The production of banks is an act of transforming inputs into outputs. The objective of production is to create value through transformation and the outputs are given in general desirable outcomes. Hence more output is better. At the same time, inputs are valuable resources, with alternative uses. Unspent quality of any input can be used for producing more of the same outputs or produce different outputs.
Technical Efficiency of Kenyan Banks- A Data Envelopment Analysis Thesis submitted to the BHARATHIDASAN UNIVERSITY, TIRUCHIRAPPALLI for the Award of the Degree of DOCTOR OF PHILOSOPHY IN COMMERCE By ISAIAH ONSARIGO MIENCHA Research Supervisor and Convener Dr M.SELVAM, Professor and Head DEPARTMENT OF COMMERCE AND FINANCIAL STUDIES School of Economics and Commerce BHARATHIDASAN UNIVERSITY TIRUCHIRAPPALLI-620 024 TAMIL NADU, INDIA AUGUST 2015 DEPARTMENT OF COMMERCE AND FINANCIAL STUDIES School of Economics and Commerce BHARATHIDASAN UNIVERSITY TIRUCHIRAPPALLI – 620 024, TAMIL NADU, INDIA Prof M SELVAM, M.Com., MBA., MADE., Ph.D Professor and Head Email ID: drmselvam@yahoo.co.in Date: CERTIFICATE The thesis entitled, TECHNICAL EFFICIENCY OF KENYAN BANKS - A DATA ENVELOPMENT ANALYSIS, is a bona fide record of research work done for the award of Doctor of Philosophy in Commerce by Mr ISAIAH ONSARIGO MIENCHA, Research Scholar (Full Time), Department of Commerce and Financial Studies, Bharathidasan University, Tiruchirappalli, Tamil Nadu, India It is the original work of the candidate and it has not previously formed the basis for the award of any Degree, Diploma, Associateship, Fellowship or other similar titles The thesis represents independent work on the part of the candidate SIGNATURE OF THE RESEARCH ADVISOR AND CONVENER i ISAIAH ONSARIGO MIENCHA Ph.D Research Scholar (Full Time) Department of Commerce and Financial Studies Bharathidasan University Tiruchirappalli – 620 024 Tamil Nadu, India Date: DECLARATION I hereby declare that the thesis entitled, TECHNICAL EFFICIENCY OF KENYAN BANKS - A DATA ENVELOPMENT ANALYSIS, embodies the result of my research work carried out under the guidance and supervision of Professor M.SELVAM, Research Advisor and that I have not submitted the above thesis to any University for any Degree, Diploma, Associateship, Fellowship or other similar titles previously (ISAIAH ONSARIGO MIENCHA) ii ACKNOWLEDGEMENT First, let me take this opportunity to thank God for everything that I have got in my life, without which I would have been nothing The individual to whom I owe the greatest debt for making this thesis possible is my research supervisor Prof M Selvam Professor and Head, Department of Commerce and Financial Studies, Bharathidasan University, Tiruchirappalli for his inspiring guidance He was the person who read every word in every draft, a task he volunteered with unflagging good cheer and enthusiasm and rearranged the text to create a more focused and usable document and invariably had excellent suggestions for improving the flow of ideas and sharpening throughout my work During this tenure, I always admired his incessant guidance, thought provoking ideas, valuable advice and constant encouragement towards my doctoral work I avail this opportunity with great pleasure to ensure my unfathomable gratitude and whole hearted thanks to my great Teachers, Dr M Babu, Dr S Vanitha and Dr J Gayathri, Assistant Professors, Department of Commerce and Financial Studies, Bharathidasan University, Tiruchirappalli for their support throughout my tenure of my research I am thankful to them for all the motivation, encouragement and valuable suggestions that they have given me I am extremely indebted to my Doctoral Committee Members, Dr Joseph Anbarasu, Associate Professor in Commerce, Bishop Heber College, Tiruchirappalli and Dr S Sekar, Principal, Urumu Dhanalakshmi College for their valuable suggestions and constant inspiration which instilled in me an unquenchable thirst to my research work I wish to record my sincere thanks to The Honourable Vice Chancellor, The Registrar, The Controller of Examinations, The Finance Officer and the entire Administration of Bharathidasan University, Tiruchirappalli for giving me the opportunity to my doctoral work iii I would like to thank my seniors, Dr M Raja, Dr G Indhumathi, Dr P Bhuvaneswari, Dr WRPK Fernando, Dr A Jeyachitra, Dr P Nageswari, Dr E Bennet, Dr R Rajesh Ramkumar, Dr V Karpagam and fellow Research Scholars, Ms M Gayathri, Mr V Vasanth, Mr K Lingaraja , Ms P Amrutha, Ms S Amridha Vasani, Mrs S Vetrichelvi and Mr Marxia Oli Sigo, Department of Commerce and Financial Studies, Bharathidasan University, Tiruchirappalli for their contribution to the completion of this thesis I would also like to thank Mr J Arokiam, Mr R Velmurugan, Mrs D Shanthi Manjula and Mrs P Meena for their support and help I am very much thankful to the Department Library, Department of Commerce and Financial Studies, Librarian, and other staff members of Central Library, Informatics Centre, Bharathidasan University, for giving me necessary reference materials and enabling me to successfully complete this thesis My heartfelt gratitude to Prof Mohan Gnana Olivu, Academic Director, Annai College, Kumbakonam, who helped me in shaping all my articles and my thesis work Last, but certainly not the least, I must acknowledge, with deep thanks, the support from my family members and my dearest friends I thank my grandparents Mr Gesicho Nyandumo (late) and Mrs Gechemba (late) who showered affection, love and care on me I thank my father and mother, Mr Charles Minyencha Gesicho, Mrs Rebeccah Moraa and Mrs Bethsheba Moraa for striving hard to provide a good education for me They have instilled many admirable qualities in me and given me a good foundation to face life with confidence They have taught me about hard work, self-respect, persistence, perseverance and they have set an example to be independent, Dad, especially, remained a great role model of resilience, strength and character They have always expressed how proud they are of me and how much they love me I am proud of them and love them very much I must thank my uncles Mr Hezron Mageto (late), Mr David Mageto (late), Mr Zechariah Mageto, Mr Moses Gesicho (late), Mr Samwel Gesicho (late), Mr Timothy Gesicho and Mr Sanduki Gesicho (late), aunties Mrs Elzabeth, Mrs Jane Mosiori and Mrs Martha David for their invaluable love and affection I wish to thank my iv Brother-in-Laws Mr Peter King’oina, Mr Gerald Matara and Mr Zablon Onyambu For their encouragement and support throughout my studies I also thank my beloved sisters Mrs Teresa Stephen, Mrs Zipporah Monyenche, Mrs Alice Bitutu, Mrs Mrs Mercy Moragwa, Mrs Gladys Nyabonyi, Mrs Florence Kemunto, Mrs Jane Nyaboke, Lilian and Mrs Linet my lovable brothers, Mr Stephen Miencha (Late), Mr Joshua Morang’a, Mr Henry, Mr Richard Oigoro, Mr Peter Nyareru and (Dr.) Haron Miencha, nephew Erick Mose and Moses Gwaro for their love and support I always fall short of words and felt impossible to describe their support in words and I am grateful for them who made my life enjoyable one ISAIAH ONSARIGO MIENCHA Date: v This Thesis is dedicated to my Brother Stephen Miencha (late) who is missed deeply and my parents who had a never-ending thirst for learning and imbued the same passion in me vi LIST OF ABBREVIATIONS AGM Annual General Meeting BCC Bankers, Charnes and Coopers CAMEL Capital, Asset, Earnings, Management, Earnings, Liquidity CBK Central Bank of Kenya CCR Charnes, Cooper and Rhodes CEO Chief Executive Officer CMA Capital Markets Authority CO-PRV Co-operative Bank of Kenya CRS Constant Return to Scale DEA Development Envelope Analysis DEAOS Data Envelopment Analysis Online Software DMU Decision Making Units DPFB Deposit Protection Fund Board FOB Foreign Owned Bank(s) GOB Government Owned Bank(s) GoK Government of Kenya IFEM Interbank Foreign Exchange Market I&M Industrial and Mortgage IPO Initial Public Offering KCB Kenya Commercial Bank KShs Kenya Shillings Max Maximum Min Minimum NBFIs Non-Bank Financial Institution (s) NIDBK National Industrial Development Bank of Kenya NH Null Hypothesis NPL Non-Performing Loans NSE Nairobi Stock Exchange OECD Organization for Economic Co-operation and Development OMO Open Market Operation vii ROA Return on Assets ROE Return on Equity Sig Significant SME Small and Medium sized enterprise SPSS Statistical Packages for Social Science STD Standard Deviation T.A Total Assets T.E Technical Efficiency USD United States Dollar VRS Variable Return to Scale WWW World Wide Web viii CONTENTS Chapter Page No Description Acknowledgement iii List of Abbreviations vii List of Tables x List of Charts xiii I Introduction II Review of Literature and Research Design 19 III Nature of Variables of Kenyan Sample Banks Using Descriptive Analysis 44 IV Relationship Between Kenyan Sample Banks Using Correlation Analysis 99 V Technical Efficiency of Kenyan Sample Banks Using Data Envelopment Analysis 128 VI Summary of Conclusion 183 Findings, Suggestions and Bibliography 191 Annexure –I- Important terms used 198 Annexure – II – Publications by the Researcher 199 ix International Business Management (3): 142-150, 2013 ISSN: 1993-5250 © Medwell Journals, 2013 Relative Efficiency of Kenyan Commercial Banks Isaiah Onsarigo Miencha, M Selvam, R Rajesh Ramkumar and V Karpagam Department of Commerce and Financial Studies, Bharathidasan University, 620024 Tiruchirappalli, Tamil Nadu, India Abstract: Banking has been considered before and after independence, as the main sector that contributes significantly to the development of national economy and hence, the efficiency of commercial banks gains significance This study aims to find the relative efficiency of a few selected Kenyan Commercial Banks The analysis of the study, using operation approach research and intermediation approach, reveals the efficiency of Kenyan Commercial Banks However, the efficiency of sample banks showed inefficiency in some areas during the study period But, small banks showed better efficiency scores during the study period Key words: Kenyan Commercial Banks, data envelopment analysis, banking industry, development, India INTRODUCTION economic reforms, initiated by the government of Kenya, have changed the landscape of the economy The financial reforms have improved the banking industry to be more transparent, efficient, disciplined and competitive by changing the pattern of cost of funds, opportunities to earn income, range of financial services and the magnitude of lending priority sector Further, these reforms created new and powerful customers and a new mix of players (public, private and foreign banks) The emerging competition caused new expectations from the existing as well as new players With the acceleration of economic growth and the revival of investment cycle, the banking sector has witnessed a transformation in the intermediation between the demand and supply of funds The banking business has become more competitive with the entry of multiplayer’s The banking sector has witnessed mergers and acquitions in the previous years and they have driven the banks to improve the delivery system and offer quality banking services to customers, matching the needs of customers at reasonable cost and by increasing network The retention of customers is the base and a complex event Apart from streamlining the processes through technology initiatives such as ATMs, Telephone Banking, Online Banking and Web Based Products, banks have resorted to cross selling of financial products, such as credit cards, mutual fund and insurance policies to augment fee based income The banks have adopted micro-marketing approach to promote their services Besides, banks share technology and infrastructure to cut down technology cost The ongoing developments in the Kenyan Banking Industry and integration of financial markets at the global level have offered countless opportunities to the banking sector The banking sector contributes substantially and greatly for the growing economy to any country and hence, the efficiency of commercial banks gains significance After the financial crisis in 1997 and 2008, the efficiency of Kenya’s Commercial Banks to the Total Factor Productivity (TFP) growth was sharply declining due to enormous Non-Performing Loans (NPLs), stemming from inappropriate lending to real estate sector (borrowing short but lending long) and the heavier repayment burden with foreign currency liabilities (Central Bank of Kenya-Bank Supervision Annual Report 2009 and 2010) However after the crisis, Kenya’s Commercial Banks made profits and regained peoples’ trust Due to the importance of commercial banks to the government, households and investors, the profitability of banks is one of the most important issues for research Moreover, people particularly the investors, expect better performance and efficiency of commercial banks under any circumstances Background of Kenyan Banking Industry: As the economy grows and becomes more complicated, banking sector is there to support and stimulate the economic growth of the nation One of the central issues faced by developing economies is how to strengthen the financial system A sound financial system stimulates economic growth by mobilizing financial saving for production purposes and managing the risks The Kenyan Financial System, particularly the banking sector may have to be strengthened to compete and integrate with the global financial system The recent Corresponding Author: Isaiah Onsarigo Miencha, Department of Commerce and Financial Studies, Bharathidasan University, 620024 Tiruchirappalli, Tamil Nadu, India 142 Int Business Manage., (3): 142-150, 2013 Review of literature: An attempt has been made in this study to review the selected research work already undertaken in the area of this study, in order to understand the methodology employed and the gaps in the research Efficiency means the maximum output that can be produced from any given total inputs In the banking sector efficiency is one of the most interesting economic issues for economists all over the world This is evident from several attempts to investigate the efficiency of commercial banks by a number of economists both in Kenya and abroad Charnes et al (1978) applied a nonlinear programming model to measure the relative efficiency of Decision Making Units (DMUs) Saha and Ravisankar (2000) found that Public Sector Banks (PSB) accounted for about 85% of the Indian Commercial Banking business and supported the DEA methodology to be useful and suitable for rating the efficiency of Indian Banks Casu and Molyneux (1998) employed DEA to investigate the efficiency in European Banking Systems The study examined whether the productive efficiency of European Banking Systems has been improved and converged towards a common European frontier The study by Shanmugam and Das (2004) studied banking efficiency using stochastic frontier production function model The study considered four inputs variables (viz deposits, other borrowings, labour and fixed assets) and four outputs (viz net interest income, non-interest income, credits and investments) Kumar and Gulati (2008) studied the technical efficiency of public sector banks in India using two data envelopment analysis models, viz the CCR model and Anderson and Petersen’s supper-efficiency models The results show that the score of technical efficiency range from 0.632-1 with an average of 0.885 Thus, the overall level of technical inefficiency in Indian public sector banks was found to be 11.5% Saha (2008) pointed out that the commercial banks like NCBs, PCBs, SCBs and FCBs have been playing a commendable role in achieving the economic growth of Bangladesh The study focused on the performance indicators of banking activities of Bangladesh According to Prasad V Joshi and J.V Bhalerao (2011), there was efficiency of major commercial banks in India and most of the banks were satisfactorily efficient The average performance of the banking sector ranges above 80% which indicates the appropriate conversion of inputs into outputs The public and private sector are equally efficient but the private sector has an edge over the public sector Chansarn (2008) examined the relative efficiency of Thai Commercial Banks during 2003-06 by utilizing Data Envelopment Analysis (DEA), the study reveals that the efficiency of Thai Commercial Banks via operation approach is very high and stable while the efficiency via intermediation approach was moderately high and somewhat volatile The literature review reveals that with the exception of a few, no comprehensive effort has been made recently towards a critical analysis of the efficiency level of the Kenyan Commercial Banks In this context, the present study would be a significant venture at analyzing the efficiency of Kenyan Commercial Banks Statement of the problem: The study of banking efficiency is very important in policy making, industry administration and many others who rely on the banking sector Kenyan banking industry was once dominated by public sector banks But, now the situation has changed due to technology and professional management of private sector banks that gained remarkable position in the banking industry The private sector banks play an important role in the development of the Kenyan economy Therefore, the present study investigates the efficiency of Kenyan public sector banks and private sector banks Many firms in the service industry face the problem of not producing better results in terms of efficiency In particular, the last decade witnessed continuous changes in regulation, technology up gradation and competition in the global financial services industry and Kenyan commercial banks are no exception to this The efficiency in the operation of banks has become an important issue in Kenya It is therefore, crucial to benchmark the performance of banks operating in Kenya and hence this study Objectives of the study: The present study examines the financial performance of banks in Kenya using Data Envelopment Analysis (DEA-Input, Output Oriented) Hypotheses of the study: The following two null hypotheses were framed and tested for this study: C C NH1: There is no significant difference in profitability among the selected banks during the study period NH2: There is no significant difference of influencing factors of profitability among the selected banks during the study period MATERIALS AND METHODS Sample selection: As on March 31st, 2009, there were totally 45; public sector banks, 28 private sector banks and 12 foreign sector banks in Kenya The present study covered only 10 Kenyan commercial banks, based on their top performance i.e., three large banks (Cooperative Bank 143 Int Business Manage., (3): 142-150, 2013 of Kenya, Barclays Bank of Kenya and Equity Bank of Kenya), medium size banks (Diamond Trust Bank of Kenya, National Bank of Kenya, Family Bank of Kenya and Commercial Bank of Africa-Kenya) and small banks (Equatorial Bank of Kenya, Jamii Bora Bank of Kenya and Development Bank of Kenya) efficiency score Generally, a DMU is considered to be efficient if it obtains a score of 1.00, implying 100% efficiency whereas a score of