Banking system adjustment to shock: The Kenyan case of liquidity-profitability trade-offs

Jared Osoro and Kiplangat Josea

No 56, KBA Centre for Research on Financial Markets and Policy Working Paper Series from Kenya Bankers Association (KBA)

Abstract: This paper has the dual objective of establishing whether episodes of market shocks necessarily trigger the choice between more liquidity and more profitability and ascertaining whether the post-shock recovery path is one of liquidity giving way to non-liquid assets growth and, therefore, more profitability that is accompanied by positive economic outcomes. Using annual bank-level data from 2002 to 2020 and a fixed-effects regression model within an unbalanced panel data framework, we establish that: (i) liquidityprofitability trade-offs exist and is amplified during period of shocks. The extent of those trade-offs is sensitive to bank-specific attributes, especially bank size. It is more pronounced among smaller banks than bigger ones (ii) The trade-offs ought to be seen beyond being self-preserving but as a necessary adjustment to assure general market stability and subsequent restoration of the positive finance-growth nexus in a calm environment. As a sufficient condition, the transition process requires a policy environment that is facilitative of real lending rates adjustments corresponding to the attendant risks as opposed to a sticky regime even on the back of expectations of a risk-based pricing mechanism being in place. Without policy disincentivizing the crowding-out, which is prevalent when asset quality is weakening, the transition after the shock to profitability aligned with the positive finance-growth nexus may be prolonged.

Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:kbawps:56

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