The effect of Credit Risk management on the financial Performance of Deposit taking Micro - Finance institutions In Kenya

Abstract

Credit risk is an important factor that institutions offering services on credit should consider seriously and also invest on. A measure of future uncertainties in achieving, program performance goals within defined cost and schedule constraints. It has three components: a future root cause, a likelihood assessed at the prese nt time of that future root cause occurring, and the consequence of that future occurrence. In general when borrowers’ assets values are less than loan values, they do not repay. They exercised their option to default. To the lender, failure to manage risk , especially credit risk, can lead to insolvency. The objective of the study was to establish the effect of credit risk management on the financial performance of Deposit taking Micro financial institutions in Kenya. The study employed descriptive research design. The target population was the Nine Deposit taking Micro finance institutions members in Kenya (the official association of Deposit taking Micro finance institutions in Kenya, 2013) registered at end June 2013 at the Central Deposit taking Micro fi nancial institutions of Kenya (CBK) which supervise the activities of Microfinance sector in Kenya. Secondary data was collected for this study, for the purpose of analyzing the effect of credit risk management on financial performance of the nine deposit taking Microfinance institutions. The dataset will be drawn from the Financial Statements of each of the deposit taking MFI under study throughout the period of study 2009 to 2013 and sourced from the Management of the institutions. Quantitative data colle cted was analyzed by the use of descriptive statistics using SPSS and presented through percentages, means, standard deviations and frequencies. From the findings, risk management by credit scoring positively impacts on the return on assets of micro - financ ial institutions. The adoption of credit scoring allows micro - financial institutions to make systematic different offers to loan applicant s with different risk profiles. Effective credit risk leads to more balanced trade - off between risk and reward, to rea lize a better position in the contends that the deposit taking Micro financial institutions industry recognizes that an institution needs not do business in a manner that unnecessarily imposes risk upon it; nor should it absorb risk that can be efficiently transferred to other participants. Rather, it should only manage risks at the firm level that are more efficiently managed there than by the market itself or by their owners in their own portfolios. Risk diversification positively influences the financial performance (ROA) of the micro - financial institutions. The study recommends that d eposit taking Micro financial institutions should devise modern risk measurement techniques such as value at risk, simulation techniques and risk - adjusted return on capital. Other than relying on credit reference bureau (CRB), the study recommends use of derivatives to mitigate financial risk as well as develop training on the guidelines to be used by the financial advisors