CHAPTER TWO

REVIEW OF RELATED LITERATURE

2.0 Introduction

This chapter provided for the review of related literature extracted from various scholars, individual opinions and report findings. The chapter explores the concept of microfinance, availability of microfinance services, related information on the growth rate of small Scale industries, the effect of microfinance services on the growth of small scale industries, challenges faced associated with small Scale industries. The chapter also presents the research gap as sated below:

2.1 The effects of loans on the profitability of Microfinance institutions

Jared (2013), in his study observed that the rapid growth of the movement in Uganda can be pinned on the fact that they have for long periods specialized in offering cheap loans at an affordable” repayment history to their clients. This gesture has attracted an exodus of clients from the formal financial institutions such as banks seeking their services (ACCOSCA, 2012).

Some MFIs in Uganda have adopted Front Office Services Activities (FOSA) to offer the services they render to clients. FOSAs have proved to be one of the key profit centers for and members have appreciated the services offered by these FOSAs. Through the full utilization of the FOSA network, provides their members with the full range of basic financial services and consolidate these services to the full satisfaction of members. The introduction of FOSA has contributed positively to the performance of s through improved profitability which has led to the declaration of a high dividend rates lo the members (IFSB, 2005).

Mwaura (2005) insists that lack of credit follow up, credit analysis, and hostile lending of money are some of the factors that have contributed to financial gap and poor performance. In Uganda, following the liberalization of the financial sector in the 1990s (Omino, 2003). The back office model of operations was found to be inadequate and as a result, man} societies introduced the Front Office Services Activities (FOSA) alternatively known as the SACCO Savings Account (SASA). This was led by a number of factors including the need to solve the problem of non-remittance through the check-off savings system and was aimed at among other tilings, improving the SACCO societies” liquidity and the promotion of the owner-user principle.

By around 2003. SACCO societies in Uganda were ahead) taking deposits from persons not drawn from the common bond, that is, public deposits, (ICA, 2003). Max (2012).slates that regular share accounts (members” savings) constitute the largest part of a credit union’s funding. In 2004 for instance.,86.1 percent of American credit unions funding came from the members” savings (Federal Reserve Bulletin, 2004).

One way in which members remit their savings to a SACCO is through the regular share accounts. A regular share accounts is the savings accounts of members (Mishkin et al, 2007). They are types of payroll savings plans by which employees can automatically set aside a portion of their salary in a savings account (Rose, 2003).

Customers cannot write cheques against these accounts although they can withdraw funds without giving prior notice or incurring any penalties. (Kwame, 2010). However, in Uganda as many other countries, shares are not withdrawal and are used as security for loans lo members (Omino, 2003).

Additionally, customers do not receive any interest on these accounts. (SACCOL, 2011) but instead receive dividends that are not guaranteed in advance but are estimated (Rose, 2003). The share account is analogous to a passbook savings account and its return is referred to as a dividend, although it is treated as interest for individual income tax liability purposes.

A study by (Landi & Venturelli, 2002) analyzed the determinants and effects of diversification on efficiency and profitability amongst the European banks and found out that diversification positively affected efficiency in terms of profits, costs and revenue growth. In an earlier study by (DeYoung et al, 1999) on the effects of product mix (diversification) on earnings volatility of commercial banks, it was found that bank’s earnings grow more volatile as banks tilt their product mixes towards fee based activities and away from traditional intermediation services.

2.2 The Effects of savings Decisions on the liquidity of commercial bank

Jared (2013) asserts that as SACCO societies grow and become regulated, the need to build capital reserves becomes a requirement not only from the regulatory authorities but as the most cost-effective financing option for new products, services, marketing and branch network expansion (WOCCU) & FSD Uganda, 2008).

The NCUA”s CAMEL (Capital adequacy. Asset quality. Management. Earnings and Asset/Liability management) rating system. (NCUA, 1994). provides that capital reserves serve to support growth as a tree source of funds. Capital reserves represent not only as a cushion for uncertainties such as asset losses and adverse economic cycles, but it also provide resources for long-term investments and funding for provision of more services to members (WOCCU& FSD Uganda. 2008).

According to (Chowdi, 2008) in order to account for financial market developments as well as lessons learned from the turmoil, a study was undertaken to review some 2000 sound practices for managing liquidity in financial organizations. Guidance has been significantly expanded in a number of key areas. In particular, more detailed guidance was provided on: the importance of establishing a liquidity risk tolerance; the maintenance of an adequate level of liquidity, the necessity of allocating liquidity costs, benefits and risks to all significant business activities: flic identification and measurement of the full range of liquidity risk: the design and use of severe stress test scenarios: the need for a robust and operational contingency funding plan: the management of intraday liquidity risk and increased public disclosure in promoting market discipline.

Clement (2012), asserts that financial stewardship being the routine financial decision-making of commercial banks, should embrace sound business practices. This should also revoke around the commercial banks financial discipline with a profound influence on the success of all businesses conducted by the SACCOs (Mudibo, 2005).

More so, prudent funds allocation strategy is an important financial practice function in am commercial bank society. This aspect usually involves decisions to commit commercial bank funds to planned investment options. Commercial banks need to make decisions to invest their funds more efficiently in anticipation of expected flow of benefits in the long run. Such investment decisions generally include expansion, acquisition, modernization and replacement of long-term assets (Maina, 2007). Thus, commercial banks value is deemed to increase where the investments are profitable and add to the wealth in the long run. This situation is obtained where a commercial bank involves itself with investments that yield benefits greater than the opportunity cost of capital.

The mechanisms that explain why liquidity can suddenly evaporate operate through the interaction of funding illiquidity due to maturity mismatches and market illiquidity. As long as a financial institutions assets pa)’ off whenever its debt is due. it cannot suffer from funding liquidity problems even if it is highly levered. However, financial institutions typical) have an asset-liability maturity mismatch and hence are exposed to funding liquidity risk. A funding shortage arises when it is prohibitively expensive both to borrow more funds (low funding liquidity) and sell off its assets (low market liquidity).

In short, problems only arise if both funding liquidity dries up high margins/haircuts, restrained lending) and market liquidity evaporates tire safe discounts (Denis & Muganga. 201 0). As Jean-Laujent (2008), observed. Liquidity ratios may have a mixed impact on the capital structure decision. Companies with higher liquidity ratios might support a relatively higher debt ratio due to greater ability to meet short-term obligations.

On the other hand, firms with greater liquidities may use them to finance their investments. Therefore, the companies” liquidities should exert a negative impact on its leverage ratio (Ozkan, 2001). Moreover, the liquid assets can be used to show to which extent the.se assets can be manipulated by shareholders at the expense of bondholders (Prowse, 1991).

2.3 The effects of mortgages on the capital levels of commercial banks

Pandey (2004), describes cash management as the process of planning and controlling cash flows into and out of the business, cash flows within the business, and cash balances held by a business at a point in lime. Ross et al, (2008), as cited by Nyabwanga (2011) asserts that efficient cash management involves the determination of the optimal cash to hold by considering the trade-off between the opportunity cost of holding too much cash and the trading cost of holding too little. Atrill (2006), there is need for careful planning and monitoring of cash flows over time so as to determine the optimal cash to hold.

A study by (Kwame, 2007) established that the setting up of a cash balance policy ensures prudent cash budgeting and investment of surplus cash. This finding agrees with the findings by (Kotut, 2003) who established that cash budgeting is useful in planning for shortage and surplus of cash and has an effect on the financial performance of the firms. The assertion b\ (Ross, 2008) that reducing the time cash is tied up in the operating cycle improves a business’s profitability and market value furthers the significance of efficient cash management practices in improving business performance. Erkki (2004), defined cash management as a part of treason management, which is defined as a part of the main responsibilities of the central finance management team.

Huseyin (2011), highlighted specific task of a typical treasury function such as: cash management, risk management, hedging and insurance management, account receivable management, account payable management, bank relations and investor relations, (Huseyin, 2011) found that (Kytonen, 2004) definition is consistent with the (Srinvasan& Kim,1986) classification of cash management areas as cash balance management, cash gathering, cash mobilization and concentration, cash disbursement, and banking system design. Cash balance management includes management of cash position, short-term borrowing, short term investing, cash forecasting.

(Huseyin, 2011) opinion is that the classifications of cash management by (Srinvasan & Kim’s, 2011) are closely related concepts. (Huseyin, 2011) classilies cash management as operating transactions and financial transactions. The operating transactions include: accounting ledgers, invoicing, terms of sales – cash collection, cash control and processing as well as cash forecasting. The financial transactions include: optimization of cash, short-term investments, short term borrowing, interest rate risk management, exchange rate risk management, payment systems, information systems and banking investor relations (Kytonen, 2004).

The cooperative form is therefore regarded as having enormous potential for delivering pro-poor growth that is owned and controlled by poor people themselves (Jared, 2013). Nevertheless it is recognized that, lacking capital and business management capacity, cooperatives have had a disappointing history in developing countries (Birchall, 2004). There is an argument that it is the broader characteristics of cooperative organization such as social ownership, people-centered objectives and their community base, rather than their precise organizational form should be advocated.

According to (Mwaura, 2010) industry statistics in Kenya show that an estimated commercial banks are way below the required minimum capital levels and are expected to turn to the members for money needed to reach the threshold. Contributing money for the capital build-up will force members to take a portion of their monthly take-home or forego annual dividends in the next four years in support of the initiative. Nation staff commercial banks has for example, asked its members to increase their share capital to Kshs 6.000 from kshs 1. 000 beginning August 2010.

As observed by (Steve, 2010) Maisha Dora commercial banks withheld part and to some, whole dividends in the year 2009 and encouraged members to invest in beefing up the core capital in order to meet the SACCO liquidity demands. Haileselasie (2003) in his study about cooperatives in Saesi-Tsaeda-lmba found out that 78.7 percent of the members became member in cooperatives through mobilization and persuasion by the civil societies such as farmers. Youth and Women’s Associations. As a result, the members’ were not aware of their duties and rights within the cooperative societies.

According to Haileselasie’s (2003) findings, out of the total respondents members” participation in the annual meeting was 12.2 per cent and 68.8 per cent of the total respondents had bought only one share. The result of the study revealed that the overall participation of members in cooperatives was weak.

Darek (2012), states that the problem of access to capital has become even more challenging in emerging markets for a variety of reasons (Benedict & Venter. 2010). First, firms in emerging markets operate in an environment of imperfect legal infrastructure (Cunningham & Rowley. 2010). Capital providers must often agree to contractual terms dial are suboptimal for them. Second, financial disclosure in emerging markets continues to be relatively poor (Sami & Zhou. 2008; Zhou. 2007; Klonowski.2007). Darek (2012), observed that many countries report financial results under their own financial standards and regulations, which arc different from those seen in international accounting standards; consequently, auditing firms must often recast the financial statements of firms operating in such markets.

Third, asymmetry of information and moral hazards are more pronounced in emerging markets (Klonowski, 2007). Access to information is a greater challenge as sources of information on firms, the competitive posture of market players, and market size and growth rates are more difficult to find (Abor & Biekpe, 2006).

Fourth, firms operating within emerging markets have more problems related to corporate governance. The corporate governance concerns are more severe and more difficult to address than those experienced by firms in developed economies (Klonowski, 2007). Key issues may include: personal use of firm’s assets, unaccounted cash withdrawals and appointment of family members in the institutions. 

2.4 Conclusion

The environment within which and Commercial banks are operating have had a major drastic change, and Commercial banks have been relying on the member’s contribution and borrowing from the banks as the major source of cash so as to give loans to the members. Among the key issue is the liquidity requirements ratios and the provision for unrealizable loan. The attainment of full compliance with the capital adequacy ratios for individual MFIs remained a challenge, with institutional capital to total assets ratio being the most non-complied with (SASRA, 2014). While the issuance of loans increased over the year, their risk level as measured by level of non-performing loans deteriorated from 4.72 percent to 5.73 percent in 2014. I his indicates an elevated credit risk due to deterioration in performance of loans (SASRA, 2014). The regulator) framework defines non-performing loan portfolio as comprising the loans which arc classified as substandard, doubtful and loss categories. The non-performing loans ha\e increased from Ugx 9.3 billion in 2013 to Ugx 13 billion in 2014. This presents a worrying trend since the majority of loans advanced by MFIs are guarantee – backed, thereby reducing the risks of defaults. It also demonstrates the fact that notwithstanding the fact that the loans and credit advances by DTSs are guarantee-backed, they are still susceptible to default, and thus additional measures to address the risks ought to be put in place. (SASRA. 2014). While the withdraw-able savings deposits do not comprise significant portion of the balance sheet. MFIs are usually faced with liquidity mismatch when issuing loans based on multiplier of savings. However, there has been a shift from the multiplier factor to earnings especially with employer based MFIs, (SASRA. 2014).