| dc.description.abstract | Banks create liquidity which in turn improves capital allocation and accelerates
economic growth. Liquidity creation is essential and critical as it may lead to a stable
financial system and provide growth opportunities. Liquidity has been observed to be
more unstable in developing countries than in developed nations. Despite the rise in
minimum deposits, commercial banks in Kenya, a developing country, struggle to
optimize their profits due to reduced liquidity creation capacity. This study aimed to
evaluate how capital adequacy, income diversification and competition impacted
Kenyan commercial banks' ability to create liquidity. From 2001 to 2020, the study
employed unbalanced panel data from Kenya's 36 licensed commercial banks. Data was
extracted from published financial statements and reports from banks. The two-step
system generalized method of moments approach was used in the study. To increase the
robustness and prevent erroneous conclusions, cross dependence, serial correlation and
instrumental validity tests were carried out. Berger and Bouwman's method was used to
determine the liquidity creation levels of commercial banks. The capital adequacy liquidity creation link of commercial banks was found to be significantly negative,
supporting the financial fragility-crowding out hypothesis. The study found a positive
linkage between income diversification and liquidity creation of commercial banks,
implying that well-diversified banks have a high level of liquidity creation and vice
versa. The study also found a significant negative effect of competition on liquidity
creation, depicting competition's value-destroying effect. A tradeoff exists between
capital adequacy and liquidity creation, which must be carefully evaluated as changes in
capital requirements are considered. Due to this tradeoff, there is a need for an optimal
level of capital. The findings suggest that reinforcement of the diversification drive in
Kenyan commercial banks is necessary. The value-destroying effect on liquidity
creation by competition presented a case for policymakers geared toward consolidating
banks' operations through possible mergers and acquisitions. The study has important
implications for Kenya's financial sector, as it guides managers and other stakeholders
regarding measures that can be taken to increase commercial banks' liquidity creation
through capital requirements, diversification, and consolidation of banks | en_US |
