Research consultancy
2.1 Theoretical perspective
It is significant to note that changes have been taking place in the credit industry and this is backed up by the recent scenario where most lending institutions have developed sustainable credit appraisal standards that help them when it comes to credit appraisal and risk management (CBK 2011 annual report). Theories have been developed by different scholars that have positively affected rather have a relation to the lending activities and organization of this lending corporations. Discussed below are theories or models related to governance, operation and management of the lending institutions.
2.1.1 Contingency Theory
Contingency theory was developed by Fred Fiedler, 1967, but several contingency approaches were also developed concurrently in the late 1960s. Contingency theory is a class of behavioral theory that claims that there is no best way to organize a corporation, to lead a company, or to make decisions. Instead, the optimal course of action is contingent upon the internal and external situation of the corporation. As far as appraisal systems are concerned, different borrowers come with different scenarios on their ratings. The lending institutions have to scrutinize every individual and view what should be done, who is to be advanced credit with and how much is appropriate at a particular time. The lending institutions too also looks at its position as far as how much they are allowed to give out as credit to strike a balance between their loan portfolio and current deposits. There sometimes is no best mechanism of appraising but looking at the situations currently prevailing.
2.1.2 The effects of Credit Standards on loan recovery
Credit standards according to Mehta (2010), in advancing loans, credit standard must be emphasized such that the credit supplier gains an acceptable level of confidence to attain the maximum amount of credit at the lowest as possible cost. Credit standards can be tight or loose (Van Home. 2010). Tight credit standards make a firm lose a big number of customers and when credit are loose the firm gets an increased number of clients but at a risk of loss through bad debts. A loose credit policy may not necessarily mean an increase in profitability because the increased number of customers may lead to increased costs in terms of loan administration and bad debts recovery.
In agreement with other scholars Van Home (2010), advocated for an optimum credit policy, which would help to cut through weaknesses of both tight and loose credit standards so, the firm can make profits. This is a criteria used to decide the type of client to whom loans should be extended. Kakuru (2010) noted that it’s important that credit standards be basing on the individual credit application by considering character assessment, capacity condition collateral and security capital.
Character it refers to the willingness of a customer to settle his obligations (Kakuru, 2010) it mainly involves assessment of the moral factors. Social collateral group members can guarantee the loan members known the character of each client; if they doubt the character then the client is likely to default. Saving habit involves analyzing how consistent the client is in realizing own funds, saving promotes loan sustainability of the enterprise once the loan is paid. Other source should be identified so as to enable him serve the loan in time. This helps micro finance institutions not to only limit loans to short term projects such qualities have an impact on the repayment commitment of the borrowers it should be noted that there should be a firm evidence of this information that point to the borrowers character (Katende, 2010).
According to Campsey and Brigham (2010) the evaluation of an individual should involve: gathering of relevant information on the applicant, analyzing the information to determine credit worthiness and making the decision to extend credit and to what tune. They suggested the use of the 5Cs of lending. The 5Cs of lending are Capacity, Character, Collateral, Condition and Capital. Capacity refers to the customer’s ability to fulfill his/her financial obligations. Capacity, this is subjective judgment of a customer’s ability to pay. It may be assessed using a customer’s ability to pay. It may be assessed using the customer’s past records, which may be supplemented by physical or observation.
Collateral is the property, fixed assets, chattels, pledged as security by clients. Collateral security, This is what customers offer as saving so that failure to honor his obligation the creditor can sell it to recover the loan. It is also a form of security which the client offers as form of guarantee to acquire loans and surrender in case of failure to pay; if borrowers do not fulfill their obligations the creditor may seize their asset (Girma, 201 0).
According to Chan and Thakor (2010), security should be safe and easily marketable securities apart from land building keep on losing value as to globalization where new technology keeps on developing therefore lender should put more emphasis on it. Capital portends the financial strength, more so in respect of net worth and working capital, evaluation of capital may be by way of analyzing the balance sheet using the financial ratios. Condition relates to the general economic climate and its influence on the client’s ability to pay. Condition, this is the impact of the present economic trends on the business conditions which affects the firm’s ability to recover its money. It includes the assessment of prevailing economic and other factors which may affect the client ability to pay (Kakuru, 2010).
Good credit management provide the institution with a reasonable and adequate return on loans and capital employed primarily through improvement in operations efficiency this generates adequate internal resources to finance the institution’s growth (Pandey, 2010). The institution may have tight credit standards that it may extend loan to the most reliance and financially strong customers such standards will result in no bad debt losses and less cost of credit administration (Pandey. 2010).
Pandey (2010) stressed that credit standards are criteria for selecting customers for credit; the fund may have higher credit standards that is extending loans to selected customers with good reputation or record. On the other hand customers have to be evaluated to see if they meet the standards set by the management before loans are extended to them. However, (Van Home. 2010) states that when an institution extends loan to only strongest customers, it will never have bad losses and will incur fewer administration expenses.
2.2. The SACCO credit on poverty reduction
Savings and credit cooperative organization, economically according to Guilford (2007) credit facilities enable impoverished persons to start businesses, rebuild after natural disasters like floods and hurricanes, and to receive both short- and long-term loans to meet their financial needs and improve their overall quality of life. The impact of micro lending is changing the economic landscape of the areas where it is most prevalent.
In Africa, micro finance contributed to productivity of farmers (Anupam, 2004) found that, through credit, farmers obtains inputs and increase their production, micro credit promotes and increase agricultural output with greater equity of farmers to the small-enterprise. Magyezi (2013) states that savings act as collateral security for the savers to acquire more and bigger loans. He confirms that such practices promote saving culture. The extent to which savers benefit from the savings remain unclear as the credit providers attach very low interest to it.
According to Gash, M. (2013) Saacos clients who attend business education and other co-curricular activities provided by Savings and Credit Schemes save on sustainable basis compared to those who do not attend.
Bundervoet, T., Annan, J, & Armstrong, M. (2012).recommends that participants in Microfinance institutions have been encouraged to save in every training session in order to improve their saving culture that leads to people in Seeta to improve their house hold income
Co-operatives have been an important part of development in East Africa. While they have seen many successes and failures, no other institution has brought so many people together for a common cause.
Following the Arusha declaration, cooperatives became the main tool for building a spirit of self-reliance during the Ujaama period. However, following the introduction of free markets, cooperatives have struggled to compete with the private sector and many have not been able to provide their members with services they need. The government responded to this problem by introducing a new cooperative development policy (2002) to help cooperatives regain their importance in the economic lives of people. A policy aimed at how government plans to facilitate the development of particular area of the economy such as agriculture, education or cooperatives. (Tanzania Federation of Cooperatives)
Brunie A, et al. (2014) contends that what SAACOs do by establishing clients’ interests and feeling through education is essential. He clarifies that education enhances learners’ self-motivation by developing inquiring mind; they gain proficiency in speaking, reading, and writing and can communicate effectively as individuals or as groups. He adds that business education develops attitudes for group work, social justice, cooperation, friendship and respect for humanity .
Sinclair, M. (2013) describes the need for education for developing participants’ skills for transfer in the new and changing situations. It develops the creativity and potential for communication. He explains that the participants apply a range of skills and techniques to develop a variety of ideas in the creation of new and modified products which win market and improves on people’s economic income.
Sacco also plays a crucial role in smoothing of incomes of households of members, where members can borrow to increase their consumption to acquire household items that they might not be able to purchase immediately. (Sinclair, M. (2013).
2.3 Financial Advise on poverty reduction
SACCOS in Uganda gain support from Co-operative Society Acts and Policies. For the example, The Co-operative Societies Act, 2003 ensure that the government created conducive environment for Cooperative Societies and their members to perform their functions in a free democratic manner and Promoting economic and social interest of the members for economic growth by setting International Cooperative Alliance (ICA) principles (Komba et al. 2005). The Co-operative Development Policy of 1997 and revised 2002 recognizes the importance of the National Poverty Reduction Strategy Paper (PRSP) accords to cooperative development. Also provide the structure of cooperative society from primary society at base level and federation at top as stressed by Section 14(1) of the Co-operative Societies.
2003, revised Edition, 2004. Further, The National Micro-finance Policy of Tanzania, 2000 emphasized on serving the low-income segment of the society whose incomes are very low with limited access to financial accessibility.
In the implementation of Public Finance Authority (PFA), the Government of Uganda has developed a strategy for RFSPP aimed at developing a financial infrastructure that can reach every sub- county in Uganda. The infrastructure is a channel for encouraging savings mobilization across the country this contributes to success of Sacco’s performance in rural area.
According to Food and Agricultural Organization (FAO) Economic and Social Development Department (2002) in their document, “savings mobilization to microfinance: A historical perspective on Zimbabwe”, it is stated that the first savings club in Eastern Africa was started by a Catholic missionary, Brother F. Waddelove, in 1963. This is certainly true of what came to be known as the savings movement in Zimbabwe. However the idea of developing means of saving amongst the poor in Zimbabwe, pre-dates the savings movement, and can be traced to the emergence of burial societies from the early years of colonial occupation after 1890. Burial societies were developed by migrant workers, often from outside of what was known as Rhodesia, namely Portuguese East Africa and Nyasaland, to both assist newly arriving migrants and assist with funeral arrangements of such workers. The average sizes of these societies were between 10 and 100. Most had a formal leadership structure of Chairman Secretary and treasurer, with some producing formal constitutions even at this early stage. In terms of fees, family, members paid a joining fee and monthly subscriptions. In the event of a death in the immediate family, members are paid lump sum payment.
Credit programmes in Uganda can be traced as far back as the early 1960s when two credit schemes namely the cooperatives credit scheme (CCS) in 1961 and the progressive farmers loan scheme (PFLS) in 1964 respectively with a focus of transforming farmers from subsistence to commercial practitioners and as a strategy to reduce poverty. Another state directed credit programme, the rural farmer’s scheme (RFS) was launched under the support of the Uganda commercial bank (UCB) in April 1988 also with similar objectives as the two credit programmes already mentioned above. All the above three credit programmes failed and were suspended due to high default rates and their failure was attributed to reasons ranging from incorrect mechanisms used to choose credit beneficiaries. Ferguson, M. (2012)
Cumbersome appraisal procedures which resulted in delayed disbursement, lack of sufficient staff to monitor the credit, the absence of readily available market for farmers’ produce. Other reasons for the failure of these credit programmes were top-down deficiencies such as bureaucracies, questionable integrity of loan officers, poor disbursement policy (in-kind), high transaction costs, and lack of security for the loan which is also affecting people .
Public Finance Authority (PFA) programme, which is planned to be achieved through the rural development strategy (RDS), emphasizes the need to enhance production, competitiveness and commercialization of the economy. This is to be achieved through increased production and productivity, promoting value addition and marketing, improved access to information and increased access to affordable financial services (Microfinance support Centre limited report, 2007).
Social capital enhances trust and through trust cooperation grows faster which involve risks (Dusuki 2008 and Clarisse’s 2005). Microfinance industry relies on social capital as part of its building blocks. Due to the membership of Sacco’s borrowers can enhance their credit worthiness as their debt is secured by their friends in the Sacco hat and Tang (2008) argued that the moral hazard that would subsequently arise due to default is greatly reduced due to the existence of strong networks within the group. They further support this claim by emphasizing on the monitoring that would arise from the guarantee mechanisms (the members guaranteeing each other) whereby members would guarantee other members with a good repayment history and ability to secure the other parties .Social adopt in place of other tangible assets when approving a loan to a member of a microfinance i.e..Sacco have been able to embrace the benefits that beget them due to social intermination..
Persons of a same vision and unifying factors are usually encouraged to join Sacco, this factor can not be left out. SACCOS are the saving grace for the persons with lower incomes and are usually viewed as the stepping stone from alleviation of poverty and growth of wealth. The major reasons that may encourage people to join Saccos include: easy access to finance through cheaper and simplified borrowing processes; there’s the mobilization of saving for further investments e.g. Uganda micro credit Sacco which has an in-investment vehicle where members save and investments and thus they get a return on investment as a dividend at the end of the financial year; Also for the interaction between members of a common bond through Sacco sanctioned activities e.g. financial literacy training; there’s also the issue of insurance in numbers where members guarantee each other for loans.(Luyirinka, 2010) in her research, her paper tested the relationship that exists between Microfinance Institutions and the socio-economic development of women in Uganda
