Liquidity Risk Compliance Levels and Technical Efficiency of Commercial Banks in Kenya: Application of Non-Parametric Data Envelopment Analysis Model

Abstract This paper analyzed the relationship between liquidity risk compliance levels and technical efficiency of commercial banks in Kenya. The study adopted quantitative research design for a period of ten year ranging from 2013 to 2022. The population of the study was 37 licensed commercial banks, which produced a balanced panel of 370 firm-year observations. Data Envelopment Analysis (DEA) was used to estimate technical efficiency scores. The impact of liquidity risk compliance levels, bank size, and the relationship between liquidity risk compliance levels and bank size on technical efficiency was estimated using a two-limit Tobit regression model estimated with the Maximum Likelihood Estimation (MLE) technique. The study findings indicate that there is a positive and statistically significant correlation between liquidity risk compliance levels and technical efficiency, which implies that banks that are more compliant with liquidity risk prudential requirements are more efficient. This implies that effective liquidity management improves operational discipline, increases resource allocation, and promotes more efficient banking operations. Bank size positively and statistically significantly influence the technical efficiency, which means that bigger banks have economies of scale and are more capable of absorbing liquidity shocks. Moreover, the interaction effect of liquidity risk compliance levels and bank size is positive and significant, which proves that bank size mediates the relationship between liquidity risk compliance levels and technical efficiency. In particular, bigger banks can more easily utilize liquidity buffers without efficiency loss. The study recommends that commercial banks in Kenya should intensify liquidity risk management procedures and ensure compliance to prudential liquidity standards as a way of improving technical efficiency. Regulators and policymakers are urged to implement proportionate liquidity risk frameworks to consider differences in bank sizes to facilitate effective and efficiency-enhancing supervision. It is suggested that future studies should build on the analysis by including other institutional variables like risk culture, corporate governance, and technological adoption to elaborate on the differences in technical efficiency among commercial banks in Kenya.