CREDIT APPRAISAL PARAMETERS AND ASSET QUALITY OF MICROFINANCE BANKS IN KENYA

Abstract

Microfinance banks play an important role in the provision of a wide range of financial services and products. However, they have been struggling with huge volumes of increasing NPLs which negatively affect their performance. The general objective of the research was to determine the effect of credit appraisal parameters on asset quality of microfinance banks in Kenya. Specific objectives were to determine the effect of borrower’s character, capacity, credit rating, credit history and collateral on asset quality of MFBs in Kenya. The research was underpinned on information asymmetry theory, transaction cost theory, theory of credit scoring and the 5 c’s model of client appraisal. The findings reveal significant relationships between credit appraisal parameters and asset quality in MFBs in Kenya. Borrower's character, capacity, credit rating, credit history, and collateral all exhibit positive coefficients, indicating that improvements in these areas are associated with better asset quality. Specifically, borrower's character, capacity, credit rating, credit history, and collateral exhibit coefficients of -0.354, -0.135, -0.163, -0.216, and -0.311, respectively, all significant at p < 0.05. These findings underscore the importance of robust credit appraisal processes in mitigating credit risk and maintaining asset quality within MFBs. Therefore, the study recommends enhancing borrower assessment mechanisms, including character evaluation, capacity analysis, credit rating procedures, credit history reviews, and collateral valuation, to progress asset quality management in Kenyan Microfinance banks.

Keywords: Asset quality, Borrower’s capacity, Borrower’s Character, Collateral, Credit history, Credit Rating