International Journal of Scientific and Education Research

Vol. 2, No. 04; 2018

http://ijsernet.org/

CREDIT MANAGEMENT PRACTICES AND FINANCIAL

PERFORMANCE OF MICROFINANCE INSTITUTIONS IN NAIROBI
CENTRAL BUSINESS DISTRICT, KENYA
Kipkirui Edwin, MBA1
&
Job Omagwa, PhD2
1
MBA Student (Kenyatta University, Kenya)-email:kipkiruiedwin26@gmail.com
2
Department of Accounting & Finance, School of Business- Kenyatta University, Kenya-
email:omagwa.job@ku.ac.ke

ABSTRACT
The link between credit management practices and financial performance remains unclear
especially in the Microfinance Sector in Kenya. Though there are studies on performance of
MFIs in Kenya, few have sought to explain the same in view of credit management practices.
Much of the available local empirical literature is in the banking context. Hence, this remains an
area of empirical interest: this formed the motivation of the study. The study sought to determine
the effect of credit management practices (client appraisal, credit risk, collection policy, and
credit terms) on financial performance of MFIs in Nairobi Central Business District, Kenya. A
descriptive survey design was adopted for the study; the target population comprised of 165
members of staff of the MFIs studied. Primary data was collected using questionnaires.
Purposive sampling was used to pick 165 respondents. Of the 165 questionnaires dispatched, 158
were filled and returned. Descriptive analysis and multiple regression analysis were used to
analyze data. The study found that credit risk control, client appraisal, collection policy and
terms of credit were all statistically significant in explaining financial performance of the MFIs
studied. The study further established that credit risk control, client appraisal, collection policy
and terms of credit had a positive relationship with financial performance. The study concludes
that unit increase in credit risk control, client appraisal, and collection policy and terms of credit
results to better financial performance of MFIs. Hence, the MFIs should endeavour to invest
more on the credit management practices as a way of improving their financial performance. The
study’s contribution to knowledge was equally highlighted.
Key words: Capital Adequacy, Client appraisal, Client Capacity, Collection policy, Credit
period and Credit risk.

I. Introduction and Background

Herrmann (2008) indicates that when seeking improved operational performance and
profitability, firms are seeking ways to improve their performance in operations in a bid to
increase profitability competition has risen up as new technologies and new firm structures crop

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up. This has made firms seek new ways of lowering their operational costs to improve their
profitability. In the same way, micro finance institutions financial performance is determined in
terms of the profitability and their return on investment. Herrmann (2008) contends that firm
profitability is usually determined by the organization earnings compared to its sales/owners and
assets investment or the value in shares. This leads to common measures of profitability
including return on equity (ROE), Income statements, Earnings per share (EPS), Return on total
assets (ROA) and Price/Earnings ratio or P/E ratio.
Credit management is an essential process for any firm that engages in the business of credit.
The process when done in the right manner ensures that the customer pays on services delivered.
According to Myers and Berkley (2013) credit management practices are the strategies used by
an organization to ensure that the level of credit in the firm is acceptable and it is managed
effectively. It is part of financial management that comprises of the analysis of credit, rating of
credit, classification and reporting of credit. Nelson (2012) defines credit management as the
practices used by an organization to manage the sales they make on credit. It is an essential
practice for all the organizations that have credit transactions since some have managed their
credit activities so well that they have zero credit risk.
Credit management is the strategies one uses to collect and control credit payments from clients.
Myers and Berkley (2013) define these practices as the strategies that organizations use to have
an acceptable level of credit and to manage this level effectively. It is part of financial
management that comprises of the analysis of credit, rating of credit, classification and reporting
of credit. When credit management is done right, then the capital with debtors reduces and the
possibility of bad debts is also reduced. Edwards (2013) contends that if you are a business and
you have not included into your selling price any costs associated with late payment or you have
a way of recovering the costs by charging an interest, then your profits is bound to be affected by
such costs. Some firms are tempted to provide credit when they think of the possibility of
increased business operations. However, businesses have to be certain that there will be more
revenue from the high sales that will outweigh the cost of credit to avoid losses.
In order to ensure better performance, MFIs are seeking to become commercial entities and are
seeking to improve their profitability. Thus it is likely that those MFIs that are self-sufficient will
not be providing the most expensive or the smallest loans to the prior people (Woodcock, 2009).
According to the Kenyan Central Bank Supervision Annual Report (2016), the net loan portfolio
in the MFI sector increased by 13.3% however, there was a decrease before tax that decreased by
19% between 2014 and 2015. The decrease in profits was as a result of more provisions for loans
that were none performing which are a credit risk in itself. According to AMFI (2016), the
quality of portfolio seems to be the most pressing issues since in 2013 59.3% of the respondents
agreed that credit risk was at the top or the second top risk of the banking sector.

II. Statement of the Problem

The relationship between credit management practices and financial performance of MFIs in
Kenya is largely unclear, and inconclusive. The available empirical work has largely dwelt on
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financial performance without attributing the same to credit management yet this is the core of
MFIs. The increased number of MFIs leads to higher forms of credit risks due to the use of credit
standards, credit analysis and appraisal and credit control as the firms seek to use the proper
practices in credit management (Mathara, 2011). However the issue of loan delinquency is still a
challenge for many of these firms even if they have tried to follow credit guidelines and policies
and tried to lend prudently (Mathara, 2011). According to the MFIs quarterly financial report
there is an increase in the loan default rate (16%) and the non performing rate increased by 15%
from Sh70.3 billion in March 2016 to Sh77.3 billion in 2017 which is as a result of the practices
used for credit management in the sector among other factors (CBK, 2017). Such a trend is a
threat to the sustainability of the institutions and also prevents them from achieving their
mandate which they sought to meet when they were formed. These include the provision of
quality loans and providing services that could satisfy the needs of those that could not afford to
get loans from the traditional financial firms (Parrenas, 2015).
The success of Micro Finance Institutions more often is dependent on the effectiveness of credit
management which improves the repayment rates and leads to higher profits (Sifunjo & Simiyu,
2014). The Kenyan MFIs use various credit management practices, policies, regulatory and
credit scoring systems. However, despite taking these measures the institutions still have high
default rates (16%) that have a negative effect on the firm’s financial performance (Muteru,
2016). Ayodele, Thomas, Raphael and Ajayi (2014) studied the impact of credit policy on the
performance of Nigerian Commercial Banks and found that, a good credit policy is important for
any organization as it helps reduce bad debts.Owizy (2013) assessed the impact of credit
management on financial performance of Nigerian banks,with particular reference to UBA Plc.
The study found that the practices used in credit management significantly affected the Nigerian
banks profitability. Muturi (2016) assessed the effect of credit management practices on loan
performance in deposit taking microfinance banks in Kenya and found that credit collection
policies, terms of credit, the standards of credit and the credit policies used had an effect on the
performance of the institutions. Although the MFIs are known to adopt credit management
practices, very few studies (Simiyu, 2008; Owizy, 2013; Muturi, 2016) have been done on this
area. Despite the few empirical studies in this era, there is increased need to evaluate the
relationship between credit management practices and financial performance especially in the
context of MFIs in Nairobi CBD, Kenya. This was a good basis for the current study. Hence, the
current research sought to determine the effect of credit management practices on financial
performance of MFIs in Nairobi CBD, Kenya.

III. Objectives of the Study

The specific objectives of the study were:
i. To determine the effect of client appraisal on financial performance of microfinance
institutions in Nairobi Central Business District, Kenya

ii. To establish the effect of credit risk control on financial performance of microfinance
institutions in Nairobi Central Business District, Kenya
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iii. To determine the effect of collection policy on financial performance of microfinance

institutions in Nairobi Central Business District, Kenya

iv. To assess the effect of terms of credit on financial performance of microfinance institutions in
Nairobi Central Business District, Kenya

*Null hypotheses were formulated and tested (at a significance level of 0.05) in regards to
each respective specific objective.
IV. Significance of the Study
The study outcome will be of significance to various stakeholders. Academicians and researchers
will use the findings to consider further research in areas that the study found unique.
Researchers will also use the empirical studies found in the current study for their research. The
research will equally use the study to enrich the body of knowledge in the finance discipline and
bridge the gap existing in the study of credit management; the current study will make
contributions to improve the practice and the existing knowledge on financial performance and
credit knowledge.
From a theoretical view point, the study provides a comprehensive framework of looking sat the
changes occurring in credit management and financial performance. The study will also assist
policy makers to make better policies in the sector. The findings in this study would be of great
help to those firms under study and to others in the financial sector. Even the organizations from
other sectors may greatly benefit from the research results since the findings will help firms in all
sectors reorganize their credit management policies and to critically review their operations so as
to come up with better processes of dealing with credit systems.

V. Review of Literature
The study reviewed relevant theories and empirical literature as captured hereunder.

A. Theoretical Review
The section highlights four theories that the study is anchored upon. They include: asymmetric
information theory, transaction cost theory, portfolio theory and loan able funds theory. This
theory was proposed by Swedish economist Knut Wicksell (1851-1926). It major assumption is
that the demand for loans and supply of credit determine the credit interest rates. Another
assumption of the theory is that there is an inverse relationship between interest rates and loan
able funds. In case there is a change in the supply and demand of credit then the rate of interest
will be determined by the movement of the demand and supply curve of the credit. The theory
explains that the demand of credit comes from foreign borrowers, consumers, domestic
borrowers and government. The supply (on the other hand) is from domestic savings and from
money created from foreign lending and from the banking sector. These are the factors that affect
interest rates in the long term however in the short term, interest rates are determining by the
economy’s monetary and financial conditions (Gorder, 2009). This theory will be used in the

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study to explain the effect of client appraisal on financial performance of microfinance

institutions.

The asymmetric information theory was first explained by Akerlof’s in the 1970. The theory
explains that information asymmetry exists when banking lending applications are being
assessed (Binks & Ennew, 1997). This theory explains when important information is unknown
to every party involved in a transaction (Ekumah & Essel, 2003). Espy (2005) explains the
condition whereby the parties that are part of transaction are not aware of all the important facts.
The theory explain that when information asymmetry is perceived then financial institutions have
two core challenges including moral hazard, in the monitoring of the behaviour of the
entrepreneur and adverse selection whereby the firm makes errors as it lends to the wrong
people. Transaction cost theory provides an important framework that is used to make decisions
that are in regard to the organizations vertical boundaries. Williamson (2000), points out that
transaction happens if a service or good is transferred across technologically separable interfaces.
When one activity ends another commences. This theory was first explained by Schwartz (1974),
whereby according to him, suppliers have an upper hand compared to lenders as they can get
information on the credit worthiness of their customers. Suppliers are also able to monitor and
ensure full payment of debts by their customers. These advantages give suppliers an advantage in
terms of cost compared to traditional lenders.
Portfolio theory first came up in the 1950s to early 1970s and was seen as an advancement in the
mathematical modelling of finance. From its development there have been numerous practical
and theoretical criticisms against the theory. One of these is that financial returns are not based
on a Gaussian distribution or any symmetrical distribution for that matter (Michael & Sproul,
1998). Portfolio theory models assets return as elliptically distributed or a normally distributed
portfolio, the risk is defined as the standard deviation of return and the portfolio is modelled as a
combination of weighted assets such that the portfolio return is a weighted combination of assets
returns. Different assets are combined that do not have a perfectly positively correlated returns
which allows the theory to reduce the portfolio return variance. The theory further assumes that
the market is efficient and the investors are able to make rational decisions (Sharpe, 1964).

B. Empirical Review
The study reviewed several empirical studies which were related to the variables under study.
Gizaw, Kebede and Selvaraj (2015) examined the impact of credit risk on profitability of
commercial banks in Ethiopia. The study objective was to look into how credit risk affected the
profitability of Ethiopian commercial banks. The data obtained for the study was obtained from 8
sample commercial banks for a period of 12 years (2003-2014) from annual reports of the
different banks and National Bank of Ethiopia. Descriptive statistics and panel data regression
was used for data analysis. According to the research findings, loan loss provisions, non-
performing loans, credit risk measures and inadequacy in capital affected the commercial banks
profitability in Ethiopia.

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Byusa and Nkusi (2012) investigated the effects of credit policy on bank performance in selected
Rwandan Commercial banks. The objective of the research was to look into how credit policy
affected the performance of the commercial banks selected. According to the findings the banks
selected had an increase in their accounts and account base while there was an improvement in
their financial indices which increased their profits. There was competition in the banking sector
which increased spreads. The high spreads and a high interest rate margin is evidence of
inefficiency and poor competition. Djankov, McLiesh and Shleifer (2007),studied the effects of
credit management on loan repayment in private credit in 129 countries in Eastern Europe, the
managers in the finance department were interviewed and an analysis of the data was done by
use of descriptive statistics. According to the conclusion of the study, credit management
practices facilitated payment of loan.
Muturi (2016) assessed the effect of credit management practices on loan performance in deposit
taking microfinance banks in Kenya. This study sought to find out how credit management
affected loan repayment. A descriptive research method was used. Analysis of the primary data
was done using standard deviation and mean. The researcher also used inferential statistics with
the help of linear regression models. The model established the effect credit risk management
had on the repayment of loans. From the findings, the study found that the terms of credit, credit
standards, collection policy and credit policy had an effect on the performance of the firms.
According to the study findings, the proper credit management system is an essential party of
any firm and cannot be ignored by any firm that deals with credit services. Proper Credit
management increases the profitability and stability of a firm.
Moti (2012) studied the effectiveness of credit management system on loan performance:
empirical evidence from microfinance sector in Kenya. The goal of the research was to
determine how effective credit management was on the performance of loan in MFIs. The
specific goals was to determine the effect of control measures, credit terms, credit risk, credit
collection policies and credit appraisal on the performance of loans. The study used a descriptive
research method. The respondents who provided the data were officers who worked at MFIs in
Meru. The findings showed that the collection policy highly affected the repayment of loans with
=12.74, P=0.000 at 5% significance level.
Pyle (2013) studied the bank risk management and identified that the banks among other
financial firms need to meet the requirement for management of their risks and capital. However
this was not the only essential requirement for the firms to establish proper system for risk
management. It was also recommended that managers needed to give proper insights on the best
places to direct the firm’s resources where the best rewards could be obtained. The managers
were required to estimate the accurate possible loses of each of the risk so that they could stay
within the limits of the firm’s capital. They were required to seek mechanisms that could enable
them take the required risks by individuals and the different departments.
Owizy (2013) examined management of credit impact on financial performance of Nigerian
banks, the case of UBA Plc. Banks annual reports provided the secondary data which was

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obtained from sampled and accounts for three years 2004-2008. For data analysis regression,
descriptive and correlation methods were used. According to the results management of credit
did affect Nigerian banks profitability.
Mwangi (2010) investigated on factors that affect MFIs credit risk management practices in
Kenya. The study’s specific objectives included how portfolio quality, market infrastructure and
market concentration affected the credit risks of MFIs. According to the study results the three
factors did affected credit risk of MFIs. Nyakeri (2012) carried out a research on how practices
relating to management of credit affects financial performance in SACCOS in Nairobi .The
research specific objectives included the effect of credit approval process, loan portfolio, credit
score and the Risk analysis on the profitability of the MFIs. According to the findings the credit
risk analysis improved the firm’s profitability, loan portfolio and returns of the MFIs.
Nagarajan (2011) assessed the risk management for MFIs in Mozambique concluded that the
process of managing risks is ever changing and could be developed and tested when risk
occurred. The processes need to consider the commitment of all the firm stakeholders for it to be
planned and executed properly. An encouraging finding was that minimizing losses was possible
by managing cash flow properly management of cash flows and portfolios, by coming up with
robust institutional infrastructure, use of skilled employees and insisting of client discipline and
effectively coordinating the stakeholders.

VI. Methodology
The section provides an overview of the key methodology adopted for the study. The research
used a descriptive survey design. The target population is usually characterized by differing traits
and is sometimes referred to as theoretical population. In view of Association of Microfinance
Institutions (2016), there are 55 MFIs in Nairobi Central Business District, Kenya. The study
adopted a census of all the 55 MFIs. In particular, the study selected 3 respondents from each of
the 55 MFIs hence a target population of 165. In particular, these were: credit managers, finance
managers and credit officers in the microfinance institutions in Nairobi Central Business District
that is one credit manager, one finance manager and one credit officer in the MFIs to be studied.
Purposive sample was used to pick respondents who were credit managers, finance managers and
credit officers.

The study used questionnaire for purposes of primary data collection. Questionnaires were
administered using drop-and-pick-later method. Data was analyzed using descriptive analysis
(mean, frequencies and standard deviation) and multiple regression analysis. Tests for normality,
mutlicollinearity and heteroscedasticity were conducted to ensure that data was suitable for
purposes of regression analysis. The results on the 3 tests were in the affirmative. Output was
presented in tables and graphs. SPSS software was used to aid data analysis.
The regression model is presented below:
Y= β0+ β1X1+β2X2+ β3X3+ β4X4+ ε

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Where:
Y = Financial Performance, β0 = constant, β1, - β4 = Coefficients, X1 = Client appraisal, X2 =
Credit risk control, X3 = Collection Policy X4 = Terms of Credit.

VII. Results and Findings

The study administered 165 questionnaires out of which 158 were filled and returned. This
constituted a 96% response rate. Data analysis, interpretation and discussion are presented
hereunder.

A. Descriptive Analysis
The first objective of the research study was to determine the effect of client appraisal on
financial performance of MFIs in Nairobi CBD. Results are shown in table 1

Table 1: Effect of Client Appraisal on Financial Performance

Disagree

Disagree
Strongly

Strongly
Statements

Neutral

Agree

Agree

Mean

Dev.
Std.
Appraisal of client is a useful strategy for 9 26 22 77 24 3.5127 1.11010
credit management.
Personnel of Microfinance Institutions are 11 26 14 61 46 3.6646 1.24977
competent for performing appraisal of clients.
Client appraisal puts into consideration the 14 18 15 48 63 3.8101 1.31213
personality of the customers looking for
facilities to offer credit.
Collateral aspects are put into consideration 10 16 30 42 60 3.7975 1.22998
while carrying out client appraisal.
Loan defaults can emerge in the instances 14 16 29 62 37 3.5823 1.20622
when customer’s capacity is not assessed
Appraisal of client examines on customer’s 17 16 33 48 44 3.5443 1.28982
ability to fulfil his financial obligations.

Source: Research Data, 2018

From the results presented in table 1 above, the study established that mean values of range 0.5
to 2.4 indicate disagreement, 2.5 to 3.4 indicate neither agreeing nor disagreeing results, and 3.5
to 4.4 indicate agreement. From the results in table 4.2 above the mean values are between 3.5 to
4.4 therefore, the respondents agreed that appraisal of client is a useful strategy for credit

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management, personnel of Microfinance Institutions are competent for performing appraisal of

clients, client appraisal puts into consideration the personality of the customers looking for
facilities to offer credit, collateral aspects are put into consideration while carrying out client
appraisal, loan defaults can emerge in the instances when customer’s capacity is not assessed and
appraisal of client examines on customer’s ability to fulfil his financial obligations.
Inkumbi (2009) contends that capital or equity and the security provided by the borrower as the
major challenges entrepreneurs face when they want to get capital. This is so common especially
for those starting out in business or those who lack sources of capital or assets that they can
provide as collateral to lenders. Efforts taken up to address the challenges existing in access to
finance should look into the challenge that entrepreneurs face when trying to access capital or
collateral required by most financial institutions. A collateral is one of the most used ways to
guarantee that the borrower will pay and if not the collateral can be used as security.
The second objective of the study was to establish the effect of credit risk control on financial
performance of microfinance institutions in Nairobi Central Business District. Results are as
shown in table 2 below.

Table 2: Effect of Credit Risk Control on Financial Performance

Std. Devi
Statements
Disagree
Disagree
Strongly

Strongly
Neutral

Mean
agree

agree
A useful strategy in improving organization 11 11 23 55 58 3.8734 1.18770
performance is to impose limits on loan size
Enhancing performance of an organization 7 12 22 48 69 4.0127 1.13422
can be achieved by use of credit checks on
regular basis.
Loan repayment can be improved through 9 15 19 77 38 3.7595 1.09678
Flexible repayment periods.

Customers get committed when Penalty for 5 18 18 71 46 3.8544 1.06374

late payment is introduced.
By using customer credit application forms 8 15 18 46 71 3.9937 1.18642
there is improvement in monitoring and
management of credit as well
involvement of credit committees in making 11 18 16 81 32 3.6646 1.13211
decisions concerning controls of credit risk

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are important in minimizing default

performance of MFI is affected by interest 7 16 25 32 78 4.0000 1.21036
rates charged on loans affect

Source: Research Data, 2018

In view of the results in table 2 above, The study established that credit checks on regular basis
enhances organization performance, interest rates charged on loans affect performance of MFI,
the use of customer credit application forms improves monitoring and credit management as
well, imposing loan size limits is a viable strategy in improving organization performance,
penalty for late payment enhances customers commitment to loan repayment, flexible repayment
periods improve loan repayment and credit committees involvement in making decisions
regarding credit risk controls are essential in reducing default/credit risk. Essential credit controls
used include loan product design, delinquency management and credit committees (Churchill &
Coster, 2011).
The third objective of the study was to determine the effect of collection policy on financial
performance of microfinance institutions in Nairobi Central Business District. The results are as
shown in table 3 below.

Table 3: Effect Collection Policy on Financial Performance

Statements
Disagree
Disagree
Strongly

Strongly

Std. Dev
Neutral

Agree

Agree
Mean

Collection policies available have helped 9 14 17 93 25 3.7025 1.02522

in effective management of credit
practices.
Microfinance institutions have been facing 7 16 20 68 47 3.8354 1.09928
a challenge in the formulation of policies
regarding collection.
implementation of guarantee policies gives 11 14 27 50 56 3.7975 1.21435
a chances to recover loan in case in the
instance of defaulters
In the process of improving recovery of 6 19 18 106 9 3.5886 .91087
delinquent loans, an effective way is staff

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incentives.
To better the state of management of 8 11 15 77 47 3.9114 1.06106
credit, reviews concerning collection
policies have been done on a regular basis.
A strict policy is effectual in recovery of 4 15 23 71 45 3.8734 1.01413
debt compared to a moderate policy

Source: Research Data, 2018

The results in table 3 above indicate that regular reviews have been done on collection policies
to improve state of credit management, a stringent policy is more effective in debt recovery than
a lenient policy, formulation of collection policies have been a challenge to the microfinance
institutions, enforcement of guarantee policies provides chances for loan recovery in case of loan
defaults, available collection policies have assisted towards effective credit management
practices and staff incentives are effective in improving recovery of delinquent loans. Many
financial firms send letters to clients who do not pay on time for instance after ten days pass after
the payment date. Others will call but if the money is not provided within thirty days then the
details of the borrower might be given to a collection firm.
This kind of policy is important for those who might not be in a hurry to make their payments on
time or those who have a history of not paying (Stiglitz & Weiss, 1981). Therefore such efforts
quicken the payments from slow payers and reduce the bad debts. Payments when made in time
increase cash flow and keep the bad debts at manageable levels. However the policy should not
have extreme practices especially to loyal customers as they might seek alternatives (Padilla &
Pagano, 2000).
The final objective of this research study was to assess the effect of terms of credit on financial
performance of microfinance institutions in Nairobi Central Business District, Kenya. The
findings are as shown in table 4 below.

Table 4: Effect Terms of Credit on Financial Performance

Statements
Disagree

Disagree
Strongly

Strongly

Std. Dev
Neutral

Agree

Agree

Mean

Credit terms specifies the credit period 8 11 15 78 46 3.9051 1.05751

given to customers.

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10 9 17 59 63 3.9873 1.14540
Credit terms specify the interest rates
charged on the loans advanced to
customers.

Terms of credit include the period of 5 13 19 50 71 4.0696 1.08913

time for loans approval.
Credit terms are assessed by client’s 8 14 12 76 48 3.8987 1.08956
position according to the ratio analysis.
Credit terms are evaluated by the trends 12 12 12 58 64 3.9494 1.21455
in cash flow.

Credit terms are evaluated by the looking 4 13 11 65 65 4.1013 1.01699

at capital position.
Credit terms are important in ensuring 7 13 16 64 58 3.9684 1.09673
that customers do not default their loan
repayment.

Source: Research Data, 2018

In view of the results presented in table 4 above, the study established that credit terms are
evaluated by the looking at capital position, credit terms include the length of time to approve
loans, credit terms specify the interest rates charged on the loans advanced to customers, credit
terms are important in ensuring that customers do not default their loan repayment, credit terms
are evaluated by the trends in cash flow, credit terms specifies the credit period given to
customers and credit terms are evaluated by the position of the client as indicated by the ratio
analysis.
Riach (2010) indicates that terms of credit are usually determined by the instrument used to
advance credit, credit period terms of discount and the credit amount. The terms can be the
length of time taken to approve the loan which is the time taken since a customer applies a loan
to when it is disbursed. It is affected by ratio analysis, capital position and availability of cash
flow. Another credit term factor is the loan maturity which is the duration it takes for the loan
and its interest to mature. Cost of the loan is yet another factor. This is the interest that the loan
attracts. Different financial institutions charge different rates depending on their competitor’s
interest rates (Padilla & Pagano, 2000).

Table 5: Credit management practices, Competition, Regulatory framework and financial

performance

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Statements

Std. Dev.
Disagree

Disagree
Strongly

Strongly
Neutral

Mean
agree

agree
Competition has a significant effect on 9 14 18 67 50 3.8544 1.13332
the relationship between client
appraisal and financial performance

Regulatory framework has a significant 10 18 14 54 62 3.8861 1.22591

effect on the association of appraisal of
clients financial performance

Source: Research Data, 2018

The output in table 5 above indicates that regulatory framework has a significant effect on the
relationship between client appraisal and financial performance and competition has a significant
effect on the relationship between client appraisal and financial performance. The management
of credit starts when the sale is done and it becomes complete when the total payment is made.
The payment part is just as important as the sale (Scheufler, 2012). What’s more, a sale is only
successful when the payment is done. It is therefore paramount that the lender will ensure that
the person he lends to is able to make timely and full payments otherwise failure to follow such
good principles of lending results to defaults which reduces profits (Nzotta, 2004).

B Regression Analysis
The study used multiple regression analysis to further analyze the data. Model summary is used
to analyse the variation of dependent variable due to the changes of independent variables. The
study analyzed the variations of financial performance of MFIs due to client appraisal, credit risk
control, collection policy and terms of credit.

Table 6: Model Summary

Model R R Square Adjusted R Square Std. Error of the Estimate

1 .990a .981 .981 .16286

Source: Research Data, 2018

From the results in table 6 above, the simple correlation coefficient (r) indicates the nature and
strength of relationship between the study variables. The study finds a strong positive
relationship between the study variables as shown by 0.990. Adjusted R-squared is 0.981
indicating that 98.1% variation of financial performance of MFIs is attributed to changes of
client appraisal, credit risk control, collection policy and terms of credit collectively. The
remaining 1.9% is attributed to other factors beyond the scope of this study.

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Table 7: ANOVA

Model Sum of Squares Do Mean Square F Sig.

1 Regression 210.032 4 52.508 1979.664 .000b

Residual 4.058 153 .027

Total 214.090 157

Source: Research Data, 2018

The analysis of variance ANOVA is used to determine whether the model overall is a good fit.
From the ANOVA statistics, the processed data (population parameters) had a significance level
of 0.000. This shows that the data is ideal for making conclusions on the population’s parameter
as the p-value is less than the significance level of 0.05.
In view of the results in table 7 above, The F calculated was greater than F critical
1979.664>2.431. This shows that project top client appraisal, credit risk control, collection
policy and terms of credit significantly influences financial performance of MFIs.

Table 8: Coefficients

Model Unstandardized Standardized t Sig.

Coefficients Coefficients

B Std. Error Beta

1 (Constant) .257 .060 4.257 .000

Client Appraisal .062 .054 .064 1.147 .253

Credit Risk Control .514 .095 .491 5.398 .000

Collection Policy .219 .091 .192 2.414 .017
Terms Of Credit .270 .064 .250 4.242 .000

Source: Research Data, 2018

The regression equation was extracted from table 8 above is as follows:

Y = 0.257+ 0.062 X1 + 0.514X2 + 0.219 X3 + 0.270X4

In view of the results in table 8 above, Client appraisal is statistically significant in explaining
financial performance of MFIs as shown by (β = 0.062). This shows that client appraisal had
significant positive relationship with performance of the MFIs. This is an indication that a unit

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increase in client appraisal will result to an increase in financial performance of the MFIs. Credit
risk control is statistically significant in explaining financial performance of MFIs as shown by
(β = 0.514). This shows that credit risk control had significant positive relationship with financial
performance of MFIs. This implies that a unit increase in credit risk control will result to an
increase in financial performance of the MFIs. In addition, Collection Policy is statistically
significant in explaining financial performance of MFIs as shown by (β = 0.219). This shows that
Collection Policy had significant positive relationship with financial performance of the MFIs.
This implies that a unit increase in Collection Policy will result to an increase in financial
performance of the MFIs. Terms of Credit is statistically significant in explaining financial
performance of the MFIs as shown by (β = 0.062). This shows that Terms of Credit had
significant positive relationship with performance of MFIs. This is an indication that a unit
increase in Terms of Credit will result to an increase in financial performance of MFIs.

The statistical significance of the independent variables in explaining financial performance is

captured throughout the p-values. Collection policy is statistically significant in explaining
financial performance of MFIs as indicated by (P = 0.017). This is an indication that collection
policy has a significant and positive effect on financial performance of the MFIs studied. In
addition, terms of credit have a statistically significant effect in explaining financial performance
of MFIs as shown by P = 0.000). (Client Appraisal is statistically significant in explaining
financial performance of MFIs as indicated by (P = 0. 253); this suggests that client appraisal has
a significant and positive effect on financial performance of the MFIs. Credit Risk Control is
statistically significant in explaining financial performance of MFIs as indicated by (P = 0.000);
this indicates that it has a positive and significant effect on financial performance of the MFIs
Consequently, with respect to hypothesis testing, the study supports the null hypothesis that
Client appraisal does not have a significant effect on financial performance of MFIs in Nairobi
CBD, Kenya while it rejects the rest of the null hypotheses that Credit risk control, Collection
policy and Terms of credit do not have a significant effect of financial performance of MFIs in
Nairobi CBD, Kenya.

VIII. Conclusions and Recommendations

The study makes several conclusions from the findings; recommendations are equally made out
of the findings and conclusion as captured below.

A. Conclusion
The study found that client appraisal was statistically significant in explaining financial
performance of the MFIs. This indicates that client appraisal had a positive relationship with
financial performance. The study concludes that a unit increase in client appraisal would lead to
an increase in financial performance. In addition, Credit risk control was statistically significant
in explaining financial performance of the MFIs. This is an indication that credit risk control has
a positive relationship with financial performance of the MFIs. The study concludes that increase
in credit risk control leads to increased financial performance the MFIs studied. In addition,
collection policy was statistically significant in explaining financial performance of the MFIs.

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This indicates that collection policy had significant positive relationship with financial
performance of MFIs. The study concludes that positive increase in collection policy would
result to an increase in financial performance of micro financial institutions. Finally the study
established that terms of credit were statistically significant in explaining financial performance.
This shows that terms of credit had significant positive relationship with financial performance
of the MFIs. The study concludes that positive increase in terms of credit will result to an
increase in financial performance of micro financial institutions.

B.Recommendations
The study also recommends that the MFIs need to enhance their client appraisal techniques to
avoid having un-credit worthy clients leading to loan delinquency. This will enable improvement
of financial performance by having credits being paid and having a positive performing loan
portfolio in terms of recovery. Micro-finance institutions have suffered loan losses through
relaxed lending standards, the borrower’s perception and unguaranteed credits. The study
therefore recommends that the MFIs enhance their credit risk controls by creating profile
assessment database of prospective and current borrowers and guarantors that can be shared
among the MFIs to help minimize non-performing loans. This will help in improving their
financial performance.

IX. Contribution to Knowledge

The makes several contributions that are noteworthy. Academicians will use the research
outcome as a basis for discussion on financial performance and credit management for financial
institutions especially micro enterprises. The study will also be an addition to the body of
knowledge in the finance discipline and bridge the gap existing in the study of credit
management especially in the Kenyan Microfinance context where there is scanty empirical
literature. The study also makes contributions to improve the practice and the existing knowledge
on financial performance and credit knowledge.

Areas for Further Studies

This study suggests further empirical investigation on credit appraisal and why it does not seem
to significantly affect financial performance of MFIs studied though this has a strong support
from theory in terms of being a key factor in explaining financial performance of financial
institutions. The study found that MFIs experience loan defaulting from clients, a study should
be done on the reasons for loan defaults from clients’ perspective in microfinance institutions.
Further study can be done on the effectiveness of collection policies adopted by MFIs.

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