Assessment of Credit Risk Management and Financial Performance of Microfinance Banks

Many times, microfinance companies price credit incorrectly and fail to take all embedded costs into account, which increases the risks involved and makes mitigation a herculean task. This study used panel data from the income statement and balance sheet of the five selected Nigerian microfinance banks (five cross-sections) for ten (10) years spanning between 2012 and 2021 to examine the effect of credit risk management (via Non-performing loan to total deposit ratio, Non-performing loan to total loan and advance ratio, Capital adequacy ratio) on financial performance (proxied by returns on asset) while making provision for key control variables like Leverage ratio and Firm size. This study made use of panel data methodology and the random effect was found most appropriate for modeling the data. The result shows that credit risk management is not significant in explaining the performance of microfinance banks in Nigeria. This is evident from the fact that the selected banks were over-prudent in their credit risk management policy which includes not giving out enough loans and hence resulting in low income. The over-prudent credit risk management by these banks is evident from their descriptive statistics. The selected microfinance banks are keeping too much money as reserves. When banks are not using their assets (giving loans and advances) to generate income, they will eventually lose money. As long as it’s tied to returns for microfinance banks, credit risk is not a bad thing. According to empirical theory, bank returns increase as risk increases, but the bank must moderate its risk and anticipate returns.