Effects of Credit Risk Management on the Financial Performance of Micro Finance Banks in Kenya

Abstract

Credit risk management in banking institutions has become more important not only because of the financial crisis that the world is experiencing nowadays but also the introduction of Basel II. Since granting credit is one of the main sources of income in commercial banks, the management of the risk related to that credit affects the profitability of the banks. This objective of the study was to establish the relationship between credit risk management and the financial performance of Microfinance Banks in Kenya. The research problem was studied by utilizing the descriptive research design method whereby secondary data was gathered from the annual reports of MFBs in Kenya. This was attributed to the fact that special emphasis was placed on the specific objective about the relationship between independent variables and the dependent variable in the study. Descriptive design was the most appropriate and was selected to enable the study test the relationship between credit risk management and the financial performance of MFBs. A census of the 9 licensed deposit taking Microfinance banks in Kenya as at 31st December 2014 will be carried out as outlined in the appendix. The study found out that Correlation matrix of the CAMEL indicators to financial performance showed different results. Capital adequacy has a weak relationship with financial performance of microfinance banks in Kenya. A weak relationship between asset quality and financial performance of microfinance banks in Kenya was observed. Management efficiency had an average relationship with financial performance. Earnings quality on the other hand, had a strong relationship with financial performance whereas liquidity hand had a weak relationship with financial performance. The study established that credit risk management by use of CAMEL indicators has a strong impact on the financial performance of MFBs in Kenya. The study recommends that MFBs should also try to keep their operational cost low as this negates their profits margin thus leading to low financial performance. The study further recommends that in order for MFBs to remain financially stable and flourish in the industry they must adopted viable credit risk management practices that will help in sustaining their financial performance.