CREDIT MANAGEMENT AND FINANCIAL PERFORMANCE IN MICROFINANCE INSTITUTIONS IN UGANDA,

A CASE STUDY MICRO FINANCE SUPPORT CENTRE, MBALE BRANCH

ABSTRACT.

The study was to examine the effect of credit management on performance of micro finance institutions in Uganda, the objectives of the study were; to examine the effect of client appraisal techniques on financial performance of micro finance support Centre ltd. Mbale Branch, to examine the effect of credit risk control tools on financial performance in micro finance support Centre ltd. Mbale Branch and to examine  effect collection policies on financial performance in micro finance support Centre ltd. Mbale Branch

The study used a case study design to in collecting data from the field. The research used a questionnaire and an interview guide in collecting data.

Findings of the study indicated that; client appraisal techniques significantly contribute to financial performance. The correlation between them is r= 0.323, with p=0.003, there is a positive significant relationship between credit risk control tools and financial performance based on the obtained correlation coefficient of .326 (**) with a significance value of .003., there is a positive significant relationship between collection policy and financial performance in MSC, based on the obtained correlation coefficient of .298 (**) with a significance value of .002.

The study recommendations were; the study recommends that MSC should redesign their client appraisal techniques so as to improve their financial performance. Through client appraisal techniques, MSC will be able to know the credit worthiness of clients and thus reduce non-performing loans. MSC should reduce on their interest rates as these affect performance of loans. This will help to bring in more borrowers. The risk aspect should be given more attention because when not handled properly, the organization may end up losing. The study also recommends that MSC should continue to strengthen its credit policies as this has been very effective in improving the organization’s financial performance

CHAPTER ONE

GENERAL INTRODUCTION

1.0 Introduction

This chapter highlights the background information of the subject matter, statement of problem, and objectives of the study, research questions, scope of the study, of the significance of the study, conceptual frame work and the definitions of the key terms.

1.1Background of the study:

Globally, the modern use of the expression ‘’micro financing’’ has roots in the 1970s when organizations such as Grameen Bank of Bangladesh with the microfinance pioneer Muhammad Yunus, were starting and shaping the modern industry of micro financing- Which initially had a limited focus based on the provision of microloans to the poor entrepreneurs and small businesses lacking access to banking and relate services, and majorly two main mechanisms for deliverance of financial services to such clients i.e. relationship- based banking for individual entrepreneurs and small businesses; and group-based models, where several entrepreneurs come together and apply for loans and other services as a group. However, over time, Microfinance has emerged as a larger movement whose object is a world in which as everyone, especially the poor and socially marginalized people and households have access to wide range of affordable, high quality  financial products and services, including not just credit but also savings, insurance, payment services, and fund transfers. According Horne and Wachowicz (1998), many of those who promote microfinance generally believe that such access was help poor people out of poverty, including participants in the Microcredit Summit campaign(1998) For many, Microfinance is a way to promote economic development, employment and growth through the support of micro-entrepreneurs and small businesses; For others it is a way for poor to manage their finances more effectively and take advantage of economic opportunities while managing risks.

Currently, Microfinance deals with the supply   of loans (credit), savings and other basic financial services to the poor, because these financial services usually involve provision of small amounts of money- small loans, small savings etc. In contrast however, for most of the microfinance institutions credit is one of the services offered to customers because it is one of the factors a firm use to influence the demand for its products. According to Myers and Berkley (2003), defined credit as a process where the possession of goods or services is allowed without spot payment upon a contractual agreement for later payment.

The idea of credit started since 1540s.with ‘’belief, faith, ’from Middle French credit (15C) ‘’Belief, trust, ’from Italian creditor, from Latin creditum’ a loan’’, thing entrusted to another, ’neuter past participle of cerdere’’ to trust, entrust, and believe. ‘’The commercial sense of confidence in the ability and intention of a purchaser or borrower to make payment at some future time’’ was in English 1570s (creditor) is mid-15c); ‘’hence sum place at a person’s disposal’ ’by Bank etc.

Therefore, the biggest risk in Microfinance is lending money and not getting if back.

Credit risk is a particular concern for Microfinance institutions because lending is unsecured i.e., traditional collateral is not often used to secure microloans, Churchill and Coster (2001). Because the people covered are those who cannot afford credit from Banks and such other financial institutions due to lack of ability to provide guarantee or security against money borrowed. Many microfinance institutions do not extend to these kinds of people due to high default risk for repayment of interest and in some cases the principle amount if self. Therefore, these institutions are required to design sound credit management. Credit management is therefore a process of granting credit, the terms it’s granted on and recovering this credit when it is due. This is a function within a bank or company to control credit policies that was improve revenues and reduce financial risks that entail the identification of existing and potential risks inherent in lending activities. Hence for effective credit management the following variables should be put in place by MFIs and these include client appraisal techniques, Credit terms, collection policy, and credit risk control tools among others. Sound credit management is a prerequisite for microfinance institution’s stability and continuing profitability, while deteriorating credit quality is the most frequent cause of poor financial performance and condition. According to Gitman (1997), the probability of bad debts as credit standards are relaxed. Firms must therefore ensure that the management of receivables is efficient and effective. Such delays on collecting cash from debtors as they fall due has serious financial problems, increased bad debts affect customer relations, if payment is made late, then profitability is eroded and if payment is not  made at all, then a total loss is incurred. On that basis, it is simply good business to put credit management at the ‘’front end’’ by managing it strategically.

In Uganda, institutionalization of Microfinance was slowly implemented. Traditionally, the private sector in Uganda has struggled with infrastructural failings such as weak commercial justice system, corruption, inadequate tax and regulation management, as well as lack of financial services (Audit report.2002; Wong 1999). Over the 1990s the closure of Banks and the raise of inflexible banking practices by Uganda commercial Bank, segregated small business and low income households from access to financial services (Carlton, et al, 2016). Furthermore, traditional Banks during this time diminished Uganda’s social capital and credit culture by mishandling credit schemes, having a profound impact on the civil population’s trust of traditional financial institutions (Carlton et al.2001), However, more traditional forms of informal financial activities have encompassed many forms and had been used for decades( Carlton at al.2001). However the first microfinance institution introduced by the government is seen in FINCA and Uganda’s Women Finance Trust (UWFT)in the 1990s, Due to governmental failings in effective poverty and development policies during this time, there was a strong reliance on NGO’s community based organizations and local ‘Resistance Councils’.

Following the introduction of the above MFIs IN Uganda, the results indicate that Microfinance is important for the society but there are some challenges such as inadequate donor funding, insufficient support from governments, improper regulations, inefficiency in credit management tools and techniques, also challenges include lack of standardized reporting and performance monitoring system for Microfinance institutions. However, the although the government of Uganda through the introduction of The microfinance support Centre to intervene and solve the above challenges of Microfinance institutions but much effort has been on poverty alleviation and less effort has been placed on credit management. Thus according to the  financial reports of MSC 2016-2018 out of 80% billion loan money disbursed only 40% billion was recovered on time and 20% was defaulted. Hence this shows a big challenge in credit management among the Microfinance intuitions thus the need for further studies.

1.2 Problem statement.

Sound credit management is a prerequisite for a micro finance institution’s stability and continuing profitability, while deteriorating credit quality is the most frequent cause of poor financial performance and condition. According to Gitman (1997), the probability of bad debts increases as credit standards are relaxed. Firms must therefore ensure that the management of receivables is efficient and effective .Such delays on collecting cash from debtors as they fall due has serious financial problems, increased bad debts and affects customer relations. If payment is made late, then profitability is eroded and if payment is not made at all, then a total loss is incurred. On that basis, it is simply good business to put credit management at the ‘front end’ by managing it strategically. MSC has established proper credit management mechanism which are aimed at ensuring that it achieves proper management of all the loans disbursed to its clients and improve its financial performance for example, there are proper policies concerning disbursement of funds, well trained credit officer and risk assessment officers. (MSC Annual Report, 2016). However, despite the above efforts, financial position of MSC has kept on deteriorating as a result of a high default rate. Thus according to the  financial reports of MSC 2016-2018 out of 80% billion loan money disbursed only 40% billion was recovered on time and 20% was defaulted. As with any financial institution, the biggest risk in microfinance is lending money and not getting it back. Credit risk is a particular concern for MFIs because most micro lending is unsecured (i.e., traditional collateral is not often used to secure microloans Craig Churchill and Dan Coster (2001). The people covered are those who cannot avail credit from banks and such other financial institutions due to the lack of the ability to provide guarantee or security against the money borrowed. This forms the background against which the researcher is to carry out a research to examine the effect of credit management on financial performance with a specific focus on Micro finance Support Centre Mbale branch.

1.3 Research Objective

1.3.1. General objectives

Examine the effects of credit management on performance of micro finance institutions in Uganda.

1.3.2. Specific objectives

1. To examine the effect of client appraisal techniques on financial performance of micro finance support Centre ltd. Mbale Branch
2. To examine the effect of credit risk control tools on financial performance in micro finance support Centre ltd. Mbale Branch

• To examine  effect collection policies on financial performance in micro finance support Centre ltd. Mbale Branch

1.4. Research questions.

1. What is the effect of client appraisal techniques on financial performance of micro finance support Centre Mbale branch?
2. What is the effect of credit risk control tools on financial performance in micro finance support Centre Mbale?

• How effective are the collection policies on financial performance in micro finance bank Mbale?

1.5. Research hypothesis

1. Thereis a strong positive and significant effect of client appraisal techniques on financial performance.
2. There is a positive and significant relationship between credit risk control tools and financial performance.

• There is a positive and significant effect of collection policies on financial performance.

1.6. Scope of the study

This was divided into content scope, geographical scope and time scope as explained below;

1.6.1. Content scope

The study concentrated on credit management as an independent variable with dimensions of; client appraisal techniques, credit risk control tools and collection policies. On the other hand the dependent variable is financial performance in micro finance Support Centre

measured by profitability, cash flow and liquidity position.

1.6.2. Time scope.

The study will be carried out for a period of 5 months, however the literature to be considered in the study will be for at least 10 years and the information from the microfinance support Centre to be considered will be in for four years.

1.6.3. Geographical scope:

The study was carried out at Micro finance support Centre, Mbale Branch is located in eastern region of Uganda, Mbale municipality. Plot 2, Bumasifwa lane along Pallisa Road in Mbale.

Mbale Microfinance support Centre has been chosen because it is one of the biggest branches of microfinance support centers in the country and it is also one of the well-funded. Therefore the Microfinance support Centre Mbale has been chosen because of challenges that faces the microfinance institutions in the area.

1.7. Significance of the Study

The result of this study may be valuable to researchers and scholars, as it would form a basis for further research. Scholars can use this study as a basis for discussions on credit management and financial performance of MFIs. It may provide the scholars with empirical studies that they may use in their studies. The study shall also add to the body of knowledge in the finance discipline by bridging gaps in credit management research in general.

This study may make several contributions to both knowledge building and practice improvement in credit management and financial performance. From a theoretical standpoint, the study proposes a comprehensive framework of studying changes in credit management and financial performance. It also expected that it was aid policy makers in their effort to revamp the sector.

It shall be of great relevance to the organizations under study as well as other financial institutions. The non-financial business firms, whether manufacturing or service oriented shall also benefit from the research findings. This is because the result of the study shall enable the users especially finance trust bank Mbale to appraise its credit policies and to review its operations critically for more result oriented approach in the dealing with its credit facilities.

1.8. Justification of the study

A number of research studies on credit management have been carried around the globe and Uganda in particular however, only a few were taken by the research basing on their relativeness to the study and they were Robert (2011), and Lydia (2012).

Robert (2011) carried out study on credit management and profitability of commercial banks with FINCA Uganda and focused on the roles of credit management profitability in commercial banks with the objectives to examine the credit policy and profitability in FINCA Uganda, to assess the causes of low profitability in FINCA Uganda  and to establish the relationship between credit management policy and profitability in FINCA Uganda .however ,as much as the Robert did his best the following gaps exist in the finding that need to be addressed .the researcher focused on the profitability of commercial banks only thus leaving other MFIs out and this prompted another researched on the roles of credit management.

Lydia (2012) carried out study on credit control and loan performance in financial institutions, case study centenary bank Mbale with the following objectives to assess the level of usage of credit control systems in centenary bank, to establish the effects of credit control systems on the deposit rates in centenary bank and recommended further study on the credit risk management and efficiency of management of financial institutions.

from the study above its clear though that the researcher did her best based on the researchers objective which were on the usage of credit control system, the effect of credit control system on loan default but did not study the challenges of credit management system and there was need to study the challenges faced in the usage of credit management and roles of credit management system on financial performance.

1.9. Definition of key terms

Financial performance

According to the business dictionary financial performance involves measuring the results of firm’s policies and operations in monetary terms. These results are reflected in the firms return on investment, return on assets and value added.

Stoner (2003), defines financial performance as the ability to operate efficiently, profitably, survive, grow and react to the environmental opportunities and threats. In agreement with this, sollenerg and Anderson (1995) assert that, performance is measured by how efficient the enterprise is in use of resources in achieving its objectives. Hitt,et al(1996) believes that many firm’s low performance is the result of poorly performing assets.

Client Appraisal

The first step in limiting credit risk involves screening clients to ensure that they have the willingness and ability to repay a loan.  MSC uses the 5Cs model of credit to evaluate a customer as a potential borrower (Abedi, 2000).

Credit management

Credit management is one of the most important activities in any company and cannot be overlooked by any economic enterprise engaged in credit irrespective of its business nature. It is the process to ensure that a customer was pay for the products delivered or the services rendered.

Myers and Brealey (2003) describes credit management as a methods and strategies adopted by the firm to ensure that they maintain an optimal level of credit and effective management

It is an aspect of financial management involving credit analysis, credit rating, credit classification and credit reporting .Nelson (2002) views credit management as simply the means by which an entity manages its credit sales. It is a pre requisite for any entity dealing with credit transactions since it is impossible to have zero credit or default risk.

The higher the amount of accounts receivables and their age, the higher the finance costs incurred to maintain them. If these receivables are not collectible on time and urgent cash needs a rise, firm may result to borrowing and the opportunity cost is the interest expense paid.

Credit Risk Control tools.

Key credit controls included loan product design, credit committees and delinquency management. (Church hill Coster, 2001).

Collection policies.

There are various policies that an organization should put in place to ensure that credit management is done effectively; one of these policies is a collection policy which is needed because all customers do not pay the firms bills in time. Some customers are slow payers while others are non-payers. The collection effort should therefore aim at accelerating collections from slow payer and reducing bad debt losses (Kariuki, 2010).

1.10The Conceptual Frame Work

INDEPENDENT VARIABLE                                          DEPENDENT VARIABLE

                                                                                  INTERVENING VARIABLE

Source: Developed by the researcher as guided by Jabareen, Y. (2009)

The figure 1:1 presents the conceptual frame work containing independent variables (credit management), the intervening variables (organization policies and values) and dependent variables (financial performance)

Credit management involves the use of credit term collection policy, credit risk control tools and client appraisal techniques geared towards the financial performance to achieve the objectives there is interplay with the intervening variable which includes the level of supervision, training clients, support documentation and government policy. The outcome is manifested in form of sales, cash flows; net profit and debtor turn over.

credit terms involve setting clear lines to be followed while selling on credit and this calls for a careful supervision at all levels In order to improve on sales and better debtors turn over on financial performance of the organization

Client appraisal techniques help in ascertaining the credit worthiness’ of the client but this needs support services and documentation in order to improve on the debtor turn over and profitability.

credit risk control tools helps in aiding and selling the product to good clients as it provides tools to be used in order to avoid event that can lead to bad sales, credit risk control, therefore calls for the training the clients on the importance of keeping the record. Documentation for themselves and close supervision by the credit management team within the organization for timely repayments in order to ascertain sales.

collection policy aim at accelerating collection form slow payers and reducing bad losses but this requires good government policies and proper documentation in order to improve on timely repayments and decrease in fault and profit for the organization.