Quantitative analysis of Operational Risk and Profitability of Kenyan Commercial Banks using Cost Income Ratio

Abstract

The objective of this study was to analyse the effect of operational risk on profitability of commercial banks in Kenya. Operational risk was measured by cost income ratio while profitability by return on equity. The period of interest was between year 2005 and 2014 for all the 43 registered commercial banks in Kenya. Data was obtained from commercial banks' annual financial reports filed with the Central Bank of Kenya. Panel data techniques of random effects estimation and generalized method of moments (GMM) were used to purge time-invariant unobserved firm specific effects and to mitigate potential endogeneity problems. Wald and F-tests were used to determine the significance of the regression while the coefficient of determination, within and between, was used to determine how much variation in dependent variable is explained by independent variable. Findings indicate that cost income is negatively associated with bank profitability both in long run and short run. Hence operating cost management is required to be given more attention by the commercial banks' management.