ASSESSMENT OF CREDIT RISK MANAGEMENT PRACTICES:

THE CASE OF UNITED BANK SOUTHWEST DISTRICT

A Thesis Proposal Submitted to the School of Graduate Studies of Jimma

University in partial fulfillment of the requirements for the Award of the Degree of
Master of Business Administration

BY:

GEREMEW TESFAYE URGA

JIMMA UNIVERSITY COLLEGE OF BUSINESS AND

ECONOMICS, DEPARTMENT OF MANAGEMENT

SEPTEMBER 2022

JIMMA, ETHIOPIA

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 Assessment of Credit Risk Management Practices: The Case of
United Bank Southwest District

BY:

GEREMEW TESFAYE URGA

Under the Guidance of

Aregu Asmare (Assit. Prof.)
And
Mohammed Yasin (MSc)

A Thesis Proposal Submitted to the School of Graduate Studies of Jimma

University in partial fulfillment of the requirements for the Award of the Degree of
Master of Business Administration

JIMMA UNIVERSITY

SEPTEMBER, 2022

JIMMA, ETHIOPIA
II
PROPOSAL APPROVAL SHEET

Submitted By:

________________ ________________ _____________

Name of Student Signature Date

Approved by:

1. ________________ _________________ _____________

Name of Major Advisor Signature Date

2. ________________ _______________ ______________

Name of Co-Advisor Signature Date

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 Table of Contents
Proposal Approval Sheet……………………………………………………………….. iii
Table of Contents ………………………………………………………………………. iv
List of Figure …………………………………………………………………………... vi
ACRONYMS/ABBREVIATIONS…………………………………………………….. vii
ABSTRACT……………………………………………………………………………. 1
CHAPTER ONE………………………………………………………………………. 2
1. INTRODUCTION ………………………………………………………………... 2
1.1 Background of the Study ………………………………………………………… 2
1.2 Statement of the Problem………………………………………………………… 4
1.3 Research Questions………………………………………………………………. 6
1.4 Objectives………………………………………………………………………… 7
1.4.1 General Objective………………………………………………………….. 7
1.4.2 Specific Objectives…………………………………………………………. 7
1.5 Significance of the Study…………………………………………………………… 7
1.6 Scope of the Study………………………………………………………………….. 8
1.7 Limitation of the Study……………………………………………………………... 8
1.8 Organization of the Paper…………………………………………………………... 9
CHAPTER TWO……………………………………………………………………… 10
2. REVIEW OF RELATED LITERATURE……………………………………… 10
2.1 Theoretical Review…………………………………………………………… 10
2.1.1 Definitions and Concepts of Credit Risk Management................................ 10
2.1.2 Credit Risk Management Process…………………………………………. 10
2.2 Review of Empirical Studies…………………………………………………. 13
2.3 Knowledge Gaps……………………………………………………………… 18
2.4 Conceptual Framework of the Study…………………………………………. 19
CHAPTER THREE…………………………………………………………………… 23
3. RESEARCH DESIGN AND METHODOLOGY………………………………… 23
3.1 Research Design……………………………………………………………….. 23
3.2 Type and Source of Data……………………………………………………… 23
3.3 Target Population……………………………………………………………… 24
3.4 Sampling Design and Sampling Technique…………………………………… 24
3.4.1 Sample Size Determination……………………………………………….. 24
3.4.2 Sampling Technique……………….............................................................. 24
3.5 Method of Data Collection……………………………………………………. 25
3.6 Methods of Data Analysis……………………………………………………... 25
3.7 Reliability and Validity of Data ………………………………………………. 25
3.8 Ethical Consideration………………………………………………………….. 26
WORK PLAN…………………………………………………………………………. 27
BUDGET PLAN………………………………………………………………………. 28

IV
REFERENCES……………………………………………………………………….. 29
APPENDIX……………………………………………………………………………. 33

V
 List of Figure

Figure 1 Conceptual Framework for the Study……………………………………. ……………19

VI
 ACRONYMS/ABBREVIATIONS

CRM Credit Risk Management

NBE National Bank of Ethiopia

NPLS Non-Performing Loans

SPSS Statistical Package for Social Scientist

VII
 ABSTRACT

Credit risk refers to the probability of loss due to a borrower’s failure to make payments
on any type of debt. Credit risk management, meanwhile, is the practice of mitigating
those losses by understanding the adequacy of both a bank’s capital and loan loss
reserves at any given time. The main objective of this study was to assess credit risk
management system and practices in selected branches of United bank of Southwest
district. Selection of branches for the study is done based on mainly amount of deposits,
foreign exchange and loan performance made by the banks. Five branches out of thirty-
three were selected based on their performances as of the financial year 2021/2022. In
this study, purposive sampling technique will be used in order to select participants of the
study. For the purpose of this study, both primary and secondary data will be used.
Primary data will be collected through questionnaires distributed to respondents that
involved professional working in the banks such as managers and officers working on
loan processing. The data will be analyzed using descriptive statistics by using SPSS
software version 21. Findings of this study would assist in forwarding recommendations
to improve the problems of credit risk management situation prevailing in the banking
sector in Ethiopia.

Keywords:

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 CHAPTER ONE
1. INTRODUCTION

Chapter one provides the general overview of the study. In this chapter back ground of
the study, statement of the problem, objectives of the study, research questions,
significance of the study, scope of the study, limitation of the study and organization of
the paper are included.

1.1 Background of the Study

Economic growth in any country is not possible without a sound financial sector
(Rajaraman and Visishtha, 2017). Good performance of these financial institutions is the
symbol of prosperity and economic growth in any country or region and poor
performance of these institutions not only hamper the economic growth and structure of
the particular region but also affects the whole world (Khan and Senhadji, 2001).
Commercial banks in most of the world economies are dominant type of financial
institution that provide installment, facilitates internal and external trades and the
movement of money and capital when compared to any other financial institution (Salas
and Saurina, 2018)

Banks play a very important role in manufacturing industries and for the overall
economic development of every nation. They have control over a large part of the supply
of money circulation and stimulus for the economic progress of a country. The financial
sectors contribution to growth lies in the central role, they play in mobilizing savings and
allocating the resources efficiently to the most productive uses and investments in the real
sector (Joseph et al., 2017). The traditional role of a bank is lending and loans make up
the bulk of their assets (Njanike, 2019). According to Havrilesky and Boorman (2020),
interest on loans contributes significantly to interest income of commercial banks.
Saunders and Cornett (2021) pointed out that traditionally 85 percent of commercial
banks’ income is contributed by interest on loans, and hence loans represent the majority

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of a bank’s asserts. However, lending is not an easy task for banks because it creates a
big problem which is called non-performing loans (Chhimpa, 2012). Due to the nature of
their business, private commercial banks also expose themselves to the risks of default
from borrowers. Credit management frameworks therefore become imperative tools in
decision- making that relates to loan-pricing, delegating lending powers, mitigating or
migrating as well as managing incidences of credit risk on bank portfolio.

The key principles in credit risk management are establishment of a clear structure,
allocation of responsibility and accountability, processes have to be prioritized and
disciplined, responsibilities should be clearly communicated and accountability assigned
thereto. Organizing and managing the lending function in a highly professional manner
and doing so pro-actively can minimize whatever the degree of risk assumed losses.
Banks can tap increasingly sophisticated measuring techniques in approaching risk
management issues with the advancements of technology (Yang, 2020).

According to Poudel (2012) poor risk management lead to the accumulation of

nonperforming loans (NPLs) under which the generated profit were not only eroded
through loan provision but also soundness, safety and stability of bank while effective
credit risk management improve credit performance through establishing appropriate
credit risk environment, maintaining credit limit at acceptable level, undertaking sound
credit granting process, proper monitoring and controlling credit risk. Nevertheless,
Ethiopian private commercial banks including United bank are suffering from serious
financial fragility manifested by high proportion of NPLs (Mehari, 2018). Recently, the
NPLs of Ethiopian private commercial banks have shown a substantial improvement and
lowered to an average of 5 % (National Bank of Ethiopia, 2019). However, NPLs are still
high as compared to the other developing countries such as Namibia, Mozambique and
Uganda (Fofack, 2018). Hence, Ethiopian private commercial banks are still expected to
reduce their NPLs as low as possible in order to achieve their optimal profit and
ultimately improve the soundness of the financial system

In light of the above points, limited empirical studies have been done on this problem and
at large and there is a limited work in United bank non-performing loan in particular.

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Therefore it is important to examine level of credit risk management system and practice
of United bank to initiate top level management and regulatory bodies to take policy
measure toward maintaining adverse effect of their credit function. The purpose of this
research is to investigate the level of credit risk management systems and practices of
United Bank, Southwest district and identify the types of risks and risk identification
method through descriptive research approach. This will provide the United Bank
managements and executives with applied knowledge on the management of identified
variables that will create a better understanding of credit risk management and loan
quality improvement in the banks.

1.2 Statement of the Problem

Ethiopian private commercial banks provide credit for establishment and expansion of
manufacturing production, agricultural, industrial and other services with the objective of
economic development in the country. In line with the above point, the loan extended to
various sectors of the economy must be recovered in full, if the objective of circulating
more and more financial resources to meet the increase demands for credit and to keep
the bank in sound financial health (Boudriga, 2019). Loan portfolio constitutes the largest
operating assets and source of revenue of most commercial banks. However, some of the
loans given out become non-performing and adversely affect the profitability and overall
financial performance of the lending institutions. This situation will paralyze the
investment program as well as the economy as a whole.

At the same time non-performing loans or uncollectable loans or bad loans are reducing
the profitability of the United bank (United bank annual report, 2019). This NPL are
highly ties huge amount of capital that can be used for productive purpose by giving
loans and advance to various economic sectors and profitable business and investments in
different sectors. At present from the total loans and advance disbursed amount
111,435,273,000.00 birr which is Birr 1,987,873,000.00 or 1.78% is under the category
of NPL in United bank as of June 2018. Even-if the NPL ratio is below the required level
of NBE it is increasing in the past five consecutive years from 293,370,000.00 birr in
year 2016 to 1,987,873,000.00 birr in year 2020 (United bank annual report, 2019). The

4
accumulation of nonperforming loans caused by lack of proper credit risk management
would have substantial adverse impact on the performance of the bank in particular and
on the overall economy in general. In turn this affects the government by reducing its tax
income and banks by imposing dawn ward pressure on their respective profits and per
share value of their stock price.

Apart from the above, significant amounts of non-performing loans emanating from lack
or poor credit risk management system could hinder development and expansion of the
Banks. It also leads clients to have lack of confidence and the Banks to lose their loyal
and prominent customers. Moreover, investors may not be willing to invest their funds on
the banks stock at the desirable price or may avoid completely purchasing the stock. This
in turn affects the capital structure of the Bank. Therefore, unless the problems are
managed properly, it would definitely result in financial crises as in case of United bank
of Ethiopia.

As stated by Rekha (2015), “Better and effective strategic credit risk management
process is a better way to manage portfolio credit risk.” The process provides a
framework to ensure consistency between strategy and implementation that reduces
potential volatility in earnings and maximize shareholders wealth. Beyond and over
riding the specifics of risk modeling issues, the challenge is moving towards improved
credit risk management lies in addressing banks’ willingness and openness to accept
change to a more transparent system, to rapidly changing markets, to more effective and
efficient ways of operating and to meet market requirements and increased answerability
to stake holders. The rational to analyze the efficiency of CRM frameworks is
particularly acute in a developing nation like Ethiopia accordingly; there is a need to
assess Credit Risk Management (CRM) practice in United bank, particularly in view of
NPLs level

In Ethiopia, to the knowledge of the researcher, few researches were conducted in this
area of credit risk management practices. Tesfaye (2014) investigated factors influencing
credit risk in the Ethiopian commercial banks. Yalemzewd (2013) assessed credit
management practice of Bunna International Bank S.C and analyzed the process of

5
accessing credit, credit control process and credit collection strategy against non-
performing loan of the bank. Tibebu (2021) in his paper examine the impact level of
credit risk management towards the profitability of selected commercial banks in
Ethiopia. He argues that credit risk management has significant impact on profitability of
banks of our country. Hagos (2016) in his study of credit management of Wegagen Bank
Share Company in Tigray region attempted to indicate the importance of credit
management in financial institutions such as commercial banks, micro finances and
others. Solomon (2018) assesses credit risk management practice of Nib International
Bank S.C and found out that risk which emanates from credit is due to high degree of
credit concentration in few sector and borrowers, the use of collateral as number one
technique to alleviate credit risk and absence of proper evaluation model.

As mentioned above, few studies have so far been conducted on credit risk management
system in commercial banks in Ethiopia. However, the previous studies made on this
issue in Ethiopian context were focused to part of credit management aspect such as
performance, profitability, credit exposures instead of assessing the credit risk
management. This existing situation along with the knowledge gap in the literatures calls
for further research to assess credit risk management policies and practices in commercial
bank. Thus, this study attempts to fill the knowledge gap and contribute to the literature
by assessing the credit risk management practices of United bank. Moreover, previous
researches did not consider United bank, which is among the highest credit providing
private banks operating in the country.

1.3 Research Questions

The following basic research questions are formulated in order to achieve the broad
objective of the research:

RQ1: Have the banks established appropriate credit risk environment?

RQ2. Have the banks undertaken sound credit granting process?

6
RQ3. Have the banks maintained appropriate credit administration, measurement and
monitoring system?

RQ4. Have the banks ensured the adequate control over credit risk?

RQ5. Do the banks have effective credit risk management system and practice?
[

1.4 Objectives

1.4.1 General Objective

The general objective of the study is to assess the credit risk management systems and
practices in United bank, Southwest district

1.4.2 Specific Objectives

[

 To examine the soundness of the existing credit risk environment

 To assess the soundness of sound credit granting process

 To evaluate the existing credit administration, measurement and monitoring process

 To investigate whether the bank ensured adequate control over credit risk

 To assess the overall credit risk management system and practice of the bank

1.5 Significance of the Study

This study is considered important to provide insights for developing regulatory
standards regarding the lending policies of different commercial banks in the industry.
The study is believed to contribute for a better understanding of the role of the variables
in credit risk management, which will help the bank manager and other concerned
officials to concentrate on the quality of loans and remedial. Results of this study are also
expected to be useful for investors who may want to factors that determine credit risk and
to predict benefits expected from their investment. Finally, this study also contribute to
the existing body of knowledge regarding credit risk management, and could serve as a
starting point for further studies that may focus on issues related to credit risk

7
determinant in the banking industry. Overall, the study also opens the issue under study
for further and detail investigations for academic scholars as well as for policy makers as
the sector continues to leap forward.

1.6 Scope of the Study

Since the term risk is a broad area of study, the study focuses on only assessing credit risk
management practices such as appropriate credit risk environment, sound credit granting
process, credit administration, measurement and monitoring process and adequate control
over credit risk. Although credit risk management is a concern of all banks operating in
the country, it is challenging to conduct the study across all banks in terms of time,
finance, and research manageability. Therefore, the scope of this study is restricted to
United bank with the rationale that the bank has been operating long enough to give
academic insights on what the study seek to offer. In addition, the scope of this study
covered the assessment of credit risk management practices those that are operating
currently.

1.7 Limitation of the Study

The study only covers United bank branches of Southwest district among several of the
banks in the country. Hence, the study is limited spatially as well as focuses only on the
current credit risk management practices. Since Ethiopian banks have a wide range of
institutional capacities, economic and environmental conditions, the result of the current
study may have limitations to make generalizations and make them applicable to the
country’s banking industry as a whole. In addition, access to data may pose a great
challenge to the research. An interview appointment with the Head of Credit of the
district may not be easily successful because of the tight schedules of the respondent.
Feedback from staff respondents would also be another constraint due to lack of time,
resulting in the case of unanswered and semi-answered questionnaires. Most of the
respondents might interrupt their work in order to provide answers to the questionnaires
making it a challenge.

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1.8 Organization of the Paper
The paper is organized into three chapters. The first chapter deals with introductory part
consisting of introduction/background of the study, statement of the problem, objectives
of the study, scope of the study and its significance. The second chapter reviews
literatures related to the study. In this chapter various theoretical concepts and empirical
literatures that relates with credit risk and credit administration is discussed. And in the
third chapter research design and methodology employed is presented.

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 CHAPTER TWO

2. REVIEW OF RELATED LITERATURE

This chapter reviews the literature on credit risk management practices. It discusses
issues on credit risk management from different perspectives and with the view of giving
a theoretical foundation to the study. It starts with an exposition on credit risk
management, followed by reviews of literature based on empirical studies done on the
topic.

2.1 Theoretical Review

2.1.1 Definitions and Concepts of Credit Risk Management

The principal goal of credit risk management was to decrease the effects of risks,
related to an influence accepted by the public (Brigham et al., 2016). Usually, loans
were the prime and most apparent source of credit risk of banks. However, there
were other sources of credit risk which exist throughout the bank activities;
including in the banking book and trading book that could appear on and off the
balance sheet. Nowadays, commercial banks were increasingly prone to reasonably
higher credit risk levels (Olson and Zoubi, 2017). These financial mechanisms
include foreign exchange transactions, interbank transactions, bonds, trade
financing, equities, swaps etc. In 2017, Brink (2017), Falkner (2017) and (Harper et
al. 2017) demonstrated that risks were several types of threats caused by humans,
technology, organizations, environment and politics. Conversely, risk management
involves all means available for person, staff, and organization to minimize or
avoid a potential peril McIlwraith (2016). It was the duty of management to set up
a credit supervision team to ensure that credit was properly maintained and
administered. Procedures for measuring a firm’s overall exposure to credit risk as
well as stringent internal rating system should be adequate (Kalunda et al., 2012).

2.1.2 Credit Risk Management Process

The process of management of credit risk in banking business tracks on the risk

10
identification, measurement, assessment, monitoring and control. It involves
identification of possible risk factors, evaluate their consequences, monitor
activities exposed to the identified risk factors and institute control measures to
prevent or reduce the unwanted effects. Problem loans were at the end of the credit
channel. Before a loan becomes bad, it needs to be granted. Moreover, as we
referred to so far, the poor quality of a loan was sometimes due to factors not
attributable to the lending bank such as adverse selection and moral hazard (Stiglitz
and Weiss, 1981) or any other external shock that may alter the borrower’s ability
to repay the loan (Minsky, 1982 & 1985). Nevertheless, there were cases where the
way banks grant and monitor credits can be responsible for the bad loan portfolio.
In other terms, weak credit risk management systems could also be sources of
problem loans (Nishimura et al, 2001).For these last reasons, it was essential to
overview the credit risk management process of banks in order to capture the
framework of the bad loans management. Significant details related to the credit
management processes were revealed here. Banks credit management processes
can be summarized in three main stages. These stages were: credit initiation,
documentation and disbursement and credit administration.

Credit Initiation

According to Edwared (2004) the credit initiation was a process that starts from a
market analysis and ends at the credit application approval. The steps involved in
credit initiation processes are listed below:

Surveys and industry studies: Loan officers/ Customer relationship officers/branch

managers scan the market and economic sectors to identify key players and
potential business for the Bank. In the same vein, industries with high potential of
growth that could be good business for the Bank are also listed with their expected
risks.

Prospect lists: some prospects (companies and individual customers) identified as

the main role players were short listed in accordance with the industry studies and
the minimum risk criteria. This prospect list was ranked in order of preference.

11
Customer solicitation: at that stage, although the primary source of target was the
prospect list, the initiation of a credit comes either at the bank request in the
frequent contact with existing customers or at the clients request if they have a
need for financing.

Negotiation: the Loan officer /relationship officer / branch manager scan identifies
the financing needs of the borrower and gathers background information such as
the latest financial statements, project details, projections over the loan life. This
information will allow the officer to check whether the risk is bearable by the bank
and its compliance with the bank's targets.

Presentation: the conformity of information given with the market and industry
analysis is the reliability of the information once again verified by consulting other
sources.

Credit committee approval: a copy of that annex and loan approval form (LAF)
was submitted to each member of the credit committee. The members review and
approve or decide on the request.

Advice to customers: once the credit was approved, the customer was advised in
writing with details concerning the terms and conditions and with the statement
that the credit could be subject to review, modification or cancellation at the bank
option or in line with the decision.

Documentation and Disbursement

The documentation and disbursement refers to the compliance of documents

provided with the law applicable and the requirements of the bank's legal
department. Documentation provided must satisfy the bank's legal department and
afford maximum protection to the bank. The documentation was periodically
reviewed to keep them in fine with ever-changing legal systems and practices
(Edwared, 2004).

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The legal department was consulted before making any compromises with the
customer. Any amendments were done in consultancy with the legal department.
Once the credit application satisfies all these conditions, a thorough analysis was
done and if the application complies with the bank's conditions, instruction was
given to the credit administration for disbursement.

Credit Administration

The credit administration refers to the credit support, control systems and other
practices necessary for the effective monitoring of credit risks taken by the bank.
Some of the important points of the credit administration were: control of credit
files, safekeeping of credit and documentation files, follow-ups for expirations of
essential documents like insurance, control of credits and excesses over approved
lines, monitoring of collateral inspections, site visits and customer calls, monitoring
of repayments under term credits Edwared (2004). Reporting: the portfolio is
periodically reviewed to make sure that the names tiered were still complying with
the risk acceptance criteria.

2.2 Review of Empirical Studies

There are many studies that have been conducted so far in credit risk management
of commercial banks. Their results have shown that, credit risk of commercial
banks are associated with internal or external or both factors. Hence, the following
section presents the empirical evidence on the credit risk management of
commercial banks.

Klein (2013) conducted the study on NPLs in Central, Eastern and South- Eastern
Europe (CESEE) in the period of 1998–2011 and used both the macroeconomic
and bank specific variables. Macroeconomic variables consist of GDP growth,
inflation, and unemployment. After applying the research technique it was revealed
that ROA and ROE have negative impact on NPLs. While in the business cycle
unemployment and increasing inflation rate had positive relation with NPLs.

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Thiagarajan (2017) conducted an empirical study to predict the determinants of the
credit risk in the commercial banking sector of Belize by using an econometric
model. The model by utilizing a panel data from 2006 to 2012 at bank level for
the 5 private sector banks and has shown some unique determinants of the credit
risk in the Belizean commercial banking sector. The results showed that the lagged
nonperforming assets had a strong and statistically significant positive influence on
the current non-performing assets and there is a significant inverse relationship
between the current GDP and the credit risk. Lagged Inflation showed a positive
and significant influence on the NPL. Generally the study revealed that both
macroeconomic and bank specific factors play crucial role in determining the credit
risk of the commercial banking sector.

Muasya (2013) investigated the relationship between credit risk management

practices and loans losses a study on commercial banks in Kenya. Descriptive
research design was utilized in this study as it aimed to see if there is a relationship
between credit risk management practices and loan portfolio losses in commercial
banks in Kenya. However, only thirty six (36) of the respondent commercial banks
completed the questionnaire. It was concluded that credit risk management
practices are common among most of the commercial banks in Kenya and that
management of these commercial banks appreciated government legislation
relating to credit risk management through the introduction of the credit sharing
information Act, and that there is a significant negative relationship between credit
risk management practices and loans losses in commercial banks in Kenya.

Wondimagegnehu, (2012) conducted a study with a purpose of identifying the

determinants of non-performing loans the case of Ethiopian banks. The study
covered the period between 2005 up to 2010. The researcher identified deposit
loans and total asset variables as affecting NPL of Ethiopian banks. Accordingly,
the researcher found that there were no statistically significant relationship between
all independent variables and NPL.

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Yang (2013) find out that the key principles in credit risk management are establishment
of a clear structure, allocation of responsibility and accountability, processes have to be
prioritized and disciplined, responsibilities should be clearly communicated and
accountability assigned on his research title Credit Risk Management in Rural
Commercial Banks in China.

Atkilti (2015) in his study find out that Credit risk, liquidity risk and operational risk are
the three important types of risks the banks mostly facing. The three widely used Risk
identification method were identified and ranked as Financial Statement Analysis firstly
and followed by audit and physical inspection and then internal communication. The
study further confirmed that four aspects of Basel’s Credit risk management principles
explain a significant level of variation on Credit risk management practice of Ethiopian
commercial banks

Girma (2011) point out on his study credit risk management and its impact on
performance in Ethiopian commercial banks that the default ratio of any bank in Ethiopia
depends on credit risk management quality of the institution.

Solomon (2013) in his paper entitled “Credit risk management techniques and practice of
NIB International Bank” has conclude that credit risk management system of commercial
Banks should incorporate a check and balance for the extension of credit that integrate
separation of credit risk management from credit sanction, credit processing/approval
from credit administration and finally establishment of an independent credit audit and
risk review function.

Tibebu (2011) “Credit risk management and profitability of commercial banks in

Ethiopia” emphasized that Banks board of directors are responsible for each and every
activities of the bank, so they need to conduct continues training for their employees
particularly for credit risk management department managers and employees as well.
Policy maker of banks (NBE) need to set policy, and guidelines which force banks to
think over their credit policy, risk management policy, and other related things .

15
NBE conducted the first survey on risk management practices of Ethiopian commercial
banks by taking sample of nine members of bank’s board of directors (National Bank of
Ethiopia, 2009). It was specially aimed to identify the status of risk management practice
of commercial bank and to improve its strength further through providing fruitful
recommendation on weakness. Inadequate risk management training, inefficient
allocation of risk management budget, lack of up to date and relevant economic and
business data for decision making, lack of documented risk management strategy and
program, lack of reviewing risk management document regularly, and poor internal
communication and lack of comprehensive risk limits system were identified as weakness
of risk management system and practice of some Ethiopian commercial banks

Sudhir et al. (2010) Credit risk management ‟. The purpose of this document is to
provide directional guidelines to the banking sector that will improve the risk
management culture, establish minimum standards for segregation of duties and
responsibilities, and assist in the ongoing improvement of the banking sector in
Bangladesh. Credit risk management is of utmost importance to Banks, and as such,
policies and procedures should be endorsed and strictly enforced by the CEO and the
board of the Bank.

Richard et al. (2008) conduct research on the credit risk management system of
Tanzanian commercial banks and found that checklist with the help of 5c (character,
capacity, condition ,credit history, and collaterals) was used to assess borrower’s
creditworthiness. Researcher also found that the quantitative credit scoring model was not
used as a result of poor record keeping and lack of effective data base system in different
sectors with in the country. Researcher further noted the difficulty of using modern credit
risk management model due to lack of information and other financial infrastructure in
under developed country.

Tesfaye (2012) studied factors influencing the level of credit risk in the Ethiopian
commercial banks. The study find out that quantity of risk and quality of risk
management related variables has got much influence on the credit risk level of banks.
Nevertheless, risk direction related measures, which are mostly external focus, have

16
limited influence on credit risk. More specifically the variation in the effect of stock and
flow measures entails banks to further enhance mostly two of Basel principles: operating
under a sound credit granting process and maintaining an appropriate credit,
administration, measurement and monitoring process.

Akotey (2012) has examined the credit risk management of selected rural banks in Ghana
and has discovered that credit risk management plays a significant and dynamic role in
the business of rural banking. The researcher find out sampled ruler commercial banks
have poor credit risk management practices and hence the high levels of the non-
performing loans in their loans portfolios. Despite the high levels of the NPLs, their profit
levels keep rising as an indication of the transfer of the loan losses to other customers in
the form of large interest margins. Therefore the findings indicate a significant positive
relationship between non-performing loans and rural banks’ profitability informative that,
there are higher loan losses but banks still earn profit.

In addition, Alebachew (2014) in his paper entitled “Assessment of Credit Risk

Management Policies and Practices in NIB International Bank” has conclude The Bank
has to establish a clearly-established process in place for approving amendment, renewal
and re-financing of existing credits and The Bank requires also to established a credit
follow up system which control consistency of all credit approvals made as per the
Bank’s written guidelines and granted by appropriate organ level of the Bank’s
management.

Ntiamoah et al. (2014) determined the association of CRM strategies and performance of
loans in micro-banking organizations in Ghana. It was revealed that CRM and
performance of loan were positively associated. Further Thomas and Raphael (2014)
determined impacts of credit policies on performance of Zenith Bank Plc in Nigeria. Data
was collected using questionnaires. Zenith Bank adopted management of credit activities
such as client appraisal hence reducing the rate of loan default.

Achou and Tenguh (2008) revealed that there is a significant relationship between bank
performance (in terms of return on asset) and credit risk management (in terms of loan

17
performance). Better credit risk management results in better bank performance. Thus, it
is of crucial importance that banks practice prudent credit risk management and
safeguarding the assets of the banks and protect the investors, interests.

2.3 Knowledge Gaps

The literature review that are discussed so far showed that, banks credit risk are
determined by macroeconomic and industry specific factors. The most of the
studies shows that, favorable macroeconomic conditions are tending to be
associated with a better quality of bank loans. Most of The studies in general
show that the association between real GDP growth, inflation, real interest rate,
unemployment rate, financial sector development, and competition. On the other
hand, bank specific factors like, bank size, financial performance, operational
efficiency, rapid loan growth, ownership type, income diversification, risk
assessment, capital adequacy, loan to deposit ratio and monitoring are found to be
having significance on the occurrence of credit risk of banks. But most of the
studies are failed to assess bank specific determinant of credit risk such as credit
portfolios diversification, credit guarantee, credit follow up, credit collection
strategies and non- performing loans

However, Most of the literatures are focused on studies that were conducted in
counties far away from Ethiopia both in financially and economic structure and
developed in their economies, (such as Spanish, Greek, Italian, Indian, Chinese,
Malaysian, and Indonesia).Consequently, the Banking sectors in most developing
economies like Ethiopia still received inadequate attention in the literature.

In addition, credit risk of different countries may not necessarily share identical
factors. Apart from the data originated from, those literatures by themselves
provided different conclusions because of different models and methodologies they
used. Besides most of the studies conducted in abroad and also to in our country
are based on empirical data and secondary source of data. Therefore, it is difficult
to generalize the findings in the context of Ethiopia.

18
 In the context of Ethiopia, the related study conducted by Wondimagegnehu,
(2012) investigated the deposit loans and total asset variables as affecting credit
risk of Ethiopian commercial banks by ignorance of all industry and
macroeconomic factors such as financial sector development, competition,
government regulation and bank specific factor such as credit guarantee, credit
follow up, credit collection strategies and the likes. Hence, the purpose of this
study is to assess the credit risk management practice of United Bank, Southwest
district by utilizing descriptive statistical tools with the help of SPSS Software.

2.4 Conceptual Framework

Based on a general overview of the relevant literatures, especially the work of Gedefaw
(2019), the researcher developed the following conceptual framework, which
standardizes this case study:

Figure 1 Conceptual framework for the study (Source: adopted from Basel, 2000).

Appropriate credit risk environment

Sound credit granting process

Credit Risk
Management
Credit administration, measurement Practice
and monitoring process

Adequate control over credit risk

Establishing an Appropriate Credit Risk Environment

19
Principle 1: The board of directors should have responsibility for approving and
periodically (at least annually) reviewing the credit risk strategy and significant credit
risk policies of the bank. The strategy should reflect the bank’s tolerance for risk and the
level of profitability the bank expects to achieve for incurring various credit risks (Basel,
2000).

Principle 2: Senior management should have responsibility for implementing the credit
risk strategy approved by the board of directors and for developing policies and
procedures for identifying, measuring, monitoring and controlling credit risk. Such
policies and procedures should address credit risk in all of the bank’s activities and at
both the individual credit and portfolio levels (Basel, 2000).

Principle 3: Banks should identify and manage credit risk inherent in all products and
activities. Banks should ensure that the risks of products and activities new to them are
subject to adequate risk management procedures and controls before being introduced or
undertaken, and approved in advance by the board of directors or its appropriate
committee (Basel, 2000).

Operating under a sound Credit granting process

Principle 4: Banks must operate within sound, well-defined credit-granting criteria. These
criteria should include a clear indication of the bank’s target market and a thorough
understanding of the borrower or counterparty, as well as the purpose and structure of the
credit, and its source of repayment (Basel, 2000).

Principle 5: Banks should establish overall credit limits at the level of individual
borrowers and counterparties, and groups of connected counterparties that aggregate in a
comparable and meaningful manner different types of exposures, both in the banking and
trading book and on and off the balance sheet (Basel, 2000).

Principle 6: Banks should have a clearly-established process in place for approving new
credits as well as the amendment, renewal and re-financing of existing credits (Basel,
2000).

20
Principle 7: All extensions of credit must be made on an arm’s-length basis. In particular,
credits to related companies and individuals must be authorized on an exception basis,
monitored with particular care and other appropriate steps taken to control or mitigate the
risks of non-arm’s length lending (Basel, 2000).

Maintaining an Appropriate Credit Administration, Measurement and monitoring

process

Principle 8: Banks should have in place a system for the ongoing administration of their
various credit risk-bearing portfolios (Basel, 2000).

Principle 9: Banks must have in place a system for monitoring the condition of individual
credits, including determining the adequacy of provisions and reserves (Basel, 2000).

Principle 10: Banks are encouraged to develop and utilize an internal risk rating system
in managing credit risk. The rating system should be consistent with the nature, size and
complexity of a bank’s activities (Basel, 2000).

Principle 11: Banks must have information systems and analytical techniques that enable
management to measure the credit risk inherent in all on- and off-balance sheet activities.
The management information system should provide adequate information on the
composition of the credit portfolio, including identification of any concentrations of risk
(Basel, 2000).

Principle 12: Banks must have in place a system for monitoring the overall composition
and quality of the credit portfolio (Basel, 2000).

Principle 13: Banks should take into consideration potential future changes in economic
conditions when assessing individual credits and their credit portfolios, and should assess
their credit risk exposures under stressful conditions (Basel, 2000).

Ensuring Adequate Controls over Credit Risk

Principle 14: Banks must establish a system of independent, ongoing assessment of the
bank’s credit risk management processes and the results of such reviews should be
communicated directly to the board of directors and senior management (Basel, 2000).

21
Principle 15: Banks must ensure that the credit-granting function is being properly
managed and that credit exposures are within levels consistent with prudential standards
and internal limits. Banks should establish and enforce internal controls and other
practices to ensure that exceptions to policies, procedures and limits are reported in a
timely manner to the appropriate level of management for action (Basel, 2000).

Principle 16: Banks must have a system in place for early remedial action on
deteriorating credits, managing problem credits and similar workout situations (Basel,
2000).

Principle 17: Supervisors should require that banks have an effective system in place to
identify measure, monitor and control credit risk as part of an overall approach to risk
management. Supervisors should conduct an independent evaluation of a bank’s
strategies, policies, procedures and practices related to the granting of credit and the
ongoing management of the portfolio. Supervisors should consider setting prudential
limits to restrict bank exposures to single borrowers or groups of connected
counterparties (Basel, 2000). Researcher tried to define credit risk management practice
as the process of reviewing and updating credit risk management documents and apply
consistently in actual credit granting process, credit administration and monitoring and
risk controlling process with appropriate credit risk environment, understanding and
identification of risk so as to minimize the adverse effect of risk taking activities.

22
 CHAPTER THREE
3. RESEARCH DESIGN AND METHODOLOGY
This chapter describes the research methodology adopted to serve the objectives of the
study, and also deals about the research design, sampling and sampling techniques, data
collection procedures and the method of data analysis. The methodology that will be used
to meet the requirement of data and analysis has been discussed in this chapter.

3.1 Research Design

To achieve the objectives of the study, the research will use a descriptive research design
using both qualitative and quantitative data. This research design is chosen because it
helps to gather information about the existing credit risk management condition. The
emphasis is on describing rather than on judging or interpreting. The descriptive
approach is also quick and practical in terms of the financial aspect.
Research approach

3.2 Type and Source of Data

According to Catherine (2007), data may be collected as either primary or secondary. In

this study both primary and secondary sources of data will be collected from the sources.
The study uses data on different variables that includes data on socio-economic
background of the respondents, and variables of credit risk management practices. In this
study, primary data will be collected using standard self-administered and close ended
questionnaire. The primary sources of data for this study will be professionals working in
the banks such as district and branch managers, and officers working as credit manager,
credit director, credit analyst, credit follow up, risk and compliance managers and risk
experts will be the major respondents. To get accurate information questionnaires will be
distributed and collected from the target group by the researcher himself.

23
Secondary data will also be used for supporting the study and to get the findings of other
researchers in the topic. Sources of secondary data include financial statements, annual
reports, NBE directives, and bulletins of the banks.

3.3 Target Population

Attention!!!!!

This study aims at assessing the credit risk management practices in United bank
southwest district. Therefore, managers and professionals working on credit and credit
related operations in five (i. e., Jimma, Metu, Agaro, Mizan-Teferi and Gambella)
selected branches out of 33 branches in southwest district, as well as employees in the
credit and loan department at the district office will be taken as participants of the study.
Consequently, the targeted population for the study includes 6 managers, 63 officers from
the five branches of Southwest district and 11 district office staff from three departments
such as credit appraisal, credit customer relation and risk departments. Therefore, for this
study all employees (N = 72) from the selected departments will be used

3.4 Sampling Design and Sampling Techniques

3.4.1 Sample Size Determination

Considering the number of targeted population which is only 72 and to increase the
accuracy of the result compared to previous studies on the same topic, population censes
method or the whole population is considered for this study.

3.4.2 Sampling Techniques

Non-probability sampling technique will be used to select the branches based on their
banking performance. Mainly banking performance evaluation includes the number of e-
banking users, deposits, foreign exchange and loan performance made by the banks.
Currently, the United bank southwest district has 33 branches, and five branches out of
these were selected based on their performances as of the financial year 2021/2022
(United bank southwest district report, 2022). In addition, respondents will be selected

24
from each branch and the district office based on convenience sampling technique.
Convenience sampling is not a probability sampling method in which a study sample is
drawn from the group of respondents easily accessible to the researcher. Hence, for the
purpose of this study, participants who are directly involved in credit processing and
administering will be selected because they would better assist to get accurate
information for determining whether the bank’s structures and risk management tools are
adequate

3.5 Methods of Data Collection

The primary data will be collected using survey questionnaire. The researcher will
distribute a close-ended questionnaire to sample respondents as the measuring
instrument. The standard questionnaire is developed based on the Basel’s credit risk
management principles/activities of 1999 and NBE’s credit risk management guideline of
2009. It contains 41 closed ended questions with five Likert-type scaling method in a
range of responses: ‘Strongly Disagree’, ‘Disagree’, ‘Neutral’, ‘Agree’, and ‘Strongly
Agree’, with a numeric value of 1-5, respectively. This particular scaling method is
widely used to assess the responses and measure the responses quantifiably.

In addition to this, the study will interview managers/department heads at the district
office to obtain responses on open ended questions. The interview questions will be
prepared to obtain additional information about the practice of credit risk management at
the bank.

Attention!
Variable definition and model specification

3.6 Methods of Data Analysis

The data obtained through questionnaire will be first edited for their completeness,
categorized, registered. The collected data will be analyzed by using descriptive statistics.
In this study descriptive analysis will be chosen because of its simplicity and clarity to
draw inferences. Averages, percentages, frequencies and tables will be used for

25
presentation of the results, which will assist in the interpretation and analysis of the data
collected to help measure the bank‘s performance as well as judge the effectiveness of its
credit risk management process. All the statistical analyses will be carried out using the
SPSS computer program (Statistical Package for Social Sciences version 21).

3.7 Reliability and Validity of Data

Validity according to Adams et al. (2007) refers to the strength of our conclusions,
inferences or propositions. It involves the degree to which you are measuring what you
are supposed to, more simply, the accuracy of your measurement. To raise the validity of
the research, questionnaires will be distributed and collected by the researcher himself in
order to maintain its validity.

Reliability estimates the consistency of the measurement or more simply, the degree to
which an instrument measures the same way each time it is used under the same
conditions with the same subjects. Reliability is essentially about consistency. To make
sure that the data collection methods were error free, and to minimize the instruments’
biases the researcher will undertake the following:

The researcher will employ Cronbach’s alpha test ensure the consistency of the
questionnaire. Yfield (2009) suggested that Cronbach’s α value of 0 .7 to 0. 8 is
acceptable and ensure the reliability of items while Pallant (2007) suggested that
Cronbach’s α value of above 0.8 is preferably to be considered reliable.

3.8 Ethical Consideration

The researcher will obtain the consent of the selected branches for the study. Respondents
will be informed about the purpose of data collection, analysis and the covenant to
maintain privacy of their responses.

26
 WORK PLAN

No. Description Due date Remarks

1 Specific topic selection or identification. Dec – 01-Feb , 2022

2 Topic refined to develop thesis. Mar-04– may 2022

3 Proposal written & submitted. 01 -Mar 2022. – April 10, 2022

4 Conducting field work & Collection April 15 – May 31, 2022

of data.

5 Analysis and interpretation of collected 01- June – 15-June, 2022

data.

6 Preparation of the research report June 15 – June 22 2022

6 Submission of the final research report June 25 – 14 -Aug 2022

27 Final draft prepared - submission of Sep 15-30, 2022

thesis

27
 BUDGET PLAN
Unit
No. Items Description Unit Quantity price Total
price
Pen Pack 20 15 300.00
Marker piece 10 10 100.00
1 Stationary RW-CD Pieces 1 120 120.00
Flash disc Number 2 500 1000.00
Photocopy Pages 300 1 300.00
Binding of proposal Number 6 25 150.00
Binding of research Number 6 80 480.00
Typing paper Number 5 85 425.00
Printing of proposal Pages 40 2.00 80.00
Printing of thesis Pages 200 2.00 400.00
Sub Total 3355.00
3 Transportation Researcher (s) 500 500.00
Subtotal 3,855.00

(Source of budget: Own)

28
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APPENDIX

APPENDIX_I

Questionnaire

JIMMA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF MANAGEMENT
Dear respondents

My name is Geremew Tesfaye Urga, and I am conducting a study on Assessment of Credit

Risk Management Practices: The Case of United Bank, Southwest District for the partial
fulfillment of master’s degree in business administration in Jimma University, college of
business and economics department of management. I would like to extend my deep
appreciation to your willingness and cooperation in undertaking this valuable research.
Taking part in this study you will contribute towards alleviating the problem of the banking
industry in Ethiopia. I kindly request your cooperation to fill and respond truthfully for the
asked Questions. Finally, I would like to appreciate and thank you in advance for your
dedication, time and genuine response to the questions.

PART I: GENERAL INFORMATION THE OF RESPONDENTS

33
 Please circle or provide your own answers where applicable.

1. Gender:
A. Male B. Female
2. Age:
A. 20-25 B. 26-35 C. 36-45 D. Above 46
3. Marital status
A. Single B. Married C. Divorced
4. Education
A. Diploma B. Graduate C. Postgraduate D. Others

Part II: Research related questions

Please provide your level of agreement using the following rates. Key: Strongly agree (5),
Agree (4), Neutral (3), Disagree (2), and strongly disagree (1).

1. Establishing Appropriate Credit risk environment

No Description of items Strongly Disagree Neutral Agree Strongly

. Disagree Agree
1 2 3 4 5
Bank’s Credit risk strategies, policies and procedures
1 are regularly reviewed and updated by the board of
directors
2 Senior managements are responsible for implementing
credit risk strategy approved by the board and for
developing credit policies and procedures
3 Boards of Directors and Senior Managers closely
monitor the major Credit Risk exposure of the Bank
4 Credit Risk management strategy, Policies and
Procedures are consistently applied in all Credit
product and activities of the bank.
The banks’ staffs take the necessary precaution
5 against default risk

Authority and Responsibility of Risk Management are

6 clearly set out and understood throughout the bank.
7 There is proper identification of Credit Risk inherent in
all products and activities of our Bank
8 There is common understanding about Credit Risk

34
 Management Strategy, Policy and Procedures across
the Bank.

2. Operating under a Sound Credit granting process

No Description of items Strongly Disagree Neutral Agree Strongly

. Disagree Agree
1 2 3 4 5
It is too risky to invest our bank’s funds in one specific
1 sector of the economy.
2 Adequacy, marketability and enforceability of
collateral requirement is properly evaluated and
measured by professional personnel or expertise.
3 The Bank conducts comprehensive credit worthiness
analysis before granting loan
4 The Bank uses well defined credit-granting
The bank critically follows sound credit granting
5 process for approving new credits as well as
amending, renewing and refinancing existing credits
The bank has established comprehensive Credit limit
6 for the main categories of risk factors in all types of
credit facilities.
7 The Bank optimally diversifies its credit exposure to
different economic sectors and geographical area.
8 The Bank undertakes Credit granting process based on
a reliable and substantial amount of date related to
macro-economic and borrower specific factors.

3. Maintaining an appropriate credit administration, measurement and monitoring

process

No Description of items Strongly Disagree Neutral Agree Strongly

. Disagree Agree
1 2 3 4 5
The bank strictly monitors loan terms and conditions
1 that have been stipulated at the time of loan approval.
2 The bank regularly reviews and monitors the
performance of Credit quality at individual and
portfolio level.
3 There is a complete, neatly organized and regularly
updated credit file in our bank.
4 The bank has developed its own internal risk rating
system and applying in credit risk management process

35
 effectively.
There is effective Credit monitoring system and
5 procedures.

The bank quantify its credit risk at individual and

6 portfolio level
7 There is effective system and practice of reporting and
Communicating risk data/ information among relevant
staffs of our bank.
8 The bank’s Credit risk management system and
practice has been integrated with appropriate
Management Information Systems.

4. Adequate control over Credit risk

No Description of items Strongly Disagree Neutral Agree Strongly

. Disagree Agree
1 2 3 4 5
The bank has appropriate policy, procedures and
1 techniques for improving loan repayment and handling
troubled loan.
2 Credit loss, Loan concentration, large exposure and
level of NPL can be reduced if banks’ Credit policy,
Procedure and Techniques are implemented properly
3 The bank’s top managements have strong
commitment toward controlling default risk
4 Appropriate and timely policy measures have been
taken for resolving loan recovery problem during the
last five years.
The Bank keeps its Actual risk profile at or below its
5 risk tolerance /appetite.

There is an appropriate level of Control over Credit

6 Risk the bank faces.
7 The Bank carry out regular independent internal Credit
quality reviews accurately.
8 There is an early identification of Credit default sign
with immediate corrective action.

5. Credit risk management practice

36
No Description of items Strongly Disagree Neutral Agree Strongly
. Disagree Agree
1 2 3 4 5
Establishing and Practicing effective Credit Risk
1 Management system is one of the main objectives of
my bank
2 Success and failure of any bank is mostly depends on
the effectiveness of Credit Risk Management System
and Practice.
3 The bank has well-documented Credit Risk
Management Strategy, Policy and Procedures that
guide the staffs in their daily activities of managing
credit risks.
4 The bank has established Sound Credit Risk
Management System in line with NBE’s risk
management guideline and directives.
There is suitable Organizational structure that enables
5 me to undertake effective Risk Management System
and practice
This Bank has adequate and qualified risk management
6 staffs and expertise
7 There is adequate Deposit mobilization and fund
utilization in this bank
8 The bank gives adequate and effective Risk
Management training for staffs
9 Overall, I consider the level of Credit Risk
Management system and Practices of the Bank is to be
excellent

• What strategies do you propose to the Bank so as to improve the quality of loans
as high as possible and enhance the overall Credit Risk Management of the
Banks?
…………………………………………………………………………………………………

…………………………………………………………………………………………………

• Please give any experience, comment or opinion about Credit Risk Management
practices which is not applicable at your organization.

…………………………………………………………………………………………………

37
Thank you for your time and Response

38
 Questionnaire

JIMMA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF MANAGEMENT

Dear respondents

The objective of this interview is to gather and analyze relevant and in-depth information that
will provide insights about credit risk management policies and practice of United Bank
Southwest District. This study is undertaken as a partial requirement for the completion of
Masters in Business Administration.

1) What are the challenges of administrating credit risk?

2) How do you evaluate credit evaluation process of the Bank?

3) What factors do you think would contribute intensifying of credit risk in the Bank?

4) How do you evaluate the Bank’s management role to control credit risk of the Bank?

5) What procedures and measures should the Bank employ to manage its problem loans?

39