmates who supported and enabled me to successfully complete this study. I also acknowledge the dedication, support and guidance received from Dr. Thomas Kibua, my supervisor. ix CHAPTER ONE: INTRODUCTION 1.1 Introduction This paper is about the effects of the 2008 regulatory increase in the minimum core capital requirement on performance of the Kenyan banking sector.

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