Market Risk, Financial Leverage and Financial Performance of Microfinance Institutions in Kenya

Abstract

Microfinance institutions are crucial in the financial sector worldwide as they facilitate the access to financial services to a wider range of customers. There has been a tremendous increase in the number of registered microfinance institutions in Kenya which has shown continuous growth with an increase in asset base and customer deposits. Despite the growth in terms of the number, customer’s deposit and asset base of the microfinance institutions in Kenya, most of them have reported a decline in their financial performance which is attributable to effects of market risk variables within the period under study. This study set out to investigate market risk, financial leverage and financial performance of microfinance institutions in Kenya. The specific objectives of the study were to investigate the effect of interest rate risk on financial performance; examine the effect of inflation risk on financial performance; establish the effect of foreign exchange risk on the financial performance; and to determine the effect of financial leverage risk on financial performance of Microfinance Institutions in Kenya. The study further sought to assess the moderating effect of a Firm’s size on the relationship between market risk, financial leverage and financial performance of microfinance institutions in Kenya. The study was anchored on the Dynamic Capabilities theory supported by Resources- Based theory, Extreme Value theory, Expectation theory of Exchange rate, International fisher effects theory and Modern Portfolio theory. This study made use of the positivism philosophy and the explanatory non-experimental research design. The target population was all the thirteen registered Deposit Taking Microfinance institutions in Kenya and a census approach was used. The study used secondary data which was collected from microfinance institution’s annual audited financial reports for the period between 2014 and 2018 using a data extraction instrument. Diagnostic tests which included Variance Inflation Factor to test on multicollinearity, Wooldridge test for autocorrelation, Likelihood ratio test for heteroscedasticity, Skewness, and Kurtosis for normality test and Fisher-type unit root tests for stationarity were applied. Panel multiple regression analysis was used to analyze the collected data with the help of STATA. The findings indicated that interest rate risk has a significant positive effect on the financial performance of microfinance institutions. Foreign exchange risk has a significant negative effect on the financial performance of microfinance institutions. The inflation rate risk had no significant effect on the financial performance of microfinance institutions. Financial leverage had a significant positive effect on the financial performance of microfinance institutions in Kenya. Lastly, the study found that firm size had a significant moderating effect on the relationship between market risk and financial performance of microfinance institutions in Kenya but no moderating effect on the relationship between financial leverage and financial performance. The study concluded that, for microfinance institutions to contribute to the Kenya Vision 2030 blueprint for the country economy to raise Gross Domestic Price (GDP) growth rate to at least 10 % and to offer financial access to citizens, the market risk variables must be addressed. The study therefore recommends that the government should put in place proper monetary and fiscal policies in the country to curb market risk variables. The CEOs of microfinance institutions should employ mechanisms of identifying market risk variables to enable them to put the necessary measures to mitigate them. The management should ensure they identify the optimal financial leverage level to operate on and enhance the financial performance of microfinance institutions in Kenya.