CHAPTER 2

LITERATURE REVIEW

2.1 Introduction

This chapter provides a comprehensive review of existing literature on microfinance

institutions (MFIs), lending strategies, and their impact on financial performance. The review

encompasses studies and scholarly articles from both academic and industry sources, aiming

to synthesize current knowledge and identify gaps that this research seeks to address.

2.2 Theoretical background

There is abundant theoretical and empirical literature that affirms a positive effect of the

financial sector (i.e. debt and equity markets, banking) on economic growth at the firm,

industry and country levels [King & Levine (1993), Levine & Zervos (1998), La Porta et al

(1998), Rajan & Zingales (1998), Beck et al (2004)]. On the other hand development oriented

scholars claim that what actually matters is the access to finance measured by its depth and

outreach [Ravallion (2001), Beck & Levine (2002), Beck et al (2007a) and others]. To ensure

sustainable economic growth improved access to finance has to reduce income inequality so

that low-income households, that still constitute a majority, have chances to escape from

poverty. Access to formal payment services is important for developed countries that have

achieved strong market-based economies. However poor households in developing countries

need access to different financial services than formal bank credits as banks often exclude

them as unattractive clients due to high risk and insufficient assets for collateral (Beck et al

2008, p.111). The provision of microfinance services in the form of small collateral-free

loans, savings and insurance facilities has thus evolved as a vital alternative for poor
households to smooth consumption, start their own business, cushion income shocks, and

improve living conditions. Microfinance is a rapidly growing industry that enjoys its own

niche in the financial sector different from formal banking. Many MFIs have achieved

financial sustainability and independence from donor subsidies, and serve a broader and more

diverse clientele. Indeed, microfinance has revealed the remarkable ability of the poor to save

and to mobilize significant though still underused household assets. Growing

commercialization of MFIs and successful IPO of pioneering Mexican MFI Compartamos in

2007 demonstrates that besides its poverty eradication mission, microfinance can be very

profitable and therefore should be also researched under financial development framework.

2.2.1 Market Segmentation Theory

Michael Porter, a distinguished authority on competitive strategy, emphasizes the importance

of differentiation and cost leadership in creating a competitive advantage. In the context of

microfinance, Porter's theories suggest that MFIs can improve their financial performance by

identifying and targeting specific customer segments more effectively than their competitors.

By differentiating their lending products to meet the unique needs of various customer

segments—such as small business owners, agricultural workers, or urban traders—MFIs can

enhance customer satisfaction and loyalty, leading to increased repayment rates and lower

default risks (Porter, 1985).

Porter’s five forces model also highlights the importance of understanding competitive

rivalry, the bargaining power of customers and suppliers, the threat of new entrants, and the

threat of substitute products. For MFIs in Kenya, applying this model means they need to

assess the competitive landscape carefully and position themselves strategically to mitigate

these forces. For instance, by offering unique lending products or superior customer service,
an MFI can reduce the bargaining power of customers and suppliers, thereby protecting its

margins and enhancing financial performance (Porter, 2008).

Yunus’s approach involves offering small loans to groups of borrowers, primarily women,

who collectively guarantee each other's loans. This group lending mechanism not only

reduces the risk of default but also fosters a sense of community and mutual responsibility

among borrowers (Yunus, 2007). Applying Yunus's principles, MFIs in Kenya can enhance

their financial performance by leveraging social capital and peer pressure to ensure high

repayment rates.

Yunus also advocates for the principle of social business, where the primary objective is to

address social issues rather than maximize profits. By adopting a social business model,

Kenyan MFIs can attract socially conscious investors and donors, thereby improving their

financial sustainability and performance (Yunus, 2010). This approach aligns with Porter’s

view on creating shared value, where companies can achieve economic success by addressing

societal needs and challenges (Porter & Kramer, 2011).

Incorporating customer segmentation theory into lending strategies, MFIs in Kenya can draw

from both Porter and Yunus. By segmenting the market based on demographic, geographic,

and psychographic factors, MFIs can tailor their products and services to meet the specific

needs of different customer groups. For example, urban entrepreneurs might require larger,

short-term loans for inventory, while rural farmers might need smaller, longer-term loans to

cover the agricultural cycle. This targeted approach can lead to better customer satisfaction

and loyalty, reduced default rates, and ultimately, improved financial performance (Porter,

1985; Yunus, 2007).

Credit rationing is a theory proposed by economists Joseph E. Stiglitz and Andrew Weiss in

their seminal paper "Credit Rationing in Markets with Imperfect Information" (1981). The

theory suggests that in the presence of imperfect information and asymmetric information

between lenders and borrowers, lenders may ration credit to potential borrowers, even if the

borrowers are willing to pay a higher interest rate.

The rationale behind credit rationing is that lenders cannot perfectly assess the risk of default

for each borrower. When lenders increase interest rates to account for higher risks, it may

attract riskier borrowers who are more willing to take on higher interest rates, a phenomenon

known as adverse selection. Additionally, higher interest rates may provide borrowers with

an incentive to undertake riskier projects, a problem known as moral hazard.

To mitigate these risks, lenders may ration credit by denying loans to some borrowers or

limiting the amount of credit extended, even if the borrowers are willing to pay higher

interest rates. This approach helps lenders manage their overall risk exposure and maintain

the quality of their loan portfolios.

In the context of microfinance institutions (MFIs) in Kenya, credit rationing can have several

implications for their lending strategies and financial performance:

1. Risk management: By rationing credit, MFIs can potentially reduce their exposure to high-

risk borrowers and minimize the likelihood of defaults. This strategy may help maintain the

quality of their loan portfolios and improve their overall financial performance.

2. Portfolio diversification: Credit rationing may lead MFIs to diversify their loan portfolios

across different sectors, geographic regions, or borrower characteristics to spread their risk.

This diversification strategy can help mitigate the impact of defaults in specific sectors or

regions.
3. Interest rate management: Credit rationing may allow MFIs to maintain interest rates at a

level that balances the need for profitability and the ability of borrowers to repay loans. This

approach can help ensure the sustainability of MFIs' operations and prevent excessive

defaults due to unaffordable interest rates.

4. Borrower selection: MFIs may employ more stringent borrower screening processes and

credit assessment criteria to identify lower-risk borrowers and allocate credit more

effectively. This strategy can help improve the overall quality of their loan portfolios and

reduce the risk of defaults.

However, it is important to note that credit rationing can also have potential drawbacks, such

as limiting access to credit for viable borrowers and potentially constraining economic

growth and development. MFIs must carefully balance the benefits of credit rationing with

their social mission of providing financial services to underserved populations.

2.2.3 Innovation Diffusion Theory

The theory of innovation diffusion, also known as the diffusion of innovations theory, was

developed by Everett M. Rogers in the 1960s. This theory explains how new ideas, products,

or practices spread through a social system over time. It is widely applied in various fields,

including marketing, sociology, and organizational studies.

According to Rogers, the diffusion of an innovation follows a typical pattern, characterized

by different categories of adopters:

I. Innovators: These are the first individuals to adopt an innovation, often driven by a strong

interest in new ideas and a willingness to take risks.

II. Early adopters: This group consists of individuals who are respected opinion leaders and

are willing to embrace new ideas before the majority of the population.
III. Early majority: These are individuals who adopt an innovation after a varying degree of

time, typically shorter than the late majority.

IV. Late majority: This group is skeptical of change and will only adopt an innovation after it

has been widely accepted by others.

V. Laggards: These are the last individuals to adopt an innovation, often due to a strong

aversion to change or limited resources.

Rogers identified several factors that influence the rate of adoption which can be applied in

more detail to understand the adoption and impact of technology in facilitating lending

strategies for microfinance institutions (MFIs) in Kenya. Here's how:

a. Perceived attributes of the innovation:

i. Relative advantage: MFIs and their clients need to perceive the technological solutions

(e.g., mobile banking, digital lending platforms) as more advantageous than traditional

lending methods in terms of convenience, accessibility, speed, and cost-effectiveness.

ii. Compatibility: The technological innovations should align with the existing values,

experiences, and needs of the MFIs and their target clientele.

iii. Complexity: The ease of use and understanding of the technological solutions will

influence their adoption rate. Simple and user-friendly technologies are more likely to be

adopted faster.

iv. Trialability: Allowing MFIs and clients to experiment with the technological innovations

on a trial basis can reduce perceived risks and facilitate adoption.

v. Observability: The more visible and tangible the benefits of the technological solutions are,

thefaster their adoption will be.

b. Communication channels:

i. MFIs should utilize effective communication channels to raise awareness and educate their

staff, clients, and potential customers about the technological innovations.

diffusion process and build trust in the new technologies.

c. Time:

i. The adoption of technological innovations in lending strategies is a gradual process, and

MFIs should allow sufficient time for different adopter categories to embrace the changes.

ii. Early adopters among MFIs and their clients can serve as role models and influence the

later adopter categories.

d. Social system:

i. The social and cultural norms, values, and beliefs of the communities where MFIs operate

can impact the rate of adoption of technological innovations.

ii. MFIs should understand and address any potential barriers or resistance within the social

system, such as digital literacy levels, trust in technology, or cultural preferences.

e. Consequences of adoption:

i. Early adopters of technological innovations in lending strategies may experience improved

operational efficiency, reduced costs, enhanced customer experience, and increased outreach,

potentially leading to better financial performance.

ii. Late adopters or laggards may face competitive disadvantages, higher operational costs,

and potentially lose market share, negatively impacting their financial performance.

By applying the principles of the innovation diffusion theory, MFIs in Kenya can

develop strategies to facilitate the adoption of technological innovations in lending. This may

involve:

- Conducting pilot programs and gathering feedback to address perceived attributes and

compatibility concerns.

- Partnering with community leaders, influencers, and early adopters to promote the benefits

and build trust in the new technologies.

enhance trialability.

- Addressing social and cultural barriers through targeted communication campaigns and

educational initiatives.

- Continuously monitoring and evaluating the adoption process, making adjustments as

needed to accelerate diffusion.

Ultimately, the successful adoption of technological innovations in lending strategies can

contribute to improved financial performance for MFIs by increasing operational efficiency,

expanding outreach, and enhancing customer satisfaction.

2.3 Conceptual Framework

A conceptual framework is a graphical or diagrammatic representation of the relationship

between variables in a study (Borg, Gall & Gall, 2012). It helps the researcher to see the

proposed relationship between the variables easily and quickly. A conceptual framework’s

proposition summarizes behavior and provides explanations and predictions for the majority

number of empirical observations (Cooper & Schindler, 2011). Descriptive categories are

placed in a broad structure of explicit propositions or statement of relationships between

empirical properties to be tested for acceptance or rejection (Nachmias & Nachmias, 2013).

The conceptual framework for this research project is based on the premise that the lending

strategies adopted by microfinance institutions (MFIs) in Kenya significantly influence their

overall performance.

The framework identifies three key components: customer segmentation,credit risk

management and technology innovations , which are interrelated and have a direct impact on
the lending performance of MFIs in Kenya. The relationship between these variables is

shown in figure 1.1

Customer Segmentation Strategy

Performance of MFIs
- Number of employees
Credit Risk Strategy - Capital investment
- Sales volume
 Loan to value Ratio
- Customer base
 Credit score
 Collateral type

Technology Innovations Strategy

Figure 1.1 Conceptual Framework

2.3.1 . Customer Segmentation

crucial role in determining lending strategies and assessing potential borrowers. The

following variables are commonly considered for customer segmentation:

a. Income Level: MFIs in Kenya often cater to low-income individuals and households. The

income level of a potential borrower is a vital factor in determining their repayment capacity

and the appropriate loan size. MFIs may segment customers based on income brackets, such

as below the poverty line, low-income, or lower-middle-income, to tailor their lending

products and services accordingly.

b. Occupation: The occupation of a borrower provides insights into their income stability and

potential cash flows. MFIs in Kenya may segment customers based on their occupations,

such as self-employed (e.g., small business owners, traders, artisans), wage earners (e.g.,

salaried employees), or farmers. This helps assess the borrower's ability to repay loans and

design suitable repayment schedules.

c. Location: The geographic location of borrowers is a significant factor for MFIs in Kenya.

They may segment customers based on urban, peri-urban, or rural locations, as each area

presents different economic opportunities and challenges. This segmentation helps MFIs

understand the local economic conditions, accessibility, and potential risks associated with

lending in specific areas.

d. Age: Age is often considered in customer segmentation as it may influence the borrower's

financial behavior and risk profile. MFIs in Kenya may segment customers into different age

groups, such as youth, working-age adults, or elderly, to tailor their lending products and

services accordingly.

e. Credit History: Credit history is a crucial factor in assessing a borrower's creditworthiness

and risk profile. MFIs in Kenya may segment customers based on their credit history,

including those with no previous credit history (often the case for many low-income
individuals), those with a good credit history, or those with a poor credit history. This

segmentation helps MFIs adjust their lending terms, interest rates, and collateral requirements

accordingly.

2.3.2 Credit Risk

Credit risk is a significant concern for MFIs in Kenya, as it can impact their financial

sustainability and lending performance. The following variables are commonly used to assess

and manage credit risk:

a. Loan-to-Value Ratio: The loan-to-value (LTV) ratio is a measure of the loan amount

relative to the value of the collateral or asset being financed. MFIs in Kenya may use LTV

ratios to determine the level of risk associated with a loan and adjust their lending terms

accordingly. A higher LTV ratio generally indicates higher credit risk, as the borrower has

less equity in the collateral [2].

b. Credit Score: Credit scores are numerical representations of a borrower's creditworthiness

based on their credit history, repayment behavior, and other factors. MFIs in Kenya may use

credit scores provided by credit bureaus or develop their own scoring models to assess the

likelihood of default and determine appropriate lending terms and interest rates.

c. Collateral Type: Collateral is an essential component of lending strategies for MFIs in

Kenya, as it serves as a secondary source of repayment in case of default. MFIs may segment

borrowers based on the type of collateral they can provide, such as land, property, inventory,

or personal guarantees. The quality and liquidity of the collateral play a crucial role in

mitigating credit risk and determining the loan amount and terms.

By considering these variables, MFIs in Kenya can develop tailored lending strategies, assess

credit risk effectively, and enhance their overall lending performance while promoting

financial inclusion for underserved populations.

Michael Porter, renowned for his work on competitive strategy, underscores the importance

of leveraging technology to create competitive advantages. In his discussion on technology

strategy, Porter emphasizes that technological innovations can drive operational efficiencies,

enhance customer experiences, and enable firms to better respond to market dynamics

(Porter, 1985). For MFIs in Kenya, adopting mobile banking platforms is a critical

component of such a technology strategy. Mobile banking facilitates greater financial

inclusion by allowing MFIs to reach underserved populations who lack access to traditional

banking infrastructure. By reducing transaction costs and improving accessibility, mobile

banking enhances customer satisfaction and broadens the customer base, thereby improving

financial performance (Porter, 2001).

In the context of MFIs, mobile banking platforms such as M-Pesa in Kenya have

revolutionized the way financial services are delivered. M-Pesa allows users to perform a

wide range of financial transactions using their mobile phones, including receiving loans and

making repayments. This platform not only increases convenience for borrowers but also

reduces operational costs for MFIs by minimizing the need for physical branches and staff.

The scalability and efficiency provided by mobile banking platforms align with Porter's

argument that technology can be a powerful tool for achieving cost leadership and

differentiation (Porter, 1985). By leveraging mobile technology, MFIs can offer competitive

interest rates and tailored financial products, enhancing their market position and financial

outcomes (Mas & Radcliffe, 2010).

Mobile banking platforms enable real-time transactions and immediate loan disbursements,

which can be crucial for customers who need quick access to funds. The convenience and

speed of mobile banking improve customer satisfaction and retention, leading to a larger and
more loyal customer base. This increased customer base translates to higher loan volumes

and, consequently, better financial performance for MFIs. Additionally, the digital nature of

mobile banking reduces the risk of fraud and errors, further protecting the financial health of

MFIs (Donovan, 2012).

Artificial intelligence (AI) further enhances the lending strategies of MFIs by enabling more

precise risk assessment and personalized customer interactions. Porter highlights that

technology-driven innovations can transform value chains and improve competitive

positioning by fostering innovation in product and service delivery (Porter, 2008). AI

algorithms can analyze vast amounts of data to assess the creditworthiness of potential

borrowers more accurately than traditional methods. This enhanced risk assessment capability

allows MFIs to extend credit to previously excluded individuals while minimizing default

rates. Additionally, AI-powered chatbots and virtual assistants can provide instant customer

support, improving customer engagement and satisfaction (Fuster et al., 2019).

AI can also be used to predict customer behavior and tailor products accordingly. For

instance, AI can identify which borrowers are likely to repay on time and which might

default, allowing MFIs to adjust their lending terms or offer additional support to higher-risk

borrowers. This predictive capability not only reduces default rates but also helps in the

creation of personalized financial products that meet the specific needs of different customer

segments. Such customization enhances customer loyalty and increases the overall efficiency

and effectiveness of the lending process (Kshetri, 2018).

Data analytics is another critical technological innovation that can significantly impact the

financial performance of MFIs. Porter emphasizes the strategic role of information and

analytics in gaining competitive advantage (Porter & Millar, 1985). For MFIs, data analytics
can provide deep insights into customer behavior, preferences, and repayment patterns. By

analyzing transaction data, MFIs can identify trends and segment their customer base more

effectively. This segmentation enables MFIs to tailor their products and marketing strategies

to different customer groups, improving loan uptake and repayment rates. Moreover,

predictive analytics can help MFIs anticipate potential defaults and take proactive measures

to mitigate risks (Davenport, 2013).

Incorporating these technological innovations into lending strategies aligns with Porter's

broader view on the role of technology in shaping competitive advantage. He argues that

firms that effectively integrate technology into their strategies can outperform their

competitors by delivering superior value to customers (Porter, 1985). For Kenyan MFIs, this

means utilizing mobile banking, AI, and data analytics to enhance their lending processes,

reduce costs, and improve customer satisfaction. These improvements can lead to better

financial performance by increasing loan disbursements, reducing default rates, and

expanding the customer base.

Data analytics also empowers MFIs to make data-driven decisions. For example, by

analyzing repayment data, MFIs can identify patterns that indicate financial distress among

borrowers and intervene early with supportive measures. This proactive approach can prevent

defaults and improve overall repayment rates. Additionally, data analytics can optimize

operational efficiencies by identifying areas where costs can be reduced or processes can be

streamlined, further enhancing financial performance (Provost & Fawcett, 2013).

The integration of technology innovations such as mobile banking platforms, artificial

intelligence, and data analytics into the lending strategies of MFIs in Kenya can significantly

enhance their financial performance. Drawing on Michael Porter's insights, we see that these
technologies can drive operational efficiencies, improve risk management, and enable more

effective customer segmentation and engagement. (Provost & Fawcett, 2013).

2.4 Empirical Literature Reviewed

This section presents a review of empirical studies conducted in the past on customer

segmentation , Credit risk and technology innovations . Various researchers have conducted a

number of studies concerning various aspects of effects of lending strategies on performance

of micro finance institutions in Kenya. It is important to review some of those studies at this

particular point to place the present study in its rightful context. This section focused on who

undertook the study, when the study was done, where the study was undertaken, the findings

and ultimately the gaps that were identified.

2.4.1 Customer segmentation strategy

Microfinance institutions (MFIs) in Kenya have been grappling with the challenge of

identifying and catering to the diverse needs of their clients, particularly in the face of

increasing competition and changing market dynamics. Customer segmentation has emerged

as a critical strategy for MFIs to improve their performance and competitiveness. This review

aims to synthesize the existing literature on customer segmentation strategies and their effects

on the performance of MFIs in Kenya.

A comprehensive search of academic databases, including Google Scholar, ResearchGate,

and ScienceDirect, was conducted. The inclusion criteria for the review were peer-reviewed

articles that specifically focused on customer segmentation strategies in the context of MFIs

in Kenya.
The literature review reveals that customer segmentation is a critical component of MFI

success, enabling institutions to tailor their products and services to the specific needs of their

clients. Several studies have employed various segmentation methods, including

demographic, psychographic, behavioural, and geographic segmentation (Kamau et al., 2018;

Mwangi et al., 2019). The most commonly used segmentation variables include age, gender,

income level, education level, occupation, and geographic location (Kimani et al., 2020).

The literature also suggests that effective customer segmentation can lead to improved

performance outcomes for MFIs. For instance, a study by Muiru et al. (2017) found that

segmented marketing efforts led to increased loan uptake and reduced default rates among

low-income clients. Similarly, a study by Ng'ang'a et al. (2019) found that targeted customer

segmentation enabled MFIs to increase their profitability by reducing costs and improving

operational efficiency.

However, the literature also highlights some challenges associated with customer

segmentation in the Kenyan context. For example, limited data availability and poor data

quality can hinder effective segmentation (Kamau et al., 2018). Additionally, the complexity

of segmenting clients can lead to conflicting priorities and resource allocation challenges

(Mwangi et al., 2019).

In conclusion, this review highlights the importance of customer segmentation strategy for

MFIs in Kenya. Effective segmentation can lead to improved performance outcomes,

including increased loan uptake, reduced default rates, and improved profitability. However,

challenges associated with data availability and complexity of segmenting clients must be

addressed to ensure successful implementation of this strategy.

Based on the findings of this review, the following recommendations are made:
i).MFIs should invest in data collection and analysis tools to improve data quality and

availability.

ii). MFIs should develop robust customer segmentation strategies that take into account

demographic, psychographic, behavioural, and geographic variables.

iii). MFIs should prioritise targeted marketing efforts to reach specific client segments.

iv). MFIs should continually monitor and evaluate their customer segmentation strategies to

ensure they remain effective and responsive to changing market dynamics.

2.4.2 Credit risk Strategy

Microfinance institutions (MFIs) have emerged as a vital component of financial systems in

developing countries, particularly in Kenya. The primary objective of MFIs is to provide

financial services to low-income individuals and small businesses, which are often excluded

from traditional banking systems. Lending strategies are a critical aspect of MFI operations,

as they determine the ability of MFIs to achieve their objectives and sustain their operations.

This literature review aims to examine the effects of lending strategies on the performance of

MFIs in Kenya.

The microfinance industry has grown significantly in Kenya over the past two decades, with

numerous MFIs operating in the country. However, the industry faces significant challenges,

including high default rates, high transaction costs, and limited access to capital (Mwangi &

Odhiambo, 2017). To address these challenges, MFIs must adopt effective lending strategies

that balance risk and profitability.

This review draws on theoretical frameworks that explain the relationship between lending

strategies and MFI performance. The primary theoretical framework is Agency Theory,
which posits that lenders and borrowers have conflicting interests, leading to agency

problems (Jensen & Meckling, 1976). According to Agency Theory, lenders must design

lending strategies that mitigate these agency problems to ensure successful loan recovery.

This literature review examines empirical studies published between 2010 and 2022 on the

effects of lending strategies on MFI performance in Kenya. The search was conducted using

academic databases such as Google Scholar, ResearchGate, and [Link]. A total of 5

studies were selected based on their relevance to the research topic.

The studies reviewed revealed that lending strategies have a significant impact on MFI

performance in Kenya. Specifically:

i). Risk-based lending: Studies by Kasyoki et al. (2016) and Odhiambo et al. (2018) found

that risk-based lending is associated with improved loan recovery rates and reduced default

rates among MFIs in Kenya.

ii). Targeted lending: Research by Mwangi et al. (2017) and Njuguna et al. (2019) showed

that targeted lending to specific groups, such as women or youth, can improve loan

repayment rates and reduce default rates among MFIs.

iii). Interest rate-based lending: Studies by Ombui et al. (2019) and Wafula et al. (2020)

found that interest rate-based lending can lead to improved loan recovery rates and increased

revenue among MFIs.

iv). Loan duration-based lending: Research by Odhiambo et al. (2018) and Kaggia et al.

(2020) revealed that loan duration-based lending can reduce default rates among MFIs.

The findings of this literature review suggest that lending strategies have a significant impact

on the performance of MFIs in Kenya. Risk-based lending, targeted lending, interest rate-
based lending, and loan duration-based lending are all associated with improved loan

recovery rates and reduced default rates among MFIs. These findings have important

implications for policymakers and MFI managers seeking to improve the performance of

MFIs in Kenya.

This literature review has several limitations. Firstly, the sample size is limited to 5 studies

published between 2010 and 2022. Secondly, the studies reviewed are based on secondary

data analysis, which may not capture real-time.

Based on the findings of this literature review, policymakers and MFI managers are

recommended to adopt risk-based lending, targeted lending, interest rate-based lending, and

loan duration-based lending strategies to improve loan recovery rates and reduce default rates

among MFIs in Kenya.

2.4.3 Technology innovation strategy

Microfinance institutions (MFIs) play a crucial role in promoting financial inclusion and

poverty reduction in developing countries like Kenya. The effectiveness of MFIs is often

measured by their ability to lend money to low-income individuals and small businesses,

thereby improving their financial well-being. However, the lending strategies employed by

MFIs have been criticized for being inadequate, leading to low repayment rates and high

default rates. This literature review aims to examine the effects of lending strategies on the

performance of MFIs in Kenya, with a focus on technology innovations as a key strategy.

The microfinance sector in Kenya has experienced significant growth over the past two

decades, with the number of MFIs increasing from 10 in 1997 to over 50 today (Central Bank
of Kenya, 2020). Despite this growth, the sector faces challenges such as high operational

costs, low repayment rates, and high default rates (Mwangi & Muchiri, 2017). Lending

strategies are critical to addressing these challenges, and technology innovations have been

identified as a key strategy for improving lending practices.

This literature review employed a systematic search strategy to identify relevant studies

published between 2010 and 2022. A total of 5 studies were selected based on their relevance

to the research topic and quality of methodology. The studies were conducted in Kenya, with

a focus on MFIs operating in urban and rural areas.

The findings of this literature review indicate that technology innovations have been

increasingly used by MFIs in Kenya to improve lending strategies. These innovations include

digital lending platforms, mobile banking, and data analytics. A study by Mwangi and

Muchiri (2017) found that MFIs that employed digital lending platforms had higher loan

repayment rates compared to those that did not. Similarly, a study by Kimani et al. (2020)

found that mobile banking increased access to credit for low-income households in Kenya.

Another key finding was that data analytics played a crucial role in improving lending

decisions. A study by Wang et al. (2019) found that the use of data analytics reduced default

rates by 20% among MFIs in Kenya. Additionally, a study by Mwirigi et al. (2020) found

that data analytics improved loan quality by identifying high-risk borrowers.

The findings of this literature review suggest that technology innovations are critical to

improving the performance of MFIs in Kenya. Digital lending platforms, mobile banking,

and data analytics have been shown to improve loan repayment rates, access to credit, and
loan quality. These findings support the notion that technology innovations can be used to

address the challenges faced by MFIs in Kenya.

Based on the findings of this literature review, it is recommended that MFIs in Kenya adopt

technology innovations as a key strategy for improving lending practices. This can be

achieved through the development of digital lending platforms, mobile banking services, and

data analytics capabilities. Additionally, policymakers should provide regulatory support for

the adoption of technology innovations by MFIs.

This literature review is limited by its reliance on secondary data sources. Future studies

should aim to collect primary data through surveys or interviews with MFIs and their clients.

Future studies should investigate the impact of technology innovations on other aspects of

MFI performance, such as operational efficiency and customer satisfaction.

2.5 Critique of existing literature reviewed

This study on the effects of lending strategies on the performance of microfinance institutions

in Kenya makes some valuable contributions to the existing literature. However, it also

exhibits several weaknesses and gaps that limit its scope and generalizability.

One of the primary weaknesses is the lack of a clear definition and operationalization of

customer segmentation. The study fails to provide a clear typology of customer segments that

microfinance institutions in Kenya cater to, making it challenging to understand how

different segments respond to various lending strategies. This omission limits the study's

ability to provide actionable insights for microfinance institutions seeking to improve their

performance.
Another significant weakness is the study's reliance on secondary data. The use of secondary

data may have limited the study's ability to capture nuanced information on the lending

strategies and their impact on performance. Primary data collection, such as surveys or

interviews, could have provided more detailed and accurate information on the experiences of

microfinance institutions and their customers.

Furthermore, the study's focus on customer segmentation, credit risk management, and

technology innovations may not capture the full range of factors that influence the

performance of microfinance institutions. Other critical factors, such as institutional

governance, regulatory environment, and market competition, may also have a significant

impact on performance. The study's narrow focus limits its ability to provide a

comprehensive understanding of the complex dynamics affecting microfinance institutions.

In terms of gaps, the study does not explore the potential interactions between customer

segmentation, credit risk management, and technology innovations. For instance, how do

different customer segments respond to different lending strategies? How do credit risk

management practices influence the adoption of technology innovations? Addressing these

gaps could provide valuable insights for microfinance institutions seeking to optimize their

lending strategies.

Additionally, the study does not provide a longitudinal analysis of the impact of lending

strategies on performance over time. A longitudinal analysis would enable researchers to

examine how changes in lending strategies affect performance over an extended period. This

could provide more robust evidence on the effectiveness of different lending strategies.
In conclusion, while this study provides some useful insights into the effects of lending

strategies on microfinance institution performance in Kenya, it is limited by its weaknesses

and gaps. Future studies should aim to address these limitations by employing primary data

collection methods, exploring additional factors influencing performance, and examining the

interactions between different variables.

2.6 Summary

This chapter examined existing literature on key factors shaping modern lending strategies,

focusing on customer segmentation, credit risk management, and technological innovation.

Customer segmentation emerged as a vital tool for tailoring financial products to specific

market needs, while credit risk management practices were highlighted for their role in

maintaining portfolio health and regulatory compliance. The exploration of technological

innovations, including AI-driven credit scoring and blockchain applications, revealed their

transformative impact on the lending landscape. These interconnected elements collectively

form the foundation for developing effective and competitive lending strategies in today's

dynamic financial market.