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ISSN No:-2456-2165
Abstract:- The purpose of the study was to establish the bank to employ available resources to increase shareholders’
effect of supervisory review on financial performance of wealth and generate sustainable profits. The current study thus,
commercial banks in Kenya. The study was founded on defined financial performance as the use of the resources
asymmetry information theory. Positivism research invested by the shareholders efficiently and effectively to
philosophy and casual research design were employed. The generate revenue. From literature, there are two types of
target population comprised of forty-three commercial financial performance measures, namely, traditional and market
banks from which a sample of thirty-eight commercial based measures. Traditional financial measures include; cost to
banks was selected using purposive sampling technique. income (CI) return on equity (ROE), return on assets (ROA),
Commercial banks which were actively operating and not non-performing loans ratio (NPLR), percentage change of pre-
under statutory management during the period of study tax profits (%GPBT) and net interest margin (NIM). Market
were selected. Data for the period between 2013-2020 was based financial measures include; total shareholders returns,
extracted from the bank supervision annual reports and price to book value and P/E ratio (Muriithi et al., 2016;
individual bank’s published annual reports using document Mwangi, Makau & Kosimbei, 2014; Odonkor & Barmor,
review guide. Data analysis involved descriptive statistics 2012). The commercial banks financial performance was
and inferential analysis. The study conducted panel unit mainly arrived using ROA since it considers all the assets
root test, multicollinearity test, normality test, utilized to generate revenue for the firm, in addition, the banks
heteroscedasticity test and autocorrelation test to avoid largest assets consists of bank loans and they are the largest
spurious results. The 5% significance level was used to test source of earnings. Thus the per Kenyan shilling return on
the research hypothesis. The panel regression findings assets is key to the commercial banks management (Muriithi et
showed that supervisory review had a positive significant al., 2016). Moreover, CBK employs return on assets to assess
effect on financial performance of commercial banks in the financial performance of commercial banks in Kenya (CBK,
Kenya. The conclusion of the study was that supervisory 2015). The present study therefore used return on assets to
review explains the variation in financial performance of measure financial performance of commercial banks in Kenya.
commercial banks in Kenya. Further, increase in
supervisory review enhances financial performance. The Commercial banks of European member countries have
study thus, recommends that commercial banks in Kenya been struggling to return to profitability after the 2008-2009
should adhere to the prudential guidelines on supervisory global financial crisis. For instance, European union banks
review so as to enhance financial performance in the long (EUB) profitability remained lower than before the crisis time
run. with the return on equity (ROE) declining from 4.4% in 2015
to 3.5% in 2016 and from 6.1% in 2018 to 5.4% in 2019
Keywords:- Supervisory Review, Financial Performance, (KPMG, 2019; Ernst & Young, 2019). The ROE seem to be
Commercial Banks. very low since the cost of capital was about 10% for most EUB
after the global financial crisis. Non-performing loans ratio
I. INTRODUCTION (NPLR) are still high in some of EU member countries after the
crisis. For example, Greece NPLR in 2016 was 46.9% and in
Financial performance is the ability of a firm to employ 2017 was 46.5% while Cyprus NPLR in 2016 was 47.4% and
the available resources efficiently in order to generate revenue. in 2017 was 42.7% (KPMG, 2017). Financial performance of
Shukla (2014) defined financial performance as the bank commercial banks in Kenya declined as noted by return on
capability to create maintainable profits or it’s the ability of a assets over the study period as shown in table 1 and figure 1.
ROA
5
4
3
ROA
2
1
0
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Year
Table 1 and Figure 1 indicate that return on assets on 2013 Demirguc-Kunt & Ross, 2006; Barth et al., 2013). In December
was at 4.7% which reduced to 3.4% in 2014 and further to 2.9% 2020, 40.46% commercial banks were ranked strong, 54.05%
in 2015. In 2016 return on assets raised to 3.2% a time when ranked satisfactory, 4.15% ranked fair, 1.25% ranked marginal
interest capping was introduced by the government of Kenya. while 0.09% ranked unsatisfactory. Supervisory review was
But in 2017, return on assets dropped to 2.7%, remained measured using the natural logarithm of the number of audits
constant in 2018 at 2.7% while in 2019 return on assets, further made by central bank of Kenya in an individual bank. Delis and
reduced to 2.6% a time when the government of Kenya Staikouras (2011) noted that improved supervision enhanced
abolished the interest capping. In 2020, return on assets reduced financial performance of banks while reducing financial crisis.
further to 1.7%. In addition, Rezende and Wu (2014) argues that frequent
examination of banks by the regulators made the banks to
Supervisory review is the standard adopted by commercial adhere to the regulations set by the regulatory authority and
banks to evaluate the extent to which commercial banks are therefore, reducing loan losses and increasing financial
adhering to stipulated rules guiding banking operations in their performance. Faten, Hachmi, Cheffon and Fredji (2014) noted
respective countries (Fapetu & Kolapo, 2015). Supervisory that onsite and off-site examination of commercial banks
review ought to be implemented by both regulatory agencies improved their financial performance hence reducing the
and respective commercial banks. Internally, banks ought to chances of failure.
develop their own assessment criterion on adherence to capital
adequacy and information disclosure strategies adopted. A. Statement of the Problem
Supervisory review call for adoption of recommended Commercial banks major role is for directing funds from
accounting standards and policies. Recently, commercial banks surplus units to deficit units. Therefore, through this role
have adopted varied risk management models through asset commercial banks contribute directly to the economic growth
liability matching strategies. This has amplified levels of and development of any country, thereby improving the lives of
accounting data transparency (David & Muendo, 2018). To the citizens. Since the global financial crisis of 2008- 2009,
achieve supervisory review standards, commercial banks financial performance of commercial banks in Kenya have
should invest in reasonable risk levels. From literature recorded a downward trend (Ernst & Young, 2019). Therefore,
reviewed, it was noted that supervisory review increased the central bank of Kenya introduced supervisory review
financial performance of commercial banks (Beck, Demirguc- regulations for adoption by all commercial banks actively
Kunt & Ross, 2006; Barth, Lin, Ma, Seade & Song, 2013). The trading in Kenya so as to enhance their financial performance
present study operationalized supervisory review as the (CBK, 2013). Nonetheless, despite the momentous efforts by
oversight of banks in order to identify insecure practices which the central bank of Kenya, there have been a reduction in
can be risky to economy or banks. Previous studies measured financial performance of commercial banks in Kenya between
supervisory review by interventionist supervisory (Chortareas 2013 to 2020 as shown by return on assets; 4.7% in 2013, 3.4%
et al., 2012), onsite examination by supervisors (Beverly, Anna in 2014, 2.9% in 2015, 3.3% in 2016, 2.7% in 2017, 2.7% in
& Matthew, 2016), minimum frequency of examination 2018, 2.6% in 2019 and 1.7% in 2020 (CBK, 2020). In addition,
(Rezende & Wu, 2014), Basel core principles index (Beck, charter house bank, imperial bank and chase bank were put
C. Research Hypothesis consists of how the research objective was achieved. That is, it
H01: Supervisory review has no significant effect on financial shows how the data was collected, measured and analyzed
performance of commercial banks in Kenya. (Saunders, Lewis & Thornhill, 2012).
Measurement
Variable
Type
The results in table 2 show that financial performance in From the results in table 2 supervisory review as measured
terms of return on assets for 284 observations had a mean value by the natural logarithm of the number of central bank of Kenya
of 0.0261067, a standard deviation of 0.0381216 with minimum audit for 282 observations had a standard deviation of
and maximum values of -0.1980881and 0.4938343 0.4709894 with a mean value of 0.4447629. The mean value
respectively. The standard deviation value was higher than the indicates that central bank of Kenya was playing its critical role
mean value, indicating that during the period of study (2013- of conducting audits in each of the commercial banks
2020) there was greater variability in return on assets across consequently instilling discipline in the banking industry.
commercial banks, which was corroborated by the difference Further, there was a higher variability in supervisory review
between maximum (0.4938343) and minimum (-0.1980881) since the mean value was lower than standard deviation value
values. The positive value of financial performance means that, that was confirmed by the minimum value of zero and
commercial banks were on average profitable but a negative maximum value of 1.098612. A positive value of supervisory
minimum value of -0.1980881 indicates that some commercial review indicates that improvement in the quality of audit by
banks were operating at a loss over the same time of study. central bank of Kenya increases financial performance of
commercial banks in Kenya.
The following model was formulated based on the V. CONCLUSION AND RECOMMENDATIONS
analysis in table 3.
𝑅𝑂𝐴𝑖𝑡 This study analyzed the effect of supervisory review on
= 0.0044411 + 0.0297212𝑆𝑅𝑖𝑡 financial performance of commercial banks in Kenya using
+ 𝜀𝑖𝑡 … … … … … … … … … … … … … … … … … … … … . (2) positivism research philosophy and causal research design. The
study found that supervisory review has positive and significant
In table 3 supervisory review coefficient (β=0.0297212, p- effect on return on assets. The finding of the current study is
value of 0.000<0.05) indicates supervisory review has a supported by several empirical studies though it also contradicts
positive and significant effect on financial performance (ROA) other studies. The study therefore concludes that as the quality
of commercial banks in Kenya hence the null hypothesis that of supervisory review of commercial banks is improved, it may
supervisory review has no significant effect on financial enhance the return on assets as commercial banks will not
performance of commercial banks in Kenya was rejected at five carryout activities restricted by central bank of Kenya. The
percent level of significance. The positive coefficient study thus recommends that central bank of Kenya should
(β=0.0297212) in the findings suggest that one percent increase design banking financial policies that increase the number and
in the frequency and quality of supervisory review of quality of audit reviews thus preventing commercial banks from
commercial banks by central bank of Kenya would increase engaging in activities restricted by central bank of Kenya. The
financial performance of commercial banks in Kenya by study also recommends that commercial banks in Kenya should
(0.0297212 divided by 100) units while holding other factors adhere to the prudential guidelines on supervisory review so as
constant. The finding was consistent with those by Faten et al. to enhance financial performance.
(2014), Rezende and Wu (2014), Vighneswara (2014) who
found a positive and significant effect of supervisory review on Suggestion for Further Research
financial performance of commercial banks. However, The scope of this study was commercial banks licensed
Chortareas et al. (2012) found that official supervisory powers and operating in Kenya between the period 2013-2020. A
improved operations of the banks while interventionist similar study can be conducted to investigate the effect of
supervisory and regulatory policies lead to higher bank supervisory review on financial performance of other financial
inefficiency levels. The inconsistency with Chortareas et al. and non-financial institutions.
(2012) study may be due to market differences.