Moderating Effect of Corporate Governance on The Relationship Between Financial Risk Exposure and Profitability of Microfinance Banks in Kenya

Abstract

This study sought to investigate the moderating role of corporate governance on the linkage between exposure of banks to financial risks and the profitability of Kenyan microfinance banks. In particular, it aimed to evaluate the influence of credit risk exposure, liquidity risk exposure, and operational risk exposure on their profitability with corporate governance as a moderator variable in this relationship. The study was guided by the modern portfolio theory, theory of financial intermediation, liquidity preference theory, and agency theory. Utilizing an explanatory research design, the study targeted 14 registered microfinance banks with the Central Bank of Kenya as of December 2023, utilizing a census sampling method. Secondary data for the context of 2019-2023 were sourced from Central Bank publications, as well as financial statements of respective individual microfinance banks. The analysis of the findings employed panel data procedures with the help of Stata 18 as well as SPSS version 26, utilizing means, standard deviations, as well as multiple regression analysis. The study established that credit risk exposure (β=0.105, p<0.05), liquidity risk exposure (β=0.121, p<0.05), as well as operational risk exposure (β=0.019, p<0.05) had a significant positive influence on profitability. Moreover, it established that though corporate governance had a negative coefficient (β=-0.221, p<0.05) indicating its significance, after the inclusion of the interaction term with corporate governance as a moderating factor under the third scenario, both corporate governance as well as the interaction remained insignificant (p<0.05). The study concluded that exposure of banks to risks had a remarkable impact on their profitability, with partial modulation by corporate governance. The study recommends that credit risk managers of microfinance banks must formulate strong credit risk handling strategies with the intent of reducing non-performing loans, hence improving their profitability. Also, marketing managers have to invest in advertising and organizing activities for promoting mobilization of deposits, enhancing liquidity. Lastly, managers have to streamline operating costs while maximizing revenues for enhancing profitability, and owners of microfinance institutions have to have strong corporate governance mechanisms, such as enhancing board independence.