Influence of Credit Risk on the Growth of Microfinance Organizations in Eldoret Municipality (Kenya)


Research Paper (postgraduate), 2018
17 Pages

Excerpt

Contents

Abstract

1. Introduction

2. Methodology
2.1. Description of Study Area
2.2. Method and Sources of Data Collection
2.3. Data Analysis

3. Result and Discussion

4. Conclusion and Recommendation

REFERENCES

Abstract

The Microfinance Institutions (MFIs) lend small amounts of unsecured loans to poor clients which signify their objectives of improving the social status of the poor while also trying to maximize their returns. Yet, lending by MFIs is a risky venture especially in developing countries because of the susceptibility of their poor clients. This study therefore determined the extent at which strategic credit risk management affect growth of MFIs in the Eldoret Municipality, Kenya. This study used probability clustered random sampling of 12 MFIs in Eldoret municipality to collect primary data and various reports and published work on MFIs between 2010 to 2015 formed the basis of secondary data. The effect of loan default, risk coverage and credit policy on growth of MFIs was measured by profit and outreach respectively. The relationship between of loan default, risk coverage and credit policy and growth was measured using multiple linear regression models. Hausmann test of endogeneity was employed to validate the results. We demonstrate that profit was significantly (p < 0.05) positively correlated with credit policy but negatively correlated with default and risk coverage. Meanwhile outreach showed a significant (p < 0.05) negative correlation with loan default and risk coverage but no relationship with credit policy. Thus credit risk was an obstacle to the sustainable growth of MFIs in both profit and breadth of outreach. As a result proactive strategies like enhanced management information system, effective internal control and redesigning of suitable customers’ oriented products should be considered.

Keywords: microfinance, financial inaccessibility, joint liability, outreach, credit risk, credit policy culture

1. Introduction

Business enterprises operate to maximize their profits as they aspire to minimize loses [1]. Many financial institutions such as banks, non-banks and organizations lend to customers focusing on making profits through the interest charged on the borrowed capital. Since many lower income borrowers are viewed to repay less nominal interests and therefore very little profit to the financial institutions, there is always a tendency to neglect their welfare needs of the lower income brackets [2]. This has witnessed the scenes of conservative banks and/or formal financial institutions to leave out the low income brackets from accessing loan facilities [3]. Several researchers have pointed out that the main reasons why the low income borrowers are excluded include: absence of credit history which banks will use as primary data for lending, lack of any collateral, especially land, to compensate in case of default and lastly it is difficult to determine the credit worthiness of these poor people since they deal with little amounts of money making it also very tedious to monitor them [4].

In 2015, about 10% of the people lived below the poverty line defined as living on less than US$ 1.90 a day [5]. Most of the poor people always living below the poverty line and in some instance extreme poor people live in the Sub Saharan Africa [SSA) [5]. In fact the population living below the poverty line in SSA is more than all the other regions combined. Recently most of the rural population has been migrating to the urban areas, not only increasing the urban population but also the urban poverty [6-9]. IN the past majority of the rural dwellers were poor, uneducated, with mostly employed in the agricultural sector. In urban areas of SSA, the situation is not different only that there are very few employed in the agricultural sector, but most find some form of jobs in the informal sector such as in the Micro and Small Enterprises (MSEs). (MSEs) that is more widespread in many urban areas in the SSA [9-12]. Yet for many of the entrepreneurs in the small business segments, accessing finance among the poor is becoming a fundamental challenge [12-14].

Access to financial credit in Kenyan among the lower income brackets have been limited and are mostly through informal or semi-formal financial Microfinance institutions [15-17]. Yet the Microfinance Institution (MFIs) also seems to share the same danger as the main formal banking institutions because of the vulnerability of their poor clients [18]. This has made the lending capacity of these MFIs to be unstable and risky venture. Many of the MFIs try to solve the problem by putting in place adequate systems for credit assessment and evaluating the risks associated therewith. As MFIs move into a new high powered world of financial operations and trading, with new risks and more difficulty in assessing asymmetric information, there is a need for sophisticated and versatile instruments for risk assessment, monitoring, and controlling risk exposures in a more scientific manner. Credit risk remains the most important risk to manage till date. [20]

Microfinance customers constitutes sub-prime markets and can be described as constituting the greater part of the population pyramid and are characterized by little or no financial means, poor credit history, low incomes, unreliable borrowers, subsistence activities and high possibility of going bankrupt. According to [21], financial service delivery has witnessed a significant change the world over in the 21st century as compared to the 19th century, especially following the deregulation of their operations. As a result they have diversified into new areas such as microcredit, estate agency, women related activities and unsecured lending. The development of a healthy national financial system is an important goal and catalyst for the broader goal of national economic development. [22] Stressed those countries with very many small and medium-sized enterprises prefer retail banking services although with an increased operating cost.

However this assertion confirms the fact that banked-liked institutions like microfinance institutions (MFIs) render better services in countries with high rates of small and medium sized enterprises that serve the needs of the vulnerable population. Contrary to this view, [23] argued that countries with a higher share of industries; with small firms relative to industries with large firms have a higher relative cost of market finance because they have a relatively high population of vulnerable customers for their products. As such they are exposed to more financing frictions than those with large firms. Although much progress has been made in serving this population, the problem has not been completely solved, and the overwhelming majority of people who earn less than $2 a day, especially in the rural areas, [6-8, and 24]. Most poor people find it difficult to mobilize resources to develop their business enterprises and provide their immediate needs which included feeding, housing, school fees and medical care. Accessible financial services could enable the poor to leverage their initiative and creativity, accelerating the process of building incomes, assets and economic security Kenyan banking sector, inclusive of MFIs, witnessed some growth which could be measured through increase in profit, outreach, and customers. This growth was not sustained as they started to experience some crisis characterized by instability. The result could be seen with so many banks and MFIs going bankrupt and Ministry of finance closing down about 82 MFIs between 2014 and 2015, The number of MFIs dropped from 645 in 2011 to 418 in 2015 [25]. The poor performance of these financial institutions could be traced to the poor handling of financial services and high vulnerability to shocks like credit risk and capital inadequacy. This study intends to find answers to the following research questions: To what extent does strategic credit risk management sustains the growth of micro-finance institutions and ease financial accessibility by the poor in Kenyan? What are the main causes of delinquency and default in MFIs in Kenyan? Is there a relationship between outstanding loans and profit of the institutions?

However, given the aforementioned, the paper is set out to identify and examine the impact of credit risk management strategies on the growth sustainability of microfinance institutions in facilitating financial accessibility in the Buea municipality and Kenyan in general. Specifically this paper wants to investigate; The effect of default and risk coverage on profit in microfinance institutions within Buea municipality, identify the causes of loan delinquency and default in MFIs, and it also seek to assess the effect of credit culture on delinquency and default of MFIs.

2. Methodology

2.1. Description of Study Area

The study was carried out in the South West Region of Kenyan, precisely in Buea subdivision with a population of 120000 inhabitants [27]. It has all the characteristics of the entire south west region and is the administrative headquarters of the region and has many branches of MFIs in all categories. The scope was limited to this region because of the vast nature of the area couple with limited financial means and also due to it advantage of having all categories of MFIs. Buea subdivision has a diverse population structure, made up of both urban poor and the suburban poor, mostly students and farmers. Also a greater part of the urban population is engaged in petty trading activities mostly carried out by women

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Excerpt out of 17 pages

Details

Title
Influence of Credit Risk on the Growth of Microfinance Organizations in Eldoret Municipality (Kenya)
College
Moi University  (Moi University, Kenya; Department of Accounting and Finance)
Author
Year
2018
Pages
17
Catalog Number
V427210
ISBN (eBook)
9783668714267
ISBN (Book)
9783668714274
File size
586 KB
Language
English
Tags
microfinance, financial inaccessibility, joint liability, outreach, credit risk, credit policy culture
Quote paper
Irene Cheptumo (Author), 2018, Influence of Credit Risk on the Growth of Microfinance Organizations in Eldoret Municipality (Kenya), Munich, GRIN Verlag, https://www.grin.com/document/427210

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