THE EFFECT OF RISK MANAGEMENT ON FINANCIAL PERFORMANCE: A STUDY ON MICRO FINANCE INSTITITUIONS (MFIs) IN ETHIOPIA

Abstract

In the aftermath of the global financial crisis, risk management became a major area of focus for the financial sector. This study was aimed to examine the effect of risk management on micro finance institutions financial performance in the context of Ethiopia. Financial performance indicator (Return on assets) is used as the dependent variables while credit, liquidity, operational, interest rate, and exchange rate risk were used as proxies for risk management. The study target population was all 42 micro finance institutions in Ethiopia and the study covered a period of 12 years from 2010 to 2021. To this end, the study adopts quantitative approach. Time Series Cross-Sectional balanced secondary panel data was analyzed. The data was obtained from published financial statements of accounts of eighteen (18) micro finance institutions in Ethiopia. Descriptive statistics, correlation, and regression analyses were applied to analyze the data. The results from regression analysis showed that Credit Risk, Interest Rate Risk and Operational Risk were have a positive and statistically significant effect on financial performance, while foreign exchange rate risk has a statistically significant and negative influence on the financial performance of the Ethiopian micro finance institutions. Based on the panel regression approach, the study concluded that the risk management variables considered in this study was a key factor in affecting the financial performance of micro finance institutions in Ethiopia. Thus, it suggested that Ethiopian micro finance institutions should maintain a proper balance between risk management practices and financial performance by engaging in appropriate credit, operational, interest rate and foreign exchange risk management practices that will ensure safety for their micro finance institution and yield positive profits.