Influence of institutional size on the relationship between equity financing and lending propensity of micro-finance banks in Kenya

Abstract

Globally, bank lending remains a critical issue, sparking continuous debate in both policy and academic circles. The lending propensity of financial institutions, including microfinance institutions (MFIs), averages 133.8% of GDP globally while Sub-Saharan Africa lags at 45.5%. In Kenya, lending as a percentage of GDP has declined sharply from 35.22% in 2015 to 12.2% in 2023, despite policy interventions such as interest rate caps, risk-based lending and capital regulation. Given that over 75% of GDP is driven by credit availability, this trend presents a significant economic concern. Existing studies have explored factors influencing lending, with mixed empirical findings regarding the role of equity financing and institutional size. However, most research is based on data from developed economies, while studies in emerging markets, including Kenya, primarily focus on commercial banks rather than microfinance banks (MFBs). Furthermore, the limited research on Kenyan MFBs largely examines financial performance rather than lending propensity. Existing studies show limited focus on effect of equity financing on lending propensity of microfinance banks (MFBs) in Kenya. Evidence on the role of institutional size is equally scarce, and its moderating influence in this relationship remains untested. This study therefore examines the influence of institutional size on the relationship between equity financing and lending propensity of Micro Finance Banks in Kenya .Specifically, the study sought to assess the effect of equity financing on lending propensity of MFBs in Kenya; to evaluate the effect of institutional size on lending propensity of MFBs in Kenya and to examine the moderating effect of institutional size on the relationship between equity financing and lending propensity of MFBs in Kenya. The Bank Capital Channel Theory and Pecking Order Theory serve as foundation for this study. The research used a correlational research design. The population for this research is 14 registered MFBs in Kenya from 2015–2023 where 10 MFBs were sampled purposively and pooled for 9 years in order to generate 90 observations. Secondary data were collected from audited financial statements using data collection sheet. Diagnostic tests verified that data satisfied classical regression assumptions. The research further utilized Moderated Multiple Regression to test Hypotheses, analyzing direct effects of equity financing as well as institutional size on lending propensity, and moderating influence of institutional size on lending propensity. Findings for Objective One are that equity financing has a negative impact on lending propensity (β = -0.421, p = 0.0001), which signifies that a unit increase with respect to equity financing by MFBs lowers lending propensity by 0.421, and that MFBs with greater use of equity financing are more likely to use a more risk-averse lending strategy. Findings for Objective Two are that lending propensity is positively influenced by institutional size (β = 0.251, p = 0.0000), which signifies that every unit increase with respect to natural log of institutional size is linked with a 0.251 increase with respect to lending propensity, which signifies that size plays a crucial role in increasing the credit expansion capability. Objective Three findings reveal a significant moderating effect (β = 0.108, p = 0.0054), confirming that institutional size conditions the effect of equity financing, offsetting its adverse influence and strengthening the case for moderation in emerging markets. The study shows equity financing reduces lending propensity of Kenyan MFBs, while institutional size positively moderates this effect. Expense ratio, regulatory capital, and risk tolerance also shape outcomes. Recommendations include financing diversification, institutional scaling, technology-driven loan recovery, and strengthened oversight with targeted support for smaller MFBs.