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Determinants of Financial Performance of Commercial Banks

2.2.2 External Factors/ Macroeconomic Factors

The macroeconomic policy stability, Gross Domestic Product, Inflation, Interest Rate and

Political instability are also other macroeconomic variables that affect the performances of banks. For

instance, the trend of GDP affects the demand for banks asset. During the declining GDP growth the demand for credit falls which in turn negatively affect the profitability of banks. On the contrary, in a growing economy as expressed by positive GDP growth, the demand for credit is high due to the nature of business cycle. During boom the demand for credit is high compared to recession (Athanasoglou et al., 2005). The same authors state in relation to the Greek situation that the relationship between inflation level and banks profitability is remained to be debatable.  The direction of the relationship is not clear (Vong and Chan, 2009).

2.3 Ownership Identity and Financial Performance

The study of the relationship between ownership and performance is one of the key issues in corporate governance which has been the subject of ongoing debate in the corporate finance literature.

The relationship between firm performance and ownership identity, if any, emanate from Agency Theory. This theory deals with owners and managers relationship, which one way or the other refers to ownership and performance. In relation to performance according to Javid and Iqbal (2008), the

identity of ownership matters more than the concentration of ownership. This is so because ownership

identity shows the behavior and interests of the owners.   Ongore (2011) argues that the risk-taking behavior and investment orientation of shareholders have great influence on the decisions of managers in the day-to-day affairs of firms. According to Ongore (2011), the concept of ownership can be defined along two lines of thought: ownership concentration and ownership mix. The concentration refers to proportion of shares held (largest shareholding) in the firm by few shareholders and the later defines the identity of the shareholders. Morck et al. in Wen (2010) explained that ownership concentration  has  two  possible  consequences.  The  dominant  shareholders  have  the  power  and incentive tcloselmonitor  the performances  of the management.  This  in turn has  two further consequences in relation to firm performance. On the one hand close monitoring of the management can reduce agency cost and enhance firm performance. On the other hand concentrated ownership can create a problem in relation to overlooking the right of the minority and also affect the innovativeness of the management (Ongore, 2011; Wen, 2010).

Concerning  the  relationship  between  ownership  identity  &  bank  performance  different

scholars came up with varying results. For instance according to Claessens et al., (1998) domestic banks' performance is superior compared to their foreign counterparts in developed countries. According to the same scholars the opposite is true in developing countries. Micco et al. in Wen (2010) also support the above argument in that  in developing countries the performances of foreign banks is better compared with the other types of ownership in developing countries. However, Detragiache (2006) presented a different view about  the foreign bank performance in relation to financial sector development, financial deepening, and credit creation in developing countries. He found that the performances of foreign banks compared to their domestic owned banks are inferior in developing countries. Ownership is one of the variables that affect the performance of banks. Specifically, ownership identity is one of the factors explaining the performances of banks across the


 

 

board; yet the level & direction of its effect remained contentious. There are scholars who claimed that foreign firms perform better with high profit margins and low costs compared to domestic owned banks (Farazi et al., 2011). Thiis so because foreign owned firms are believed to have tested management expertise in other countries over years. Moreover, foreign banks often customize and apply their  operation systems  found  effective at  their  home countries  (Ongore,  2011).  It  is  also assumed that banks crossing boundaries are often those big and successful ones.   For instance in countries such as Thailand,  Middle East and  North Africa region,  it was  found that foreign banks performance is better than domestic counterparts (Azam and Siddiqui, 2012; Chantapong, 2005; Farazi et al. 2011). The study conducted in Pakistan by Azam and Siddiqui (2012) concluded that "...foreign banks are more profitable than all domestic banks regardless of their ownership structure by applying regression analysis." They further suggest that "...it is better for a multinational bank to establish a subsidiary/branch rather than acquiring an existing player in the host country. Moreover, Chantapong (2005) by studying domestic and foreign bank performance in Thailand concluded that foreign banks are more profitable than the average domestic banks profitability. It is also supported by Okuda and Rungsomboon (2004) that foreign owned banks in Thailand are found to be efficient compared  to  their  domestic  counterparts  due  to  modernized  business  activities  supported  by technology, reduced costs associated with fee-based businesses and improved their operational efficiency.  These  indicate that  ithe area  studied  above foreign  banks  were found  tbe  more profitable than their domestic counterparts. The major reason behind these assertions is that foreign banks were believed to be strong & efficient.

However, there are scholars who argue that domestic banks perform better then foreign banks.

For instance (Cadet, 2008) stated that "... foreign banks are not always more efficient than domestic banks  in  developing  countries,  and  even  in  a  country  with  low  income  level."    Yildirim  and Philippatos in Chen and Lia (2009) also support the above view that foreign owned banks performed not better, even less than the domestic banks in relation to developing countries especially in Latin America. The study conducted in Turkey by Tufan et al. (2008) also found that domestic banks perform better  than their  foreign counterparts. There are also other  scholarwho argue thathe performance of domestic and foreign banks varies from region to region. Claessens et al. (1998), for example, stated that foreign banks perform better in developing countries compared to when they are in developed countries. Thus, they conclude that domestic banks perform better in developed countries than when they are in developing countries.  They further assert that an increase in the share of foreign banks leads to a lower profitability of domestic banks in developing countries. Thus, does ownership identity influence the performance of commercial banks? Studies have shown that bank performance can be affected by internal and external factors (Athanasoglou et al. 2005; Al-Tamimi, 2010; Aburime,

2005.) Moreover, the magnitude of the effect can be influenced by the decision of the management.

The management decision, in turn, is affected by the interests of the owners which is determined by their investment preferences and risk appetite (Ongore, 2011). This implies the moderating role of ownership  identity.  This  studattempted  to  examine  whether  ownership  identity  significantly moderate the relationship between commercial banks' financial performance and its determinants in Kenya or not.

2.4. Conceptual Framework

The conceptual framework is developed from the review of literature discussed above and

presented in the following diagram (figure 1).  It shows the relationship between the dependent (ROA, ROE, NIM) and explanatory (bank specific and macroeconomic) variables. It also demonstrates the moderating role of ownership identity.