Prudential Regulations and Profitability: Empirical Evidence from Microfinance Banks in Kenya

Abstract

Microfinance banks carry out important roles in the economic growth and development of countries. In order to protect depositors, governments have introduced legislations and regulations to guide the activities of Microfinance banks. Over the years in Kenya, several regulations have been put in place by the Central Bank. However, the underlying argument is whether prudential regulations significantly contribute to the profitability of Microfinance banks in Kenya. In view of this, the study sought to examine the effect of prudential regulations on profitability of Microfinance Banks in Kenya. Agency Theory and Capital Buffer Theory were adopted to support the relationship between prudential regulations and profitability. Descriptive analysis and panel regression analysis were applied in the study. The hypotheses testing were based on the threshold of 0.05 significance level. It was found that capital regulation and liquidity regulation had insignificant effect on profitability of Microfinance Banks in Kenya. The study established that credit regulation had significant effect (β=-5.016 and p-value=0.038) on profitability of Microfinance Banks in Kenya. The study recommends that the managers of Microfinance banks in Kenya should tighten their credit risk management through effective assessment and monitoring. This will in turn reduce the rate of non-performing as well as the bad debts written-off against profits. The study suggests that further research can be done on the effect of capital regulation and liquidity regulation on profitability of Microfinance Banks in Kenya. Through this, the insignificant effect of capital regulation and liquidity regulation on profitability can be probed or further examined which can be based on different methodology such as time period and/or measures of variables.

Keywords: Prudential Regulations, Capital Regulation, Liquidity Regulation, Credit Regulation, Profitability and Microfinance Banks

DOI: 10.7176/RJFA/12-24-04

Publication date: December 31^st 2021