MACROECONOMIC FACTORS VOLATILITY, BANK SIZE AND FINANCIAL PERFORMANCE OF TIER III BANKS IN KENYA

Abstract

The unstable state of the global and regional macroeconomic conditions such as frequent financial shocks and unstable growth cycles and variable rates of GDP, interest rate, exchange rate and inflation rate, which disproportionately impacted the smaller banking institutions drove the study. Although the world has shown that the small banks are more vulnerable during the volatile times, the situation in the region and in Kenya in general shows that Tier III banks are the most vulnerable as they have smaller capital buffer, limited market coverage, and rely on unstable policy environments. This study discussed the impact of the volatility of macroeconomic factors on the financial performance of Tier III banks in Kenya during the years 2004 to 2024 and bank size was also added as the moderating variable. It was anchored by the Keynesian Economic Theory, Risk–Return Trade-off Theory, Intermediation Theory of Banking, and the Resource-Based View (RBV) Theory. The research design applied was a correlation, based on secondary data of the 22 tier II banks in Kenya. The analysis of data was performed through the multiple and moderated regression models on SPSS. The regression findings indicated that GDP volatility had a negative albeit insignificant effect on financial performance (β = -0.00122, t = -0.881, p = 0.394), whereas the interest rate volatility also had a negative but insignificant effect (-0.00311, t = -2.101, p = 0.056). Financial performance was positively and statistically significantly related to exchange rate volatility (0.00109, t = 2.414, p = 0.031) and inflation volatility (0.00513, t = 4.926, p = 0.0003). The moderation model showed that the size of banks did not have a significant effect on these relations, so the asset base is not a sufficient buffer against macroeconomic volatility in smaller banks. The research faced theoretical limitations in the methods of incorporating macroeconomic volatility into the firm level banking theories; methodological limitations because of the correlational design and use of secondary data; contextual limitations because the study focused only on Tier III banks; and empirical limitations by the fact that the study did not find long period comparative studies in other similar developing economies. The research has added value to the discourse at the global, regional and local levels by providing an empirical understanding through 21 years on the effect that macroeconomic volatility has on the performance of small banks in emerging markets. It urges Tier III banks to embrace proactive risk management, diversify their sources of income and develop resilience by progressively increasing their capital base and policy makers to maintain steadiness in macroeconomic stability to protect the stability and competitiveness of the lower tier banks within the financial sector in Kenya.