Risk Identification Practices and Financial Performance: Evidence from Microfinance Institutions in Nairobi County, Kenya

Risk identification practices are increasingly important in the microfinance sector, where institutions operate amid credit, liquidity, operational, market, and emerging risks. Effective risk identification enables institutions to take corrective measures, minimize losses, and sustain financial performance. This study examined the effect of risk identification practices on the financial performance of microfinance institutions in Nairobi County, Kenya. Guided by Enterprise Risk Management Theory, the study adopted a positivist philosophy, a descriptive and correlational research design, and a quantitative approach. The target population comprised managers, risk officers, credit officers, and finance officers in licensed microfinance institutions. The study collected primary data using structured five-point Likert-scale questionnaires. Of 165 questionnaires issued, 144 were returned, representing an 87.3% response rate. We analyzed the data in SPSS using descriptive statistics, Pearson correlation, and simple linear regression. Risk identification practices were generally implemented (M = 3.95, SD = 1.15), with risk prioritization recording the highest mean (M = 4.06) and documented risk mapping the lowest (M = 3.74). Risk identification practices were strongly and positively related to financial performance (r = 0.638, p < 0.01). Regression results showed that risk identification explained 40.7% of the variation in financial performance (R² = 0.407), with a positive and significant effect (β = 0.218, t = 2.907, p = 0.004). The model was statistically significant, F (1, 142) = 97.21, p < 0.001. A pilot study of 10 respondents across two microfinance institutions in Kiambu County showed satisfactory reliability, with Cronbach’s alpha coefficients ranging from 0.812 to 0.879 and an overall alpha of 0.861. The study concluded that risk identification practices significantly influenced financial performance. It recommends strengthening risk mapping, early-warning systems, employee risk awareness, and identification and prioritization of emerging risks, while maintaining systematic documentation of identified risks across institutional functions and decision-making processes at all levels.