Effect of Capital Adequacy on Operational Efficiency of Commercial Banks in Kenya

Jedidah Wanjagi; Tabitha Nasieku; Olanrewaju Fatoki

doi:10.19044/esj.2024.v20n22p49

Jedidah Wanjagi Department of Economics, Accounting and Finance, School of Business and Entrepreneurship, Jomo Kenyatta University of Science and Technology, Nairobi, Kenya
Tabitha Nasieku Department of Economics, Accounting and Finance, School of Business and Entrepreneurship, Jomo Kenyatta University of Science and Technology, Nairobi, Kenya
Olanrewaju Fatoki Department of Economics, Accounting and Finance, School of Business and Entrepreneurship, Jomo Kenyatta University of Science and Technology, Nairobi, Kenya

DOI: https://doi.org/10.19044/esj.2024.v20n22p49

Keywords: Operational Efficiency, Capital Adequacy, Market Structure, Stochastic Frontier Analysis, Generalized Method of Moments

Abstract

This study investigates the impact of capital adequacy on the operational efficiency of Kenyan banks, highlighting its importance for financial stability and risk management using a two-step analytical approach: first, Stochastic Frontier Analysis was used to determine operational efficiency scores for each bank; second, a panel Generalized Method of Moments (GMM) regression model assessed the relationship between these scores and capital adequacy. The study employed a panel GMM Method, accounting for individual and time-specific effects as well as endogeneity and correlation biases. The study concentrated on data from 2008 to 2022, from verified audited financial statements from the Central Bank of Kenya and the respective banks' websites. The study revealed a positive relationship between capital adequacy and operational efficiency. Specifically, increased capital adequacy was associated with a 10.32% improvement in operational efficiency. The study also found that market structure plays a significant role in this relationship. Based on these findings, policymakers should adopt comprehensive strategies focusing on stringent capital adequacy regulations to enhance bank performance and stability.

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