Financial risks, financial regulation and financial performance of deposit taking microfinance institutions in Kenya

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.