INFLUENCE OF FINANCIAL DISTRESS ON PERFORMANCE OF COMMERCIAL BANKS IN KENYA

Abstract

Commercial banks have continued using various financial models for determining financial 
distress. However, commercial banks have not identified all the factors influencing financial 
performance and to which extent they influence financial performance of commercial banks in 
Kenya. This study was focused on the influence of financial distress on financial performance for 
commercial banks regulated by Central Bank of Kenya (CBK) since they provide an important 
contribution to the economy. The study was prompted by the increased number of commercial 
banks in the recent past facing financial difficulties. The objective of the study was to examine 
the effects of capital distress, liquidity distress, operating inefficiency and assets quality distress 
on the performance of commercial banks in Kenya. To strengthen the conceptual framework the 
study adopted theories such as agency theory, liquidity theory, theory of efficient market 
hypothesis and buffer theory of capital adequacy. The study showed a diagrammatic 
representation of the relationship between the independent variables and the dependent variable. 
The target population was129 employees of commercial banks in Kenya. The sample size was99
employees of commercial banks in Kenya. A modified Likert scale questionnaire was developed 
and divided into three parts. A pilot study was carried out to refine the instrument. The quality 
and consistency of the study was further assessed using Cronbach's alpha. Data analysis was
performed on a PC computer using Statistical Package for Social Science (SPSS Version 23) for 
Windows. Analysis was done using frequency counts, percentages, means and standard 
deviation, regression, correlation and the information generated was presented in form of graphs, 
charts and tables. The study findings revealed that there was a positive correlation between 
capital distress, liquidity distress and operating inefficiency but asset quality distress had a 
negative correlation. The study concluded that capital distress, liquidity distress and asset quality 
have no significant effect on financial performance of commercial banks in Kenya. Further, the 
study concluded that operational inefficiency has a significant effect on financial performance of 
commercial banks in Kenya. The study recommends that commercial banks must consider using 
debt in their capital structure, non-current debt should be prioritized ahead of short-term debt. 
This recommendation is based on the finding that long term debt as measure of liquidity reduces 
the incidence of financial distress among commercial banks; Commercial banks should endeavor 
to employ more equity and less debt capital to finance their operations. This recommendation is 
based on the revelation that a reduction in financial leverage is a major recipe for corporate 
financial distress; The use of collaterals as security of granting loans should be further reviewed 
to reduce further incidence of bad debts and credit management should be viewed as part of a 
coordination group efforts made by all departments involved with customers to minimize bad debts and maximize profit instead of leaving it in the hands of the credit risk management 
department