INTERNATIONAL JOURNAL OF LATEST TECHNOLOGY IN ENGINEERING,
MANAGEMENT & APPLIED SCIENCE (IJLTEMAS)
ISSN 2278-2540 | DOI: 10.51583/IJLTEMAS | Volume XIV, Issue III, March 2025
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Risk Management Practices and Financial Performance of Licenced
Microfinance Nstitutions in Kenya
George Mukanzi Peter, Dr. Fred Gichana Atandi
Department of Economics, Finance and Accounting, Kibabii University, Bungoma
DOI : https://doi.org/10.51583/IJLTEMAS.2025.140300027
Received: 17 March 2025; Accepted: 29 March 2025; Published: 08 April 2025
Abstract: The aim of this study was to investigate the influence of credit risk management practices on financial performance of MFIs in
Kenya. The target population was 136 senior and middle level management staff of 14 registered MFIs in Kenya; from where Yamame’s
sampling formula was applied to get a sample size of 126 respondents who were selected using simple random sampling. Data was
collected using structured questionnaires and computed using SPSS; where descriptive and inferential statistics were generated. A total of
112 out of 126 respondents completely filled online questionnaires depicting a response rate of 88.9% which is good for generalizability
of research findings to a wider population. The study concluded that credit risk management practices significantly influence the financial
performance of Microfinance in Kenya. The study recommended that managers of MFIs Organizations should provide regular training
for credit officers and financial managers to improve their competency in identifying, assessing, and mitigating credit risks.
Key Words: Risk Management, Licensed Microfinance Institutions, Financial Performance, Resource Based View
I. Introduction
1.1 Background of the Study
Financial performance of MFIs as measured by profitability has attracted many investors and borrowers alike (Parvin et al., 2020).
Therefore, efforts by the MFIs management to improve financial performance must be matched with adoption of financial management
practices that provide MFIs with competitive advantage over their rivals. One cannot claim autonomy over the list of financial
management practices since they are diverse (Navin & Sinha, 2021). Credit risk is the most expensive risk in financial institutions and its
effect is more significant as compared to other risk as it directly threatens the solvency of financial institutions. The magnitude and level
of loss caused by the credit risk as compared to other kind of risks is severe to cause high level of loan losses and even institutional
failure (Boateng & Dean, 2020). Risk management is a process of thinking systematically about all possible risks, problems or disasters
before they happen and setting up procedures that will avoid the risk, or minimize its impact, or cope with its impact. It is basically
setting up a process where you can identify the risk and set up a strategy to control or deal with it (Noor, 2019)
Risk management (CRM) is increasingly recognized as a critical component in the financial performance of microfinance institutions
(MFIs) globally (Omowole et al., 2024). In an era where financial institutions face a multitude of risks ranging from credit, market,
operational, to liquidity risks adopting effective CRM practices has become essential to ensure their sustainability and growth. The
relevance of CRM practices in MFIs is particularly pronounced in developing regions, where financial markets are often volatile and
regulatory frameworks are still evolving.
In Asia, countries like India and Bangladesh have demonstrated significant strides in integrating CRM into the operations of MFIs. In
India, MFIs have adopted CRM strategies that include credit risk management and diversification of loan portfolios to mitigate potential
financial losses (Alabdullah et al., 2022). Similarly, in Bangladesh, the birthplace of modern microfinance, institutions like Grameen
Bank have implemented robust CRM frameworks that emphasize client screening and monitoring, contributing to their financial
sustainability (Bhat et al., 2020).
In contrast, in Latin America, countries like Brazil and Mexico have taken a different approach. Brazilian MFIs focus heavily on market
risk management, given the country’s economic volatility. The adoption of CRM practices, such as interest rate hedging and foreign
exchange risk management, has played a crucial role in stabilizing the financial performance of these institutions (González et al., 2019).
In Mexico, MFIs have incorporated CRM practices into their financial management systems to reduce operational risks, particularly in
rural areas where financial literacy remains low (Moser et al., 2015).
In Africa, the role of CRM in MFIs has also gained prominence. In South Africa, MFIs operate in a highly competitive and regulated
environment. The adoption of CRM practices in South African MFIs has been focused on credit and operational risk management, with
institutions implementing sophisticated credit scoring models and risk assessment tools. These practices have not only improved the
financial performance of South African MFIs but have also contributed to greater financial inclusion by making credit more accessible to
underserved populations (Mushonga, 2018).
Similarly, in West Africa, countries like Ghana and Nigeria have made strides in integrating CRM into their financial systems. In Ghana,
CRM practices that emphasize credit risk assessment have been crucial in maintaining the resilience of MFIs during economic downturns
(Okyere, 2021). In Nigeria, technology-driven CRM strategies have been adopted to mitigate operational risks, which has been vital for
the stability and growth of MFIs in the region (Rabiu, 2023).
INTERNATIONAL JOURNAL OF LATEST TECHNOLOGY IN ENGINEERING,
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In East Africa, Uganda and Rwanda have also made strides in CRM practices within their MFIs. In Uganda, MFIs have increasingly
adopted CRM strategies that prioritize credit risk management and regulatory compliance, which have been instrumental in maintaining
their financial stability despite the challenges posed by economic and political uncertainties (Kadima, 2023). Rwanda, on the other hand,
has focused on integrating CRM into the overall governance of MFIs, emphasizing risk management in strategic planning and decision-
making processes (Ngabonziza & Mugiraneza, 2022). These practices have not only enhanced the financial performance of Rwandan
MFIs but also increased their credibility and trustworthiness among stakeholders.
In Tanzania, the application of CRM practices has become increasingly important as MFIs face challenges such as credit and liquidity
risks. Tanzanian MFIs have adopted client risk assessment models and portfolio diversification strategies as part of their CRM efforts,
which have been pivotal in enhancing their financial resilience. The focus on managing these specific risks has enabled Tanzanian MFIs
to improve their financial performance and sustain their operations amidst economic fluctuations (Ngowi & Nkwabi, 2020).
In Kenya, CRM practices have gained significant attention due to their impact on the financial performance of MFIs. A study by Omondi
and Muturi (2020) highlighted that MFIs in Kenya that have implemented comprehensive CRM frameworks, especially those focusing
on credit and operational risks, have experienced improved financial outcomes. The integration of digital platforms for risk management
has further enhanced these institutions' ability to manage risks effectively, contributing to their overall financial sustainability.
Furthermore, a study by Karanja and Ndirangu (2021) emphasized the role of operational risk management in improving the financial
performance of Kenyan MFIs. Their findings revealed that MFIs that adopted robust operational risk management practices, such as
internal controls and risk assessment protocols, were better positioned to navigate financial challenges and maintain profitability.
Additional research by Wambua and Muriuki (2020) explored the relationship between market risk management and financial
performance in Kenyan MFIs. Their study found that MFIs that actively managed market risks through diversification strategies and
market analysis tools achieved greater financial stability and growth.
Similarly, Kamau and Ochieng (2019) examined the impact of liquidity risk management on the financial performance of Kenyan MFIs.
Their research demonstrated that MFIs with effective liquidity risk management strategies, including maintaining adequate cash reserves
and diversifying funding sources, were more resilient during economic downturns and exhibited stronger financial performance.
Lastly, a study by Mwangi and Wanjiru (2021) on the governance and risk management practices in Kenyan MFIs highlighted that
institutions with strong governance structures that integrate risk management at the board level are more likely to achieve sustainable
financial performance. Their research underscored the importance of aligning risk management with overall corporate governance to
ensure long-term financial viability.
These studies collectively underscore the critical role of CRM practices in enhancing the financial performance of MFIs in Kenya. By
adopting comprehensive risk management strategies that address credit, operational, market, and liquidity risks, Kenyan MFIs have
improved their financial stability and sustainability in a dynamic economic environment.
1.2 Statement of the problem
Despite the critical role microfinance institutions (MFIs) play in promoting financial inclusion and economic development, especially in
rural areas, their sustainability and financial performance remain a significant concern in Kenya. The region, which is characterized by a
high concentration of MFIs, faces unique challenges that hinder the effectiveness of these institutions. One of the most pressing issues is
the inadequate implementation of corporate risk management (CRM) practices, which directly impacts the financial stability of MFIs
(Omondi & Muturi, 2020).
Research has shown that many MFIs in Kenya struggle with high levels of credit risk, stemming from the inability to effectively assess
and manage borrower risk profiles. This has led to increased loan defaults, which in turn erode the financial base of these institutions
(Karanja & Ndirangu, 2021). Despite the existence of CRM frameworks, the application of these practices in Busia County is often
inconsistent and lacks the rigor required to mitigate such risks effectively. As a result, many MFIs in the region face liquidity challenges,
which further compromise their ability to sustain operations and serve their clientele.
Additionally, credit risks in Kenya’s MFIs are exacerbated by the limited adoption of technological innovations and inadequate staff
training on risk management practices. Studies have indicated that many MFIs in the region are still reliant on manual processes for risk
assessment and management, which are prone to human error and inefficiencies (Wambua & Muriuki, 2020). This lack of modernization
not only hampers the efficiency of risk management but also increases the operational costs, thereby affecting the overall financial
performance of these institutions.
Moreover, market risks, including competition and regulatory changes, pose significant threats to the financial performance of MFIs in
Kenya. The region has seen a proliferation of financial service providers, including commercial banks and mobile money platforms,
which have encroached on the traditional customer base of MFIs. Without robust market risk management strategies, many MFIs find it
challenging to maintain their market share and profitability (Mwangi & Wanjiru, 2021). The cumulative effect of these challenges is a
declining financial performance, which threatens the long-term sustainability of MFIs in Kenya and their ability to fulfil their mission of
providing financial services to underserved populations.
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1.3 Objective of the study
The general purpose of the study was to investigate the impact of Risk Management Practices and Financial Performance of Licensed
Microfinance Institutions in Kenya.
1.4 Research Hypothesis
Risk management practices have no statistically significant relationship on financial performance of Licensed microfinance institutions in
Kenya.
II. Literature review
2.1 Theoretical literature
2.1.1 Risk Management Theory
The Risk Management Theory posits that organizations can mitigate risks and improve performance through structured risk management
processes (Hubbard, 2020). This theory is rooted in the premise that risks are inherent in all organizational operations, and their effective
management is critical for achieving financial and operational stability. It emphasizes a systematic approach to identifying, assessing,
prioritizing, and addressing risks to minimize potential negative impacts and maximize opportunities.
In the context of microfinance institutions (MFIs), the Risk Management Theory provides a framework for understanding the relationship
between risk management practices and financial performance. MFIs operate in environments characterized by high levels of uncertainty,
including credit defaults, market volatility, and liquidity challenges. By adopting structured risk management processes, MFIs can
anticipate and mitigate risks, thereby enhancing their financial sustainability (Shad et al., 2019).
The theory underpins the study's focus on credit, operational, market, and liquidity risk management practices as critical components
influencing the financial performance of MFIs. For instance, effective credit risk management ensures that MFIs maintain quality loan
portfolios by assessing borrowers’ creditworthiness and implementing robust repayment monitoring mechanisms. Similarly, operational
risk management minimizes disruptions caused by internal inefficiencies or fraud, while market risk management addresses fluctuations
in economic conditions that could impact lending activities (DuHadway et al., 2019).
Furthermore, liquidity risk management ensures that MFIs maintain sufficient cash flow to meet their financial obligations and
operational requirements. The systematic application of these practices, as advocated by the Risk Management Theory, fosters
organizational resilience, reduces financial losses, and supports long-term growth (Ahmed et al., 2018)s. In essence, the theory aligns
with the study's objectives by highlighting how structured risk management processes directly enhance the financial performance of
MFIs, thereby contributing to their sustainability and overall impact.
2.1.2 Resource-Based View (RBV) Theory
The Resource-Based View (RBV) Theory emphasizes that an organization’s resources and capabilities are fundamental for achieving
competitive advantage and superior performance (Alvarez & Barney, 2017). These resources, which must be valuable, rare, inimitable,
and non-substitutable (VRIN), form the basis of an organization’s strategic positioning and long-term success. The RBV Theory
underscores the role of internal capabilities in driving financial and operational performance (Mansourinia & Badsar, 2023).
In the context of microfinance institutions (MFIs), the implementation of effective risk management practices can be viewed as a critical
organizational resource. Risk management capabilities, including expertise in credit evaluation, advanced technological tools, and robust
internal control systems, provide MFIs with a competitive edge. These resources enable MFIs to navigate the complex financial
environment, manage uncertainties, and enhance their financial performance (Mansourinia & Badsar, 2023).
The RBV Theory also highlights the importance of leveraging intangible resources, such as organizational culture, employee expertise,
and leadership commitment to risk management. By embedding a culture of risk awareness and equipping staff with the necessary skills,
MFIs can strengthen their resilience and adaptability.
Moreover, this theory aligns with the study’s objective of analysing how credit risk management strategies contribute to the competitive
positioning of MFIs. Effective risk management practices not only mitigate potential losses but also enhance stakeholder confidence,
attract investments, and improve client retention. Thus, the RBV Theory provides a robust framework for understanding how MFIs’
internal resources and capabilities drive their financial sustainability and long-term success (Gichuhi, 2022).
2.3 Conceptual Framework
Figure 2.1: conceptual Framework
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III. Research Methodology
This study adopted quantitative research design on the impact of credit risk management practices on the financial performance of
microfinance institutions (MFIs). The target population was 126 senior and middle level management staff of 14 registered MFIs in
Kenya; from where Yamame’s sampling formula was applied to get a sample size of 112 respondents who were selected using simple
random sampling. Data was collected using structured questionnaires and computed using SPSS; where descriptive and inferential
statistics were generated.
IV. Results and discussion
4.1 Descriptive statistics: Risk Management Practices and Financial Performance of Licensed Microfinance Institutions in
Kenya.
Table 1
Statement
Mean
Std dev
Effective risk management practices are critical to the financial sustainability of microfinance institutions.
3.57
1.317
The adoption of risk mitigation strategies has enhanced our organization's competitive advantage.
3.69
1.246
Integrating risk management into strategic planning improves financial outcomes.
3.45
1.176
Regulatory compliance driven by risk management efforts positively impacts financial performance
3.62
1.132
Risk management practices have positively influenced our return on assets (ROA)
3.58
1.183
Overall mean
3.428
1.124
Source: Field Data
The data presented in Table 1 offers insights into the relationship between Risk Management Practices and Financial Performance of
Licensed Microfinance Institutions in Kenya. The analysis reveals a general agreement among respondents on the significance of these
practices, though the varying levels of agreement highlight areas of divergence.
Firstly, the statement that effective risk management practices are critical to financial sustainability recorded a mean score of 3.57 and a
standard deviation of 1.318. This indicates that respondents moderately agree with the importance of risk management in ensuring
sustainability, though the relatively high variability in responses suggests differing levels of experience or understanding among the
participants.
Similarly, the adoption of risk mitigation strategies enhancing competitive advantage garnered a mean score of 3.29, with a standard
deviation of 1.245. While the moderate mean reflects a general recognition of the benefits of these strategies, the variability points to
potential differences in how MSMEs implement or perceive their effectiveness in achieving a competitive edge. The integration of risk
management into strategic planning emerged as a particularly significant factor, with the highest mean score of 3.59 and a standard
deviation of 1.179. This finding underscores the critical role of embedding risk management into broader strategic objectives to drive
financial outcomes. It reflects a consensus that strategic planning processes benefit from incorporating risk considerations, leading to
enhanced organizational performance.
Regulatory compliance, driven by risk management efforts, was also viewed favorably, with a mean score of 3.37 and a standard
deviation of 1.136. This demonstrates that respondents appreciate the positive impact of compliance on financial performance, likely due
to the reduced risks of penalties and improved stakeholder confidence. The lower variability here suggests a more consistent
understanding of the link between compliance and financial success. Lastly, risk management practices’ influence on return on assets
(ROA) achieved a mean score of 3.32, with a standard deviation of 1.182. Respondents moderately agreed that such practices contribute
to improved ROA, though variability again indicates differing levels of perceived impact.
The overall mean score of 3.428 and standard deviation of 1.01 summarize the collective responses, suggesting general agreement on the
significance of risk management for financial performance while highlighting room for improvement and consistency in practice across
the sector. These findings align with existing literature. For instance, studies by Kaplan and Mikes (2014) highlight the importance of
integrating risk management into strategic planning, emphasizing its role in driving improved financial outcomes. Similarly, Ernst &
Young (2018) found that regulatory compliance not only mitigates risks but also enhances financial performance and organizational
reputation.
Table 4.2 Inferential statistics
Model Summary
Model
R
R Square
Adjusted R
Square
Std. Error of the
Estimate
Change Statistics
R Square Change
F Change
Sig. F Change
1
.815
a
.664
.661
.941
.664
89.921
.000
a. Predictors: (Constant), Credit risk management practices
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ANOVA
a
Model
Sum of Squares
df
Mean Square
F
Sig.
1
Regression
79.662
1
79.662
89.921
.000
b
Residual
80.618
91
.886
Total
160.280
92
a. Dependent Variable: Financial Management.
b. Predictors: (Constant), Credit risk management practices
The regression model indicates a strong positive relationship (R=0.705) between credit risk management practices and financial
management, with 66.4% (R
2
=0. of the variability in financial management explained by the model. The adjusted R
2
(66.4%) confirms
the model's robustness. The F-statistic of 89.921 and the associated p-value of .000 demonstrate that the model is highly significant,
suggesting that credit risk management practices are a critical predictor of financial management outcomes. The ANOVA table supports
these findings, with significant variability explained by the model and a small residual error (Mean Square Residual=0.886). Overall, the
results highlight the importance of credit risk management practices in driving financial management performance. Prior studies, such as
Nyamu (2019), focused on commercial banks, this analysis may extend the understanding of credit risk management to non-bank
financial institutions, highlighting its broader applicability. Unlike Muriuki and Waweru (2017), who found moderate correlations, this
study’s R=0.705 suggests that the impact of credit risk management on financial management could vary significantly across sectors or
regions.
V. Conclusion
The findings of this study underscore the critical role of credit risk management practices in enhancing financial management
performance. With a strong positive correlation (R=0.815) and nearly half of the variability in financial management (R
2
=66.4%)
explained by the model, it is evident that effective credit risk management significantly contributes to financial stability and efficiency.
The model’s statistical significance (p=0.000) highlights the robustness of this relationship, reinforcing the importance of prioritizing
credit risk mitigation strategies. These results are consistent with previous studies, which have consistently shown that organizations
implementing sound credit policies experience improved financial outcomes. This study adds to the growing body of evidence by
emphasizing the universal applicability of credit risk management practices across financial sectors and regions.
Ultimately, the research provides actionable insights for financial managers, policymakers, and stakeholders, emphasizing that robust
credit risk management is not merely a regulatory requirement but a strategic imperative for achieving sustainable financial performance.
VI. Recommendations
Based on the findings of the study, the following recommendations are proposed:
i. Enhance Risk Management Policies - Financial institutions should develop and implement robust credit risk management
policies, including comprehensive credit evaluation processes, continuous monitoring of credit exposures, and timely risk
mitigation measures. These practices will help to strengthen financial performance, as evidenced by the strong relationship
between credit risk management and financial management.
ii. Invest in Risk Management Training - Organizations should provide regular training for credit officers and financial managers
to improve their competency in identifying, assessing, and mitigating credit risks. Skilled personnel are better equipped to apply
advanced credit management techniques, ensuring effective risk control and enhanced financial outcomes.
iii. Leverage Technology in Risk Management - Institutions should adopt modern technological tools, such as predictive analytics
and credit scoring systems, to enhance the accuracy and efficiency of credit risk assessments. Technology-driven approaches can
reduce residual risks and improve decision-making, further bolstering financial management performance.
iv. Develop Comprehensive Risk Diversification Strategies - To mitigate the adverse effects of credit defaults, financial institutions
should diversify their credit portfolios across various sectors, geographic locations, and customer demographics. This reduces
exposure to concentrated risks and stabilizes financial performance.
v. Strengthen Regulatory Compliance - Financial institutions should ensure full compliance with regulatory frameworks governing
credit risk management. Adhering to established standards and best practices not only minimizes risk exposure but also
enhances stakeholder confidence and organizational sustainability.
vi. Encourage Continuous Research and Benchmarking - Financial institutions should regularly benchmark their credit risk
management practices against industry leaders and conduct research to identify emerging trends and challenges. Continuous
improvement ensures the alignment of practices with evolving market dynamics and enhances overall financial performance.
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