The Effect Of Electronic Banking On The Financial Performance Of Commercial Banks In Kenya

Description

TABLE OF CONTENTS

DECLARATION……………………………………………………………………………………………………………. ii

DEDICATION………………………………………………………………………………………………………………. iii

ACKNOWLEDGEMENT……………………………………………………………………………………………… iv

LIST OF ABBREVIATIONS……………………………………………………………………………………….. vii

LIST OF TABLES……………………………………………………………………………………………………….. viii

ABSTRACT…………………………………………………………………………………………………………………… ix

CHAPTER ONE…………………………………………………………………………………………………………….. 1

INTRODUCTION………………………………………………………………………………………………………. 1

• Background of the study……………………………………………………………………………………………….. 1
  • Electronic banking……………………………………………………………………………………………….. 2
  • Financial performance………………………………………………………………………………………….. 4
  • Effect of E-Banking on financial performance of banks……………………………………………. 5
  • Banking industry in Kenya……………………………………………………………………………………. 6
• Research Problem…………………………………………………………………………………………………….. 7
• Objective of the Study……………………………………………………………………………………………… 8
• Value of the Study…………………………………………………………………………………………………… 9

CHAPTER TWO………………………………………………………………………………………………………….. 10

LITERATURE REVIEW…………………………………………………………………………………………….. 10

• Introduction…………………………………………………………………………………………………………… 10
• Theoretical Review…………………………………………………………………………………………………. 10
  • Technology Acceptance Theory………………………………………………………………………….. 10
  • Theory of Planned Behavior……………………………………………………………………………….. 11
  • The Theory of Reasoned Action…………………………………………………………………………. 12
• Measures of E-Banking and Financial Performance…………………………………………………….. 13
  • Capital Adequacy……………………………………………………………………………………………… 14
  • Asset Quality……………………………………………………………………………………………………. 14
  • Management Quality…………………………………………………………………………………………. 14
  • Earning Performance…………………………………………………………………………………………. 15
  • Liquidity………………………………………………………………………………………………………….. 15
  • Sensitivity to Market Risk………………………………………………………………………………….. 16
• Empirical Studies……………………………………………………………………………………………………. 16
• Summary of Literature Review………………………………………………………………………………… 20

CHAPTER THREE……………………………………………………………………………………………………… 21

RESEARCH METHODOLOGY………………………………………………………………………………….. 21

• Introduction…………………………………………………………………………………………………………… 21
• Research design……………………………………………………………………………………………………… 21
• Population……………………………………………………………………………………………………………… 21
• Data Collection……………………………………………………………………………………………………… 21
• Data Analysis………………………………………………………………………………………………………… 22
  • Analytical Model…………………………………………………………………………………………….. 22

CHAPTER FOUR………………………………………………………………………………………………………… 24

DATA ANALYSIS, FINDINGS AND DISCUSSION…………………………………………………….. 24

• Introduction…………………………………………………………………………………………………………… 24
• Variables……………………………………………………………………………………………………………….. 24
• Descriptive statistics……………………………………………………………………………………………….. 24
• Regression Analysis……………………………………………………………………………………………….. 25
• Interpretation of Findings……………………………………………………………………………………….. 27

CHAPTER FIVE………………………………………………………………………………………………………….. 29

SUMMARY, CONCLUSIONS AND RECOMMENDATION……………………………………….. 29

• Introduction…………………………………………………………………………………………………………… 29
• Summary……………………………………………………………………………………………………………….. 29
• Conclusion…………………………………………………………………………………………………………….. 30
• Recommendation…………………………………………………………………………………………………… 31
• Limitations of the Study…………………………………………………………………………………………. 31
• Areas for Further Research………………………………………………………………………………………. 32

REFERENCES…………………………………………………………………………………………………………….. 33

APPENDICES……………………………………………………………………………………………………………… 37

 

LIST OF ABBREVIATIONS

 

ANOVA –	Analysis of Variances
ATM –	Automated Teller Machine
ASP –	Application Service Providers
CBK-	Central Bank of Kenya
EFT-	Electronic Funds Transfer
E-Banking-	Electronic Banking
ICT-	Information, Communication Technology
IT-	Information Technology
KEPSS-	Kenya Electronic Payment and Settlement system
N.S.E –	Nairobi Securities Exchange
PC-	Personal Computer
POS –	Point Of Sale
SMS-	Short Message Service
TAT-	Technology Acceptance Theory
TPB-	Theory of Planned Behavior
TRA-	Theory of Reason Action
TV –	Television

 

LIST OF TABLES

Table 4.1.1 Descriptive Statistics of variables Table 4.1.2 Model Summary

Table 4.1.3 ANOVA

Table 4.1.4 Coefficients

ABSTRACT

 Electronic banking is the use of electronic and telecommunication networks to deliver a wide range of value added products and services to bank customers. E-business is therefore revolutionizing the way business is conducted in every industry and commercial banks are no exception to this transformation. Electronic banking services as an invention has proven to be a fundamental innovation in the Kenyan banking industry. It is against this background that this study investigated the relationship between e-banking and performance of commercial banks in Kenya. Specifically, the study was meant to establish whether there exists a relationship between the dependent variable, for example, performance measured by profit after tax and the independent variables consisting of number of ATMS, number of debits and credit cards issued to customers, number of point of sales terminals and the usage levels of Mobile banking, Internet banking and Electronic funds transfer, as components of e-banking.

The study used secondary data which was collected from the annual report of commercial banks and Central Bank of Kenya. The study used both descriptive and inferential statistics in analyzing the data.

The findings of the study were that e-banking has a strong and significant effect on the profitability of commercial banks in the Kenyan banking industry. Thus, there exists positive relationship between e-banking and bank performance. The significance test showed that the influence of bank innovations on bank profitability was statistically significant meaning that the combined effect of the bank innovations in this research is statistically significant in explaining the profits of commercial banks in Kenya.

The study recommends to the management of those banks that are slow in innovation adoption, to move in and adopt various innovations in their operations in order to shore up their profitability. This recommendation is well supported by the fact that highly profitable banks are mostly the fast movers in adoption of new technologies. It also recommends that the Government policy makers should review policies related to promotion of innovation adoption and transfer of technology. Adoption of innovations will improve profitability of organizations because it will translate to better tax revenues for the government.

Background of the Study

CHAPTER ONE INTRODUCTION

 

Electronic banking is the use of electronic and telecommunication networks to deliver a wide range of value added products and services to bank customers (Steven, 2002). The use of information technology in banking operations is called electronic banking. Ovia, (2001) argued that Electronic banking is a product of e-commerce in the field of banking and financial services. Banks are also offering payment services on behalf of their customers who shop in different e- shops. It is an umbrella term for the process by which a customer may perform banking transactions electronically without visiting a brick-and-mortar institution, (FinCen, 2000).

Today’s business environment is extremely dynamic and experience rapid changes as a result of technological improvement, increased awareness and demands that banks serve their customers electronically. Banks have traditionally been in the forefront of harnessing technology to improve their products and services. The Banking industry of the 21st century operates in a complex and competitive environment characterised by these changing conditions and highly unpredictable economic climate. Information and Communication Technology (ICT) is at the centre of this global change curve of Electronic Banking System in Kenya today. Managers in the banking industry in Kenya cannot ignore Information Systems because they play a critical impact in current Banking system by pointing out that the entire cash flow of most banks are linked to Information Systems.

Kalakota and Winston (2009) arguably indicated that e-payment systems are becoming central to online business process innovation, as companies look for ways to serve customers faster and at lower cost. In line with this, Chhabra (2009) suggested that electronic payment systems are being used in air ticketing, insurance, banking, retail, health care, online markets and even governments – in fact, everywhere money needs to change hands. There are many evident advantages of an electronic mode of transfer compared to the conventional clearing house, because banks are increasingly turning to technology for managing their payments (Kumar 2009). Some of the value attributes include secure payments, cost cutting, payment on due date and easier cash management compared to conventional systems. They have invested huge

 

amounts of money, in implementing the self-banking services with the objective of improving the quality of customer service. The development of e-banking services is expected to decongest banking halls and reduce the incidences of long queues in banking halls. ICT –based financial services have made a significant contribution in reducing the cost of offering financial services (CBK 2009).

 

The payment industry in Kenya has over the last few years been transformed with the new wave of IT advancements. Currently the use of cash has been replaced by digital cash and digital wallets. It can be rightly said that this is the fourth stage of evolution after Barter, Currency, Paper money (Cheques) and now digital cash. From the reports of Central Bank of Kenya (CBK), Kenyan banks have exponentially embraced the use of information and communication technologies in the provision of banking services which has enhanced the application of e- payments. The application of information and communication technology concepts, techniques, policies and implementation strategies to banking services has become a subject of fundamental importance and concern to all banks and indeed a prerequisite for local and global competitiveness banking. The advancement in technology has played an important role in improving service delivery standards in the banking industry. In its simplest form, Automated Teller Machines (ATMs) and deposit machines now allow consumers carry out banking transactions beyond banking hours. (CBK annual report, 2012)

 

Electronic Banking

E-banking is the use of electronic means to deliver banking services, mainly through the Internet. The term is also used to refer to ATMs, telephone banking, use of plastic money, mobile phone banking and electronic funds transfers. Electronic Banking offers different online services like balance enquiry, request for cheque books, recording stop payment instructions, balance transfer instructions, account opening and other form of transitional Banking services. With online banking, individuals can check their account balances and make payments without having to go to the banking halls. This is gradually creating a cashless society where consumers no longer have to pay for all their purchases with hard cash. For example: bank customers can pay for airline tickets and subscribe to initial public offerings by transferring the money directly from their accounts, or pay for various goods and services by electronic transfers of credit to the sellers

 

account. E-Banking has made banking transactions easier around the World and it is fast gaining acceptance in Kenya. Virtually almost all Banks in Kenya have Electronic Banking. E- Banking’s greatest promise is timelier, more valuable information accessible to more people, at reduced cost of information access (DeYoung , 2005).

 

Common embodiments of e-banking include the following: Mobile/SMS Banking, Telephone Banking, Electronic funds transfers, Self Service (PC) Banking, POS Banking (Credit and Debit cards), ATMs, Interactive TV and Branchless Banking. In Kenya, for example, we have M- Shwari which is offered by Commercial Bank of Africa in conjunction with Safaricom Kenya Limited. M-Shwari is the revolutionary new banking product for M-PESA customers that allow one to save and borrow money through the phone while earning interest on money saved. With M-Shwari, one is entitled to affordable emergency loans. This is a paperless banking service offered through M-PESA that will enable a customer open and operate an M-Shwari bank account through a mobile phone, through M-PESA, without having to visit any bank to fill out bank account opening forms. It provides the ability to move money in and out of an M-Shwari savings account to an M-PESA account at no charge. It also gives an opportunity to save as little as Ksh.1 and earn interest on the saving balance and the cash is moved into the savings account using a handset via the M-PESA Menu. It enables access micro credit product (loan) of a minimum of Ksh.100 anytime and receive a loan instantly on an M-PESA account (CBK, 2012).

 

Another form of E-Banking in Kenya is Eazzy 247 offered by Equity Bank of Kenya. This is a mobile banking service that allows one to access to bank services using a mobile phone. Eazzy 247 access is available through all the mobile telephone companies namely, Safaricom, Orange, YU, Airtel & MTN . Equity Bank of Kenya limited also has M-KESHO which is a Bank Account enabling send money/Funds transfer between the bank account (M-KESHO) & M- PESA system (Deposit & Withdrawal).There is also Straight to Bank (S2B) offered by Standard Chartered Bank of Kenya which allows one-stop online Banking and Cash management solution. With S2B, customers enjoy control and convenience of managing their own cash flow without having to step out of their doors. SME Straight 2 Bank is a cash management solution which uses online banking as a platform to give you more convenience by performing the following tasks online: Checking balances, Payroll, Direct Debits, Direct Credits, Payments of Utilities, taxes

 

(URA), NSSF, Telegraphic transfers. In Kenya, there is also the Hello Money offered by Barclays Bank of Kenya among other forms of electronic banking offered by commercial banks in Kenya (CBK annual report, 2012)

Financial Performance

Financial performance is a subjective measure of how well a firm can use assets from its primary mode of business and generate revenues. This term is also used as a general measure of a firm’s overall financial health over a given period of time, and can be used to compare similar firms across the same industry or to compare industries or sectors in aggregation. Some useful measures of financial performance are coined into what is referred to as CAMEL. The acronym “CAMEL” refers to the five components of a bank’s condition that are assessed: Capital adequacy, Asset quality, Management, Earnings, and Liquidity. A sixth component, a bank’s Sensitivity to market risk was added in 1997; hence the acronym was changed to CAMELS, (Gilbert, Meyer and Vaughan 2000).

 

One of the benefits banks derive from electronic banking products and services delivery is improved efficiency and effectiveness of their operations so that more transactions can be processed faster and most conveniently, which will undoubtedly impact significantly on the overall performance of the banks. Despite the potential benefits of ICT and e-commerce, there is debate about whether and how their adoption improves bank performance. Use of and investment in ICT requires complementary investments in skills, organization and innovation and investment and change entails risks and costs as well as bringing potential benefits. There are positive impacts of e-banking on bank turnover and profitability and to a lesser extent on employment, most notably when e-commerce is part of larger business strategies of bank. The use of e-banking can contribute to improved bank performance, in terms of increased market share, expanded product range, customized products and better response to client demand. E- banking continues to influence banks activities and their income structure. Among the activities that may be subject to stronger pressures for change are those that, up to today, have remained relatively insulated from ICT developments. This applies mainly to some retail banking activities that are suitable for standardization, and also to developments in remote banking (Kariuki, 2005).

 

Effect of E-Banking on Financial Performance of Commercial Banks

Commercial banks assaulted by the pressure of globalization and competition from non-  banking functions must find new ways to add value to the services. The question “what drives performance?” is at the top in understanding superior performance and hence striving for it. Substantial research efforts have gone into addressing this question, starting from the strategic level and going down to operational details. Customers in developing economies seems to keep the “technological factors” of services as the yardstick in differentiating good & bad services and the human factor – the employees seem to play a lesser role in discriminating the quality of service for banks. The variation in services offered by the banks develops the excellence for service quality. Banking is no longer regarded as a business dealing with money transaction alone, but it also seem as a business related to information on financial transaction (Padwal 1995). As electronic banking is becoming more prevalent, so level of customer satisfaction is also changing the scenario of technological environment. Informational technology in form of e-banking plays a significant role in providing better services at lower cost. Several innovative IT based services such as Automated Teller Machines (ATM), Internet banking, Smart cards, Credit Cards, Mobile banking, Phone banking, Anywhere-Anytime banking have provided a number of convenient services to the customer so as the service quality improves, the probability of customer satisfaction increases. Increase in customer satisfaction in turn increases the mutual understanding, customer retention and a bond of trust between the customer and bank. The banks which are providing these services at large extent to customers are more reputed in the eyes of customers. But at the same time technology based product is different in public and private sector banks.

 

E-banking is an improvement over traditional banking system because it has reduced the cost of transaction processing, improved the payment efficiency, financial services and the banker-customer relationship. The relationship between e-banking and service quality can be studied with the level of satisfaction. The customer satisfaction is the function of customer expectation level and service quality level provided by the organization. E-banking plays a pivotal role in giving satisfaction to the customers because e-banking fills the gap between the expected and perceived service quality. So in order to fill this gap, banks should find ways of making electronic services more accessible and by allowing the customer to verify the accuracy of the e-banking transactions. On the whole we can say that e-banking has become pre-imminent method of carrying the banking transaction and increase the

 

customer satisfaction (Sathye, 1999).

Banking Industry in Kenya

According to the Central Bank of Kenya annual report as at 31st December 2012, the banking sector consisted of the Central Bank of Kenya, as the regulatory authority, 44 banking institutions (43 commercial banks and 1 mortgage finance company -MFC), 5 representative offices of foreign banks, 8 Deposit-Taking Microfinance Institutions (DTMs), 2 Credit Reference Bureaus (CRBs) and 112 Forex Bureaus. Out of the 44 banking institutions, 31 locally owned banks comprise 3 with public shareholding and 28 privately owned while 13 are foreign owned. The 8 DTMs, 2 CRBs and 112 forex bureaus are privately owned. The foreign owned financial institutions comprise of 9 locally incorporated foreign banks and 4 branches of foreign incorporated banks. As indicated in the CBK reports, local banks dominate Kenyan banking sector in terms of numbers, and account for 66.6% of the sectors total net assets, while foreign owned banks account for 33.4%. Banks in Kenya have exponentially embraced the use of information and Communication Technologies both in their service provision and as a strategy to ensure their survival. They have invested huge amounts in implementing the self and virtual banking services with the objective of improving quality of customer service.

 

Some ICT based products and services include introduction of SMS banking, ATM’s, Anywhere banking softwares, core banking solutions, Electronic clearing system and direct debit among others. In mid 2005, Kenya’s banking industry moved a milestone by introducing RTGS which was renamed Kenya Electronic Payment and Settlement system ( KEPSS). In October, 2009, Value Capping was introduced. This was meant to decongest banking halls and reduce long queues. Digital-based financial services have made significant contribution in covering the cost of offering financial services. As the banking fraternity continues to make forays into the retail segment of the market, it is becoming more paramount that customers must be given value for their hard earned deposits (Market intelligence, 2005). The Kenyan banking industry has been embracing the new technology in order to fulfil the dreams of their customers and to create healthy competition. The new banking environment is about differentiating banking products, increased choices, security and accessibility. The ability of financial Institution to deliver

 

products and services in the most efficient and effective manner, will therefore be the key to performance and relevance. In Kenya, majority of banks have introduced e-payment facilities, Internet banking and mobile banking to enhance delivery channels to their customers. Kumar (2009) argues that there are many evident advantages of an electronic mode of transfer compared to the conventional clearing house, because of which banks are increasingly turning to technology for managing their payments. These include but are not limited to Secured payments.

 

R esea rch Problem

In line with rendering quality and acceptable services, most Banks in Kenya are gearing toward investing large sum of money in Information and Communication Technology. Expectedly such Banks services have been improved. Equity Bank of Kenya, Standard Chartered Bank of Kenya, Kenya Commercial Bank, Commercial Bank of Kenya,(to mention few) are in the  forefront  in  the use of IT in rendering services to their Customers . They also seek the challenges involved in Electronic Banking and best industrial practice and the approach of implementing them in  the Kenyan Banking system. While the rapid development of information technology has made some banking tasks more efficient and cheaper, technological investments are taking a larger share of bank’s resources. Currently, apart from personnel costs, technology is usually the biggest item in the budget of a bank, and the fastest growing one. Another problem associated with this financial innovation is plastic card fraud, particularly on lost and stolen cards and counterfeit card fraud. Banks need to manage costs and risks associated with electronic banking. It is therefore important that e-banking innovations are made through sound analysis of risks and costs associated so as to avoid harms on the bank performance, (Davenport 2003). On one hand the bank performance is directly related to efficiency and effectiveness of electronic banking, but on the other tight controls and standards are needed to prevent losses associated with electronic banking. The banks have to balance these two options in order not to impair its overall prosperity. This is only possible if overall effects of electronic banking on the banks and its customers are understood.

 

Despite the potential benefits of ICT and e-commerce, there is debate about whether and how their adoption improves bank performance. Several attempts have been made to investigate the impact of electronic banking on bank performance. A research carried out by Kariuki (2005)

 

showed the positive impacts of ICT on their banking performance using bank turnover and profits as measure of performance. He established that those banks with high profit growth are more likely to be using greater numbers of advanced ICTs. He concluded that e-banking leads to higher profits though in long-term but not in short-term due to high ICT investment cost. All this studies used profit and turnover as measures of bank performance. A cording to Davenport (2003) and Oshikoya (2007) suggest that use of and investment in ICT requires complementary investments in skills, organization and innovation, investment and change entails risks and costs which might reduce bank profits in shorter term. Hence there is need to use some non-financial performance measures such as efficiency and effectiveness to assess the impact of ICT investment on banking performance. This is the gap that will seek to be addressed in this study.

 

Regardless of the importance of e-banking in explaining banking performance, the impact of e- banking on banks performance, is still misunderstood for two main reasons; first, there is a lack of understanding about the drivers of innovation and secondly innovation’s impact on bank’s performance remains untested Mabrouk & Mamoghli ( 2010). Previous reseachers like Pooja and Singh (2009), Francesca and Claeys (2010), Batiz- Lazo and Woldesenbet (2006) and Mwania and Muganda (2011) have produced mixed results regarding the impact of innovations on bank performance. Pooja and Singh (2009), in their studies they concluded that innovations had least impact on bank performance, while Batiz-Lazo and Woldesenbet (2006) and Mwania and Muganda (2011) concluded that financial innovation had significant contribution to bank performance. It is at the center of such mixed conclusions that creates and necessitates the need to carry out a study from a Kenyan context to establish the effect of E-Banking on commercial banks performance. The study will address the following research question: What is the effect of electronic banking on financial performance of commercial banks in Kenya?

 

Objective of the study

To establish the effect of electronic banking on the financial performance of Commercial Banks in Kenya.

 

Value of the Study

This study will be of great importance to:

Banking Industry

The recommendations and findings of this study will assist commercial banks in Kenya identify and monitor challenges facing electronic banking adoption and also evaluate the development and growth of Electronic banking. In addition, banks will have the knowledge of electronic banking as a product of electronic commerce with a view to making strategic decisions.

Academia

Academicians will also benefit from this research work since it will suggest possible solutions and strategies to the problems in electronic banking and have thorough knowledge of electronic banking.

Policy Makers

The study will also contribute to the body of knowledge and to additional information in the banking industry. Scholars will use the study for reference and research based on findings of study. Thus, the study will bring out the differences arising from different environmental and organizational factors unique to the bank relevant for successful E-banking.