Abstract:
Microfinance institutions provide loans to low-income borrowers including SME’s who
traditionally lack access to mainstream sources of finance from Banking Institutions as
they are considered as high-risk borrowers. Despite the key role the MFIs plays in the
economy – in poverty eradication and entrepreneurial activities, these firms ‘reported
poor financial performance .The decline is caused by declining financial support from
donors and this has prompted them to opt for debt and the credit risk associated with it.
Prior Studies claimed that financing structure affects financial performance however
the findings are not conclusive therefore moderating effect of credit risk. The general
objective of the study was to examine the moderating effect of credit risk on the
relationship between financing structure and financial performance among
microfinance institutions in Kenya. The specific objectives were to establish the effect
of equity capital, debt capital, retained earnings and deposits on financial performance
of MFI. The study also sought to investigate the moderating effect of credit risk on the
relationship between: equity capital, debt capital, deposits and retained earnings on
financial performance. This study was guided by Pecking order theory, The Agency
Theory and The Modigliani-Miller Theorem. The study adopted longitudinal and
explanatory research design. The target population consisted of all 53 Microfinance
Institutions in Kenya for the period between 2010 and 2019. However, after applying
an inclusion/exclusion criterion the final sample comprised of 31 Microfinance
Institutions in Kenya. Data was extracted from World bank MIX market database and
the annual reports of the selected microfinance banks. The data was analyzed through
descriptive and inferential statistics. The study found out that equity capital (β=0.252,
ρ<0.05), debt capital (β=0.383, ρ<0.05), retained earnings (β=0.339, ρ<0.05 and
deposits (β=0.225, ρ<0.05 had a significant and positive effect on financial performance
of microfinance institutions in Kenya. Moreover, the study found that credit risk
significantly moderates the relationship between equity capital (β= 0.6994, ρ<0.05),
debt capital (β=-0.878 ρ<0.05), retained earnings (β=0.9128, ρ<0.05), deposits
(β=0.6036, ρ<0.05) and financial performance. This study's findings are supported by
the pecking order theory, emphazing the hierarchical order of financing to financial
performance. Therefore, the study concluded that equity capital, debt capital, retained
earnings and deposits had a significant effect on financial performance. Further, the
study showed that credit risk significantly moderate the relationship between financing
equity capital, debt capital, retained earnings and deposits a contribution to the existing
literature. This study contributes to the pecking order theory emphazing the hierarchical
order of finance to financial performance. The study recommends that microfinance
institutions should mobilize on minimizing credit risk by adopting more stringent
lending guidelines and cost saving measures thus ultimately improving performance.