Asset Quality and Financial Stability: An Empirical Review of Commercial Banks in Kenya


  • Joseph Kimemia Kuria Catholic University of East Africa
  • Anne Kiboi Catholic University of East Africa
  • Joseph Macheru Catholic University of East Africa



Asset quality, financial stability, capital adequacy, credit risk and commercial banks


The purpose of this paper is to evaluate the role of asset quality on the financial stability of commercial banks in Kenya. The study employed an unbalanced panel dataset comprising 43 commercial banks in Kenya spanning the period from 2000 to 2021, resulting in 789 bank-year observations. Asset quality was assessed using non-performing loans (NPLs), while financial stability was measured using Z-scores. Utilizing panel data estimation methods, the findings indicate a negative relationship between asset quality and financial stability, emphasizing that an increase in NPLs leads to a decrease in financial stability within the banking sector. The findings are consistent even after using different measures of financial stability i.e., Risk adjusted return on assets (RAROA) and Risk adjusted return on equity (RAROE). Moreover, capital adequacy which is employed as a control variable, reveal that improving capital adequacy can provide the commercial banks with the required stability to absorb losses and improve the ability to encounter unexpected financial shocks. The research results provide important policy implications for regulators, bank managers and policy makers on the better methods of customer screening to reduce the level of non-performing loans and prudent management of credit risk.

Author Biographies

Joseph Kimemia Kuria, Catholic University of East Africa

Student, Catholic University of East Africa

Anne Kiboi, Catholic University of East Africa

Lecturer, Catholic University of East Africa

Joseph Macheru, Catholic University of East Africa

Lecturer, Catholic University of East Africa


Adamako, S., Danso, A., & Damoah, J. O. (2016). The Moderating Influence of Financial Literacy on the Relationship between Access to Finance and Firm Growth in Ghana. An International Journal of Entrepreneurial Finance.

Adem, M. (2023). Impact of Income Diversification on Bank Stability: A Cross-Country Analysis. Asian Journal of Accounting Research, 8(2), 133-144.

Aghion, P., Bolton, P., & Dewatripont, M. (2000). Contagious Bank Failures in a Free Banking System. European Economic Review, 44(4), 713-718.

Al-Malkawi, H., & Pillai, R. (2018). Analyzing Financial Performance by Integrating Conventional Governance Mechanisms into the GCC Islamic Banking Framework. Journal of Managerial Finance, 44(5), 604-623.

Alshatti, A. S. (2015). The Effect of Credit Risk Management on Financial Performance of the Jordanian Commercial Banks. Journal of Investment Management and Financial Innovations, 12(1), 338-345.

Barra, C., & Zotti, R. (2020). Market Power and Stability of Financial Institutions: Evidence from the Italian Banking Sector. Journal of Financial Regulation and Compliance, 28(2), 235-265.

Barth, J. R., Caprio, G., & Levine, R. (2013). Bank Regulation and Supervision in 180 Countries from 1999 to 2011. Journal of Financial Economic Policy, 111-219.

Barus, J., Muturi, W., Kibati, P., & Koima, J. (2017). Effect of Capital Adequacy on the Financial Performance of Savings and Credit Societies in Kenya. American Journal of Finance, 1(4).

Bhattacharya, S., & Fulghieri, P. (1994). Uncertain Liquidity and Interbank Contracting. Economics Letters, 44(3), 287-294.

Bloomberg, L. D. (2019). Completing your Qualitative Dissertation (4 ed.). United States of America: SAGE Publication Inc.

Boachie, R., Aawaar, G., & Domehar, D. (2021). Relationship between Financial Inclusion, Banking Stability and Economic Growth: A Dynamic Panel Approach. Journal of Econmic and Administrative Sciences.

Calomiris, C., & Gorton, G. (1991). The Origins of Banking Panics: Models, Facts and Bank Regulation. National Bureau of Economic Research, 109-174.

Chari, V., & Jagannathan, R. (1988). Banking Panics, Information and Rational Expectations Equilibrium. The Journal of Finance, 43(3), 749-761.

Chen, L., Danbolt, J., & Holland, J. (2014). Rethinking Bank Business Models: The Role of Intangibles. Accounting, Auditing and Accountability Journal, 27(3), 563-589.

Chi, Q., & Li, W. (2017). Economic Policy, Uncertainty, Credit Risk and Banks' Lending Decisions: Evidence from Chinese Commercial Banks. China Journal of Accounting Research, 10, 33-50.

Diamond, D. W., & Dybvig, P. H. (1983). Bank Runs, Deposit Insurance and Liquidity. Journal of Political Economy, 91(3).

Elbadry, A. (2018). Bank's Financial Stability and Risk Management. Journal of Islamic Accounting and Business Research, 9(2), 119-137.

Elhajjar, S. (2020). Examining Lebanese Consumers' Negative Attitudes Toward Banks. International Journal of Bank Marketing, 38(7), 1511-1528.

Elliott, D. J. (2014). Report on Bank Liquidity Requirements: An Introduction and Overview.

Epstein, G. (2019). The Asset Management Industry in the United States. Financing for Development.

Epure, M., & Lafuente, E. (2015). Monitoring Bank Performance in the Presence of Risk. Journal of Productivity Analysis, 44(3), 265-281.

Ghosh, A. (2017). Impact of Non-performing Loans on US Product and Labour Markets. Journal of Financial Economic Policy, 9(3), 302-323.

Gueyie, J., Guidara, A., & Lai, V. (2019). Banks' Non-Traditional Activities Under Regulatory Changes: Impact on Risk, Performance and Capital Adequacy. Journal of Applied Economics, 51(29), 3184-3197.

Harkati, R., Alhabshi, S. M., & Kassim, S. (2020). Does Capital Adequacy Ratio Influence Risk-Taking Behaviour of Conventional and Islamic Banks Differently? Empirical Evidence from Dual Banking System of Malaysia. Journal of Islamic Accounting and Business Research, 11(10), 1989-2015.

Kamel, M. A., Mousa, M. E.-S., & Hamdy, R. M. (2021). Financial Efficiency of Commercial Banks Listed in Egyptian Stock Exchange using Data Envelopment Analysis. International Journal of Productivity and Performance Management.

Khan, M. A., Siddique, A., & Sarwar, Z. (2020). Determinants of Non-performing Loans in the Banking Sector in Developing State. Asian Journal of Accounting Research, 5(1), 135-145.

Kim, T., Koo, B., & Park, M. (2013). Role of Financial Regulation and Innovation in the Financial Crisis. Journal of Financial Stability, 9(4), 662-672.

Klein, A., Schardin, J., & Baily, M. N. (2017). The Impact of the Dodd-Frank Act on Financial Stability and Economic Growth. Journal of the Social Sciences.

Masud, A. K., & Haq, M. (2016). Financial Soundness Measurement and Trend Analysis of Commercial Banks in Bangladesh: An Observation of Selected Banks. European Journal of Business and Social Sciences, 4(10), 159-184.

Mateev, M., & Bachvarov, P. (2019). Risk Exposure, Liquidity and Bank Performance: New Evidence from the Recent Financial Crisis of 2007-2008. Journal of Creative Business and Social Innovations for a Sustainable Future, 219-244.

Menicucci, E., & Paolucci, G. (2016). The Determinants of Bank Profitability: Empirical Evidence from European Banking Sector. Journal of Financial Reporting and Accounting, 14(1), 86-115.

Moudud-Ul-Huq, S., Ahmed, K., Chowdhury, M. A., Sohail, H. M., Biswas, T., & Abbas, F. (2021). How do Banks' Capital Regulation and Risk-Taking Respond to Covid-19? Empirical Insights of Ownership Structure. International Journal of Islamic and Middle Eastern Finance and Management .

Nguyen, L.-T., & Dinh, H. (2021). Ex-ante Risk Management and Financial Stability during the Covid-19 Pandemic: A Study of Vietnamese Firms. China Finance Review International, 11(3), 349-371.

Odundo, O. G., & Orwaru, M. J. (2018). Bank Size and Financial Stability of Commercial Banks in Kenya: Empirical Evidence. Journal of Emerging Issues in Economics, Finance and Banking, 7(1).

Ozili, P. (2017). Bank Profitability and Capital Regulation: Evidence from Listed and Non-listed Banks in Africa. Journal of African Business, 18(2).

Patton, M. Q. (2015). Qualitative Research and Evaluation Methods (4 ed.). United States of America: SAGE Publication Inc.

Riahi, Y. (2020). Examining the Relationship Between Bank Stability and Earning Quality in Islamic and Conventional Banks. International Journal of Islamic and Middle Eastern Finance and Management, 13(5), 803-826.

Saif-Alyousfi, Asish, S., & Rohani, M.-R. (2020). The Impact of Bank Competition and Concentration on Bank Risk Taking Behaviour and Stability: Evidence from GCC Countries. Journal of Economics and Finance, 51.

Salina, A., Zhang, X., & Hassan, O. (2021). An Assessment of the Financial Soundness of the Kazakh Banks. Asian Journal of Accounting Research, 6(1), 23-37.

Sarkar, J., & Sarkar, S. (2018). Bank Ownership, Board Characteristics and Performance: Evidence from Commercial Banks in India. International Journal of Financial Studies, 16(17).

Sarwar, B., Muhammad, N., & Azhar, U. (2021). Financial Stability and Competitiveness of Commercial Banks in Pakistan: An Emprirical Analysis. Journal of Managerial Sciences.

Sood, H. A., & Ansary, O. E. (2017). Asset-Liability Management in Islamic Banks: Evidence from Emerging Markets. Pacific Accounting Review, 29(1), 55-78.

Trad, N., Trabelsi, M. A., & Goux, J. F. (2017). Risk and Profitability of Islamic Banks: A Religious Deception or an Alternative Solution? Journal of European Research on Management and Business Economics, 23(1), 40-45.

Yildirim, H. H., & Ildokuz, B. (2020). Relationship between CAMELS Variables and Profitability: An Application on Banks in the BIST Bank Index. Issues in Business, Economics and Finance, 104, 85-103.




How to Cite

Kuria, J. K., Kiboi, A., & Macheru, J. (2024). Asset Quality and Financial Stability: An Empirical Review of Commercial Banks in Kenya. Journal of Finance and Accounting, 8(3), 22–38.