Effect of financial innovations on financial performance of commercial Banks in Kenya

Abstract

Commercial banking industry in all economies have been facing increased performance fluctuations due to high competition, interest rate changes, high credit risk, exchange rate fluctuations and liquidity problems. To overcome these challenges, commercial banking is evolving globally from conventional banking through financial innovations. A lot of innovations have been undertaken in banking sector that have led to proliferation of financial products, activities and organizational forms that have improved the efficiency of the financial system. Financial innovations such as branch networking, agency banking, mobile banking, electronic funds transfer are currently perceived to enable cost effective service delivery in the banking sector. In spite of uptake of these cutting edge innovations by the banking sector, return on assets and return on equity still remain low and unpredictable. Furthermore, loans uptake in terms of volume and quality remain low in relation to banked and general population. Despite its importance and the presence of extensive literature on financial innovations, a number of past studies have largely focused on process innovation as opposed to product and financial services innovation. Secondly, most past studies on Kenya have covered relatively shorter study periods which may not reliably capture the financial trends, more so given the short shelf life of financial studies caused by rapid changes in the financial sector. This study therefore examined the effect of financial innovation on the financial performance of commercial banks in Kenya between the year 2007 and 2017. The choice of research area was the need for justification of finnovs for better banking and financial sector performance due to its vital role in economic development. The specific objectives of the study were to; determine the effect of financial innovation on banks’ return on assets; to establish the effect of financial innovation on loan portfolio and to examine the effect of financial innovation on banks’ return on equity. This study was modeled on Constraint–induced and Schumpeter’s financial innovation theories and applied correlation research design. The target population was 42 Central Bank of Kenya registered commercial banks. The 12 Nairobi Securities Exchange listed commercial banks were purposively sampled. Secondary data for the study period was obtained from the Central Bank for Stata 15 panel data diagnostics and regression analytics. Results indicated that financial innovations had mixed effects on commercial banks. For return on assets; finnovs accounted for 51.34% of all variations as denoted by overall = 0.5134. Mobile banking, branch networking and total assets had positive effects on financial performance with coefficients of 0.052, 0.373 and 0.130 respectively with corresponding p-values of 0.050, 0.000 and 0.014. ROE and LA as regressors had negative impact on ROA. Finnovs accounted for 59.28% variations in loan portfolio as denoted by overall = 0.5928. Branch networking and total assets had positive effects with coefficients of 0.382 (p-value = 0.000) and 0.015 (p-value = 0.017) respectively. Both enhanced bank productivity from loans. However, ROA and ROE had -0.278 (p-value = 0.020) and -0.291 (p-value = 0.001) coefficients respectively. Both were significant but negative on loans, meaning they led to financial losses. For return on equity, finnovs accounted for 20.77% of all variations as depicted by overall = 0.2077. Mobile banking services, branch networking and total assets had positive effect denoted by coefficients 0.046 (p-value = 0.016), 0.307 (p-value = 0.000) and 0.130 (p-value = 0.050) respectively. The study concluded that use of some financial innovations improved financial performance; some innovations were however loss prone while a few had insignificant effect. In this view, the study recommends that banks and stakeholders should research, innovate and employ effective financial innovations to improve performance. This study may be useful to private and public sector financial policy makers as well as a source of information to academicians and investors. Further research should focus on; role of finnovs on performance of non-banking financial sub-sector as well as a study on challenges facing market available finnovs in Kenya.