Effect Of Financial Risk Management On Operational Efficiency Of Tier One Commercial Banks In Kenya

Abstract

Commercial banks are vital for the socioeconomic growth of nations and therefore their operational efficiency is critical. A study by Kenya Bankers Association indicated that though bank’s profitability has improved over the years, their operational efficiency has deteriorated from 2019 to 2023. The main objective of the study is to determine the effects of financial risk management on the operational efficiency of Tier One commercial banks in Kenya. The research’s specific objectives are to examine the effect of credit risk management on operational efficiency of Tier One commercial banks in Kenya, to assess the effect of capital adequacy risk management on operational efficiency of Tier One commercial banks in Kenya, to investigate the effect of lending risk management on the operational efficiency of Tier One commercial banks in Kenya and to examine the effect of liquidity risk management on the operational efficiency of Tier One commercial banks in Kenya. The study was anchored on modern portfolio theory enterprise risk management theory and buffer theory of capital adequacy. This study applied the correlational research design. Tier 1 commercial banks in Kenya who are registered with the Central Bank of Kenya and have been in business for five years running between 2019 and 2023 made the study's population. This study adopted a census technique with all the nine Tier 1 commercial banks in Kenya participating in the study. This study used secondary data which was gathered from the audited annual financial statements of the commercial banks and CBK annual bank supervision reports. The study analysed the data using panel regression analysis through the Stata statistical software. The analysis was preceded by diagnostic tests that included Hausman test, and tests of homoscedasticity, multicollinearity, serial correlation, and normality. The findings of the study indicate that financial risk management practices have varying impacts on the operational efficiency of Tier One commercial banks in Kenya. The regression analysis revealed significant insights into the effects of financial risk management on the operational efficiency of Tier One commercial banks in Kenya. Capital Risk Management (CRM) emerged as a strong positive influence on operational efficiency, with a coefficient of 2.51 (p < 0.01), highlighting its critical role. Lending Risk Management (LRM) also positively impacted efficiency, evidenced by a coefficient of 0.26 (p < 0.05). Conversely, Credit Adequacy Risk (CAR) and Liquidity Risk Management (LR) displayed less significant relationships, with CAR showing a marginally positive effect and LR exhibiting a negative impact. Overall, the findings underscore the importance of effective capital and lending risk management practices in enhancing operational efficiency within the banking sector, while suggesting that improvements are needed in liquidity and credit adequacy strategies. The study concludes that banks should refine their risk management strategies, emphasizing data-driven approaches and integrating risk management with operational practices. Recommendations include adopting advanced analytics for credit assessments and optimizing capital allocation strategies. Future research should explore a broader range of financial institutions and employ mixed-methods approaches to capture qualitative insights, as well as longitudinal studies to understand the evolving impacts of risk management over time.