Financial Innovations and Financial Performance of Microfinance Banks in Kenya

Abstract

The microfinance banks in Kenya have experienced a fluctuating and mixed performance between 2014 and 2020. For example, the financial performance measured in terms of pre-tax profits and return on assets was 1,002 million shillings and two percent in 2014 respectively. Further in 2020, the banks recorded a pre-tax loss of 2,240 million shillings and a return on assets of negative three percent. This presented a threat to their financial soundness, efficiency, stability, and sustainability, which has raised concern among financial scholars, regulators, and practitioners. Firms' financial performance has long been associated with financial innovations. Nonetheless, the available empirical literature failed to provide a consensus on the effects of financial innovations such as product innovations, process innovations, and institutional innovations on financial performance. In view of this, the current study assessed the effect of financial innovations on the financial performance of Kenyan microfinance banks for the period 2014-2020. The specific objectives were to examine the effect of product innovations, process innovations, and institutional innovations on the financial performance of microfinance banks in Kenya. In addition, the study determined the moderating effect of the regulatory framework and the mediating effect of competitiveness on the relationship between financial innovations and financial performance. The study was guided by financial intermediation, constraint-induced innovation, transaction cost innovation, regulation innovation theories, and Merton’s Market theories of innovation. The positivism research paradigm was employed. The assessment was guided by a descriptive research design. The assessment targeted all the 14 microfinance banks registered by the Central Bank of Kenya. A census was carried out and a document review guide was used to collect secondary data from the financial records of these banks. Means, standard deviations, median, maximum, minimum, skewness, and kurtosis were used for purposes of descriptive analysis while panel multiple regression and correlation were used for inferential analysis. The study found and concluded that financial innovations positively and significantly affect the financial performance of microfinance banks. Specifically, product innovations and process innovations have significant statistically positive effects while institutional innovations have no statistically significant effect on the financial performance of microfinance banks in Kenya. The study further established that the regulatory framework moderated the relationship between financial innovations and financial performance. The research also established that competitiveness mediated the relationship between financial innovations and the financial performance of microfinance banks. The study concluded that financial innovations enhance the financial performance of microfinance banks. Consequently, the study recommended that the Central bank of Kenya reward innovative banks through tax reliefs and strengthen its regulation and oversight while the management should focus on product differentiation strategy, aggressive advertising, and research and development to foresee new and innovative ideas. The study also recommends that microfinance banks should enhance their competitiveness by increasing their market shares to improve their financial performance.