The effect of credit risk management practices on loan performance in microfinance institutions in Nairobi, Kenya

Abstract

Credit risk has always been a concern not only to bankers but to the entire business world because the risks of a borrower not fulfilling his obligations in full on due date can seriously jeopardize the performance of a financial institution. This study sought to review the effect of credit risk management on the loan performance of microfinance institutions in Kenya. The research design used in this study was descriptive research design as it involved an in depth study of credit risk management and its relationship with loan performance in micro finance institutions. Primary data was collected through questionnaires while Secondary data collected from the micro finance institutions annual reports (2007-2011) was used. The study populations were the 9 micro finance institutions licensed by the Central bank of Kenya; however data was obtained from 5 micro finance institutions. The data collected from the annual reports of the micro finance institutions was analyzed using multiple regression analysis. In the model return on equity was used as the profitability indicator while non-performing loans ratio and capital adequacy ratio as credit risk management indicators. This study showed that there is significant relationship between loan performance and credit risk management. The results of the analysis states that both non-performing loans ratio and capital adequacy ratio have negative and relatively significant effect on return on equity with NPLR having higher significant effect on ROE in comparison to CAR. Hence, the regression as whole is significant; this means that NPLR and CAR reliably predict ROE. Having established a relationship between credit risk management and the financial performance of micro finance institution, the research suggests that all micro finance institutions should adopt accredit risk grading system