The effect of government regulation on the financial sustainability of microfinance institutions in Kenya.

Abstract

In Kenya all Microfinance institutions are required to be regulated through Micro Finance Act 2006 and supervised by the Central bank of Kenya. They can either transform to a Deposit Taking Microfinance or through the Regulations set by the ministry of Finance as conferred by the Microfinance act as credit only Microfinance. The purpose of this study was to determine the effect of the government regulation on the financial sustainability of Microfinance institutions in Kenya. Using capital adequacy, liquidity and loan provisioning requirements as the independent variables while sustainability as the dependent variable, capital requirement was calculated as ratio of Equity against risk weighted assets as prescribed by the Microfinance act, 2006. Liquidity was calculated as the ratio of current assets over current liabilities, loan provisioning was calculated as the ratio of portfolio in arrears over the outstanding loan portfolio and sustainability was measured by operational self sufficiency calculated as the ratio of operational income over operational costs. A sample of 30 retail Microfinance institutions was drawn from a target population of 48 retail Microfinance institutions in Kenya using disproportionate stratified random sampling for this study. Secondary data was collected from audited financial statements for each institution for 3 years and analyzed using a multivariate regression model. The study found that capital adequacy and liquidity requirements had a positive effect on the financial sustainability of Microfinance Institutions in Kenya with less than 50% positive correlation on the financial sustainability. It further found that Loan provisioning had a negative effect on the financial sustainability and less than 50% negative correlation on the financial sustainability of MFIs in Kenya. The study will help Microfinance institutions willing preparing to transform to DTMs to understand that government regulations boost their sustainability as well as help them improve loan quality hence will be encouraged to transform to DTMs.