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

Abstract

This study aimed to investigate the influence of credit risk management on the financial performance of deposit-taking microfinance institutions (DTMIs) in Kenya. Drawing on theories including credit risk theory, agency theory, and modern portfolio theory, the research sought to discern the intricate connections between credit risk management practices and financial performance outcomes within the microfinance landscape. Employing a descriptive research design, the study cantered on all 14 Central Bank of Kenya (CBK)-registered DTMIs. Secondary data extracted from CBK and MFIs' websites, along with annual reports, formed the basis of the analysis. The study spanned a decade, from 2013 to 2022. The findings unveiled a spectrum of financial performance, credit risk management, capital adequacy, liquidity, and interest rate spread across DTMIs. While the regression model demonstrated an ability to explain around 27.3% of financial performance variance, the F-statistic underscored a significant relationship between the combined effect of credit risk management, capital structure, liquidity ratio and interest rate spread on financial performance. The study revealed that credit risk management had a negative significant effect on the financial performance of Deposit-Taking Microfinance (DTM) institutions, emphasizing the need to enhance this practice by reducing the non-performing loan ratio, for improved financial outcomes. The research underscored a substantial positive correlation between interest rate spread and financial performance, signifying its significant effect on the financial outcomes of these institutions. Capital adequacy and liquidity ratio both demonstrated no significant influence on the financial performance of DTM institutions, suggesting limited impact on financial outcomes. The study suggested that policymakers focus on bolstering credit risk management policies, ensuring a balanced liquidity approach, and maintaining ethical interest rate spread management practices. Emphasizing strategies to enhance credit risk management and interest rate spread while ensuring stability in capital adequacy and liquidity levels is crucial for the reliability and financial outcomes of microfinance institutions.