FACTORS THAT LED THE SUCCESS OF RETAIL BANKING IN KENYA. A CASE STUDY OF COMMERCIAL BANKS IN NAKURU TOWN.

BY

CHRIS HUMPHERY RUMENDA C12/60013/08 JOASH SIMIYU WAKOLI C12/60054/08

WINNIE WANJIRU NYANTIKA C12/60051/08

A Management Research Paper submitted in partial fulfilment of the requirements of the award of Bachelor of Commerce (Finance Option), Department of Accounting Finance and Management science.

EGERTON UNIVERSITY

FEBRUARY 2012

CHAPTER ONE INTRODUCTION 1.0 Background to the study In recent years, retail banking has increasingly gained popularity in Kenya due to various changes in the market. Retail banking has been defined as the provision of cluster products and services by banks to consumers and small businesses through branches, the Internet and other channels (Ashcraft, 2005). Retail banking aims to be the one-stop shop for as many financial services as possible on behalf of retail clients. Some retail banks have even made a push into investment services such as wealth management, brokerage accounts, private banking and retirement planning. While some of these ancillary services are outsourced to third parties (often for regulatory reasons), they often intertwine with core retail banking accounts like checking and savings to allow for easier transfers and maintenance (Llewellyn,1992). This is as opposed to corporate banking, which consists of different banking services to large companies, governments or other big institutions. Within the financial services industry, banking is the largest sector including a wide range of activities. There are various forms of banking namely corporate, commercial, retail banking and investment banking therefore banks can offer more than one form of banking. Banking industry in Kenya is divided into three categories i.e. banks, micro-finance institutions, Foreign exchange bureaus and Non-banks financial institutions. The banking industry in Kenya is governed by the companies act, the banking act and the central bank of Kenya act. The Central Bank of Kenya under the docket of Ministry of Finance is responsible for formulating and implementing monetary policy .It also formulates and implements foreign exchange policies. Key among the functions of the central bank is to license and supervise players in the money market. Banks have come together under the Kenyas Bankers Association which serves as a lobby for the banking sectors interests. The KBA serves a forum to address issues affecting members (Banking Act 2009). There are forty-six bank and non-bank financial institutions, fifteen micro-finance institutions and forty-eight foreign exchange bureaus. Thirty-five of the banks, most of which are small to medium sized, are locally owned. A few large banks most of which are foreign-owned, though some are partially locally owned, dominate the industry. Six of the major banks are listed on the Nairobi Stock Exchange (PWC report, 2007). Commercial banks dominate this industry offering a full range of services for individuals and businesses from safeguarding money and valuables to the provision of loans, credit, and payment services. In their role as financial

intermediaries, they use the funds they receive from depositors to make loans and provide mortgages to individuals and businesses. Commercial banks are, in other words, intermediaries operating between the agents who provide the capital, the investors, and those who use it, the borrowers (Sahal, 1981). The commercial banks and non-banking financial institutions in Kenya offer corporate and retail banking services but a small number, mainly comprising the larger banks, offer other services including investment banking (PWC report, 2007). Retail banks exist to service the financial needs of business and society. The deregulation of financial services markets in the 1980s, and in particular the growing focus of both consumers and producers on quality, has created a process of structural change in the banking industry. Retail banking is a commodity service and the effects of these changes are therefore experienced by most of the population. (Llewellyn, 1992). Indeed, by the late 1990s, the mainstream banks started restructuring their services towards wealthier people, and savings services became wealthier people, and savings services became sufficiently expensive that even middle-income people sought cheaper alternatives. From the year 2002 there has been renewed interest from the banks in reaching the mass of middleincome salaried individuals such as teachers and civil servants and this market segment is quite competitive (Johnson, 2004). In the last four years there has been increased competition from new entrants into the banking industry, forcing banks to cut costs and improve efficiency through automation and price rationalization (Paulson and McAndrews, 1998). While the banks have been forced to cut costs and improve efficiency, there is increasing internal and political pressure on banks to expand their products and services to the unbanked and under-banked.(Bitner, et al 2000). Due to the competitiveness of the banking industry many banks which were doing corporate banking changed to partially or completely to retail banking. This is evident from a lot of advertisements made by banks using various forms and also by use of sales people, who have tried to convince many individuals to open accounts (Banking supervision Annual Report, 2005). Banks which have actually incorporated retail banking in Kenya are CFC, Standard chartered, Barclays, National bank of Kenya, Kenya Commercial Bank, Consolidated bank, NIC bank, Co-operative bank of Kenya (PWC Report, 2005). Retail banking has been undergoing dramatic operational transformation in the recent years. Mergers and acquisitions, increased competition, and new regulatory requirements have 2

driven banks to rethink their retail strategies. It has become important for retail banks to leverage technology to optimize sales and fulfilment processes, manage distribution channels, and streamline operations to acquire, satisfy, and thereby retain customers. (Chen, 1999).The retail finance sector is currently one of the most competitive in the banking industry. The increasing volume of transactions however called for greater rapidity as well as safety, issues that through the years have posed compelling challenges to the evolution of this sector. However, in order to succeed in such a dynamic market place, Berry (2007) argues that the skills required to be a successful retail banker are many and varied: ability to demonstrate a deep understanding of consumer needs and revenue generating methods, ability to develop new market entry and customer retention strategies, application of new business models and translating them into revenue generating projects and programmes.

Financial institutions that are interested in tapping underserved households need new strategies to segment the large under banked market. The rise in the number of financial institutions that are designing new initiatives to pursue the under banked consumer market illustrates the recent realization of retail banking (Karty and Stewart, 2006). Rapid technological advances have introduced significant changes in retail banking. Bank branches alone are no longer sufficient to provide banking services to cater for the needs of todays sophisticated and demanding customers. Information Technologies have undoubtedly played a major role through the years for they create a link between the economic incentives of banks in investing large portions of their capital to sustain the technological transformation of their activity, and the evolution of the sector through a wide range of dynamics involving organizational changes and demand growth. The provision of banking services through electronic channels (e-channels) namely ATMs, personal computer banking and phone banking have provided an alternative means to acquire banking services more conveniently. (How croft et al, 2002)

Several contributions assessed the significance of changes occurred in retail banking in relation to the modified competitive dimension of this sector (Channon, 1986; Revell, 1985; Stevenson, 1986). The analysis of competition in retail banking has been grounded either on the evaluation of the net balance between interest rates and the amount of deposits/loans or on the expansion of the business at corporate level or at the extension of the geographical coverage (Child & Loveridge, 1990). These parameters, however, often neglect the large scale benefits entailed by new technology resulting, for example, in the creation of an 3

integrated network. The implementation of Information Technologies in banking usually involve the creation of a transaction infrastructure that yields internal changes, together with the creation of new operative procedures, and external ones, such as the expansion of the product line. Moreover, in the attempt to confront the competitive pressures of an increasingly homogenous sector, by virtue of the emergence of a network structure, over the last decade many banks diversified and expanded into new business lines such as credit cards, stock brokerage, investment management services and insurance. This expansion of the retail activity reconfigured the array of existing strategies once aimed at enhancing information processing and later became progressively embedded in the development of a larger variety of processes and products (Frazer, 1985). Conversely, the implementation of technical changes in banking enhanced productivity in both old and new activities and, in particular, stimulated the shift of employed human and capital resources towards the provision of services.

Other changes that have been used by the banks to penetrate into the market are the use of downscaling. Under the concept of downscaling the banks are trying to modify their services to meet the needs of the low- income earners. Low-income markets can be served on a sustainable basis, that is, with full cost recovery and a market return, without subsidy. As a result, in a growing number of countries, the formal financial sector has begun to take notice and to service these traditionally marginalized sectors. (Young et al, 2005). Verga (2009) predicted that by 2012, most banks will be retail and commercial banking institutions serving regional or local markets. Some big banks with strong regional franchises will divest lossmaking divisions and instead focus on their core markets and customer segments. We anticipate that many European players may eventually fall into this category. The handful of global banks likely to be flourishing in 2012 will owe much of their success to having significantly scaled back the complexity of their operations. The challenge will be to become simpler and more specialized.

It is against this back drop that study seeks to determine the factors that have to the success of retail banking in Kenya. In such a perspective, the changing structure of the banking industry emerges as a defining property of the processes of structural transformations involved. To measure the aspect of success, the study will look at the number of individuals with bank accounts as compared to accounts of large companies, parastatals and government.

1.2 Problem statement Retail banking in Kenya in the past years had been severely underdeveloped and marginalized, since the majority of Kenyans live below the poverty line and cannot afford the luxury of an idle Ksh 1000. Banks mainly made their money from corporate clients and huge government deposits. Since many Kenyans were marginalised from retail banking, they had to develop alternative avenues of finance and investments for example co-operatives and welfare organizations (CBK Amendment Act, 2000). In the past three years Kenyan banking sector has progressed towards increasing retail banking and decreasing the corporate banking. This is evident in the efforts banks are putting to attract retail customers through advertisements and sales promotion (Financial standard, 2006). This study therefore intends to find out the extent of successfulness of offering retail banking. To measure the aspect of success, the study will look at the number of individuals with bank accounts as compared to accounts of large companies, parastatals and government 1.3 Objectives of the study i. ii. iii. To identify factors that have led to the success of retail banking. To evaluate the factors that lead to success of retail banking To determine the effect factors on retail banking.

1.4 Importance of the Study. This study will benefit the bank managers since it will identify an opportunity that has not been ventured into by many banks. This opportunity therefore can help them diversify their risks and improve the profitability of their operations. The paper also will help the under banked in the long run. This is because when the banks identify potential opportunity i.e. retail banking they will try to fill in the gap and the underserved market will get an opportunity to use services provided by these banks. Other researchers interested in the problem under this study will also benefit, as their search will lay a platform on which further research on the topic can be undertaken. The study will also contribute to the existing knowledge and provide literature to scholars in the field of retail banking. Future researchers will also have the opportunity to use the finding of this study to further research in this area.

1.5 Research questions The study is carried out to answer the following questions: i. ii. iii. What are the factors that have led to the success of retail banking in Kenya? What extent has the factors contributed to the success of retail banking? To determine the impact factors on retail banking?

1.6 Scope and Justification of Study This study attempts to assess the factors that have led to the success of retail banking in Kenya. The study covers the factors and impacts of these factors to retail banking. It concentrated on commercial banks in Nakuru town. Respondents were selected from among top managers, middle and clerical staff of the banks. The scope of the study was chosen to ensure that all data related to the factors that have led to the success of retail banking are captured. 1.7 Limitations of the study Some of the banks classify most of their information that is necessary for the completion of this work as private and confidential due to certain management policies. The research area is wide as we have to cover most banks to achieve a relevant sample that is representative of most banks in Kenya. The escalating cost of transport due to fuel prices increase and financial impediments which made the cost of carrying out the research to be expensive. Time factor also added to the problems since the duration for the research is limited and a lot of data has to be collected and analysed before the dead line. The research findings of a case study cannot be used to make generalization on the industry. This constrained the scope as well as the depth of the study. In overall the above limitations do not compromise the validity and accuracy of the research.

1.8 Definition of terms and variables Retail banking: Banking in which banking institutions execute transactions directly with consumers, rather than corporations or other banks. Services offered include: savings and transactional accounts, mortgages, personal loans, debit cards, credit cards, and so forth. Cross selling activities: Refers to the practice of providing other services that potential banking clients might find useful in addition to the traditional banking services currently being provided by banks. Liberalization: This is a way to free somebody or something from political, religious, legal or moral restrictions. Liquidity:

CHAPTER TWO LITERATURE REVIEW 2.0 Introduction Literature review will discuss the historical development of retail banking, the extent of retail banking by commercial banks that have opted to expand into retail banking as a new line of business. It will also review the challenges and the future of retail banking. Furthermore the study will show other studies done on this topic by other researchers and finally a detailed conceptual framework that will show how the factors affect the success of retail banking. 2.1 Historical development of retail banking. Basic retail banking services such as deposits for safe keeping, saving, or borrowing for personal or business use is as old as human civilisation. Organised banking services started in 15th and 16 century Europe, when banks began opening branches in commercial areas of large cities. By the last quarter of the 19th century, banks were consolidating their branch networks so that they could operate in a more integrated manner (Consoli, 2003). Mergers and acquisitions allowed banks to grow quickly but, in the absence initially of information and communication technologies, their services remained largely local. The policy of opening new branches continued throughout the twentieth century as a means of business expansion, but services were limited to the provision of routine operations such as deposits, withdrawals and basic loan services. To cope with the increasing volume of work, and to achieve consistency across branch networks, banks started to standardise their record keeping and accounting practices. This also helped them to effectively connect branches. Standard

record keeping also resulted in the appearance of new professions such as bank clerks. The arrival of the typewriter in the late nineteenth century helped to standardise internal/external communications, and other tools such as the telegraph made communications between branches and headquarters a daily routine. After the end of the Second World War, early forms of computers began to find their way into the banking industry, initially to automate routine data processing operations. This later gave way to more organized data processing to make data more accurate and easier to access. More advance database tools enabled the automation of clearing systems and retail money transfer which cleared the way for banks to widen their reach and improve and increase the delivery of financial services (Macesich 2000).

At this stage, these technological developments were often confined to the banks headquarters, while branches continued to operate paper based systems. In the mid 1960s IBM developed a magnetic strip on which data could be stored to be used through plastic cards for electronic reading (Consoli, 2003). Banks were again one of the first users of this technology, beginning with the development of cash machines. Later these became known as Automated Teller Machines (ATMs). ATMs not only provided cash but also showed balances, mini statements and requests for banking stationary such as cheque books. During the 1980s the automation of data processing spread rapidly to branches, and most internal operations were fully automated, making considerable savings for banks. Their benefits to customers however remained very limited. In the late 80s and early 90s the use of computers started spreading to all areas of banking, and intra-bank networks further enhanced and enabled standardization of products and service delivery. This meant that technology itself was ceasing to be a source of competitive advantage, and banks had to differentiate their products and services in order to grow (Boland 2009). The standardization of products, processes and technologies, as well as liberalization of banking regulations, allowed the entry of new financial agents who operated in a diversified manner by offering, at lower prices, services traditionally available exclusively from banks. The use of IT, which drastically reduced entry costs (Consoli, 2003), further accelerated this trend. ATM use grew significantly as functionality improved, and this growth continues to the present day. The arrival of early forms of online banking further revolutionized the banking sector. 2.2 Factors have led to the success of retail banking. Retail banking has been triggered off by a number of factors namely multiple distribution channels, cross-selling services and liberalization of financial sector. 2.2.1. Multiple distribution channels The rapid pace of development in information technology and communications (ICT) has offered a wide range of delivery channels in retail banking. Banking institutions need to exploit opportunities that arise for these developments to bring significant gains to their customers. The successful banking institutions will therefore be those that are able to derive most from information and communications technology development. The winners will be those that are able to harness the capability of ICT in making decisions in terms of business

alignment, work management and better customer relationship. (Central bank of Kenya, 2003)The efforts to optimize distribution channel strategies have led banks to place renewed focus on their branch networks and concentrate on transforming them into centres for high value product sales and advice. A key driver for branch renewal is the imperative for delivering optimum advice to improve cross-sell and up-sell rates and further the aim of becoming providers of integrated financial solutions. In doing so, banks are faced with the challenges of replacing antiquated IT infrastructures in branches and enabling them to deliver sales and advice. Furthermore, banks will have to transform traditional teller roles in branches into seller and customer relationship manager roles either by replacing or training existing staff. (McDonald, 2003) In the last five years, many financial institutions in Europe have implemented advanced technological platforms, introducing a number of interactive marketing channels: e- banking, Internet banking, mobile banking and ATMs. The research has shown that sustainable profitability in the banking sector depends on mastering the skills of managing and integrating customer relationships across multi channels, by using advanced data and communication technologies (Kirby, 2001; Yulinsky, 2000).

An important factor in the introduction of additional banking channels was the progress of information technology applications, especially Internet and mobile communication (Hadidi, 2003; Isarescu, 2001). The increased informatization of society has determined a transition toward an e-payments economy, in which money is perceived as information stored or transmitted through various communication channels (Pastore, 2001).

In time, the search for greater convenience makes customers access various channels, depending on personal needs and circumstances. These multichannel customers expect and request a similar level of service from every delivery channel. On the other hand, the necessity to improve customer loyalty through personalized customer relationship management determines the financial institutions to introduce a unique platform technology, integrating the information flows from all existing channels (Martz, 2003). The banks are therefore adopting a multichannel approach, which is characteristic for a fully informatized economy in which information has become the primary strategic asset for building and maintaining competitive advantage.

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CHANNELS OF RETAIL BANKING

PHYSICAL CHANNELS

VIRTUAL CHANNELS

SELF SERVICE CHANNEL

EMPLOYEE SERVICE CHANNEL

SELF SERVICE CHANNEL

EMPLOYEE SERVICE CHANNEL

AUTOMATIC TELLER MACHINE ATM

INTERNET CALL CENTRE BRANCH TELLER SMS BANKING

AUTOMATIC CLEARANCE HOUSE

VOICE RESPONSE UNIT(VRU)

Fig 1.0 Multiple Distribution channels.

According to rational channel planning models (e.g. Stern and Sturdivant, 1987; Stern et al.,1996), retail banks should identify profitable customer segments attracted to branch banking, telephone banking, PC banking and Internet banking or combinations thereof. Based on this knowledge, they have to decide which distribution channels they want to offer their present and future customers. Hence, they have to predict both the consumer acceptance of these distribution channels and the dominating distribution channel strategies of their competitors. In nearly all banks in the United States, internet banking usage enjoys strong growth rates. Nordic countries are most advanced, whereas Southern European countries seem to be lagging behind. Currently, the internet is most attractive for the distribution of standardized products whereas more complex products are almost exclusively distributed via branches. However, this is likely to change as more and more customers become familiar and equipped with modern and cheap telecommunication and internet services. At the same time, the currently limited supply of cross-border online banking services (especially those offered by specialist providers such as internet banks) is another major factor restraining market development (Meuter, 2000).

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2.2.2 Availability of Cross-selling services Cross-selling services refers to the practice of providing other services that potential banking clients might find useful in addition to the traditional banking services currently being provided by banks. Cross-selling services can be useful marketing tools for banks to reach segments of the population that do not yet use traditional banking services (Deborah and Young, 2005). According to Vogel (2005) the following are examples of services that could be provided are: Money orders, consumer lending, overdrafts account, mortgages, affordable alternatives to payday loans, consumer lending and mutual funds Free tax preparation assistance to low-income individuals In fast growing markets, such as the Central European countries, banks still compete to gain significant market share which lets them create a customer base for further cross selling initiatives and thus enhance revenues

Although loans and deposits are the primary products, retail banking units provide a range of other financial services to consumers and small businesses. For individual consumers, these services include sales of investment products (such as mutual funds and annuities), insurance brokerage, and financial and retirement planning. For small businesses, they include merchant and payments services, cash handling, insurance brokerage, and payroll and employee benefits services. (McDonald, 2003). Retail banks can reach a large number of the currently unbanked by providing services that commonly are used by that segment of the population. Such access allows individuals to avoid the high cost of fringe financial services, such as check cashing and payday loans - ultimately benefiting the whole community when those savings are reinvested in families and communities (Harper 2005). Banks view retail banking as a strong opportunity for cross-selling products depending on a banks overall strategy; it may enter traditionally marginal markets with one or many products. For example, banks may be mobilizing deposits and accepting utility payments from individuals with low income, but may not have considered lending to customers at a lower rate.(Drake et al,2005) Although loans and deposits are the primary products, retailbanking units provide a range of other financial services to consumers and small businesses. For individual consumers, these services include sales of investment products (such as mutual funds and annuities), insurance brokerage, and financial and retirement planning. For small businesses, they include merchant and payments services, cash handling,

insurance brokerage, and payroll and employee benefits services. (Dick, 2006)

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In addition to new product development, banks find opportunities to cross-sell existing financial services. Loan proceeds are typically disbursed into savings accounts that clients also use to make their payments, leaving a residual balance that may grow over time. (Kasey 2003). Depending upon the laws and regulations, to which a particular bank is subject, banks can offer services that potential clients might find appealing. These services might include income tax preparation, low or no fee checking/savings accounts, lower fee money transmission and check cashing services and convenient money deposits into foreign bank accounts. Experience has shown that the strategy of cross-selling is a highly effective means of reaching unbanked communities (Jennifer et al, 2003). Many banks in Kenya are putting in more efforts by trying to differentiate their product and service to suit and innovating more. This study therefore will found out whether this strategy of offering several services and is fruitful especially to retail banker. 2.2.3 Liberalization of financial markets. Competition is growing in retail banking, however, as new banks enter the market under banking laws that allow more freedom of entry and a less repressed regulatory environment. The struggle to survive is forcing many of these banks to look at new markets, and the deregulation of financial markets is creating an environment in which these opportunities can now be explored for the first time (Churchill and Berenbach, 1997). With the advent of structural adjustment and financial liberalization in the 1980s, banking industry expanded rapidly in the Western economies thus all interest rates had been deregulated, creating the opportunity to freely charge the higher, more realistic interest rates required for lending to individuals with low income at a below market rate. (Almeyda and Gloria, 1996). Studies also show that the change of the political regime in Romania, in December 1989, oriented the national policy toward the development of a freemarket economy. The creation of a complex financial and banking sector has represented an important priority in this context. Before 1990, the Romanian banking system was limited to a handful of banks that managed the financial operations of state enterprises, and by the national savings banks that were servicing the needs of the population. After the fall of the communist regime, the country attempted to open its structures toward the world and to adopt the models used in industrialized countries (McNamara, 2003). Policy makers are increasingly concerned by the relative lack of retail banking in Europe. For many, the long-term success of the Single Market depends on bringing the benefits of economic liberalization in a

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tangible form to consumers and the public at large (McDonald,2003). Liberalization and deregulation of the Greek banking industry, mainly of their tail sector, has intensified competition, which is particularly noticeable in the area of banking charges (Gortsos , 1992). In developing countries like Kenya liberalization has not been achieved and thus some initiatives to enhance access to financial services. These initiatives include promoting marketing discipline through targeted communication of lending rates, fees and charges. This initiative is expected to result in increased competition in the banking sector with attendant lowered costs and easily enter into retail segments by pricing their product at considerable price to their customers (Ahmad and Buttle, 2002). 2.2.4 Changing consumer needs The final, and perhaps the most important, force of change in the banking industry is the rapid evolution of consumer wants and desires. Lake and Hickey (2001) Consumers are demanding anytime-anywhere delivery of financial services along with an increased variety in deposit and investment products. Choice of demand deposit accounts with a desired fee structure, the advent of new investment vehicles such as index funds, etc. All fuel the banking customers desire for new and better financial products. In addition, consumers are moving away from the use of checks to other financial products, albeit slowly. Consumers are also demanding variety of delivery channels available for their use. Consumers are demanding and receiving a larger variety of traditional and new banking products and delivery systems. The question, however, is how banks capture the value generated by this increase in variety. At present, one only need to look at the controversy surrounding ATM fees to understand that this increase in variety may be detrimental to a banks profitability (Gronroos, 2001)

Over decades, banks have invested heavily in ATM machines due to their cost advantage on a Per-transaction basis. As one can see, the traditional teller transaction is almost an order of magnitude more expensive than ATM and automated phone systems. This has led banks to attempt to change consumer behaviour through the additional of fees. However, despite these efforts, the total cost of serving certain customer segments has not changed significantly due to their resulting change in transaction behaviour. It is this change in behaviour that will most likely yield the greatest benefit to the banks in terms of cost reduction. Thus, banks must continue to innovate in order to meet the changing needs and desires of the consumer, while at the same time developing new fee structures to migrate consumers away from high-cost 14

delivery systems. This blend of innovation and behaviour change lies at the heart of the modern banking organization (Bauer et al., 2005; Lee and Lin, 2005; Parasuraman et al., 2005).

2.3 Theoretical literature review. 2.3.1 Monetary circuit theory It holds that money is created endogenously by the banking sector, rather than exogenously by central bank lending; it is a theory of endogenous money. It is also called circuitism and the circulation approach. Circuitism is easily understood in terms of familiar bank accounts and debit card or credit card transactions: bank deposits are just an entry in a bank account book (not specie bills and coins), and a purchase subtracts money from the buyer's account with the bank, and adds it to the seller's account with the bank (Keen 2007). Credit money is created by a loan being extended. Crucially, this loan need not (in principle) be backed by any central bank money: the money is created from the promise (credit) embodied in the loan, not from the lending or relending of central bank money: credit is prior to reserves. When the loan is repaid, with interest, the credit money of the loan is destroyed, but reserves (equal to the interest) are created the profit from the loan. In practice, commercial banks extend lines of credit to companies a promise to make a loan. This promise is not considered money for regulatory purposes, and banks need not hold reserves against it, but when the line is tapped (and a loan extended), then bona fide credit money is created, and reserves must be found to match it. In this case, credit money precedes reserves. In other words making loans pulls reserves in (assuming that the regulatory need for bank reserves exists), instead of reserves being pushed out as loans which is assumed by the mainstream model. 2.3.2 Commercial loan theory It originated in the 18th century in England by Adam Smith. It is also called the real bill theory. According to this theory banks should provide short term self liquidating loans to borrowers for meeting their working capital requirements. The logic behind this theory is that commercial banks deposit are demand liabilities and should therefore be committed in self liquidating obligations (Kubasu 2011).This enables banks reduce the chances of default risk. In practice this theory can be used to justify the existence of retail banking. Commercial

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banks used to provide loans to cooperatives amounting to huge sums and had to be paid over a long period of time. With the introduction of retail banking banks offer small loans to individuals and are paid back after a short time (Dawson 2005). 2.4 The extent of successfulness of retail banking in Kenya Many studies have been carried out in other countries to explain the successfulness of retail banking. Stewart (2006) argues that over time retailing and retail banking have developed side by side, albeit far from independently. There are several intersection points. The most important ones are cantered round the point of sale (POS) and the customer payments of purchased goods. Holmberg and Suslin (2001) argues that at the time of the deregulation of the financial market in the mid of the 1980s there was a clear-cut borderline between retailing and banking. Retail banking was developed by investors who perceived opportunities to exploit gaps in financial markets. Foreign and government owned banks were generally conservative in their lending policies; they concentrated only on the multinational corporations (MNCs) and other large corporate customers (Harvey, 1993). In recent years, retail banking has become a key area of strategic emphasis in the U.S. banking industry, as evidenced by rising trends in retail loan and deposit shares on commercial bank balance sheets and a continuing increase in the number of bank branches (American banker, 2005) Retail banking is a relatively a new market opportunity for many banks in developing countries like Kenya. Interest in the social, economic and business potential of low-income market segments has grown and financial products have been created to meet their needs. These financial services include loans for business and personal use, savings and other deposit products, remittances and transfers, payment services, insurance, and potentially any financial product or service a bank can offer to this market segment. The market segments include low-income salaried employees, day labourers, pensioners, and poor households, which have historically been un-served or underserved by banks. The products and services can be targeted to meet the financial needs of the households as well as their income generating activities. (Drake et al, 2005). Many commercial banks in Kenya are beginning to examine retail banking as an opportunity to explore and are even changing their operations from corporate banking to retail banking. This is because there is stiff competition in the banking industry that has forced them to

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diversify into new markets. These banks do not only initiate this form of banking but they always want to be successful. 2.5 Challenges faced by banks in implementing retail banking New entrants to retail banking confront significant challenges even in a purely domestic environment, in particular due to economies of scale and network effects that apply to the industry. At low volumes and numbers of clients, new entrants suffer higher marginal and average costs (Bergman, 2002). Retail banks firstly face challenges achieving profitability while financing the large fixed investments often needed in order to establish a service and acquire clients. Although the Internet has reduced the importance of having a local presence, branch networks continue to be important, and costly. Secondly, retail banks may be subject to important constraints on competition and innovation in the provision of payment services. A new entrant working through existing networks may be unable to diverge from established practices and pricing. But in seeking to introduce new payment instruments, they would face very significant challenges due to the strong network features of payment services and the market power of the existing collaborative payment organizations . There is increased risk in retail banking. Bankers perceive individuals with low income can cause a bad credit risks. This is because clients cannot repay their loans. The perception is that clients with low income do not have stable, viable businesses for which for which to generator payment. Moreover, these potential clients lack traditional collateral to guarantee their loans. Banks also do not appropriate technologies to serve this clientele i.e. correct screening mechanisms to separate good from bad credit risks. (Chakravorti etal, 2006).

Retail banking has a heavy initial investment cost. Retail financial services require heavy investments in information technology and branch network IT systems represent significant fixed costs for retail banks. And the investments can be important even if a bank is serving just a small numbers of clients. IT systems have increasingly enabled banks and other financial services providers to automate processes for large volume standardized services, increasing the role of economies of scale. New entrants may need to acquire a large number of clients before they are able to break even while charging competitive market rates. (Massoud, 2004).Branch networks are still important means of acquiring and serving clients, in particular for higher margin products for which clients still demand (or require)advice. And within a limited area, there may be increasing returns to branch network size i.e.

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clients may be more inclined to choose a bank that has numerous branches in the areas in which they work and live. This will be costly for banks to initiate. (Alistair and Tang, 2005).

Client acquisition can be slow and expensive. Acquiring clients is expensive, both in terms of time and money. Marketing costs can represent a significant portion of total costs during the early stages of development for a new financial services provider. The quicker a critical mass of clients can be acquired, the sooner a new operator can break even. Hence many foreign expansion strategies are based on a stepping-stone model, building on existing networks or following other strategies associated with smaller up-front investments and lower risks; alternatively, expansion abroad is conducted through acquisition of an existing client base (Rochet and Tirole, 2000).

Although retail banking has been practised in Kenya for several years, it might be successful due to some challenges and thus the study was to find out the factors that hinder its successfulness.

2.6 The role of information technology in retail banking Information and communication technologies are playing a very important role in the advancements in banking. In fact information and communication technologies (ICT) are enabling banks to make radical changes to the way they operate. According to Console (2003), the historical paradigm of IT provides useful insights into the learning opportunities that opened the way to radical changes in the banking industry such as the reconfiguration of its organizational structure and the diversification of the product line. Banks are essentially intermediaries which create added value by storing, manipulating and transferring purchasing power between different parties. To achieve this, banks rely on ICT to perform most functions, from book keeping to information storage and from enabling cash withdrawals to communicating with customers.

In developed countries at least, this high degree of reliance on ICT means that banks spend a large chunk of their budget on acquiring as well as maintaining these technologies ( Dubec 2008). Internal as well as external pressures often result in questions being asked about the return on ICT investments. A focus on Return on investment (ROI) reveals that ICTs provide a very limited return unless accompanied by changes in organizational structures and business processes. These changes also need to be followed by a diversification of service 18

offerings, with many banks introducing new product lines such as credit cards, stock brokerage and investment management services. Thus ICT has mostly enhanced productivity as well as increased the choice for customers both in terms of variety of services available and the ways in which they are able to conduct their financial activities (Clarke 2009).

2.7 Empirical studies Porter and Qing Amie (2006) set out to show the impact of internet on retail banking in the UK and also explain the recent increasing trend in internet retail banking in the UK. The study examined the provision of internet banking in UK retail banking and its impact on banks performances in terms of profit and customer satisfaction and competition edge over other banks. A survey was carried in 151 senior managers responded. The responding managers came from both small and large retail banks and in addition from building societies. Interviews were formulated and undertaken. The findings showed that internet banking had a direct impact on size and type of retail banking and this affected the banks performance in terms of profit, customer satisfaction and competition. It was concluded that constantly being flexible and innovative and responding quickly to the changing environment was required for banks to be successful.

European commission sector Inquiry in Banking opened an inquiry into retail banking in 2007.It was concerned that competition may be restricted or distorted and this will affect economic growth. The inquiry focused on the market for current accounts and the market for payment cards and payment systems. The study observed that on the supply side, market was fragmented; there was significant cooperation between participants (payment systems), multimarket contact, varying degrees of price transparency and significant entry barriers. On the demand side there was information asymmetry and high switching costs. These factors reduced customer mobility hence competition and in turn profits.

In 1999 World Bank (Purcell &Toland, 2003) survey set out to determine the extent of retail internet banking penetration in developing countries. A survey was carried out in 23 developing nations in Africa. The study reported the average on-line banking penetration for developing countries to be only 5%. It found out that the main challenges encountered by developing countries in implementing multichannel banking activities are the ability to adopt global technology to the local requirements, the ability to strengthen the public support for efinance, the ability to create the necessary level of regulatory and institutional frameworks 19

and the ability to mainstream SMEs toward e-finance(Martz, 2003). The findings concluded that the customers did not adopt the new interactive channels, such as internet banking or mobile banking, with overwhelming enthusiasm and continued to rely on bank branches as their main channel of banking services.

Roy Chua (2008) set out to find out how retail banks can attract potential customers and which channel of service is preferred by customers in retail banking. The study was conducted in china. A questionnaire survey was administered to the urban residents in two Chinese regions. Contingency analysis and optimal scaling were adopted in the analysis. The findings revealed that preference of service delivery differ among different types of consumers. The study concluded that necessary to have the market segmented so as banks can know which of the potential consumers they want to attract. The segmentation was to be based on demographics characteristics of consumers.

According to the survey carried out by Baliamoune (2004) on Vodafone bank in Europe, retail banking involves a lot of difficulties. The main objective of the study was to determine the challenges that faced retail banking. A survey was carried out in Vodafone bank and questionnaires administered to the top management. It was concluded that retail banks face challenges achieving profitability while financing the large fixed investments often needed in order to establish a service and acquire clients. It also showed that there was increased risk in retail banking as many of the individual customers are of low income and dont have stable and viable sources of income(Chakravorti et al, 2006). . 2.8 Conceptual framework The independent variable is the one to which different subjects are exposed to in different degrees or the variable on which the groups of subjects to be compared are different (Kathuri & Pals, 1993). The authors posit that the independent variable is expected to bring about or account for a difference or a change in the dependent variable; the researcher builds the independent variables into the design in order to determine the effects of those factors on the dependent variables. Figure 2.0 shows the conceptual framework of this study, which shows the relationship between home factors, school factors, teacher factors, learner factors with students performance in biology. This framework was adopted in this study.

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Multiple distribution channels

Availability of cross selling activities

Number of transactions Number of customers (accounts)

Liberalization of Financial markets. Regulators (CBK) Changing consumer needs Economic conditions Competition

Banks Profitability Number of services offered

Independent variables

Moderating variables

Dependent variable

Figure 1.0.: Conceptual Framework of the Factors that have led to the success of retail banking in Kenya.

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CHAPTER THREE RESEARCH METHODOLOGY 3.1 Introduction This chapter discusses how the study will be conducted, explaining the methods and steps that will be used to conduct this research. The basis of any meaningful research depends on the methods and procedures employed in data collection and a clear definition of the target group of respondents. The sub-topics include: the research design, target population, sample size, sampling methods, and data collection methods and data analysis. 3.2 Research Design This will be a qualitative research. Qualitative research is concerned with subjective assessment of attitudes, opinions and behaviour. This type of research also provides an understanding of how or why things are as they are. Survey research design was employed in selecting the banks to assess the factors that led to the success of retail banking . The design was chosen as dictated by the nature of the study, which primarily involves gathering of facts. 3.3 Target population The population of interest involves selected banks in Nakuru Town that are pursuing retail banking. According to Financial standard (2010) there are 10 banks, which have actively incorporated retail banking in their operations. The target population in the banks are the marketing managers and branch managers, middle level managers randomly selected customers.

3.4 Sample Design Since the population is small i.e. 10 banks a census will be carried out to give appropriate results. Purposive sampling was done to select all the 10 branches to be studied. Respondents were selected from among top managers, middle and first line managers and clerical staff to help avail manageable population for the study to ensure representativeness. Bank customers were also sampled out. The researcher interviewed all the 10 branch managers and randomly selected 10 middle/first line managers and clerical staff comprising over 30% of the population in each category.

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3.5 Data Collection The data collection instruments for this study were questionnaires administered to 10 middle/first line managers and clerical staff, interview schedule for 10 branch managers. These instruments were used to gather data relating to respondents background information, perceptions on factors that led to the success of retail banking as illustrated in the conceptual framework. 3.5.1. Questionnaire The questionnaires that were administered in the study consisted of both closed and openended items. Closed-ended questions allowed the generation of demographic information while the open ended ones generated specific responses from individuals on the issue of savings mobilization. The questions asked were consistent with the research objectives and questions. The advantage of using this type of items is that they are easy to administer and economical to use in terms of time and money. Moreover, they are easy to analyze. Openended questions have the advantage of giving insight into the respondents views and opinions on the subject. In addition, these questions make it possible to use qualitative analysis. 3.5.2 Interviews Interviews were conducted to gather data from branch managers aimed at providing a high degree of objectivity, uniformity and also allow for probing and clarification at the same time. The interview schedules for managers sought background information, their views on factors that led to the success of retail banking. 3.5.3 Validity and reliability of research instruments The questionnaires were designed carefully to ensure no ambiguity and that all respondents could understand and respond to all issues in exactly the same way as expected by the research. In addition the instruments were subjected to thorough appraisal and discussion with colleagues, supervisors and other experts both in research and in the field of banking. 3.6 Data Analysis Descriptive statistics, frequencies, percentages, means and qualitative analysis were used in analyzing the data gathered. The responses given by various respondents would be in different forms ranging from the interview schedule responses to closed and open-ended items in the questionnaire.

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