THE IMPACT OF UPSCALING OF MICROFINANCE INSTITUTIONS ON THE FINANCIAL PERFORMANCE OF COMMERCIAL BANKS: A CASE STUDY OF FINCA UGANDA AND OPPORTUNITY BANK, KAMWOKYA BRANCH

LIST OF ABBREVIATIONS

MFIs Microfinance Institutions

FOSA Front Office Services Activities 

SASA SACCO Savings Account 

CAMEL Capital adequacy, Asset quality Management Earnings and Asset/Liability management

SACCO Saving and Credit Cooperative Organizations

ABSTRACT

The study was carried out at Finca Uganda Kamwokya branch and opportunity bank with the purpose investigating the impact of up scaling of microfinance institutions mortgages, loans and savings on financial performance of commercial banks. The specific objectives of the study were; to establish effects of loans on the profitability of commercial banks, the effects of savings decision on liquidity of commercial banks and to examine the effects of mortgages on the capital level of commercial banks.

The study adopted a cross-section research design where both qualitative and quantitative approaches of data collection were adopted. The researcher used questionnaire and interview method to collect data from 90 respondents using purposive sampling. 

The study concludes that the performance of microfinance institutions has improved as a result of upscaling since the credit follow up, credit analysis, favourable loans term have increased profits. The knowledge of formal credit history of clients increases profits. Also proper saving decisions, low interest rates, regular share accounts have improved the liquidity of the institution. Improved repayment schedules, terms and policies ensure no default in loan repayment and simplified terms increase the number of customers thus mortgages increase the capital levels of MFIs.

The study recommended that the organization should revise on the credit control policies and make some changes where necessary. Also, top management of organizations should be willing to extend overwhelming support to the loan department so as to ensure good financial performance.

CHAPTER ONE

INTRODUCTION

1.0 Introduction

This chapter focused on the background of the study, statement of the problem, purpose of the study, objectives of the study, research questions, scope of the study, significance of the study, and definition of terms.

1.1 Background of the study

1.1.1 This consist s of the historical, conceptual and contextual backgrounds.

Microfinance has long been considered a powerful tool for sustainable development. The idea of granting loans at fair conditions to alleviate financial constraints of the poor has gained widespread acceptance among academics, investors and the public sector alike. The market for microcredit has expanded over many years, with microfinance institutions (s) extending loans to more than 200 million clients by the end of 2010. Through various socio-economic ties of the borrowers and their families, microfinance has impacted upon the lives of around 1 billion people in emerging markets and developing countries (Henry, 2014).

Over the last ten years, development policy has focused on improving financial access for as many people as possible, for some time it seemed that development objectives and commercial profitability could be accomplished simultaneously and without friction. Sustainability of market growth was rarely questioned, as microfinance was transformed into a more and more financially efficient industry. The market experienced notable growth rates in terms of both the number of borrowers as well as asset volume while delivering a stable return on assets of 2-3%. Many institutions were able to achieve high growth rates by retaining profits and by attracting additional funds from commercial sources. Over time, an increasing share of institutions no longer depended on donations to expand their business, although many still benefit from them (Mwanje, 2014).

In recent years, in India have evolved into a vibrant segment of the financial sector, exhibiting a variety of business models. Non-adherence to rules and irresponsible actions of some s had brought a setback to the sector, albeit temporarily. But the section from 2012-13 onwards and is showing consistent growth. A spate of policy actions to strengthen the regulation of the microfinance sector, inclusion of loans to banks under the priority sector, benefited the sector considerably. Lending has exhibited robust growth with a compound annual growth rate of approximately 34% in loans disbursed (Sooka, 2015).

Currently, the regulated microfinance market in India has over 30 million clients, served by more than 70 regulated institutions, with a network of 10.553 branches and 80.097 employees across 32 states and union territories, activity is set to grow, especially because only 8% of adults have loans from formal financial institutions.

In autumn 2015, banking licenses to 11 payment banks and 10 small finance banks. This again put the spotlight on the microfinance sector as 8 of the 10 newly licensed small finance banks are s. The entry of s in the small finance bank segment is a revolutionary step since these entities are very familiar with the nuances of banking with poor borrowers. Thus far, s were not allowed to accept deposits and engaged in extending credit after sourcing money from commercial banks. Now, by getting access to banking, these entities can tap public deposits, which will significantly lower their cost of borrowing and enable them to bring down their rate of interest on loans from the current 24-26% to a level decided by the market competition—possibly lower double-digit figures. This is likely to increase the cost pressures on existing s and force them to tap new geographies and markets for growth and sustenance (Ben, 2016).

1.1.2 Conceptual Background to the study

Over 1.4 billion people in the world are considered poor (subsisting on less than one US dollar per day) and one of the United Nation’s concerns in the Millennium Development Goal is to get these people out of poverty (Littlefield, Morduch & Hashemi, 2003). In most instances, the poor are denied access to many essential services including financial, education and medical services, because they cannot afford them. Poverty has continued to be a concern and attracts attention both in the developed world and developing world. Unfortunately, in man) poor countries the gap between the poor and the rich is big and growing (Littlefield et al, 2003 ).

There has been a close association between economic development and financial access. Demirguc-Kunt (2006) argues that, although there is no consensus on the nature of the association between the two, some scholars are of the view that financial systems are a catalyst in alleviating market restrictions and hence influencing savings rates, investment decisions, technological innovations and therefore long-run growth rates. Demirguc-Kunt (2006) also points out that financial systems help mobilise and pool savings, provide payment services that facilitate the exchange of goods and services, produce and process information about investors and investment projects. These facilitate business transactions.

Since there is evidence that links the provision of financial services to economic growth as well as both increase and distribution of income, the concern has shifted to who has access to these services (Littlefield et al, 2003). Of interest is the extent to which the poor have access to financial services. Small enterprises and poor households face much greater obstacles in their ability to access finance all around the world hence isolating diem from development (Demirguc-Kunt, 2006: Honohan & Beck. 2007). Microfinance has been accepted as a viable approach to reaching the poor with financial services. It has also been linked with growth of micro and small businesses (Omino, 2005).

Microfinance as a business has proved to be profitable and sustainable (Gross & Silva. 2003: Wendt & Eichfeld. 2006). In some countries in Latin America. Asia and Africa some microfinance institutions have grown big and transformed into deposit-taking businesses specially regulated or within the conventional banking laws (Hishigsuren, 2006). In other cases commercial banks have expanded their services to serve the poor and small businesses. Analysis in the MIX market report of June 2009 shows that deposit-taking microfinance institutions performed better (Gonzalez & Meyer, 2009) and access to local savings helps such institutions scale up their operations (Wright & Kaplan, 2001). Access to local savings has been the main motivation for microfinance institutions to lobby for regulation.

1.1.3 Contextual Background to the study

The term “microfinance” (MF) refers to the provision of banking services to lower-income
people, especially the poor. These services include small loans for microenterprises and
individuals, savings, money transfer services, means of payment and insurance. Given their
nature, micro entrepreneurs tend to operate on the margins of the formal economy, often without permits and commercial documentation, and usually lacking fixed assets that could serve as collateral. Formal expense and income records are generally scarce. Income is often on the lower end of the scale, although operating margins for microenterprises in percentage terms can be significant. A Microfinance institution is an organization that provides financial services in terms of loans, funds at a given interest rates, for example the modern microfinance movement started in the 1970s when pilot programs in Bangladesh. Bolivia, and other countries  began  to  provide  small  loans  to  groups  of vulnerable  women  to invest in economic activities.

According to Ledgerwood (2010) the term microfinance refers to the provision of financial services to low income client including self-employed. Everyone needs a diverse range of financial instruments to run their business, build asset, stabilize consumption and shield themselves against risks. Financial services needed by the poor include working capital loans, consumer credit, savings pension insurance and money transfer services.

On the contrary, commercial banks are banks “that offer a broad range of deposit accounts, including checking, savings, and time deposits, and extend loans to individuals and businesses” and they are well suited to play a role in microfinance for the following reasons. First of all, they are regulated and supervised. Indeed, the sources of capital that are obtained reside in an entity independent. This is a very important factor that guarantees the How of funds to microfinance as it installs trust in donors. Indeed, one of the problems encountered by microfinance institutions is the lack of a systematic control of these organizations. There arc very few credit-rating agencies supervising these institutions leading, to difficulties in the procurement of capital.

Jamil (2012) asserts that the existence of microfinance institution continue to affect the operation of commercial because this industry charges low interest rates, accept voluntary savings from the poor which is not the case with commercial banks. He further explains that microfinance is the entire flexible structures and processes by which financial services are delivered to micro entrepreneurs as well as the poor and low income population on a sustainable basis. Africa remains one of the least developed, and the most under banked continent. A series of impact studies conducted in Uganda in the past years have demonstrated that the provision of microfinance services contributes to reduce client vulnerability to economic risks, results in strengthening linkages of clients and their households to the agricultural sector, and enables clients to acquire valued skills.

The demand for microfinance services has rarely been met by commercial banks, and this may be due to several reasons, including the following: failure lo perceive the poor households” demand for financial services, lack of collateral b\ the poor, poor saving culture among the poor, belief that microfinance cannot be profitable for banking institutions, existence of public, legal and regulatory policies that ignore MFI high operating costs, lack of specific experience in the provision of microfinance services, lack of adequate platforms for the provision of microloans. 

1.2 Statement of the Problem

Despite the fact that the government has made a significant initiative to support MFIs through legislation so as to achieve the millennium development goals and vision 2040 objectives of increasing financial inclusion. They still borrow expensively from commercial banks to bridge temporary illiquidity and this has evidently threatened financial stability of the institutions and hence safety of member deposits. In particular, this structural problem has negatively impacted on the pricing of credit facilities to members and these continue to substantially depend on expensive commercial banks loans, and inefficient contingent liquidity plans. This makes them prone to the liquidity shortage, and no matter how small this could be. It can cause great damage to MFIs (Monnie, 2009). It was against this background that a study should be carried out on effects of up scaling of mortgages, loans and savings on financial performance of commercial banks.

1.3 Purpose of the study

The purpose of the study was to investigate the impact of up scaling of microfinance institutions mortgages, loans and savings on financial performance of commercial banks.

1.4 Specific Objectives

The specific objectives were;

1. To establish effects of loans on the profitability of commercial banks?
2. The effects of savings decision on liquidity of commercial banks
3. To examine the effects of mortgages on the capital level of commercial banks

1.5 Research Questions

The research questions were:

1. What are the effects loans on the profitability of Commercial Banks?
2. What are the effects of saving decisions on the liquidity of commercial banks’? 
3. What are the effects of mortgages on capital levels of commercial banks’.’

1.6 Scope of the study

1.6.1 Content scope

The study was based on the effects of loans on the profitability of effects of saving decisions on the liquidity of commercial banks and the effects of mortgages on capital levels of commercial banks.

1.6.2 Geographical scope

Geographically, the study was carried in Kampala taking on Finca Uganda Kamwokya branch which is an MFI and Opportunity bank Kamwokya branch Kampala which is a commercial bank.

1.7 Significance of the study

This study might generate data and information on credit terms and how they affect performance of small Scale industries in Uganda.

They could use this to come up with acceptable terms to their clients.

The small industries could also use the findings of this study as ground to negotiate appropriate credit terms that will not constrain their performance.

The study would also add to the existing literature on the impact of upscaling of MFIs.

The research would be important to the academicians and other researchers who would use it as a spring board for other research studies.

1.8 Conceptual framework

Topic: The impact of upscaling of microfinance institutions on the financial performance of commercial banks

Independent Variable Dependent variable

Intervening variable

Intervening variable

Source: Doug, 2008

The figure shows independent variables which are upscaling of MFIs such as loans, savings and mortgages. Dependent variables of financial performance like profitability, liquidity and level of capital and intervening variables like government policies management practices and type of business.

There is a linkage between upscaling and financial performance and intervening variables. If the independent variables are effectively administered then financial performance is likely to improve however, if they are poorly administered, financial performance will decline.