Impact of prudential regulatory framework on financial performance of deposit taking SACCOs in Kenya

Regulation of the financial sector is critical aspect of consideration by the regulating authority. This is because the financial sector tremendously influences the performance of the entire economy. The study aims at determining the impact of a prudential regulatory framework on the financial performance of SACCOs in Kenya. The specific objectives in this case are; to determine the relationship between liquidity requirements and performance of deposit taking SACCOs in Kenya, to establish the relationship between capital requirements and performance of deposit taking SACCOs in Kenya, to investigate the relationship between loan provisioning requirements and performance of deposit taking SACCOs in Kenya, and to evaluate the relationship between minimum investment requirements and performance of deposit taking SACCOs in Kenya. The study reviewed literature under theoretical and empirical review. The theoretical review focused on portfolio theory, agency theory and stakeholder theory. The empirical review was done in line with the study objectives. The empirical review focused on past studies that have done in relation to the individual study variables. These reviews facilitated in creating an understanding of the available literature as well as in helping identify the existing research gap. The study adopted a descriptive survey design in addressing the research problem. The study was based in Kenya focusing on deposit taking SACCOs in the country. The population of the study was comprised of these deposit taking SACCOs in Kenya which are 181 in number. Since the study population was not significantly immense, all the elements in the population were used in the data collection exercise thus eliminating the need for sampling. The study used secondary data that was analyzed using quantitative data analysis techniques. The analyzed data was presented in figures, tables, and detailed discussions made. A regression model was also developed to test the relationship of the independent variable with the dependent variables. For the dependent variable return on investment was used to represent financial performance of deposit taking SACCOs in Kenya. On the other hand, prudential regulatory framework formed the independent variables which were specified as capital requirement, investment requirement, loan provisioning requirement, and liquidity requirement. An empirical analysis was thus done to determine how the four independent variables affected return on investment. Moreover, correlations and analysis of variance were done on the study variables and on the model as whole to determine the level of significance of each in the model. The study model was found to be significant in explaining the relationship between the independent variable and return on investment. The study found that the application of prudential regulatory requirement was even among all the SACCOs in Kenya. The study further found the implication of loan provisioning requirement was highest in influencing financial performance of SACCOs in Kenya. The four independent variables were found to have a positive relationship with return on investment. Liquidity were requirement was however found to have the least impact on financial performance on Deposit Taking SACCOs in Kenya holding the other variables constant. The study further recommended that SACCOs can re-evaluate their approach towards issuance of loans mainly because the level of non-performing loans was seen to be relatively higher that the prevailing levels on interest. CHAPTER ONE INTRODUCTION 1.1 Background of the study According to the International Cooperative Alliance (ICA 2007), a cooperative is an autonomous association of people brought together on their own volition. The main uniting factor is being able to meet their economic, social, and cultural expectations through jointly owned and democratically controlled enterprise system. Marvin (2006) further found that the said co-operative values and principles have withstood the test of time. They offer the best model for tackling inequality and abject poverty in society. The fundamental principle behind advancement of the co-operative movement lies in the ability to pool scarce resources, remove middlemen and to thus move towards a common goal. Cooperative Societies derive their strength and validation from member’s solidarity, cooperation and concern for the wellbeing of each other (Ministry of Cooperative Development and Marketing, 2007). Savings and credit cooperatives differ from banks and do not operate under the same legislative environment. All SACCOs are a creation of individual’s depositors, borrowers, & owners who join hand to provide financial services. These services are hitherto inaccessible to the same individuals; they are non-profit making institutions and have no external shareholders. This leads to limited ability to raise capital because the regulator does allow them access to capital markets (Marvin, 2206). In Kenya, savings and credit cooperative societies have for a long time been managed under the Co-operative Societies Act Cap 490. According to Nyagah (2010), the cooperative values and principles have withstood the test of times and offer the best model for fighting poverty and inequality in society. There is a universal view that cooperatives are the best mode for guiding socio-economic development in Kenya. Nevertheless, the rapid growth of the savings and credit cooperatives sub-sector created the need for savings and credit cooperative specific legislation hence the enactment of the Sacco Societies Act (2008) to specifically regulate and supervise their operations. The enactment of the Sacco Societies Act (2008), made provisions for licensing, regulation, supervision, promotion of Sacco Societies and establishment the Sacco Societies Regulatory Authority (SASRA). This agency situation brings to light the need for a strong regulatory environment to safeguard member’s deposits and investments (SASRA, 2008). This is the main agenda for this research in Kenya where under the act, SACCOs are required to fully comply capital requirements, liquidity requirements, monitor member borrowings, engage in businesses as prescribed by the authority and conform to financial reporting as per the society (SASRA, 2008). The Act and the regulations cover capital, liquidity, the extent of external borrowing, asset categorization and provisioning, maximum loan size, and insider lending (SASRA, 2008). 1.1.1 Savings and Credit Cooperatives Formal cooperatives in Kenya started taking shape much later when European settlers formed the Lumbwa Cooperative Society in 1908. For about two decades, the society was restricted to the settler population. Africans were only allowed to establish cooperatives after 1930s. The first piece of legislation on cooperatives was the Cooperative Societies Ordinance enacted in 1931. On February 8, 1931, the Kenya Cooperative Creameries (KCC) was the first cooperative to be registered, followed shortly in the same year by the Kenya Farmers Association The Kenya Planters Cooperative Union (KPCU) was registered in 1937 and the Horticultural Cooperative Union (HCU) in 1951. Before this date, however, not only did some authentic cooperatives really exist, some of which are still in existence, but the essential features of co-operative thought were already shaped (Lambert, 1963). According to the Government annual economic survey, as at December 2009 there were more than 2,400 active SACCOs with membership in excess of 1.5 million people in Kenya. Share capital stood at Kshs. 65 billion while outstanding loans were Kshs. 59 billion. The Sacco Societies act of Kenya (2008) terms SACCOs as “Sacco business” and defines it as a financial intermediation and any other activity by a Sacco society based on co-operative principles and in accordance with the act. This is by way of; either receipt of withdraw able deposits, domestic money transfer services, loans, advances and credit facilities; or receipt of non-withdrawable deposits from members and which deposits are not available for withdrawal for the duration of the membership of a member in a Sacco society and may be used as collateral against borrowings and domestic money transfer services. The government through the Ministry regulates the cooperative movement using the Co-operative Societies Act. The rules were enacted in 1966 and later revised in 2004. 1.1. 2 Deposit taking SACCOs According to the Sacco societies act of 2008 a deposit-taking Sacco is defined as business in which the person conducting the business holds himself out as accepting deposits on a day-to-day basis. They can also be described as any other activity of the Sacco business which is financed, wholly or to a material extent, by lending or extending credit for the account and at the risk of the person accepting the deposit, including the provision of short-term loans to members. According to Mudibo (2005), Deposit taking Savings and Credit Co-operatives (SACCOs) have impact on the Kenyan economy in a great way. They contribute 45% of the gross domestic product (GDP) in Kenya (Mudibo, 2005). This is despite the fact that they were not previously incorporated in the formal financial system. This led the government through Sacco Societies Regulatory Authority (SASRA) to make a decision to single out the potential that lies in strong SACCOs. It came with targeted legislation which would usher in regulations and benchmarks in line with the new Sacco environment commonly referred to as SACCOs Societies Act, 2008 (SASRA, 2012). This provided the groundwork for entrenching Sacco Societies Regulatory Authority. Societies Regulatory Authority ushered in prudential regulations to promote and maintain financial soundness of SACCOs (SASRA, 2012). 1.1. 3 Financial Performance According to Piesse and Townsend (1995) members of SACCOs are interested in minimizing the cost of funds for loans while at the same time