EFFECTS OF HIGH INTEREST CHARGES ON THE GROWTH OF BUSINESSES IN KAMPALA

CASE STUDY: ST BALIKUDEMBE MARKET

CHAPTER ONE

INTRODUCTION

This chapter presents the background of the study, statement of the problem, purpose of the study, research questions, scope of the study, significance of the study, and definition of key terms.

1.1 Background to the Study

The concept of interest dates back several millennia, with early forms of lending recorded in ancient Greek and Roman civilizations, and even referenced in biblical texts (Shafiel et al., 2010). During the 14th century in Italy, moneylenders operated from benches in marketplaces, known as “banca”, a term that later evolved into the modern word “bank.” These lenders charged interest on borrowed funds and, in some cases, accumulated significant wealth (Kovacevic, 2009).

Another historical form of lending was indentured servitude, which was common during the Middle Ages and continued into the 19th century. Under this system, individuals borrowed money for essential needs such as travel or property acquisition and repaid the debt through labor, often with interest (Boca Raton, 2009). Although modern loan systems are more structured, the practice of lending has deep historical roots that predate modern financial institutions.

Globally, high interest charges remain a major concern in financial systems. Many financial institutions rely on interest income to maintain liquidity (Guttentag, 2007). However, excessive interest rates have contributed to financial strain among borrowers and have been associated with poor loan repayment performance. The 2008 global financial crisis highlighted weaknesses in loan management systems, where major financial institutions such as Barclays, HSBC, and Citibank suffered significant losses linked to poor credit practices (World Bank Report, 2008).

A loan is generally defined as a financial arrangement in which one party provides money to another under agreed conditions of repayment, including interest (Guttentag, 2007). However, lending is inherently risky because repayment is not always guaranteed. Effective loan management is therefore essential for the sustainability of financial institutions (Falk et al., 2004; Fehr et al., 2005).

Microfinance institutions provide financial services such as loans, savings, and insurance to individuals who lack collateral and cannot access formal banking services. These institutions typically serve low-income entrepreneurs in developing countries, including traders, farmers, and small-scale business operators. Although microloans are usually small and short-term, they are essential for supporting livelihoods and promoting economic empowerment (Orebiyi, 2002; Enslow, 2003).

Despite the importance of credit in business development, many small enterprises struggle to survive due to high interest charges. In St. Balikuddembe Market, Kampala, a significant number of businesses rely on borrowed capital but often fail to repay loans due to high interest rates, leading to business collapse within a few years. This study therefore seeks to examine the effects of high interest charges on business growth in Kampala.

1.2 Statement of the Problem

Mcloughlin (2013) notes that policymakers have long expressed concern about the high interest rates charged by microfinance institutions to low-income borrowers.

In Kampala, especially within St. Balikuddembe Market, many small businesses depend on credit to operate and expand. However, despite access to financial services, a large number of enterprises fail within their early years, often before reaching five years of operation. This situation raises concerns among market stakeholders regarding the role of high interest charges in business failure. Therefore, this study seeks to investigate how interest charges affect the growth and survival of business enterprises in Kampala.

1.3 Purpose of the Study

The purpose of the study is to examine the effects of high interest charges on the growth of businesses in St. Balikuddembe Market, Kampala.

1.4 Objectives of the Study

i. To examine the challenges of credit management on the growth of businesses in Kampala.
ii. To assess ways of improving credit management that promote business growth in Kampala.
iii. To establish strategies for enhancing the growth of business enterprises in Kampala.

1.5 Research Questions

i. What challenges does credit management pose to the growth of businesses in Kampala?
ii. What strategies can improve credit management to support business growth in Kampala?
iii. What measures can enhance the performance and growth of business enterprises in Kampala?

1.6 Scope of the Study

1.6.1 Content Scope

The study focuses on challenges of credit management, strategies for improving credit management, and approaches for enhancing business growth in relation to credit access.

1.6.2 Geographical Scope

The study will be conducted in St. Balikuddembe Market, Kampala.

1.6.3 Time Scope

The study will consider data from 2012 to 2015, while literature reviewed will cover studies conducted between 2000 and 2015.

1.7 Significance of the Study

The findings of this study are expected to:

• Assist the Central Bank and other financial regulators in improving credit risk management policies.
• Contribute to existing literature on business growth and credit systems in Kampala.
• Provide a foundation for further research on lending policies and credit management challenges.
• Help commercial banks and microfinance institutions develop better lending strategies that support business growth.
• Inform government policy formulation on credit and financial sector regulation.

CHAPTER TWO: LITERATURE REVIEW

2.1 Introduction

This chapter reviews existing literature on credit and its impact on small and medium enterprises (SMEs). It examines challenges of credit management, strategies for proper credit control, and methods for improving business performance.

Conceptual Overview of Credit

Small and medium enterprises (SMEs) are defined differently across countries, but commonly refer to businesses with 0–250 employees. SMEs play a crucial role in economic development, especially in developing economies.

2.2 Challenges of Credit Management on Business Growth

Researchers identify several challenges affecting credit management, including:

• Poor financial management practices among borrowers and lenders (Burki & Perry, 2006).
• Difficulty in assessing borrower creditworthiness due to weak lending systems (Nguyen, 2007).
• Low-income borrowers who face high repayment risks (Hahn, 2002).
• High competition among financial institutions leading to risky lending practices (Bofondi et al., 2003).
• Government interference in lending decisions (Krugman, 2003).
• Macroeconomic instability affecting repayment ability (Saudi Arabian Monetary Agency, 2003).
• Low levels of deposits and financial concentration risks (IMF, 2003).
• Lack of collateral among borrowers (Njoroge et al., 2009).
• Non-performing loans and default risks (Barth et al., 2004).
• Information asymmetry between lenders and borrowers (Ray, 2008).

2.3 Proper Credit Management and Business Growth

Effective credit management includes:

• Balancing risk and reward in lending decisions (Fedorowicz, 2003).
• Conducting proper credit risk analysis before loan approval (McCarthy, 2002).
• Establishing strong internal lending guidelines (Burki & Perry, 1998).
• Using modern credit assessment models for decision-making (Alec & Annan, 2004).
• Employing skilled and experienced financial staff (Erridge, 2003).

2.4 Ways of Improving Business Performance

Key strategies include:

• Capacity building and staff training (Vento, 2004).
• Improving infrastructure such as roads, ICT, and communication systems (Murray & Boros, 2002).
• Increasing funding for business development (Norell, 2001).
• Improving access to reliable business information (Armendariz et al., 2010).
• Strengthening credit management systems (NBE, 2010).
• Enhancing regulation and supervision of financial institutions (Najoragan, 2000).

2.5 Conclusion

The literature reviewed highlights that while credit is essential for business growth, high interest charges and weak credit management systems significantly hinder the survival of small businesses. However, most studies do not specifically focus on St. Balikuddembe Market, creating a contextual gap that this study seeks to address.