Effect of Debt to Equity Ratio on Financial Performance of Microfinance Institutions in Kenya

International Journal of Research and Scientific Innovation (IJRSI) | Volume VI, Issue VII, July 2019 | ISSN 2321–2705

Effect of Debt to Equity Ratio on Financial Performance of Microfinance Institutions in Kenya

Wycliffe Mugun, Scholastica A. Odhiambo, Gideon Momanyi

Department of Economics, Maseno University, Kenya

Abstract-Microfinance is the provision of a broad range of financial services such as deposits, loans, payment services, money transfers and insurance to the poor and low-income households and their micro enterprises. However, owing to the fact that there is limited literature on the determinants of financial performance, various studies conducted indicate divergent views on the effect of debt to equity ratio on financial performance. For this reasons it is not clear whether or not debt to equity ratio affect financial performance of microfinance institutions (MFIs) in Kenya. The main objective of the study was to investigate the effect of debt to equity ratio on financial performance of MFIs in Kenya. The specific objectives were to; find out the effect of debt to equity ratio, portfolio to assets ratio and operating expense ratio on the financial performance of MFIs in Kenya. Sample size consisted a panel data set of 12 MFIs selected using purposing sampling method for the period from 2009 to 2013 and secondary data was collected. Fixed effect model was the preferred model based on the Hausman specification but the study used random effect model since fixed effect model gave insignificant results. Random effect model results revealed that debt to equity ratio had a negative but insignificant relationship with return on assets ratio. Portfolio to assets ratio had a positive relationship with financial performance but the relationship was not significant. Operating expense ratio had negative and significant relationship with return to assets ratio. The coefficient for lagged return to assets ratio was 0.4733, debt to equity ratio was -0.0026, portfolio to assets ratio was 0.0090 and coefficient for operating expense ratio was -0.1857. P-values for DER was 0.878 , PAR, 0.686 and OER, 0.000. The study recommends that AMFI should conduct audit to ensure that all MFIs maintain a proper balance between debt and equity.

Keywords: Microfinance, Financial ratios, Financial performance, Kenya

I. INTRODUCTION

1.1 Concept and Scope of Micro Finance

According to Robinson, (1998) micro finance refers to the provision of a broad range of financial services such as; deposits, loans, payment services, money transfers and insurance products-to the poor and low income households for their micro enterprises and small businesses to enable them to raise their income levels and improve their living standards. Anan (2002) further elaborates this by describing the core principles of micro finance to include;

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