Abstract:
Despite increasing competitiveness and volatility within the financial sector there has
been inconclusive evidence on the effect of financial risk on financial performance
among deposit taking microfinance institutions. This study determined how financial
risk; liquidity risks, credit risks, foreign exchange risk and interest rate risk affect the
financial performance of deposit taking microfinance institutions. The moderating
effect of financial regulation on the relationship between financial risks management
strategies and the performance of deposit taking microfinance institutions was also
determined in this study. The theories that guided the study included the shiftability,
stakeholder, risk management, new theory of financial regulation and micro prudential
regulation. Explanatory research design was employed in this study targeting 13-
regulated deposit taking microfinance institutions in Kenya for the period 2010-2018.
Secondary data collected from financial reports were analyzed using descriptive and
inferential statistics. Pearson correlation results showed that liquidity risk and interest
rate risk have a positive and significant association with financial performance of
microfinance institutions while credit risk and foreign exchange risk have a negative
and significant association with financial performance of microfinance institutions.
Regression analysis indicated that liquidity risks (β =0.336584, p=0.000<0.05) and
interest rate risk (β=0.558724, p=0.049<0.05) have a positive significant relationship
with financial performance of microfinance institutions. There was a negative and
significant relationship between credit risk and performance of micro financial
institutions (β= -0.01059, p=0.023<0.05). A negative and significant relationship
between foreign exchange risk and performance of micro financial institutions (β= -
0.78296, p=0.004<0.05) was also revealed. Financial regulations moderate financial
risks and financial performance of microfinance institutions in Kenya since R2
improved from 48.83% before moderation to 53.87% after moderation. Based on
research finding it can be concluded that liquidity risk, credit risk, foreign exchange
risk and interest rate risk affects financial performance of Microfinance Institutions. It
was also concluded that financial regulations is a significant moderator. The study gives
recommendations that MFIs should manage liquidity risk by reinforcing its own
resources since depositors could at any time and under unexpected reasons, withdraw
their deposits to seek investment elsewhere with higher returns. The study recommends
that MFIs should enhance credit risk management practices which include portfolio
asset management, MFIs loan policy procedure, risk monitoring, risk analysis and
assessment, credit scoring mechanism. The study recommends that MFIs should
explore avenues to enhance capacities within them for managing foreign exchange risk.
The study also recommends that firms should look at instituting a sound risk
management system and also needs to formulate their hedging strategy that suits their
specific firm characteristics and exposures. MFIs should set their interest rates within
the ranges that are set by the Central bank of Kenya.