CAPITAL ADEQUACY AND FINANCIAL PERFORMANCE OF DEPOSIT TAKING MICRO FINANCE BANKS IN KENYA

Abstract

Maintaining sufficient capital is a vital aspect in the functioning of financial institutions, ensuring that they possess an adequate financial buffer to absorb potential losses. Adequate capital becomes critical for a robust financial system as it fosters stability and safeguards the interests of stakeholders at the same time ensuring a resilient financial system. The purpose of the study was to determine how capital adequacy directly impacts the ability of deposit-taking microfinance banks to generate profits and sustain operations. This ensures that these banks can absorb shocks without becoming insolvent, given that they serve vulnerable populations and small businesses, which exposes them to profitability challenges. The study investigated the effect of capital adequacy on the financial performance of deposit-taking microfinance banks in Kenya for the 2018 – 2022 financial period utilizing secondary data from all 13 registered deposit-taking microfinance banks. It adapted the explanatory correlational research design and relied on secondary data generated from the Central Bank of Kenya and individual websites of the 13 deposit taking micro finance banks. Returns on Assets and Returns on Equity were regressed on capital adequacy predictors using Generalized Methods Method approach and the panel data analysis revealed positive betas for all predictors at a 0.05 significance level. The study concluded that capital adequacy has a significant effect on micro finance banks in Kenya and recommended that microfinance banks should maintain a minimum risk-based capital adequacy ratio of 12.5% to 15%, depending on the risk levels in their loan portfolios. Additionally, these firms must publicly disclose both qualitative and quantitative information about their risk exposures, including their risk management strategies; disclose stress testing results to potentially assist stakeholders understand the nature and magnitude of the risk exposures. By providing comparative data from previous years, they will assist financial statement users a perspective on trends in underlying exposures.