Stability of microfinance institutions in Nepal

Abstract

This study examines the factors affecting the financial stability of Microfinance Institutions (MFIs) in Nepal focusing on the institutional, operational, financial and macroeconomic factors. Financial stability is assessed by the Z-score, which combines profitability, capital adequacy, and earnings volatility. The research uses a quantitative research design with panel data of 15 licensed D-class MFIs in Nepal for ten years (Fiscal Years 2072-2081) from institutional financial statements. Multiple regression analysis shows that internal financial management practices are the main drivers of stability of MFI. Capital structure (equity to asset ratio) and operational efficiency (operating expense ratio) are the most significant predictors, with capital adequacy having a positive impact on stability and operating inefficiency having a negative impact on stability. Credit risk, as measured by the NPL ratio, is also highly negatively correlated with stability. Contrary to conventional expectations, there are negative associations between institutional age and profitability (ROA) and stability, which suggests that older and more profitable MFIs may engage in riskier behaviors or are constrained by their legacy. Institutional size and macroeconomic variables (inflation and GDP growth) do not have statistically significant impacts on stability. The study concludes that proper management of capital, cost efficiency, and solid credit risk management are essential for increasing the resilience of Nepalese MFIs. The findings challenge conventional assumptions about age and profitability as stability-enhancing and implicate the need for context-specific regulatory and managerial strategies. Recommendations are made to policymakers, regulators, MFI managers, and investors tocreate a more stable and sustainable microfinance sector in Nepal.