IMPACT OF LOAN MANAGEMENT AND PERFORMANCE MICROFINANCE INSTITUTION PERFORMANCE

INTRODUCTION

This chapter covers the background of the study, Statement of the problem, purpose of the study, research questions, and scope of the study, significance of the study and definition of terms.

1.1       Background to the Study

Acting as a provider of loans is one of the principal tasks for financial institutions, for other institutions, issuing of debt contracts such as bonds is a typical source of funding. In finance, a loan is a debt provided by one entity (organization or individual) to another entity at an interest rate, and evidenced by a note which specifies, among other things, the principal amount, interest rate, and date of repayment. A loan entails the reallocation of the subject asset(s) for a period of time, between the lender and the borrower, (Guttentag , 2007). Loan management has been the biggest challenge for financial institutions globally the world leading financial institutions of Barclays bank, HSBC bank, CITI bank lose billions of dollars as a result of poor loan management, according to the world bank most leading financial institutions lose billions of dollars as a result of poor loan management, during the world recession of 2008 most leading financial institutions were blamed for the poor loan management  which led to the global recession of 2008, (world bank report, 2008). Lending is a risky enterprise because repayment of loans can seldom be fully guaranteed, it involves implicit contracts between lenders and borrowers, thus, a well management loan can lead to better performance of microfinance institution, (Falk et al, 2004),  . Loan management is a system which is very essential for lending institutions to stay in business and as such an institution with poor loan management ability is at risk of collapse, (Fehr et al, 2005). A loan can be defined as an arrangement in which a lender gives money or property to a borrower, and the borrower agrees to return the property or repay the money, usually along with interest, at some future point(s) in time. Usually, there is a predetermined time for repaying a loan, and generally the lender has to bear the risk that the borrower may not repay a loan (though modern capital markets have developed many ways of managing this risk, (Zehnder et al, 2005). They posit that in credit markets dominated by short-term interactions, borrowers may only be motivated to repay if they know that, due to credit reporting, their current behavioris observable by other lenders and most of all the impact of credit reporting on repayment behavior and credit market performance is highly dependent on the potential loan management, (Zehnderm et al, 2005). Microfinance refers to an array of financial services, including loans, savings and insurance, available to poor entrepreneurs and small business owners who have no collateral and wouldn’t otherwise qualify for a standard bank loan. Most often, microloans are given to those living in still-developing countries who are working in a variety of different trades, including carpentry, fishing and transportation (orebiyi 2002).Microloans typically are not more than several hundred dollars. Examples of uses include money for tools to start work in construction, or makeup and other supplies needed to become a cosmetologist. Because they are the ones that commonly use their profits to provide for their families with things like food, clothing, shelter and education, women currently comprise roughly two-thirds of all microfinance clients. The goal of micro financing is to provide individuals with money to invest in themselves or their business to help get them out of poverty. When providing loans, micro financing institutions do not require collateral, but do insist that the loan is repaid within six months to a year (enslow 2003).

As borrowers with a good track record receive better credit offers, all borrowers have a strong incentive to sustain their reputation by repaying their debt (Orebiyi, 2002). Therefore, by repeatedly interacting with the same borrower, lenders establish long-term relationships that enable them to condition their credit terms on the past repayments of their borrower. As only a good reputation leads to attractive credit offers from the incumbent lender, borrowers have strong incentives to repay. With respect to Centenary Bank, the major problem facing the bank has been identified as failure to manage loan default (Centenary Bank Annual Reports, 2005, 2006, 2007). The management of the bank depends on incentives to repay on time; instant arrears information and delinquency tracking; immediate action to enforce repayment; and rigorous recovery in case of defaulting to achieve loan repayment (Annual Report, 2005). Out of the 28 operational branches of Centenary Bank micro lending performance indicates that the total portfolio for the headquarter branch is approximately UGX. 14.1 billion of which UGX. 3.7 billion is in individual micro loans with a total arrears rate of 3.7% for the year 2007. For the years 2006 and 2005, the bank closed with arrear rates of 3.6% and 5.46% respectively. In addition, the bank’s micro lending performance for the last three years reveals that it has continued to record average arrear rates of 4.24% and Non-Performing Assets (NPA) rates of individual micro loans of 1.4% where the acceptable rate by Bank of Uganda is 1%. The above weaknesses may be responsible for the high default rate. It is upon this background that the study seeks to investigate the impact of loan management on microfinance institution performance, case study centenary bank, kireka branch.

1.2       Statement of the Problem

The management of loan in Centenary Bank has been poor as evidenced by the annual report of Centenary Bank (2009) which revealed that the recovery rate and arrears rate were low, profitability margins had dropped and there was poor capacity utilization. Further evidence indicates continuous increase in the default rate from 2006-2009. Basing on this level of poor performance of centenary bank this study therefore seeks to investigate into the impact of loan management on microfinance institution performance.

1.3       Purpose of the Study

The study seeks to examine the impact of loan management on microfinance institution performance at centenary bank Kireka Plot1653, Jinja road branch, kampala (u).

1.4       Objectives of the Study

1. To examine the challenges of loan management onperformance of micro finance institutionat centenary bank.
2. To investigate ways of proper loan management at centenary bank.

• To establish different ways of improving the performance of micro finance institution at centenary bank.

1.5       Research Questions

1. What are the challenges of loan management on performance of micro finance institution at centenary bank?
2. What are the ways of proper loan management at centenary bank?

• What are the different ways of improving the performance of micro finance institution at centenary bank?

1.6       Scope of the Study

1.6.1 Study Scope

The study will specifically look at challenges of loan management on performance of micro finance institution, ways of proper loan management, and different ways of improving the performance of micro finance institution

1.6.2 Geographical Scope

The study will be carried out at centenary bank Kireka Plot1653, Jinja road branch, Kampala (u).

1.6.3 Time scope

The study will be carried out from February to September 31^st 2014.

1.7       Significance of the Study

The study is expected to provide guidance to the Central Bank and other regulators in the credit risk management policy formulation.

The study will add to the already existing literature on determinants of micro finance institution performance.

The study is expected to stimulate further research into the area of lending policy formulation and performance of loans

The study is expected to enable commercial banks identify the loan management policies that are critical in the lending business.

The study will help the government in formulation of policies regarding microfinance institutions in the country.

Conceptual frame work

Loan management (I/V)             Micro institution performance (D/V)