CREDIT MANAGEMENT AND FINANCIAL PERFORMANCE OF MICROFINANCE INSTITUTIONS IN UGANDA: A CASE STUDY OF THE MICROFINANCE SUPPORT CENTRE, MBALE BRANCH
ABSTRACT
This study investigates the relationship between credit management and financial performance among microfinance institutions (MFIs) in Uganda, using the Microfinance Support Centre (MSC), Mbale Branch, as a case study. The research was guided by three main objectives: first, to examine the effect of client appraisal techniques on the financial performance of MSC Ltd.; second, to assess the effect of credit risk control tools on its financial performance; and third, to evaluate the effect of collection policies on its financial performance.
The study population comprised 60 respondents from various departments, including Finance (2), Human Resource Administration (5), Loans Officers (15), Information Communication Technology (2), Marketing and Corporate Affairs (13), Legal Officers (10), Customers (10), and Internal Audit (5).
Data will be collected using questionnaires and interviews. A structured questionnaire will be administered to members and staff of MSC to gather information on credit management and financial performance. Additionally, face-to-face interviews will be conducted with MSC staff to collect in-depth qualitative data on the same subject. The researcher will arrange meetings with respondents from the specified categories to conduct these interviews.
CHAPTER ONE: GENERAL INTRODUCTION
1.0 Introduction
This chapter presents the background information on the research topic, the statement of the problem, study objectives, research questions, scope of the study, significance of the study, conceptual framework, and definitions of key terms.
1.1 Background of the Study
Globally, the modern concept of “microfinancing” emerged in the 1970s with organizations such as the Grameen Bank of Bangladesh, founded by microfinance pioneer Muhammad Yunus. These institutions shaped the modern microfinance industry, which initially focused narrowly on providing microloans to poor entrepreneurs and small businesses lacking access to traditional banking services. Two primary delivery mechanisms were used: relationship-based banking for individual entrepreneurs and small businesses, and group-based models where several entrepreneurs applied for loans and other services collectively. Over time, microfinance has evolved into a broader movement aiming for a world where everyone—particularly the poor and socially marginalized—has access to a wide range of affordable, high-quality financial products and services, including credit, savings, insurance, payment services, and fund transfers. According to Horne and Wachowicz (1998), many microfinance proponents believe such access helps lift people out of poverty, a view shared by participants in the Microcredit Summit Campaign (1998). For some, microfinance promotes economic development, employment, and growth by supporting micro-entrepreneurs and small businesses; for others, it helps the poor manage their finances more effectively, seize economic opportunities, and mitigate risks.
Currently, microfinance involves supplying loans (credit), savings, and other basic financial services to the poor. These services typically involve small amounts of money—small loans, small savings, etc. However, for most MFIs, credit is one of the key services offered because it influences demand for their products. Myers and Berkley (2003) defined credit as a process where possession of goods or services is granted without immediate payment, based on a contractual agreement for later payment.
The concept of credit dates back to the 1540s, derived from the Middle French word credit (15th century) meaning “belief, faith,” from Italian credito, and from Latin creditum—”a loan, thing entrusted to another,” neuter past participle of credere (“to trust, entrust, believe”). The commercial sense—”confidence in the ability and intention of a purchaser or borrower to make payment at some future time”—appeared in English in the 1570s (with creditor appearing in the mid-15th century), leading to the phrase “sum placed at a person’s disposal by a bank, etc.”
Therefore, the greatest risk in microfinance is lending money and not recovering it. Credit risk is particularly concerning for MFIs because lending is often unsecured; traditional collateral is not commonly used to secure microloans (Churchill & Coster, 2001). Their clients are typically individuals who cannot obtain credit from banks or other financial institutions due to an inability to provide guarantees or security. Many MFIs are reluctant to serve these populations due to high default risk for interest payments and, in some cases, the principal amount itself. Consequently, these institutions must design sound credit management systems. Credit management is the process of granting credit, defining its terms, and recovering it when due. It is a function within a bank or company that controls credit policies to improve revenues and reduce financial risks, involving the identification of existing and potential risks inherent in lending activities. For effective credit management, MFIs should implement variables such as client appraisal techniques, credit terms, collection policies, and credit risk control tools. Sound credit management is a prerequisite for MFI stability and sustained profitability, while deteriorating credit quality is the most frequent cause of poor financial performance. According to Gitman (1997), the probability of bad debts increases as credit standards are relaxed. Firms must therefore ensure efficient and effective receivables management. Delays in collecting cash from debtors cause serious financial problems, increase bad debts, and affect customer relations. Late payments erode profitability, and non-payment results in a total loss. On this basis, it is sound business practice to place credit management at the “front end” by managing it strategically.
In Uganda, the institutionalization of microfinance progressed slowly. Traditionally, Uganda’s private sector has struggled with infrastructural failings, including a weak commercial justice system, corruption, inadequate tax and regulatory management, and lack of financial services (Audit Report, 2002; Wong, 1999). During the 1990s, bank closures and inflexible banking practices by the Uganda Commercial Bank excluded small businesses and low-income households from financial services (Carlton et al., 2016). Furthermore, traditional banks of that era damaged Uganda’s social capital and credit culture by mishandling credit schemes, profoundly undermining public trust in traditional financial institutions (Carlton et al., 2001). However, more traditional forms of informal financial activities have existed for decades (Carlton et al., 2001). The first government-introduced MFIs were FINCA and Uganda’s Women Finance Trust (UWFT) in the 1990s. Due to government failures in effective poverty reduction and development policies at the time, there was heavy reliance on NGOs, community-based organizations, and local “Resistance Councils.”
Following the introduction of these MFIs, results indicate that while microfinance is important for society, challenges remain, including inadequate donor funding, insufficient government support, improper regulations, inefficiency in credit management tools and techniques, and a lack of standardized reporting and performance monitoring systems for MFIs. Although the Ugandan government introduced the Microfinance Support Centre to address these challenges, most efforts have focused on poverty alleviation, with less emphasis placed on credit management. According to MSC’s financial reports from 2016–2018, of the 80 billion Ugandan shillings disbursed in loans, only 40 billion was recovered on time, and 20 billion was defaulted. This highlights a significant challenge in credit management among MFIs, underscoring the need for further research.
1.2 Problem Statement
Sound credit management is a prerequisite for an MFI’s stability and continued profitability, while deteriorating credit quality is the most frequent cause of poor financial performance. According to Gitman (1997), the probability of bad debts increases as credit standards are relaxed. Firms must therefore ensure efficient and effective receivables management. Delays in collecting cash from debtors lead to serious financial problems, increased bad debts, and damaged customer relations. Late payments erode profitability, and non-payment results in total loss. Therefore, strategically positioning credit management at the “front end” is simply good business. MSC has established credit management mechanisms aimed at ensuring proper management of all loans disbursed to clients and improving financial performance. These include sound policies for fund disbursement, well-trained credit officers, and risk assessment officers (MSC Annual Report, 2016). Despite these efforts, MSC’s financial position has continued to deteriorate due to a high default rate. According to MSC’s financial reports from 2016–2018, of the 80 billion shillings disbursed, only 40 billion was recovered on time, and 20 billion defaulted. As with any financial institution, the biggest risk in microfinance is lending money and not getting it back. Credit risk is especially concerning for MFIs because most microlending is unsecured (Craig Churchill & Dan Coster, 2001). Their clients are those who cannot obtain credit from banks due to an inability to provide guarantees or security. This forms the background against which the researcher will examine the effect of credit management on financial performance, with a specific focus on the Microfinance Support Centre, Mbale Branch.
1.3 Research Objectives
1.3.1 General Objective
To examine the effect of credit management on the financial performance of microfinance institutions in Uganda.
1.3.2 Specific Objectives
i. To examine the effect of client appraisal techniques on the financial performance of Microfinance Support Centre Ltd., Mbale Branch.
ii. To examine the effect of credit risk control tools on the financial performance of Microfinance Support Centre Ltd., Mbale Branch.
iii. To examine the effect of collection policies on the financial performance of Microfinance Support Centre Ltd., Mbale Branch.
1.4 Research Questions
i. What is the effect of client appraisal techniques on the financial performance of the Microfinance Support Centre, Mbale Branch?
ii. What is the effect of credit risk control tools on the financial performance of the Microfinance Support Centre, Mbale Branch?
iii. How effective are the collection policies on the financial performance of the Microfinance Support Centre, Mbale Branch?
1.5 Research Hypotheses
i. There is a strong, positive, and significant effect of client appraisal techniques on financial performance.
ii. There is a positive and significant relationship between credit risk control tools and financial performance.
iii. There is a positive and significant effect of collection policies on financial performance.
1.6 Scope of the Study
1.6.1 Content Scope
The study will focus on credit management as the independent variable, with dimensions including client appraisal techniques, credit risk control tools, and collection policies. The dependent variable is financial performance, measured by profitability, cash flow, and liquidity position.
1.6.2 Time Scope
The study will consider information covering ten years. This period is chosen because the Microfinance Support Centre expanded into several areas of Uganda during this time, and ten years is sufficient to predict an organization’s future trajectory.
1.6.3 Geographical Scope
The study will be conducted at the Microfinance Support Centre, Mbale Branch, located in eastern Uganda, Mbale Municipality, at Plot 2, Bumasifwa Lane, along Pallisa Road. Mbale Municipality is bordered by Sironko District to the north, Bududa District to the northeast, Manafwa District to the southeast, Tororo District to the south, Butaleja District to the southwest, and Budaka District to the west. Pallisa and Kumi districts lie to the northwest. Mbale District was chosen because it hosts one of the largest microfinance support centres in the country.
1.7 Significance of the Study
The results of this study will be valuable to researchers and scholars, forming a basis for further research. Scholars can use this study as a foundation for discussions on credit management and financial performance of MFIs. It will provide empirical studies for use in their work and will contribute to the body of knowledge in finance by bridging gaps in credit management research generally.
This study will contribute to both knowledge building and practical improvement in credit management and financial performance. Theoretically, it proposes a comprehensive framework for studying changes in credit management and financial performance. It is also expected to aid policymakers in their efforts to revitalize the sector.
The findings will be highly relevant to the organizations under study and other financial institutions. Non-financial business firms, whether manufacturing or service-oriented, will also benefit, as the results will enable users—especially Finance Trust Bank, Mbale—to appraise their credit policies and critically review their operations for a more results-oriented approach to credit facilities.
1.8 Justification of the Study
Numerous studies on credit management have been conducted globally and in Uganda, but only a few are directly relevant to this research, notably those by Robert (2011) and Lydia (2012).
Robert (2011) studied credit management and profitability of commercial banks using FINCA Uganda, focusing on the role of credit management in profitability. The objectives were to examine credit policy and profitability at FINCA Uganda, assess the causes of low profitability, and establish the relationship between credit management policy and profitability. However, Robert focused only on commercial bank profitability, leaving out other MFIs, which prompted further research on the role of credit management.
Lydia (2012) studied credit control and loan performance in financial institutions, using Centenary Bank, Mbale as a case study. The objectives were to assess the level of usage of credit control systems at Centenary Bank, establish the effects of these systems on deposit rates, and recommend further research on credit risk management and management efficiency in financial institutions. Although Lydia conducted a thorough study based on her objectives (usage of credit control systems and their effect on loan default), she did not examine the challenges of credit management systems. Therefore, further study is needed on the challenges faced in using credit management and the role of credit management systems
