ENVIRONMENTAL SUSTAINABILITY PRACTICES AND FINANCIAL PERFORMANCE OF COMMERCIAL BANKS IN KENYA: THE SUPPRESSING ROLE OF FIRM SIZE

This paper examined the effect of environmental sustainability practices on the financial performance of commercial banks in Kenya and established the conditions under which that effect becomes observable. Kenyan banking profitability declined over the last decade, sector return on assets contracting from 3.24 per cent in 2015 to 1.90 per cent in 2024 while the number of loss-making institutions rose from two to nine, and the question of whether environmental engagement contributes to or detracts from profitability has acquired practical urgency. Environmental exposure in banking arises principally through the credit a bank extends rather than through its own production processes, so the appropriate measure of environmental practice is the composition of the loan book rather than an operational efficiency indicator. The study adopted a positivist philosophy and an explanatory longitudinal panel design. The target population comprised all 38 commercial banks licensed by the Central Bank of Kenya, a census was adopted, and secondary data were extracted from audited annual reports, sustainability disclosures and regulatory publications for 2015 to 2024, yielding a balanced panel of 380 bank-year observations with complete coverage. Environmental sustainability practices were measured by the green loan ratio and financial performance by return on assets. Estimation used hierarchical panel fixed effects regression with HC1 robust standard errors, following a full diagnostic battery and a Hausman specification test. In the direct-effects model the environmental coefficient was negative and statistically insignificant (β = -0.005, SE = 0.044, p = 0.904) and the null hypothesis was not rejected. Once firm size was controlled, the coefficient became positive and statistically significant (β = 0.175, SE = 0.077, p = 0.023), remained significant with the interaction terms present (β = 0.165, SE = 0.081, p = 0.042), and strengthened in the post-2021 sub-period following the Central Bank of Kenya Climate Risk Management Guideline (β = 0.276, p = 0.006). The reversal is the signature of a suppression effect arising from the strong association between bank size and green lending (r = 0.868). The interaction between environmental practices and firm size was insignificant (β = 0.249, p = 0.419), so the return to green lending does not depend on scale. Environmental sustainability is therefore financially relevant in Kenyan banking, but its relevance is visible only in specifications that control for size.