Environmental Risk, Firm Size and Financial Performance of Commercial Banks in Kenya

Abstract

Financial institutions play a key role in spurring the growth of the economy. However, they operate in a highly volatile environment which threatens their ability to achieve their desired goals. The purpose of this study was to establish the relationship between environmental risk and the financial performance of commercial banks in Kenya as moderated by firm size. The specific objectives of the study were to; establish the relationship between economic risk and financial performance, determine the relationship between reputational risk and financial performance, determine the relationship between technological risk and the financial performance and finally to assess the moderating effect of firm size on the relationship between environmental risks and the financial performance of commercial banks in Kenya. The study was anchored on five theories namely agency, stakeholder, prospect, diffusion of innovation and growth of the firm theories. Longitudinal and cross-sectional research design was used. The population of the study was 42 commercial banks in Kenya. 32 purposively sampled commercial banks which had audited financial accounts for the years 2016 to 2021 were included in the study. Secondary panel data collected using an extraction tool validated by experts from banks and academia was analyzed using R statistical software version 4.3.2. Reliability of the data was ensured by using audited financial reports. Descriptive and inferential data analysis techniques were used. Inferential statistics used were linear mixed effects multiple regression allowing random effects to vary by banks. The study findings showed that economic risk significantly influence financial performance with high liquidity and credit risks associated with lower ROE (beta; -10.36; 95% Confidence Interval (CI): ( -18.45 to -2.27), p-value: 0.012) and (beta: -0.29; 95% CI (-0.46 to -0.13), p-value: 0.001.)) respectively. Reputation risk had a significant influence on the financial performance of commercial banks with increase in number of branches being associated with a positive ROE (beta: 0.11, 95% CI; p-value: 0.003). Number of CSR activities showed a positive but insignificant influence on ROE. Technological risk contributed significantly to higher ROE with number of branches showing ROE (beta: 0.15; 95%CI: (0.06 – 0.24); p-value: 0.001) signifying that technological risk influences financial performance of commercial banks in Kenya. Number of ATMs and number of agents showed a positive insignificant relationship. Mixed effects regression model to assess the moderating effect of environmental risk on financial performance of commercial banks showed that firm size significantly moderates the relationship between environmental risk and financial performance of commercial banks in Kenya. The number of branches shows a significant moderating effect in tier 3 banks compared to tier 1, where a higher number of branches negatively affects ROA (beta: -0.22, 95% CI: (-0.31 – -0.14), p-value: <0.01). The study concluded that there is a statistically significant relationship between economic risk, reputational risk, and financial performance of commercial banks in Kenya as well as a moderating effect of firm size on the relationship between environmental risk and the financial performance. Based on the findings from this study, it is recommended that commercial banks may adopt a holistic approach to risk management by emphasizing economic, reputational and technological risks, invest and deploy technology as well as engage in reputational building activities like CSR to attract the market and counter threats. This study may significantly benefit the government, CBK and the commercial bank management in Kenya to inform policy framework as well as the academia and researchers as far as environmental risk, firm size and financial performance of commercial banks is concerned