The Effect of Liquidity on Profitability of Microfinance Banks in Kenya

Abstract

Many institutions worldwide lack a formal and suitable financial policy on the administration and management of liquidity. For financial institutions experiencing fast-paced growth like microfinance banks, the establishment of norms and policies to administer cash and liquidity is nonetheless crucial for the institutional viability as much in the short term as in the long term. This study sought to establish the effect of liquidity on profitability of microfinance banks in Kenya. The population of the study was comprised of all 9 microfinance banks in Kenya operating in the years 2011 to 2014. For a microfinance bank to qualify it needed to have been in operation during the whole period of the study and therefore institutions that were not in operation in the whole period of study were eliminated Secondary data was used in conducting the study. The study involved secondary data collection of the return on assets, to measure profitability and the ratio of loans to deposits to measure liquidity during a specific year. The study used secondary data obtained from Central Bank of Kenya annual supervision reports and Association of Microfinance institutions annual publications. The study used descriptive statistics and regression analysis to establish the relationship between the study variables. The response rate was 67% that is a total 6 out of 9 licensed microfinance banks in Kenya that satisfied the data collection criteria. The study found out that there is a weak negative relationship between liquidity and profitability of microfinance banks in Kenya. Liquidity was found to be one of the determinants of profitability of Microfinance Banks in Kenya. The study recommends that the finance managers of microfinance banks maintain optimal levels of liquidity in order to remain profitable.