Bank Specific and Macroeconomic Determinants of Commercial Bank Profitability in Kenya

Abstract

This study examines the bank specific and macroeconomic determinants of commercial bank profitability in Kenya using a balanced panel of eleven leading banks observed annually over the ten year period from 2014 to 2023, yielding 110 bank year observations. Profitability is proxied by the return on assets, while the explanatory variables comprise bank size, capital adequacy, liquidity, asset quality measured by the non performing loans ratio, operational efficiency measured by the cost to income ratio, the loan to deposit ratio and two macroeconomic controls, namely real gross domestic product growth and inflation. Three competing estimators were applied: pooled ordinary least squares, a one way fixed effects model and a random effects model. Specification testing through the redundant fixed effects F test rejected the pooled specification in favour of a panel structure, while the Hausman test could not reject the orthogonality of the individual effects, indicating that the random effects estimator is both consistent and efficient for these data. The random effects results show that asset quality, operational efficiency and liquidity exert statistically significant negative effects on profitability, whereas bank size and the rate of economic growth exert significant positive effects. Capital adequacy, the loan to deposit ratio and inflation are not statistically significant once unobserved heterogeneity is accounted for. The non performing loans ratio emerges as the single most influential variable, underscoring the centrality of credit risk management to bank earnings in the Kenyan market. The findings carry direct implications for bank managers seeking to protect margins and for the regulator in calibrating prudential expectations.