ADDIS ABABA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING AND FINANCE

DETERMINANTS OF APPROVAL AND REPAYMENT

PERFORMANCE OF HOUSING FINANCE IN ADDIS
ABABA IN CASE OF ZEMEN BANK S.C

A research proposal Submitted to The Department of

Accounting and Finance Presented in Partial Fulfillment of
the Requirements for the Degree of Master of Science in
Accounting and Finance

By; Mihretu Bayeh

Advisor; Takele Fufa (PhD)

0ctober, 2021

Addis Ababa, Ethiopia

Table of Contents
CHAPTER ONE..........................................................................3
1. INTRODUCTION...............................................................3
1.1. Background of the study...........................................................................................3
1.2. Statement of the problem..........................................................................................6
1.3. Objectives of the study..............................................................................................7
1.3.1. General objective..............................................................................................7
1.3.2. Specific objectives............................................................................................7
1.4. Research hypothesis..................................................................................................8
1.5. Significance of the study...........................................................................................9
1.6. Scope of the study.....................................................................................................9

CHAPTER TWO.......................................................................10
2. REVIEW OF RELATED LITERATURE........................10
2.1. Theoretical literatures.............................................................................................10
2.1.1. House..................................................................................................................10
2.1.2. Importance of Housing........................................................................................10
2.1.3. The Concept of Housing Finance........................................................................12
2.1.4. Demand side of Housing finance........................................................................13
2.1.6 Conditions for Loan approval of housing finance...............................................14
2.1.6.1. Loan assessment..........................................................................................15
2.1.6.2. Due diligence Assessment...........................................................................15
2.1.6.3. Credit appraisal study..................................................................................16
2.1.6.4. Credit Documentation.................................................................................17
2.2. Review of empirical studies....................................................................................18
2.2.1. Approval and Recovery performance of housing finance................................18
Knowledge Gap..................................................................................................................22
2.3. Variables of the study.............................................................................................23
2.3.1. Dependent variable.........................................................................................23

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 2.3.2. Independent variables......................................................................................23
2.4. Conceptual framework of the study........................................................................28

CHAPTER THREE...................................................................30
3. RESEARCH DESIGN AND METHDOLOGY................30
3.1. Research design......................................................................................................30
3.2. Sampling design...........................................................................................................30
3.2. Data sources............................................................................................................30
3.3. Data collection instruments.....................................................................................30
3.4. Data analysis...........................................................................................................31

Work plan..................................................................................32
Cost Budget...............................................................................33
References.................................................................................34

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 CHAPTER ONE

1. INTRODUCTION

1.1. Background of the study

Commercial banks play an important role in the process of money transfer from
surplus to deficit sector and thereby stimulate economic growth of a country. Loans
are the most famous and perhaps the most important service provided by commercial
banks. In the banking business, lending to the private sector plays a significant role,
particularly lending to households where the most significant role is played by
housing loans, which also contributes to economic growth due to its direct and
indirect effects. (Datta & Jones, 2001).

Credit risk evaluation and lending decisions made in the past by lending institutions
put a lot of emphasis on security than other similar important considerations
(Kashuliza 2011). There are instances in the past when it was easier to get a loan from
a financial institution as long as the borrower had security to be charged rather than
the ability to service the loan. Cash flow projections, viability of the project, character
of the borrower, previous loans completion and ability to repay were not considered
as important. This way a number of lending institutions ended up with many loan
defaults due to incomplete, poor and unprofessional credit risk assessment and
valuation particularly using all the 5C’s of credit appraisal model that is: capacity,
credibility, capital, collateral and character. Effective loan portfolio management
begins with oversight of the risk in individual loans Sundarajan (2007). Prudent risk
selection is vital to maintaining favorable loan quality. Therefore, the historical
emphasis on controlling the quality of individual loan approvals and managing the
performance of loans continues to be essential Payner, and Redman (2002).

The main objective of the banks are they deliver loans, savings, money transfer, etc.
to a large number of productive resource; people in the country in a cost-effective and
sustainable way. The primary objective of banks are to provide financial services like

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(credit & saving) to the people in order to release financial constraint and help
alleviating poverty. Each bank tries to maximize its repayment performance, whether
or not it is profit oriented. High repayment rates are indeed largely associated with
benefits both for the banks and the borrowers (Sengupta and Aubuchon, 2008, cited
by Fikirte, 2011). They enable the banks to cut the interest rate it charges to the
borrowers, thus reducing the financial cost of credit and allowing more borrowers to
have access to it.

Improving repayment rates might also help reduce the dependence on subsidies of the
banks, which would improve sustainability. It is also argued that high repayment rates
reflect the adequacy of bank`s services to clients` needs. They limit the incidence of
cross subvention across the borrowers. Finally, yet importantly, repayment
performance is a key variable for donors and international funding agencies on which
many banks still depend for their access to funds (Godquin, 2004).

Arene (2008) outlines the main factors that determine loan repayment performance as
loan size, enterprise size, income, age, number of years of business experience,
distance between home and source of loan, education, household size, adoption of
innovations, and credit needs. Like in other areas of the world, peoples in Ethiopia are
living under poverty. Finance institutions in general and banks in particular plays
crucial role in the development of Ethiopia in general and Addis Ababa in particular.

Though credit operation of commercial banks in Ethiopia shows a dramatic increase

in loan approval and disbursal there are non-performing loans, which resulted from
clients’ default, which in turn come about from lack of follow-up, market problems,
environmental problems, credit policy of the Bank, and so forth (Derege, 2010). This
raises a question on how can commercial banks in Ethiopia increase the recovery
performance of its borrowers of housing finance. This in turn entails a question on
what are the factors that determine loan approval and recovery performance of
borrowers. It is thus important to investigate and provide empirical evidence on
factors that determine loan approval and recovery performance of housing finance of
commercial banks in Ethiopia Addis Ababa city. Therefore, the researcher will
investigate determinants of loan approval and recovery performance of housing
finance in Addis Ababa in case of Zemen bank S.c.

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 1.2. Statement of the problem
Ethiopia’s population growth and rapid rate of urban expansion are placing substantial
pressure on housing. The availability of finance is a key issue for any housing
development activity. It affects developers, contractors and the ultimate buyers of the
housing units. An efficient and sustainable housing finance regime is a pre-requisite
for sustainable housing finance for the citizens of a nation. Housing finance market is
an important medium for financing housing around the globe (Boamah, 2010).
Housing finance market contributes significantly to addressing the problem of
housing inadequacy or insufficiency by providing home buyers with long-term
Housing loans with relatively moderate monthly installments. Housing investment has
long duration and requires large amount of long-term finance. This can be adequately
provided when sustainable housing finance market is in place.

The commercial banks' involvement in housing loans is limited due to many

unfavorable factors. Besides unsatisfactory legal situation with regard to the property
title deeds, macro-economic instability, high inflation, volatile real estate prices and
non-availability of long term funds at reasonable interest rates also come in the way of
the banks' active involvement in the home loan market. Similarly, housing finance is
not a flourishing activity in the transition economies. Many countries in this category
do not have strong and vibrant banking system, reliable legal system to confer
property rights and financial stability to promote on a massive scale housing finance.
Sudhir (2005)

With regard to extending loan to the housing finance it seems that the amount is
getting smaller and banks are focusing more on business loans. The overall lending
amount is also very small compared to the population size and housing demand. It is
one thing to provide loan, but it is also another thing to make it more accessible.
Recently accessing loan for housing purpose is not easy and dogged with multiple
conditions. Mobilized deposits remain the major source of funding for banks in
Ethiopia as well. Behon (2011).

Gebeyo, (2002) conducted a study on major challenges of accessing housing project

finance in Addis Ababa. The author indicated that the housing facility provision has
two major challenges; affordability and quality. If citizens cannot afford, the
construction of the houses cannot meet the intended purposes. The finding, however,
has not discussed other determinants that the affordability in order to introduce new
ways of doing. This study thus attempts to look at other variables.

Regarding credit services, another study conducted by Derege, (2010) indicated that
loan access is the serious problem for the targets of the housing. Besides, it has been
underlined that the problem of credit occurs because of the problem in the regulatory,
legal frameworks, and lengthy and costly legal procedure. The study did not disclose
others other than the credit related problem Such as income from other sources,
occupation, marital status, spouse income source, interest rate, employment status,
timeliness, loan diversion, supervision and loan utilization which will be addressed in
this research.

Consequently, this study looks at the determinants of approval and recovery

performance of housing finance from the borrower’s perspective. Most research on
housing finance in Ethiopia has concentrated on the relationship of housing prices and
housing mortgage implications only. However, that kind of empirical inclination has
not looked at a number of variables such as income from other sources, occupation,
marital status, spouse income source, interest rate, employment status, timeliness,
loan diversion, supervision and loan utilization that have been mentioned in this
study. However, these variables play a key role in determining the housing finance in
Addis Ababa city and Ethiopia as a whole.

Since housing drives economic activity with both backward and forward linkages, a
study on housing finance is important. There are a number of studies conducted
related to credit approval and repayment performance of housing finance. For
instance, Reza and Mansoori (2009), Pishbahar et.al (2015), Rifas, Nimsith and
Shibly (2016), Belete (2015), Fikadu (2019), Feysa (2009), Saroha and Yadav (2016),
Biniam (2018), and Yinebeb (2015) were conducting their study related to lending
decision and repayment performance at European and other African countries.
However, the economic performance, political, social and cultural factors are various
from country to country. As a result, the identified determinant factors might not use
for Ethiopia in general and in particular commercial banks. Additionally, most of the

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undertaken studies were conducted at micro finance institution and Small scale
business. This in turn, that the types of the loans were short term and working capital
loan. While commercial banks in nature has financed short, medium and long term
project (housing finance) and have higher risk than short term finance. Through
various researches have been conducted on loan repayment performance at different
places and time period but the results of the findings by various researchers are
different and therefore inconclusive and not present with an assessment of credit
approval. As per researcher knowledge, no study is conducted to examine the
determinant of approval and repayment performance of housing finance at the same
time. Thus, by taking in to account these and some other knowledge gaps and keeping
the results or findings of the former studies, the researcher attempts to investigate the
determinants of approval and repayment performance of housing finance in Addis
Ababa with a particular emphasis of Zemen bank by seeking answer for the following
research question;

1. What are the factors that determine approval of housing finance in Addis
Ababa?
2. What are the factors that determine the loan repayment performance of
housing finance in Addis Ababa?

1.3. Objectives of the study

1.3.1. General objective

The general objective of this study is to assess the determinants of Approval and
Repayment Performance of Housing Finance in Addis Ababa city.

1.3.2. Specific objectives

The specific objectives of this study include the following;

1. To investigate the factors that determines approval of housing finance in Addis

Ababa.

2. To analyze factors that determines the loan repayment performance of housing

finance in Addis Ababa.
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1.4. Research hypothesis
Ho1: income from other sources has no significant impact on recovery performance of
housing finance.

Ho2: average house hold income has no significant impact on recovery performance
of housing finance.

Ho3: employment status has no significant impact on recovery performance of

housing finance.

Ho4: Interest rate has no significant impact on recovery performance of housing

finance.

Ho5: timeliness has no significant impact on loan recovery performance of housing

finance

Ho6: loan utilization has no significant impact on loan recovery performance of

housing finance

Ho7: loan diversion has no significant impact on loan recovery performance of

housing finance

Ho8: loan supervision has no significant impact on loan recovery performance of

housing finance

Ho9: saving culture has no significant impact on loan approval of housing finance

Ho10: change of inflation in the economy has no significant impact on recovery

performance of housing finance

Ho11: home loan repayment period has no significant impact on recovery

performance of housing finance

Ho12: loan size has no significant impact on recovery performance of housing finance

Ho13: spouse income source has no significant impact on loan recovery performance
of housing finance

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1.5. Significance of the study
This study is believed to be an input for policy makers in improving the understanding
of the gaps and problems with regard to housing finance. It gives some insights in to
the bank to understand the gaps in approving as well as repayment performance of
housing finance and work towards filling up the gap. This study will assist the bank to
identify aspects or areas where burrowers experience challenges. The finding of this
study could also help the bank to improve loan repayment performance. Finally, this
study believed to be relevant for further and future researchers.

1.6. Scope of the study

In this study the researcher attempts to identify determinants of approval and recovery
performance of housing finance. To make the study manageable and to evaluate the
problem in detail, the researcher is only confined to the determinants of approval and
repayment performance of housing finance in Addis Ababa in case of Zemen bank.

1.7. Organization of the study

This paper will consist of five chapters. The first chapter deals with introductory part
which contains background of the study, statement of the problem, objective of the
study, research hypothesis, significance of the study, scope of the study and
organization of the study. Chapter two presents the review of related literature that is
related to housing finance. The third chapter contains brief description of the research
methods that will use to conduct the study. The fourth chapter will contain result and
discussion of the data that will be collected. Finally, chapter five deals with summary,
conclusions and its recommendations

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 CHAPTER TWO

2. REVIEW OF RELATED LITERATURE

2.1. Introduction
This chapter summarizes theoretical literatures related to finance, loan approval,
repayment performance and the information from other researchers who have carried
out their research in the same field of study

The study includes three theories, theory of finance, portfolio theory and pricing
theory. Like any other lending business, the lender is out to earn a return on the
money advanced in the form of interest on top of the principal. This therefore means
that they have to thoroughly evaluate the borrowers to make sure that they only
extend credit to borrowers with ability and capacity to repay. These theories explain
the reasoning and bases of credit extension and management of nonperforming loans
among customers of commercial banks

Based on this available knowledge, the research pursues the realities of determinants
of loan approval and repayment performance of housing finance in Addis Ababa.

2.2. Theoretical literatures

2.2.1. The Theoretical Concept of Finance

2.2.1.1 Theory of Finance

The theory of finance is concerned with how individuals and firms allocate resources
through time. In particular, it seeks to explain how solutions to the problems faced in
allocating resources through time are facilitated by the existence of capital markets
(which provide a means for individual economic agents to exchange resources to be
available at different points in time) and of firms (which, by their production-
investment decisions, provide a means for individuals to transform (current resources
physically into resources to be available in the future). Numerous economists have
explained the role of finance in the market with the help of different finance theories.
The concept of finance theory involves studying the various ways by which
businesses and individuals raise money, as well as how money is allocated to projects
while considering the risk factors associated with them.

The concept of finance also includes the study of money and other assets, managing
and profiling project risks, control and management of assets, and the science of
managing money (Hull, John C, 2002). In simple terms, 'financing' also means
provision and allocation of funds for a particular business module or project. The
Arbitrage Pricing Theory, for example, addresses the general theory of asset pricing.
Proper asset pricing is necessary for the proper pricing of shares. The Arbitrage
Pricing Theory states that the return that is expected from a financial asset can be
presented as a linear function of various theoretical market indices and macro-
economic factors. Here it is assumed that the factors considered are sensitive to
changes and that is represented by a factor-specific beta coefficient. The Prospect
Theory, on the other hand, takes into consideration the alternatives that come with
uncertain outcomes. The model is descriptive by nature and attempts to represent real-
life choices but not optimal decisions.

2.2.1.2 Portfolio Theory

Since the 1980s, banks have successfully applied modern portfolio theory (MPT) to
market risk. Many banks are now using value at risk (VAR) models to manage their
interest rate and market risk exposures. However, even though credit risk remains the
largest risk facing most banks, the practical of MPT to credit risk has lagged
(Margrabe, 2007). Banks recognize how credit concentrations can adversely impact
financial performance. As a result, a number of sophisticated institutions are actively
pursuing quantitative approaches to credit risk measurement, while data problems
remain an obstacle. This industry is also making significant progress toward
developing tools that measure credit risk in a portfolio context. They are also using
credit derivatives to transfer risk efficiently while preserving customer relationships.
The combination of these two developments has precipitated vastly accelerated
progress in managing credit risk in a portfolio context over the past several years.

Traditionally, banks have taken an asset-by-asset approach to credit risk

management. While each bank’s method varies, this approach involves periodically
evaluating the credit quality of loans and other credit exposures, applying a credit risk
12
rating and aggregating the results of this analysis to identify a portfolio’s expected
losses. The foundation of the asset-by-asset approach is a sound loan review and
internal credit risk rating system. A loan review and credit risk rating system enable
management to identify changes in individual credits or portfolio trends in a timely
manner. Based on the results of its problem; loan identification, loan review, and
credit risk rating system management can make necessary modifications to portfolio
strategies or increase the supervision of credits in a timely manner.

In the expert system, the credit decision is left in the hands of the branch lending
officer. His expertise, judgment and weighting of certain factors are the most
important determinants in the decision to grant loans. The loan officer can examine as
many points as possible but must include the five “Cs”; character, credibility, capital,
collateral and cycle (economic conditions). In addition to the 5 Cs, an expert may also
take into consideration the interest rate.

Due to the time consuming nature and error- prone nature of the computerized
expertise system, many systems use induction to infer the human expert’s decision
process. The artificial neural networks have been proposed as solutions to the
problems of the expert system. This system simulates the human learning process. It
learns the nature of the relationship between inputs and outputs by repeatedly
sampling input/output information.

Credit Scoring Systems is where a credit score is used to represent the

creditworthiness of a person. A credit score is primarily based on credit report
information. Lenders, such as banks use credit scores to evaluate the potential risk
posed by giving loans to consumers and to mitigate losses due to bad debt. Using
credit scores, financial institutions determine who are the most qualified for a loan, at
what rate of interest, and to what credit limits. This lending technology uses a
summary statistic about the borrowers expected future loan performance (Feldman
1997, and Mester, 1997). In fact credit scoring assumes that credit analysis ultimately
determines that the personal credit history of small business owners is highly
predictive of the loan repayment prospects of the business (Berger, Frame and Miller,
2002). Rutherford (1994, 1995) observes that although credit scores have been used
for some time now in the U.S in underwriting consumers’ loans, this lending approach
has only been recently applied to small commercial credits which have been thought

13
to have non-standardized documentation and to be too heterogeneous. The method for
the use of credit scoring involves attaching heavy statistical weights to the financial
conditions and history of the principal owner given that the credit worthiness of the
owner and that of the firm are closely related for most small businesses (Feldman
1997, Mester 1997)

2.2.1.3 Pricing Theory

This theory subscribes to the fact that an estimate of the benefits of diversification
would require that practitioners calculate the covariance of returns between every pair
of assets. In the Capital Asset Pricing Model (CAPM), William Sharpe (1961, 1964)
and John Lintner (1965) solved this practical difficulty by demonstrating that one
could achieve the same result by calculating the covariance of every asset with respect
to a general market index. With the necessary calculating power reduced to
computing these far fewer terms (betas), optimal portfolio selection became
computationally feasible.

A more interesting alternative was the Arbitrage Pricing Theory (APT) of Ross
(1976). Stephen Ross’s APT approach moved away from the risk vs. return logic of
the CAPM, and exploited the notion of pricing by arbitrage to its fullest possible
extent. As Ross himself has noted, arbitrage-theoretic reasoning is not unique to his
particular theory but is in fact the underlying logic and methodology of virtually all of
finance theory. The following famous financial theorems illustrate Ross's point. The
famous theory of option pricing by Fisher Black and Myron Scholes (1973) and
Robert Merton (1973) relies heavily on the use of arbitrage reasoning. Intuitively, if
the returns from an option can be replicated by a portfolio of other assets, then the
value of the option must be equal to the value of that portfolio, or else there will be
arbitrage opportunities. Arbitrage logic was also used by M. Harrison and David M.
Kreps (1979) and Darrell J. Duffie and Chi-Fu Huang (1985) to value multi-period
(i.e. long-lived) securities. All this spills over into the Neo-Walrasian theories of
general equilibrium with asset markets (complete and incomplete) developed by Roy
Radner (1967, 1968, 1972), Hart (1975) and many others since.

The famous Modigliani-Miller theorem on the irrelevance of corporate financial

structure for the value of the firm also employs arbitrage logic. This famous theorem
Franco Modigliani and Merton H. Miller (1963) can be thought of as an extension of
14
the Separation Theorem originally developed by Irving Fisher (1930). Effectively,
Fisher had argued that with full and efficient capital markets, the production decision
of an entrepreneur-owned firm ought to be independent of the inter-temporal
consumption decision of the entrepreneur himself. This translates itself into saying
that the profit maximizing production plan of the firm will not be affected by the
borrowing/lending decisions of its owners, that is, the production plan is independent
of the financing decision. Modigliani-Miller extended this proposition via arbitrage
logic. Viewing firms as assets, if the underlying production plans of differently-
financed firms are the same, then the market value of the firms will be the same for, if
not, there is an arbitrage opportunity there for the taking. Consequently, arbitrage
enforces that the value of the firms to be identical, whatever the composition of the
firm's financial structure.

2.2.2. The Concept of Housing Finance

Housing finance involves the far larger sums spent by households and housing
organizations that are derived from income and from borrowing. A consideration of
what housing finance is tells us where the money comes from. It shows us that, whilst
some finance comes from government, we need also to consider other sources such as
earned income and private finance [ CITATION Pet05 \l 1033 ]

Finance connects people who need money and those who want to borrow money to
earn interest, which stimulates the economic vitality of individual economic entities.
Housing loans also play such a role. In general, it takes a large amount of money to
buy a house. The literature on finance reveals that there are only two broad types of
finance available: debt and equity finance. Financing of a project either by debt or
equity depends on the characteristics of assets being financed and transaction cost
reasoning suggests the use of debt to finance re-deployable assets and equity used to
finance non-re-deployable assets (Williamson, 2012). Furthermore, Hasnah (2012) in
the study of theory of firms argue that debts are utilized if the ability to exploit
potentially profitable investment opportunities is limited by the resources of the
owner.

However, equity finance gives its suppliers the right to the firm’s residual returns after
payments to the suppliers of debt finance, and in addition, the right to vote on
decisions concerning the firm’s operation in states when a firm is not bankrupt. When

15
the firm goes bankrupt, limited liability provisions mean that suppliers of equity
receive nothing. In such state, they even loose the right to make decisions about the
firm’s operations in such states. In situation of non-bankruptcy, suppliers of equity
finance have the right to the firm’s residual return; they do not have the right to
receive a fixed payment in every period which may be yearly or half-yearly (Fisher,
2003).

In the context of the developing world, debt finance can be obtained from formal
financial institutions like banks, micro-finance arrangements, indigenous
moneylenders, family members, employers and government. Financial instruments
vary widely according to the characteristic of term to maturity. Sight deposits at banks
have zero term to maturity, as they can be withdrawn on demand. Consequently,
equity has no redemption date and therefore possesses an infinite term to maturity
(Nubi, 2008).

2.2.3. Demand side of Housing finance

Home ownership remains the key priority of most Ethiopians. However due to limited
sources of mortgage financing, this priority has remained a dream for a significant
proportion of the population. The demand for housing in the country has risen
tremendously. Whilst many private developers have concentrated on the middle and
upper end of the housing market, very few private developers have concentrated on
affordable and economic housing for Ethiopians masses and the average Ethiopians
worker leading to a deficit in housing delivery. Housing is not easily accessible to
majority of Ethiopians partly due to financial constraints. The demand for loanable
funds is a representation of demand for an increased stock of debt, to finance present
aggregate demand for consumption, investment or government expenditure on goods
and services (Petersen and Rajan, 2011). The demand for loanable funds is
determined by the following factors:

Investment demand – Long term investment for capital projects like housing are
usually financed by borrowing. When the need arises, these are usually considered as
investment demand which results in demand for loanable funds. Again, when the
income of individuals is increased, they are prepared to consider increased borrowing
in that they can afford extra borrowings (Poole, 2003). On the demand side of
housing finance, the most important factor being considered by banks is the ability of

16
the borrower to repay the money borrowed. This can be secure, if the borrower is in
employment at the point of borrowing. Considering the macroeconomic situations in
the emerging economies and in particular Ethiopia, there is no way anybody can
predict how long a borrower would be in employment. In developed economies, total
sum borrowed is usually restricted to three to four times the applicant’s salary
(Warnock, 2008).

2.2.4 Conditions for Loan approval of housing finance

The loan approval process is the first step towards, holding of good portfolio quality.
When individual credits are underwriting with sound credit principles, the credit
quality of the portfolio is much more likely to be sound. The primary means to control
loan quality is strengthening the approval process. The process should be compatible
with the Bank’s credit culture, its risk profile, and the capability of its lenders, further,
the system for loan approvals needs to be establishing accountability.

An effective loan approval process establishes minimum requirement for the

information and analysis upon which accredit decision is based, it provides guidance
on the documents needed to approve new credit, renew credit, increase credit to
existing borrowing, and change terms of previously approved credit. (Caracelli, 2009)

Under the severe macroeconomic conditions in the 1990s, particularly after the
financial crisis in November 2007, the availability of bank loans is the focal point for
housing finance. Extending credit is the careful balance of limiting risk and
maximizing profitability while maintaining a competitive edge in a complex, global
marketplace. Banks go through a thorough process in approving credit to hit the
balance. Credit approval is the process of deciding whether or not to extend credit to a
particular customer. It involves two steps: gathering relevant information and
determining credit worthiness (Ross, 2003).

The quality of credit approval processes depends on two factors, i.e. a transparent and
comprehensive presentation of the risks when granting the loan on the one hand, and
an adequate assessment of these risks on the other. Furthermore, the level of
efficiency of the credit approval processes is an important rating element. Due to the
considerable differences in the nature of various borrowers and the assets to be
financed as well the large number of products and their complexity, there cannot be a

17
uniform process to assess credit risks. The quality of the credit approval process from
a risk perspective is determined by the best possible identification and evaluation of
the credit risk resulting from a possible exposure (Paul, 2013).

The credit risk can be distributed among the following risk components: Probability
of default (PD), Loss given default (LGD) and Exposure at default (EAD).
(Blackwell, Winters, 2003):

Default probability is the likelihood that the business will default on its repayment
over the term of the facility. Reviewing a borrower’s probability of default is basically
done by evaluating the borrower’s current and future ability to fulfill its interest and
principal repayment obligations.

Exposure at default is the magnitude or exposure that would be materialized in the

event of a default. It addresses what fraction of the exposure may be recovered
through bankruptcy proceedings or through some other form of settlement in the event
of a default. The loss given default is affected by the collateralized portion as well as
the cost of selling the collateral. Therefore, the calculated value and type of collateral
also have to be taken into account in designing the credit approval processes. In the
vast majority of the cases described here, the exposure at default corresponds to the
amount owed to the institution. Thus, besides the type of claim; the amount of the
claim is another important element in the credit approval process. (Blackwell,
Winters, 2003)

2.2.4.1 Loan assessment

The first stage in the loan granting process is the credit assessment. The stage at
which the necessary documentations are presented to the bank by the loan applicant in
order to obtain a credit facility is credit assessment (Njoroge, Kariuki & Ogollah,
2014).

2.2.4.2 Due diligence Assessment

This first steps of analysis of the borrower characteristics to go to the next step.
Through conducting in-depth analysis of the creditor the credit officer either accept or
reject the credit application based on the Bank criteria set. This is due to potential risk
involved in a potential investment, a due diligence assessment is essential to the pre-
funding commitment. The biggest investment a lender or creditor can make in a

18
business is taking the time to determine the key aspects of the business environment,
from the day-to-day operations practices, to human resource considerations, to the
necessary practices to maintain customers. A due diligence assessment provides the
answers to these questions, allowing creditors and lenders to decide if they are willing
to proceed given the existing factors. As such, it is a helpful tool in making a more
informed credit or investment decision (Martin, 2007).

Due diligence assessments also provide information which can be used when crafting
lending or investment instruments for the benefit of lending or investing entities.
Although the structure of each engagement is unique, projects typically focus on
answering the following questions:

Market positioning, including competition, capabilities, market dynamics by segment;

Execution capabilities, including strategy, management capabilities, cost structure,
customer service, quality, product innovation, Attainability of business plan and
projections; Cash flow forecast, quality of earnings and debt service capabilities and
Focus Management Group rapidly assesses a company to identify key issues and
drives; drawing conclusions regarding the advisability of the lender/investor to
proceed with the transaction under consideration (Martin 2007).

2.2.4.3 Credit appraisal study

This is the basic stage in the lending process. It is described as the 'heart' of a high
quality portfolio. This involves gathering, processing and analyzing of quality
information as way of discriminating the client's credit worthiness and reducing the
incentive problems between the lenders as principals and the borrowers as agents. The
Bank's credit policy, procedures and directives guide the credit assessment process.
Banks should base their credit analysis on the basic principles of lending which are
Character, Capacity, Capital, Collateral and Conditions (Matovu and Okumu, 2006).
It is designed to ensure lenders take actions which facilitate repayment or reduce
repayment likely problems. This information about the riskiness of the borrower
makes the financial institution to take remedial actions like asking for collateral,
shorter duration of payment, high interest rates and other form of payment (Stiglitz,
2006) when a financial institution does not do it well, its performance is highly
affected. And stressed the importance of credit analysis when he observed that its
abandonment often resulted into several Banks using credit card to process. The

19
variable in the researcher, according to Hunte (2006), included the length of time
taken to process applications, credit experience and proportion of collateral security to
the loan approved. It was found out that long waiting time reflected a shortage of
credible credit information required to make informed credit decisions. This in turn
leads to greater risk more intense credit rationing and low repayment rates.

The 'heart' of a high quality portfolio is credit appraisal. It involves determining the
loan applicant’s creditworthiness and reducing the default between the lenders as
principals and the borrowers as agents through the process of gathering, processing
and analyzing of quality information about the borrower. The credit assessment
process is usually guided by the Banks credit policy, procedures and directives.
Character, Capacity, Capital, Collateral and Conditions are the various principles of
lending which banks base their credit appraisal (Matovu and Okumu, 2006). The
principles are designed to ensure that actions that will facilitate repayment and reduce
default rate are taken by lending institutions. Financial institutions take measures like
requesting for collateral, shorter loan repayment period, high interest rates and other
form of payment when the information gathered signals the possibility of the
borrower to default payment (Stiglitz, 2006). The performances of financial
institutions are highly affected when they do not adequately appraise loans.

2.2.4.4 Credit Documentation

The credit assessment process covers the credit documentation and disbursement
process. The Process ensures that collateral securities and formal documentation is
completed before the credit facility is disbursed. It further ensures that all the
documentation is within the credit polity of the institution. Martin (2007), noted that
documentation process should take into accounts the maintenance of updated credit
files. He further stated that, lending institutions should impose relevant fees, update
records and notification of credit reviews and renewal dates.

Loan documentation process involves reviewing the documents submitted by the

borrower, checking the collateral security provided and a making a legal draft. It
clearly outlines the necessary security and covenant before the credit facility is
approved and disbursed. The legal aspect of the documentation process provides
financial institutions the grounds to take legal action against borrowers in the event of
default (Martin, 2007).

20
Credit documentation and disbursement is another aspect of credit assessment
process. It encompasses the conduct of key exposure control measures that ensures
securities and documentation is obtained before funds are disbursed, and that
modification on all credit facilities is approved within credit policy. It also includes
the maintenance of orderly updated credit files and the imposition of relevant fee’s,
updating of records and prompts notification of credit reviews and renewal dates.
Loan documentation involves the legal drafting, document review, collateral checks
and the waiver of terms. While the disbursement function involves checking the
validity of notes as well as ensuring that the documentation for the credit facilities are
properly executed. Loan documentation defines the necessary security and covenant
before the loan is made. It provides risk protection by providing grounds for the Bank
to take legal action when borrowers fail to honor their obligations. Credit
documentations clearly states the credit terms which are the conditions attached to the
loan after the borrower’s loan application has been favorably appraised (Martin,
2007). Credit documentations clearly states the credit terms attached to the loan after
the borrower's loan application has been favorably appraised.

2.2.5 Repayment Performance of housing finance

According to Muluken, (2014), banks safety and soundness lies in having an efficient
control loan recovery & credit function. Loan recovery performance (LRP) refers to
the process by which the debt from a loan or credit line is recouped in either part or
whole after being written off categorized as a bad debt. A written off or bad debt
forms a loss whilst recovered bad debt constitutes an income to the account.
Assessing the LRP encompasses the review of steps taken by the bank management in
identifying and controlling the risk in the entire loans process. The evaluation focuses
on the processes undertaken to determine challenges prior proceeding into challenges.

Recovery forms backbone of every lending institution and consequently the institution
success depends much on how the recovery process being controlled. Hence, any
credit institutions study, loan recovery need be based on characteristics of client’s
financially and on financial sector, economic & competitive circumstances in addition
the commonly utilized practices of lending within institution regulated by constitution
(Madura et al 2004as cited by Muluken, 2014). For long, great LR managers have

21
focused their effort on issuant carefully monitoring loan performance & approving
loans (Bornstein & David, 2007as cited by Muluken, 2014).

Efficiently loan recovery performance starts with overlooking of risk in loans of

individual. Issuant selection of risk is crucial in controlling commendable quality of
loan. An essential is controlling the quality of individual’s loans and the management
of the loans performance, which has been an historical emphasis. Better management
designs have been enhanced by the implementation of better technology and
rejoinders systems. Hence, early indications of increasing risks can be established by
the recovery management through having in place comprehensive review of the loan
portfolios (Koopahi, and Bakhshi, 2002).

According to various researchers, financial institutions loan recovery performances

can be influenced by a number of factors identified as borrower’s characteristics and
lender’s lending characteristics. The lending approaches of banks can be classified as
group-based approach and individual-based approach for housing finance. A common
characteristic of group lending approach is that the group obtains the loan under joint
liability, where each member in a group is responsible for repayment of loans of his or
her peers. Screening of the viable loan applicants, monitoring the individual
borrower’s efforts and enforcing recovery of their peers‟ loan among the members are
listed as the major characteristics of group-based lending approaches of housing
finance (Zeller, 1999 as cited in Abafita, 2003)

Group lending approaches creates better information on borrower’s efforts in settling

the loan obligations and have better monitoring advantages among the members than
that of individual borrowers. Members can get important information like reputation,
indebtedness and asset ownership of the loan applicants at a lower cost. They can also
easily monitor individual efforts made towards ensuring repayment. Moreover, group
members appeared to be in a better position to assess the reason for default and
inform to the lending institutes for the shocking experience exercised by the members
which seems beyond their control (Zeller, 1999 as cited in Abafita, 2003).

Individuals are supposed to select those whom they trust to form a group with; that is,
they are more interested to form group with those whom can make regular repayments
and have a good concern about the possible loss they face in case of non-repayments
(Abafita, 2003). In most of the cases, in group-lending approaches the functions of

22
screening, monitoring and enforcement of repayments are mainly endorsed to the
group members than the lending institutes (Abafita, 2003). Furthermore, in addition to
the above benefits from group-based lending approach, commitment of the borrower
to feel indebtedness to the obligation they entered into is an exemplified character of
borrowers for on-time loan recovery performances (Florence & Daniel, 2014).

On the other hand, individual based lending approach is the other approach that loan
contract obligation is endorsed only to the single individual borrower. According to
(Reikne 2006 as cited in Abafita, 2003), individual based lending approach may have
better recovery performance than that of the group lending approach. This is due to
the possible existence of fragmented geographical locations and high market share
competitions among the group members which in turn affects mutual indebtedness’s.

Besides, borrowers‟ characteristic that is the ability to repay the loan on- time can be
determined by: 1) the willingness of borrower to repay the loan, 2) capacity (how
much debt a borrower can handle) and 3) the cumulative capital (Assets) owned by
the borrower. Before delivering credit service, identifying and analyzing the
characteristics of the borrowers is an important issue to be considered by the credit
managers to judge whether the borrowers exerts the lowest efforts to honor the credit
obligations (Abrham 2002).

Recovery performance of borrowers can be affected due to various factors. An

economic theory suggests that a flexible repayment schedule set by the lending
institutes can benefits borrowers and potentially enhances their capacity of repaying
their debts. On the contrary, banks practitioners believed that high repayment
recovery rate can be realized through maintaining the regular repayment time
schedules (Abdulfettah 2009, Armendariz and Morduch, 2002 and Morduch, 1999 as
cited by Derege 2010).

According to Bayang (2009 cited in Derege 2010), lack of sufficient monitoring and
reporting to ensure whether funds are utilized for the intended purposes are another
possible factors that determines repayment coverage. Furthermore, the repayment rate
improved as borrowers get closer to the loan limit, which is the maximum available
loan. In other words, motivation for reaching the maximum loan level is positively
associated to the repayment performance.

23
Cowling, (2011) also considers the effect of housing finance-bank relationship on
loan approval. As pointed out in Petersen, and Rajan, (2011), it is anticipated that a
closer relationship between bank and borrower will result in an increased probability
of a loan request. But, this relationship was not confirmed by the data. The recent
research concerning the Japanese housing finance by Olotuah, and Aiyetan (2006)
pointed out that rejection of a loan request has become a common phenomenon for
both old and new customers or main bank and non-main bank customers alike Some
authors link the recovery performance with firm characteristics such as Olotuah, and
Aiyetan (2006) mention that firm’s profit significantly influenced loan recovery.
Besides that, Kashuliza (2011) raise the question of whether default is random,
influenced by erratic behavior, or systematically influenced by area characteristics
that determine local productions conditions or branch level efficiency. Olotuah, and
Aiyetan (2006) study on Grameen overdue loans supports the idea of partial influence
of area characteristics. Rural electrification, road width, primary educational
infrastructure and commercial bank density are positively correlated with a low
default rate as well as predicted manager’s pay. Kashuliza (2011) shows also that
access to other credit sources, market selling activities and urban location were linked
to a better recovery performance. Khan and Ahmed (2001) argued that some banks
factors that related to risk management structures put in place by banks were to blame
for loan defaults. These banks factors include tax procedures used in credit risk
assessment. Negligence in monitoring loan defaults, insider loans, lack of trained
personnel and unaggressive credit collection methods.

According to Chijoriga, (2007) awarding credit is a journey, the success of which

depends on the methodology applied to evaluate and award the credit. This journey
starts from the application for credit through acquisition of credit sales and ends at the
time the debt is fully paid. Numerous approaches have been developed for
incorporating risk into the decision making process by lending organizations. They
range from relatively simple methods such as the use of subjective or informal
approaches to the use of fairly complex methods like the computer simulation models
(Lino, 2009). Many lending decisions by the financial institutions are based on the
decision makers’ subjective feelings about the risk in relation to the expected
recoveries of the borrower.

24
Several studies (Pearson, and Greef. (2006) show that when a loan is not repaid, it
may be a result of the borrowers’ unwillingness and/or inability to recover. Stiglitz,
and Weiss, (2006) recommend that the banks should screen the borrowers and select
the “good” borrowers from the “bad” borrowers and monitor the borrowers to make
sure that they use the loans for the intended purpose. This is important to make sure
the borrowers can pay back their loans.

Green and Thakor (2015), suggest to look at a borrower’s past record and economic
prospects to determine whether the borrower is likely to recover or not. Besides
characters of the borrowers, collateral requirements, capacity or ability to recover and
condition of the market should be considered before giving loans to the borrower.

Matin (2007), analyzing the determinants of the recovery performance of Grameen

Bank borrowers, found that multiple NGO membership, which he associates to access
to other sources of ‘cheap’ finance had a negative impact on the recovery
performance. He also found that education and the area of the operated land, which
can be proxies’ for wealth of the borrower, had a positive impact on the recovery
performance. The membership period was positively associated with default while the
loan size did not have a significant impact on the recovery performance.

2.3 Review of empirical studies

2.2.1. Approval and Recovery performance of housing finance

There are various research works have been conducted on credit approval and
repayment in world. Among these research, Reza and Mansoori (2009), conducted
their study on Factors Affecting loan Repayment Performance of Farmers in
Khorasan-Razavi Province of Iran. They investigated the factors influencing on
repayment behavior of borrower farmers that received loan from agricultural bank by
using a logit model and a cross sectional data of 175 farmers of Khorasan-Razavi
province in 2008. Their result showed that loan interest rate is the most important
factor affecting on repayment of agricultural loans. Experiences in farming and total
cost of application are the next factors, respectively. In their research titled as: “
Factors Influencing Agricultural Credits Repayment Performance among Farmers in
East Azarbaijan Province of Iran”, Pishbahar, Ghahremanzadeh, Ainollahi, and
Ferdowsi (2015) carried out a study used sample of 779 individual farmers who had

25
previously received loans from Agricultural Bank during the period 2004-2008 and
investigated that an activity besides farming, extension of the repayment period of the
loan, and large volume of received loans are the factors that had statistically
significant negative impacts on loan repayment. On the other hand, factors such as:
high interest rates of loans, having collateral of guarantor, services received from the
banks, and long term maturity period for the loans increase the probability of timely
loan repayment significantly.

Rifas, Nimsith & Shibly (2016), conducted their study on the title of factors
influencing to recover the bank loans in the Islamic financial institution: special
reference to Amana Bank PLC. In their study the four factor, credit policy,
installment, climate and political factors were tested. The findings of their study
indicated that all the four factors positively impact on loan recovery. There is
significant relationship between credit policy, installment, climate and political
factors on loan recovery, all factors are contributing to recovery the bank loan in
Islamic financial institutions.

Using survey instrument with a sample size of 422 respondents and total of fifteen
explanatory variable aimed at identifying the major socio-economic factors and loan
related factors that determine loan repayment performance of borrowers in OCSSCO,
Belete (2015) investigate that, sex, age, group size, business experience, timelines of
loan release, suitability of loan repayment period were found an important factor that
influence loan repayment performance of the borrowers. However, as per his finding
educational level, training, loan size, frequency of collection and loan diversion were
found to be statistically insignificant.

The study by Fikadu (2019) indicated that, age of the borrowers, level of education,
income from activities financed by the loan, suitability of, family size, loan diversion
rate, residential area, loan size and grace period were significantly affect loan
repayment performance.

A study titled as “The trend of Loan Recovery Performance in Banking Industry” and
carried out by Feysa (2009), indicated that there are many factors which hamper loan
recovery performance of the Awash International Bank s.co. For example: poor loan
assessment procedures; lack of effective use of man power; lack of revision

26
appropriate revision of credit manual and lack of willingness of borrowers to disclose
their information fully.

On the other hand there are few studies have been conducted on credit approval.
Among these, research conducted in India by Saroha and Yadav (2016) titled as,
“An Analytical Study of Housing Finance in India with special reference to HDFC
and LIC Housing Finance Ltd”, found that increased rivalry among banks and
housing finance companies increases regulator fears well lead to a dilution in
underwriting and appraisal standards. Due to a greater competition between lenders to
stepping up volume to maintain profit arise from waiver of pre-payment penalty
charges, housing finance industry could be saddled with an increasing number of bad
loans. Biniam Tilahun (2018), carried out his study on factors affecting lending
decision of commercial banks in Ethiopia and founds that commercial banks various
types of lending models in evaluating credit applications and mostly they consider on
collateral, capital, capacity, liquidity, profitably, debt ratio and credit track records.

A study by Yinebeb Girma (2015) founds that all banks in Ethiopia are highly
engaged in the provision of loans for working capital requirements and trade
facilitation services, housing project finance is given minimal attention, insufficient
amount of fund set aside for it, CBE give priorities in the provision of long-term
finance for public projects leaving housing projects insufficiently attended, and
private banks complain about the directive of the National Bank of Ethiopia requiring
them to purchase government bond for 27% of any outstanding loan they issue.

According to Muluken, (2014), banks safety and soundness lies in having an efficient
control loan recovery & credit function. Loan recovery performance (LRP) refers to
the process by which the debt from a loan or credit line is recouped in either part or
whole after being written off categorized as a bad debt. A written off or bad debt
forms a loss whilst recovered bad debt constitutes an income to the account.
Assessing the LRP encompasses the review of steps taken by the bank management in
identifying and controlling the risk in the entire loans process. The evaluation focuses
on the processes undertaken to determine challenges prior proceeding into challenges.

Recovery forms backbone of every lending institution and consequently the institution
success depends much on how the recovery process being controlled. Hence, any
credit institutions study, loan recovery need be based on characteristics of client’s

27
financially and on financial sector, economic & competitive circumstances in addition
the commonly utilized practices of lending within institution regulated by constitution
(Madura et al 2004as cited by Muluken, 2014). For long, great LR managers have
focused their effort on issuant carefully monitoring loan performance & approving
loans (Bornstein & David, 2007as cited by Muluken, 2014).

According to various researchers, financial institutions loan recovery performances

can be influenced by a number of factors identified as borrower’s characteristics and
lender’s lending characteristics. The lending approaches of banks can be classified as
group-based approach and individual-based approach for housing finance. A common
characteristic of group lending approach is that the group obtains the loan under joint
liability, where each member in a group is responsible for repayment of loans of his or
her peers. Screening of the viable loan applicants, monitoring the individual
borrower’s efforts and enforcing recovery of their peers‟ loan among the members are
listed as the major characteristics of group-based lending approaches of housing
finance (Zeller, 1999 as cited in Abafita, 2003)

Group lending approaches creates better information on borrower’s efforts in settling

the loan obligations and have better monitoring advantages among the members than
that of individual borrowers. Members can get important information like reputation,
indebtedness and asset ownership of the loan applicants at a lower cost. They can also
easily monitor individual efforts made towards ensuring repayment. Moreover, group
members appeared to be in a better position to assess the reason for default and
inform to the lending institutes for the shocking experience exercised by the members
which seems beyond their control (Zeller, 1999 as cited in Abafita, 2003).

Individuals are supposed to select those whom they trust to form a group with; that is,
they are more interested to form group with those whom can make regular repayments
and have a good concern about the possible loss they face in case of non-repayments
(Abafita, 2003). In most of the cases, in group-lending approaches the functions of
screening, monitoring and enforcement of repayments are mainly endorsed to the
group members than the lending institutes (Abafita, 2003).

On the other hand, individual based lending approach is the other approach that loan
contract obligation is endorsed only to the single individual borrower. According to
(Reikne, 2006 as cited in Abafita, 2003), individual based lending approach may have

28
better recovery performance than that of the group lending approach. This is due to
the possible existence of fragmented geographical locations and high market share
competitions among the group members which in turn affects mutual indebtedness’s.

Matin (2007), analyzing the determinants of the recovery performance of Grameen

Bank borrowers, found that multiple NGO membership, which he associates to access
to other sources of ‘cheap’ finance had a negative impact on the recovery
performance. He also found that education and the area of the operated land, which
can be proxies’ for wealth of the borrower, had a positive impact on the recovery
performance. The membership period was positively associated with default while the
loan size did not have a significant impact on the recovery performance.

Knowledge Gap
A review of past studies on the credit approval and repayment performance indicate
interesting findings. For instance, Reza and Mansoori 2009 investigate that, interest
rate, farming experience and application cost are the factors affecting agricultural
loan. With this regard a study carried out by Pishbahar, Ghahremanzadeh, Ainollahi,
and Ferdowsi (2015), examined that, besides farming, repayment period and volumes
of the loan are the factor that significantly impact on loan repayment.

However, studies were conducted on agricultural loans and the economic

performance, political, social and cultural factors are various from country to country.
As a result, the identified determinant factors might not use for Ethiopia.
Additionally, most of the other undertaken studies were conducted at micro finance
institution and Small scale business. This in turn, that the types of the loans were short
term and working capital loan. While commercial banks in nature has financed short,
medium and long term project (housing finance) and have higher risk than short term
finance. Through various researches have been conducted on loan repayment
performance at different places and time period but the results of the findings by
various researchers are different and therefore inconclusive and not present with an
assessment of credit approval. As per researcher knowledge, no study is conducted to
examine the determinant of approval and repayment performance of housing finance
at the same time. Thus, by taking in to consideration this research gaps, the
researcher attempts to investigate the determinants of approval and repayment

29
performance of housing finance and tries to fill the gap by focusing on analyzing the
determinants of approval and recovery performance of housing finance.

2.3. Variables of the study

2.3.1. Dependent variable

Approval and recovery performance of housing finance is the dependent variables of
the study.

2.3.2. Independent variables

Determinants of loan approval and Loan Recovery Performance of housing finance
are described below.

AGE

Age is another criterion that banks look at before giving a loan. To give you an idea,
people in the age group of 30-50 years are most preferred as they are considered more
financially stable. They also have a decent number of working years left to repay their
loans. On the other hand, people above 60 fare the worst in the internal scoring model
of banks. Some researchers have taken the ages of the borrowers as a variable that can
influence the approval and repayment performance of borrowers. In lending
approaches, Abafita, 2003 have revealed that the more youngsters the age of the
borrowers the less acceptance of loan they request and the less recovery rates
achieved by the lending institutes; that means the more the aged group borrowers can
take the responsibility of being liable and creditworthy than that of the youngsters.
Similarly, the more the older and aged the borrowers are the more likely they are
accepted and creditworthy borrowers that have better repayment performances while
the young borrowers are more likely to be unaccepted and defaulter borrowers

30
(Fikirte, 2011). Both authors have been conducted the research on the lending
approaches whereas this study might answer for some other borrowers too.

Gender

This research considers the gender characteristics of the borrowing groups as an

explaining factor to evaluate how the gender is probably determining the approval and
repayment status of the borrowers. As (Teferi 2000 and Berhanu, 1999 cited by
Abafita, 2003), it was argued that female borrowers are more creditworthy than that
of male borrowers. The assumption was females took great obligations and sense of
responsibilities while managing their households. This study also intends to see the
magnitude of these gender characteristics in the cases of borrowers.

Family Size

If the group member has large household size, a considerable amount of income from
the project could be diverted away from loan repayment, which is the sign of group
ineffectiveness and had no profitability to household consumption (Kashuliza, 2011)

Occupation

There are some occupations that banks prefer. For example, in many government
banks, government and PSU employees are most preferred as they have a stable job.
After government employees, banks prefer people working with blue-chip companies
and doctors. Further down the line come chartered accountants, engineers and
lawyers. People working in private companies and self-employed get the lowest
scores. Occupation is one of the important factors taken into consideration while
appraising a home loan. It is important because repayment capacity depends on the
income of the person. For example, in case of a person working in a certain company
which has a poor history of paying salaries/dues to its employees, the loan application
is weakened. Similarly, a borrower switching jobs frequently gives a negative
impression. Also, every application is treated equally irrespective of whether it is of a
government or a private sector employee because each one has its merits and demerits
(Campbell, 2008).

Household Income

31
The amount of money someone is paid in, calculated from gross income from
employment, net income from self-employment, and income from other sources
(Abafita, 2003)

Income from other sources

Borrowers with some diversified income sources can make recovery performances
more successful. Income from other sources can be listed as follows but not limited to
Salary/Wages, equipment rental services (such as house rent, and others). An increase
in other source of income earned by borrowers might have the possibility that loan
could probably approved to and repaid by respective borrowers on time (Abafita,
2003)

Marital status

Marital status is the legally defined marital state and the distinct options that describe
a person’s relationship with significant other. Married, single, divorced, and widowed
are examples of such status and sometimes may be a source of discrimination.
Therefore, it is expected to have positive relationship with approval and recovery
performance of housing finance (Abafita, 2003)

Spouse's income source

Home loan eligibility goes up in case of joint home loans as the repayment capacity
goes up (depending on the income of co-applicant). However, if your spouse is
working, both yours as well as your spouse's income will be considered to determine
your repayment capacity. Moreover, you can avail of home loan at five basis points
below the normal home rate if the loan is in your wife's name (Kashuliza, 2011)

Credit history

Banks always prefer people with clean financial habits. A credit score tells a lot about
your financial health. Whether you pay your EMIs on time or default can be easily
checked through your credit report, which is maintained by different bureaus. If you
have a good credit score from a credit bureau, you could get your loan faster and with
fewer checks by the lender. So it is expected to have positive relationship with
approval of housing finance.

32
Saving culture

Saving the portion of income not spent on current expenditures. Borrowers usually
save from their proceeds for consumption smoothing purposes throughout the year,
accumulation of wealth, and for contingency purposes in case of bad accident. In this
study saving habit is expected to have a positive relationship with loan repayment.
Therefore, if the group borrowers developed saving habit practice, may help them to
use the borrowed money properly than non-developed saving habit borrowers, and
more the amount of savings, the greater the capacity to repay as opposed to low
amount of savings (Abafita, 2003)

Collateral

Collateral refers to security or guarantee for the loan borrowed. Collateral acts as an
indication enabling the bank to attenuate or eliminate the adverse selection problem
caused by the existence of information asymmetries between the bank and the
borrower at the time of the loan decision. Although bank knows the credit quality of
the customers, the collateral helps to alleviate moral hazard problems once the loan
has been granted (Aghion, 2004).

Consequently, problem of moral hazard faced by the bank in lending could be

restrained by having collateral. As stated by Bolton (2010), collateral can be seen as
an instrument ensuring good behavior on the part of borrowers, given the existence of
a credible threat. Hasnah (2012), has found that character plays a significant role on
the probability of loans approved by credit officers.

Employment status
Employment status is the status of a worker in a company on the basis of the contract
of work or duration of work done. A worker may be full time employee, par-time
employee, or an employee on a casual basis. It is the status of an economically active
person with respect to his or her employment, that is to say, the type of explicit or
implicit contract of employment with other persons or organizations that the person
has in his/her job. So it is expected to have negative relationship with approval and
recovery performance of housing finance (Asqual, 2010)

Interest rate

33
An interest rate is the rate at which interest is paid by borrowers for the use of money
that they borrow from the lending institution. Rose (2011) defined interest rate as the
price of the loanable funds. Interest rates can be looked at from two perspectives, that
of the borrower and the lender. Interest rate is the costs of borrowing money
expressed as a percentage of the amount borrowed. The borrower assesses the returns
of the proposed project and considers the interest rate of the credit facility before
deciding to take the facility. Lenders on the other hand consider costs such as
production cost, the inflation rate, personnel, administrative costs, provision for loan
loss and capital growth before determining the interest to be charged on a particular
facility at a particular time. Financial institutions should charge rates that can cover
costs and make a contribution for the institution. Rate of interest is generally taken as
the price of credit; the amount of interest paid or earned depends on a number of other
factors: the amount lent or borrowed, the length of time involved, the stated (or
nominal) annual rate of interest, the interest payment schedule, and the method used
to calculate interest (Zeller and Sharm, 2008)
Repayment period

The shorter the repayment period, the more your bank likes you. For example, several
banks give maximum score to people who opt for a repayment period of up to five
years. It falls to half if the repayment period is between 10 and 15 years. And it is at
the lowest end for those opt for a payment period of 15-20 years. So, the next time, try
to shorten your loan period if approval becomes difficult (Abafita, 2003)

Loan size

Loan size refers to the amount of money disbursed to the borrower. The loan amount
can be small, medium or big. Banks prefer bigger loans to smaller ones because the
transaction costs of bigger loans are lower than small and medium loans but have
higher returns. Efficient loan size should fit the capability of the borrower to repay
and stimulate enterprise performance. Poor loan sizing is illustrated by extensive
credit rationing, which issues too little credit to too many borrowers (Pische, 1991).
However, Chirwa (1997), points to the fact that borrowers are tempted to divert
portions of loans when the amount is relatively large for the project. He explained that
most of such loans are diverted for non-business purposes, hence the default. This
refers to the loan size that the commercial banks approved to the borrowers’ business

34
appraisals. As it was revealed by some researchers, this factor can negatively or
positively influence the repayment performance of borrowers. The assumption is that
the more the sufficient loan amount disbursed to the requesters the more they can
finance the proposed purpose and the more they can succeed the profitably. On the
other hand, the less approved loan size below the proposed purpose to the borrower,
the higher the possible difficulties they can face while achieving their objective due to
insufficiency of funds available by the commercial banks.

Inflation
Inflation is the scourge of the modern economy. It is one of the primary persistent
threats that will undermine or even destroy decades of economic growth if unleashed
and not curbed. It is feared by central bankers globally and forces the execution of
monetary policies that are inherently unpopular. It makes some people unfairly rich
and impoverishes others. It is the inflation rate is the percentage increase in prices
over a period of time (Zeller and Sharm, 2008)

2.4. Conceptual framework of the study

According to (Cresswell, 2003) indicates that a conceptual framework is a diagram
that elucidates the main concepts being studied and the relationship among the
variables. The conceptual framework provides a visual presentation on what the study
is all about and the expected outcome of the study based on theory and previous
studies that are similar to the study in question. The conceptual framework that will
be applied in this study is presented in Figure 2.1. The conceptual framework
indicates that the independent variables that are expected to have an effect on the
dependent variable.

35
Figure 2.1 the conceptual framework.

Independent variables Dependent variable

Demographic factors:

 Age
 Gender
 Educational level
 Occupation
 marital status
 Family size

Institutional factors:

 credit History
 Relationship with bank
 Loan diversion
 Loan utilization
Loan Approval and
 Interest Rate recovery performance of
 Collateral housing finance
 Property right
 Loan Size
 Home loan Repayment period
 Loan supervision
 Change of inflation
 Timeliness

Socio-economic factors:

 Income per month

 Employment status
 Saving culture
 Spouse income source
 Other source of income

36
(Source: researcher’s own based on his reading)

37
 CHAPTER THREE

3. RESEARCH DESIGN AND METHDOLOGY

3.1. Research design

This study assesses social problems in terms of approval and recovery performance of
housing finance. To this end, the research has planned to look at the problem from the
approval and repayment of loan to solve the related problems in the housing sector.
The design to be utilized for this purpose was phenomenological design, because
through this design, it is possible to identify problems and give them meanings
depending on the existing situation. Thus, the major problem of approval and
recovery performance of housing finance was identified through this design and their
impact was discussed in details.

This research design was descriptive- because it was necessary to have clear picture
of the phenomenon on which the researcher wishes to collect data prior to the
collection of the data (Robson, 2002). Thus, the existing current problems were
described in details to attain the objective of the research. And explanatory because it
can identify the relationship between two or more variables. (Admas and Schvanevel,
2001). And its great advantage was that it was flexible and adaptable to change. The
relationship between inter dependents and the relationship between dependent and
independent variables was clearly discussed to address the objective of the research.

The design was used to describe a tool to organize data into patterns that emerge
during analysis. Types of descriptive designs used for this study were surveys studies.
It was considered as a research design and method of inquiry that dictates the
direction for the collection and data analysis whereby the collection and data analysis
had a qualitative research processes (Creswell and Plano Clark, 2007). The researcher
was used the qualitative methods of research to materialize as the objectives of the
study looking at the problem from different angles. This research design was
preferred because it allowed unlimited collection of data and enhanced a
comprehensive and in-depth scrutiny.

3.2. Sampling design

The sampling design employed was purposive sampling method. Thus, Addis Ababa
City is purposively selected because this capital city is expanding rapidly resulting
huge housing needs and housing finance.

3.2. Data sources

The housing finance is a complex business which can be studied in a number of
different ways. In this study the researcher will use both primary and secondary data.
As a result, the data will be collected from primary and secondary sources of data
respectively. Data collection was done via semi- structured questionnaires.

3.3. Data collection instruments

To gather data for this study, the researcher will use questioner. For conducting this
study, the researchers will use different methods of data collection. The primary data
for this study will be collected through questionnaire and interview most information
will be collected through questionnaire because, it is cost effective and it gives
enough time to respondents. The questionnaire will contain both open ended and close
ended questions and the interview will be both structured and unstructured interview.
The secondary data will be collected through verifying the available documents and
manuals of the bank.

3.4. Data analysis

After administering and scoring research tools and scripts, data will be collected and
organized. The collected data are known as raw data. The raw data are meaningless
unless certain statistical treatment is given to them. In this study the collected data
will be analyzed using descriptive statistics analysis and econometric regression
model. The descriptive analysis will used to summarize the data that will be collected
from the respondents

39
40
 Work plan
Activities Period of time
1st 2nd 3rd 4th 5th 6th 7th 8th 9th
month mont month mont mont month mont mont month
h h h h h
1. Title selection 
2. Reviewing related  
literature
3. Preparation of the 1st 
proposal draft

4. Re-writing the 
proposal if any
comment
5. Submission of the 
final proposal
6. Indepth literature 
review
7. Data collection 
8. Data analysis 
9. Report writing 
10. Submission of the 1st 
draft thesis
11. Submission of final 
thesis

Cost Budget
Items Quantity Unit price Total cost
pc 1 15,000 birr 15,000 birr
Pen 5 10 birr 50 birr
Taxi 500 birr
Coffe and tea 500 birr
Binder 1 110 birr
miscellaneous 5% 808 birr
16,968 birr

42
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