EFFECT OF LIQUIDITY ON FINANCIAL PERFORMANCE OF MICROFINANCE BANKS IN KENYA
EFFECT OF LIQUIDITY ON FINANCIAL PERFORMANCE OF MICROFINANCE BANKS IN KENYA
Sammy Mutiria Murige - Tharaka University, Kenya
Dr. Tumaini Mwikamba - Tharaka University, Kenya
Dr. James Nyamu - Tharaka University, Kenya
ABSTRACT
Microfinance banks (MFBs) play a critical role in ensuring financial inclusion for low-income individuals and small businesses excluded from commercial banking. However, the sector’s financial performance has deteriorated sharply in recent years, with the Central Bank of Kenya reporting a sector-wide pre-tax loss of approximately Ksh 3.5 billion in 2024, up from Ksh 2.4 billion in 2023, and a negative return on assets of 6.1 percent, attributed to high non-performing loans, capital erosion, shrinking deposits and operational inefficiencies. Despite the sector’s economic importance, literature remains inconclusive regarding the precise relationship between liquidity and the financial performance of MFBs in Kenya. This study therefore assessed the effect of liquidity, operationalised through Cash Management (CM), Asset-Liability Mismatch (ALM) and Operating Cash Flow (OCF), on the financial performance of Kenyan MFBs, measured using Return on Assets (ROA). The study was anchored on the Cash Management Theory and adopted a positivist research philosophy together with an explanatory and descriptive research design. A census of all 14 Central Bank of Kenya-licensed MFBs was undertaken, yielding secondary panel data spanning 2011 to 2024. Data were analysed using STATA version 19.0 and R version 4.6.1, employing robust panel regression to draw empirical inferences following diagnostic testing for multicollinearity, heteroskedasticity and model specification. The Hausman specification test favoured the Random Effects estimator, under which Cash Management exerted a strong positive and statistically significant effect on Return on Assets (β = 8.9450, p < 0.01), while Asset-Liability Mismatch (β = -0.0034, p < 0.10) exerted a weak negative effect and Operating Cash Flow (β = -0.7887, p > 0.10) was statistically insignificant. The model explained approximately 39.7 percent of the variance in ROA (χ² = 131.128, p < 0.01), leading to rejection of the null hypothesis that liquidity has no statistically significant effect on financial performance. The findings imply that prudent cash management is the dominant liquidity lever available to MFB managers, while structural asset-liability mismatches erode profitability at the margin. The study recommends that MFB management strengthen cash management practices, align asset and liability maturities more closely, and that the Central Bank of Kenya adopt a differentiated, risk-based liquidity regulatory framework, encouraging smaller MFBs to prioritise cash reserves while guiding larger institutions to deploy excess liquidity into productive assets, particularly against the backdrop of the sector’s deepening losses through 2024.
