IOSR Journal of Economics and Finance (IOSR-JEF) e-ISSN: 2321-5933, p-ISSN: 2321-5925. Volume 12, Issue 4 Ser. II (Jul. –Aug. 2021), PP 52-58 www.iosrjournals.org DOI: 10.9790/5933-1204025258 www.iosrjournals.org 52 | Page Moderation Effect of Interest Rates on the Nexus between Firm Characteristics and Financial Stability of Microfinance Banks in Kenya Robinson Changaya Kweyu 1 , Job Omagwa PhD 2 & Farida Abdul PhD 3 ( 1 Corresponding Author, Accounting and Finance Department, School of Business, Kenyatta University, Email address: 2 School of Business, Kenyatta University, P.O. Box 43844-00100, Nairobi, Kenya. 3 School of Business, Kenyatta University, P.O. Box 43844-00100, Nairobi, Kenya) Abstract Microfinance institutions provide financial services in small scale to the unbanked who are unable to receive credit from the formal banking sector and as well as other standard financial systems. However, over the years, the financial stability of microfinance banks in Kenya has attracted key consideration from policy makers. The study sought to assess the moderating effect of interest rates on the relationship between firm characteristics and financial stability of Microfinance Banks in Kenya. The study is guided by Financial Intermediation Theory. The study targeted the 13 microfinance banks in Kenya, hence a census study. The study concluded that interest rates had significant moderating effect (β=34.223, p=0.000) on the relationship between firm characteristics and financial stability of Microfinance Banks in Kenya. The study also presented a workable empirical model on firm characteristics, interest rates and financial stability as it statistically established significance on the nexus between these variables. The study recommends that the setting of interest rates should be guided by the underlying economic conditions of the country Keywords: Interest Rates, Firm Characteristics, Financial Stability and Microfinance Banks --------------------------------------------------------------------------------------------------------------------------------------- Date of Submission: 28-06-2021 Date of Acceptance: 12-07-2021 --------------------------------------------------------------------------------------------------------------------------------------- I. Introduction and Background of the Study In addressing the ever-increasing demand for financial services in Africa, a number of microfinance institutions over time have been established (Bengi & Njenje, 2016). With some of them providing credit, while others both credit and deposit services and others only involved in the collection of deposit. In Sub-Saharan Africa, the sector encompasses a combination of geographically dispersed and diverse institutions which give financial services to the low-income earning customers and thus contribute to poverty alleviation. These roles, however, can only be performed by stable microfinance banks. Kenya’s financial sector has over the years been under distress as a result of the Central Bank’s tightening oper ational rules (Wangila, 2017). Banks’ financial stability may be influenced by both internal processes and as well as external shocks thereby bringing about the presence of weak spots (Laeven, Ratnovski & Tong, 2014). Interest rates influence the linkages in the difference emanating from interest earning assets and liabilities (Otambo, 2016; Huseynov, 2018). In 2016, the Central Bank of Kenya, on its drive to boost the banking industry, licensed another deposit-taking microfinance institution. The Central Bank of Kenya notably has the key role of solvency, liquidity, and financial system stabilization (Central Bank of Kenya, 2018). Interest rates refer to the charges imposed on borrowing money (Ngaira & Miroga, 2018). Interest rate is also regarded as the amount of interest charged in a given time period per unit of time, usually one year (annually). Varying rates of interest depict borrowers’ enthusiasm and capability of meeting their obligations and the degree to which the promissory note or bond, debenture, mortgage or other indebtedness indication can be converted into money (Kiganda, 2014). Interest rates therefore reflect the quality of the money which a borrower’s indebtedness is denominated. Interest rates are regarded as the earnings which a lender anticipates by parting ways with liquidity for a specified period. It is based on two notions in that those with (owners of) surplus funds will have higher future returns part with some of it (Al-Qudah & Jaradat, 2013). Higher interest rates on the other hand discourage customers from borrowing. However, at equilibrium, interest rates are equal to demand, investment, supply and as well as savings in the market. Interest rates influence the banks’ financial stability. The underlying influences of interest rates on the linkages between firm characteristics (internal decisions and operations) and banks’ financial stability is, therefore, key to bank management.