IMPACT OF LOAN MANAGEMENT AND PERFORMANCE MICROFINANCE INSTITUTION PERFORMANCE
CASE STUDY: CENTENARY BANK KIREKA BRANCH
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
The history of loans can be documented at least several thousand years back; forms of lending were evident in ancient Greek and Roman times, and monetary loans were even mentioned in the Christian bible, (Shafiel et al, 2010). In the ancient (14 century), Italian moneylenders would set up benches in the local marketplace, with the word for bench being “banca”, from which we eventually derived the word “bank”. The moneylenders would charge interest on their loans at a rate that they set, and would sometimes be quite successful and become very wealthy, (Kovacevic, 2009). One of the early forms of lending that should be explored in the history of loans is the indentured loan (also known as indentured servitude.) Initially practiced in the Middle Ages and through the 19th century by land owners and the wealthy, indentured servitude allowed poor individuals to borrow the money needed for major expenses such as travel and real estate, then the borrowers would pay back with an interest, (Boca Raton, 2009). The modern history of loan management started much later than these ancient times, it is, however, important to realize that lending started much earlier than many people would imagine and has its origin in much older times.
Globally loan management is a global issue that is given much concern and most financial institution in the world maintain their liquidity through charging interest in the loans, (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). 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 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).
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
Loan management is beneficial to a financial institution as effective loan management helps a financial institution in increasing its liquidity, and also enables it to pay back debts, workers, and increase its capital base among many other benefits of loan management, (Orebiyi, 2002).
However despite of the adoption of loan management policies by centenary bank the bank is faced with numerous performance challenges including, poor levels of recovery rates of loans from borrowers, low profitability margins, poor performance as compared to its other similar financial institutions, and above all increased complaints by bank top management about the low levels of the institutions performance (Centenary Bank Annual Reports, 2005, 2006) , this study therefore questions the impact of loan management on the performance of microfinance institutions, case study centenary bank, Mapeera branch, Kampala Uganda.
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
- To examine the risks of loan management in an organization
- To examine the benefits of loan management to an organization
- To establish the relationship between loan management and microfinance institution performance.
1.5 Research Questions
- What are the risks of loan management in an organization?
- What are the benefits of loan management to an organization?
- What is the relationship between loan management and microfinance institution performance?
1.6 Scope of the Study
1.6.1 Study Scope
The study will specifically look at, the risks of loan management in an organization, the benefits of loan management to an organization, the relationship between loan management and microfinance institution performance.
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 period of data to be considered in the organization will be from 2012-2014 and period of body of knowledge in reviewing literature will be from 2000-2014.
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.
1.8 Conceptual frame work
Loan management (I/V) Micro institution performance (D/V)
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Intervening variables
Figure 1 conceptual frame work for impacts of loan management on performance of microfinance institutions.
Adopted and modified from the systems theory of Bertalanffy, (1951), Rogers, (2003), theory of diffusion of innovation and the unified theory of acceptance and the use of technology, (Venkatesh, et al, 2003).
This study conceptualizes the relationship between loan management (the independent variable) and performance of microfinance institution, (dependent variable).
Loan management indices are various risks which include, financial risks, People risks and Techniques which are predictors of micro finance institution performance; Reliability, Efficiency, Timeliness, Flexibility. Profitability, (Moslehand Shannak, 2009), Pearlson and Saunders, (2006), however it is conceptualized that loan management at its various indices’, which are critical to the performance of an organization.
