Determinants of Financial Distress in Microfinance Institutions in Ethiopia

Abstract

In developing nations, Micro-Finance Institutions (MFIs) are essential to the financial system because they offer financial services to those who are unable to access traditional banking services. Examining the factors that contribute to financial distress in the context of certain MFIs in Ethiopia was the primary goal of this study. Twenty microfinance institutions from the total population of fifty-three microfinance institutions operating in the nation were included in the sample, which spanned the years 2019–2020 and 2023–2024. The data were analyzed using balanced fixed effect panel regression. The study measured the financial healthiness of MFIs using their Altman's Z score, which served as a stand-in for financial distress. According to the study, the age of microfinance institutions, capital adequacy, earning capacity, and liquidity all significantly worsen their financial distress. Although statistically minor, MFIs' operational efficiency, as determined by operating expenditure to gross loan portfolio, has a detrimental impact on their financial health. The financial distress of MFIs in Ethiopia is not significantly impacted by macroeconomic factors like as GDP or inflation. Based on the results, the study suggests that MFI managements make sure that frequent loan monitoring is strictly followed and that MFI credit regulations are revised on a regular basis. Additionally, MFI management should place a high priority on appropriately managing the capital to asset ratio. Because well-capitalized MFIs are better equipped to handle issues resulting from unforeseen losses, regulators and policymakers must also establish minimum capital adequacy criteria for MFIs.