Empirical analysis on relationship between Liquidity risk management and financial performance of microfinance banks in Kenya

Liquidity management is necessary for all commercial Banks and microfinance banks (MFBs). Nevertheless, this is not an effortless task because managers must ensure that the bank is running in an efficient and profitable manner and in most cases there are high possibilities of mismatch of current assets and current liabilities during this process. If this happens and bank’s manager failed to manage it properly then it will affect bank’s growth and performance which will further lead to financial distress not only to the bank but also to the small enterprises that form the bulk of emerging economies. In Kenya, the microfinance banking subsector has been faced with liquidity risk management among other challenges. This necessitated the adoption of the Risk Based Supervision approach of supervising Microfinance banks in 2010. However, most MFBs are recording negative growth with level of profitability and sustainability of the sector dropping significantly with ROE and ROA reported at 8% and 1% respectively. In terms of solvency position, the microfinance sector shows a decreasing trend of capital adequacy ratio dropping from 22.8% as of Dec 2009 to 18.9% in 2013. Hence the major objective for this study was to establish the relationship between liquidity risk management and financial performance of Microfinance banks in Kenya. Specific objectives were: to establish the relationship between Financial gap ratio (FGR) and performance of MFBs and to determine the relationship between Capital adequacy ratio (CAR) and performance of MFBs. Longitudinal research design utilizing panel data covering the period from 2011 to 2015 was used. Target population comprised 12 licensed MFBs. Purposive sampling was used to obtain a sample of 6 MFBs. Document analysis guide was used to gather secondary quantitative data from the MFBs financial reports. Descriptive statistics were used to show the trend of MFB risk exposure and performance. Pearson correlation was used to determine strength and association among variables. Panel data analysis based on system GMM technique was used to estimate a multiple regression model and test for significance of relationship between Liquidity Risk management and financial performance. The findings were that Liquidity risk management with FGR and CAR parameters had a strong Positive correlation (r=0.45), giving a significant negative relationship with both ROAA and ROAE performance measures as depicted by regression coefficient of 0.3 estimated by GMM. Thus, the study concluded the existence of a significant relationship Liquidity risk management and performance and that liquidity risk management impacts positively on performance of MFBs. The study recommended establishment of a funding strategy that provides effective diversification in the sources and tenor of funding and regularly gauge its capacity to raise funds quickly from each source. Also Finance managers to identify the main factors that affect MFBs ability to raise funds and monitor those factors closely to ensure that estimates of fund raising capacity remain valid. Keywords: Liquidity risk, Microfinance banks and Performance