The Effect of Credit Risk Management on the Financial Performance of Microfinance Institutions in Kenya

Abstract

Credit risk is on an increasing rate is becoming an area of concern to many people and institutions in the lending business globally. This kind of exposure leads to instability and poor financial performance of financial institutions. Therefore, this research sought to evaluate the effect of credit risk management on the financial performance of DTMs and non-deposit taking MFIs in Kenya. The research design exploited descriptive research design in this research as it draws in a comprehensive analysis of credit risk management and its correlation with financial performance in micro finance institutions. Secondary data gathered from microfinance institutions yearly reports (2011- 2015) was utilized. The study population was 13 microfinance institutions licensed by CBK and 22 nondeposit taking MFIs, though data was attained from 27 MFIs. The data collected was subjected to a multiple regression analysis, correlation, and ANOVA. In the analysis, ROE was used as a profitability indicator whereas PAR 30 was a measure of credit risk. This study depicted that there is a considerable correlation involving financial performance and credit risk management. From the model, the ROE (Financial performance) was 10.676 when other factors (Credit risk, Liquidity risk and Interest rate risk) are held constant. A unit increase in credit risk holding other factors constant results in a 2.165 decrease in the return on equity (ROE). Additionally, a unit increase in liquidity risk results in a 0.224 increase in the return on equity other factors held constant. Finally, from the model, when other factors are held constant, (Credit Risk and Liquidity risk), a unit increase in the central bank of Kenya interest rates results in a decrease in the ROE of the microfinance institutions by 0.518. The credit risk and interest risk were the most significant variables as their p-values were less than 0.05. The study recommends that the Mfis in Kenya must pay constant attention to credit risk being a major risk to NPLs. Secondly; CBK needs to come up with strong regulations on the unregulated nondeposit making MFIs. Thirdly, the regulators must come up with adequate capital adequacy requirements to shield the MFIs from financial risks. Further research needs to be done on the effects of absence of regulations on the MFIs in Kenya.