Financial Risk, Firm Size and Financial Performance of Microfinance Banks in Kenya

Abstract

Microfinance play pivotal role in providing financial services to low-income household and small business that are excluded by traditional banking thus aiding alleviating poverty. Therefore, this study was inspired by critical facts; firstly, microfinance banks have performed poorly in the past by reporting losses compared to their counterpart, commercial banks have continued to be resilient to report improved financial performance. Secondly, there exists a contradiction in past studies on the significance of financial risk on the financial performance Microfinance Banks (MFBs). Further, the research aims at demonstrating and modeling the effect of credit risk, operational risk and liquidity risk as the financial risk components on the financial performance of MFBs in Kenya. The general objective was to assess the effects of financial risk on the financial performance of MFBs in Kenya. The study's specific objectives were: To analyze the effect of credit risk on the financial performance of MFBs in Kenya; operational risk on the financial performance of MFBs in Kenya; liquidity risk on the financial performance of MFBs in Kenya; and to analyze the moderating effect of firm size on the relationship between financial risk and the financial performance of MFBs in Kenya. The study was guided by positivist paradigm approach. Descriptive research design and explanatory research design were adopted. All 14 MFBs licensed by Central Bank of Kenya (CBK) at the end of 31st December 2021 formed the study's target population. The study also obtained quantitative data. The quantitative data were obtained from the CBK, Bank Supervision Annual Report, and audited financial statements of MFBs for the period between 2011-2021, which was analyzed through panel data analysis. Panel regression was used to establish the association between independent and dependent variables. The following diagnostic test was conducted; To test normality, Kolmogorov -Smirnov test and Shapiro test were carried out and found that data was following normal distribution; Augmented Dickey-Fuller (ADF) test was conducted to test unit root and found that all variables had unit roots and were non-stationary; Wooldridge test was conducted found that data never violated serial correlation; Variance inflation Factor (VIF) was carried out and found out no presence of multicollinearity; Breusch-pagan test and Levene test were carried out and revealed no evidence of heteroscedasticity; and finally Hausman specification test was conducted and revealed that fixed effect models were suitable for Return on Assets (ROA). The finding on results and test of Hypothesis revealed that credit risk exerted a negative and statistically significant effect financial performance of MFBs while Operational risk and Liquidity risk had a negative and statistically insignificant relationship with ROA as measures of the Financial performance of MFBs. The study therefore recommends that, MFBs should adopt strategies and policies that ensure vetting and issuance of credit facilities to credit worth customers. The bank should also develop and implement policies to improve managerial efficiency to reduce operational cost