ADDIS ABABA UNIVERSITY

COLLEGE OF BUSINESS & ECONOMICS

DEPARTMENT OF ACCOUNTING AND FINANCE

The Effect of Credit Risk Management Practices on Loan Performance

in Micro Finance Institution: On the Case of Addis Credit and Saving
Institution.

A Research Project Submitted to Department of Accounting and

Finance for the Partial Fulfillment of BA Degree in Accounting and
Finance

By:

Bewketu Geremew
BER/4686/06

Advisor:
Bizuneh Girma

June, 2017
Addis Ababa, Ethiopia
 Acknowledgment
It is a pleasure to convey my gratitude to those who helped me in making this research project. In
the first place I would like to thank God for being my creator, savior and source of strength and
his holy mom saint Virgin Mary, your love and pray is always with me. I am also sincerely
grateful for Ato Bizuneh Girma for his invaluable assistance and guidance during the course of
my study. I was extremely fortunate in having him as my advisor and course instructor. This
paper would not have been possible without the support of the staffs of different organizations
especially managers and employees of; Addis credit and saving institutions (arada sub
city),wereda employees of ADCSI mainly W-05,07,09,and 10. I would also like to thank my best
friend koyachew who has helped me by edited and writing the paper, members of those
organizations, especially those who are working in the operation department of the credit risk
management section for giving me helpful information to finish this research project. Ato
zelalem from ADCSI Arada sub city deserves a special thank for the information he provided
me. My boss ato admasu mitkie deserve special mention for his moral support, and giving a time
freedom to do the paper. Finally, I would like to thank my friends specially behere teachers and
everybody who was important to the successful realization of my paper as well as expressing my
apology that I could not mention personally one by one. You are all dear to me. Thank you.

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 Table of Contents

Acknowledgment ............................................................................................................................. i
Abstract ........................................................................................................................................... v
CHAPTER ONE ............................................................................................................................. 1
1. INTRODUCTION ...................................................................................................................... 1
1.1. Background of the study ..................................................................................................... 1
1.2. Statement of the Problem .................................................................................................... 3
1.3. Objective of the study ......................................................................................................... 4
1.3.1. General objective .......................................................................................................... 4
1.3.2. Specific objective .......................................................................................................... 4
1.4. Significant of the Study ...................................................................................................... 5
1.5. Research Design and Methodology .................................................................................... 5
1.5.1 Source of Data ................................................................................................................ 5
1.5.2. Method of Data Collection ............................................................................................ 5
1.6. Sampling Design and Technique ........................................................................................ 5
1.7. Method of Data Analysis .................................................................................................... 6
1.8. Scope of the Study .............................................................................................................. 6
1.9. Limitation of the Study ....................................................................................................... 6
1.10. Organizational Structure of the Paper ................................................................................. 6
1.11. Cost and Time Budget ........................................................................................................ 7
1.11.1. Cost Schedule............................................................................................................ 7
1.12.1. Time Schedule .......................................................................................................... 8
CHAPTER TWO ............................................................................................................................ 9
2. LITERATURE REVIEW ........................................................................................................... 9
2.1. Introduction ......................................................................................................................... 9
2.2. Theoretical review .............................................................................................................. 9
2.2.1. Agency Theory ............................................................................................................ 9
2.2.2. Transaction Cost Theory ............................................................................................. 9
2.2.3. Portfolio Theory ........................................................................................................ 10
2.2.4. Capital Asset Pricing Model...................................................................................... 10

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 2.3. Determinants of Loan Performance .................................................................................. 11
2.3.1. Interest Rate in Credit Management ........................................................................... 11
2.3.2. Loan size in credit Management ................................................................................. 11
2.3.3. Loan Value .................................................................................................................. 12
2.3.4. Saving Rates................................................................................................................ 12
2.4. Loan Policies...................................................................................................................... 13
2.5. Empirical Studies .............................................................................................................. 13
2.6. Summary of Literature Review ......................................................................................... 15
CHAPTER THREE ...................................................................................................................... 16
3.1. Introduction ........................................................................................................................ 16
3.1.1. Survey results .............................................................................................................. 16
3.1.2 Analysis and interpretation‟s from the questioner‟s ..................................................... 18
3.2. Challenges during Repayment Process/period ................................................................... 21
3.3. Credit risk management practice ........................................................................................ 23
3.3.1. Credit risk identification (selection criteria) ................................................................ 23
3.3.2 Credit risk minimizing and rating ................................................................................. 26
3.3.3. Credit risk assessment (monitoring mechanism) ......................................................... 30
3.4. Data analysis from secondary sources or Documents ....................................................... 32
3.4.1 Credit Policy and Collateral ......................................................................................... 33
3.4.2. Factors that affect Loan Repayment Performance ...................................................... 33
CHAPTER FOUR ......................................................................................................................... 38
4. CONCLUSION AND RECOMMENDATION ...................................................................... 38
4.1. Conclusion ........................................................................................................................ 38
4.2. Recommendations ............................................................................................................. 39
4.3. Limitations of the Study.................................................................................................... 40
References
Appendix

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 List of Tables
Table 3.1: survey response rate ............................................................................................. 16
Table 3.2 Demographic characteristics of respondents (employees) .................................... 17
Table 3.3 use of banking system for the customer ................................................................ 18
Table 3.4. Criterion................................................................................................................ 19
Table 3.5 risk identification ................................................................................................... 19
Table 3.6 risk identification ................................................................................................... 20
Table 3.7. Criterion................................................................................................................ 20
Table 3.8 risk identification ................................................................................................... 23
Table 3.9 Risk minimizing .................................................................................................... 26
Table 3.10. Risk rating .......................................................................................................... 28
Table 3.11: Credit risk assessment (monitoring mechanism)................................................ 30
Table 3.12 ADCSI 2013-2016 YEAR END REPORTS ...................................................... 32
Table 3.13 loan size and repayment period ........................................................................... 33

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 Abstract

Credit management is one of the most important activities in any company and cannot be
overlooked by any economic enterprise engaged in credit irrespective of its business nature.
Sound credit management is a prerequisite for a financial institution’s stability and continuing
profitability, while deteriorating credit quality is the most frequent cause of poor financial
performance and condition. Credit risk has always been a concern not only to bankers but to the
entire business world because risks of a borrower not fulfilling his obligations in full on due date
can seriously jeopardize the performance of finale institutions. This study sought to review the
credit risk management and loan performance of MFIs in case of Addis Credit and saving
institution. The research design used in this study was descriptive research design as it involved
an in depth study of credit risk management and its relation with loan performance in MFIs.
Primary data will have used to collect through questionnaires while secondary data will collect
from the micro finance institution annual report (2005-2009) will used. The study will focus on
Arada Sub city ADCSI. The data which will collect from the annual reports of the MFIs will
analyze using multiple regression analysis. The main purpose of this study is to access the credit
risk management practice of Addis credit and saving institutions specially the clients screening
and delinquency will address.

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 CHAPTER ONE

1. INTRODUCTION
1.1. Background of the study

Microfinance institutions refer to any activity that includes the provision of financial
services such as: credit, saving and insurance to low income individuals which falls just
above the nationally defined poverty line and poor individuals who fall below that poverty
line, with the goal of creating social value. The goal of micro finance institution is mostly
to alleviate poverty by targeting clients who previously have not access to formal financial
services (Smith, 2006). MFIs give the provision of financial services to poor and low
income households with access to formal financial institutions (Corvey, 2003). Alemayehu
(2010), micro finance as a provision of financial service to low income clients or solidarity
lending groups including customers and the and the self employed, who traditionally lack
access to banking and related services.

Improving access to financial services is an important development tool because, it helps

to increase their income and consumption which would in the financial analysis reduce
poverty. Lack of financial services the abceuse of loan products, micro insurance products,
convenience saving instruments and various other financial instruments are a major
constraint limiting the accumulation of assets by the poor and the development of
indigenous enterprises (Peck and W/Yohannes, 2009).

Credit management involves many activities ranging from credit investigation to contract
with borrowers, appraisal review and follow up, documentation nursing, recovery and
write off having two main functions: credit decisions of institutions (Yaregal, 2007). Even
though proactive risk management is essential to the long term sustainability of MFIs, but.
Money micro finance stakeholders are unaware of various components of comprehensive
risk management procedure.

Credit risk is most critical and expensive risk associated with financial institutions. It‟s
impact is quit significance compared to any other risks associated with lending institutions
as it direct theat to solvency of the institution (Chijoriga, 2011). Credit risk is not only

1
directly. Associated to solvency but its magnitude as well as level of loss is severe
compared to other risks. It may result loan losses of high level and even failure of financial
institution (Richard etal., 2008, Chijoriga, 2011).

Loan portifalio is it considered as a largest asset as well as predominant source to generates

revenue but one of the biggest risk sources for the financial institutions and soundness an
safety as well (Richard etal, 2008). Hence credit risk management is considered to be one
of the road maps for soundness and safety of the sector through prudent actions as well as
monitoring and performance. Despite of the efforts made by the financial institutions
number of problems increased significantly in both, emerging as well as matured
economies of the world (Basel, 2007).

There should be systematic distribution of loans according to well established credit

policies and procedures provided by (Schreiner, 2003). Well formulated loan policy is
beneficial for institutional performance. Since it helps organizations to follow the same for
risk management as well as fulfilling regulatory requirements (Joana, 2000).

Loan performance refers to rate of profitability or rate of return of an investment in various

loan products. Thus, broadly it looks a number of clients applying for loans, how much
they are borrowing, timely payment of installments, security pledged against the borrowed
funds, rate of arrears recovery and the number of products on the chain. Hittet.al,(1996)
believes that many firms low performance is the result of poorly performing assets. To do
that the credit management works well to avoid unnecessary risks. Loan performance is
determined by: interest rate in credit management, loan size in credit risk management,
loan value etc. therefore, there is a relationship between credit term, client appraisal, credit
risk control and collections policy.

Loan appraisal is an application/request for funds, evaluated by financial institutions. The

aspect to be focused in appraisal includes: purpose of the client, need genuineness,
repayment capacity of the borrower, quantum of loan and security. Loan appraisal plays an
important role to keep the loan losses to minimum level, hence if those officers appointed
to loan appraisal are competent then there would be high chances of lending money to non-
deserving customers (Boldizzoni, 2008). Collection procedures are a systematic way
required to recover the post due amount from clients with in the lawful jurisdiction.

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1.2. Statement of the Problem

Credit management is the most important activity in micro finance institutions. An

attending credit management policy and procedure make it sound at the time managing
credit risk and credit decision. Mulat (2003) argues that if you do not follow the credit
management policies and procedures one cannot think of managing credit risk and at the
same time credit decision will become arbitrary, subject to individual discrimination and
judgment. Credit risk refers to a likelihood a potential borrower will default on his
financial obligations with lending institutions. It is the risk the borrower may be unable or
unwilling to repay the dept. credit risk management is the lending institutions primary line
of defense top protect itself against customers who fail to meet the terms of the loan. Credit
risk management is necessary tool that you should use before going into business with
other companies and also it can help to protect the business from any financial danger and
unnecessary risk of losing the assets.

As Nuancy etal (2001), noted that an effective credit risk management process is required
to help institutions. To do that top leadership establishes rules to prevent operating losses
in relation with human error, employee carelessness, technological malfunctioning or
fraud. Hence credit evaluation orn performance decisions are important for the financial
institutions involved due to the jigh level of financial institutions are critical for the
survival and growth of MFIs. But, in practice MFIs face double challenges, not only do
they have granting financial services to the poor, but also they have to cover their costs due
to uncollectable because of poor credit and collection performance (Luzzi and Weber,
2006).

As the researcher‟s knowledge few studies have been conducted istle area of credit risk
management and collection performance of MFIs which is found in Ethiopia. For instance,
the study conducted by Goshim, 2011 on “performance off micro finance Institutions in
credit risk management: the case of five micro finance institutions in Addis Ababa.” He
found that the overall repayment performance of borrowers and the screening techniques
was sound and the credit scheme has contributed positivity in terms of improving the
incomes, access to education, access to health facilities and nutritional status of the
borrowers. The other study which is done by Esubalew Assefa, 2010 – dealt with problem

3
of information asymmetry and providing loans without collateral requirements and also
find out the multiple borrowing heavy debt bourdons, low requirements. As the researchers
knowledge and experience there is still a gap on the above studies which intends the
researchers to do on the following variables like: turnover of skilled personnel,
entrepreneurial quality of the client modern core financing (technology), distance and work
supervision. So, the study will fill the gaps as well as access the credit risk management
and collection performance of Addis credit and saving institutions which is found in Arada
sub-city.

To meet the objective the study will raise the following research questions:

1.What are the relationship between credit risk management and loan performance?

2.What kind of requirements did the applicants must fulfill for the loan?

3.What are the the credit risk control and rating mechanisms?

4.What are the monitoring and follow up mechanisms to collect credit in your institutions?

1.3. Objective of the study

1.3.1. General objective

The objective of the study is to determining the effects of credit risk management practices
and loan performance of microfinance institutions in case of Addis credit and saving
institution.

1.3.2. Specific objective

To accomplish the general objective, the following specific objectives are developed and
stated below:

- To assess the loan requirement of the client.

- To investigate the credit risk control and ratings.
- To assess the relationship between credit risk management and loan performance.
- To identify the monitoring mechanisms used by the institutions to collect credit.

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1.4. Significant of the Study

The study will be significant to the management of MFIs in Ethiopia as they will be able to
uncover the credits risk management practice and loan performance and adopt appropriate
credit risk management practices in reducing level of nonperforming loans and enhance
loan performance. The study will provide an insight on the best credit risk management
approached MFIs, should adopt in order to effectively manage and enhance profitability.

1.5. Research Design and Methodology

In this study descriptive research method is used to describe these credit risk management
and collection performance of Addis credit and saving institutions. To do that necessary
and important data will be collect to accomplish the objective of the study.

1.5.1 Source of Data

To make the study tangible both primary and secondary data source are used for the study.
The study will largely focus on secondary data sources (there portfolio, financial
statements, their default risk will be taken as a source). The primary data will be used to
add more information‟s that needs more clarification through questioner.

1.5.2. Method of Data Collection

The researcher will collect primary data through questionnaire because this method of data
collection makes the study and inter presentation of data more meaningful and vivid. The
primary data to be collected is from borrowers/clients. Employees many on loan (who
works on loan). For secondary data document review is an appropriate method of data
collection, which is review of loan portfolio, documents.

1.6. Sampling Design and Technique

From the 33 MFIs in Ethiopia the study takes the one which is Addis credit and saving
institutions which is founded around Addis Ababa. Since it is found in the two sub cities.
Arada- sub city is taken as a representative. From the different ways of sampling the study
will focus on systematic sampling and convenience sampling will use to select the study.

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1.7. Method of Data Analysis

Data will be analyzed interpreted to attain the main purpose of the study after the
researcher collect necessary and relevant data for the study. To do that the researcher uses
multiple regression method of data analysis to process and analysis the collected data.

1.8. Scope of the Study

The study incorporated one MFI from the 33 MFIs which is found in Ethiopia that is Addis
credit and saving institution. Due to different cases the study uses or includes the last three
consecutive years‟ financial statement and portfolio document. The result of the study is
based on the data collected from clients and employees and the analysis of financial
statements.

1.9. Limitation of the Study

In doing the study the researcher faces the challenge of motive to give reliable information,
it may also difficult to get those skilled personnel to communicate in detail do you to
willingness or lack of time.

1.10. Organizational Structure of the Paper

To provide flow of ideas the study will be organized into four chapters. The first chapter
consists of the problem and its approach, which mainly consists back ground of the study,
statement of the problem, objective of the study, significant of the study, research design
and methodology, scope of the study, limitation of the study and the time and cost budget.
Chapter two- review of related literature, chapter three methodology and chapter four is
conclusion and recommendation.

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1.11. Cost and Time Budget

1.11.1. Cost Schedule

No Major Costs Amount in Birr

1 Transport costs 120
2 Typing costs 260
3 Other related costs 180
4 Total costs 560

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 1.12.1. Time Schedule

Month Dec. Jan. Feb. Mar. Apr. May June

Week 1&2 3&4 1&2 3&4 1&2 3&4 1&2 3&4 1&2 3&4 1&2 3&4 1&2

Proposal of the research   

Literature review  

Data collection   

Data analysis  

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 CHAPTER TWO

2. LITERATURE REVIEW
2.1. Introduction

This chapter is concerned with the review of literature related to the study, the theoretical
review, determination of loan performance, empirical review and the conceptual
framework. In the literature, it reviews other authors works on credit risk management
practices and loan performance. The last section is the summery of the literature which
points out the research gaps on the empirical studies done.
2.2. Theoretical review

This section discusses the theories established by others, authors and scholars and relevant
to financial innovations. The study specifically reviews the agency theory, transaction cost
theory, portfolio theory and capital pricing theory.

2.2.1. Agency Theory

According to the agency theory, the principal agency problem can be reduced by better
monitoring such as establishing more appropriate incentives for managers. There are
lacking Malaysia for the following reseans: first, market takeover of poorly managed firms
by raiders is more difficult ion Malaysia because of various government restrictions on
corporate equity owner ship. Marker takeover serves as check on the behavior of
managers. Second, many major financial institutions are owned by government Mccolgam,
(2001). Third, stock options are rarely used in Malaysia to award bank managers. When
bank managers are given remuneration in terms of stock options they will major decisions
which will increase the price of the price of the company in the stock market Bonin etal
(2001).

2.2.2. Transaction Cost Theory

Transaction costs are the costs associated to the division of work. Williamson (2000),
indicated that a transaction occurs when a good or service is transferred across

9
technologically separable variable that describe a transactions are, among others the
specificity, the uncertainty and the frequency of the transaction whether an asset or a
specific transaction. In the following human capital specificity (the work out managers),
the assets specificity (the location of the collateral) are taken into account, Reddy (2002).
Low specificity exists if there is a range of homogenous services or goods and suppliers
are secured. Since goods and services are comparable and competitions may imply
motivation and quality Yousaiken (2001).

2.2.3. Portfolio Theory

It was developed in the 1950s through the 1970sa and considered an important advance in
the mathematical modeling of finance. Since then, many theoretical and practical criticisms
have been leveled against it. This includes the fact that financial returns do not follow a
Gaussian distribution and indeed any symmetric distribution, and those corrections
between asses class4s, Michal, Sproul (1998).

Portfolio theory of investment which tries to making portfolio return for a given amount of
portfolio risk, or carefully choosing the proportions various asses. Although portfolio
theory is widely used in practice in the financial industry and several of its creators won a
noble prize for the theory, in recent years the basic portfolio theory have been widely
challenged by fields such as behavioral economics, Marckowitz (1952).

2.2.4. Capital Asset Pricing Model

William Sharpe (1964) published the capital asset pricing model (CAPM) parallel works
was also performed by Treynor (1961) and Lintner (1965). CAPM extended Harry
Markowitz‟s portfolio theory to introduce the nations of systematic and specific risk. All
investors will hold the market portfolio. As the market moves, each individual asset is
more or less affected. Specific risk is a risk which is unique to an individual asset. It
represents the components of an asset‟s return which tis uncorrelated with general market
moves, Lintner, (1965).

The key element of the model is that it separates the risk affecting an asset‟s return into
two categories. The first type is called unsys5temtic or co0mpany specific risk. The long

10
term average returns for this kind of risk should be zero. The second type of risk, called
systematical risk is due to general economic uncertainty. The CAPM states that the return
as assets should on average, equal the yield on a risk free bond held over that time the
stock possesses, Markowitz (1952). In general, unsystematic risk is present due to the fact
that a very company is endowed with a unique collection of assets, ideas and personnel
whose aggregate productivity may vary.

2.3. Determinants of Loan Performance

2.3.1. Interest Rate in Credit Management

Godquin, (2004) marked the beginning of attempts at explanations of credit rationing in

the credit management markets. The asserted that interest ratio charged by a credit
institution are seen as having a dual role off sorting potential borrowers (lending to adverse
selection), and affecting the actions of borrowers (lending to the incentive effect).
Weinberg (2006) advocated that interest charged and the amount of debt are two main
factors affecting repayment obligation. Some banks use the interest rate that an individual
is willing to pay as a screening device to identify borrowers with a high probability of
repayment. This may be dangerous since high risk takers are the worst rate payers, in the
process of affecting default by bowwows on loan.

2.3.2. Loan size in credit Management

Von Piscke (1991) noted that efficient loan sizes fit borrowers‟ repayment capacity and
stimulate enterprise. If the amount of loan released is enough for the purpose of intended, it
will have a positive impact on the borrowers‟ capacity to repay. If the amount of loan
exceeds what the borrower needs and can handle, it will be more of a burden than help and
extra funds may go toward personal use Norell, (2011), there by undermining repayment
performance. If the loan is too small, it may also encourage borrowers to diver the loan to
other purposes, Vigano, (1993).

However, from the lessons derived from micro finance programs UNDP, (1997). Micro
finance institutions extend small, short term primarily for working capital on simplified

11
terms. Small short term loans are intended to test the clients commitment to repay and
allow client to learn on the loan.

2.3.3. Loan Value

The second- best perspective of improving repayment performance is by increasing the

value of outstanding debts repaid on time. The MFI deals with credit applications coming
from borrows heterogeneous in there localization, lending group, ability and preferences.
The behavior of the loan borrower i.e demand for credit and repayment is also a
consideration to the size and duration that maximizes his expected return. For a given
borrower and duration of the loan, it is argued Fremer and Gorden, (1965) that the
repayment probability decreases with the size of the loan.

2.3.4. Saving Rates

Credit is linked to saving, and in most cases loan sizes are relates to the amount each
borrowers has saved. Saving can play a significant role in increasing levels of institutional
sustainability and enhancing levels of outreach. Therefore, MFIs that offer saving facilities
have a cheap source of funds for further lending to more sustainable operations- on the
other side, voluntary saving builds the equity of poor households and protects then against
unforeseen economic and personal crisis (AEMFI, 2010). Zeller (1996) also agree with the
importance of saving to influence the repayment rate.

The micro finance information exchange (MIX) reports that African regional deposits,
made up 54% gross loan portfolio. In contrast, voluntary saving representation merely 22%
of the Ethiopia micro finance portfolios (AEMFI, 2010). In case of Addis credit and saving
institutions, mobilizing voluntary saving is only 10% of their gross loan portfolio.
Therefore, the microfinance sector in Ethiopia still depends on denoted funds and has not
been in a position to finance its future business by generating income operation (NBE,
2010).

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2.4. Loan Policies
Loan policy provide a general rule to guide decisions concerning credit management. It
also provides a framework for a credit management process. They set standard and
parameters to guide managers and credit officers in evaluating, granting and loan
monitoring and follow up actions. They provide directors, regulators, auditors with a basis
for evaluating performance Me Naughton, (1992). Credit terms such as interest change,
loan size, loan period, collateral requirement and eligibility criteria credit standards and
collection effort Pandey (1995). It is therefore, important to scrutinize the three loan policy
decision variable portfolio performance.

2.5. Empirical Studies

Olomola (2002) found that repayment performance is significantly affected by borrowers
characteristics,, lender characteristics and loan characteristics repayment problems can be
in forms of loan delinquency and default. Whatever the forms, the borrowers alone cannot
be held responsible wherever problems arises; it is important to examine the extent to
which both borrowers and lends comply with the loan contract as well as the nature and
duties responsibilities and obligations of both parties as reflected in the design of the credit
program rather than heaping blames only on the borrowers.

Reta (2011) carries out a study on determinants loan repayment performances using on a
case study in the Addis credit and saving institution, Addis Ababa, Ethiopia. The objective
was to analyze and identify the factors that influence the loan repayment performance of
the beneficiaries of ADCSI micro finance institution. In order to alluvia this objective,
primary data was collected from 200 randomly selected clients (100 defaulters and too non
defaulters) by using structured interview. Moreover, secondary data were obtained from
the record of ADCSI the data analysis involved, descriptive statistics including mean,
frequency and percentages to describe the socio economic characteristics of the borrowers.
Moreover, t-test and chi-square analysis were employed to compare the defaulters group
and non-defaulter also. A binary log it model was used to analyze the socio economic
factors that influence loan repayment. A total of twelve explanatory variables were
included in the regression. Out of these, six variables were found to be significant for the
probability of being defaulter. Age and five business type (Baltina and petty market, kiosk

13
and shop, service providing, weaving and tailoring and urban agriculture) were important
in influencing loan repayment performance of the borrower. In addition, sex and business
experience of the respondents were found to be significant determinants of loan repayment
rate. ADCSI has a number of internal and external problems like shortage of loanable
funds for further expansion, competition and improper interference of third party in the
decision of loan approval.

Gestel and Baesens (2009) risk managements is primarily concerned with reducing
earnings volatility and avoiding large loses. In a proper risk management process, one
needs to identify the risk, measure and quality the risk and deve4lopmenyg strategies to
manage the risk. The highest concern in risk management is the most risky products.

Korie etal (2012) carried out a study on determinates of loan repayment of microfinance
institutions in south east states of Nigeria. The objectives of the study was to analyze the
loan repayment performance, institutional factors, and factors affecting repayment rate of
MFIs in the south-east states of Nigeria. It was carries out the three states namely, Eboni,
Engu and Imo, out of the five south east states. Using across sectional data a multi-stage
sampling technique was employed in selecting a total of 36 MFIs from the three states that
is 12 MFIs per state. The three states purposely selected based on the performance index of
United Nations Development Program in the selection of micro start projects which made
the final list in the south east states of Nigeria. For the sample size four MFIs were chosen
each from formal, semi-formal (NGOs) and informal (rotating saving and credit
associations). Results from the study, affirmed with higher quality and well-motivated staff
than the semi-formal and informal segments.

Korir (2011) study was to investigate the impact of credit risk management practices on
the financial performance of Deposit taking institutions in Kenya. The study used a
descriptive survey approach of respondents. The number of respondents was 36 staff
working in all licensed deposit taking microfinance institutions in Kenya.

From the findings the study concludes that deposit taking MFI, in Kenya adopted credit
risk management practices to counter credit risks they are exposed to ands it also concludes
that deposit taking MFIs adopt various approaches in screening and analyzing risk before

14
awarding credit to clients to minimize on loan loss. This included establishing capacity,
conditions and use of collateral and character of borrowers were used in screening and risk
analysis in attempt to reduce credit risk. The study further concludes that there was a
positive relationship between credit risk management practices and the financial
performance of deposit taking micro finance institutions.

2.6. Summary of Literature Review

Studies have shown that even through banks are affected by many types of risk, the main
type that has to be measured and monitored closely is the credit risk. Mismanagement of
this type of risk has been found to bring about the occurrence of non-performing loans and
ultimately the bank rapcy of financial institutions facing major financial crises in various
corners of the world affecting both developing and under developed economies.

Various studies also show that credit risk management practice improved on performance
in microfinance institutions. For instance, Mutrie, (2001) studied the relationship between
credit scoring practices in Kenya commercial banks and NPLs. From the review of
literature, study focus on influence of credit risk management and effects on the
performance. This study aims at researching on credit risk management practice and loan
performance of Addis Credit and saving institution in Addis Ababa, Arada Sub city.

15
 CHAPTER THREE
3.1. Introduction

This chapter is a presentation of results and findings obtained from field data, both
descriptive and inferential statistics have been employed specifically using statistics to
establish the significance of the model and also to establish the link between credit risk
management practices and microfinance institutions in ADCSI. The first section presents
the results of the survey, interview questioner and observation of documents. Next, in the
second section the results obtained by using all methods (questionnaire, interview and
documents) are combined and analyzed to address the research question.
3.1.1. Survey results

Table 3.1: survey response rate

Total Sample size 25

Completed and collected questionnaires 22
Response rate 91.67%
Source; survey results 2017

Data for the analysis in this study were collected from 24 employees of Addis credit and
saving institutions located in Addis Ababa, Arada sub-city. Those employees were selected
randomly and a response rate of 91.67% was achieved. Some customers did not participate
because they are too busy and unwilling to be one of the respondents. The questionnaires
that were physically distributed are about 25. Out of the whole 25 distributed
questionnaires 22 were completely collected. Therefore, the response rate is 91.67%

16
Table 3.2 Demographic characteristics of respondents (employees)

No Item Frequency of responses

Sex No %

Male 10 45.45

Female 12 54.55

Total 22 100

2 Level of education No %

Technical /Vocational 10 45.45

certificate(diploma)
Degree 12 54.55

Masters - -

Others - -

Total 22 100

3 Work experience

Less than 6 years 11 50

6-10 years 6 27.27

11-15 years 2 9.09

16-20 years 2 9.09

Above 20 year 1 4.54

Total 22 100

Source; survey results 2017

From the table we understand that from the target employees 45.45% are females and the
rest 54.55 are male.

With regard to the educational status of respondents, about 54.55 percent had degree and
while 45.45 percent have diploma. When we see the working experience of employees the
table shows from the total population (22) 11(50%)have an experience of less than
6,6(27.27%) have an experience of 6-10,2(9.09%) have worked from 11-15,2(9.09%) have

17
worked from 16-20 and 1(4.45%) has experienced over 20 years. From this demographic
data we can conclude that from the starting point work experience is one of the important
determinant of managing credit risk and loan repayment performance is the experience of
the employees who works smoothly with the worker. as we have seen from the table most
of the workers 50% of the employees are worked less than 6 years.

3.1.2 Analysis and interpretation’s from the questioner’s

Table 3.3 use of banking system for the customer

No Item Frequency of response

1 Does your institution use banking No %

system for the client to repay the
payment?

Yes 22 100

No - -

Total 22 100

Source; survey results 2017

As we have seen from the table ADCSI does not use modern core financing (banking
system) and for this the employees gave different reasons like: mostly the check users have
no enough mone on their account and gave the payment receipt which has risk and also it
takes time when the bank processes, they use a manual system/excel which our employees
and customers are accustomed, in addition to this those employees who worked in wereda
level answers that the reason that we did not use banking system was that since our
customers are small business runners and low societies whose educational background is
low we do not need banking system. In general, the managers of ADCSI in Arada sub city
has said that we are on the way in the near future we will begin the system. we did not use
before this time because the institution has begun in the last few years it has on an infancy
stage. Therefore, there is a direct relationship between loan performance and the system
itself which adversely affects loan repayment because there is distance, change of location
and time which can be avoided by the system.

18
Table 3.4. Criterion

No Item Frequency of response

2 Do all the customers full fill the No %
criterions?
Yes 19 86.36
No 4 13.64
Total 22 100
Sources: survey questionnaire 2017

In table 3.4 item no 2 it is depicted that 12(86.36%) of the employees witnessed that the
customers know all the criterion were as only four said that all the customers don‟t fulfill
all the criterion. This indicates that the most of the customers 86.36% have fulfilled the
criterion but some of them don‟t, because of different reasons. For example, since the
institution uses social collateral or group lending method, the institution expected positive
pressures of customers over the other customer.

Table 3.5 risk identification

No Item Frequency of response

3 Which one of the following risk is No %
mostly happen and riskier in your
institution?
A. Liquidity risk 3 13.64
B. Market risk 3 13.64
C. Credit risk 16 72.72
D. Foreign risk - -
Total 22 100
Sources: survey questionnaire 2017

The table insists that in MFI credit risk is the most difficult and always happen which is
around 72.73% which indicates it needs a great attention on the management of credit risk.
Most of the customers are unable to repay their debt due to management problem. Three of
the employees said (13.63%) there is a market risk which we could not compete with other
institutions like banks. And the other 3(13.63%) said liquidity risk is difficult for the

19
company which we cannot got enough cash due to lag payment of the customer that leads
to low working capital.

Table 3.6 risk identification

No Item Frequency of response

4 Do you have any mechanism to No %

differentiate the entrepreneurial
quality of the client?

A. Yes 18 81.82

B. No 4 18.18

Total 22 100

Sources: survey questionnaire 2017

From the above table we can conclude that 81.82% of the institution differentiates the
entrepreneur quality of the client means that they had seen the client‟s collateral, capacity,
character, conditions etc. But the rest 18.18% of the employees had said that they did not
check the entrepreneur quality of the client. This is why those answers are given by
employees of weredas i.e. in that area most of the clients need a small amount of birr and
also there is a group lending system which did not emphasize on the entrepreneurial
quality of the client because their collaterals are there groups and the organization. In
general, even if the amount of money they lend are small the default risk is high in the
group lending system which leads or affects the performance of the loan.

Table 3.7. Criterion

Item Frequency of response

No
No %
5 Do you give any training how the
customers use the loan?
A. Yes 22 100
B .No - -
Total 22 100
Sources: survey questionnaire 2017

20
The above statistics shows that ADCSI gave 100% training for his clients how to use the
loan and it is one of the institutions credit policy to meet its objective. Therefore, giving a
training could minimize the default risk and increases repayment performance of the
customer and profitability of the institution.

Data analysis from the open ended question

In addition to survey of employees in closed ended questions, the researcher had used open
ended questions to get elaborative answers and information.

Challenges of giving a loan

Some of the challenges faced during the giving of the institution or taking of the customer
are the following:

 No enough collateral either human or material

 lack of mandatory documents
 Problem of getting the amount needed due to lack of collateral.
 Lack of commitment in the group (in group lending) or unwillingness of the member.

3.2. Challenges during Repayment Process/period

As indicated in the above questioners, there are different difficulties that face during the
period of repayment. Those are borrowers used the loan they get from the institution for
unintended purposes such as ceremony, wedding clothing and others. Due to this they
cannot be profitable rather than being the owner of much accrued debts and they cannot
pay the loan properly based on the agreement. And other difficulties that face during the
repayment period are:

1. Unwillingness of borrowers to pay their loan.

2. Due to little knowledge of borrowers about the amount interest paid they are not
good to repay the principal with its interest.
3. They have bad feelings with the institutions during the due date of the loan.
4. Customers do not use the loan according to the agreement that leads to fail to repay
the interest.

21
 5. Customer change address due to this location problem which is related to distance
clients do not pay on time.
6. Failure of the business

As we had seen from the above points from the challenge of taking the loan the most and
sires problem is getting back the loan. Therefore, we should focus on the repayment terms
selection criteria and the history of the client because borrowers are not that much good to
repay their loan timely.

Measurement taken on low performing customers

 phone calling
 field supervision and asking the reason why not pay on time.
 penalty
 litigation (going to court)
 snatching the property of the client(collateral)

22
 3.3. Credit risk management practice
3.3.1. Credit risk identification (selection criteria)

Table 3.8 risk identification

NO
. SA A u D S To
Items D tal
Fr % Fr % F % Fr % Fr % Fr %
r
1. Analyze the business 9 40.91 10 45.45 3 13.63 - - - 22 100
plan to identify risk
exposure.

2. Consider 6 27.27 10 45.45 4 18.18 1 4.54 1 4.54 22 100

professionalism in
the respective area.

3. Consider capacity of 10 45.45 8 36.36 4 18.18 22 100

the applicants.
4. Looking at the long 5 22.73 10 45.45 3 13.63 2 9.09 2 9.09 22 100
term planning
horizon of every loan
applicant.
5. looking at the 6 27.27 11 50 3 13.63 2 9.09 - - 22 100
conditions i.e.
economic, political
and social condition
before we finance a
proje.

6. Consider the net 6 27.27 8 36.36 6 27.27 - - 2 9.09 22 100

worth of the business
.
7. Consider the past 5 22.73 8 36.36 8 36.36 1 4.54 - - 22 100
track record of
repayment .
8. Looking at the 6 27.27 13 59.09 3 13.63 - - - - 22 100
character of loan
applicants
9. looking at the credit 5 22.73 9 40.91 7 31.81 1 4.54 - - 22 100
trustworthiness of
loan applicants
Source: survey results 2017
SD= strongly disagree D = disagree SA= strongly agree A=agree U=uncertain

23
The above table (3.8) had shown the results of the Likert scale questioners in tabular form
and the researcher analyses in words in the following ways. In general, the above table
results are selection criteria questions. The first item in relation to analyzing the business
plan of the client 10 respondent‟s (45.45%) gave their opinion to agree,9(40.91%)strongly
agree and few respondents 3(13.63%) were uncertain. Therefore, almost all respondents
identify the risk by analyzing the business plan of the applicant.

In the second item with professionalism consideration, 10(45.45%) agree with this
idia.69(27.27%) strongly agree,4(18.18%)were uncertain(4.54%)disagree and 1(4.54%)
strongly disagree. From this we can conclude that above 50% of the respondents consider
the entrepreneur quality of the client by considering their professionalism. But few of them
did not have an idea about it and few disagrees with the criteria.

Capacity of the client is one of the selection criteria to run a business. For that
resean,10(45.45%)of the respondents strongly agree 8(36.36%)agree(18.18%)of the
respondents are uncertain. This result shows almost all credit management body considers
the capacity or financial strengthen of the loan applicant when they give a loan.

Item number 4 consideration of long term planning horizon of the applicant

6(27.27%)strongly agree, 10(45.45%) agree,3(13.63%)uncertain 2(9.09%) disagree and
2(9.09%)strongly disagree. Even if, majority of the respondents had seen the criteria few of
them did not consider the long term horizon due to their loan is for short term purpose.

The other selection criteria to minimize credit risk is the condition such as: economic,
political and social issues. When we saw in practice half 11(50%) of the respondents agree
with this criteria(27.27%) strongly agree(13.63%)respondents are uncertain and
2(9.09%)disagree with the condition criteria due to its un occurrence nature.

From item number 6, net worth of the business consideration 6(27.27%)strongly agree
8(36.36%)agree(27.27%)uncertain and 2(9.09%)strongly disagree this idea. Although net
worth or profitability is one of the selection criteria some creditors who worked in the
institution did not consider it.

24
If the borrower was a customer of the company or taken a loan before this time one of the
selection criteria is mainly the past history or loan repayment performance of the loan
applicant is mandatory. As a result ,5(27.73%)strongly agree ,8 (36.36%) agree ,8
(36.36%)uncertain and 1(4.54%)disagree with this criterion.

One of the credit policy from the 5c‟s is character of the loan applicant therefore
,6(27.27%)strongly agree, 13(59.09%)agree and 3(13.63%)respondents were uncertain.
Around 86.86% of the respondents follow this criterion.

The trustworthiness or reliability of the client /loan applicant is also another criterion for
the loan applicant. Due to that 5(22.73%)of respondent agree, 9 (40.91%) agree, 7
(31.81%)uncertain and 1(4.54%)respondents disagree the criteria. Generally, the above
selection criteria are analyzed in this way and developed with recommendation with the
next chapter.

25
 3.3.2 Credit risk minimizing and rating

Table 3.9 Risk minimizing

NO
SA A U D SD Total
Items
Fr % Fr % Fr % Fr % Fr % Fr %
1. Hefty 10 45.45 12 54.55 - - - - - - 22
penalties are
charged on
loan
defaulters
2 Our clients 8 36.36 10 45.45 - - 2 9.09 2 9.09 22 100
are requested
to provide
guarantees
3 Loans are 6 27.27 14 63.64 2 9.09 - - - - 22 100
awarded after
signing of a
binding
contract
4 Management 7 31.82 10 45.45 3 13.64 1 4.54 1 4.54 22 100
report to
board of
directors on
non-
performing
loans
5 We 8 36.36 12 54.55 2 9.09 - - - - 22 100
participate in
loan portfolio
hedging
against risk
Source: survey results 2017
Although it is difficult to control or avoid risk, it is possible to minimize it by using
different techniques or methods. Table 3.8.1 shows the mechanisms of credit risk
minimization which is analyzed in the following ways.

26
On item no. 1 charging hefty penalties on loan defaulters 10(45.45%) of the respondents
are strongly agree and 12(54.55%) are agree with the mechanism. This results shows that
penalties are the good mechanism of minimizing loan defaulters. Item no. 2 providing loan
based on clients guarantee 8(36.36%) strongly agree, 10(45.45%) agree, 2(9.09%) disagree
and 2(9.09%) of respondents are strongly disagree .in item no. 3 giving loan after signing
of a binding contract 6(27.27%) are strongly agree, 14(63.64%) agree and 2(9.09%) of the
respondents are uncertain. This result shows that if things are done before the customer has
a chance to gain the loan after signing the contract. Item no. 4 management report to the
board of director on the non-performing loan 7(31.82%) responds strongly agree
10(45.45%) agree(13.64%) uncertain(4.54%) disagree and 1(4.54%) of the respondent
strongly disagree. Item no. 5 participating in loan portfolio hedging against risk 8(36.36%)
strongly agree 12(54.55%) agree and 2(9.09%) of respondents are uncertain about this
mechanism. Generally, those the above mentioned criteria are used used by the institution
that minimizes the credit risk problem and to increase loan performance of the client.

27
 Table 3.10. Risk rating

NO
S A u D S Tota
Items A D l
Fr % Fr % F % F % Fr % Fr %
r r
1 The micro finance 7 31.82 11 50 3 13.64 1 4.54 - - 22 100
has an internal
credit rating
system.
2 We do credit rating 5 22.73 3 13.64 4 18.18 7 31.82 3 13.64 22 100
for all loans
3 The micro finance 11 50 10 45.45 1 4.54 - - - - 22 100

has a loan
classification
procedure
4 The micro finance 10 45.45 12 54.55 - - - - - - 22 100

has limits on the

amount of
loan one can get
5 The micro finance 8 36.36 12 54.55 2 9.09 - - - - 22 100
has a credit
committee
6 The micro finance 9 40.91 11 50 1 4.54 - - - - 22 100
has a lender
approval limit for
loan issued
Source: survey results 2017
Managements have different mechanisms to measure the loan repayment performance of
the client. From those mechanisms the institution has its own internal credit rating system

28
to check whether customers are performing based on the agreement of the loan or not.
Table 3.8.2 shows those risk rating methods.

Item no.1 internal credit rating system of the institution 7(31.82%) responds strongly
agree,11(50%) agree,3(13.64%) uncertain and 1(4.54%) respondent disagree. As result,
above 80% of the institutions employees have done well with this system.in item no.2
rating for all loans 8(22.73%) strongly agree,3(13.64%) agree,4(18.18%) uncertain
7(31.82%) disagree and 3(13.64%) of the respondents are strongly disagree. This indicates
that those who have said disagree and strongly disagree respondents are worked in small
micro enterprises who are tied for short term loans but in the head office in arada branch it
is used. Item no.3 on loan classification presider 11(50%) respondents strongly
agree,10(45.45%) agree and 1(4.54%) responds uncertain. This means that based on the
selection criteria those loan applicants are classified based on the amount needed. Item
no.4 on the loan limit 10(45.45%) strongly agree and the rest12(54.55%) agree.it shows
those loan applicants cannot get the amount of money they want because it has its own
limit criteria. Item no.5 about credit committee 8(36.36%) respondent strongly agree
,12(54.55%) agree and 2(9.09%)respondent is uncertain. This shows there is a structured
credit committee in the institution like other committees. Item no.6 approval of the limit
for the issued loan 9(40.91%) respondents are strongly agreeing,11(50%) agree and
1(4.54%) respond uncertain. Therefore, the result shows there is a flow/chain of
management system.

Generally, those risk rating criteria‟s are used to control the internal working capacity of
institution as well as the externals by differentiating loan defaulter‟s and performers
according the rating criteria.

29
 3.3.3. Credit risk assessment (monitoring mechanism)

Table 3.11: Credit risk assessment (monitoring mechanism)

NO Items
SA A N D SD Tota

Fr % Fr % Fr % Fr % Fr % Fr %
1 Periodically 4 18.18 16 72.73 2 9.09 - - - - 22 100
assess funded
projects
2 Have a credit 10 45.45 12 54.55 - - - - - - 22 100
evaluation
committee
3 Have monthly 10 45.45 8 36.36 4 18.18 - - - - 22 100
review of loan
performance
4 Have a loan 3 13.64 17 77.27 1 4.54 1 4.55 - - 22 100
recovery
mechanism
5 Calculate ratio 6 27.27 13 59.1 3 13.64 - - - - 22 100
analysis for
profitability,
efficiency,
leverage
6 Analyze growth in 6 27.27 15 68.18 1 4.55 - - - - 22 100
sales of our clients/
Borrowers
7 Periodically 8 36.36 14 63.64 - - - - - - 22 100
assess credit
quality of our loan
portfolio
8 Invest in different 4 18.18 7 31.82 5 22.73 2 9.09 2 9.09 22 100
loan products
9 Decision to - - - - 5 22.73 10 45.45 7 31.82 22 100
diversify our
investment is only
made by
Management
10 Our loan portfolio 7 31.82 10 45.45 5 22.73 - - - - 22 100
is fully insured
Source: survey results 2017
After giving the loan for the loan applicant by following the selection criteria which are
listed in table 3.8 the next step is assessing or monitoring the business by different follow

30
up and supervision mechanisms to have a good loan performance and to be profitable. So
that differ questions were asked and responded by the respondents to check or monitor the
business, the opinion of them are analyzed in the following section.

From table 3.9 item number 1, for the periodic assessment of funded projects 4(18.18%) of
respondents are strongly agree 16(72.73%) of them agree(9.09%)are uncertain. In general,
above 90% of the respondent uses this mechanism which is used to minimize uncollectible.
In item no.2 related the credit evaluation committee 10(45.45%) of the respondent strongly
agree 12(54.55%) agree, that means that all the works are done by the committee members
and are known by the employees of the company. Therefore, this committee have their
own responsibilities on the profitability and default risk of the company and they are
accountable the they have done. Item no. 3 on monthly review of loan performance
10(45.45%)respondents are strongly agreeing 8(36.36%)agree, and 4(18.18%) of
respondents are uncertain. This mechanism is also followed by the institution which is
good for the loan performance. Item no. 4 with the loan recovery mechanism 3(13.64%)
strongly agree 17(77.27%) agree,1(4.54%) uncertain and 1(4.54%) of the respondents
disagree. even if this mechanism is followed by majority of the respondents few of them
are unfamiliar with this criterion. In item no. 5 related ratio analysis like profitability
efficiency and profit margin analysis the company is followed 6(27.27%) strongly agree
13(59.1%) agree, and 3(13.64%) of the respondents are uncertain about the mechanism.
Item no. 6 analyzing growth in sales of the borrowers 6(27.27%) strongly agree
15(68.18%) agree(4.54%) are uncertain. This shows that almost all employees analyze the
growth of sale as a monitoring mechanism. Item no. 7 periodical assessment of the loan
applicants credit quality 8(36.36%) respondent‟s opinion is strongly agreeing, the rest of
the respondents 14(63,64%)of them are agree. Item 8 about diversification of the loan
product which is one mechanism of avoiding risk putting the business in different
functional areas.in relation to this 4(18.18%) of the respondents were strongly
agree(31.82%) agree(22.73%) uncertain(9.09%) disagree and 2(9.09%) of the respondents
are strongly disagree. This mechanism is not as effective as the other mechanisms because
half of the respondents are not good enough to follow this mechanism as an assessment of
credit risk management. Item no.9 decision of the investment made only by the
management no respondents are strongly agree or agree(22.73%) of them are uncertain

31
10(45.45%) disagree and 7931.82%) are strongly disagree. Therefore, this results shows on
the investment decisions all stockholders of the institution are participated with the
management about the investment which is a good trend. Item no.10 company‟s loan
portfolio insurance 7(31.82%) respondents are strongly agreeing 10(45.45%) agree and
5(22.73%)of the respondents are uncertain about the insurance policy of the loan.
Generally, from table 3.9 about the monitoring mechanism or risk assessment mechanism
except item no.9 decisions made by management majority of the other items are used as a
monitoring mechanism which increases the performance of loan repayments.

3.4. Data analysis from secondary sources or Documents

In addition to the aforementioned techniques for collecting data‟s the researcher also
revises financial statements and annual reports regarding to repayment performance of the
institution, Addis credit and saving institution. The financial reports, (disbursement,
collection and defaults) for four successive years were taken from the institution. The
researcher uses those financial reports for measuring the loan performance in relation with
their credit management system of the institution by comparing and contrasting the four
years results. The results are show below.

Table 3.12 ADCSI 2013-2016 YEAR END REPORTS

YEAR Disbursement
No.of Amount Collection Default % of
customer default
2013 32641 838940066.42 504799377.26 75412961 8.99
2014 33572 1487569654.6 834280614.6 86312540 5.8
2015 39214 2105268695.4 988415750.10 96938850.83 4.6
2016 32198 1812630412.56 1697899078.87 102050019.49 5.63
Source; Financial statements of ADCSI

From the above table we can conclude that the default risk minimizes from time to time
except the last year case. This data shows that the repayment performance of the client
increases from time to time. therefore, the secondary gained from the documents meet with
the primary data that we collect.

32
3.4.1 Credit Policy and Collateral

In addition to documents ADCSI has the following policies in terms of interest rate it
charges 9% of lending interest for installment and micro lease and 9% for term loans
per annum on flat rate basis and 2% service charge is paid for all micro lease and small
loans. For the housing and consumption loan, the interest rate is 10% per annum on
decline rate basis. As noted in the manual loan size and time of repayment is as shown
below:

Table 3.13 loan size and repayment period

Loan size (birr) Maximum time allowed for repayment(

in month)
Up to 200 Up to 18
2001-5000 24
Above 5000 36
Term loan 18
Housing loan 60
Source, manual of ADCSI

From the above table we can conclude that when the amount of money borrowed
increases the time of payment period increases which may affect loan performance
either positively or negatively. In addition, to that the credit payment period is related
with the type of business they are doing. For profitable businesses and small
enterprises 36 month, for mortgage 60 month, for short term credit 10 month, for
private(consummation) purpose 24 months, for agricultural purpose 18 month which
paid once and for buying automobiles 50 months.

3.4.2. Factors that affect Loan Repayment Performance

1. Age: Vigano (1993) noted that with increase in age, it is usually expected that borrowers
get more stability and experience. In this regard the researcher founds this variable to have
a positive impact on repayment performance. Since as people get older, their ability to
effectively use finance and generate income declines, but their choice to invest is with

33
minimum risk level. The elders like to have a constant income where as adults are risk
takers and like to invest that generates the highest return.

2. Educational Level of Borrower: This factor has a positive impact on repayment

performance in general. Considering normal circumstances, a more educated borrower is
expected to use the loan effectively as compared to a less educated one. However, in the
survey all respondents were able to repay their liability, there is no difference between.

3. Loan size: The loan size affects the repayment performance both negatively and
positively. If amount of loan released is enough for the purposes intended, it will have a
positive impact on the borrower‟s capacity to repay. If on the other hand the amount of
loan exceeds what the borrower needs and can handle, it will be more of a burden than
help, thereby undermining repayment performance. Also positive or negative sign may be
expected if the loan is too small. If the loan is too small, it may be easy to repay such loans
thus enhancing performance (i.e. positive sign). However, too large loan cannot have
repaid periodically. They elongate the repayment period because of their inability to repay
the loan & as the period enlarges the size of loan increases and also this may lead to be
defaulter totally

4. Suitability of Repayment period: It is fact that borrowers who find the repayment period
suitable, perform better. Hence about 90% of the respondents are in suit to the institutions
loan repayment period and they can repay their liability, so suitability of repayment period
has positive effect.

5. Availability of other sources of credit: If borrowers have other sources of credit, they
may use these sources to be able to settle their loan obligation in case they want to
continue borrowing from the same source. In this study most of respondents have no other
source of loan.

6. Number of years of waiting as being customer; from the respondents file, based on
number of years as being customer, the researcher founds that as customers‟ gets
experience through long time they become as being familiar with the institutions rules and
regulations. And also they their loan for the intended purpose effectively. If a borrower is a
repeat borrower he/she may have acquired more experience on the institution‟s rules and

34
regulations, and hence could efficiently utilize the loan for the intended purpose. Since it
has a positive impact on loan repayment performance.

Solidarity Group Collateral

Peer pressure collateral- Loan clients who are going to use this guarantee alternative has to
establish a group whose member shall range from 3 to 5. Under this scheme a group
member has to assume responsibility for any unpaid loan balance by the group members.

Group leader guarantee /Collateral – it is similar to the above method except that, this
method shall give more responsibility to the group leaders for the unpaid balance of the
loan. The group leader in this case is required to make ready some property or person as
co-signer.

Cross guarantee /collateral- under this scheme all members of the group are required to
provide family or any other person as collateral. Although for any unpaid balance of a
loan, the first responsibility is given to group members the cross collateral has
responsibility for whom they sign for. Micro leasing loan guarantee – individual,
organization or any other institutions that will give protection of machine/ equipment
movements by any third party or customer from a given agreed up on places. Personal
guarantee – the loan will be extended for the client based on the written agreement of the
employer. Loan extended in this manner will not exceed birr 50000.00 unless otherwise
special decision is made.

Property collateral

A loan shall be given based on property collateral. There are different alternatives of this
type:

 House collateral- for individual as well as enterprises whose loan requirement

exceed birr 50000.00, it is possible to make the collateral from own property or any
other third party, as long as, the house is in the capital city or Oromia region
surrounding Addis Ababa Oromia zone.
 Vehicles- any vehicles which are legally registered in Addis Ababa and nearby
Oromia zone transport authority not before 10 years will be used as collateral for

35
 loan. This type of collateral will be used only for loans which does not exceed birr
10000.00
 Machines- machines which cannot move easily from place to place and which are
registered through trade and industry bureaus will be used as collateral. The value
of the machine has to be more than 50% of the loan and its purchased date should
be on or latter than 5 Years.

Saving collateral

All saving clients of the institution are allowed to take a loan if they need so by using their
savings as collateral. The amount of loan extended in this manner will not be more than of
his/her savings.

Saving deposit on banks other than the institution- anyone who needs loan from the
institution can use their or others savings deposited in any commercial banks as collateral.
In order to use this alternative, the bank has to provide written document for the institution,
which indicate the bank will not allow the depositor to withdraw its savings unless prior
confirmation of the institution are given. Receivables- a person/group or cooperatives,
which have any receivable from governmental and nongovernmental organization, will be
allowed to take a loan up to 75 % of its receivable with a written confirmation from the
employer. Check with some other collateral- this type of collateral will be allowed only for
a short term loan type. The collateral applies in a way that, the loan client or any other
person will sign a postdated check to be paid to ADCSI at the maturity date of the loan.
The signer should have to accumulate a sum of money at the end of the loan term in his/her
account. Educational testimony with family co-signing- graduates of technical and
vocational school or any other higher education can use their educational documents as
collateral for a maximum amount of birr 5000.00. In addition to that the college has to be
willing to confirm the institution that it will not deliver the original document to the client
until it is told to do so

Business collateral- repeat borrower of the institution who are well known by their regular
repayment of their loan are allowed to be a guarantor for a third party loan up to birr
5000.00. Beside repeat borrower of the institution, well known in their repayment of loan

36
whose business capital are estimated to be more than birr 50000.00 can access a loan up to
birr 10000.00 using their business property as collateral. Insurance bond- if a client has an
insurance coverage at a well-known insurance company and the insurance company is
willing to give a written confirmation which specifically indicate that, if in case the client
is unable to repay the loan within /according the schedule the insurance company will be
willing to pay for ADCSI, the un paid balance, then the client will be allowed to take 75 %
of its insurance coverage.

37
 CHAPTER FOUR

4. CONCLUSION AND RECOMMENDATION

This chapter as a whole presents the concluding remarks for the main findings of the
research and important recommendations as per the main problems investigated in this
research study respectively.

4.1. Conclusion

Both primary (interview questionnaire) and secondary sources (documents) were used to
carry out the study. A number of specific research questions were developed based up on
the general objective of the research. In order to accomplish this general objective, the
researcher used mixed approach. Mostly it uses questionnaire for the purpose of obtaining
a primary data from the targeted respondents. In the selection criteria the study finds out
collateral is one among the main requirements for assuring the lending institution‟s
repayment performance of loan provided for the clients. This is the reason why most of the
financial institutions did not grant a loan without any collateral. Since bounding the
borrower with high valuable collateral make a feeling for them not to lose the property due
to defaulting to repay their loan. In the manual presented above about respondents were
highly collateralized as their loan is higher. As a result, the institution is not granting loan
without any collateral. This enabled the institution to have minimized risk from credit
defaulting. Therefore, borrowers become in a good position to repay the debt.

In the credit risk management practice ADCSI Client appraisal, credit risk control and
collection policy significantly influence financial performance of the company. Due to that
the institution uses the 5‟cs model of client appraisal is used when appraising clients,
therefore microfinance Institutions take a greater consideration on character of the client,
capacity of the customer to Repay, collateral attached as security, history of repayment,
need assessment and size of the business, consider credit insurance, signing of covenants,
credit rating, reports on Financial condition, refrain from further borrowing and
diversification this is because they have a great value of the company.

When we see loan performances of the client there are different factors that are found to be
significant determinants of loan repayment performance from which age, education, loan

38
size, number of years waiting as a customer, availability of other credit sources, and
suitability of loan repayment period. All of these factors except loan size increase the
probability of loan repayment. About 91.7% of the respondents reported that the
repayment period is suitable. This belief is likely to have a positive impact on loan
repayment. All of the respondents believe that loan from such lending institutions is
something to be repaid back. Similarly, all reported that loan was released timely. This
enables the institution to recover its loans. Microfinance institutions should consider the
interest rates they charge on loans; this is because interest rates have a negative effect on
loan performance to a great extent.

There is also need for MFIs to enhance their credit risk control this will help in decreasing
default levels as well as their non-performing loans. This will help in improving their
financial performance.

4.2. Recommendations

 It is recommended that ADCSIs should use the services provided by Credit Reference
Bureaus for the purpose of determining the credit worthiness of borrowers as a means of
minimizing bad debts. CRBs help lenders make faster and more accurate credit decisions.
It is recommended that MFIs needs to invest on debt collections and this will entail hiring
qualified and experienced debt collectors, lawyers so as to increase litigation of defaulters
and auctioneers. It is recommended that management should organize regular trainings in
areas like credit management, risk management and financial analysis. This would sharpen
the knowledge and skills of credit officers so as to improve on the quality of credit
appraisals.

 It is recommended that the institution should use modern core financing which
facilitates payment, avoids extra expense like transportation, timing and also liquidity
risk is minimized and it is advantages to get the money when the client changes
location.
 Even if the credit is not collected with the specified period, the institution must be
ready to make change like;

39
  Increasing the grace period of those activities which require longer period and
sale the product e.g. Metal works wood works.
 Appreciating customer, which pay on time, by giving them a discount and
having strict follow up for those customers, which do not pay on time at the
same time the institution should train and create awareness on its customers
about the time value of money.
 Since the group lending method has problems ask for social guarantee for
those who are suspected based on experience. For example, for those young
customer and illiterate customers.
 It should lend for more than one year and try to lend for individual who are
not grouped .
 The supervision and follow mechanism of the institution is mostly after the default is
happened that should be corrected by adopting continues supervision mechanism
which minimizes the risk and used to take corrective action at the root.

In general, From the findings and conclusion, the study recommends an in-depth study to
be carried out on the relationship between increase in interest rate and loan performance of
MFIs. In order to better the effects of credit information sharing on default risk, there is
need to a study to be carried out to determine the impact of credit information sharing on
loan performance in MFIs, this will assist in MFIs increase loan performance and also
reduce the default risk.

4.3. Limitations of the Study

As it had tried to mention in the scope and limitation of the study in chapter one, this
research has its own limitation in terms of its scope and methodology used. These are due
to time customers (borrowers) information are not included in the questioners to get
additional information. The other limitations are:

 The respondents approached are likely to be reluctant in giving information fearing that
the information sought would be used to intimidate them or print a negative image
about them or their Micro Finance Institution. Some respondents may even turn down
the request to fill.

40
 Unwillingness of the respondents to do the questioners.

 Getting the respondents in bureau is difficult since they mostly worked in fields.
 Respondents are tied up with routine works, which are boride to give response.
 It is difficult to get full information on the open ended questioners.
 Appreciating customer, which pay on time, by giving them a discount and having strict
follow up for those customers, which do not pay on time at the same time the
institution should train and create awareness on its customers about the time value of
money.
 Since the group lending method has problems ask for social guarantee for those who
are suspected based on experience. For example, for those young customer and
illiterate customers.
 It should lend for more than one year and try to lend for individual who are not
grouped
 Lack of proper documentation about the disbursement, collection and profitability.

41
References

ADCSI (2016), Profile of Addis Credit and Saving Institution S.C: financial statements
and Organizational Report. Addis Ababa.

Addisu. (2006). factors affecting loan repayment performance.

Arnold, G. (2003). Corporate Financial Management. New Jersey

Belayneh, D. e. (2005 2006). factors affecting loan repayment performance.

Brigham., Gapenski, L., Dave‟s, P. (1999). Intermediate Financial Management. Florida:

The Dryden press

Conroy. (2013) factors affecting loan repayment performance.

Daniel Kassa. 2010. Credit Management in microfinance institutions in Ethiopia,

Arbaminch University, Arba Minch, Ethiopia.

Federal Government of Ethiopia, proclamation No/40/1996, Addis Ababa, Ethiopia

Florence Angaine1, Daniel Nderi Waari, (2013), “factors influencing loan repayment
performance”, Kenya.

International Journal of Business and Management Review Vol.4, No.4, pp.1-12, May
2016

Jemal Abafita, 2003 Analyzed the microfinance repayment performance of Oromia credit
and saving institution in Kuyu, Ethiopia.

Meaza L. 2010. Loan management and credit facilities, Jimma University, Jimma,
Ethiopia.

Myers, C. & Brealey, R. (2003). Principles of Corporate Finance. New York: McGraw-
Hill

Sommer, S. et al., (1992). Fundamentals of Marketing, peacock publishing Inc.

Tucker, M., Miles, G., 2004. Financial performance of microfinance institutions: a
comparison to performance of regional commercial banks by geographic regions.
Journal of Microfinance/ESR Review, 6(1), pp.41-54

Turyahebwa, A (2013) Financial Performance in the Selected Microfinance Institutions in

Uganda (unpublished master‟s thesis) Kampala International University, West
campus,

Williamson, E. (1981). The Economics of Organization: The Transaction Cost Approach.

The American Journal of Sociology, 87 (3), 548-577

Woolcock, M. (1999). Learning from Failures in Microfinance: What unsuccessful cases

tell us how group base programs work. American Journal of Economics and
Sociology 58(1),17-42
APPENDIXES
Appendix 1
ADDIS ABABA UNIVERSITY
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE
Deer respondents, first of all, I would like to extend my sincere gratitude for helping me by
filling this questioner. The purpose of this questioner is to collect data to be used in the
first degree research on the credit risk management and loan performance of ADCSI in
Arada Sub City. All information you provide here after will be used at most confidentiality
as part of overall response, therefore fell free to provide your valuable response that will
make this research paper successful.
PART1: General profile

Please kindly tick (√) your answer in the appropriate boxes or respond by writing if
required.

1. Gender: Male □ Female □

2. Academic level: Technical / vocational certificate (Diploma) □ Bachelor’s degree
□ Master’s degree □ Other (specify) ___________________________
3. Working Experience

Less than 6 years □ 6 to 10 years □

11 to 15 year □ 16 to 20 years □ Over 20 years □

Part 2: Questions Related to the relationship between credit risk management and
loan performance.
2.1 Loan performance
1. Does your institution use modern core financing (banking system) for the
repayment of loan?
A. Yes B. No
In item no.1 if yes, what are the advantages of it for the customer. list them
___________________________________________________________________
___________________________________________________________________
_______________
 If no, why? state the reason
___________________________________________________________________
___________________________________________________________________
____________________________
2. Do all customers fulfill the criterion?
A. Yes B. No
3. which one of the following risk is mostly happen and risky in your institution?
A. liquidity risk B. market risk C. credit risk D. foreign risk
4. Do you have any mechanism to differentiate the enterprenual quality of the client?
A. Yes B. No
5. Do you give any training how the customers use the loan?
A. Yes B. No
6. List the challenges you have faced and possess in the time of giving and getting
back loan from customers.
_____________________________________________________________________
______________________________________________________________________
What are the relationship between credit risk management and loan performance?
______________________________________________________________________
______________________________________________________________________
What are the measurements you take on low repayment performing customers?
______________________________________________________________________
______________________________________________________________________
__________________________________________________________________.
 2.2. Credit Risk Management Practices
2.2.1 Credit Risk Identification (selection criteria)
Please respond to the following statements by indicating the extent to which you agree or
disagree as per the given choices and tick (√) your answer on the space provided.

No Item of Questions Opinion

5 4 3 2 1

Uncertain

Disagree
Strongly

Strongly
disagree
Agree
agree
1 Analyze the business plan to identify risk
exposure
2 Consider professionalism in the respective
business

3 consider capacity of the loan applicants

4 looking at the long term planning horizon of

every loan applicant
5 looking at the conditions i.e. economic,
political and social condition before we finance
a project
6 Consider the net worth of the business

7 Consider the past track record of repayment

8 at the character of loan Looking applicants

9 looking at the credit trustworthiness of loan

applicants
10 periodically monitor projects financed
 2.2.2 Credit risk control and rating

A. RISK CONTROL

No Item of Questions Opinion

5 4 3 2 1

Uncertai

Disagree
Strongly

Strongly
disagree
Agree
agree

n
1 Clients are vetted before accessing loans
2 Hefty penalties are charged on loan defaulters
3 Loans are awarded after signing of a binding
contract
4 Management report to board of direct directors on
non-
performing loans
5 We participate in loan portfolio hedging against
risk
6 Our clients are requested to provide guarantees
B. RISK RATING

Opinion
5 4 3 2 1
No Item of Questions
Uncertai

Disagree
Strongly

Strongly
disagree
Agree
agree

1 The micro finance has an internal credit rating

system.
2 We do credit rating on all for all loans

3 The micro finance has a loan classification

procedure
4 The micro finance has limits on the amount of
loan one can get
5 The micro finance has a credit committee

6 The micro finance has a lender approval limit for

loan issued
 2.3 Credit Risk Assessment (monitoring mechanisms)
Please respond to the following statements by indicating the extent to which you agree or
disagree as per the given choices and tick (√) on the space provided.

No Item of Questions Opinion

5 4 3 2 1

Uncertai

Disagree
Strongly

Strongly
disagree
Agree
agree

n
1 Periodically assess funded projects

2 Have a credit evaluation committee.

3 Have monthly review of loan performance

4 Have a loan recovery mechanism

5 Calculate ratio analysis for profitability,

efficiency, leverage
6 Analyze growth in sales of our clients/
Borrowers
7 Periodically assess credit quality of our loan
portfolio

8 Invest in different loan products

9 Decision to diversify our investment is only

made by
Management
10 Our loan portfolio is fully insured