The relationship between capital structure and financial performance of Microfinance institutions in Kenya

Abstract

This study examined the relationship between capital structure and performance of MFIs in Kenya. Capital structure theories predict that leverage level influences a firm’s performance. In MFIs outreach levels and default rates are considered essential performance indicators that capture the success and sustainability of MFIs. Using these indicators the relationships between capital structure and performance of MFIs can therefore be measured in short term and long term. The objective of this study was to establish the relationship between capital structure and financial performance of MFIs in Kenya. A survey that explores how capital structure relates to outreach level and default rate was carried on Nairobi based MFIs. The population comprised 36 MFIs registered by AMFI as at December 2008.Convenient sampling method was employed The main source of data were the annual Financial and income statements from the MFIs gathered from the MFIs offices and websites. From the financial and income statements panel data covering five-year period from 2004 to 2008 was summarized using a secondary data collection form and analyzed using ratios, descriptive statistics and multiple regression analyses. The multiple regression models used considered performance as the dependent variable and was measured in terms of Outreach and default rate. The independent variables in the regression models included Short term debts, long term debts and total debts as a ratio of totals assets while firm size, risk level and firm age were also used as control variables to make up for other omitted. Variables The findings showed that most of the MFIs employed high leverage. The mean total debt ratio was 76%. Further the results showed that MFIs financed their operations with long term as against short-term debts suggesting a considerable dependence on long-term debts by MFIs for their operations. The MFIs studied were also found to enjoy satisfactory performance recording mean values of 36% and 33% for ROA and ROE respectively. A few MFIs were also found to be doing well while most of them are not as suggested by standard deviation of 1.52 with respect to ROA hence overall mean could be driven by a few MFIs. It was revealed that short-term debt significantly impacted MFI outreach positively. Long term debt however showed positive relationship with outreach but was not significant with regard to default rates, both short and long term debts showed expected results but were not significant indicating that maturity may not necessarily be of essence. Generally highly leveraged MFIs were found to perform better by reaching out to more clients. It was also revealed that such MFIs also enjoyed economies of scales and therefore were better able to deal with moral hazards and adverse selections which also enhanced their ability to manage risks.