The Effect of Funding Structure on the Financial Performance of Deposit Taking Microfinance Institutions in Kenya

Abstract

Capital structure is a financial tool that helps to determine how firms choose their funding structure. Most DTMFIs in Kenya started off as NGOs and had built significant supply side competencies, as such, funding structure had no relevance. However, with growth and commercialization, MFIs are spinned off to become fully independent, the puzzle of funding structure that will ensure sustainability and profitability becomes relevant. In this study, an attempt has been made to fill in the existing knowledge gap by determining effects of funding structure on the financial performance of Deposit Taking Micro Finance institutions in Kenya. This study analyzed the funding structure and financial performance of Deposit taking microfinance institutions in Kenya for the period 2011 to 2012. For the purpose of this study, the data was extracted from the published institution’s annual audit reports and CBK’s banks supervision annual reports for the 2 years under examination. This study used descriptive statistics to explain the main features of a collection of data in quantitative terms while correlation and linear regression analysis are used for analyzing the data. Financial performance was measured using return on assets while capital structure of DTMFIs was measured using customer’s deposits and borrowings divided by total assets. The results revealed there is positive relationship between funding structure and financial performance. The study concluded that increase in customer deposits and assets in DTMFIs would significantly improve financial performance of DTMFI while borrowing significantly decreases DTMFIs financial performance. Further this study concluded that DMFIs preferred source of fund was customer deposit and increase in asset, while borrowing generally has decreased in importance in the DMFI funding structure as it led to low profitability. From the findings the study concludes that that most of DTMFIs in Kenya were using borrowed funds but incrementally utilizing more of deposits as financial performance improve. Use of customer deposits has given the deposit-taking microfinance institutions (DTMFIs) headroom to cut their reliance on expensive borrowings as increased customer deposits provide an alternative source of cash. A proportionate increase in deposit base as a percentage of total assets typically lead to an overall lower cost of funds hence high profit margin. The study recommend management in DTMFIs should focus on enhancing Customer Deposits and assets as a source of funds as there existed a positively and strongly correlation between deposit and ROA. The results of the study were valuable to DTMFI organizations in Kenya in getting reliable insights on relationship between profitability and funding structure. DTM managers agrees that while mobilizing customer deposits is slower than they would like, they expect CBK and Treasury to change rules to allow DTMs attract big depositors. The findings indicated that a proportionally higher deposit as a percentage of total assets is associated with improved profitability, assuming that the deposits program is cost efficient. Although borrowings had negative significantly correlation to ROA, this study calls for the development of appropriate regulatory policies that enable DTMFIs to have access to long-term debt which may in turn improve their profitability. This may include relaxation of their listing requirements in the capital market