Effect Of Macroeconomic Variables On Profitability Of Commercial Banks Listed In The Nairobi Securities Exchange

Abstract

Based on vital contribution of the commercial banks to economic progression in Kenya, this study endeavored to establish the effect of macroeconomic variables on the profitability of commercial banks listed in the Nairobi Securities Exchange (NSE) for years 2001 – 2012. Panel data model was used to examine the effects of three major macroeconomic variables which included Gross Domestic Product (GDP), dollar foreign exchange rate, and interest rates on profitability which was measured through return on Assets (ROA). The study correlation findings indicated that real GDP growth rate did not have any significant relationship with financial profitability of the listed commercial banks which was measured using ROA. Further, dollar exchange rate and real interest rate had a significant relationship with profitability of commercial banks. Panel regression results indicated that Real GDP had an insignificant positive effect on profitability of listed commercial banks in Kenya. Further, real interest rates had a significant negative effect on profitability of commercial banks. Dollar exchange rate had a significant positive influence on profitability of quoted commercial banks in Kenya. The findings have implication for the Government, regulatory authorities and the listed commercial banks themselves. The government and regulatory agencies should ensure that these important macroeconomic variables are well managed as they have implications for the growth in the various major industries in the economy. Secondly, rise in interest rates should be managed by applying effective policies and measures by the central bank. Banks also should have effective measures to manage interest rate risks so that their profitability is not affected adversely. Thirdly, though rise in exchange rate was associated with increase in bank profitability in this study, it is a fact that a fast depreciating local currency can create instability within other macroeconomic variables. This necessitates the efforts by the Central Bank of Kenya which is the pivot monetary authority in Kenya to put in place different measures at stabilizing the local currency. The Central Bank of Kenya needs to focus more on macroeconomic policies mostly in areas relating to exchange management with a view to achieving a realistic exchange rate that will aid economic growth and achieve a relative stability in the value of the Kenya shilling against the dollar. However, banks should also have in place risk mitigating strategies to counter foreign exchange fluctuations.