Relationship Between Financial Risk Management And The Financial Performance Of Microfinance Institutions In Kenya

Abstract

The Kenyan Microfinance Institutions are wrestling with multiple challenges originating from the inherent risks within the environment they are operating in both internal and external. Financial risk management is one of the main hurdles threatening the sustainability and viability of the microfinance institutions in Kenya, therefore, this study aimed to establish the relationship between financial risk management and the financial performance of the Microfinance Institutions in Kenya. A descriptive research design was employed on this study to test how operational risk, market risk, liquidity risk and credit risk posed a major threat to the financial performance of the Kenyan Microfinance Institutions. The study incorporated a target population of 58 microfinance institutions in Kenya as at 31st December 2020 with an aggregate loss of 2 billion. Secondary Panel data was analyzed as obtained from the available financial statements of the 58 Microfinance Institutions over a period of 5 years running from January 2016 to December 2020.The data was collected from CBK (Central Bank of Kenya) and AMFI (Association of Microfinance Institutions) because CBK requires that all regulated Microfinance banks to publish their audited financial statements to the public every year. To minimize potential endogeneity challenges the study utilized financial ratio analysis and panel data methods of random effects and fixed effects estimation. The study also determined the correlations between the variables and used Wald and F- tests to determine the significance of the regression whereas the overall, within and between R2 of the coefficient of determination, were utilized to establish how much dependent variable’s variations were explained by the independent variables. Tests such as Breusch and Pagan Lagrange multiplier (LM) were adapted to test between the fixed effects model and the appropriateness of the random effects model respectively. The study findings depicted that there exists a significant negative relationship between Operational risk, Market risk, Liquidity risk, Credit risk and financial performance of Kenyan MFIs. The study concluded that financial risk management and the financial performance of the Microfinance Institutions of Kenya are inversely related. Therefore, the microfinance Institutions should establish an efficient and salient financial risk management framework in order to overturn their loss-making position.