Effect of Financial Risk on Financial Performance of Microfinance Institutions in Kenya

Abstract

Micro finance institutions in Kenya play a role in financial intermediation which has included 2.9% Kenyans. Despite this, the financial risk for most MFIs has increased but focus has mostly been on the banks. The MFIs in Kenya have recorded a rise in the level of NPLs in the last decade which signifies rising credit risk. The MFIs have also recorded a rise in liquidity risk which lenders them vulnerable to customers withdrawal. Financial risk management is said to be an enabler of financial performance among financial institutions. The main aim of this study was to determine the effect of financial risk on financial performance of MFIs in Kenya. The independent variables for the research were credit risk, liquidity risk, operating risk and interest rate risk. Capital adequacy and MFI size were the control variables while the dependent variable was financial performance measured as ROA. The study was guided by information asymmetry theory, shiftability theory and financial intermediation theory. Descriptive research design was utilized in this research. The 47 MFIs in Kenya as at December 2021 served as target population. The study collected secondary data for five years (2017-2021) on an annual basis from CBK and individual MFIs annual reports. Descriptive, correlation as well as regression analysis were undertaken and outcomes offered in tables followed by pertinent interpretation and discussion. The research conclusions yielded a 0.530 R square value implying that 53% of changes in MFIs ROA can be described by the six variables chosen for this research. The multivariate regression analysis further revealed that individually, both credit risk and liquidity risk have a negative effect on ROA of MFIs as shown by (β=-157, p=0.000) and (β=-0.160, p=0.000) respectively. Operating risk and interest rate risk displayed non-statistically significant influence on ROA. Capital adequacy and firm size exhibited a positive and significant influence on ROA as shown by (β=0.739, p=0.000) and (β=0.293, p=0.000) respectively. The study recommends that MFIs should implement effective measures of managing financial risk. Specifically, the MFIs should work at reducing their liquidity risk and credit risk as these two adversely affects ROA. Future research ought to focus on other financial institutions in Kenya to corroborate or refute the conclusions of this research.