THE IMPACT OF CREDIT POLICY ON LOAN PORTFOLIO PERFORMANCE IN MICROFINANCE INSTITUTIONS. A CASE STUDY OF OPPORTUNITY BANK KAMWOKYA BRANCH, KAMPALA

ABSTRACT

The study was conducted in opportunity bank in Kamwokya on Kira road just 3 kilometers from the city center Kampala with the purpose of examining the impact of credit policy on loan portfolio performance of opportunity bank. The research objectives included; to evaluate the effects of credit standards on loan recovery in opportunity bank, to examine the effects of credit variables on loan repayment in opportunity bank and to determine the effects of credit rationing on the loan recovery in opportunity bank.

The study employed a cross chapteral research design where both quantitative and qualitative approaches of data collection were employed to collect data from 50 respondents. The participants were selected using two sampling techniques; purposive and simple random sampling. The data was collected using questionnaire and interview guide which was then analyzed descriptively.

Most of the MFIs lack the efficient risk management mechanism that will help eradicate or sieve out serial defaulters. To effectively lock out these serial defaulters, MFIs requires referencing solution that will enable them submit and share data whilst processing their customers’ credit application.

The study revealed that all the institution that participated in the study have a loan risk management policy that is in operation. The stakeholders who are involved in credit policy formulation to a great extent are the members of these organizations and the regulator while the employees and the directors are involved in the credit formulation process only to a moderate extent. The study confirmed that the existing credit policy of the organization forms the basis for developing a new credit policy that is used by the organization. The institution has set up well funded risk management functions, with enhanced risk awareness among lenders, risk strategies are followed in disbursement of credit, the institution conducts thorough risk assessment on the potentials clients and it has also set up fund to cater for the risks that the institution may incur in its transactions. The other factors that directly/indirectly affect loan performance include adequacy of staff members, staff monitoring roles, credit skill knowledge, credit approval procedure, loans software in place, access to clients’ information, monitoring of accounts, interest rates, competition, character, capacity and collateral of the borrower,

CHAPTER ONE

INTRODUCTION

1.0 Introduction

This chapter covers the background of the study, statement of the problem, purpose of the study, objectives of the study, research questions, scope of the study and the significance/ justification of the study.

1.1 Background of the Study

The background of the study included historical, conceptual and contextual background to the study as explained below;

1.1.1 Historical Background to the Study

Micro finance institutions belong to a wider group of financial institutions regarded as semi formal financial institutions. These are institutions which are registered as non-government organizations performing financial functions of lending and taking deposits (Microfinance Act 2012).

A credit policy 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 guide lines, 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 policy has direct effects on the cash How 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 opportunity bank. A good credit policy should help management to attract and retain customers, without having negative impact on cash flow.

The importance of a credit policy is to maximize the value of a firm. (Puxty and Dodds, 2011). An optimum credit policy is achieved through proper adjustment of credit standards. Credit terms and collection efforts. These are the controllable decision variable that should be considered in accounts receivable. Credit policy is a guide to successful credit administration and benefits must be weighed against the cost to ensure the benefits are worth the effort of administering the credit. Benefits like increase in market share, retention of existing customers, acquisition of new ones, must be weighed against cost s like selling and production costs, administration costs incurred during assessment, supervision and collection of credit and bad debts losses (Pandey. 2010)

1.1.2 Conceptual Background to the Study

A credit policy is an institutional method for analyzing credit requests and its decision criteria for accepting or rejecting applications (Girnf 2010).A credit policy is important in the management of accounts receivables. A firm has time flexibility of shaping credit policy within the confines of its practices. It is therefore a means of reducing high default risk implying that the firm should be discretionary in granting loans (Pandey. 2010).

Policies save time by ensuring that the same issue is not discussed over and over again each time a decision is to be made. This ensures that decisions are consistent and fair and that people in the same circumstance get treated in the same manner (Khandkar and Khan, 2010). According to McNaughton (2010), credit policy provides a frame work for the entire management practices.

Most financial institutions have written credit policies which are the cornerstone of sound credit management, they set objectives, standards and parameters to guide micro finance officers who grant loans and manage loan portfolio. The main importance of policies is to ensure operation’s consistency and adherence to uniform sound practices. Policies should always be the same for all and is the general rule designed to guide each decision, simplifying and listening to each decision making process. A good credit policy involves effective initiation analysis, credit monitoring and evaluation.

Credit policies are set of objectives, standards and parameters to guide bank officers who grant loans and manage the loan portfolio. Thus, they are procedures, guidelines and rules designed to minimize costs associated with credit while maximizing the benefit from it (Ahimbishwe. 2011). The main objective of credit policy is to have an optimal investment in debtors that minimizes costs while maximizing benefits hence ensuring profitability and sustainability of microfinance institutions as commercial institutions. The credit policy of an organization may be stringent or lenient depending on the manager’s regulation of variables. There are three main variables namely credit terms .credit standards and credit procedures (Hulmes.l992).Managers use these variables to evaluate clients credit worthiness .repayment period and interest on loan collection methods and procedures to take in case of loan default. A stringent credit policy gives credit to customers on a highly selective basis. Only customers who have proven creditworthiness and strong financial base are given loans, the main target of a stringent credit policy is to minimize the cost of collection, bad debts and unnecessary legal costs (Pandey. 2011).

1.1.3 Contextual Background to the Study

A credit policy 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 guide lines, 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 policy 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, accredit 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 Uganda Finance Trust. A good credit policy should help management to attract and retain customers, without having negative impact on cash flow.

On the other hand, loan portfolio refers to the total amount of money given out in different loan products, to the different types of borrowers, this may be comprised of; salary loans .group guaranteed loans .individual loans and corporate loans (Puxty et al, 2011). It looks at the number of clients with loans and the total amount in loans (Wester.2012). Survival of most financial institutions depends entirely on any successful lending program that revolves on funds and loan repayments made to them by the clients (Oregon, 1986). This therefore requires a restrictive credit control system to be put in place so as to restrain from unnecessary lending thus, improving on profitability of micro finance institutions. (K.akuru.2010). Credit management is the executive responsibility of determining customer’s credit ratings as part of the credit control function (Terry, 2010).

Increased demand for high working capital and cash for expansion has made most institutions and enterprises having to resort to borrowing of fund from financial institutions like banks, microfinance institutions and other lending agencies like insurance companies and mortgages.

Opportunity bank is one of the active institutions in loan extension to the entire community. On the contrary loan portfolio in opportunity bank has greatly affected the entire performance of the organization through increased arrears rates, high costs in loan recovery, constant bad debts written off, and high costs of administering loans that result from small scale and week) loan repayment.

However, the quality of the trade accounts accepted the length of the credit period, the cash discount for an easy payment and the collection procedures have not been effective in loan recovery. This in turn becomes costly to the institution on lop of affecting the volume of sales .Such decreases in the percentage of a loan recovery could be attributed to inappropriate credit policies that are not effective .therefore this instigates that there appears to be a problem in paying back the loans got from the microfinance institutions by their clients and this can be partly attributed to credit policy employed.

1.2 Statement of the problem

Opportunity bank was established to improve the living standards of the local population moreover, initially it was a non-profit making organization, and however it has been diverted to a micro deposit taking institution (MDI), which is a profit maximizing institution. However Opportunity bank just like any other financial institution, has credit policies as a way of administering loans. The policies have objectives of maximizing profits to the benefit of the shareholders as well. Since 2010, the institution has laced hardships in loan recovery, portfolio at risk despite all the efforts of attaching assets to secure loans, building up equality loan portfolios and keeping the rate of deficit under control. The branch manager cited that problem is as a result of inadequate application of the tools of credit policy management (refer to the New vision Monday 23rd July 2012) locking it into a large and increasing proportion of nonperforming loans. According to Mugisa (2010) bad quality assets (loans) not only erode the institution’s ability to recycle its financial resources but also threaten their survival and deprive the economy of a continuous flow of capital. It’s was against this background that the researcher has felt concerned and decided to go ahead and carry out the study to examine what impact credit policy would have on loan portfolio performance using opportunity bank Kamwokya branch, as the a case study.

1.3 Purpose of the Study

The main purpose of the study was to examine the impact of credit policy on loan portfolio performance of opportunity bank.

1.4 Objectives of the Study

The objectives of the study were;

1. To evaluate the effects of credit standards on loan recovery in opportunity bank.
2. To examine the effects of credit variables on loan repayment in opportunity bank
3. To determine the effects of credit rationing on the loan recovery in opportunity bank

1.5 Research Questions

The study was guided by the following research questions:

1. What are the effects of credit standards on loan recovery in opportunity bank?
2. What are the effects of credit variables on loan repayment in opportunity bank?
3. What are the effects of credit rationing on the loan recovery in opportunity bank?

1.6 Scope of the Study

1.6.1 Content Scope

The study focused on the impact of credit policy on loan portfolio performance of opportunity bank. Specifically, the study evaluated the effects of credit standards on loan recovery, the effects of credit variables on loan repayment and the effects of credit rationing on the loan recovery.

1.6.2 Geographical scope

The study was conducted in opportunity bank in Kamwokya on Kira road just 3 kilometers from the city center Kampala.

1.6.3 Time scope

The study focused on material facts about credit policy and loan portfolio performance in microfinance institutions which covered a period of 5 years , that is from 201 1-2016 but Period of body of knowledge was longitudinal in nature from 2011-2016. Therefore, this research was conducted from January 2017 to May 2017.

1.7 Significance / justification of the study

The study would help identify weaknesses in credit management policies of opportunity bank. This would help management to find means of strengthening their operations and other necessary remedial actions.

The study would help to enhance the researcher’s knowledge and understanding of the study variables

The study would add to the body of existing literature and provide a basis for future studies and references for future researchers.

1.8 Conceptual Framework

The impact of credit policy on loan portfolio performance in microfinance institutions

Independent variable                                                Dependent variable

Intervening variable

Source: Self developed from Literature of, Kareta (2009),

The conceptual framework shows (two independent variables credit policy and loan portfolio performance. Outreach is a moderating variable whereas customer retention is a dependent variable. Zeller & Lapen notes that microfinance lending is associated with default risk which compels management to formulate and implement credit policies which are used by managers to influence credit accessibility inform of outreach. Once credit is accessed by customers, manager play a big role with staff in retaining customers which is achieved on the assumption that managers are competent enough to make financial decisions which facilitates the achievement of corporate.

CHAPTER TWO

LITERATURE REVIEW

2.0 Introduction

This chapter summarizes the information from the available literature in the same field of study. It reviewed theories of credit management as well as empirical studies on credit management and financial performance in Kenya and in other countries.

2.1 Theoretical literature review

It is significant to note that changes have been taking place in the credit industry and this is backed up by the recent scenario where most lending institutions have developed sustainable credit appraisal standards that help them when it comes to credit appraisal and risk management (CBK 2011 annual report). Theories have been developed by different scholars that have positively affected rather have a relation to the lending activities and organization of this lending corporations. Discussed below are theories or models related to governance, operation and management of the lending institutions.

2.1.1 Contingency Theory

Contingency theory was developed by Fred Fiedler, 1967, but several contingency approaches were also developed concurrently in the late 1960s. Contingency theory is a class of behavioral theory that claims that there is no best way to organize a corporation, to lead a company, or to make decisions. Instead, the optimal course of action is contingent upon the internal and external situation of the corporation. As far as appraisal systems are concerned, different borrowers come with different scenarios on their ratings. The lending institutions have to scrutinize every individual and view what should be done, who is to be advanced credit with and how much is appropriate at a particular time. The lending institutions too also looks at its position as far as how much they are allowed to give out as credit to strike a balance between their loan portfolio and current deposits. There sometimes is no best mechanism of appraising but looking at the situations currently prevailing.

2.2 Credit Policy

A credit policy is an institutional method for analyzing credit requests and its decision criteria for accepting or rejecting applications (Girma 1996). Credit policy is important in the management of accounts receivables.

A firm has time flexibility of shaping credit policy within the confines of its practices. It is therefore a means of reducing high default risk implying that the firm should be discretionary in granting loans (Pandey, 1995). Policies save time by ensuring that the same issue is not discussed over and over again each time a decision is to be made. This ensures that decisions are consistent and fair and that people in the same circumstance get treated in the same manner (Khandkar and Khan, 2010)

According to Mc Naughton (1996), credit policy provides a frame work for the entire management practices. Written credit policies are the cornerstone of sound credit management, they set objectives, standards and parameters to guide micro finance officers who grant loans and manage loan portfolio. The main reach for policy is to ensure operation’s consistency and adherence to uniform sound practices. Policies should be the same for all and is the general rule designed to guide each decision, simplifying and listening to each decision making process. A good credit involves effective initiation analysis, credit monitoring and evaluation.

2.3 Performance of loan portfolio

According to the findings by (Comptroller’s hand book, 2006) on the impact of loan recovery on the performance of microfinance institution using cross chapteral research design argued that Portfolios are loans that have been made or bought ad are held for repayment. Loan portfolios are the major asset of microfinance institutions, thrifts, and other lending institutions. The value of a loan portfolio depends not only on the interest rates earned on the loans, but also on the quality or like hood that interest and principal will be paid. The loan portfolio is typically the largest asset and the predominate source of revenue. As such, it is one of the greatest sources of risk to a microfinance institution’s safety and soundness. The level of interest risk attributed to the microfinance institution’s lending activities depends on the composition of its loan portfolio and the degree to which the terms of its loans (e.g., maturity, rate structure, and embedded options) expose the microfinance institution’s revenue stream to changes in rates.

Effective management loan portfolio and credit function is fundamental to a microfinance institution’s safety and soundness. Loan portfolio management is the process by which risks that are inherent in the credit process are managed and controlled. Good loan portfolio managers have concentrated most of their effort on prudently approving loans and carefully monitoring loan performance. All financial institutions need to have basic loan portfolio management principles in place in some form. This includes determining whether the risks associated with the microfinance institution’s lending activities are accurately identified and appropriately communicated to senior management and the board of directors, and, when necessary, whether appropriate corrective action is taken (Comptroller’s hand book, 1998). Loan portfolio management (LPM) is the process by which risks that are inherent in the credit process are managed and controlled. Because review of the loan portfolio management process is so important, it is a primary supervisory activity. Assessing LPM involves evaluating the steps microfinance institution management takes to identify and control risk throughout the credit process. The assessment should focus on what management does to identify issues before they become problems (Comptroller’s Hand Book, 2002).

2.4 The effects of Credit Standards on loan recovery

Credit standards according to Mehta (2010), in advancing loans, credit standard must be emphasized such that the credit supplier gains an acceptable level of confidence to attain the maximum amount of credit at the lowest as possible cost. Credit standards can be tight or loose (Van Home. 2010). Tight credit standards make a firm lose a big number of customers and when credit are loose the firm gets an increased number of clients but at a risk of loss through bad debts. A loose credit policy may not necessarily mean an increase in profitability because the increased number of customers may lead to increased costs in terms of loan administration and bad debts recovery.

In agreement with other scholars Van Home (2010), advocated for an optimum credit policy, which would help to cut through weaknesses of both tight and loose credit standards so, the firm can make profits. This is a criteria used to decide the type of client to whom loans should be extended. Kakuru (2010) noted that it’s important that credit standards be basing on the individual credit application by considering character assessment, capacity condition collateral and security capital.

Character it refers to the willingness of a customer to settle his obligations (Kakuru, 2010) it mainly involves assessment of the moral factors. Social collateral group members can guarantee the loan members known the character of each client; if they doubt the character then the client is likely to default. Saving habit involves analyzing how consistent the client is in realizing own funds, saving promotes loan sustainability of the enterprise once the loan is paid. Other source should be identified so as to enable him serve the loan in time. This helps micro finance institutions not to only limit loans to short term projects such qualities have an impact on the repayment commitment of the borrowers it should be noted that there should be a firm evidence of this information that point to the borrowers character (Katende, 2010).

According to Campsey and Brigham (2010) the evaluation of an individual should involve: gathering of relevant information on the applicant, analyzing the information to determine credit worthiness and making the decision to extend credit and to what tune. They suggested the use of the 5Cs of lending. The 5Cs of lending are Capacity, Character, Collateral, Condition and Capital. Capacity refers to the customer’s ability to fulfill his/her financial obligations. Capacity, this is subjective judgment of a customer’s ability to pay. It may be assessed using a customer’s ability to pay. It may be assessed using the customer’s past records, which may be supplemented by physical or observation.

Collateral is the property, fixed assets, chattels, pledged as security by clients. Collateral security, This is what customers offer as saving so that failure to honor his obligation the creditor can sell it to recover the loan. It is also a form of security which the client offers as form of guarantee to acquire loans and surrender in case of failure to pay; if borrowers do not fulfill their obligations the creditor may seize their asset (Girma, 201 0).

According to Chan and Thakor (2010), security should be safe and easily marketable securities apart from land building keep on losing value as to globalization where new technology keeps on developing therefore lender should put more emphasis on it. Capital portends the financial strength, more so in respect of net worth and working capital, evaluation of capital may be by way of analyzing the balance sheet using the financial ratios. Condition relates to the general economic climate and its influence on the client’s ability to pay. Condition, this is the impact of the present economic trends on the business conditions which affects the firm’s ability to recover its money. It includes the assessment of prevailing economic and other factors which may affect the client ability to pay (Kakuru, 2010).

Good credit management provide the institution with a reasonable and adequate return on loans and capital employed primarily through improvement in operations efficiency this generates adequate internal resources to finance the institution’s growth (Pandey, 2010). The institution may have tight credit standards that it may extend loan to the most reliance and financially strong customers such standards will result in no bad debt losses and less cost of credit administration (Pandey. 2010).

Pandey (2010) stressed that credit standards are criteria for selecting customers for credit; the fund may have higher credit standards that is extending loans to selected customers with good reputation or record. On the other hand customers have to be evaluated to see if they meet the standards set by the management before loans are extended to them. However, (Van Home. 2010) states that when an institution extends loan to only strongest customers, it will never have bad losses and will incur fewer administration expenses.

2.5 Credit variables on loan repayment

A credit term is a contractual stipulation under which a firm grants credit to customers (Wamasembe, 2011); furthermore these terms give the credit period and the credit limit. The firm should make terms more attractive to act as an incentive to clients without incurring unnecessary high levels of bad debts and increasing organizations risk. Credit terms normally stipulate the credit period, interest rate, method of calculating interest and frequency of loan installments.

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 loan. 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 loans, this is the time taken from applicants to the loan 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 loan, this is the time period it takes loan to mature with the interest there on. Cost of loan. This is interest charged on loans, 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 loan amount per cycle are determined basing on the purpose of the loan and the ability of the client to repay (including guarantee).

2.6. Effect of credit rationing on loan recovery

According to the study by Chijoriga (2009) on the impact of training on Performance of Micro and Small Enterprises Served by Microfinance Institutions in Tanzania, It involves making accurate forecasts about the future performance of the portfolio and ensuring that there is proper management and monitoring of third party servicers who should ensure strict compliance with management policies. He added that the Loan portfolio performance enhancement can help an organization improve on its cash flows hence make the portfolio more profitable. Raghavan (2005) also observes that loan portfolio quality improvement can go as far as conducting independent credit audits to check for the status of compliance, review of risk rating and pick up warning signals and recommendation for corrective action taken with the objective of improving credit quality. He further notes that the need for credit portfolio management emanates from the necessity to optimize the benefits associated with diversification and reducing exposure to interest rate risk. There is therefore need for rapid portfolio reviews and proper ongoing system for identification of credit weaknesses in advance.

KPMG (2001) mentions that loans that get into trouble bring both direct and indirect losses to the microfinance institution, which reduces the returns on its portfolio. They further recommend that there should therefore be a sound credit management system with adequate control mechanisms like credit disbursement controls, credit audits and credit Management information systems that can guide proper credit pricing and adequate credit work outs before loan approval. Then the microfinance institution should develop a recovery strategy carefully analyzed according to the industry dynamics which involves determining the nature of the industry environment and the borrower’s position within the industry, the borrowers’ financial condition which involves determining the borrower’s capacity to repay through cash flows, collateral liquidation, or other sources.

The microfinance institution can thereafter come up with either portfolio exit where the decision not to issue credit to the prospective client is undertaken or come up with restructuring policies where a decision to negotiate for reducing the principal with the client is undertaken, once restructuring policies are undertaken, a loan loss provision should be maintained to safeguard against loan losses, Kakuru (2009).

Chowdbury (2008) argued that loan portfolio performance measures the rate of profitability or rate or return of an investment in various loan products thus broadly, it looks at the number of clients applying for loans, how much they are borrowing, timely payment of installments, security pledged against the borrowed funds, rate of arrears recovery and the number of loan products on the chain. The loan products may comprise of; Salary loans, Group guaranteed loans, Individual loans and corporate loan (Puxty et al, 2007). Since one of the main tasks of commercial microfinance institutions is to offer loans and their main source of risk is credit risk, that is, the uncertainty associated with borrowers’ repayment of these loans.

A non- performing loan (NPL) may be defined as a loan that has been unpaid for ninety days or more (Greenidge and Grosvenor, 2010). Such loans unpaid affect the microfinance institution loan portfolio performance. For effective loan portfolio performance microfinance institutions should pay attention to several factors when providing loans in order to curtail the level of impaired loans (Khemraj and Pasha 2007).

Specifically, commercial microfinance institutions need to consider the international competitiveness of the domestic economy since this may impair the ability of borrowers form the key export oriented sectors to repay their loans which in turn would result in higher nonperforming loans. These lending institutions should also take the performance of the real economy into account when extending loans given the reality that loan delinquencies are likely to be higher during periods of economic downturn. Finally, microfinance institutions should constantly review the interest rates on loans since loan delinquencies are higher for microfinance institutions which increase their real interest rates, Chowdbury (2008).

Lending is the principal business activity for most financial institutions. The level of interest risk attributed to the institution’s lending activities depends on the composition of its loan portfolio and the degree to which the terms of its loans expose the institution’s revenue stream to changes in rates. Good loan portfolio managers have concentrated most of their effort on prudently approving loans and carefully monitoring loan performance, Chowdbury (2008)

According to Comptroller’s hand book, (2008), all microfinance institutions need to have basic loan portfolio management principles in place in some form. This includes determining whether the risks associated with the microfinance institution’s lending activities are accurately identified and appropriately communicated to senior management and the board of directors, and, when necessary, whether appropriate corrective action is taken. The loan portfolio is typically the largest asset and the predominate 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, loan portfolio problems have historically been the major cause of bank losses and failures. Effective management of the loan portfolio and the credit function is fundamental to a bank’s safety and soundness.

Boah (2010) in his findings on the Assessment Methodologies for Microfinance using quantitative approaches revealed that a credit policy is the primary means by which senior management and the Board of an institution guides the lending activities, the profit over time due to financial instruments. In a loan structure whatsoever, the interest rate is the difference between money paid back and money got earlier, keeping into account the amount of time that elapsed.

CHAPTER THREE

RESEARCH METHODOLOGY

3.1 Introduction

This chapter discusses the research design, data type and sources, sample size and selection, data collection tools/methods, data presentation and analysis, data collection procedure and limitation of the study.

3.2 Research Design

A cross-section research design was used because it is flexible in both quantitative and qualitative data collection. Descriptive research design was used because it is effective to analyze non-quantified topics and issues, the possibility to observe the phenomenon in a completely natural and unchanged natural environment and the opportunity to integrate the qualitative and quantitative methods of data collection which other designs do not provide.

3.3 Data type and sources

Data was collected from both primary and secondary source.

Primary data was collected by use of questionnaires and interview guide. Secondary data was collected from published journals, reports, text books, and company records.

3.4 Study Population

The target population of the study was the senior management, human resource officers, research and development, banking officers, credit officers and customer care attendants.

3.5 Sample Size and Composition

The researcher used a sample size of 80 respondents and these were categorized in the following manner, 2 from the senior management level. 6 from the human resource department.8 customer care attendants. 12 banking officers, 28 credit officers and 10 research and development officers. This number was determined using Krejcie, R.V & Morgan, D.W (1970).

Table 3:1 showing the sample size of respondents

Source: Krejcie, R.V & Morgan, D.W (1970)

3.6 Sampling Technique

The researcher used a purposive sampling technique where managers, credit officers who have long experience in credit policy and loan portfolio performance in microfinance institutions in order to get reliable and consistent information in a broad perspective and group using a simple random technique.

3.7 Data Collection Tools and Methods

This chapter revealed the nature of data collection tools and methods as explained below:

3.7.1 Questionnaire

The researcher developed both open and closed ended question which was approved fast by the super visor before they are presented to the respondents to be answered. The questionnaire was used because large amounts of information can be collected from a large number of people in a short period of time and in a relatively cost effective way.

3.7.2 Interview Guide

Face to face in depth interviews was conducted to collect data from opportunity bank officials and other respondents. Structured questions and open ended statements was used by the researcher in trying to interview senior managers, employees from the loans department, employees from accounts chapter, Credit department under opportunity bank Kampala.

3.8 Data Collection Procedure

A letter of introduction was obtained from the research coordinator, Economics and Statistics, Kyambogo University seeking permission to conduct the study. It was presented to the officials of opportunity ban seeking permission to carrying out the study in the division. After being granted the permission, the researcher proceeded to make appointments with the selected respondents. Thereafter, the researcher administered questionnaires and the required data was collected. The researcher personally administered questionnaires to the respondents in order to avoid delay, to avoid collecting wrong data, ensure completeness and accuracy and confidentiality of the data collected was strictly adhered to.

3.9 Data Processing and Analysis

Completed questionnaire was edited for completeness and consistency. The questionnaire was coded to allow for statistical analysis. According to Mugenda (2010).data must be cleaned, coded and properly analyzed in order to obtain a meaningful report. The Statistical Package for Social Science (SPSS) version 12 was used to analyze and interpret the collected data where appropriate. The percentage frequencies was posted to excel worksheets to generate graphical summaries that also used to indicate the direction of respondents, tables and charts was used to summarize responses for further analysis and facilitate comparison.

3.10 Reliability and Validity of Research Instruments

The questionnaire was well structured to achieve the purpose of the research thereby meeting the test of reliability. The reliability of the research instruments was tested through a pre-test.

In order to ensure validity the questionnaire was made clear and understandable, the questionnaire was first discussed by the researcher with the supervisor; this included careful choice of words, order and structure of questions. After receiving the questionnaires, manual editing was done, followed by coding. Frequency count of different provisions was done and this gave the number of occurrences and percentages out of total occurrences for different responses. And lastly simple conclusions were drawn from the given percentages and numbers.

CHAPTER FOUR

PRESENTATION, ANALYSIS AND DISCUSSION OF FINDINGS

4.0 Introduction

This chapter consists of the presentation, analysis and discussion of the findings from the study. It provides results which were analyzed from raw data collected in the field. It is in two categories; the first one represents the demographic characteristics of the respondents while the other category represents the responses of the questions that were asked concerning research objectives. The analysis was done and data is represented in form of tables, graphs and pie-charts.

4.1 Overview of the Study

The study was carried out at opportunity bank. Questionnaires and interview guides were designed to obtain data from a sample size of 80 was selected. The findings of the study were presented in accordance to the study objectives.

4.1.1 Response Rate

A sample of 80 respondents was selected using purposive sampling methods. Questionnaires, and interview guides were administered to them for data collection. Among the 80 respondents, all of them returned the questionnaires, giving a response rate of 100%.

4.2 Demographic Characteristics of the Respondents

The background characteristics compiled show the gender, age, the education level and period of work. This data was analyzed and is presented below;

Figure 4.1: Showing gender of the respondents

Source: Primary Data

From figure 4.1 above, it’s indicated, majority of respondents (53%) were males and the females were only 47% of the total respondents. This implies that men were found to be active in the study under investigation. However, both ideas were relevant for the study. This indicates that the institution employees more males than females in procurement and stores department.

Table 4.1: Age of Respondents                                                                                n=80

Source: Primary Data

Table 4.1 shows that, the majority (40%) of the respondents were predominantly between the ages of 31 and 40 years. A significant percentage (25%) of the respondents was in the age bracket of 41 and 50years. The remaining 20% of the respondents were in the age bracket of 18 and 30years and another 15% of them were in the age group of 50 and above. 31-40years had the highest number because these are the most active age group hence they are actively involved in management in the organizations, therefore they had rich experiences and could also appreciate the importance of the study.

The table above shows that most of the interviewed respondents (55%) were of degree holders, 30% were of Certificate/Diploma and only 15% of the study respondents were of A’ level while none of the respondents had a postgraduate nor of O’ level therefore, provided information based on the academic knowledge, skills and experience they have gain in management. This shows that company employees are qualified and competent to execute their duties and also appreciated the study under investigation.

Findings in figure above, it was revealed that majority (45%) of respondents have worked at organization between 4years and above, followed by 1-3 years  with 30% and less than 1year with (25%). This implies that the majority of the employees are experienced in the activities of the firm and they act as the role models for the newly recruited staff members with regard to study.

4.3 Effect of Credit Standards on Loan Recovery.

To complete the findings for objective one, Respondents were asked some questions. The results were obtained and are presented below;

Table 4.2: Effect of Credit Standards on Loan Recovery

Source: Primary Data

According to the table above, most of the respondents (62.5%) of the respondents agreed with the organization sets and follows the credit standards and terms, 22.5% of them disagreed and only 15% of them were not sure. This implies that setting and following credit standards and terms has improved loan portfolio performance at opportunity bank.

Table above also indicate that 65% of the respondents agreed with tight credit standards make banks loose a big number of customer, 15% of the respondents disagreed, 20% of the respondents were not sure. This implies that tight credit standards reduce overall bank performance.

The table indicates that, most of the respondents (75%) of them agreed with credit standards give confidence to credit suppliers, 15% of them disagree, 10% of the study respondents were not sure. This implies that majority of the respondents agreed that credit standards have given improved loan recovery at bank by giving confidence to credit suppliers.

Respondents (90%) agreed with the organization considers clients character before extending a loan to them, none of them disagreed and only 10% of them were not sure. This implies that considering client’s characters has improved loan recovery thus improving bank performance.

The table above shows that most of the respondents (82.5%) agreed with there is always training to all employees on the standards and policies set by the organization, 7.5% of them disagree while only 10% of them were not sure. This implies that majority of the respondents agreed. This is because the bank trains all employees on the standards and policies set by the organization which has improved loan recovery.

4.4 Effects of credit variables on loan recovery

The study sought to establish the effect of credit variables on loan recovery. Results were obtained and are presented below;

Table 4.3: Effects of credit variables on loan recovery

Source: Primary Data

Table above show that majority of study respondents (87.5%) agreed with available collection policies have assisted towards effective credit management, 7.5% of them disagreed while 5% of them were not sure. This implies that credit policies at Opportunity bank has improved loan repayment.

Findings also indicate that majority of the respondents (90%) disagreed with formulation of collection policies have been a challenge in credit management, 5% of the study respondents agreed, also 5% of the respondents were not sure. This implies that the organization has easily formulated collection policies to improve credit management.

Table above also shows that majority of the study respondents (62.5%) agreed with enforcement of guarantee policies provides chances for loan recovery in case of loan defaults, while 25% of them disagreed, a significant percentage (12.5%) were not sure implying that as a result of guarantee policies at Opportunity bank, chances of loan recovery has improved.

The study findings as indicated in the table above show that majority of the respondents (67.5%) agreed with staff incentives are effective in improving recovery of delinquent loans, while 12.5% of them disagreed, 20% of the respondents were not sure. However, most of the responses were positive implying that as a result of staff incentives at Opportunity bank, recovery of delinquent loans has improved at the bank.

Finally, study findings in the table above indicate that majority of the respondents (55%) agreed with regular reviews have been done on collection policies to improve stale of credit management, 27.5% of the respondents disagreed, 17.5% of the respondents were not sure. However, from the results most of the respondents were on a positive side implying that the bank has been instrumental on recovery of loans with regular reviews of collection policies.

4.5 Effects of credit rationing on loan recovery

Five statements about effects of credit rationing on loan recovery were presented to respondents. There were requested to respond to the statement using a five Likert scale from “Strongly disagree to “Strongly agree”. Findings are presented in table followed with an analysis and interpretation.

Table 4.4: Effects of credit rationing on loan recovery

Source: Primary Data

From Table above, findings show that fewer respondents (35%) opposed the statement that it is very easy for customers to get loans in your organization compared to those who concurred (57.5%) while only 7.5% were not sure. This implies that, credit rationing has enabled the organization to improve its credit management.

Fewer respondents (30%) opposed the statement that the organization incurs a lot of costs in recovering loans given to customers compared to those who concurred (62.5%) while only 7.5% were not sure. This implies that, the organization expenses are increased as a result. Loan involves all of costs including telephone costs, transport costs among others.

Fewer respondents (35%) opposed the statement that in cases of failure to pay the loan the organization takes measures to recover it compared to those who concurred (50%) while 15% were not sure. This implies that organization has several fall back procedures that have been set up to improve credit management.

Fewer respondents (35%) opposed the statement that the organization offers a variety of loan products to its customers compared to those who concurred (42.5%) while 22.5% were not sure. This implies that sometimes, the organization offers a variety of loan products to its customers.

Fewer respondents (40%) opposed the statement that loan products have increased the organizational profitability levels compare to those who concurred (52.5%) while only 7.5% were not sure. This implies that in most cases, credit management has helped to increase on volume of sales.

CHAPTER FIVE

SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATION

5.1. Introduction

This chapter presents the summary, conclusion and recommendations of the study carried out on the contribution of product diversification to growth of microfinance institutions.

5.2 Summary of Findings

5.1.1 Effect of Credit Standards on Loan Recovery.

According to study findings, the organization sets and follows the credit standards and terms, credit standards give confidence to credit suppliers, the organization considers clients character before extending a loan to them, there is always training to all employees on the standards and policies set by the organization. This implies that the organization has followed the required credit policies in extending loans to clients. This as a result improved loan recovery hence enhancing loan portfolio performance at Opportunity bank.

5.1.2 Effects of credit variables on loan recovery

Study results observed that available collection policies have assisted towards effective credit management, enforcement of guarantee policies has provided chances for loan recovery in case of loan defaults, staff incentives are effective in improving recovery of delinquent loans, while regular reviews have been done on collection policies to improve stale of credit management. This implies that credit variables at Opportunity have been observed while extending loans to clients and this has improved loan portfolio performance at Opportunity bank.

5.1.3 Effects of credit rationing on loan recovery

From the results, it was observed that it is very easy for customers to get loans in your organization, the organization incurs a lot of costs in recovering loans given to customers, in cases of failure to pay the loan the organization takes measures to recover it, the organization also offers a variety of loan products to its customers and loan products have increased the organizational profitability levels. This implied that credit rationing has been effective in improving organization performance in terms of loan repayment.

5.3 Conclusion

The study revealed that all the institution that participated in the study have a loan risk management policy that is in operation. The stakeholders who are involved in credit policy formulation to a great extent are the members of these organizations and the regulator while the employees and the directors are involved in the credit formulation process only to a moderate extent. The study confirmed that the existing credit policy of the organization forms the basis for developing a new credit policy that is used by the organization. The institution has set up well funded risk management functions, with enhanced risk awareness among lenders, risk strategies are followed in disbursement of credit, the institution conducts thorough risk assessment on the potentials clients and it has also set up fund to cater for the risks that the institution may incur in its transactions. The other factors that directly/indirectly affect loan performance include adequacy of staff members, staff monitoring roles, credit skill knowledge, credit approval procedure, loans software in place, access to clients’ information, monitoring of accounts, interest rates, competition, character, capacity and collateral of the borrower,

5.4 Recommendations

The study also recommends for effective and regular monitoring. One of the most potent means of curbing the incidence of non-performing loans is by effective and regular monitoring of the loan from the time of disbursement till the final repayment. This will help to prevent diversion and misapplication of funds which are identified as two important causes of non-performing loans in MFIs. This activity also affords the loan officers the opportunity to inspect the books of accounting of the customers and help the customers to keep proper records of their business transactions.

Most of the MFIs lack the efficient risk management mechanism that will help eradicate or sieve out serial defaulters. To effectively lock out these serial defaulters, MFIs requires referencing solution that will enable them submit and share data whilst processing their customers‟ credit application.

5.5 Suggestions for Further Research

The study recommends that further studies should be done on;

• The reasons for loan defaults from clients’ perspective in microfinance institutions in Uganda.
• The effect of Credit Referencing of customers on loan performance in microfinance institutions.

5.6 Limitation and delimitations of the study

Cost. The researcher experienced a problem of limited finances during the study which included transport, printing and photocopying of relevant materials. However, the researcher borrowed some money from relatives, friends and used it sparingly so as to overcome the cost constraint.

Time. The researcher experienced time constraint in data collection, analyzing of data and in final presentation of the report. However, the researcher overcame this problem by putting the time element into consideration while fulfilling all appointments with respondents and fully meeting them.

Non and late responses. The researcher also experienced a problem of late responses or no responses at all from some respondents who were given the questionnaires to fill. However, the researcher assured the respondents that any information given was treated with maximum confidentiality.

REFERENCES

Anon, P. (2002). Both business and society benefit from working together: Speech at’business day’ Business action for sustainability Development. Johannesburg:M-cri 11 Press

Abedi, S. (2000), Highway to Success, Credit Management Journal, http:// leatherspinters.com

Ahlin and Jiang, N. (2008), “Can micro-credit bring development?”../owrw// of Development Economics, vol. 86, pp. 1-21

Butterworth’s, B. (1990),” Risk Management: A Modern Perspective.” McGraw Hill.

Bystrom, H. (2007), Structured microfinance, Lund University in Lund. Sweden: Swiss printers

Baron, J. and Staten M. (2002), The Value of Competitive Credit /?e/?orte,Carnbridge,USA press

Brown, J. D. (2007), Statistics Corner. Questions and answers about language testing statistics: Sample size and power.

Shiken: J ALT Testing & Evaluation SIG Newsletter, / /(1). 31 -35. Also retrieved from the World Wide Web at http://jalt.org/test/bro_25.htm

Brown, J. D, Hilgers, T, &Marsella, J. (1991). Essay prompts and topics: Minimizing the effect of differences. Written Communication, 5(4), 532-555.

Churchill, G. (2010), Groups credit and empowerment, the case of debit credit and savings institutions In Ethiopia. Research paper.

Craig. R. (2010). Efficiency, customer service and financial institutions, journal of marketing. Vol. 13 No 1, pp 3

CBK, (2007), Bank supervision Annual Report. Nairobi: Government printers. CGAP, (1999), Measuring microcredit delinquency: Occasional paper no. 3 CGAP Secretariatl818 h street. Government printers.

CMCM Report (2000). Baseline study on lending methodologies of MFIs in Uganda.

Dawkin, S. (2010). Micro finances double bottom line. The relationship lending cox\s,tY\\ct&,JoiirnaI of Microfinance Vol 1 No 7 pp5.

Esposito, J. L. (2002), Interactive, multiple-method questionnaire evaluation research: A case study. Paper presented at the International Conference in Questionnaire Development, Evaluation, and Testing (QDET) Methods. Charleston, SC.

Fisher and Brown. The Purchasing Power of Money (New York. 1911), pp. 58 IT. Fofack, H. (2005). Nonperforming loans in Sub-Sahara Africa: Causal analysis and macroeconomic implication. World Bank Policy Research Paper 3769 Vol. 21; ppl6

Groves. R. M., (1987). Research on survey data quality. Public Opinion Quarterly. 51. 156-172.

Kakuru j. (2003). The Management of loan portfolios and the performance of indigenous commercial banks in Uganda: A case study of Uganda Commercial Bank and Centenary Rural Development Bank. MBA.Thesis. Makerere University. Kampala.

Kyereboah. A. (2007). ”The impact of capital structure on the performance of microfinance Instilulors”, Journal of Risk finance, vol. 8. pp. 56-71.

Kareta,B.(2010), Outreach of financial performance analysisi of microfinance institutions in Ethiopia Research paper

Ledgerwood,  J.  (1999).  “‘Microfinance  handbook:  An  institutional and financial perspective”, the World Bank publications, USA

Mattius. M.(2009). Using the credit policy in achieving microfinance missions. Credit Manual for lending Institutions

Muganda. O. &Mugenda. (2003). Research Methods: Quantitative and Qualitative Approaches.

Moore G.H. (1956), “The Quality of Credit in Booms and Depressions”. Journal of Finance, Vol. 11. M ay.

Mitchell, N. (2009), Social performance indicators for microfinance using poverty impact Benchmarks, Journal of microfinance outreach Vol 2 Nol pp32.

Moira, E.(2010), establishing the managerial fit and staff empowerment . Journal of Management Science. Vol 12. No 1 pp 11.

Uganda Microfinance act (2012)

Mutebile, H.(2010), Microfinance deposit taking institutions outreach to the poor Journal of microfinance Finance. 12.15. 35

Matul, N. (2011), Assessing customer services in microfinances institutions .Research paper.

Narvanjas, M.(2009), Baking on customer loyalty in service industries. Journal of public relations Vol.12 No 1 l.

Payle D (1997), “Bank Risk Management”, Working Paper No.272. University of California.

Nirmal. X. (2009). customer relationship management in financial institutions. Journal of Marketing. Vol.3 No 2. pp 1 1.

Opio. M. (2010), Bank of Uganda regulations on microfinance deposit taking institutions. Press release. Vol 2. pp31.

Okpra.A.(2010),Microfinance lending in Ghana. A case study of projects in Apah village. Dissertation

Rajan R. (1995). “The Effect of Credit Market Competition on fending Relationships “. The Quarterly Journal of Economics

Rajedom, R. (2010). The lending policy and customer defection in finance organization, Journal of finance and marketing Vol 1 No 15 pp 11.

Riach, M. (2010), Credit risk management and policy implications for microfinance institutions. Research Paper.50

Reicheld, Z. & Sasser, N. (2010). Enhancing customer retention through relationship marketing. Journal of Marketing

Schmittlen, M. (2010),micro credit and the poorest of the poor, theory and evidence from Bolivia, Journal of microfinance Vol 2 No 1 pp 12.

Tabachnick. B. G., &Fidel, L. S. (2001). Using Multivariate Statistics (5th ed.). Upper Saddle

River. NJ: Pearson Allyn & Bacon.

APPENDICES

APPENDIX I: QUESTIONNARE FOR MANAGEMENT

Dear respondent,

I am Birungi Sharon, a final year student pursuing a Bachelor’s Degree of Microfinance of Kyambogo University. This questionnaire serves to gather data concerning the “impact of credit policy on loan performance in microfinance institutions. I therefore request to offer a helping hand by either ticking of filling as need be. Data gathered shall be kept with utmost confidentiality for academic purposes and probably the betterment of our education system.

Chapter A: Background information about the respondent

1. Gender of the respondent

Male                            Female

2. Age bracket of respondent in years

18 –30                         31-40                           41-50                           Over 50

3. Highest level of education attained by respondent

“O” Level                    “A” Level                    Certificate/Diploma                Degree Postgraduate

4. For how long have you been working in this organization?

Less than 1 Year                     1-3 Years                                4 Years and above

CHAPTER B

EFFECTS OF CREDIT STANDARDS ON LOAN RECOVERY IN OPPORTUNITY BANK, KAMWOKYA – KAMPALA

5. Indicate the extent to which you agree with the following observations on the performance of opportunity bank, Kamwokya branch. Please use the key below to answer the following questions by indicating: (1) for strongly agree, (2) agree, (3) for Not sure. (4) disagree, (5) strongly disagree.

If any other specify

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

CHAPTER C: EFFECTS OF CREDIT VARIABLES ON LOAN RECOVERY IN OPPORTUNITY BANK KAMWOKYA.

6. In this chapter, tick the best option by using strongly Agree (SA), agree (A), Not Sure (NS), Disagree (D).

CHAPTER D: THE EFFECTS OF CREDIT RATIONING ON LOAN RECOVERY IN OPPORTUNITY BANK

7. In this chapter, tick the best option by using strongly Agree (SA), agree (A), Not Sure (NS), Disagree (D).

THANK YOU FOR YOUR COOPERATION AND PRECIOUS TIME.