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CHALLENGES FACING BANKING INSTITUTE IN KISII
A RESEARCH PROJECT SUBMITTED IN PARTIAL FULFILLMENT OF
THE REQUIREMENT FOR THE AWARD OF THE BACHELOR'S
IN ……...
JUNE 2021
DECLARATION I declare that this project is my original work and has not
been submitted for an award of a degree in any other university for
examination /academic purposes.
SIGNATURE.......................................... DATE..................................
FAITH OMBUI
This research project has been submitted for examination with my approval as the
college supervisor
SIGNATURE.......................................... DATE..................................
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Mr/mrs ………
…..
ii
DEDICATION
To my future family, always remember that the sky's the limit. May you be blessed with
patience to endure all
situations.
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iii
ACKNOWLEDGEMENT
I thank the Lord Almighty for giving me the strength and endurance to come this far.
my
parents Mr and Mrs ……. for their continuous encouragement, good
education
background, exposure and continuous encouragement to know that the sky is the
limit.
. My supervisor Mr/mrs……..
invaluable support, guidance and patience during the study period which was
instrumental to the
successful completion of this study. I am truly
grateful.
I wish to thank the management of the bank institutions and their employees for
participating
in this study as the main respondents. Lastly, I thank my colleagues and friends
for their
continued moral support and
encouragement.
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i
v
ABSTRACT
The purpose of this project is to introduce practical evidence about challenges facing
bank institutions in Kisii and to examine what can be done to control the challenges.
A survey research method has been adopted to examine challenges facing bank
institutions in
Kisii. The data were collected through questionnaires filled by the respondents equally
selected from commercial bank in Kisii, Kenya. The results of the
questionnaire were then analyzed.
The results showed that the Bank institutions have a positive impact on alleviation of
poverty
among poor people. Misconception about bank institutions due to their newly inception,
inadequate
loans, less mentionable support from government and donor funding hinder the
bankinginstitutions
flourishing and hence this research provides contribution in the field of challenges
facing banks in Kisii
v
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CHAPTER ONE
1.0 INTRODUCTION
The chapter focuses on the background of the problem
statement of the problem ,objectives of the study , aims,
research questions and hypotheses,significance of the
study, limitations of the study and the conceptual
framework
1.1 Background to the Study
Risk management is an important discipline in business especially the Banking
institutions.
Recently, banks put great emphasis on risk management as this determines their
survival
and business performance. bank institutions are in the risk.
various types of risks for individuals, businesses and companies. It is therefore,
necessary that
Bank institutions manage their risk exposure and conduct proper analysis to avoid
losses due
loans lended/borrowed to individuals and businesses. However, Kadi (2003) observes
that most
Bank institutions give out loans cover without carrying out proper analysis of the
expected
returns and how to recover the money from clients.
reduction
methods.
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Poor management of risk, by bank institutions, leads to accumulation of loans from the
clients hence leading to increased losses and hence poor financial performance
(Magezi, 2003).
Risk management activities are affected by the risk behaviour of managers. A robust
risk
management framework can help organizations to reduce their exposure to risks, and
enhance
their financial performance ( Mirakhor, 2007) .Further; it is argued that the selection of
particular risk tools tends to be associated with the firm’s calculative culture the
measurable
attitudes that senior decision makers display towards the use of risk management
models. While
some risk functions focus on extensive risk measurement and risk based performance
management, others focus instead on qualitative discourse and the mobilization of
expert
opinions about emerging risk issues (Mikes and Kaplan,
2014).
In recent years, bank institutions have increased their focus on risk management due to
the challenges they facing. Meredith
(2014) suggests that there should be careful judgement, by management of bank
institutions,
of loan risks in order to avoid excessive losses. It follows that risk
management is an important factor in improving financial performance (Okotha, 2003).
According to Standard and Poor’s (2013), insurers, as risk-bearing institutions can, and
do, fail if
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risks are not managed
adequately.
The central function of an bank institutions is its ability to distribute risk(loans) across
different
participants (Merton, 1995). Saunders and Cornett (2008), also state that modern
insurance
companies are in the risk management business. They discuss that bank institutions
undertake risk bearing and management functions on behalf of their customers through
the
pooling of risks and the sale of their services as risk specialists. This indicates that
management
of risks should take the centre stage in the operations of bank
institutions.
Risk Management
Risk is defined as the uncertainty associated with a future outcome or event (Banks,
2004).
Further, risk is a concept that denotes a potential negative impact to an asset or some
characteristic of value that may arise from some present process or future event
(Douglas and
Wildavsky, 1982). Rejda (2008) defines risk management as the process through which
an
organization identifies loss exposures facing it and selects the most appropriate
techniques for
treating such
exposures.
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In risk management, a prioritization process must be followed whereby the risk with the
greatest
loss and greatest probability of occurrence is handled first and risks with lower loss are
handled
later (Kiochos, 1997, and Stulz, 2003). There is however, no specific model to
determine the
2
balance between risks with greatest probability and loss and those with lower loss,
making risk
management difficult. Banks (2004) notes that the key focus of risk management is
controlling,
as opposed to eliminating, risk exposures so that all stakeholders are fully aware of how
the firm
might be
impacted.
Bank institutions lend heavily to the risk management process suggested by Kiochos
(1997). According to Kiochos (1997), the risk management process involves four steps:
identifying potential losses, evaluating potential losses, selecting appropriate risk
management
techniques for treating loss exposures and implementing and administering the risk
management
program. Kimball (2000) concurs that risk management is the human activity which
integrates
recognition of risk, risk assessment, developing strategies to manage it and mitigation
of risk
using managerial resources. Generally, a proper risk management process enables a
firm to
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reduce its risk exposure and prepare for survival after any
unexpected crisis.
Financial Performance
Financial performance can be measured through evaluating a firm’s profitability,
solvency and
liquidity. A firm’s profitability indicates the extent to which a firm generates profit from its
factors of production. Financial performance can be measured by monitoring the firm’s
profitability levels. Zenios et al. (1999) states that profitability analysis focuses on the
relationship between revenues and expenses and on the level of profits relative to the
size of
investment in the business through the use of profitability ratios. The return on equity
(ROE) and
the return on assets (ROA) are the common measures of profitability. By monitoring a
firm’s
profitability levels, one can measure its financial
performance.
Solvency measures give an indication of a firm’s ability to repay all its indebtedness by
selling
all of its assets. It also provides information about a firm’s ability to continue operating
after
undergoing a major financial crisis. Quach (2005) states that solvency measures the
amount of
borrowed capital used by the business relative to the amount of owners’ equity capital
invested
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in the business as an indication of the safety of the creditors interests in the
company.
Liquidity indicates a firm’s ability to meet its financial obligations as and when they
mature
without disrupting the normal operations of the business. According to Quach (2005),
liquidity
can be analysed structurally and operationally. Further, operational liquidity refers to the
cash
flow measures while structural liquidity refers to the composition of the
balance sheet.
The incidence and relative magnitude of internal or external disruptions to business
activities
from risk events also vary considerably across firms depending on the nature of
activities and the
sophistication of internal risk measurement standards and control mechanisms. While
companies
should generate enough expected revenues to support a net margin that absorbs
expected risk
losses from predictable internal failures, they also need to hold sufficient capital
reserves to
cover the unexpected losses or resort to insurance (Zsidison, 2003). This ensures that
losses do
not impact negatively on the firm’s financial
performance.
Risk Management and Financial Performance
The main focus of risk management has mainly been on controlling and for regulatory
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compliance, as opposed to enhancing financial performance (Banks, 2004). However,
this risk
management often leads to enhanced financial performance as regulatory compliance
and control
of risks enables the organization to save on costs. Banks (2004) further suggests that
by poor
managing risks, the managers are not able to increase the value of the firm through
ensuring
continued profitability of the
firm.
Standard and Poor’s (2013) identifies poor liquidity management, under-pricing and
under-
reserving, a high tolerance for investment risk, management and governance issues,
difficulties
related to rapid growth and/or expansion into non-core activities as main causes of
financial
distress and failure in insurance companies. It is important that these factors be
managed
efficiently by insurance companies, to avoid financial failure and bankruptcy to
the firm.
In the 21
st
century has seen great efforts to risk management. Babbel and Santomero
(1996) note
that insurers should assess the various types of risks they are exposed to and devise
ways of
effectively managing them.
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Improper risk management is not importantin the daily operations of any bank institution
it leads to
financial losses and bankruptcy. This is in line with Jolly (1997) contribution that
preventing
losses through precautionary measures is a key element in reducing risks and
consequently, a key
driver of profitability. The efficiency of risk management by bank institutions will
generally
influence their financial performance. Gold (1999), asserts that bank institutions could
not
survive with increased loss and expense
ratios.
Meanwhile, risk management has been linked with shareholder value maximization
proposition.
Ali and Luft (2002), suggested that a firm will only engage in risk management if it
enhances
shareholder value; Banks (2004), contributed that it is important for each firm to retain
and
actively manage some level of risk if it is to increase its market value or if the probability
of
financial distress is to be lowered; Pagano (2001), confirms that risk management is an
important
function of insurance institutions in creating value for shareholders and
customers.
Generally, company operations are prone to risks and if the risks are not managed the
firm’s
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financial performance will be at stake. Firms with efficient risk management structures
outperform their peers as they are well prepared for periods after the occurrence of the
related
risks. This study hopes to come up with an expected positive relationship between risk
management and performance of insurance
companies.
1.2 STATEMENT OF THE PROBLEM
bank institutions are in the core business of
managing risks.the companies manage risks of
both their clients and their own risks.this requires
an integration of risk management into the
companies system processes and culture various
stakeholders pressure their organisations to
effectively manage their risks and to the
transparency report their performance across
such risk management initiates banks (2004)
argues that some risks can and should be
maintained as part of the core business
operations and actively managed to create value
for stakeholders ,while others should be
transferred elsewhere as long as it cost effective
to do so.According to stulz(1996) some risks
present opportunities through which the firm can
acquire comparative advantage and hence
enable it to improve on financial
performance.Generally, review of the literature on
risk management practices result in improved
financial performance,insurance of the firm by
linking risk management practices and
performance, insurance firms can move
effectively understand the value of implementing
a risk management framework. Despite the
contribution of insurance corporation to the
growth of the business enterprise in the economic
development,failure and slow growth still exists
and the public doubts its management.(smith
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2009)
According to CBK,
1.3 PROJECT AIM
.The aim of the project;
To Determine challenges facing bank institutions in kisii,
kenya.
1.4 PROJECT OBJECTIVES
The research objective for this study are as follows
1.To identify bank services to the individual and business enterprise.
2.To determine the role of bank institutions in kisii.
3.To determine how the challenges may be solved.
1.5 RESEARCH
QUESTIONS AND
HYPOTHESIS
I) What are the major bank
services to the individual
and business enterprise.
II) What are the roles of
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bank institutions in kisii
III) What are the steps
taken to overcome the
challenges facing banks in
kisii
1.6 SIGNIFICANCE OF
THE STUDY
i) The study will
theoratically
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1
0
CHAPTER TWO
LITERATURE REVIEW
2.1
Introduction
This chapter critically reviews the available literature on bank services,roles and how to
overcome the challenges they are facing.The review will be guided by the specific
objectives .
2.2 REVIEW OF LITERATURES
The concept of risk management theory involves studying the various ways by which
businesses
and individuals raise money, as well as how money is allocated to projects while
considering the
loans associated with them (Sarkis, 1998). The theories reviewed in this section are the
agency theory, the stakeholders’ theory and the optimal capital structure
theory.
2.2.1 VARIOUS REVIEWS
Agency theory extends the analysis of the firm to include separation of ownership and
control,
and managerial motivation. In the field of corporate risk management agency issues
have been
shown to influence managerial attitudes toward risk taking and hedging (Smith and
Stulz, 1985).
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Theory also explains a possible mismatch of interest between shareholders,
management and
debt holders due to asymmetries in earning distribution, which can result in the firm
taking too
much risk or not engaging in positive net value projects (Mayers and Smith, 1987).
Consequently, agency theory implies that defined hedging policies can have important
influence
on firm value (Fite and Pfleiderer,
1995).
Stulz (1984) first suggested a reason for the interest in risk management by managers
of a firm.
He asserts that managers are presumed to be working on behalf of firm owners and
therefore,
concern themselves with both expected profit and the distribution of firm returns around
their
expected value. They have an inclination to avoid risk in order to minimize the variability
of firm
returns and hence achieve the. For firm owners, risk management saves on agency
costs since, by
reducing the variability of returns of their firms, managers are working in line with the
shareholder wealth maximization
goal.
Managerial motivation factors in implementation of corporate risk management have
been
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empirically investigated in a few studies with a negative effect (Faff and Nguyen, 2002;
MacCrimmon and Wehrung, 1990; Geczy et al., 1997). Notably, positive evidence was
found
however by Tufano (1996) in his analysis of the gold mining industry in the US.
Financial policy
hypotheses were tested in studies of the financial theory, since both theories give
similar
predictions in this respect. However, the bulk of empirical evidence seems to be against
agency
theory
hypotheses.
Agency theory provides strong support for risk management as a response to mismatch
between
managerial incentives and shareholder interests. Shareholders and managers have
different
interests to the firm and risk management objectives vary for the different stakeholders.
While
shareholders may require high risk high return investments, management prefer low
risk and
1
2
return investments. The agency theory emphasizes the need for risk management to
align the
interests of mangers and shareholders and to contribute to the financial performance
of the firm.
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Stakeholder Theory
Stakeholder theory, developed originally by Freeman (1984) as a managerial
instrument, has
since evolved into a theory of the firm with high explanatory potential. Stakeholder
theory
focuses explicitly on equilibrium of stakeholder interests as the main determinant of
corporate
policy. The most promising contribution to risk management is the extension of implicit
contracts theory from employment to other contracts, including sales and financing
(Cornell and
Shapiro, 1987). In certain industries, particularly high-tech and services, consumer trust
in the
company being able to continue offering its services in the future can substantially
contribute to
company value. However, the value of these implicit claims is highly sensitive to
expected costs
of financial distress and
bankruptcy.
Since corporate risk management practices lead to a decrease in these expected costs,
company
value rises (Klimczak, 2005). Therefore stakeholder theory provides a new insight into
possible
rationale for risk management. However, it has not yet been tested directly.
Investigations of
financial distress hypothesis (Smith and Stulz, 1995) provide only indirect evidence
(Judge,
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2006). This theory is useful to risk management research. It helps to address the
importance of
customer trust and financial distress costs to bank institutions. Finally the theory
suggests
that smaller firms are more prone to financial problems, which should increase their
interest in
risk management
practices.
The stakeholder theory emphasizes the need for risk management in bank institutions
and its
importance in improving the value of the company. It however does not indicate the
influence of
risk management on the financial performance and the resulting relationship between
the two
variables apart from suggesting that risk management leads to growth in
company value.
Theory of Optimal Capital Structure
According to the optimal capital structure theory, there is an optimal, finite debt equity
ratio,
resulting from a trade-off between the expected value of bankruptcy costs and the tax
savings
associated with the deductibility of interest payments (Kim, 1976). Bankruptcy occurs
when the
fixed obligations to creditors cannot be met. There are direct and indirect costs related
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to
bankruptcy. Direct costs include legal, accounting and trustee fees as well as the
possible denial
of income tax carryovers and carrybacks. Indirect costs relate to opportunity costs
resulting from
disruptions firm-supplier relationships that are associated with the transfer of ownership
or
control (Barker, 1976). Warner (1977) and Weiss (1990) give evidence of financial
distress and
state underline the significance of bankruptcy costs to a
business.
Allen and Santomero (1996) suggest that the cost of bankruptcy is more important in
regulated
industries where large losses may lead to license or charter withdrawal and the loss of a
monopoly position. This theory offers a significant rationale as to why firms would be
engaged
in risk management. Stulz (1996) provides further evidence by suggesting that the
expected
present value of bankruptcy costs will be reflected in a firm’s current market value if
shareholders view bankruptcy as a real possibility. He further states that a risk
management
program that costlessly eliminates the risk of bankruptcy effectively reduces such costs
to zero,
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thereby increasing the value of the
firm.
Bankruptcy costs are significant to insurance business in Kenya. Once a company is not
able to
pay customer claims, the regulator declares it bankrupt and puts it under receivership.
Recently,
Blue Shield Insurance and Concord Insurance were put under receivership due to
failure to meet
the customer claims (KTN, 2014). This indicates that bankruptcy costs should be
considered in
the risk management of bank institutions. However, Standard and Poor’s (2013)
observe that
unlike corporate failures caused by the incomplete or untimely payment on all or
some financial obligations, including debt restructurings, an bank institutions failure
most
often becomes apparent when the regulator takes action because the debtor's financial
position
has become untenable. They further contend that nonpayment of a debt obligation do
not
generally prompt a default. Anyway, debtors tend to have low debt burdens, but high
policy
obligation
s.
2.2.2 INSURANCE SERVICES OFFERED BY
BANKS IN KISII TO INDIVIDUAL AND
BUSINESS ENTERPRISE
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The insurance offer the following services to
business enterprise in Kenya
I)Work injury benefit act - if the employee in the
business are injured accidentally while working the
la state the employee should be compensated
covers against him/her against this liability
II)Fire and peril insurance - the insurance covers
physical assets like the premises of the business e.g
offices and warehouse, the vehicles ,equipment and
the furniture and fittings .covers damages caused by
fire and floods, earthquakes e.t.c
III)Consequential loss -covers business from loss of
profit due to business interruption as a result of
causes under the fire and peril policy
IVBurglary insurance -when business location under
threat robbery burglary the policy will compensate
for losses or damage to property contained in the
business premises due to act or attempt of burglary
or robbery
2.2.3 ROLES OF BANK INSTITUTIONS IN
KISII
Regulation of Monetary Supply
Banking Services
Insurance Services
Capital Formation
Investment Advice
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Brokerage services
Pension Fund Services
Trust Fund Services
Financing the Small and Medium Scale Enterprises
Act as A Government Agent for Economic Growth
2.2.4 OVERCOMING CHALLENGES FACING THE BANK INSTITUTIONS IN
KISII
Sufficient knowledge on regulations procedures
Adequate Staff to regulate microfinance institution
The Institutions should be free of Politics
Proper Information Dissemination
Qualified Staffs for both Institutions (MFIs & FR)
Effective and efficient government policies
There should be a vibrant regulatory framework
Dealing with Triggers and Changes
Effective Coordination the Supervision of the
institutions
Financial Stability
Proper loan monitoring & Management
Government and Donor Support
Control of Interest Rate
Dealing with Corruption, Fraud, and
Mismanage
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CHAPTER THREE
RESEARCH METHODOLOGY
3.1
Introduction
This chapter describes the research methods and procedures used in conducting the
study. It
outlines the research design, population of the study and sampling design, data
collection and
data
analysis.
3.2 Research
Design
Mugenda & Mugenda (2003) describe a research design as the plan or structure of
investigation
conceived to obtain answers to research questions that includes an outline of the
research work to
enable the representation of results in a form understandable by all. A descriptive
research design
was adopted for this study. Descriptive research enables the researcher to describe the
existing
relationship by using observation and interpretation methods. It provides the researcher
with the
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appropriate methodology to illustrate characteristics of the variables under study.
Causal research
determines causal linkages between study variables by studying existing phenomena
and then
reviewing available data so as to try to identify workable causal
relationships.
3.3 Population of the
Study
A population is the aggregate of all elements that conform to some general set of
specifications
(Paton, 2002). The study adopted a census survey of all the 5 registered bank
institutions
operating in kisii, Kenya . A census approach enables one to collect more accurate and
reliable data. The observable characteristics of the target population should be strongly
related to
the characteristics intended to be generalized by the study (Mugenda &
Mugenda, 2003).
3.4 Data
Collection
Both primary and secondary data was used in this study. Primary data was collected
through the
use of questionnaires. Questionnaires were picked and dropped to the risk managers in
the
Bank institutions. Questionnaires were structured to collect both qualitative and
quantitative
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data. Questionnaires are also a common tool for data collection in social sciences.
Secondary
data was collected from secondary data sources like Bank survey reports from CBK and
the
audited financial statements of all Bank institutions as presented. Secondary data for
the period 2008 to 2012 was used in this
study.
3.4 Data
Analysis
This research employed descriptive statistics to analyse the data. It is argued (Mugenda
&
Mugenda, 2003) that descriptive statistics enable the researcher to get meaningful
description of
scores and measurements for the study through the uses of few indices or statistics.
The data
obtained from the questionnaires was edited and then coded for the purposes of data
analysis. It
was further summarized using descriptive statistics which usually include measure of
central
tendency, measures of variability, and measures of reliability and frequency among
others.
Measures of central tendency such as the mean, median and the mode state the best
estimate of
the expected score or measure from a group of scores in a group of scores in a study.
The
Statistical Package for Social Sciences (SPSS) was used to analyse the independent
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and
dependent variables. The findings are presented in the form of charts, tables and pie
charts in
chapter 4.
3.5 The Analytical Model
The goal of the study was to describe the relationship between risk management and
financial
performance among Bank institutions in kisii,Kenya. The study used a regression model
to
determine the existing relationship. The following regression model was used for the
study:
Y=β
0
+ β
1
X1 + β
2
X2 + β
3
X3+ β
4
X4+ ε
Where:
Y = Financial Performance (Measured using ROA)
X1
= Risk identification (Measured using inspection, Financial statements
analysis,
establishing standards and risk rating and collateral.
X2 = Risk assessment (Measured using approximations & projections)
X3
= Risk mitigation (Risk control and risk financing measures)
X4
= Risk management implementation and monitoring (Controls, responses, reporting &
review)
ε
= the error term
The values of X1, X2, X3&X4 were computed from the mean score of the responses on
each
Likert scaled data for each insurance company (either life, general or composite). The
mean
35
score was obtained for the respective variables for each insurance company, and
values used for
the regression analysis. The Y value is an average for the 5 year period,
2008-2012.
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3.6 Diagnostic
Tests
F-test was tested for joint significance of all coefficients and t-test for significance of
individual
coefficients. Measures of central tendency (mean) and a measure of
dispersion/variation
(standard deviation) was used to analyse
the data

Unformatted Attachment Preview

CHALLENGES FACING BANKING INSTITUTE IN KISII A RESEARCH PROJECT SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENT FOR THE AWARD OF THE BACHELOR'S IN ……... JUNE 2021 DECLARATION I declare that this project is my original work and has not been submitted for an award of a degree in any other university for examination /academic purposes. SIGNATURE.......................................... DATE.................................. FAITH OMBUI This research project has been submitted for examination with my approval as the college supervisor SIGNATURE.......................................... DATE.................................. Mr/mrs ……… ….. ii DEDICATION To my future family, always remember that the sky's the limit. May you be blessed with patience to endure all situations. iii ACKNOWLEDGEMENT I thank the Lord Almighty for giving me the strength and endurance to come this far. my parents Mr and Mrs ……. for their continuous encouragement, good education background, exposure and continuous encouragement to know that the sky is the limit. . My supervisor Mr/mrs…….. invaluable support, guidance and patience during the study period which was instrumental to the successful completion of this study. I am truly grateful. I wish to thank the management of the bank institutions and their employees for participating in this study as the main respondents. Lastly, I thank my colleagues and friends for their continued moral support and encouragement. i v ABSTRACT The purpose of this project is to introduce practical evidence about challenges facing bank institutions in Kisii and to examine what can be done to control the challenges. A survey research method has been adopted to examine challenges facing bank institutions in Kisii. The data were collected through questionnaires filled by the respondents equally selected from commercial bank in Kisii, Kenya. The results of the questionnaire were then analyzed. The results showed that the Bank institutions have a positive impact on alleviation of poverty among poor people. Misconception about bank institutions due to their newly inception, inadequate loans, less mentionable support from government and donor funding hinder the bankinginstitutions flourishing and hence this research provides contribution in the field of challenges facing banks in Kisii v CHAPTER ONE 1.0 INTRODUCTION The chapter focuses on the background of the problem statement of the problem ,objectives of the study , aims, research questions and hypotheses,significance of the study, limitations of the study and the conceptual framework 1.1 Background to the Study Risk management is an important discipline in business especially the Banking institutions. Recently, banks put great emphasis on risk management as this determines their survival and business performance. bank institutions are in the risk. various types of risks for individuals, businesses and companies. It is therefore, necessary that Bank institutions manage their risk exposure and conduct proper analysis to avoid losses due loans lended/borrowed to individuals and businesses. However, Kadi (2003) observes that most Bank institutions give out loans cover without carrying out proper analysis of the expected returns and how to recover the money from clients. reduction methods. Poor management of risk, by bank institutions, leads to accumulation of loans from the clients hence leading to increased losses and hence poor financial performance (Magezi, 2003). Risk management activities are affected by the risk behaviour of managers. A robust risk management framework can help organizations to reduce their exposure to risks, and enhance their financial performance ( Mirakhor, 2007) .Further; it is argued that the selection of particular risk tools tends to be associated with the firm’s calculative culture – the measurable attitudes that senior decision makers display towards the use of risk management models. While some risk functions focus on extensive risk measurement and risk based performance management, others focus instead on qualitative discourse and the mobilization of expert opinions about emerging risk issues (Mikes and Kaplan, 2014). In recent years, bank institutions have increased their focus on risk management due to the challenges they facing. Meredith (2014) suggests that there should be careful judgement, by management of bank institutions, of loan risks in order to avoid excessive losses. It follows that risk management is an important factor in improving financial performance (Okotha, 2003). According to Standard and Poor’s (2013), insurers, as risk-bearing institutions can, and do, fail if risks are not managed adequately. The central function of an bank institutions is its ability to distribute risk(loans) across different participants (Merton, 1995). Saunders and Cornett (2008), also state that modern insurance companies are in the risk management business. They discuss that bank institutions undertake risk bearing and management functions on behalf of their customers through the pooling of risks and the sale of their services as risk specialists. This indicates that management of risks should take the centre stage in the operations of bank institutions. Risk Management Risk is defined as the uncertainty associated with a future outcome or event (Banks, 2004). Further, risk is a concept that denotes a potential negative impact to an asset or some characteristic of value that may arise from some present process or future event (Douglas and Wildavsky, 1982). Rejda (2008) defines risk management as the process through which an organization identifies loss exposures facing it and selects the most appropriate techniques for treating such exposures. In risk management, a prioritization process must be followed whereby the risk with the greatest loss and greatest probability of occurrence is handled first and risks with lower loss are handled later (Kiochos, 1997, and Stulz, 2003). There is however, no specific model to determine the 2 balance between risks with greatest probability and loss and those with lower loss, making risk management difficult. Banks (2004) notes that the key focus of risk management is controlling, as opposed to eliminating, risk exposures so that all stakeholders are fully aware of how the firm might be impacted. Bank institutions lend heavily to the risk management process suggested by Kiochos (1997). According to Kiochos (1997), the risk management process involves four steps: identifying potential losses, evaluating potential losses, selecting appropriate risk management techniques for treating loss exposures and implementing and administering the risk management program. Kimball (2000) concurs that risk management is the human activity which integrates recognition of risk, risk assessment, developing strategies to manage it and mitigation of risk using managerial resources. Generally, a proper risk management process enables a firm to reduce its risk exposure and prepare for survival after any unexpected crisis. Financial Performance Financial performance can be measured through evaluating a firm’s profitability, solvency and liquidity. A firm’s profitability indicates the extent to which a firm generates profit from its factors of production. Financial performance can be measured by monitoring the firm’s profitability levels. Zenios et al. (1999) states that profitability analysis focuses on the relationship between revenues and expenses and on the level of profits relative to the size of investment in the business through the use of profitability ratios. The return on equity (ROE) and the return on assets (ROA) are the common measures of profitability. By monitoring a firm’s profitability levels, one can measure its financial performance. Solvency measures give an indication of a firm’s ability to repay all its indebtedness by selling all of its assets. It also provides information about a firm’s ability to continue operating after undergoing a major financial crisis. Quach (2005) states that solvency measures the amount of borrowed capital used by the business relative to the amount of owners’ equity capital invested in the business as an indication of the safety of the creditors interests in the company. Liquidity indicates a firm’s ability to meet its financial obligations as and when they mature without disrupting the normal operations of the business. According to Quach (2005), liquidity can be analysed structurally and operationally. Further, operational liquidity refers to the cash flow measures while structural liquidity refers to the composition of the balance sheet. The incidence and relative magnitude of internal or external disruptions to business activities from risk events also vary considerably across firms depending on the nature of activities and the sophistication of internal risk measurement standards and control mechanisms. While companies should generate enough expected revenues to support a net margin that absorbs expected risk losses from predictable internal failures, they also need to hold sufficient capital reserves to cover the unexpected losses or resort to insurance (Zsidison, 2003). This ensures that losses do not impact negatively on the firm’s financial performance. Risk Management and Financial Performance The main focus of risk management has mainly been on controlling and for regulatory compliance, as opposed to enhancing financial performance (Banks, 2004). However, this risk management often leads to enhanced financial performance as regulatory compliance and control of risks enables the organization to save on costs. Banks (2004) further suggests that by poor managing risks, the managers are not able to increase the value of the firm through ensuring continued profitability of the firm. Standard and Poor’s (2013) identifies poor liquidity management, under-pricing and underreserving, a high tolerance for investment risk, management and governance issues, difficulties related to rapid growth and/or expansion into non-core activities as main causes of financial distress and failure in insurance companies. It is important that these factors be managed efficiently by insurance companies, to avoid financial failure and bankruptcy to the firm. In the 21st century has seen great efforts to risk management. Babbel and Santomero (1996) note that insurers should assess the various types of risks they are exposed to and devise ways of effectively managing them. Improper risk management is not importantin the daily operations of any bank institution it leads to financial losses and bankruptcy. This is in line with Jolly (1997) contribution that preventing losses through precautionary measures is a key element in reducing risks and consequently, a key driver of profitability. The efficiency of risk management by bank institutions will generally influence their financial performance. Gold (1999), asserts that bank institutions could not survive with increased loss and expense ratios. Meanwhile, risk management has been linked with shareholder value maximization proposition. Ali and Luft (2002), suggested that a firm will only engage in risk management if it enhances shareholder value; Banks (2004), contributed that it is important for each firm to retain and actively manage some level of risk if it is to increase its market value or if the probability of financial distress is to be lowered; Pagano (2001), confirms that risk management is an important function of insurance institutions in creating value for shareholders and customers. Generally, company operations are prone to risks and if the risks are not managed the firm’s financial performance will be at stake. Firms with efficient risk management structures outperform their peers as they are well prepared for periods after the occurrence of the related risks. This study hopes to come up with an expected positive relationship between risk management and performance of insurance companies. 1.2 STATEMENT OF THE PROBLEM bank institutions are in the core business of managing risks.the companies manage risks of both their clients and their own risks.this requires an integration of risk management into the companies system processes and culture various stakeholders pressure their organisations to effectively manage their risks and to the transparency report their performance across such risk management initiates banks (2004) argues that some risks can and should be maintained as part of the core business operations and actively managed to create value for stakeholders ,while others should be transferred elsewhere as long as it cost effective to do so.According to stulz(1996) some risks present opportunities through which the firm can acquire comparative advantage and hence enable it to improve on financial performance.Generally, review of the literature on risk management practices result in improved financial performance,insurance of the firm by linking risk management practices and performance, insurance firms can move effectively understand the value of implementing a risk management framework. Despite the contribution of insurance corporation to the growth of the business enterprise in the economic development,failure and slow growth still exists and the public doubts its management.(smith 2009) According to CBK, 1.3 PROJECT AIM .The aim of the project; To Determine challenges facing bank institutions in kisii, kenya. 1.4 PROJECT OBJECTIVES The research objective for this study are as follows 1.To identify bank services to the individual and business enterprise. 2.To determine the role of bank institutions in kisii. 3.To determine how the challenges may be solved. 1.5 RESEARCH QUESTIONS AND HYPOTHESIS I) What are the major bank services to the individual and business enterprise. II) What are the roles of bank institutions in kisii III) What are the steps taken to overcome the challenges facing banks in kisii 1.6 SIGNIFICANCE OF THE STUDY i) The study will theoratically 1 0 CHAPTER TWO LITERATURE REVIEW 2.1 Introduction This chapter critically reviews the available literature on bank services,roles and how to overcome the challenges they are facing.The review will be guided by the specific objectives . 2.2 REVIEW OF LITERATURES The concept of risk management theory involves studying the various ways by which businesses and individuals raise money, as well as how money is allocated to projects while considering the loans associated with them (Sarkis, 1998). The theories reviewed in this section are the agency theory, the stakeholders’ theory and the optimal capital structure theory. 2.2.1 VARIOUS REVIEWS Agency theory extends the analysis of the firm to include separation of ownership and control, and managerial motivation. In the field of corporate risk management agency issues have been shown to influence managerial attitudes toward risk taking and hedging (Smith and Stulz, 1985). Theory also explains a possible mismatch of interest between shareholders, management and debt holders due to asymmetries in earning distribution, which can result in the firm taking too much risk or not engaging in positive net value projects (Mayers and Smith, 1987). Consequently, agency theory implies that defined hedging policies can have important influence on firm value (Fite and Pfleiderer, 1995). Stulz (1984) first suggested a reason for the interest in risk management by managers of a firm. He asserts that managers are presumed to be working on behalf of firm owners and therefore, concern themselves with both expected profit and the distribution of firm returns around their expected value. They have an inclination to avoid risk in order to minimize the variability of firm returns and hence achieve the. For firm owners, risk management saves on agency costs since, by reducing the variability of returns of their firms, managers are working in line with the shareholder wealth maximization goal. Managerial motivation factors in implementation of corporate risk management have been empirically investigated in a few studies with a negative effect (Faff and Nguyen, 2002; MacCrimmon and Wehrung, 1990; Geczy et al., 1997). Notably, positive evidence was found however by Tufano (1996) in his analysis of the gold mining industry in the US. Financial policy hypotheses were tested in studies of the financial theory, since both theories give similar predictions in this respect. However, the bulk of empirical evidence seems to be against agency theory hypotheses. Agency theory provides strong support for risk management as a response to mismatch between managerial incentives and shareholder interests. Shareholders and managers have different interests to the firm and risk management objectives vary for the different stakeholders. While shareholders may require high risk – high return investments, management prefer low risk and 1 2 return investments. The agency theory emphasizes the need for risk management to align the interests of mangers and shareholders and to contribute to the financial performance of the firm. Stakeholder Theory Stakeholder theory, developed originally by Freeman (1984) as a managerial instrument, has since evolved into a theory of the firm with high explanatory potential. Stakeholder theory focuses explicitly on equilibrium of stakeholder interests as the main determinant of corporate policy. The most promising contribution to risk management is the extension of implicit contracts theory from employment to other contracts, including sales and financing (Cornell and Shapiro, 1987). In certain industries, particularly high-tech and services, consumer trust in the company being able to continue offering its services in the future can substantially contribute to company value. However, the value of these implicit claims is highly sensitive to expected costs of financial distress and bankruptcy. Since corporate risk management practices lead to a decrease in these expected costs, company value rises (Klimczak, 2005). Therefore stakeholder theory provides a new insight into possible rationale for risk management. However, it has not yet been tested directly. Investigations of financial distress hypothesis (Smith and Stulz, 1995) provide only indirect evidence (Judge, 2006). This theory is useful to risk management research. It helps to address the importance of customer trust and financial distress costs to bank institutions. Finally the theory suggests that smaller firms are more prone to financial problems, which should increase their interest in risk management practices. The stakeholder theory emphasizes the need for risk management in bank institutions and its importance in improving the value of the company. It however does not indicate the influence of risk management on the financial performance and the resulting relationship between the two variables apart from suggesting that risk management leads to growth in company value. Theory of Optimal Capital Structure According to the optimal capital structure theory, there is an optimal, finite debt equity ratio, resulting from a trade-off between the expected value of bankruptcy costs and the tax savings associated with the deductibility of interest payments (Kim, 1976). Bankruptcy occurs when the fixed obligations to creditors cannot be met. There are direct and indirect costs related to bankruptcy. Direct costs include legal, accounting and trustee fees as well as the possible denial of income tax carryovers and carrybacks. Indirect costs relate to opportunity costs resulting from disruptions firm-supplier relationships that are associated with the transfer of ownership or control (Barker, 1976). Warner (1977) and Weiss (1990) give evidence of financial distress and state underline the significance of bankruptcy costs to a business. Allen and Santomero (1996) suggest that the cost of bankruptcy is more important in regulated industries where large losses may lead to license or charter withdrawal and the loss of a monopoly position. This theory offers a significant rationale as to why firms would be engaged in risk management. Stulz (1996) provides further evidence by suggesting that the expected present value of bankruptcy costs will be reflected in a firm’s current market value if shareholders view bankruptcy as a real possibility. He further states that a risk management program that costlessly eliminates the risk of bankruptcy effectively reduces such costs to zero, thereby increasing the value of the firm. Bankruptcy costs are significant to insurance business in Kenya. Once a company is not able to pay customer claims, the regulator declares it bankrupt and puts it under receivership. Recently, Blue Shield Insurance and Concord Insurance were put under receivership due to failure to meet the customer claims (KTN, 2014). This indicates that bankruptcy costs should be considered in the risk management of bank institutions. However, Standard and Poor’s (2013) observe that unlike corporate failures caused by the incomplete or untimely payment on all or some financial obligations, including debt restructurings, an bank institutions failure most often becomes apparent when the regulator takes action because the debtor's financial position has become untenable. They further contend that nonpayment of a debt obligation do not generally prompt a default. Anyway, debtors tend to have low debt burdens, but high policy obligation s. 2.2.2 INSURANCE SERVICES OFFERED BY BANKS IN KISII TO INDIVIDUAL AND BUSINESS ENTERPRISE The insurance offer the following services to business enterprise in Kenya I)Work injury benefit act - if the employee in the business are injured accidentally while working the la state the employee should be compensated covers against him/her against this liability II)Fire and peril insurance - the insurance covers physical assets like the premises of the business e.g offices and warehouse, the vehicles ,equipment and the furniture and fittings .covers damages caused by fire and floods, earthquakes e.t.c III)Consequential loss -covers business from loss of profit due to business interruption as a result of causes under the fire and peril policy IVBurglary insurance -when business location under threat robbery burglary the policy will compensate for losses or damage to property contained in the business premises due to act or attempt of burglary or robbery 2.2.3 ROLES OF BANK INSTITUTIONS IN KISII Regulation of Monetary Supply Banking Services Insurance Services Capital Formation Investment Advice Brokerage services Pension Fund Services Trust Fund Services Financing the Small and Medium Scale Enterprises Act as A Government Agent for Economic Growth 2.2.4 OVERCOMING CHALLENGES FACING THE BANK INSTITUTIONS IN KISII ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● Sufficient knowledge on regulations procedures Adequate Staff to regulate microfinance institution The Institutions should be free of Politics Proper Information Dissemination Qualified Staffs for both Institutions (MFIs & FR) Effective and efficient government policies There should be a vibrant regulatory framework Dealing with Triggers and Changes Effective Coordination the Supervision of the institutions Financial Stability Proper loan monitoring & Management Government and Donor Support Control of Interest Rate Dealing with Corruption, Fraud, and Mismanage CHAPTER THREE RESEARCH METHODOLOGY 3.1 Introduction This chapter describes the research methods and procedures used in conducting the study. It outlines the research design, population of the study and sampling design, data collection and data analysis. 3.2 Research Design Mugenda & Mugenda (2003) describe a research design as the plan or structure of investigation conceived to obtain answers to research questions that includes an outline of the research work to enable the representation of results in a form understandable by all. A descriptive research design was adopted for this study. Descriptive research enables the researcher to describe the existing relationship by using observation and interpretation methods. It provides the researcher with the appropriate methodology to illustrate characteristics of the variables under study. Causal research determines causal linkages between study variables by studying existing phenomena and then reviewing available data so as to try to identify workable causal relationships. 3.3 Population of the Study A population is the aggregate of all elements that conform to some general set of specifications (Paton, 2002). The study adopted a census survey of all the 5 registered bank institutions operating in kisii, Kenya . A census approach enables one to collect more accurate and reliable data. The observable characteristics of the target population should be strongly related to the characteristics intended to be generalized by the study (Mugenda & Mugenda, 2003). 3.4 Data Collection Both primary and secondary data was used in this study. Primary data was collected through the use of questionnaires. Questionnaires were picked and dropped to the risk managers in the Bank institutions. Questionnaires were structured to collect both qualitative and quantitative data. Questionnaires are also a common tool for data collection in social sciences. Secondary data was collected from secondary data sources like Bank survey reports from CBK and the audited financial statements of all Bank institutions as presented. Secondary data for the period 2008 to 2012 was used in this study. 3.4 Data Analysis This research employed descriptive statistics to analyse the data. It is argued (Mugenda & Mugenda, 2003) that descriptive statistics enable the researcher to get meaningful description of scores and measurements for the study through the uses of few indices or statistics. The data obtained from the questionnaires was edited and then coded for the purposes of data analysis. It was further summarized using descriptive statistics which usually include measure of central tendency, measures of variability, and measures of reliability and frequency among others. Measures of central tendency such as the mean, median and the mode state the best estimate of the expected score or measure from a group of scores in a group of scores in a study. The Statistical Package for Social Sciences (SPSS) was used to analyse the independent and dependent variables. The findings are presented in the form of charts, tables and pie charts in chapter 4. 3.5 The Analytical Model The goal of the study was to describe the relationship between risk management and financial performance among Bank institutions in kisii,Kenya. The study used a regression model to determine the existing relationship. The following regression model was used for the study: Y=β0 + β1X1 + β2X2 + β3 X3+ β4X4+ ε Where: Y = Financial Performance (Measured using ROA) X1 = Risk identification (Measured using inspection, Financial statements analysis, establishing standards and risk rating and collateral. X2 = Risk assessment (Measured using approximations & projections) X3 = Risk mitigation (Risk control and risk financing measures) X4 = Risk management implementation and monitoring (Controls, responses, reporting & review) ε = the error term The values of X1, X2, X3&X4 were computed from the mean score of the responses on each Likert scaled data for each insurance company (either life, general or composite). The mean 35 score was obtained for the respective variables for each insurance company, and values used for the regression analysis. The Y value is an average for the 5 year period, 2008-2012. 3.6 Diagnostic Tests F-test was tested for joint significance of all coefficients and t-test for significance of individual coefficients. Measures of central tendency (mean) and a measure of dispersion/variation (standard deviation) was used to analyse the data Name: Description: ...
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