Competition And Profitability Of Commercial Banks In Kenya

ABSTRACT

The banking sector in Kenya is characterized by intermediation inefficiency in the form of interest driven exceptional bank profitability.Competition among commercial banks should remedy this situation by driving bank profitability to the competitive norm. This study examined how competition is correcting this inefficiency byinvestigating competition and profitability of commercial banks in Kenya.Specifically, the study ascertained the level of competition among commercial banks; determined the speed of adjustment of commercial banks profitability to the competitive norm; and investigated the effect of changes in the competitive landscape on commercial banks profitability. The study used a balanced panel data set for 36 commercial banks covering the period 2001 to 2014.The study used the performance dynamics approach and the generalized method of moments to estimate the resulting dynamic panel models. The investigation established thatthe level of competition among commercial banks in Kenya was low and characterized by 96.1 per cent persistence in profitability. The speed of adjustment of commercial banks profitability to the competitive norm was 3.9 per cent per year with a half-life of 17.42 years. The study also found that in the short run,increase in level of technology reduces exceptional bank profitability by 0.852 per cent. The study further found thatconsolidation has a negative effect on exceptional bank profitability in the short run and a positive effect in the long run. Finally, the study established that the progressive increase in core capital requirement for commercial banks in 2008 enhanced persistence of exceptional bank profitability and reduced bank competition. Arising from the study findings, it is important that the government intervenes to rectify the intermediation inefficiency occasioned by ineffectiveness of competition and the slow speed of adjustment towards the competitive norm. It is also important that small sized banks in the sector voluntarily merge with other smaller banks in order to exert substantial competition to the large and medium sized banks. For effectiveness, the findings imply that intervention by government should target swift adoption of technology by all commercial banks and trigger consolidation among the target tiers of commercial banks up to the optimal level. In addition, the findings imply that banks with exceptionally low levels of profitability should seek other forms of recovery. The options here include exiting the market, or mergers and acquisitions. This is because as established in the study, market forces may not help such commercial banks to return to sustainable profitability in the short run.