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EFFECT OF LOAN PERFORMANCE ON DEVELOPMENT OF SMALL AND MEDIUM ENTERPRISE IN KIREKA MARKET WAKISO DISTRICT

CHAPTER ONE

1.0 INTRODUCTION

This chapter will include; background of the study, statement of the problem, purpose of the study, objectives of the study, research questions, scope of the study , significance of the study and operational definition of key terms.

1.1 Background

Commercial banks play a very important role in the economic resource allocation of countries and they determine the development of both small and big business in a country. They channel funds from depositors to investors continuously after generating the necessary income to cover their operational cost they incur in the due course of their business (Ongore and Kusa, 2013).

Loans are essential for business to be able to acquire capital and enable business organizations especially small and medium enterprises to be able to meet their day to day financial requirement in this competitive age (Azeem, 2012).

The traditional role of a bank is lending and loans make up the bulk of banks’ assets (Njanike, 2009). However, lending is not an easy task for banks because it creates a big problem which is called non-performing loans (Chhimpa, 2002) as cited in Upal (2009). According to Alton and Hazen (2001), non-performing loans are those loans which are ninety days or more past due on their payment or no longer accruing interest, cited from (Area, 2016).

Financial constraints are one of the most important obstacles to starting and running a business for small and medium enterprises (SMEs), particularly in less– developed and transition economies (Menkhoff et al. 2006 and 2012).

On a global view, Banks have been faced with the challenge of credit risk management and the aftermath of the credit crisis whose roots started with the bursting of the housing bubble and high default rate on sub–prime mortgages in the United states, a situation that was a result of high appetites for credit and weak credit controls that saw Lehman Brothers collapse while Merrill Lynch and Bear Stearns were sold at fire sale prices (The Economist, 2009).

Loans is the most common source of external finance for many SMEs and entrepreneurs, which are often heavily reliant on traditional debt to fulfill their start-up, cash flow and investment needs. While it is commonly used by small businesses, however, traditional bank finance poses challenges to SMEs, in particular to newer, innovative and fast growing companies, with a higher risk-return profile (OECD, 2015).

The vast majority of firms around the world fall into the category of micro, small- or medium-sized enterprises (SMEs). In terms of enterprises, more than 95 percent fall into this category, but even in terms of employment in low- and lower-middle-income countries, more than 50 percent of employees work in companies with fewer than 100 employees (Ayyagari, Demirguc-Kunt and Maksimovic, 2011a). While SMEs thus constitute an important component of the private sector in the developing world, they report significantly higher obstacles to their operation and growth than large enterprises (Beck et al., 2006a). Among these obstacles, the lack of access to appropriate financial services, especially lending services, looms large.

Africa’s financial systems are small, shallow and costly, with limited outreach. This is not just reflected in aggregate financial development indicators but also in firm and household data gauging the use of formal financial services; however this has had an effect on the performance of most of the SMES in the continent leading to unemployment and poverty (Beck and Cull, 2014).

Lending to SMEs is generally more risky than larger firms. Thus, most financial institutions and non-financial institutions require collateral in the form of land or buildings in addition to other stringent requirements to reduce default. Thus, SMEs find it difficult to obtain external financing from banks and capital markets given their size and characteristic opaqueness, (Kravchenko, 2011).

According to enterprise-level data collected by the World Bank (2011), SMEs in Sub-Saharan Africa are more financially constrained than in any other developing region. Only 20 per cent of SMEs in Sub-Saharan Africa have a line of credit from a financial institution compared, for example, with 44 per cent in Latin America and the Caribbean, and only 9 per cent of their investments are funded by banks versus 23 per cent in Eastern Europe and Central Asia.

In Uganda the SME sector contributes 20% to Gross Domestic Product and it provides employment to over 1.5 million people which accounts for 90% of total non-farming private sector workers (ADB, 2012). The benefits of the small and medium enterprises in the Ugandan economy cannot be overstated. Small and medium enterprises play a substantial role in employment and income generation, producing import substituting options that significantly drive the Ugandan economy. Predictably though, Odongo (2014) exposed impediments like unsatisfactory liquidity, ineffectual financial efficiency of resource utilization, high risk of solvency leading to financial distress and high lending terms of financial institutions as being linearly related to the financial performance of SMEs, with the lending terms contributing to 26.6% loss in revenue of SMEs that borrowed in Uganda, which in turn handicapped their growth efforts.

A number of obstacles have continued to constrain the financiers’ further engagement with the SME segment in Uganda. According to the National-Small-Business Survey-report (2015), the key constraints to growth which SMEs feel confront them are financial. They centre on both ‘limited access to finance’ (74.3%), and the ‘cost of finance’ (73.2%). Above and beyond, Nahamya (2013) and Atupele (2013) have advanced that the fundamental challenge of SMEs is the extent to which financial institutions have stringent requirements around security (collateral) which SMEs are not able to meet.

Basing on this Background this study intends to investigate into effect of loan performance on development of small and medium enterprise in wakiso district.

1.2 STATEMENT OF THE PROBLEM

SME owners (91%) raise their own start-up capital compared to only 9% who take a loan to start the businesses in Uganda. Accordingly, the National Small Business Survey report emphasizes that those who take loans mostly rely on family and friends (39%), money lenders (26%), SACCOs (13%) but very few take loans from financial institutions (10%).

Its common knowledge that credit availability, accessibility and above all affordability is crucial in driving the engine of Small and medium-sized enterprises (SMEs) not only in Uganda but worldwide. However, it is important to note that credit accessibility has increasingly become a challenge in Uganda due to the high lending rates by the commercial banks standing in the range of 23% to 25% way higher than the central bank rate (CBR) standing at 14% (Bank of Uganda, 2016). Furthermore, Lending rate has been left to be determined by the market forces of demand and supply which with no deliberate action by the central bank to lower these rates may pause a big challenge to the operations of the SMEs in Uganda. Nevertheless, many micro finance institutions lend to very poor people expecting to start a business in Uganda today in disguise of quick loans, this however has lead to the collapse of most of the SMEs in Uganda there by leading to the failure of most of the SMEs in the first five years after their creation. Against this Background this study therefore intends to investigate into effect of loan performance on development of small and medium enterprise in Wakiso district.

1.3 OBJECTIVES OF THE STUDY

1.3.1 General objective

The purpose of study is to examine the effect of loan performance on development of small and medium enterprise in Wakiso district.

1.3.2 Specific objectives

To examine the challenges of loan acquisition by SMEs in Kireka market.
To analyze the Benefits of loans to SMEs in Kireka market.

To investigate the relationship between loan performance and development of SMEs Kireka market?

1.4 RESEARCH QUESTIONS

What are the challenges of loan acquisition by SMEs in Kireka market?
What are the Benefits of loans to SMEs in Kireka market?

What is the relationship between loan performance and development of SMEs in Kireka market?

1.5 SCOPE OF THE STUDY

This section will include content scope, time scope and geographical scope.

1.5.1 Content scope

This study will include; challenges of loan acquisition by SMEs, challenges to the development of SMEs and the relationship between loan performance and development.

1.5.1 Time scope

The study will be carried out from February to august 2018.

1.5.2 Geographical scope

The study will be carried out in Kireka market in Wakiso district.

1.6 SIGNIFICANCE OF THE STUDY

The study will enable the government of Uganda have information regarding the challenges of acquisition by SMEs in Kireka market.
The study will also provide information on the challenges to the development of SMEs in Kireka market.

The study will also provide the future academicians with information on the relationship between loan performance and development of SMEs in Kireka market.