Credit Insurance and Quality of Loan Portfolio of Microfinance Banks in Kenya

The microfinance sector in Kenya has been grappling with deteriorating loan portfolio quality, as evidenced by the 5.55 percent net non-performing loans ratio between 2019 and 2022, exceeding the International Monetary Fund and World Bank's 5 percent vulnerability threshold. The absolute value of non-performing loans escalated from KES 4.198 billion in 2019 to KES 5.718 billion in 2022, creating a critical contradiction where expanded insurance coverage coincided with worsening portfolio performance. Therefore, this study assessed the effect of credit insurance on loan portfolio quality in Kenya's microfinance banks. The research was grounded in risk management theory. The study employed a positivism research philosophy and descriptive research design, targeting all 14 Central Bank of Kenya-regulated microfinance banks. Secondary data spanning 2019-2023 was analyzed using STATA through descriptive and inferential panel regression techniques. Credit insurance was measured as the ratio of insured loan amounts to total loans issued, while portfolio quality was measured as non-performing loans to total loans ratio. The study found that credit insurance has a statistically significant and negative effect on loan portfolio quality in Kenya’s microfinance banks. The results show that each unit increase in credit insurance is associated with a 0.266-unit decline in loan portfolio quality (β = −0.266, p = 0.000), confirming the rejection of the null hypothesis. This indicates that, rather than strengthening portfolio performance, increased reliance on credit insurance may undermine loan quality within the microfinance sector. The study recommends that regulatory bodies, specifically the Central Bank of Kenya, enforce stricter oversight frameworks for credit insurance implementation in microfinance banks to mitigate identified moral hazard effects. Regulations should mandate complementary monitoring systems that maintain rigorous credit appraisal standards and borrower screening processes even when insurance coverage exists, preventing insurance presence from encouraging lax lending practices. Microfinance institutions should integrate enhanced loan supervision mechanisms alongside insurance adoption, including periodic portfolio reviews, borrower repayment behavior monitoring, and insurance claim pattern analysis to detect early warning signals of moral hazard. Keywords: Credit insurance, quality of loan portfolio, Microfinance Banks, Kenya