INVESTIGATING THE IMPACT OF RISK MANAGEMENT ON THE

PROFITABILITY OF BANKS: A CASE STUDY OF KENYAN COMMERCIAL

BANKS.

BY
GRACE NYAMBURA

A RESEARCH PROJECT SUBMITTED TO THE SCHOOL OF MANAGEMENT

AND LEADERSHIP IN PARTIAL FULFILMENT OF THE REQUIREMENT FOR
THE AWARD OF THE DEGREE OF BACHELOR OF COMMERCE OF THE
MANAGEMENT UNIVERSITY OF AFRICA

SEPTEMBER,2023
 DECLARATION.
This project is my original work and has not been represented for a degree in any other
university.

Signature--------------------------------- Date-----------------------
GRACE NYAMBURA NJOROGE
BCOMK/4/00163/3/19

This research project has been submitted for examination with my approval as university
supervisor.
Signature--------------------------------------------- Date---------------------------

MR. BROWN KITUR

THE MANAGEMENT UNIVERSITY OF AFRICA

DEDICATION
I dedicate this research to my adorable lovely family members who have been very
supportive mostly my lovely father Mr. Joel Njoroge and my mom Mary Wanjiru for their
constant love, support, encouragements, prayers and patience throughout my life and success
of my studies, with love and appreciation thank you all.

iiĺ
 ACKNOWLEDGEENTS
I express my sincere gratitude first to Almighty God for the gift of life, wisdom, courage,
more understanding and constant love has sustained me throughout my studies. I thank my
lectures at The Management university of Africa and especially my supervisor Mr. Brown
Kitur for the support, guidance and patience towards the success of my research. God bless
you all.

iiiĺ
 ABSTRACT
The banking sector in any economy serves as a catalyst for growth and development. Banks
are able to perform this role through their crucial functions of financial intermediation,
provision of an efficient payment system and facilitating the implementation of monetary
policies. Bank profitability is usually expressed as a function of internal and external
determinants. The overall performance and profitability of the banking sector in Kenya has
improved over the last 10 years. The aim of this study was to close the gap in knowledge by
investigating the impact of risk management on the profitability of commercial banks in
Kenya. The study used secondary data from annual Bank Survey Reports from CBK and
Economic Survey Reports from KNBS for the period of 202018-2022. A multiple regression
model was employed to obtain desired results. The analysis showed that Non-Performing
Loan ratio, capital adequacy ratio, cash reserve ratio, credit to deposit ratio, current ratio and

ivĺ
liquid assets ratio have statistically significant impact on profitability. Based on the results
and findings, the study recommend that banks should design and formulate strategies that will
not only minimize the exposure of the banks to risk but will also enhanced profitability, the
study also provides additional knowledge about Kenyan commercial banking sector
profitability that is important in policy making.

TABLE OF CONTENTS
DECLARATION………………………………………………………………………............
..................……ii
AKNOWLEDGEMNTS……………………………………………………………................
...........……...iii
DEDICATION………………………………………………………………………................
...............……. iv
LIST OF
ABBREVIATIONS……………………………………………………….........................
……...ix
LIST OF
TABLES…………………………………………………………………….............................
…….x
LIST OF
FIGURES………………………………………………………………………........................
.......xi

vĺ
 ABSTRACT…………………………………………………………………….
……..............................……xii
CHAPTER 1………………………………………………………...
……………….............................………1
INTRODUCTION………………………………………….
……………………….............................……….1
1.1Background of the
study…………………………………………………………..............................………1
Statement of the 1.2
problem………………………………………………………...........................…………3
Research 1.3
problem…………………………………………………………………..................................
…….4
Objective of the 1.4

study…………………………………………………………..............................………....5

Value of the 1.5

study…………………………………………………………….................................….
……….6
Scope of the 1.6
study………………………………………………………………….................................
…….6
Limitation of the 1.7
study…………………………………………………………….................................……7
CHAPTER
TWO……………………………………………………....................................................9
LITERATURE
REVIEW………………………………………………………............................……………
9
2.1
Introduction………………………………………………………………………......................
...............………9
Theoretical 2.2
Review………………………………………………………………..................................……
10
Determinant’s of Commercial banks profitability……………………............. 2.3
…………………11

viĺ
Empirical literature Review…………………………………………….......................... 2.4
…………………13
Conceptual 2.5
Framework…………………………………………………….............................……………
13
Operationalization of variables................................................................................14 2.6
Chapter Summary...................................................................................................14 2.7
CHAPTER THREE…………………………………………...…………..........................
………………15
RESEARCH DESIGN AND METHODOLOGY………………………....................
…………………15
3.1ntroduction………………………………………………………………...
…...............................................15
Research Design………………………………………………………............................... 3.1
………………….15
Target Population…………………………………………………………............ 3.2
…....................………….16
Sample and sampling Method………………………………………………....................... 3.3
……………16
Instruments...............................................................................................................16 3.4
Pilot Study..................................................................................................................17 3.5
Data 3.4
collection……………………………………………………………….................................
……………18
3.5
Hypothesis………………………………………………………………………........................
...........………..18
Data 3.6
analysis…………………………………………………………………….................................
..……….19
3.6.1Analytical
model……………………………………………………………....................................………
19
Measuring of variables..........................................................................................20 3.6.2
CHAPTER
FOUR………………………………………………………..............................................21

viiĺ
RESULTS, FINDINGS AND DISCUSSION………………………………….....................
…………21
4.1
introduction……………………………………………………………………..........................
............………21
Descriptive 4.2
statistics……………………………………………………………...............................
……..21
Pearson’s correlation 4.3
tests……………………………………………………..........................………..22
Regression analysis on return on 4.4
Equity…………………………………………...................……23
Hypothesis 4.5
Testing………………………………………………………….................................…………
24
Discussion and research findings…………………………………………...................... 4.6
……………25
CHAPTER
FIVE………………………………………………………………………............................
……27
CONCLUSIONS AND RECOMMENDATIONS…………………………….....................
…………27
5.1
Introduction……………………………………………………………………..........................
.........…………27
5.2
Conclusions…………………………………………………………………………..................
................…...27
5.3
Recommendations…………………………………………………………………....................
..........…….28
Limitations of the 5.4
study…………………………………………………………............................………33
Areas for further study..............................................................................................38 5.5
APPENDICES……………………………………………………………............................
…………………43
Appendix I: LETTER OF INTRODUCTION
……………………………………………….........………46

viiiĺ
Appendix II:
QUESTIONNAIRE………………………………………………..........................………46
Appendix III: List of licensed commercial banks in Kenya as at 31.12.2020……...…43

LIST OF TABLES
Table 3.1: Operational Framework………………………………………........................
………………….13

ixĺ
Table 4.1: The relationship between the risk management and profitability of commercial
banks in Kenya……………………...................
…………………………………………............21
Table 4.2: Correlation coefficients of the relationship between risk management and
profitability of commercial banks in Kenya ………………………………….....................
……………22
Table 4.3: Regression analysis on Return on Equity (ROE)…………………………..........
………23
Table 4.4: Model
Summary………………………………………………………….............................………24
Table 4.5: Hypothesis
Testing…………………………………………………………….........................….25
Table 4.6: Analysis of Variance (ANOVA) results of the relationship between risk
management and profitability of commercial banks in Kenya………………........
…………….26

LIST OF FIGURES
xĺ
Figure 1: Conceptual framework……………………………………………….......................
…….....……12

xiĺ
 LIST OF ABBREVIATIOS
MPT Modern Portfolio Theory
CBK Central Bank of Kenya
ROE Return on Equity
ROA Return on Assets
NPLR Non-Performing Loan Ratio
CAR Capital Adequacy Ratio
CDR Credit to Deposit Ratio
CRR Cash Reserve Ratio
CR Current Ratio
LAR Liquid Assets Ratio

OPERATIONAL DEFINITION OF TERMS

Risk Management Risk Management is the identification, assessment,
prioritization risks followed by coordinated and

iĺ
 economical application of resources to minimize, monitor
and control the profitability .

Profitability This can be defined as the degree of a company to use the

resources and capital at its disposal to generate benefits
which exceed the costs incurred.
NPLR this is the ratio of bank non-performing loans to total gross
loans divided by the total value of the loan portfolio
(including non- performing loans before the deduction loan
provisions).
Capital Adequacy Ratio It is a measure of how much capital a bank has available,
reported as a percentage of bank’s risk weighted credit
exposures. The purpose of CAR is to establish that banks
have enough capital on reserve to handle a certain amount of
losses.
Cash Reserve Ratio It is the percentage of a bank’s total deposit that it needs
to maintain as liquid cash. This is an RBI requirement, and
the cash reserve is with the RBI. It can refer to a specified
minimum fraction of the total deposits of customers, which
commercial banks have to hold as reserves either in cash
or as deposits with the central bank.
Credit to Deposit Ratio this is the ratio between the bank’s total loans and total
deposits.The ratio is generally expressed in percentage
terms where, if the ratio is lower than one, the bank relied on
its own deposit to make loans to its customers.

iiĺ
 CHAPTER ONE
INTRODUCTION
1.0 Introduction
The chapter includes an overview of the background of the study as well as insight into
dependent and independent variables, objectives, research problem, value of the study,
significance , limitation, the scope of the study and chapter summary.
1.1 Background of the study
Banks act as profit seeking intermediaries between borrowers and lenders in economies
(Breuer et al.,2010). Commercial banks position as financial intermediaries ensures that
funds are directed into productive projects as documented by Marshal and Onyeka chi
(2014). The role played by commercial banks in economies is crucial and cannot be
overemphasized. This is so because, governments implement monetary policies and
connect the general populace by issuing of Treasury bills through commercial banks.
Moreover, commercial banks also provide capital for industries through loans, for
expansion purposes. All other things being equal, as companies expand their financial
operations, the revenue of there is a robust and vibrant financial sector (Baidoo et al.,2020;
Sakyi et al.,2021).
It is acknowledged that commercial banks mostly accept deposits and give out and
conversion of building societies into banks; United States of America responded to its
banking crisis which spanned between 1982 and 1990 by consolidation through mergers
and acquisition; Span responded to its banking crisis by establishment of the bank hospital
known as the Guarantee fund; Malaysia responded to its banking crisis of major banking
consolidation exercises in 1999 with gradual removal of the barrier to the entry of foreign
banks (Do Garawa,2006;Karwar,2006 and Yuqi, 2008)
Banks play a very important role as a primary lender to both big and small businesses. By
its nature, banks face a number of challenges within five internal and external business
environments. The nucleus of banks is intertwined with risks which includes; market risk,
due to changes in the economic environment that it operates; interest rate risk, being a risk
due to change in prime lending rate and banks’ lending rate and operational risk, which
arises as a result of poor management that causes failure or allow loopholes for fraud
penetration (Yuqi,2008). The risks faced by if not properly managed have the potentials to
affect the profitability of the banks and at extreme cases leads to their failure. According to
Khan and Ahmed (2001), the survival and success of financial organizations depend
critically on the efficiency of managing these risks. Good risk management is highly
relevant in providing better returns to shareholders Al Tamimi %
$ Al Marzouki, (2007). Among the various components of risk, credit risk has received
more attention from banks; they mostly have credit risk management unit and regulators
setting standards for minimizing credit loss.
Banks are part and parcel of financial intermediaries that mobilize savings from surplus
economic units to deficit economic units. They are also considered to be special financial
intermediaries that mobilizes funds between depositors and borrowers participating in an
economy (Heffernan,1996; Yuqi,2008). How well they perform this intermediary function
has direct linkage with banks profitability and economic health of a nation. Profitability of
banks has effects on growth and development of an economy. Because of this reason,
banking regulatory authorities in many nations, worldwide came up wit various banking
reforms agenda with specific emphasis on variables determining banks profitability.
Banking industries had experienced major reforms worldwide for over three decades now
in their operating environments.

1.1.1 Commercial Banks in Kenya

There are currently 43 commercial banks in the country, 1 mortgage finance company,8
deposit taking microfinance institutions, 7 representative offices of foreign banks,
108foreign exchange bureaus and 2 credit reference bureaus. Central Bank of Kenya
expects the banking sector to sustain its growth momentum largely driven by adoption of
cost-effective delivery channels and increased presence of Kenyan banks in the East
African Community partner states and South Sudan. The risks of inflation and the resulting
high interest rates are expected to reduce in the course of the year (Central Bank Kenya;
2013).
On gore (2011) study shows that performance of firms can also be influenced by
ownership identity. The domestic vis-à-vis foreign classification is based the nature of the
existing major ownership identity in Kenya. In terms of asset holding, foreign banks
account for about 35% of the banking assets as of 2013.In Kenya the commercial banks
dominate the financial sector. In a country where the financial sector is dominated by
Commercial Banks any failure in the sector has an immense implication on the economic
growth of the country. This is due to the fact that any bankruptcy that could happen in the
sector has a contagion effect that can lead to bank runs, crises and bring overall financial
crisis and economic tribulations. The banking sector in Kenya is supervised and regulated
by the Government through the central bank of Kenya and other legislations such as the
company law, Banking act and various prudential guidelines issued by central bank of
Kenya. The sector is the flow of money from the depositors to the borrowers. As at 31st
December 2013.

1.1.2 Risk Management and profitability.

Risk management has mainly been on controlling and for regulatory compliance, as
opposed to enhancing financial performance (Banks, 2004). However, this risk
management often leads to enhanced financial performance as regulatory compliance and
control of risks enables the organization to save on costs. Banks (2004) further suggests
that by managing risks, the managers are able to increase the value of the firm through
ensuring continued profitability of the firm. Stulz (1984) suggested that risk management
is a viable economic reason why firm managers, might concern themselves with both the
expected profit and the distribution of firm returns around their expected value, hence

2ĺ
providing a rationale for aligning firm objective functions in order to avoid risk. Proper
risk management is important in with Jolly (1997) contribution that preventing losses
through precautionary measures is a key element in reducing risks and consequently, a key
driver of profitability. The efficiency of risk management by commercial banks will
generally influence their financial performance.
1.1.3 Profitability of commercial banks
Profitability is the ability to make profit from all business activities of an organization,
company, firm, or an enterprise. It measures management efficiency in the use of
organizational resources in adding value to the business (so Yemi, Ogunleye & Oshogbo,
2014). profitability is the relationship of income to some balance sheet measure which
indicates the relative ability to earn income on assets. Irrespective of the fact that
profitability is an important aspect of business, it may be faced with some weakness such
as use of different accounting principles (Aduda,2011). Return on Assets (ROA) is a major
ratio that indicates profitability of banks. It is a ratio of income to its total
assets(knrawish,2011)
Return on Equity (ROE) is a financial ratio that refers to how much profit a company
earned compared to the total amount of shareholders equity invested or found in the
balance sheet (ongore,2011). (Willie and Hopkins ,1997), indicated that the ultimate
measure of strength of any financial institution is not its asset size, number of branches or
the pervasiveness of its electronic is rather the true measure of its return on Equity. Thus,
the higher the ROE the better the company is in terms of profit generation.
⁷
1.2 Statement of the Problem
Despite the banking sector registering a 30.4 per cent growth in profits as at 30th June
2012, some banks reported decline in profits while others reported losses. Wide interest
margins, high inflation and foreign exchange rates as witnessed in Kenya are all signs of a
repressed and inefficient financial sector (Odour, 2011). The cost of credit and interest rate
spread remains high, the spread is a major challenge in the banking sector because it acts
as an impediment to expansion of credit, development of financial risk and signals
inefficiency in the sector (ROK, 2011).
Risk management reduces agency costs as it aligns managerial interests with the interests
of capital suppliers (Ameer, 2010). Gacy (1997) noted that banks use risk management to
reduce cash flow variations which could otherwise prevent banks to invest in different
growth prospects. However, the main reason why banks implement financial risk
management techniques are the motivation to reduce the variability of cash flows and
contribute to maximizing financial performance (Triantis, 2000). Boyapati and Tokay
(2004) state that increasing shareholder value by enhancing firm value through the
management of risk exposures is the main objective of risk management programs.
Despite the well-established literature on the conventional financial institutions, studies on
the relationship between risk management techniques and the profitability of commercial
banks remain scanty. The growing market demand and attention given to the commercial
banks have escalated the research interest in this area as well. Previous study has focus on

3ĺ
liquidity risk in oil companies in Kenya for instance Ouko (2011) studied the management
of financial risks exposure of fuel price changes in the Airlines while Kairu (2011) carried
a study on the impact of risk management on profitability of the Kenya power and lighting
companies staff retirement benefits scheme. Despite the Islamic banks financial
environment operates in, no study that has been carried out to determine the impact of
financial risk management techniques adopted by the oil companies on financial
performance. This study therefore seeks to determine the impact of risk management on
profitability of commercial banks in Kenya. Therefore, the omissions of studies on risk
management financial on profitability of commercial banks in Kenya forms the research
gap that this study wishes to address. This study therefore intends to fill in this research
gap by investigating the impact of risk management on profitability of commercial banks
in Kenya.

1.3 Research Problem

It is description of issues which will be addressed by a research. The type of risk
management structures in a commercial bank can be influenced by issues such as the
ownership structure, the regulatory requirements, the geographical location where the bank
is located, the inherent risks in the country where the bank operates and also the calibre of
the bank’s management. However, banks operating in the same jurisdiction may have risk
management structures that are close to each other than the structures for banks in other
jurisdiction or economy. This is so because different economies have different inherent
risks that exist in them. As earlier discussed, banks are increasingly finding the need to
manage the risk that they face for continuity purpose. However, despite the emphasis that
has been placed in risk management, there have been no enough studies done on it
(Githinji, 2013).Studies that have been carried out in the past to investigate the causes of
collapse of banks and failure of the banking system globally, have all pinpointed to
inadequate management of risk as the main cause of collapse of the banking systems. This
has sent an alarm call to the current day banks management to come up with stringent risk
management measures to cushion themselves from repeat of history. Commercial banks
have embarked on installing sophisticated technology to mitigate various types of risk and
conducting stress tests to check whether they can survive in the case of adverse conditions.
Stress test is a hypothetical analysis by banks whereby they put themselves under
unfavourable economic conditions to determine whether the bank has enough shock
absorbers to withstand those harsh conditions (Kieran, et. al, 2016).
According to a study done by CBK in 2005 to examine the effect of managing risks by
banks, they found that 90% of the banks had reduced their loses and the management of
these banks mainly attributed this reduction in the losses to the increased risk awareness in
the management and the establishment of controls to prevent and detect these risks.
Previously, studies done to examine on the subject matter have concentrated on credit risk.
Although Basel II accord says that credit risk constitutes the biggest risk facing financial
institutions, we would also want to find out using this study the influence of other risks on
profitability. Therefore, this study addresses research questions below; first, are profits in
banks influenced by management of risk? Secondly, what types of risks significantly affect
banks’ profit?

4ĺ
1.4 Objective of the Study
1.4.1 General Objective
To investigate the impact of risk management on profitability of commercial banks in
Kenya.
1.4.2 Specific Objectives
The specific objectives of the study were to;

i. To explore the effect of risk management practices as wholes and separately on

commercial banks.
ii. To explore the risk in commercial banks.
iii. To find the relation between risk management and profitability
iv. To find out the method used to manage risks that may hinder profitability of
banks
v. How risk management affects profitability.
1.5 Value of the Study
Management Arms of Commercial Banks; The results of my study will be important for
managers of the banks since they are the ones charged with design and implementation of
procedures and policies related to investment strategies. The studies will also be important
because the performance of the bank can be compared to the overall bank’s performance.
This would be a good indicator for them to understand their banks performance against the
industry. Finance managers of various banks across the world will be able to appreciate the
importance of the final recommendations of this study in terms of the strategies that can be
taken to improve bank profitability.
Government and Corporate Policy Makers; The government would be interested in this
study to be able to come up with good policies of revenue collection in order to maximize
its revenue. Government and the corporate world policy makers will be able to borrow
from this study and identify areas that will need policy development and/or enhancement
in order to enhance profitability in both the public and private sector commercial banks.
Academia and Researchers; Students of finance will find this study helpful in analysing the
factors affecting profitability of commercial banks; this study will provide area for further
research which can be used to add value in this area of study. The study will also be
available in the University repository system for access to future researchers.
Regulators; Regulators are interested to know in order to enhance regulation and
monitoring function. The findings would be important in the issue of prudential guidelines
on profitability that can be used in policy formulation. The Central Bank of Kenya could
employ the findings of this study in formulating guidelines that will enhance profitability
in the banking sector while protecting those who rely on bank credit.
Investors; in a competitive financial market bank performance provides signal to
depositors whether to invest or withdraw funds from the bank. Depositors need to know
previous performance of banks in order to determine whether it is beneficial to deposit
their extra money to earn profit. Depositors often look at the interest rate that the banks

5ĺ
offer for deposits. By analysing bank performance, they will be able to get more and
reliable information about the strength of the banks. So, the findings of this study will
guide on the best performing institutions that they can invest their money in for them to get
higher returns.

1.6 Scope of the Study

This study was limited to investigate the impact of risk management techniques on the
Profitability of commercial banks. The study, due to its limited scope concentrated on
Kenyan commercial banks since the researcher does not have the capacity to cover the
whole banking sector. The study was carried out between the months of April and July
2023.
1.7 Limitation of the Study
In pursuit of this study, several limitations were anticipated. The sensitivity of the matters
regarding risk management, especially issues touching on profitability performance are
kept secret by most organizations. Commercial banks were not an exception, thus
accessing such vital information was a challenge because respondents may not be willing
to share information due to the fear of victimization. The researcher assured respondents
that the information collected was treated with utmost confidentiality and was for academic
purposes only. The respondents gave inadequate information regarding the study and this
was mitigated by having a questionnaire with both closed and open-ended questions.
1.8 Chapter Summary
The section has provided background information that was used to examine the impact of
risk management the profitability of commercial banks in Kenya. The current context
necessitates placing the study within the proper framework following the study’s goal. The
chapter has also covered the study variables, significance of the study and the scope.
Therefore, it serves as the fundamental tenet on which literature reviews, established
theories and developed methodologies was based to accomplish the objectives, which are
specific to the Kenyan Commercial Banks.

6ĺ
 CHAPTER 2
LITERATURE REVIEW
2.1 Introduction
In this chapter, the study is focusing on the theoretical and empirical reviews, the various
profitability determinants and conclude on how the research will fill the gap in the
knowledge that exists.
Goddard has worked on the profitability of European bank: A cross sectional and dynamic
panel analysis. The result of empirical analysis suggests that despite the growth in
competition in European financial market, there is still significant persistence of profit
from one year to the next. The author also concludes the difference between countries in
the relationship between the importance of OBS business in a bank portfolio and its
profitability. The general conclusion of empirical analysis is that the increasing integration
of European banking market not withstanding national factors still seem to play an
important role among the determinant of bank performance.

2.2 Theoretical Review

This study covers common risk management theories, particularly; moral hazard theory,
modern portfolio theory and Merton’s default risk theory. Finally, concludes on the theory
that we adopted in our study.

2.2.1 Modern Portfolio Theory

The hypothesis of Modern Portfolio Theory (MPT) is a speculation set forth by Harry
Markowitz in his paper. The hypothesis was distributed in 1952 by the Journal of Finance.
The venture hypothesis depended on the possibility that risks disinclined financial
specialists in the business can build portfolios to expand expected stock returns based on
the level of market risks in a speculation, understanding that risks are an inborn and huge
piece of higher reward in venture. The hypothesis came to be among the most critical and
noteworthy financial speculations in the realm of fund and venture. The hypothesis is
additionally alluded to as portfolio hypothesis and proposes that it is workable for financial
specialists to build a proficient bleeding edge of ideal portfolios, which offers the most
extreme and conceivable expected returns for a particular given level of risk. It encourages
and recommends that, for speculators it is not sufficiently just to centre at the normal risks
and stock return of one particular stock. By putting resources into numerous stocks, a
financial specialist can win in case of broadening, by diminishing the risks in the portfolio
given. 'This hypothesis consequently tries to measure the advantages of enhancement.
For most investors, the risk part is that any return from an investment might be lower than
the expected returns or put in other words, the variations from the expected stock returns.
According to the theory, each stock has its own deviation from the stock mean. This
standard deviation from the mean is called risk, (Markowitz, 1952). The hypothesis
likewise clarifies on CAPM. As per CAPM, every single sane financial specialist ought to
put the market portfolio, utilized or deleveraged with positions in the risk-free resource.

7ĺ
Notwithstanding this, CAPM likewise thought of beta which relates an advantage's normal
return. Portfolio hypothesis in this way gives a plain setting for comprehension the
connections results of orderly risks and rewards. It has extensively formed how monetary
institutional portfolios are overseen and persuaded the utilization of dishonourable and
aloof speculation methods in the commercial banks. The comprehension of portfolio
hypothesis and CAPM is utilized as a part of money related risks administration systems.
In connection to this hypothesis, Commercial banks have a commitment to investigate all
venture exercises by figuring the normal returns
2.2.2 Moral Hazard Theory
This theory has been widely used in Economics world. The theory argues that one party
takes more risks because other parties elsewhere bear the costs for those risks. This may
occur where the actions of someone may change to the detriment of another party
participating in an active role in economic or financial transactions (Krugman, 2009).It
states that sometimes the party which is covered against a particular risk or peril may
intentionally get involved in the risk knowing very well that another party will incur the
cost associated with the risk. This theory was developed by Economist Paul Krugman
(Krugman, 2009). This theory states that moral hazard only occurs when there is
asymmetry of information on either or both parties. This theory applies in the day to day
activities and it mostly affects institutions in the financial industry, i.e. insurance
companies and banks. For example, a borrower may engage in activities that are against
the covenant in the loan agreement without the knowledge of the lender. This expose the
lender to the risk because in the event of the borrower defaulting, the lender will not be
able to recover its funds back hence a loss will be incurred. In the case of an insurance
company, a driver may drive carelessly just because he or she is protected by the insurance
cover and in case of any accident he or she will be compensated. This will eventually lead
to a loss on the side of the insurance company. Due to moral hazard, financial institutions
have every reason to design, implement and monitor the operating effectiveness of risk
management structures to cushion themselves from such losses which arise as a result of
negligence. The risk management structures vary for businesses in various sectors and
industries. Financial institutions are however prone to more risk especially arising from
default by borrowers. To this effect, banks must come up with stringent risk management
measures which in effect reduce the probabilities of default thus reducing loses and by
extension improving the bank’s performance i.e. profitability.
2.2.3 Merton’s Default Risk Model
This theory originates from Robert C Merton (Merton, 1974) and it measures default risk.
Actuaries and other credit evaluation personnel in banks use this model to assess a
borrower’s capability to repay a debt and the probability of default by a borrower. The
model can therefore help security analysts and officers who attempt to determine an
organizations credit fault risk will utilize the model in the analysis. The model suggests
that the analysts should better value the financial institutions, and also check on its ability
to remain liquid through the through the period under analysis and debt maturity.
The Merton’s default model was advanced to Black-Scholes model for options which
became a Nobel-Prize winning model. This model is used to calculate the pricing of
European derivative options without considering the dividends paid out during the life of

8ĺ
the option. The Merton default theory is also used by investors to understand the credit
ratings and spread of a company and comprehend the capital structure of an organization.
This helps them to minimize on the risk of investing in a company that will run into
liquidity problems soon after making an investment. Banks also use this theory before
extending credit facilities to borrowers. This is crucial as it assists the banks to cushion
itself from risk of default by borrowers which forms the biggest risk affecting commercial
banks according to Basel II. The Merton default theory has triggered most banks to come
up with risk management measures especially before lending money to borrowers such as
obtaining the history of the borrower’s account, obtaining security for the amount to be
awarded so that in case of default the bank can recover the amount and also coming up
with stringent loan covenants to cover the bank from potential losses.

Based on the theories above, our study will be based on theory number 3, Merton’s default
Risk Model. This theory is based on some simple assumptions about the capital structure
of the l firm’s finances. In the event of default, the firm’s market value of the assets owned
by the firm in relation to the liability of the firm falls below the set certain threshold and
therefore the firm are considered to be in default. One of the reasons for the default in the
banks is the Credit risk which forms part of the risks based by banks.
2.3 Determinants of commercial banks profitability
Increasing wealth of shareholders is the main goal of every business. Banks being
businesses like others, also have the responsibility and objective of maximizing the
shareholders wealth. This is achieved by ensuring that the business is making profits and
increasing this profit over time. In addition to maximizing the wealth of shareholders,
banks also have a very crucial task in the economy of every country hence their stability
and progress also mean prosperity of the whole economy. However, in the pursuit of the
objective to make profits and growing the economy, commercial banks are encountered
with several factors which affect their profitability. These factors can be bank specific (i.e.
the obstacles specific to a bank) and they can be another micro and macro-economic factor.
In this study we are only focusing on the main factors affecting the profits of banks. They
include; economic conditions, corporate administration, ownership structure and risk
management.
2.3.1 Economic Condition
This refers to the current state of an economy in a country. The economic environment and
associated economic conditions that a bank operates in affect its profits. These economic
conditions include GDP rate of growth, rates of inflation in the economy, stability of the
local currency, lending rates and the level of government interference in the running of the
economy. According to (Ntim, 2009) these factors have a significant influence on an
organization’s ability to generate benefits using the available resources.
A bank which operates in an environment where the currency is stable is likely to generate
more profits than a bank operating in an economy whose currency is very volatile. This can
only be so if all other factors are held constant. In Kenya for example, there was capping of
interest rates from 2016 to 2019, i.e. the banks could not charge interest on loans beyond a

9ĺ
certain percentage. This gave mixed effects in the economywide. from the point of view of
a borrower, it benefited them as they were able to obtain finances at a cheaper rate and they
were cushioned against extreme volatility in interest rates. From the side of the commercial
banks however, this had negatively affected them profitability as it had reduced the
income, they were earning in terms of interest income.
Commercial banks in Kenya have been highly affected by inflation rates and cost of
borrowing and lending rates to borrowers. Unfavourable economic conditions such high
interest rates, high inflation rates and low-income levels negatively affect financial
performance of Banks in Kenya. Economic conditions which have been experienced in the
country has been stable despite the political disruptions experienced in the post-election
which occurred in the end of 2007 and early 2008.
2.3.2 Corporate Administration
Corporate administration is defined as the practices and the structures that guide how firm
sets its destinations, creates set methodologies and persistent arranging, observing and
reporting its budgetary execution, and deal with its given risks (Reddy, 2010). Analysts
have likewise hypothesized that great corporate administration prompt upgrade of the
financial performance of the firm (Chugh et al., 2009). Numerous studies hold the view
that there are two models of corporate structure, the shareholder model and partner held
model. Shareholder model has been found to concentrate on the boosting the riches of
shareholders while the other model spreads more extensive viewpoint and worries about
the more extensive point of view of the firm (Maher and Anderson, 1999). According to
his study (Brooks and Iqbal, 2007) discovered that corporate administration on firm
performance is expanded by making files for board qualities in the association,
straightforwardness and revelation in the firm, and shareholder and possession attributes
coupled with satisfactory management. The study therefore subsequently infers that fitting
corporate management is an indication of a decent money related performance of the
business substance.

2.3.3 Ownership structure

This is the composition of the owners of a company, it can either be institutional investors
versus individual investors, government owned versus private owned or a mixture of all.
The ownership structure influences company’s profitability because it determines the
amount of capital injected into the company and the management style of the company.
(Berle and Means, 2000), broadly classified the ownership structure of companies into two
group. The first category is whereby a company is controlled by its owners and the second
category are a management-controlled company. The ownership structure of a company
also determines the level of agency problem in that company.
In the first category, there will be no agency conflict because the agent will also be the
principal hence no agency-principal conflict. However, in the second category, the agency
conflict is inherent, and this can only be mitigated by placing some controls. This also
applies for commercial banks and the ownership structure plays a big role in a bank’s
performance. Commercial banks owned by government or those which have large portion

10ĺ
of its shares being owned by government, may encounter the problem of political
interference, hence affecting its profitability.
2.3.4 Risk Management
It is the evaluation of risks and laying down procedures to mitigate them. Management of
risk can influence a company’s performance and more so banks which are prone to so
many risks. ‘Banking business is a very risky venture and the relationship between such a
business and returns from it ought to be efficient to reward risk seekers investors’ (Forbes,
2002). Banks with strong internal controls and other measures put in place to mitigate risks
are more likely to be profitable than banks which have weak internal controls to mitigate
risks. Commercial banks can manage their risks by performing thorough due diligence
Risk management in a firm setting can determine the financial performance of firms.
Firms engaging in risky operations attract investors who like to take risks. The relationship
between the risk businesses and returns need to be efficiently worked so that the risk-
taking investors do get the returns associated with the risks undertaken (Forbes,2002). Risk
management is a key determinant in the performance of commercial banks in Kenya, since
banking sector is a risk sector.
Risk administration can likewise be viewed as the strategies and instruments put in by the
business banks to keep away from dangers. T credit assessment before issuing credit
facilities, hedging against currency fluctuations, diversifying portfolios and products so
that in case one product is not doing well; they can benefit from the others and also by
automating processes and putting in place measures to protect themselves from
cybercrime.
2.4 Empirical Literature Review
This is a review of past research done in the same field and analysis of findings from such
studies. Many studies on this area have been done both at the local and international level.
A study conducted to analyse execution of management of risks by banks in Malaysia,
(Mohd and Salina, 2010). It was done for the period between 2006 and 2008 and it used
five independent variables i.e. environment, policies and procedures, mitigation and
monitoring as per the guidelines of Basel committee on supervision practices. These
independent variables were then assessed on how they affected the profits measured by
ROE. Results were that banks with better risk management practices reported higher ROE.
Another study was done by (Oluwafemi and Obatala, 2010) covering ten Banks in Nigeria
between year 2006 – 2009 on the same subject. The dependent variable was measured
using the ratio of ROA and the independent variables included capital, liquidity and credit
risks. Results were that there was a strong relationship in the variables.

2.6 Conceptual Framework

According to Young (2009), conceptual framework is a diagrammatical representation that
shows the relationship between dependent variable and independent variables. The
ultimate goal is to assist the researcher to bring out a clearer and complete picture of what
he or she wants to bring about by linking the dependent variables to the independent

11ĺ
variables (Tobin, J. et. al. (1968). The function of the conceptual framework is to assess
and refine goals, develop realistic and relevant research questions, select appropriate
methods, and identify potential validity threats to the conclusions. It also helps in justifying
the research (E&Y,2009).

FIGURE 1
Conceptual Framework

Independent Variables Dependent Variable

Market Risk Management

· Non-performing loan ratio
· Capital adequacy ratio
Profitability
· Cash reserve ratio
· ROE
· ROA

Liquidity risk

· Credit to deposit ratio

· Current ratio
· Liquid assets ratio

12ĺ
Figure 2.1 Conceptual Framework
Source: Researcher 2023

2.6.1 Market risk management

Risk management is the process of identifying and measuring risk and ensuring that the
risks being taken are consistent with the desired risks. Market risk is the risk arising from
changes in the markets to which an organization has exposure.
2.6.2 Liquidity risk
Liquidity risk is the ability of a bank to fund increases in assets and meet obligations as
they become due, without incurring unacceptable losses.

2.7 Operationalization of variables

This section of the study clearly outlines the study variables as well as variable indicators
and how they were measured to meet study objectives as tabulated below.
Table 1.1 Operationalization of variables
Variables Attributes Analysis Measurement
Scale
Profitability Return on assets Descriptive Ratio
Return on Equity statistics
Non- performing loan Liquidity ratio Descriptive Ratio
ratio Lending interest statistics
rate
Capital Adequacy ratio Capital Descriptive Ratio
Weighted asset statistics
Cash reserve ratio Total deposits Descriptive Ratio
Net demand statistics
Credit to deposit ratio Total advances to Descriptive Ratio
Total deposits statistics
Current ratio Total current asset Descriptive Ratio
Total current statistics
liabilities
Liquid assets ratio Bank total loans Descriptive Ratio
Total deposits statistics
Source: Researcher,2023
2.8 Chapter Summary
The chapter has reviewed earlier research that is relevant to the study variables and is
consistent with the goals of the study. Along with the analysis of previous known facts,
which has outlined the organized understanding of earlier studies and the key issues, the
existing theories are clarified. In addition, the chapter discusses conceptual frameworks,
the operationalization of variables, empirical literature review and chapter summaries.

13ĺ
 CHAPTER THREE
RESEARCH DESIGN AND METHODOLOGY
3.0 Introduction
This chapter describes the methodology followed in conducting the study. It gives
description of the research design adopted, the population, sample size determination,
sampling procedures, data collection instruments, collection procedures and finally it
presented the data analysis procedure.

3.1 Research Design

The study adopted a descriptive case design because the design has the ability to provide
reliable descriptive data of characteristics of a sample from the population (Mugenda and
Mugenda, 2008). Similarly. because this study aimed at establishing the relationship
between two variables; the dependent and independent variables, then the design is
appropriate. Descriptive analysis is also appropriate when the actual sample is large
enough and the data collection requires the respondent to give description of their actual
experiences, perceptions and attitudes on the subject of the study and in their actual
experiences. This design is expected to get a deeper understanding of the study questions
being addressed (Mugenda and Mugenda, 2008).
Many research designs could be used to study business problems (Hair et al.,2011, p.1447).
depending on the way in which researchers asked their research questions and present their
purpose, the research design could be classified into their groups, namely as exploratory,
descriptive and explanatory study (Saunders et al.,2009. p.138 $ 139). According to Hair et
al.,2009 p. 139). Therefore, exploratory research must be flexible and adaptable to change.
That is to say, researchers are willing to change their direction as a result of new data that
appear and new insights that occur to them (Saunders et al.,2009, p.140).

14ĺ
3.2 Target Population
Target population, according to Amin (2005), are all the people or things that the
researchers are interested in generalizing their findings to. The key aim of this research is
to determine the links between bank profitability and risk management associated with
banks. The target population comprised of the forty-two (42) commercial banks as per
appendix III.
3.3 Sample and Sampling Method
According to Kothari (2009) sampling is the process of selecting a number of individuals
for a study in such a way that the individual represents a larger group from which they
were selected from. Sampling means selecting a given number of subjects from a defined
population as representative of that population. Previous researches provide a researcher
with an empirical and comparative benchmark upon which the researcher can base his/her
judgements on what the most appropriate sample size for the study. The sample size that
was used by a researcher can serve as a guide to determine the sample size that is adequate
for the purpose of a research.
According to Mugenda and Mugenda (2003), a sample size of between 10% and 50% 0f
the target population is considered appropriate. A sample size of 55 was used. according to
Kothari (2014), at least 50% 0f the total population is adequate sample size for descriptive
studies. The selected sample size was a representative of the selected commercial banks in
Kenya staff which are Barclays bank of Kenya, First community bank and Development
bank of Kenya. These compromised of 6 finance managers, 9 risk managers, 9 operational
managers and 50 agents. Hence a total sample of 55 was used.
Table 2.1 sample size
Management Risk Bank Population Sample size (50%)
of target
population
Finance managers Barclays bank 7 3
First community 8 4
bank
Development bank 6 4

Risk managers Barclays bank 9 4

First community 10 4
bank
Development bank 9 3

Operational Barclays bank 8 5

managers First community 10 4
bank
Development bank 7 4

Agents Barclays bank 36 16

First community 30 22
bank
Development bank 30 12

15ĺ
 Total 170 85

3.4 Instruments
Research instruments include measurement equipment such as tests, questionnaires,
interviews and surveys. According to Saunders, Lewis & Thornhill, 2018) questionnaires
are thought to e cost effective, simple to administer and they are tie saving. This enabled
the researcher to prefer questionnaires in the study as the major data collection tool.
According to other researchers who have used it in the sae field of study, the
questionnaires are preferred due that they are thought to be less expensive date collecting
instruments and the researcher ay collect big volumes. Moreover, the main disadvantage of
using questionnaires as one of the data instruments is that it cannot be presented to
illiterate respondents who cannot read or write (Creswell and Creswell,2018).
3.5 Pilot Study
According to Kathrin and Pals (1993), the correctness and significance of conclusions
drawn from study findings constitute validity. This suggest that the degree to which
conclusions drawn after data analysis accurately reflect the phenomena under research is
known as validity. The researcher conducted a thorough literature investigation on the
topic study and spoke with the subject matter experts to improve content validity. These
will make it easier to make sure that the questionnaires accurately reflect their contents are
appropriate for the sample and are detailed enough to gather all the data
required to answer the study’s objectives’ goal of the process is to establish whether the
results from the instruments provided the necessary feedback to help the study achieve
its goals as outlined in the methodology. The pilot study is also significant because it
established the reliability and validity of research data collection equipment (Cooper &
Schindler, 2018).
3.5.1 Validity
Validity refers to a research tool’s ability to produce predicted results (Saunders, Lewis &
Thornhill, 2018). The validity test is to identify and rectify any defects in the research
instrument before it is given to the sample group. A separate study population having
features comparable to the study population to be examined is used as a pilot study
population to test the research questions (Kumar, 2005). The management staff from the
selected commercial banks in Kenya participated in the study instruments’ pilot testing.
The respondents, who were picked at a random and did not take part in the actual study,
they were given 15 questionnaires.
3.5.2 Reliability test
Throughout the piloting phase, the study also conducted a reliability test. Saunders, Lewis
& Thornhill (2018) defines reliability as the ratio by which study questionnaires are
evaluated for consistency. If the research instruments are reliable, they should produce the
same results as the pilot study when given to the actual sample size, according to Kothari
and Garg (2015), and this is coraborated by Cooper and Schindler (2018). The research
tool’s level of internal constancy over time determines how reliable it is. Therefore, a

16ĺ
dependable instrument is one that consistently yields the anticipated findings when used
several times to gather information from two samples taken from the same population. A
pilot study at the selected commercial banks using the split- half approach with randomly
chosen management departments improved the instrument’s reliability. (Mugenda and
Mugenda, 2003).

3.5 Data collection

Data collection procedures is the means that statistic is collected by the researcher. The
empirical data about study variables for the period of three years (2016-2018) is collected
from bank scope database which is contains the data of all commercial banks. Two types of
empirical data (dependent and independent) variables are collected based on the theoretical
model of the study. The dependent variables ROE (Return on Equity) and ROA (Return on
Assets) and conversely the independent variables are the impacts that affect bank
profitability in risk management on Kenyan commercial banks. Therefore, the researcher
used questionnaires because they enable and simplify correlation, descriptive and
inferential statistical analysis. These questions will aid in the effective enrichment of the
qualitative methodology. The questionnaires were used to collect the primary data.
3.6 Hypothesis
There are two types of hypothesis.
3.6.1 Null Hypothesis
Ho1= there is no significant relationship between ROA and NPLR.
Ho2= there is no significant relationship between ROA and CAR.
Ho3= there is no significant relationship between ROA and CDR.
Ho4= there is no significant relationship between ROA and CRR.
Ho5= there is no significant relationship between ROA and CR.
Ho6= there is no significant relationship between ROA and LAR.
3.6.2 Alternative Hypothesis
Ho1= there is significant relationship between Non performing Loan Ratio and
profitability.
Ho2= there is significant relationship between Capital Adequacy Ratio and Profitability.
Ho3= there is significant relationship between Credit Deposit Ratio and Profitability.
Ho4= there is significant relationship between Cash Reserve ratio and Profitability.
Ho5= there is significant relationship between Current Ratio and Profitability.
Ho6= there is significant relationship between Liquid Asset Ratio and Profitability.

17ĺ
3.7 Data Analysis
Descriptive statistics was used to describe the data and examine the relationship between
the variables under investigation. Descriptive statistics used included Tables, Means,
Standard Deviation, Correlation and Regression are used for the purpose of presentation
and analysis of data. Regression analysis is done to check the model’s fit and p-values
generated from the regression have been analysed to test the hypotheses. Inferential
statistics was used to examine the casual relationships between the financial risk
management and the bank’s profitability.
The model in the study includes;
Model 1: ROA = β0 + β1NPLR + β2CAR + β3CDR + β4CRR + β5CR + β6LAR + £…….
(I)
Model 2: ROE = β0 + β1NPLR + β2CAR + β3CDR + β4CRR + β5CR + β6LAR + £…….
(ii)
Where ROA = Return on Assets, ROE = Return on Equity, β0 = constant, β1, β2, β3, β4,
β5 and β6 are the regression coefficients for Non-performing Loan Ratio, Capital
Adequacy Ratio, Current Ratio and Liquid Assets Ratio, respectively, and £ = error term in
the model
3.7.1Analytical Model
The study utilized the regression analysis with the equation of the form Y = α+ b1
X1+b2X2+b3X3+b4X4+b5X5+b6X6+b7X7+£. The model provided a statistical technique
for estimating the relationship between the risk administration in Kenyan commercial
banks and its impact in the profitability performance.
Y = α + b1 X1 + b2X2 + b3X3 + b4X4 + b5X5 + b6X6 + £.
Where:
α = constant/ the interception point of the regression line and the y- axis
b1, b2, b3……b6 = the coefficients of the independent variables that will be determined.
Y = profitability measured by the simple average ROA
X1 = Non performing Loan Ratio.
X2 = Capital Adequacy Ratio.
X3 = Credit Deposit Ratio.
X4 = Cash Reserve Ratio.
X5 = Current Ratio.
X6 = Liquid Assets Ratio.
£= Error term.
3.7.2 Measuring the variables

18ĺ
Table 3.1
Return on Equity (ROE) Return on Equity (ROE) can be computed
as net income returned as a percentage of
shareholder’s equity. A simple average for
the selected commercial banks for five
years was used.
Non- Performing ratio The ratio of bank non-performing loans to
total gross loans is the value of non-
performing loans (gross value of the loan
as recorded on the balance sheet) divided
by the total value of the loan portfolio
(including non-performing loans before the
deduction of loan provisions.
Capital Adequacy Ratio Capital adequacy ratio is a measure of how
much capital a bank has available, reported
as a percentage of bank’s risk weighted
credit exposures.
Cash Reserve Ratio Cash reserve ratio can be computed as the
percentage of a bank’s total deposits that it
needs to maintain as liquid cash. The ratio
is currently 4.25% of the total of a bank’s
domestic and foreign currency deposit
liabilities.
Credit to Deposit Ratio To calculate the loan to deposit ratio,
divide a bank’s total amount of loans by
the total amount of deposits for the same
period. Typically, the ideal loan to deposit
ratio is 80% to 90%. A loan to deposit ratio
of 100 percent means a bank loaned one
dollar to customers for every dollar
received in deposit it received.
Current Ratio Current ratio describes the relationship
between a colony’s assets and liabilities it
measures financial strength of a company
whether it has enough resources to meet its
short-term obligations.
Liquid assets Ratio Liquid asset ratio (LAR) it is defined as the
obligation of commercial banks to
maintain a predetermined percentage of
total deposits and certain other liabilities in
the form of liquid assets.

3.7.3Tests of Significance
The study used Statistical Package for Social Science (SPSS) to determine the nature and
strength of the relationship between risk management and profitability. The Tests of
Significance are Regression Analysis expected to yield Coefficient of Determination (R2),
Analysis of Variance along with relevant t – tests, f- tests and p values. Inferential
Statistical techniques were done at 95% Confidence level. (α = 0.05).
19ĺ
 CHAPTER FOUR
DATA ANALYSIS, RESULTS AND DISCUSSIONS
4.1 Introduction
This chapter presents the empirical findings of the impact of the risk management on the
profitability of banks in Kenya for the period 2018 – 2022 under study, both descriptive
and inferential statistics have been specifically using logistic regression analysis to provide
an insight depth of the relationship between risk management and profitability of
commercial banks in Kenya.it provide detailed analysis and panel regression evaluation.
4.4 Descriptive Statistics
This summarizes the sample characteristics of the relationship between risk management
and profitability of commercial banks in Kenya. The results tests on the differences in
means of all variables of the model were considered i.e. Non-performing loan ratio, Capital
adequacy ratio, Credit to deposit ratio, Cash reserve ratio, Current ratio and Liquid assets
ratio. The findings were as indicated in Table 4.1.

Table 4.1 The relationship between the risk management and profitability of
commercial banks in Kenya

N Minimum Maximum Mean SD

NPLR 100 0,011 24.30 1.907 2.881
CAR 100 0.14 0,81 0.321` 0.032
CDR 100 65.34 96.69 82.612 6.74
CRR 100 3.66 35.14 17.176 9.557
CR 100 0.09 0.423 0.172 0.0211
LAR 100 7.08 38.041 16.24 5.646
ROA 100 -3.43 3.25 1.452 0.828
ROE 100 -55.9 32.78 14.97 9.743

20ĺ
In the table above, we can see, in relation to the Non-performing loan ratio (NPLR), the
average was 1.90% with a standard deviation of 2.88%. For Capital Adequacy ratio the
average was 0.14% with a standard deviation of 0.03%. with respect to Credit to Deposit
ratio, the average of 82.61%, with a standard deviation of 6.74%. For Cash Reserve ratio,
the average was 17.18%, with a standard deviation of 9.56%. regarding Current ratio, the
average was 0.17% with a standard deviation of 0.02%. For Liquid Assets ratio, the
average was 16.24%, with a standard deviation of 5.65%. For Return on Assets, the
average was 1.45%, along with a standard deviation of 0.82%. Finally, with respect to
Return on Equity, the average was 14.97%, along with a standard deviation of 9.74%.
4.5 Correlation Analysis
The study further determined the correlation between the independent and dependent
variables in the study. The dependent variables are Return on equity (ROE) and Return on
assets (ROA) while independent variables include: Non-performing loan ratio, capital
adequacy ratio, credit to deposit ratio, cash reserve ratio, current ratio and liquid assets
ratio. For this analysis Pearson correlation was used to determine the degree of association
within the independent variables and also between the independent variables and
dependent variable. In other words, this analysis of these correlations seems to support the
hypothesis that each independent variable in the model has its own particular informative
value in the ability to explain profitability of commercial banks in Kenya. The findings are
indicated in Table 4.2
Table 4.2 Correlation coefficients of the relationship between risk management and
the financial performance of commercial banks in Kenya
Correlation CAR CDR NPLR CRR CR LAR ROA ROE
Probability
CAR 1
CDR 0.455 1
NPLR -0.329 -0.266 1
CRR -0.014 -0.063 -0.045 1
CR 0.113 -0.054 -0.046 -0.027 1
LAR -0.233 -0.238 0.532 -0.022 0.539 1
ROA 0.136 -0.018 -0.394 -.0.228 0.058 -0.383 1
ROE -0.263 -0.023 -0.247 -0.037 0.049 -0.215 0.745 1

The above table shows that there is a positive relationship of return on assets with Capital
Adequacy ratio and Current ratio. This indicates that higher the Capital Adequacy ratio and
Current ratio higher would be the return on assets. However, credit to deposit ratio, non-
performing loan ratio, cash reserve ratio and liquid assets ratio have a negative relationship
with return on assets. This indicates that an increase in credit to deposit ratio, non-
performing loan ratio, cash reserve ratio and liquid assets ratio leads to decrease in return
on assets. The return on equity is positively related to current ratio higher would be the
return on equity. Furthermore, return on equity is negatively related to capital adequacy
ratio, credit to deposit ratio, non-performing loan ratio, cash reserve ratio and liquid assets
ratio. This indicates that higher the capital adequacy ratio, credit to deposit ratio, non-

21ĺ
performing loan ratio, cash reserve ratio and liquid asset ratio, lower would be the return
on equity.

4.6 Regression analysis

Table 4.3: Regression Analysis on Return on Equity (ROE).
Variable Coefficient Std Error t-statistic Probability Model
summary
Constant 64.512 13.102 4.796 0 R=0.223
CAR -1.471 0.786 0.786 0.045 A r= 0.172
CDR -0.291 0.154 0.154 0.048
NPLR 0.078 0.475 0.475 0.0145 F-value =
4.588
CRR -0.118 0.094 0.098 0.206 P value=0.00
CR 69.243 31.061 28.005 0.003
LAR -0.967 0.264 0.203 0

There is a positive relationship between dependent variable (ROE) and independent

variable NPLR and CR and there is negative relationship between ROE and CDR, CAR,
CRR and LAR. The relationship between independent variable (CDR, CAR, CR and LAR)
and dependent variable (ROA) is significant, as shown by the corresponding p- values. The
highest beta for current ratio indicates that 69.24% variation in return on assets is
explained by current ratio and is followed by non-performing loan ratio, whose coefficients
of CAR, CDR are -1.471 and -0.291 respectively. In the model summary selection of the
table, the value of R2 is0.223, which suggests that the dependent variable in the model.
The F-value for the model is 4.588 and is significant, as shown by the p-value below 0.05,
confirming that the relationship between dependent and independent variables is
statistically significant and that the model is a good fit for the data.
Table 4.4 Model summary
Model R R square (R²) std. error of the estimate
1 .223 .172 .846
The study further used one-way analysis of variance (ANOVA) in order to test the
significance of the overall regression model. Salkind and Green,2003 post that
ANOVAhelps in determining the significant relationship between there research variables
Table 4.4 Hypothesis Testing
Independent variables Dependent p-values Hypothesis
variable support
CAR ROA 0.00(p>0.05) H1 rejected
CDR ROA 0.00(p>0.05)
NPLR ROA 0.00(p<0.05) H3 accepted
CRR ROA 0.00(p>0.05) H4 rejected
CR ROA 0.537(p<0.05 H5 accepted

22ĺ
 LAR ROA 0.00(p<0.05) H6 accepted
Capital adequacy ratio ROE 0.00(p<0.05) H7accepted
Credit to deposit ratio ROE 0.00(p<0.05) H8accepted
Non-performing loan ratio ROE 0.00(p<0.05) H9rejected
Cash reserve ratio ROE 0.00(p>0.05) H10 rejected
Current ratio ROE 0.537(p<0.05) H11 accepted
Liquid assets ratio ROE 0.00(p<0.05) H12 accepted

From the above table, we can see that in relation to ROA, there was significant impact of
Non-Performing loan ratio, Current ratio, Liquid assets ratio on ROA, as suggested by p-
values less than zero. On contrary, there was insignificant impact of Capital Adequacy
ratio, credit to deposit ratio, and Cash reserve ratio on ROA, as suggested by p-values
which were greater than zero.
Now, in relation to ROE, significant impact of Capital Adequacy ratio, Credit to deposit
ratio, Current ratio and Liquid asset ratio was seen on ROE, as suggested by p-values that
were less than zero. On the contrary, insignificant impact of Non-Performing loan ratio,
Cash reserve ratio was seen on ROE, as suggested by p-values which were greater than
zero.
Table 4.5 Analysis of variance ANOVA results of the relationship between risk
management and profitability of commercial banks in Kenya
Sum of df Mean f f F significance
squares square critical
value
Regression 4 19.95 22.06 104.75 0.00
Residual 23 4.588
Total 27
The value of f statistic, 22.06 indicates that the overall regression model is significant
hence it has some explanatory value i.e. there is a significant relationship between the
predictor variables and profitability of commercial banks in Kenya.
4.7 Discussion and Research Findings
The results of tests on the differences in means of all variables of the model were
considered i.e. Capital adequacy loan ratio, Credit to deposit ratio, Non-Performing loan
ratio and Liquid assets ratio.
In this study, correlation coefficient result shows that there is positive relationship between
Capital adequacy ratio (CAR) and Return on Assets (ROA). Similarly, where is a negative
relationship between Capital Adequacy ratio (CAR) and Return on Equity (ROE). This
result is consistent to the result of (Nelson, 2020) [39]. However, this result is
contradicting to the findings of (Bhattarai,2014). Likewise, there is a negative relationship
between Credit to Deposit ratio (CDR) and profitability. This result is consistent to the
result of (Samad & Hassan, 2000). However, this result is contradicting to the findings of
(Chowdhury & Zaman, 2018). Similarly, there is a negative relationship between Non-
performing loans ratio (NPLR) and profitability. This result is similar to the result of
(Nelson, 2020). However, the result is contradicting to the findings of (Li and Zou, 2014)

23ĺ
and also there is a negative relationship between Cash reserve ratio and profitability. This
result is consistent to the result of (Nelson,2020). However, this result is contradicting to
the findings of (Uremadu,2012). The Current ratio (CR) is positively correlated with
profitability. Th result is consistent to the findings of (Pradhan and Gautam, 2019).
However, this result is contradicting to the findings of (Saleem & Rehman,2011).
Furthermore, there is negative relationship between Liquid assets ratio and profitability.
The result is consistent to the findings of (Pradhan & Gautam, 2019). This result
contradicts to the findings of (Chowdhury & Zaman, 2018).

CHAPTER FIVE
CONCLUSIONS AND RECOMMENDATIONS
5.1 Introduction
This chapter presents the summary, conclusions and recommendations derived from the
findings of the study. Section 5.2 is a brief discussion of the research findings, section
5.3provides the conclusions. Section 5.4 provides the recommendations. Section 5.5 finally
provides the limitations of the study.

5.2 Conclusions
This study investigates the impact of risk management on the profitability of commercial
banks Kenya. The estimated results regression models reveal that capital adequacy ratio,
credit to deposit ratio, non-performing loan ratio and liquid assets ratio are major
explanatory variables of profitability. Management should focus on capital adequacy ratio,
credit to deposit ratio, non-performing loan ratio and liquid assets ratio to build
competitive position. Similarly, current ratio has significant positive impact on profitability
of commercial banks in Kenyan commercial banks. When capital adequacy ratio, credit to
deposit ratio, non-performing loan ratio and liquid assets ratio rise, the profitability of
commercial banks may fall. Similarly, if current ratio rises profitability of commercial
banks also increased.

24ĺ
The study has shown that non-performing loans rations have a negative effect on the
financial profitability performance on the selected commercial banks in Kenya. Capital
adequacy ratio has also negative effect on return on asset measure. This highlights the
importance of risk management practices in commercial banks, specifically focusing on
these ratios, to build a competitive position. Secondly, the study found that the current ratio
has a significant positive impact on profitability, which suggest that this variable is also an
important explanatory factor of profitability. This implies that management should focus
on maintaining an appropriate level of current ratio to increase profitability.
Based on the findings, the study, therefore, concludes that capital adequacy ratio, credit to
deposit ratio, deposit ratio, non-performing loan ratio, current ratio and liquid assets ratio
influence the profitability. The study has some important policy implications for the
profitability sector in Commercial banks in Kenya. First, following the negative
relationship between non-performing loans and profitability performance, it is suggested
that commercial banks should adopt stringent risk management policies which will be
updated regularly to reflect a decline in their value. The commercial banks should ensure
that collateral documentation is obtained prior to disbursement and checked for accuracy
and completeness. Furthermore, top management of commercial banks should also ensure
they, provide training of risk management staff, especially those involved in the
disbursement, monitoring and recovery of loans. If these measures highlighted are well
executed, non-performing loans will be reduced, even if not totally eliminated, the
profitability performance through risk management of commercial banks will be enhanced.

Finally, based on the positive relationship between current ratio and profitability, it
becomes imperative for commercial bank managers to be innovative and introduce more
products to the markets in order to earn fees to enhance their performance. Managers of
commercial banks should also broaden their operational activities by establishing more
branches and investing in modern technology. Managers of commercial banks should also
put measures in place to regain the trust of the populace in order to gain more customers
which will in turn increase their deposits, and eventually, risk management in the
profitability performance of the commercial banks will be improved to lead to good
financial performance of the Kenyan Commercial banks. Overall, the study highlights the
importance of risk management practices in commercial banks and the need for
management to focus on maintaining appropriate levels of capital adequacy ratio and credit
to deposit ratios.
5.3 Recommendations
In view of our discoveries, we need to draw a few proposals based on factual information
from the bank managers, we recommend, firstly, the Kenyan commercial banks should
expand their risk management measures techniques and adopt more technical and reliable
measures so as to adequately manage different financial risks. This may result for the
increased financial innovations in the banking sectors.it has been made a reality by use of
advanced information techniques.
On the risk management practices, the mentioned above risks are not only the risk that can
influencing the profitability performance of commercial banks in Kenya. Capital adequacy
ratio and Current ratio were included in the study due to wake of commercial banks going
25ĺ
to bankrupt due to the inability to meet its financial obligations .in reference to this, there
are other risk management practices should be put in to consideration by the Kenyan
commercial banks.
Finally, this study recommends to the practitioners to pursue deposits, especially more call
deposits than tine deposits. On loans, commercial banks Fin Kenya should use available
resources to improve profitability and lead toa proper and good performance to their main
functions.

5.4 Limitation of the study

The key limitation of this research study was that, out of the forty-two (42) commercial
banks in Kenya that are listed as the population, only 35 commercial banks gave their
feedback as per the questionnaire that was send out. Moreover, some respondents decided
to withhold their factual information about the capital adequacy ratio risk management
practices. Unfortunately, most respondents considered the information seeking in the
questionnaire sensitive hence they failed to respondent appropriately.
Secondly, since the research was relying mostly on secondary data, obtained online, from
published end of year accounts of financial statements, the researchers encountered many
challenges particularly during the process of data collection. Most of the financial
statements were obtained online from the various reliable search engines such as Google.
The search for the information was a bit time consuming due to slow network on the search
sites. Hence, the information posted by some banks was insufficient enough to facilitate
the research. This is because some banks never disclosed the actual figures on some items
like non-performing loans as they feared that the information might be used by competitors
to their disadvantage.
The variable used in this study are not exhaustive as there are other impact on risk
management on profitability of banks such as credit risk management, monetary policies
and among others.
Lastly due to some unforeseen constraints such as finances and time, the researcher did not
carry out any interviews on the actual impact on the risk management on the profitability
of commercial banks. This could be the cause of data available was limited since all the
findings were based on the questionnaires and the researcher’s personal knowledge of the
region under that particular study.

5.5 Areas for Further studies suggestion.

The research seeks to establish on the impact of risk management on the profitability of
Kenyan commercial banks, thus area of further studies could consider on other companies
in Kenya. This study adopts six (6) independent variables and how they have impact on the
26ĺ
risk management on the profitability of banks which are measured using return on assets
(ROA). Therefore, future research studies can incorporate other variables such as credit
risk, asset quality and income diversification since they are also capable of affecting the
profitability of commercial banks in their financial performance.
In addition to the above recommended research, other research can be recommended on the
finding of how Kenyan commercial banks have, adopted and embraced the base II
recommendations and whether the detailed recommendations have affected their financial
risk management and the profitability performance. Lastly, a study may be directed
towards relationship between monetary crisis and profitability of Kenyan commercial
banks.

REFERENCES

Abel, S., 2016. Determinants of Banking Sector Profitability in Zimbabwe. International Journal of

Economics and Financial Issues, 845- 854.

Alqisie, Ahmad., 2018. Impact of Risk Management on Profitability. European Journal of Scientific

Research, 319-332.

27ĺ
Bhattarai, Y. R. (2016). Effect of credit risk on the performance of Nepalese commercial banks. NRB

Economic Review, 28(1), 41–64.

Boahene, S., Dasah, J., & Agyei, S. (2012). Credit risk and profitability of selected banks in Ghana.

Research Journal of Finance & Accounting, 3(7), 6–15.

Breuer, T., Jandacka, M., Rheinberger, K., & Summer, M. (2010). Does adding up of economic capital

for market-and credit risk amount to conservative risk assessment. Journal of Banking & Finance, 34(4), 703–712.

https://doi.org/10.1016/j.jbankfin.2009.03.013

Chijoriga, M. M. 1997. An Application of Credit Scoring and Financial Distress prediction Models to

commercial Bank Lending: The case of Tanzania. Ph.D. Dissertation Wirtschaftsuniversitatwien (WU).

Chodecal, D. (2004). Impact of lending policy on banking industry in Nigeria. Journal, 7(4), 12–22.

Ekinci, R., & Poyraz, G. (2019). The effect of credit risk on financial performance of deposit banks in

Turkey. Procedia Computer Science, 1581, 979–987. https:// doi.org/10.1016/j.procs.2019.09.139

Embaye, S. S., Fatime, C. Z., & Tahir, A. (2017). The impact of credit risk management on financial

performance of commercial banks - Evidence from Eritrea. Research Journal of Finance .

Gladwell, M. (2005). The moral-hazard myth. The New Yorker, 29(1), 44–49. https://facultystaff.rich

mond.edu/~bmayes/pdf/moralhazard_gladwell_nyor ker.pdf

Goddard, J., 2004. The Profitability of European Banks: The Manchester School, 72, 363-381

Hallunovi, A., 2018. The Relationship Between Risk Management and Profitability of Commercial

Banks in Albania. Asian Themes in Social Sciences Research.

Herath, M. K., Ahamed, L. M., & Athambawa, H. (2021). Credit risk and profitability of banking sector

in Sri Lanka. Journal of Economics, Finance and Accounting Studies, 3 (1), 65–71. https://doi.org/10.32996/jefas.2021.3.1.6

Kadar, K., & Rikumahu, B. (2018). Relationship Analysis between EVA, EPS, ROA, ROE on MVA for

measuring financial performance.

Kaimu, A., & Muba, S. (2021). The relationship between credit risk and financial performance:

Evidence from commercial banks in Tanzania. East African Journal of Business and Economics, 4(1), 22–23. https://doi.

org/10.37284/eajbe.4.1.478

Kane, E. J., & Malkiel, B. G. (1965). Bank portfolio allocation, deposit variability, and the availability

doctrine. The Quarterly Journal of Economics, 79(1), 113–134. https://doi.org/10.2307/1880516

Kithinji, A.M., 2010. Credit Risk Management and Profitability of Commercial Banks in Kenya. School

of Business, University of Nairobi.

28ĺ
Krugman, P. 2009 . How did economists get it so wrong? New York Times 2(9): 1–15.

http://faculty.econ.ucda vis.edu/faculty/kdsalyer/LECTURES/Ecn200e/krug man_macro.pdf

Kutum, I. (2015). Predicting the financial distress of NonBanlöng companies listed on the Palestine

Exchange (PEX). Research Journal of Finance & Accounting, 6(10), 79–83.

Li, F., 2014. Impact of Risk Management on Profitability of Commercial Banks. Umea School of

Business and Economics.

Noman, A. H. M., Pervin, S., Chowdhury, M. M., & Banna, H. (2015). The effect of credit risk on the

banking profitability:

Ogilo, F. (2012). The impact of credit risk management on financial performance of commercial

banks. DBA Africa Management Review, 3(1), 22–37. http://jour nals.uonbi.ac.ke/damr/article/view/1089

Oketch, J. R., Namusonge, G. S., & Sakwa, M. (2018). Effect of credit risk management policies on

financial performance of commercial banks in Kenya.

Rwayitare, J. B., Shukla, J., & Ruhara, C. (2016). Credit risk and commercial bank profitability in

Rwanda. International Journal of Advanced Research, 4(9), 294–325. https://doi.org/10.21474/IJAR01/1482

Saeed, M. S., & Zahid, N. (2016). The impact of credit risk on profitability of the commercial banks.

Journal of Business & Financial Affairs, 5(2),

Sakyi, D., Onyinah, P. O., Baidoo, S. T., & Ayesu, E. K. (2021). Empirical determinants of saving habits

among commercial drivers in Ghana. Journal of African Business, 22

Samuel, O. L. (2015). The effect of credit risk on the performance of commercial Banks in Nigeria.

African Kwashie et al., Cogent Economics & Finance (2022)

Sayilgan, G., 2009. Determinants of Profitability in Turkish Banking Sector: 2002-2007determinants

Profitability in Turkish Banking Sector: 2002-2007. International Research Journal of Finance and Economic

Shijaku, G., 2017. Does Concentration Matter for Bank Stability? Evidence from The Albanian Banking

Sector. Journal of Central Banking Theory and Practice, 67-94.

Short, B.K., 1979. The Relation Between Commercial Bank Profit Rates and Banking Concentration in

Canada, Western Europe, And Japan. Journal of Banking and Finance 3, 209-219.

Sun, C., Chang, X., 2018. The Impact of Credit Risk on Profitability of Commercial Banks. Christina

Atanasova.

29ĺ
 APPENDICES

Appendix 1: LETTER OF INTRODUCTION

Dear respondent,

My name is Grace Nyambura Njoroge a student at Management University of Africa,at least in

part, complete a requirement for the award of degree in bachelor of commerce that institution
offers. I am conducting a study:INVESTIGATING THE IMPACT OF RISK MANAGEMENT ON THE
PROFITABILITY OF BANKS:A CASE STUDY OF COMMERCIAL BANK IN KENYA. As a result, I
respectfully request that you complete the following questionnaire to your knowledge in the
field.Your contributions were used purely for academic purposes; Your name won’t be included
in the study where your suggestions are extremely beneficial to the success of this study
endeavour.

30ĺ
Thank you very much

Yours Trully,

Grace Nyambura Njoroge

Bcomk /4/00163/3/19.

APPENDICES II: QUESTIONNAIRES

This questionnaire is intended to provide information for the study on the effect of risk
management on the financial performance of commercial banks in Kenya. Please note that the
information provided will be used for academic purpose only and will be treated with utmost
confidentiality. Kindly answer the following questions by ticking (x) in the appropriate box or by
giving the necessary details in the spaces provided

31ĺ
TABLE 1: Capital Adequacy ratio

ITEM 1 2 3 4 5
1.Presence of liquidity needs in times of specific bank
3.The bank has forecastable and easily analysed liquidity
2.Bank has both tier one and tier two capital
4.The bank perform a risk weighting for all its assets
5.Promote the stability and efficiency of financial sector
around the world
6.There is analysis of a bank’s risk of failure as it
compares capital to risk weighted assets
7.Banks ensures have enough capital on reserve to
handle a certain amount of losses before being at risk of

32ĺ
 insolvent
8.The bank considers protection of depositors and
promote the stability and efficiency of financial systems

Note: 1 = Strongly Disagree 2 = Disagree 3 = Neutral 4 = Agree 5 = Strongly Agree

TABLE 2. Credit to Deposit Ratio

ITEM 1 2 3 4 5
1.Measure the quality of the loans that a bank has
issued
2.There is multiple factors that drive changes in the loan
3.Helps investors to assess the health of a bank’s
balance sheet
4.The ideal loan to deposit ratio is 80% to 90%
5.If the bank enhances a ratio of 100% it means it has
loaned one dollar to customer for every dollar received
6.Does not measure the quality of the loans issued by
bank
7.The bank relies on its own deposits to make loans to

33ĺ
 its customers if the ratio of lower

Note 1 = Strongly Disagree 2 = Disagree 3 = Neutral 4 = Agree 5 = Strongly Agree

TABLE 3. Non- performing Loan Ratio

ITEM 1 2 3 4 5
1.The bank uses gross value of the loan as recorded on
the lance sheet at a particular date of that given
financial year
2.They have developed over the past few years
3.There is effect on the past rapid growth on its average
quality
4.The bank should ensure and manage their record of
the rapid growth on its average quality
5.There is computerized support system for analysing
the quality of this loans

34ĺ
 6.Adequate record keeping should be enhanced

Note: 1 = Strongly Disagree 2 = Disagree 3 = Neutral 4 = Agree 5 = Strongly Agree

TABLE 4: Cash Reserve Ratio

ITEM 1 2 3 4 5
1.The bank meet its short-term obligations when
cash is hold as reserves
2.The liquid cash is used for investing and lending
purposes
3.The bank earn interest from the liquid cash
maintained with RBI
4.The bank percentage net demand increases as the
liability time increases
5.The bank cannot use the liquid cash maintained
for investing and lending purposes
6.The bank percentage of its total deposits should be

35ĺ
 higher

Note: 1 = Strongly Disagree 2 = Disagree 3 = Neutral 4 = Agree 5 = Strongly Agree

TABLE 5: Current Ratio

ITEM 1 2 3 4 5
1.Higher ratio means the company has more assets than
liabilities
2.The bank measures if it has enough resources to meet
its short-term obligations
3.The measures its financial strength of a given financial
year
4.The ratio compares a company’s current assets to its
current liabilities
5.The bank calculate the ratio by dividing a company’s
total current assets by its total current liabilities
6.The bank needs to have more value of its current asset
compared to its current liabilities

Note: 1 = Strongly Disagree 2 = Disagree 3 = Neutral 4 = Agree 5 = Strongly Agree

36ĺ
TABLE 6: Liquid Assets Ratio

ITEM 1 2 3 4 5
1.Has obligation of commercial banks to maintain a
predetermined percentage of its total deposits
2.The bank should ensure it has other liabilities in the
form of liquid assets
3.Investment securities act as an indicator of the liquid
asset ratio
4.The bank mush ensure it have enough trading
securities
5.The bank need to have proper and ore means of cash
management
6.They should enhance all interbank transactions for
good management
7.They should include and keep all records for the
securities bought under repurchase agreements

Note 1 = Strongly Disagree 2 = Disagree 3 = Neutral 4 = Agree 5 = Strongly Agree

37ĺ
APPENDIX III: Directory of Licensed Commercial Banks in Kenya

1. ABC Bank (Kenya)

2. Bank of Africa

3. Bank of Baroda

4. Bank of India

5. Barclays Bank of Kenya

6. CFC Stanbic Holdings

7. Chase Bank Kenya (In Receivership)

8. Citibank

9. Commercial Bank of Africa

10. Consolidated Bank of Kenya

11. Cooperative Bank of Kenya

12. Credit Bank

13. Development Bank of Kenya

14. Diamond Trust Bank

15. Eco bank Kenya

16. Equity Bank

38ĺ
17. Family Bank

18. Fidelity Commercial Bank Limited

19. First Community Bank

20. Giro Commercial Bank

21. Guaranty trust Bank Kenya

22. Guardian Bank

23. Gulf African Bank

24. Habib Bank

25. Housing finance company of Kenya

26. I & M Bank

27. Imperial Bank

28. Jamii Bora Bank

29. Kenya Commercial Bank

30. Middle East Bank Kenya

31. National Bank of Kenya

32. NIC Bank

33. Oriental Commercial Bank

34. Paramount Universal Bank

35. Prime Bank (Kenya)

36. Sidian Bank

37. Spire Bank

38. Habib Bank

39. Standard Chartered Kenya

40. Trans National Bank

41. United Bank of Africa

39ĺ
42. Victoria Commercial bank

40ĺ
41ĺ
42ĺ
43ĺ