Research

THE INFLUENCE OF CREDIT RISK ON THE FINANCIAL PERFORMANCE OF MICROFINANCE INSTITUTIONS IN UGANDA,

A Case Study of Pride Microfinance Nakawa Branch

CHAPTER ONE

INTRODUCTION

1.0 Introduction

This chapter covered the background of the study, statement of the problem, purpose of the study, objectives of the study, research questions, and scope of the study, significance of the study, conceptual framework and definition of terms.

1.1 Background to the Study

The financial indicators of financial performance are: sales growth, return on investment (ROI), return on sales (ROS), return on equity (ROE), and earnings per share. The popular ratios that measure organizational performance can be summarized as profitability and growth: return on asset (ROA), return on investment (ROI), return on equity (ROE), return on sale (ROS), revenue growth, market shares, stock price, sales growth, liquidity and operational efficiency. Banks that charge lower interest rates have a bigger consumer base compared to those that charge high inters rates leading to an increased financial performance. Interest represents the average interest rate on all new public and publicly guaranteed loans contracted during the year. Competitive interest rates on deposits encourage customers of banks to deposit more (Crane, 2010).

The outcomes are not universal in nature but largely depend on the organizational context hence selection of the measures that represent performance of a particular organization is done based upon the circumstances of the organization being rated. It is important to remember that interest rates are not the only factors affecting a firm’s financial performance rather measuring a group performance is more important than focusing on only one or two measures at the exclusion of others (Parasuram, 2019).

Credit risk is the blue print used by a business in making its decision to extend credit to a customer. Thus, the main goal of a credit policy is to avoid extending credit to customers who are unable to pay their accounts. Credit policy for some larger businesses can be quite formal; involving specific documented guidelines, credit checks and customer credit applications, the policy for small businesses tends to be quite informal and lacks the items found in the formal credit policy of larger businesses. Many small business owners rely on their business instincts as their credit policy (Blair, 2011). Credit risk management has direct effects on the cash flow of any business. Hence, a credit policy that is too strict will turn away potential customers, reduce sales and finally lead to a decrease in the amount of cash inflows to the business. On the other hand, a credit policy that is too liberal will attract slow paying (even non-paying) customers .increase in the business average collection period for accounts receivables .and eventually lead to cash inflow problems in microfinance bank. A good credit risk management should help management to attract and retain customers, without having negative impact on cash flow.

Credit portfolio performance continues to attract attention of scholars and policy-makers due to the long reputable need for credible Microfinance institutions (MFIs) like PRIDE microfinance. Some empirical evidence has shown that in most developing economies, MFIs have brought millions of citizens into cohesive financial institutions which are succeeding very well in providing financial services to its members for improving their standard of living (Collier, Katchova, & Skees, 2011; Kumar & Golait, 2009; Moti et al., 2012). In continuing with this service, Biekpe and Kiweu (2009) point out that Credit portfolio performance of MFIs is critical. With issues of over-indebtedness emerging among microfinance customers.

Microfinance institutions aim at maximizing the return to portfolio while keeping the risk within acceptable bound (Van der Maas, 2006). This maximization requires a balancing of high repayment rates, low arrear rates, low default rates as well as low portfolio at risk. Unfortunately for Ugandan case, MFIs suffer from poor credit allocation strategies and weak risk management practices according to Association of Microfinance Institutions Uganda (AMFIU report (2014). Credit portfolios are the major asset of MFIs and various studies have been undertaken as regards to, for example, Credit portfolio performance (González-Vega, 2003; Kropp & Katchova, 2011; Qinlan & Izumida, 2013).With respect to PRIDE microfinance, the major problem facing the bank has been identified as failure to manage Credit default (PRIDE microfinance Annual Reports, 2005, 2006, 2007). The management of the bank depends on incentives to repay on time; instant arrears information and delinquency tracking; immediate action to enforce repayment; and rigorous recovery in case of default to achieve Credit repayment (Annual Report, 2005). Out of the 28 operational branches of PRIDE microfinance Bank, micro lending performance indicates that the total portfolio for the headquarter branch is approximately UGX. 14.1 billion of which UGX. 3.7 billion is in individual micro Credit with a total arrears rate of 3.7% for the year 2007. For the years 2006 and 2005, the bank closed with arrear rates of 3.6% and 5.46% respectively. In addition, the bank’s micro lending performance for the last three years reveals that it has continued to record average arrear rates of 4.24% and Non-Performing Assets (NPA) rates of individual micro Credit of 1.4% where the acceptable rate by Bank of Uganda is 1%. The above weaknesses may be responsible for the high default rate. It is upon this background that the study seeks to investigate the influence of credit risk on the performance of microfinance institutions in Uganda.

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1.2 Statement of the Problem

Credit risk management is beneficial to a financial institution as effective Credit risk management helps a financial institution in increasing its liquidity, and also enables it to pay back debts, workers, and increase its capital base among many other benefits of Credit management (Orebiyi, 2002).

However despite of the adoption of credit management policies by PRIDE microfinance banks, the bank is faced with numerous performance challenges including, poor levels of recovery rates of Credit from borrowers, low profitability margins, poor performance as compared to its other similar  financial institutions such as commercial banks, village banks and above all increased complaints by bank top management about the low levels of the institutions performance (PRIDE microfinance Bank Annual Reports, 2005, 2006). This study therefore sought to examine the influence of credit risk on the performance of microfinance institutions in Uganda, with specific reference to PRIDE Microfinance Nakawa Branch.

1.3 Purpose of the Study

The study sought to examine the influence of credit risk on the performance of Microfinance institutions in Uganda, with specific reference to PRIDE Microfinance Nakawa Branch.

1.4 Objectives of the Study

1. To examine the influence of transactional risk on microfinance performance.
2. To determine the effects of portfolio risk on performance of microfinance.

• To establish the relationship between credit risk management and the performance of microfinance institutions.

1.5 Research Questions

1. What are the influence of transactional risk on microfinance performance?
2. What are the effects of portfolio risk on performance of microfinance?

• What is the relationship between credit risk management and the performance of microfinance institution?

1.6 Scope of the Study

1.6.1 Study Scope

The study specifically concentrated on influence of transactional risk on microfinance performance, the effects of portfolio risk on performance of microfinance and the relationship between credit risk management and the performance of microfinance institution.

1.6.2 Geographical Scope

The study was carried out at PRIDE microfinance Nakawa Branch.

1.6.3 Time scope

The period of data to be considered in the organization was from 2012-2019 and period of body of knowledge in reviewing literature was from 2010-2020

1.7 Significance of the Study

The study is expected to provide guidance to the Central Bank (Bank of Uganda) and other regulators in the credit risk management policy formulation.

The study will add to the already existing literature on determinants of micro finance institution performance.

The study is expected to stimulate further research into the area of lending policy formulation and performance of Credit.

The study is expected to enable commercial banks identify the Credit management policies that are critical in the lending business.

The study will help the government in formulation of policies regarding microfinance institutions in the country.

1.8 Operational definition of key terms

Credit

Credit is generally defined as a contractual agreement in which a borrower receives something of value now and agrees to repay the lender at a later date generally with interest.

Risk

Risk is defined in financial terms as the chance that an outcome or investment’s actual gains will differ from an expected outcome or return. Risk includes the possibility of losing some or all of an original investment.

Microfinance

Microfinance refers to an array of financial services, including loans, savings, and insurance, available to poor entrepreneurs and small business owners who have no collateral and wouldn’t otherwise qualify for a standard bank loan.

Microfinance is a broad term to define financial services for people with low incomes or those who do not have access to traditional banking services.

Financial performance

Carton (2018) also defines financial performance of an organization as the measure of the change of the financial state of an organization or the financial outcomes that results from management decisions and the execution of those decisions by members of the organization.

CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

This chapter discussed what various scholars wrote about the influence of credit risk on the performance of microfinance institutions in Uganda.

2.1.2 The transactional risk on microfinance performance

Transaction risk exists in all products and services. It is a risk that arises on a daily basis in the MFI as transactions are processed. Transaction risk is particularly high for MFIs that handle a high volume of small transactions daily. When traditional banks make credits, the staff person responsible is usually a highly trained professional and there is a very high level of cross-checking. Since MFIs make many small, short-term credits, this same degree of cross-checking is not cost-effective, so there are more possibilities of committing error and fraud.

Credit risk Management is a discipline at the core of every financial institution and encompasses all the activities that affect its risk profile. It involves identification, measurement, monitoring and controlling risks to ensure that; the individuals who take or manage credit risks clearly understand it, the organization’s risk exposure is within the limits established by Board of Directors;  Risk taking decisions are in line with the business strategy and objectives set by BOD, the expected payoffs compensate for the risks taken, risk taking decisions are explicit and clear, sufficient capital as a buffer is available to take risk (Nagarajan 2011).

Transaction Risk is the exposure to uncertainty factors that may impact the expected return from a deal of transaction. This could include but is not limited to foreign exchange risk, commodity, and time risk. It essentially encompasses all negative events that can prevent a deal from happening. A deal that has a high transaction risk will typically require a higher expected return therefore, it is important to consider such risk when evaluating prospective investment. In some instances, transaction risk can stop a deal from going through due to potentially negative outcomes associated with the transaction.

The acceptance and management of credit risk is inherent to the business of MFI as financial intermediaries (Nusselder, 2013). Risk management as commonly perceived does not mean minimizing risk; rather the goal of risk management is to optimize risk-reward trade -off. Despite the fact that MFIs are in the business of taking risk, it should be recognized that an institution need not engage in business in a manner that unnecessarily imposes risk upon it: nor it should absorb risk that can be transferred to other participants (Nusselder, 2013).

The following are the strategies to reduce transactional risk in microfinance institution

Risk-based pricing: Lenders generally charge a higher interest rate to borrowers who are more likely to default, a practice called risk based pricing. A lender considers factors relating to the Credit, such as credit purpose, credit rating, and credit to value ratio and estimates the effect on yield. Covenants: Lenders may write stipulations on the borrower, called covenants into Credit agreements: Periodically report its financial condition; Refrain from borrowing further or other specific, voluntary actions that   negatively affect the company’s financial position; Repay the Credit in full, at the lender’s request, in certain events such as changes in the borrower’s  debt to equity ratio or interest coverage ratio tightening: Lenders can reduce credit risk by reducing the amount of credit extended, either in total or to certain borrowers, from the above findings it is evident that Risk based pricing enables the lenders to reduce transactional risks of their different products in the lending business (Nusselder, 2013).  .

Diversification: Lenders to a small number of borrowers (or kinds of borrower) face a high degree of unsystematic credit risk, called concentration risk.  Lenders reduce this risk by diversifying the borrower pool. Nawai and Shariff (2010) in their study found that close and informal relationship between MFIs and borrowers help in monitoring and early detection of problems that may arise in non-repayment of Credits that finally lead to credit risk.  In addition, cooperation and coordination among various agencies that provide additional support to borrowers may help them success in credit risk management in their business.  Method used is that quantitative research method.

Laurentis and Mattei (2019) conducted research on Lessors’ recovery risk management capability and found that the development of modern reliable systems of risk management can enhance even more those management capabilities.  This means that credit institutions should invest significant resources in projects aimed at correctly implementing rating systems and credit risk models, and highlights once more the importance of these tools well beyond the scope of regulatory compliance. The research method used is that mixed research method.

Chua et al. (2010) conduct research on microfinance, risk management, and poverty indicated that the relationship between risks to the client and risks to the Credit portfolio has been largely important to the microfinance industry.  This is because a more explicit recognition of this relationship in the design of products and services can reduce both the risk of borrowing for clients and the risk of lending for MFIs.  Products, services, and delivery mechanisms that are designed to improve the capacity of clients to deal with risk in their lives (reduce their vulnerability) and to reduce the risk of taking a Credit can lead to better repayment, fewer dropouts, and, accordingly, lower operating costs.

Character of the clients before the Credit disbursement is very essential. Character 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 Credit 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 Credit sustainability of the enterprise once the Credit is paid. Other source should be identified so as to enable him serve the Credit in time. This helps micro finance institutions not to only limit Credits 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.

The state of the collateral security of the lender. Collateral is the property, fixed assets, chattels, pledged as security by clients. This is what customers offer as saving so that failure to honor his obligation the creditor can sell it to recover the Credit. It is also a form of security which the client offers as form of guarantee to acquire Credits and surrender in case of failure to pay; if borrowers do not fulfill their obligations the creditor may seize their asset (Girma, 2010).

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).

2.3 Effects of portfolio risk on performance of microfinance.

Credit portfolio constitutes Credits that have been disbursed or bought and are being held for repayment. Credit portfolios are the major assets of the lending institutions. The value of the Credit portfolio depends not only on the interest rates earned on Credits but also on the likelihood that interest and principal will be paid. Lending is the principal business activity for most commercial banks. The Credit portfolio is typically the largest asset and the predominant source of revenue.

As such, it is one of the greatest sources of risk to a bank’s safety and soundness. Whether due to lax credit standards, poor portfolio risk management, or weakness in the economy, Credit portfolio problems have historically been the major cause of bank losses and failures (Mehta, 2010).

Micro Finance Institutions (MFIs) are increasingly a central source of credit for the poor in many countries. Weekly collection of repayment instalments by bank personnel is one of the key features of micro-finance that is believed to reduce default risk in the absence of collateral and make lending to the poor viable. Some of the factors that lead to credit default include; inadequate or non-monitoring of micro and small enterprises by banks, leading to defaults, delays by banks in processing and disbursement of credits, diversion of funds, over-concentration of decision making, where all credits are required by some banks to be sanctioned by Area/Head Offices (Kakuru, 2010).

Developing cheap ways of gathering information, Armendariz et al, (2010) stated that the information asymmetry problems could potentially be eliminated if lenders had cheap ways to gather and evaluate information on their clients and to enforce contracts, he further indicates that financial institutions do not need to have expensive loans as this increases the risk of default and rather Banks should set loans with in the capacity of the clients so that they are able to pay Back their loans.

Lenders typically face relatively high transactions costs when working in poor communities since handling many small transactions is far more expensive than servicing one large transaction for a richer borrower. Another potential solution would be available if borrowers had marketable assets to offer as collateral. In this sense, any problem on the Credit was covered by the borrower’s asset. Thus, the lender could lend without risk. But the starting point for microfinance is that new ways of delivering Credit are needed precisely because borrowers are too poor to have much in the way of marketable assets. However, Behrman and Srinivasan (2015) stated that one way for the government to improve enforcement conditions for credit markets is to improve the possibilities for usable sources of collateral like implementation of land registration.

Information asymmetries generate problems of adverse selection, allocation of credits to borrowers with undesirable characteristics such as a high level of risk or inability to take advantage of the credit as well as moral hazard the borrower may behave in an undesirable way. Adverse selection and moral hazard increase the proportion of borrowers who cannot repay their credits on time. Borrowers that have enough money to reimburse their credit might also default strategically. The cost of strategic default might indeed be low if the lending institution has low collateral requirements and if the legal system gives little power to the financial institution to enforce contracts. Financial institutions try to restrict the occurrence of those three types of situations in designing appropriate credit schemes (Chan and Thakor (2010).

According to the consultative paper issued by the Basel committee on banking supervision (Hassan and Sanchez (2009)); most banks’ credits are the largest and most obvious sources of credit risk. Banks are increasingly facing credit risk in various financial instruments other than credits, including acceptances, interbank transactions, trade financing, foreign exchange transactions, financial futures, swaps, bonds, equities, options, the extension of commitments and guarantees and the settlement of transactions (Rosenberg, Gonzalez, & Narain, 2009).

Regulation and Supervision Microfinance institutions in the formal sector operates within a rigid regulatory and supervisory environment which presents some challenges for innovation, outreach and overall performance of the institutions. There is also an absence of specific BoG regulatory guidelines for the apex bodies in the semi-formal and informal sectors for the supervision of their members.

2.4 Relationship between credit risk management and the performance of microfinance institution.

Good credit management provide the institution with a reasonable and adequate return on credits 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 credit 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 credits 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 credits are extended to them. However, (Van Home. 2010) states that when an institution extends credit to only strongest customers, it will never have bad losses and will incur fewer administration expenses.

Reducing default on borrowed funds could be voluntary and involuntary. Involuntary default on borrowed funds could arise from unfavorable circumstances that may affect the ability of the borrower to repay. On the other hand, voluntary default, whereby a borrower does not repay even if he/she is able to do so (Stigliz and Weiss 1981). Therefore, the lender must understand the causes and the possible solutions of default. According to Norell, (2001) the most common reasons for the existence of defaults are the following: if the MFI is not serious on Credit repayment, the borrowers are not willing to repay their Credit; the MFI staffs are not responsible to shareholders to make a profit; clients’ lives are often full of unpredictable crises, such as illness or death in the family; if Credit are too large for the cash needs of the business, extra funds may go toward personal use; and if Credit are given without the proper evaluation of the business (Norell, 2001).

In order to achieve self-sufficiency, reducing default rate is very crucial for any MFI. MFIs can take a number of actions to reduce default rate or the amount of arrears. Norell (2001) writes about some strategies for preventing or reducing default. Giving training to the clients prior to the transaction of each Credit and financial incentives for the credit officers can be used to lower the default rates. Vento (2004) also defined the incentives from the promise to access to the subsequent Credit improves timely repayment and reducing default.

In addition, quick follow-up visits right after a missed payment and the formation of strong solidarity groups are also key to preventing high default rate. Limiting geographic scope reduces time and money wasted traveling from the office to clients’ businesses. If credit officers have a specific geographic region, they can visit clients more often and it helps to develop relationships in their neighborhoods. Credit should be given to the borrowers who have been in business at least twelve months. Businesses are most likely to fail within the first year of operation. If the business existed for at least one year on the owner’s equity, the Credit from an MFI should be a lower risk than if the business is a start-up. Some MFIs use six months as a minimum; others three. The lower the number of months, the higher the risk for the MFI Norell (2001).

Norell agreed on the four categories of client in the MFIs: willing and able to repay; willing but unable to repay; unwilling but able to repay; and unwilling and unable to repay. For very late Credit (group Credit over five weeks without payment, individual Credit at sixty days without payment), credit officers should visit each late payer and the credit officer should classify the client into one of the above four categories of client. Based on the classification of borrowers, the Credit officer shoud take corrective action. The appropriate action taken by Credit officer in each category are: (1) having the credit officer and the supervisor visit the client’s business, (2) rescheduling should be considered for clients with a very good excuse, (3) the institution can pursue legal action or inform the community and influential persons of clients’ unwillingness to repay. Because religious and community leaders can push them to pay. Moreover, their names can be publicly posted and (4) following up on such groups is apoor use of staff time. They are best referred to debt collectors or written off the Credit (Norell, 2001).

Kakuru (2010) explains the significance of discounts in credit terms. Discounts are offered to induce clients to pay up within the stipulated period or before the end of the credit period .This discount is normally expressed as a percentage of the credit. Discounts are meant to accelerate timely collection to cut back on the amount of doubtful debts and associated costs.

Ringtho (2010) observes that credit terms are normally looked at as the credit period terms of discount and the amount of credit and choice of instrument used to evidence credit. Credit terms may include; Length of time to approve credits, this is the time taken from applicants to the credit disbursement or receipt. It is evaluated by the position of the client as indicated by the ratio analysis, trends in cash flow and looking at capital position. Maturity of a credit, this is the time period it takes credit to mature with the interest there on. Cost of credit. This is interest charged on credits, different micro finance institutions charge differently basing on what their competitors are charging. The chartered institute of bankers and lending text (2012) advises lending institutions to consider amount given to borrowers. Robinson MS (2010) pointed out that the maximum credit amount per cycle are determined basing on the purpose of the credit and the ability of the client to

repay (including guarantee).

CHAPTER THREE

METHODOLOGY

3.0 Introduction

This chapter presents the methodology which consists of the research design, area of study, study population, sample population and selection, sampling technique, data collection method, data quality control, data collection procedures and limitations of the study.

3.1 Research Design

The researcher used cross sectional survey research design. The function of quantitative research design was to ensure that the evidence obtained enables the researcher to answer the initial question as unambiguously as possible.

Quantitative approach deals with numerical expression in figures in terms of quantity which involves measurement of quantity and amounts.

However quantitative approach was used because of the following reasons; this approach eliminated behavioral biases whereby the behavioral beliefs were done away with, the approach led to accuracy whereby results were not guessed, operational risks are reduced. Quantitative approach was used in a way of getting actual figures and taking on calculations then getting answers.

3.2 Area of the Study

The study was carried out at PRIDE Microfinance Ltd, Nakawa Branch.

3.3 Study Population

The study included the workers of PRIDE microfinance Nakawa Branch employees who included; Bank administrators, the credit (loan) officers, accountants/cashiers, and secretaries and their total population is 35.

3.4 Sample size and sampling technique

According to (Amin, 2005) sampling involves selecting a sample of the population in such a way that samples of the same size have equal chances of being selected.

The respondents were selected using purposive sampling techniques. Berg (2006) purposive sampling, the researcher chooses the sample based on where they think would be appropriate for the study. A Purposive sampling technique was used because it’s cheap.

Using Krejcie and Morgan’s (1970) table for sample size determination approach, a sample size of 30 employees were selected from the total population of 35 employees.

Table 1 below shows the summary of the sample size of the respondents and the sampling techniques that was used in the study.

Source: Primary data

3.5 Data Sources

Source of data was from both primary and secondary sources.

• Primary source

Primary data is the data collected from the field. Primary data was obtained through the use of questionnaires administered to the target respondents to gain opinions and practices on impacts of Credit management on the performance of microfinance institutions.

• Secondary sources

Secondary data is data which has been collected by individuals or agencies for purposes other than those of a particular research study. It is data developed for some purpose other than for helping to solve the research problem at hand (Bell, 1997).

Secondary data comprised literature related to impacts of Credit risk on the performance of microfinance institutions in Uganda in relation to the case study.

Secondary data was sourced because they yield more accurate information than data obtained from primary sources. In addition, obtaining secondary data is cheaper than obtaining primary data. This is because obtaining secondary data never made the researcher to incur any transport cost as the case was in obtaining primary data.

3.6 Data Collection methods

The major instruments for data collection were questionnaires and interview guide. Surveys were just one part of a complete data collection and evaluation strategy. The major method of data collection for the study was the survey, which was done using selected instruments like questionnaires. The questionnaire provided respondents with ample time to comprehend the questions raised and hence, they were able to answer factually.

3.6.1 Questionnaires

The questionnaire was used to collect quantitative data. The researcher administered the questionnaires to respondents in different departments including, finance and accounts department (cashiers and accountants), administration, and secretaries, which was designed basing on study objectives and questions. Respondents read and wrote the questionnaires themselves. The questionnaires were open and close ended, and was considered convenient because they were administered to the literate and its anonymous nature fetched unhindered responses.

3.7 Validity of the Instrument

Validity of Instruments is the extent to which the instruments used during the study measure the issues they are intended to measure. To Ascertain the Validity, questions will be discussed with the supervisor, given to two independent lecturers. This was done to clear any lack of clarity and ambiguity to assess the relevancy of the questions with the objective of the study and the content validity index therefore be computed using the formulae below.

Content validity index (CVI) =   Number of items rated relevant

Total Number of Items in the questionnaire

The content validity index was calculated basing on the different sections of the questionnaire. This is supported by Amin (2005) who stated that for any instrument to be accepted as valid, the average index should be greater than 0.5 therefore since the computed value were greater than 0.5 i.e. 0.9, the instrument was considered valid and the researcher used them for data collection.

3.8 Reliability of Instrument

Reliability is the extent to which the measuring instrument produces consistent scores when the same groups of individuals are repeatedly measured under the same conditions (Amin, 2004).

For consistency of research results from the study instrument, the researcher used Cronbach’s alpha method with the help of SPSS as indicated below, so as to determine reliability of this instrument.

The instrument was taken to the supervisor to check its correctness there after pretesting study was carried out to find out if it measures what it is meant to for.

3.8 Data Processing

Data processing involves reduction of accumulated data to a manageable size, developing summaries, looking for patterns and applying statistical techniques.

Using statistical package for social scientists (SPSS) to process quantitative data, the study was in position to avail descriptive frequency tables that generated preliminary findings and later inferential tables was used to generate conclusive (Amin, 2005).

3.9 Data Analysis

The researcher only analyzed quantitative data.

The study entered data collected from the field into SPSS. For analyzing the data collected from the field.

3. 10 Limitations to the Study

Financial constraint, cash flow did not flow as   expected but this did not affect the study. Respondents delayed in filling the questionnaire and fear to give information, but they were persuaded that the information was to be kept secret.

CHAPTER FOUR

PRESENTATION, ANALYSIS, INTERPRETATION AND DISCUSSION OF FINDINGS

4.0     Introduction

This chapter presents the results in reference to objectives in chapter one. Gender of respondents, age of respondents, education level of respondents, and different objectives.

4.1 Findings on general information

Table 4.1: shows the findings on the gender of the respondents

Source: Primary Data

Table 4.1 above shows that 63.33% of respondents were male and 36.67% were female. That means that the biggest percentage of respondents and employees in PRIDE Microfinance bank were males and therefore the ones who highly participate in disbursing credit (loans) as well as in the credit risk management.

Also Table 4.1 shows that male employees would highly attract male clients to access microfinance products such as microcredit, micro savings, micro insurance from the financial institutions. In addition, dominance of male staff implies that they take the greatest responsibility of managing credit risk from male borrowers.

4.2 FINDINGS ON THE AGE OF RESPONDENTS.

Table 4.2: Shows findings on age of the respondents

Source: primary data

The Table 4.2 above shows that majority of the respondents are at the age of 30-39 this is evidenced by a high percentage of 36.67% while 20% of the respondents are at the age of 40-49 years, minority of the respondents are at the age of 50 years and above and below 25 years, 16.67% of the respondents are at the age of 25-30 years. The low numbers of respondents below 25 years also further shows that the organization employees only mature people and therefore this group of respondents were able to articulate issues very well and give reliable information that could be relied upon on credit management and therefore they also have knowledge regarding credit management in a microfinance institution.

Table 4.3: shows findings on education level of respondents

Source: primary data

Table 4.3 above shows that the majority of staff are degree holders and their percentage is 50%, masters 13.33%, while 20% of the respondents are diploma holders and the rest of the respondents have other qualification this table therefore shows that majority of the respondents could read and write and therefore they were able to answer the questions that they were asked. The good academic qualification also further shows that the respondents have good knowledge of the subject topic and are conversant with credit. The high numbers of degree holders also further shows that PRIDE microfinance employs employees who have knowledge on credit management skills and therefore their responses could be relied upon.

4.2 Findings number of years of working

Table  4.4: showing the number of years respondents have worked at PRIDE Microfinance bank

The Table 4.4 shows that majority of the respondents have worked for the time period of 6-10 years, and their percentage stands at 50% of, 20% of the respondents have worked for 3-5 years, while 16.67% of the respondents have worked for and respondents who have worked for above 10 years have percentage of 13.33%. The low numbers of respondents who have worked below 2 years also further indicates that the employees of PRIDE microfinance had good knowledge of credit management because they have worked for long and therefore the responses could be relied upon.

4.4 Influence of Transactional Risk on Microfinance Performance

Table 4.5: shows the influence of transactional risk on microfinance performance.

Table 4.5 above reveals that the bank has high chances of losing money from clients who borrow; this is supported by the strong percentage of 47% strongly agreeing, while 33% agreed and 10% disagreed while the remaining percentage of respondents strongly disagreed. This results also further shows that the risk is always high for the Bank when lending money and it was also further supported by the Nagarajan (2011) who indicated that there are many risks when lending money and some of them include even risks of taking a decision so as ensuring that the risks the decision are in line with the programs of the organization. He further indicated that there is need for identification, measurement, monitoring and controlling risks to ensure that; the individuals who take or manage credit risks clearly understand it, the organization’s risk exposure is within the limits established by Board of Directors.

Table 4.5 also indicates that the majority of the respondents strongly and agreed that the clients have chances of shifting their business after receiving the loan while none of the respondents was neutral, disagreed, and strongly disagreed. This therefore shows that indeed clients have chances of shifting their business after receiving the loan this view was also further shared by Nusselder, (2013) who indicated that the acceptance and management of credit risk is inherent to the business of MFI as financial intermediaries and therefore the microfinance institution should be aware of the changing ways of the client who at times can shift their business location after getting the loan.

According to table 4.5; 46.67% of the respondents strongly agreed that client business capacity is established before a loan is disbursed, while 33.33% of the respondents agreed while 20% of the respondents where neutral this was also further asserted by Nusselder, (2013) who indicated that Risk management as commonly perceived does not mean minimizing risk and therefore the client’s business capacity has to be established in order to minimize the level of risks involved in the business transaction.

According to researchers’ findings, 60% of the respondents strongly disagreed that a clients are comfortable with the banks interest rates while the rest of the respondents agreed and it has also been further indicated that this high disagreement indicates that the clients are not comfortable with the Bank’s Interest rates and it also further shows that the interest rates are high and therefore the Business minded people are affected by the bank’s high interest rates  this view was also further shared by Nusselder, (2013) who asserts that   Lenders generally charge a higher interest rate to borrowers who are more likely to default, a practice called risk based pricing. A lender considers factors relating to the Credit, such as credit purpose, credit rating, and credit to value ratio and estimates the effect on yield.

According to the table 4.5, 66.7% of the respondents strongly agreed that the character of clients is considered before a loan is disbursed while 16.67 agreed and the remaining percentage disagreed. From the findings it is therefore acknowledged that the character of the individual is crucial to consider when advancing a loan to them and therefore pride microfinance should ensure that it completely considers it before advancing a loans to any of them.

The study findings from table 4.5 indicate that the majority 50% of the respondents strongly disagreed that most clients pay back their installments timely. This factor therefore indicates that most clients do not pay back their installments as required timely. The study results further indicates that 33% of the respondents also disagreed and only 3% agreed, from the above findings it can therefore be acknowledged that clients do not pay back their installments timely.

The study results also further shows that majority 57% of the respondents strongly disagreed that most clients pay all their loans as required. This further indicates that clients do not pay their loans as required therefore implying that PRIDE Microfinance is facing challenges in getting back the installment payments this was also further indicated by Nawai and Shariff (2010) in their study found that close and informal relationship between MFIs and borrowers help in monitoring and early detection of problems that may arise in non-repayment of Credits that finally lead to credit risk.  In addition, cooperation and coordination among various agencies that provide additional support to borrowers may help them success in credit risk management in their business.

4.2.1 Effects of portfolio risk on performance of microfinance

Table  4.6: shows Effects of portfolio risk on performance of microfinance:

Source: Primary Data

From table 4.6 above, findings revealed that, 50% of respondents strongly disagreed that the bank has developed better ways of managing cases of loan default, 33% disagreed while 17% were neutral. This therefore shows that majority of respondents agreed from the above analysis. This finding is also in line with Mehta, (2010) who indicated the greatest sources of risk to a bank’s safety and soundness whether due to lax credit standards, poor portfolio risk management, or weakness in the economy, Credit portfolio problems have historically been the major cause of bank losses and failures and since most banks are reluctant to develop better ways of risk management they therefore fall into the trap.

According to the table 60% of the respondents strongly agreed that there is better system in place to manage loan default, while the remaining 40% agreed. This therefore shows that all the respondents agree with the better loan management strategy as it can help the microfinance bank reduce the credit risk. This view was also shared by Kakuru, (2010) who further indicated that some of the factors that lead to credit default include; inadequate or non-monitoring of micro and small enterprises by banks, leading to defaults; delays by banks in processing and disbursement of credits, diversion of funds, over-concentration of decision making, where all credits are required by some banks to be sanctioned by Area/Head Offices.

Table 4.6 also shows that, 73 % of the respondents strongly disagreed that the interest are set in line to the capacity of borrowers, while 17% disagreed, 3% of the respondents were not sure while the remaining 10% agreed.  This study results also shows that the loan interest are not in line with the capacity of the borrowers. This therefore shows that the Bank needs to have manageable interest rates for loans so that the clients are able to back the loans promptly without defaulting. This view was also further shared by Armendariz et al, (2010) who stated that; financial institutions do not need to have expensive loans as this increases the risk of default and rather Banks should set loans with in the capacity of the clients so that they are able to pay Back their loans.

It has been reported that the respondents indicated that 83% of respondents strongly agreed that the Bank has a limit to how much it can lend, while 17% of the respondents agreed. This view also indicates that the Bank has the limit it can lend and this therefore shows that there is need for the Bank to have limit to how much credit they can offer in a single disbursement.

The study results indicate that majority, that is, 50% of the respondents indicated that there is improvement in credit management system when the PRIDE microfinance improves on the management of its portfolio risk management. Table 4.6 also indicates that 40% agreed and only 10% strongly agreed.  This view was also shared by Behrman and Srinivasan (2015); who stated that: one way for the government to improve enforcement conditions for credit markets is to improve the possibilities for usable sources of collateral like implementation of land registration.

The study results also further indicate that Better information gathering on clients has been implemented by the bank, this is indicated by the fact that 60% of the respondents strongly disagreed, 20% disagreed and 10% of the respondents strongly agreed. The study results further shows that 60% of the respondents indicated that there is need for screening of the clients before the loan is advanced this view was also in line with Chan and Thakor (2010) who indicated that Borrowers that have enough money to reimburse their credit might also default strategically. The cost of strategic default might indeed be low if the lending institution has low collateral requirements and if the legal system gives little power to the financial institution to enforce contracts. Financial institutions try to restrict the occurrence of those three types of situations in designing appropriate credit schemes.

The study results further indicates that 67% of the respondents strongly agreed with the findings that there is  proper regulation and supervision of the microfinance credit portfolio, while 33 % of the respondents agreed with that view, none of the respondents agreed or strongly agreed this therefore indicates that the respondents do not believe that there is proper regulation and supervision and this to some extend shows that the Bank needs to have proper regulation and supervision so as to enhance the efficiency of its operations.

4.2.2   Relationship between credit management and microfinance institution performance.

Table 4.7: Shows Relationship between credit management and microfinance institution performance

Table 4.7 above shows that 60% of the respondents strongly agreed that there is need for reduction on default on borrowed funds while the remaining 40% agreed. This high percentage further shows that the bank needs to seriously work on the system of reducing default on borrowed funds so as to Pandey (2010) indicated that good credit management provide the institution with a reasonable and adequate return on credits and capital employed primarily through improvement in operations efficiency this generates adequate internal resources to finance the institution’s growth.

According to table above it indicates that, 73 % of the respondents strongly agreed that creation of self-sufficiency, while 27% agreed, while none of the respondents was neutral, disagreed, and strongly disagreed. This view was also in line with Van Home. (2010) who indicates that it is important for the financial institution to create an environment of self-sufficiency and therefore the customers’ ability need to evaluate so as to minimize the risks and create self-sufficiency.

Findings revealed in table above, shows that 50% of the respondents strongly agreed that formation of a strong solidarity groups is key in promoting loan recovery, and this promotes liquidity in the Bank and the other 50% agreed that formation of solidarity groups helps in promoting a healthy loan portfolio.  This therefore shows that 100% of the respondents agree with the fact that formation of strong solidarity groups is essential to enable PRIDE microfinance Bank be in position to make most of the adjustments need to ensure better credit management and improve its performance. This view was also in line with Kakuru (2010) who explains the significance of discounts in credit terms. Discounts are offered to induce clients to pay up within the stipulated period or before the end of the credit period .This discount is normally expressed as a percentage of the credit. Discounts are meant to accelerate timely collection to cut back on the amount of doubtful debts and associated costs and discounts are better offered when the borrowers are in a group.

According to the table 57% of the respondents strongly agreed that creation of client groups, while the remaining 36% of the respondents strongly agreed, and 7% of the respondents were neutral on the relationship between creation of clients’ group and credit risk management in microfinance while none of the respondents disagreed or strongly disagreed on such. This view was also agitated for by Ringtho (2010) who observes that credit terms are normally looked at as the credit period terms of discount, the amount of credit and choice of instrument used to evidence credit and further indicates that when borrowers are organized in groups they are able to negotiate better terms of trade.

CHAPTER FIVE

SUMMARY, CONCLUSIONS AND RECOMMENDATIONS

5.0 Introduction

This section presents the; Discussion, Conclusions and Recommendations.

5.1 summary of the study

This section of the study include; to examine the influence of transactional risk on microfinance performance, to determine the effects of portfolio risk on performance of microfinance and to establish the relationship between credit risk management and the performance of microfinance institution.

5.1.1 Influence of Transactional Risk on Microfinance Performance

The results shows that  PRIDE microfinance has high chances of losing money from clients who borrow, this therefore indicates that financial institutions lose money sometimes to clients during the issuing of credit and also further implies that the Bank needs to design better way of managing its transactional risks.

In the study majority of the respondents strongly and agreed that the clients have chances of shifting their business after receiving the loan while none of the respondents was neutral, this therefore indicates that the clients that clients sometimes shift their location of the business in order to default from paying the loan.

According to the study findings it is imperative to note that Client’s business capacity is established before a loan is disbursed, this also enables the Bank from minimizing the risks involved in the lending business and it is through this that the Bank establishes the amount that the client deserves to be given so as to avoid cases of over funding.

According to researchers’ findings, majority of the respondents strongly disagreed that a Clients are comfortable with the banks interest rates, this finding therefore indicated that clients are not comfortable with the Bank interest rates since they perceive it to be high and exorbitant, and, therefore unfair to them.

The study results further shows that majority of the respondents indicated that character of clients is considered before a loan is disbursed , this practice also helps the Bank in minimizing the transactional risks before the loan is disbursed to a client.

Majority of the respondents strongly disagreed that most clients pay back their installments timely. This factor therefore indicates that most clients do not pay back their installments as required timely, therefore the study results indicates that clients are mostly not able to pay back their installments timely.

The findings in the study indicated that clients do not pay all their loans as required.  This further indicates that clients do not pay their loans as required therefore further indicating that PRIDE Microfinance is facing challenges in getting back the installment payments.

5.1.2 Effects of portfolio risk on performance of microfinance

The study results further indicates that majority of the respondents disagreed that the bank has developed better ways of managing cases of loan default, this results also further indicates that the bank is currently facing challenges of loan default.

The results in the study indicates that there is need to adopt a better system to manage loan default from this results therefore it indicates that the respondents hold the view that adopting a better system to deal with loan default is one of the challenges facing the Bank

According to the study results majority of respondents strongly disagreed that the interest are set in line to the capacity of borrowers. This view therefore indicates that the Bank interest are not set in line with capacity of Borrowers.

The study results also indicates that the Bank has a limit to how much it can lend, this view therefore also indicates that the Bank has the limit  on the amount of the money it can lend to the clients it Borrows.

The study results also indicate that there is Improvement in credit management system when the PRIDE microfinance improves on the management of its portfolio risk management. The results also indicate that the Bank is improving the credit management system.

The study results also indicates that Better information gathering on clients has been implemented by the bank, this enables the bank to be in position to screen the clients so as to enable the Bank reduce the chances of getting

5.1.3 Relationship between credit management and microfinance institution performance.

The findings in the study indicates that Reduction on Default of borrowed funds is essential to enhancing the performance of microfinance institutions this enables in the reducing the several risks involved in the performance of microfinance institutions.

The results indicates that Creation of self-sufficiency of the Bank clients is one of the challenges of the Microfinance institution since most of the clients of PRIDE microfinance, keep on getting loans year in year to enable them survive.

Giving out credit to the people is essential in the Formation of strong solidarity groups, this is because when the microfinance institutions in the country give credit to the people they become empowered and therefore enhances the solidary groups.

The study results also indicate that the Creation of client groups, can be achieved through the credit management by the PRIDE microfinance institutions.

5.2 Conclusion

The study results indicates that PRIDE microfinance has high chances of losing money from clients who borrow, the clients have chances of shifting their business after receiving the loan, Client’s business capacity is established before a loan is disbursed, and the Clients are not comfortable with the banks interest rates, the character of clients is considered before a loan is disbursed.

PRIDE Microfinance has to ensure that they develop better ways of managing cases of loan default, the loan interest are not set in line to the capacity of borrowers, the Bank has a limit to how much it can lend, there is Improvement in credit management system, Better information gathering on clients has been implemented by the bank, this enables the bank to be in position to screen the clients so as to enable the Bank reduce the chances of getting the loans.

Reduction on Default of borrowed funds is essential to enhancing the performance of microfinance institutions this enables in the reducing the several risks involved in the performance of microfinance institutions, Creation of self-sufficiency of the Bank clients is one of the challenges of the Microfinance institution ,Formation of strong solidarity groups, this is because when the microfinance institutions in the country give credit to the people they become empowered and therefore enhances the solidary groups and  also the Creation of client groups, can be achieved through the credit management by the PRIDE microfinance institutions.

5.3 Recommendations

The study recommends that PRIDE microfinance should always mind of the capacity of the borrowers so as to reduce of the cases of default and also shifting the location of their business after the loan has been disbursed.

The study also recommends that the bank should set the interest rates that are manageable to the clients and fair instead of setting high and exorbitant interest rates.

The bank should also ensure that the security issued by the borrower is of value to prevent the clients from defaulting with the payment of loans.

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Appendix 1: Questionnaire

P.O. BOX 1, KYAMBOGO

Faculty of Arts and Social Sciences

Department of Economics and Statistics

Bachelor of Microfinance

TOPIC: THE INFLUENCE OF CREDIT RISK ON THE FINANCIAL PERFORMANCE OF MICROFINANCE INSTITUTIONS IN UGANDA,

A CASE STUDY: A CASE STUDY OF PRIDE MICROFINANCE NAKAWA BRANCH

Dear respondent;

I am OKAMO ALBERT a student of Kyambogo University; pursuing Bachelor of Microfinance and carrying out a study on the above stated topic. You are one of the respondents randomly selected to participate in the study. The information given shall be treated with at most confidentiality and shall only be used strictly for academic purpose. Your response to the following questions will be highly appreciated and supported by utmost gratefulness.

SECTION A:           GENERAL DATA

• In what capacity are you serving the PRIDE microfinance bank?

Administration             Accounts and Finance department t

Credit (loan) department            Secretarial department

• Sex: Male               Female

• Age a) 18 -29 b) 30 – 39 c)  40 and above

• Educational level

Master’s degree                 1^st degree                          Diploma                    others

5. For how long have you been working with PRIDE microfinance bank?

Less than two years                           3-5 years

6-10 years                                          10 above

6. Are you well conversant with credit management?

Yes                                                                      No

7. What is your responsibility as far as credit management is concerned?

…………………………………………………………………………………………………

SECTION B: Influence of transactional risk on microfinance performance.

ey: SA=strongly agree, A=agree, N=neutral, D=disagree, SD=strongly disagree

SECTION C: Effects of portfolio risk on performance of microfinance

1. Does your organization enjoy some benefits as a result of good credit management?

                               Yes                                     No

2. If yes mention any benefit?

………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………

Key: SA=strongly agree, A=agree, N=neutral, D=disagree, SD=strongly disagree

Please mention other benefits of credit management in your organization?

……………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………….

Please tick one appropriate.

Please tick one appropriate.

SECTION D: Relationship between credit management and microfinance institution performance

• Does your organization work towards improving the efficiency of its organization?

Yes                                            No

• If yes what does it do to improve its efficiency?

………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………

Key: SA= strongly agree, A=agree, N=neutral, D=disagree, SD=strongly disagree

THANK YOU FOR YOUR RESPONSES