MODERATING EFFECT OF INCOME DIVERSIFICATION ON THE RELATIONSHIP BETWEEN FINANCIAL STRUCTURE AND FINANCIAL SUSTAINABILITY OF MICROFINANCE INSTITUTIONS IN KENYA

Abstract

Microfinance Institutions (MFIs) play a critical role as a driver of socio-economic development promoting the achievement of Sustainable Development Goals (SDGs). MFIs in developing countries boost entrepreneurial activities and financial inclusion through the provision of microcredit. The MFI industry has seen a drop-in donor support threatening their ability to serve the impoverished or settle their operating expenses towards achieving financial sustainability. MFI literature also shows that financially sustainable MFIs are more competitive and effective in serving poor borrowers. Although studies have pointed out that financial structure affects the financial sustainability of MFIs, their findings have provided mixed results. In addition, recent microfinance literature suggests that income diversification affects MFI’s financial sustainability and financing decisions. The general objective of this study was to determine whether income diversification has a moderating effect on the relationship between financial structure and the financial sustainability of the MFIs. The specific objectives were to determine the effect of deposits, debt, equity and donations on financial sustainability of the MFIs in Kenya. The study was grounded on the life cycle theory, the profit incentive theory, the modern portfolio theory and the pecking order theory. The study adopted the positivism paradigm and employed both the explanatory and longitudinal research design. The population of interest consisted of fifty-three (53) MFIs operating and registered in Kenya. However, after carrying out the survey of the MFIs and applying an inclusion/exclusion criterion, the final sample was 32 MFIs. The study used secondary data collected over ten years from 2010 to 2019. Data was extracted from the Microfinance Information Exchange (MIX) market database. The data were analysed through descriptive and inferential statistics. The study applied the hierarchical multiple regression and the outcome of the Hausman test informed the choice between the fixed effect model and the random effect model as the panel data estimation technique. The study established that deposits (β=0.349, ρ<0.05), and equity (β=0.186, ρ<0.05 had a significant and positive effect on financial sustainability of MFIs in Kenya whereas, debt capital (β=-0.187, ρ<0.05) and donations (β= -0.711, ρ<0.05) had a significant and negative effect on financial sustainability of the microfinance institutions. Moreover, the study found that income diversification significantly moderates the relationship between deposits (β= 0.098, ρ<0.05), debt (β=-0.24 ρ<0.05), equity capital (β=0.159, ρ<0.05), donations (β=0.118, ρ<0.05) and financial sustainability of MFIs. The results support the modern portfolio theory that proposes a positive association between income diversification and MFIs’ financial sustainability. The study concluded that equity capital, debt capital, deposits and donations are significant determinants of MFI’s financial sustainability and that income diversification has an influence on the relationship between financial structure and financial sustainability of MFIs. The study recommends that microfinance institutions should mobilize internal resources such as savings and equity and limit reliance on debt capital and donor support for better financial sustainability.