Microfinance institutions (MFIs) are recognized as a niche market where microloans and other financial services are provided to the poor, especially in developing economies. This study examines the association between the Internal Audit (IA) function, loan losses, and financial performance in MFIs. Results from 1025 MFIs across 63 countries suggests that IA function reduces the rate of loan loss occurrence in MFIs. This shows the potentiality of the IA function for improving governance and risk management in MFIs. Similarly, the IA function improves the financial performance of MFIs through its significant positive effect on institutional operational self-sufficiency. Further findings suggest that the negative relationship between loan losses and financial performance is not significantly higher in MFIs without IA, than in those with IA. This indicates that although IA reduces the risk of loan loss occurrence and improves profitability in MFIs, it cannot solitarily eliminate the adverse impact of loan losses on MFI financial performance. The results are robust to various measurements and estimations.