Bethlehem Tadesse

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ST.

MARY’S UNIVERSITY
FACULTY OF BUSINESS
DEPARTMENT OF MANAGEMENT

AN ASSESSMENT ON CAUSES AND


CONSEQUENCES OF NON-PERFORMING LOANS IN
THE CASE OF UNITED BANK SHARE COMPANY

BY:
BETHLEHEM TADESSE

JUNE 2014
SMU
ADDIS ABABA

1
AN ASSESSMENT ON CAUSES AND CONSEQUENSES
OF NON-PERFORMING LOANS IN THE CASE OF
UNITED BANK SHARE COMPANY

A SENIOR ESSAY SUBMITTED TO THE


DEPARTMENT OF MANAGEMENT
BUSINESS FACULTY
ST. MARY’S UNIVERSITY

IN PARTIAL FULFILLMENT OF THE REQUIREMENTS


FOR THE DEGREE OF BACHELOR OF ARTS IN
MANAGEMENT

BY:
BETHLEHEM TADESSE

JUNE, 2014
SMU
ADDIS ABABA
ST. MARY'S UNIVERSITY

AN ASSESSMENT ON CAUSES AND


CONSEQUENCES OF NON-PERFORMING LOANS IN
THE CASE OF UNITED BANK SHARE COMPANY

BY:
BETHLEHEM TADESSE

FACULTY OF BUSINESS
DEPARTMENT OF MANAGEMENT

APPROVED BY THE COMMITTEE OF EXAMINERS

Department Head Signature

Advisor Signature

Internal Examiner Signature

External Examiner Signature


ACKNOWLEDGMENTS

First and for most I would like to thank the almighty GOD for giving me
the strength and patience in every aspects of my life. Secondly, I would
like to show my heartfelt appreciation to my mother W/o Alemseged
Chanyalew for her undying encouragement. This research couldn't have
been successful without her support. Then my sincere appreciation to
my advisor Ato Zelalem Tadesse for his valuable advice, unreserved
guidance, constructive comments and follow-ups made on this paper
from start till its completion.

Also I would like to extend my thanks to my brother Ato Binyam Tadesse,


my uncle Ato Wondwosson Chanyalew, my families and friends for their
great support. I also like to give my gratitude to Ato Daniel Lemma who
helped me to get the necessary supporting materials and for sharing the
knowledge he acquired.

Last but not least, I also give my thanks to all employees of United Bank
who provide me the essential information for the completion of this
senior research paper.

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TABLE OF CONTENTS

Content Page
Acknowledgments i
Table of Contents ii
List of Tables and Graphs iv
List of Abbreviations/Acronyms v

CHAPTER ONE
1. INTRODUCTION
1.1. Background of the Study …………………………………….. 1
1.2. Statement of the Problem ……………………………………. 2
1.3. Research Questions …………………………………………… 3
1.4. Objectives of the Study ……………………………………….. 4
1.4.1. General Objective ……………………………………… 4
1.4.2. Specific Objective ……………………………………… 4
1.5. Significance of the Study …………………………………….. 4
1.6. Delimitation or Scope of the Study ………………………… 5
1.7. Research Design and Methodology ………………………… 5
1.7.1. Research Design ……………………………………. 5
1.7.2. Population and Sampling Technique ………….. 5
1.7.3. Types of Data Collected …………………………… 6
1.7.4. Method of Data Collection ……………………….. 6
1.7.5. Method of Data Analysis …………………………. 6
1.8. Limitation of the Study ……………………………………….. 6
1.9. Organization of the Study ……………………………………. 7

CHAPTER TWO
2. REVIEW OF RELATED LITERATURE
2.1. Definition & Meaning of NPL -------------------------------- 8
2.2. Classification of Loans --------------------------------------- 10
2.2.1. Pass -------------------------------------------------- 10

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2.2.2. Special Mention ------------------------------------ 11
2.2.3. Substandard ---------------------------------------- 11
2.2.4. Doubtful --------------------------------------------- 11
2.2.5. Loss -------------------------------------------------- 11
2.3. Reasons of Loans being NPL --------------------------------- 12
2.4. The Determinants of NPL ------------------------------------ 14
2.5. Causes of NPL ------------------------------------------------- 14
2.6. Market Discipline as a Mechanism to Curb -------------- 15
2.6.1. Open & Competitive Capital Markets ------------- 16
2.6.2. Information ------------------------------------------- 16
2.6.3. Borrower’s Response Market Discipline 17
2.7. Evaluation of Borrowers Creditworthiness ---------------- 18
2.8. Consequences of NPL ---------------------------------------- 20

CHAPTER THREE
3. DATA PRESENTATION, ANALYSIS AND INTERPRETATION 23
3.1. General Characteristics of Respondents …………………. 24
3.2. Analysis of the Major findings ……………………………… 26

CHAPTER FOUR
4. SUMMARY, CONCLUSIONS AND RECOMMENDATIONS 52
4.1. Summary of Major Findings ………………………………… 52
4.2. Conclusions ……………………………………………………... 55
4.3. Recommendations ……………………………………………... 57

BIBLIOGRAPHY ……………………………………………………. 59
APPENDICES

iii
LIST OF TABLES AND GRAPHS

LIST OF TABLES
Table 2.1: Provisioning Requirements for Loans ............................... 11
Table 2.2: The Six Basic Cs of Lending ............................................. 18
Table 3.1: Characteristics of Respondents ......................................... 24
Table 3.2: Practice of Credit Policy ................................................... 26
Table 3.3: Sectors that are Exposed to NPL ...................................... 30
Table 3.4: Factors that Cause NPL ...................................................... 33
Table 3.5: Problems Associated with NPL .......................................... 36
Table 3.6: Procedure that the Bank has Used to Reduce the Amount of NPL 40
Table 3.7: Impact of NPL on the Goal of the Bank ............................ 43
Table 3.8: Relation of the Borrowers in Doing Business with UB ....... 45
Table 3.9: Questions that Assess about the Loan .............................. 46
Table 3.10: Ratio of Outstanding Loan to Deposit ……………………….. 49
Table 3.11: Ratio of NPL to Outstanding Loan ……………………………. 51

LIST OF GRAPHS
Graph 1: Growth Rate of Outstanding Loan and Deposit ..................... 49
Graph 2: Growth Rate of Outstanding Loan by Economic Sector ......... 50

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LIST OF ABBREVIATIONS/ACRONYMS

BC: Building & Construction


DTS: Domestic Trade and Service
LC: Letter of Credit
NBE: National Bank of Ethiopia
NPD: Non-Performing Debt
NPL: Non-Performing Loan
OTL: Outstanding Loan
SD: Standard Deviation
UB: United Bank
UBSC: United Bank Share Company
UCC: Universal Commercial Code

v
CHAPTER ONE
INTRODUCTION

1.1. Background of the Study

“Non-Performing Loan” means loans or advances whose credit quality has


deteriorated such that full collection of principal and/or interest in accordance
with the contractual repayment terms of the loan or advance is in question.
For purposes of these, loan or advances with pre-established repayment
programs are non-performing when principal and/or interest is due and
uncollected for 90 (ninety) consecutive days or more beyond the scheduled
payment date or maturity (NBE, 2008:2).

Furthermore, according to Rajiv Ranjan and Sarat Chandra Dhal (2003:103), a


non-performing loan entails that the borrower does not renege from the loan
contract but fails to comply the repayment schedule due to evolving
unfavorable conditions.

United Bank was incorporated as a Share Company on 10 September 1998 in


accordance with the Commercial Code of Ethiopia of 1960 and the Licensing
and Supervision of Banking Business Proclamation No. 84/1994. The Bank
obtained a banking services license from the National Bank of Ethiopia and is
registered with the Trade, Industry and Tourism Bureau of the Addis Ababa
City Administration. (UB, 2010:6)

United Bank is a full service Bank that offers its customers a full range of
commercial banking services with a network that includes 79 branches. These
branches render all type of banking services with the uncompromised
commitment of service quality to the utmost satisfaction of the customers. The
operation of the bank is, therefore, fully conducted through its branches. (UB,
2010:6)

The bank renders deposit services including demand deposit, savings deposit
and time/fixed time deposit; a credit service like DTS, OD and International

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Banking services like; opening letters of credit (LC) for importers, handling of
incoming LCs for exporters, purchase of outward bills, purchasing and selling
of foreign currency denominated notes, receiving and transferring foreign
currency payment by swift and handling incoming and outgoing international
letters of guarantee. (UB, 2010:6)

The loan disbursement and collection practice has required considerable


attention by senior management and the banks credit committee. The student
researcher believes that accepting customers’ deposit and giving loans are most
valuable activities in banks to run a business and accomplish its objectives
(goals).

To this end, the student researcher inspired to conduct an assessment on


causes & consequences of Non-Performing Loans in United Bank S.C.

1.2. Statement of the Problem

Under The Ethiopian banking business directive, non-performing loans are


defined as “Loans or Advances whose credit quality has deteriorated such that
full collection of principal and/or interest in accordance with the contractual
repayment terms of the loan or advances in question” National Bank of
Ethiopia. (NBE, 2012: 4)

Non-performing loans are loans or advances whose credit quality has


deteriorated such that full collection of principal and/or interest in accordance
with the contractual repayment terms of the loan or advances are in question;
or when principal and/or interest is due and uncollected for 90 (Ninety)
consecutive days or more beyond the scheduled payment date or maturity.
(NBE, 2008:2)

Effective liquidity management requires maintaining sufficient cash reserves on


hand (to meet client withdrawals, disburse loans and fund unexpected cash

2
shortages) while also investing as many funds as possible to maximize earnings
(putting cash to work in loans or market investments). (GTZ, 2000).

Causes for non-performing loans are merely varied from bank to bank but in
United Bank S.C. some of the causes are lack of continuous follow up of
repayment, overstating the collateral value at the time of estimation, diversion
of the borrowed fund to other purposes and poor follow-up and others (UB,
2010:17).

Beginning from its establishment United Bank S.C. has now over 364,883
customers through its 79 branch offices in Addis Ababa and in regions (Source:
Bank’s Weekly Deposit Report from Dec. 2, 2013 – Dec. 7, 2013). However, the
rate of the growth in loans and advances is not keeping pace with the fast
growth of deposits on which the bank incurs cost. The Bank’s annual progress
report (FY 2012/13:9) shows that the ratio of non-performing loans of the bank
at the end of June, 2013 was 2.53% which is higher from the banks plan
1.61%. An increase in the non-performing loan is an indication of the
deterioration to the total portfolio. It is clear that banks are issuing credits not
on their own money, but money belonging to other depositing customers. With
this in mind, the banks must be careful in handling credit facility since lending
is the major cause of banks losses and failure.

In addition to the above facts, years of experience in United Bank, the student
researcher observed that there are also problems over the years faced by the
bank with regard to credit such as complain of customers, lack of adequate
client guidance and advisory service and follow up, collateral related problems.

Therefore, this study intends to assess the causes and consequences of NPL in
United Bank S.C.

1.3. Research Questions

• What does the credit policy of United Bank S.C. looks like?

• What are the major causes of Non-Performing Loans?

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• What are the consequences of Non-Performing Loans (NPL) in the bank’s
liquidity and profitability?

1.4. Objectives of the Study


1.4.1. General Objective
The general objective of the study is to identify causes and consequences of
NPL in United Bank S.C.

1.4.2. Specific Objective


The specific objectives of this study are:-
• To describe the practice of credit policy in UB
• To investigate the causes associated with the non-performing loans (NPL)
in United Bank S.C.
• To explore the consequences of non-performing loans in the profitability
of the bank to provide appropriate recommendations.
• To evaluate the effect of NPL in the banks liquidity

1.5. Significance of the Study

Among the various financial services given by banks, lending is the most
important and principal activity which generate higher profit and existence of
the bank. The optimum utilization of efforts to increase the bank’s loan
portfolio is unquestionable. Following this, the significance of this paper
emphasized on the following points.
• Tries to highlight the factors in the credit system, which causes non-
performing loans.
• After assessing the problems in lending activity of the bank, this study
has given recommendations that can provide possible solution to the
problems.
• The research may also serve as a reference for other researchers who are
interested to conduct research in the same/related topic.

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1.6. Delimitation of the Study

This study was delimited to investigate causes and consequences of non-


performing loans in United Bank S.C. Student researcher gathered data only
during the period from years 2008/2009 – 2011/2012. This period was
selected because of its nearness and readily availability of data. In addition,
this research investigated data related to non-performing loan from the bank’s
head office and three selected branches. These branches were: Beklobet
Branch, Bole Medhanialem Branch and Lideta Branch. These branches were
selected for the reason that they take the highest share of NPL rate from the
total NPL rate of the bank. (UB annual progress report, 2011/12: 6).

1.7. Research Methodology


1.7.1. Research Design

To seek answers for the research questions and to meet the objectives, the
student researcher used explanatory research method. Furthermore, this
method enabled the student researcher to identify the causes and
consequences related to non-performing loans.

1.7.2. Population, Sampling Techniques and Sample Size

To address the research questions the target population was confined to those
involved in credit managers, credit analysis and appraisal, credit monitoring
and branch credit committee members of the bank. For United Bank
employees the total population size were 86 out of which 30 staffs were selected
based on their relevance to the study objectives, through purposive sampling
from UB head office credit department and from the three branches. This
selection included 1 Credit manager, 5 credit analysts, 2 branch managers, 2
assistant branch managers, 1 loan supervisor, 6 loan officers, 6 loan clerks
and 7 other clerical staffs who have taken loan from the bank.

5
In addition, 15 loan customers who are having NPL were selected from the
three branches, a census data were collected from customers from the three
branches through self administered questionnaire.

1.7.3. Type of Data Collected

The types of data that were used for this study were primary and secondary.
Primary Data:- The primary data was collected through self-administered
questionnaire distributed to the selected employees of the bank and interview.
The questionnaires included open and close ended questions.

Secondary Data:- The sources for secondary data was policies, procedures,
annual reports, publications, journals, articles, books and web-sites/internet.

1.7.4. Method of Data Collection

In the investigation of this research, questionnaires were handed out to the


respondents by hand so that threat of getting low response rate is totally
eliminated. Questionnaire respondents were 15 customers from the selected
three branches and 30 staffs of the bank who are mentioned above. From
those staffs 5 of them were also participated in the interview.

1.7.5. Method of Data Analysis

Data collected through questionnaire and interview was presented in


tabulations whenever appropriate. The student had analyzed and interpreted
the data collected through percentages, graph, mean, standard deviation, and
ratio methods.

1.8. Limitation of the Study

The student researcher had encountered problems in finding related literature


review during secondary data collection for this research paper.

6
The student researcher also had faced problems while collecting data from
customers in which most of the time they were not willing to fill the
questionnaire due to various reasons.

1.9. Organization of the Study

This study is organized in to four chapters. The first chapter deals with the
introduction part composed of background of the study, statement of the
problem, research questions, objectives of the study, significance of the study,
scope of the study, research design and methodology, and limitation of the
study. The second chapter focuses on the review of related literature; the third
chapter focuses on data presentation, analysis and interpretations. The last
chapter presented the summary, conclusions and recommendations of the
study.

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CHAPTER TWO
REVIEW OF RELATED LITERATURE

Among the functions of a modern bank, lending is one of the most important
activities. It is evident that a substantial proportion of the total revenue of all
banks in Ethiopia comes from interest on loans and advances. Loans and
advances comprise a very large portion of a bank’s total asset, and they also
form one of the most essential operations of a bank. The strength of a bank is
thus judged by the soundness of its advances. Wise and prudent policies and
procedure in regard to credit management are considered important factors
inspiring confidence in depositors and prospective customers of a bank (UB,
2010:1).

2.1. Definition and Meaning of Nonperforming Loans


Loan becomes non-performing when it cannot be recovered within certain
stipulated time that is governed by some respective laws. So, non-performing
loan is defined from the institutional point of view, generally from the lending
institutions side. (Mohammed Islam et al, 2005:3).

Currently, there is still no standard on loan classification which has been


uniformly adopted by all countries in the world, so the meaning of NPLs largely
depends on the regulatory framework of loan classification mechanism in
different countries (Angklomkliew et al, 2009:70). Although ninety days is
normally considered the watershed of dividing line between loans that are
classified as performing and loans that are classified as non-performing,
(Cortavarria et al, 2000:11)

According to Xiao (2006:65), loans can be either performing or nonperforming


depending on their level of profitability. If the enterprises are making profits,
the quality of their debts (more specifically their total liabilities) are termed
“performing.” If they are making losses, their debts are regarded as
“nonperforming.” The amount of non performing debt (NPD) for a specific

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enterprise group is then the sum of the total liabilities in the loss-making
enterprises for that group. The NPD ratio for the group is simply the ratio of the
sum of total liabilities in the loss-making enterprises divided by the sum of
total liabilities in both the loss-making and profit making enterprises in the
group. These simple definitions of NPD and the NPD ratio make our NPD
statistics objective, easy to measure, and easy to understand.

According to Nobuo et al (2003:106-107) there are at least three definitions


that are referred to, and these definitions have been changed over time.
• Risk management loans and loans disclosed under the Financial
Reconstruction Law (FRL) classification are officially published NPLs
in the sense that they are based on the criteria specified by a law or by
law. Although they have different breakdowns, their two definitions
broadly coincide, and hence produce similar figures for outstanding
loans.
• Loans subject to self-assessment are classified, depending upon
borrower creditworthiness, in line with guidelines (the “Inspection
Manual”) produced by the Financial Services Agency (FSA):
• These definitions have substantially changed over time. The criteria
became tougher and their coverage became wider in response to public
demand for better disclosure.

Under the Ethiopian banking business directive, non-performing loans are


defined as “loans or advances whose credit quality has deteriorated such that
full collection of principal and/or interest in accordance with the contractual
repayment terms of the loan or advances in question (NBE, 2008:2).” It further
provides that:
“…, loans or advances with pre established repayment programs
are nonperforming when principal and/or interest is due and
uncollected for 90 (ninety) consecutive days or more beyond the
scheduled payment date or maturity (NBE, 2008:2).

9
In addition to the above mentioned category of non- performing loans,
overdrafts and loans or advances that do not have pre-established repayment
program shall be non-performing when:
• The debt remains outstanding for 90 (ninety) consecutive days or more
beyond the scheduled payment date or maturity;
• The debt exceeds the borrower’s approved limit for 90 (ninety)
consecutive days or more;
• Interest is due and uncollected for 90 (ninety) consecutive days and
more; or for the overdrafts,
I. The account has been inactive for 90 (ninety) consecutive days or
II. Deposits are insufficient to cover the interest capitalized during 90
(ninety) consecutive days or
III. The account fails to show the 20% of approved limit or less debit
balance at least once over 360 days preceding the date of loan
review. (NBE, 2008:2)

2.2. Classification of Loans


According to NBE (2012: 7-9), finance institutions shall classify all their loans,
into the following classification categories using the criteria described below:

2.2.1. Pass
Loans in this category are fully protected by the current financial and paying
capacity of the borrower and are not subject to any criticism. Notwithstanding
the generality of this statement, the following loans shall be classified pass:
a) Short term loans past due for less than 30 (thirty) days.
b) Medium and long term loans past due for less than 180 (one hundred eighty)
days; and
c) Any loan, or portion thereof, which is fully secured, both as to principal and
interest, by cash or cash-substitutes, regardless of past due status or other
adverse credit factors.

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2.2.2. Special Mention
The following loans at a minimum shall be classified special mention:
a) Short term loans past due for 30 (thirty) days or more, but less than 90
(ninety) days;
b) Medium and long term loans past due 6 (six) months or more, but less than
12 (twelve) months;

2.2.3. Substandard
The following non-performing loans at a minimum shall be classified
substandard:
a) Short term loans past due 90 (ninety) days or more, but less than 180 (one-
hundred-eighty) days;
b) Medium and long term loans past due 12 (twelve) months or more, but less
than 18 (eighteen) months;

2.2.4. Doubtful
The following non-performing loans at a minimum shall be classified doubtful:
a) Short term loans past due 180 (one-hundred-eighty) days or more, but less
than 360 (three-hundred-sixty) days;
b) Medium and long term loans past due 18 (eighteen) months or more, but
less than 3 (three) years;

2.2.5. Loss
The following non-performing loans at a minimum shall be classified loss:
a) Short term loans past due 360 (three-hundred-sixty) days or more;
b) Medium and long term loans past due 3 (three) years or more;

Table 2.1. Provisioning Requirements for Loans


Minimum Provision for Short,
Article Classification Category
Medium and Long Term Loans
8.3.1 Pass 1%
8.3.2 Special Mention 3%
8.3.3 Substandard 20%
8.3.4 Doubtful 65%
8.3.5 Loss 100%

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2.3. Reasons of Loans Being Non-Performing
As cited by Mohammad Islam et al. (2005: 3-6), in developing and under-
developed country, the reasons of being default have a multidimensional
aspect. Various researches have concluded various reasons for a loan to be
default. Some of them are discussed below that are very much pertinent to the
study.

A. Reduced Attention to Borrowers


Workers perceptions that someone is paying attention to them get better
result that perception of inattention, of being ignored. Borrowers may
also perform in this manner.

B. Moving Along the Risk Curve


This means that risk increases and are always to some degree unknown
as the low risk situations become saturated.
i

C. Increasing Loan Size Increases Risk


As the sizes of the loans granted to companies increased the risk level
increased by the same proportion.

D. Lenders Lack Plans to Deal with Risk


Donor-funded credit programs are usually designed without a clear focus
on risk. In micro finance promotion there seems to be no clear vision of
risk or no industry-wide concern about means of addressing it, other
than running a tight ship.

E. Borrowers Probe a Credit Operation’s Weaknesses


Credit programs have no special claim to infallibility. A borrower may be
determined repay on time but because of some unexpected events fail to
do so. If the lender does not follow up promptly with a query, the
borrower will take note. A second way in which borrowers are tempted to
probe a credit program’s weaknesses is when some borrowers blatantly
refuse to pay on time or skillfully avoid payment.

12
F. Rent-Seekers Capture the Credit Program
Credit programs attract rent seeking of all sorts, especially when some
subsidy is involved. In certain cases hijacking is blatant, as when the
patterns of funding follow election year cycles.

G. Lenders and Project Designers have Low Expectation


In some cases credit is provided by donors because it is the easiest thing
to offer, it makes many people happy and it corresponds to a certain view
of development and the conditions required for it to occur. In this case
repayment is not terribly important to donors because the objective is
almost overwhelmingly to get the money working in order to stimulate
development.

H. The Lender is Unwilling to Collect


Unwillingness may arise from a number of factors, but almost always
requires soft funds that the lenders can afford to lose. Unwillingness to
collect may result from the realization that the credit program was poorly
designed, destined to fail. It may also reflect a view that the beneficiaries
are poor while the sponsors are not, and that a sense of fairness
precludes any serious action against defaulters.

I. Lack of Good Models


Lenders are simply not familiar with successful examples of dealing with
bad and doubtful debts.

J. Loan Sanctioned by Corruption


Sometimes loan sanctioning authority sanctions loans for satisfying their
self-interested behavior. This is the result of too much politicization and
power-relatedness in the institutional system.

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K. Donors give Loans to Dominate
The strategies that most donor country follows are to weaken countries
system so that they can hold the bargaining option to ensure their
dominance.

L. Weak Follow-Up Weaken the System

People five more importance on current consumption. So they do not


mind to spend the borrowed fund to spend for consumption if they are
not strictly followed up. People hold a very short vision of thinking for
today leading sufferings tomorrow.

2.4. The Determinants of Non-Performing Loans

The literature identifies two sets of factors to explain the evolution of NPLs over
time. One group focuses on external events such as the overall macroeconomic
conditions, which are likely to affect the borrowers’ capacity to repay their
loans, while the second group, which looks more at the variability of NPLs
across banks, attributes the level of non-performing loans to bank-level factors.
(Klein, 2003:4)

2.5. Causes of Non-Performing Loans

According to IMF working paper (Adriaan M. Bloem and Cornelis N. Gorter,


2001:4-5), there are some causes of loans to become doubtful.

The first one is wrong economic decisions by the individual and plain bad luck
(inclement weather, unexpected price changes for certain products, etc). Under
such circumstances, the holder of loans can make an allowance for a normal
share of non performance in the form of bad loan provisions, or they may
spread the risk by taking out insurance. Enterprises may well be able to pass a
large portion of these costs to customers in the form of higher prices. For
instance, the interest margin applied by financial institutions will include a
premium for the risk of nonperforming on granted loans.

14
The amounts involved in nonperforming loans may rise considerably as a result
of less predictable incidents, such as when the cost of fuel, prices of key export
products, foreign exchange rates, or interest rate change abruptly.

• A fall in the prices of loan collaterals(often real estate) m cause more


loans to become classified as doubtful;
• Large bad loan portfolios will affect the ability of banks to provide credit,
and the resulting liquidity crunch may suffocate otherwise good
creditors,

• Depositors and foreign investors may start a run on the banks, pushing
them into liquidity problems.

The chances for the financial sector to derail are usually considered to be much
higher under conditions of deficit bank management, poor supervision, and
overoptimistic assessments of credit worthiness during boom economies, and
moral hazard that results from (too) generous government guarantees or the
expectation of assured bailouts. (Adriaan M. Bloem and Cornelis N. Gorter,
2001:4-5)

Major Banks crises are common, and they may be very costly for the taxpayer.
This is particularly costly tend to be guarantees provide by the government in
the forms of blanket deposit insurance.

2.6. Market Discipline as a Mechanism to Curb


According to Adriaan M. Bloem and Cornelis N. Gorter, (2001:60-67)
unsustainable borrowing and its conditions unsustainable borrowing, that is,
borrowing without the means or even the intention of repaying, directly leads to
NPLs. Market discipline is one force that may limit such abuse of financial
markets: market discipline implies that lenders penalize excessive borrowing,
first, by requiring a higher interest rate spread and, ultimately, by excluding
the borrower from the market.

15
2.6.1. Open and Competitive Capital Markets
This is required so that unsustainable borrowing will face the borrower with
increased interest rates or exclusion from the market. In the case of financial
institutions, if legal restrictions that limit competition for deposits - such as
geographic scope of activities, or on the activities permitted to particular
categories of institutions - give particular institutions a degree of market
power, this may reduce the market's ability to discriminate between prudent
and imprudent financial intermediaries, and thereby render market discipline
in- effective. (Adriaan M. Bloem and Cornelis N. Gorter, 2001:60-67)

2.6.2. Information
A second requirement for effective market discipline is to allow lenders to
obtain relevant information about the borrower's outstanding debts. Due to the
imperfect accounting rules, financial institutions can conceal their losses from
both creditors and regulators. This seriously undermines the market discipline.
The weaknesses identified by the IMF include: (1) High corporate leverage was
hidden by related-party transactions and off-balance sheet financing; (2) High-
level foreign exchange risk exposure by corporations and banks resulting from
large, short-term borrowing in foreign currency was not evident; (3) Disclosure
of loan classification, loan loss provisioning, and accrual of interest was weak.
Although most banks disclosed the accounting policy for loan loss provisioning,
they did not disclose in the balance sheet the aggregate amount of loans and
advances for which they had stopped accruing interest; (4) In Korea, the
practice of cross- guarantees made it hard to assess the solvency of the largest
borrowers; (5) Consolidation of accounts was generally absent; (6) Detailed
information on sector concentration was largely absent, even though all
countries had large exposure limits in place; (7) Disclosure regarding derivative
financial instruments was weak; and (8) Contingent liabilities of the parent of
conglomerate, or of financial institutions, for guaranteeing loans (particularly
foreign currency loans) were generally not reported. Andrew Sheng, the
chairman of the Hong Kong Securities and Futures Commission, summarized

16
the information problem as " 'Bad accounting = bad information = poor
decision-making = bad risk management = financial crisis.' (Adriaan M. Bloem
and Cornelis N. Gorter, 2001:60-67)

2.6.3. Borrower's Response Market Discipline takes two Forms:

Initially, the borrower faces a rising interest rate spread and eventually access
to further credit is denied. Because the second stage is often associated with a
financial crisis, it is not a normal form of market discipline. Thus, a condition
for the smooth operation of market discipline is that borrowers respond to the
signals provided by the market in time to avoid a crisis. A rational agent, when
faced with a higher interest rate, would respond by reduced borrowing in order
to get back onto a sustainable path. In fact, if a rational agent possessed as
much information as the lender did, it would not wait for a market signal: a
rational borrower would anticipate that further borrowing would lead to a
higher interest rate spread, and, taking that knowledge into account, would
refrain from unsustainable borrowing. Borrowers who believe that there is a
high probability of insolvency, however, will not respond to market signals or
anticipate them: they have nothing to lose by borrowing, even at a high
interest rate.67 In other words, market discipline does not work through
interest rate spreads if borrowers are already near insolvency; it can only work
by excluding insolvent borrowers from the market. (Adriaan M. Bloem and
Cornelis N. Gorter, 2001:60-67)

Issues of non-performing loans and cost efficiency are related in several


important ways. First, a number of researchers have found that failing banks
tend to be located far from the best practice frontier. (Adriaan M. Bloem and
Cornelis N. Gorter, 2001:60-67)

17
2.7. Evaluation of Borrowers Creditworthiness

Table 2.2. The Six Basic Cs of Lending


Source: Peter S. Rose, “Loans in a Troubled Economy,” The Canadian Banker 90, no. 3 (June 1983), p. 55.

Character Capacity Cash Collateral Conditions Control


Identity of Take-home pay for Ownership of Applicable laws and
Customer’s
customer and an individual; the assets regulations
current position in
Customer’s past guarantors past earnings, regarding the
industry and
payment record dividends, and sales character and
expected market
record for a business quality of
share
firm acceptable loans
Copies of Social Adequacy of past Vulnerability of
Security cards, and projected cash assets to
driver’s licenses, flows obsolescence
Customer’s
corporate Adequate
Experience of performance vis-à-
charters, documentation for
other lenders with vis comparable
resolutions, examiners who may
this customer firms in the same
partnership review the loan
industry
agreements, and
other legal
documents
Description of Availability of liquid Liquidation value
history, legal reserves of assets
structure, owners,
Signed
nature of Competitive
acknowledgements
operations, climate for
Purpose of Loan and correctly
products, and customer’s
prepared loan
principal product
documents
customers and
suppliers for a
business borrower
Customer’s track Turnover of Degree of Sensitivity of Consistency of loan
record in payables, accounts specialization in customer and request with
forecasting receivable and assets industry to lender’s written

18
business or inventory Liens, business cycles loan policy
personal income Capital structure encumbrances, and changes in Inputs from non
credit rating and leverage and restrictions technology credit personnel
against property Labor market (such as economists
held conditions in or political experts)
customer’s on the external
industry or factors affecting
market area loan repayment
Expense controls Leases and Impact of inflation
mortgages issued on customer’s
against property balance sheet and
Coverage ratios and equipment cash flow
Recent performance Insurance Long-run industry
of borrower’s stock coverage or job outlook.
and price-earnings Guarantees and Regulations,
Presence of (P/E) ratio warranties issued political and
cosigners or Management quality to others environmental
guarantors of the factors affecting
proposed loan Lender’s relative
position as the customer
Recent accounting creditor in and/or his or her
changes placing a claim job, business, and
against industry
borrower’s assets
Probable future
Financing needs

19
2.8. Consequences of Non-Performing Loans

Capital Formation-Investment-Recovery Loop Extended

Capital formation has at least two dimensions, i.e., domestic and international.
The attraction should be institutionalized so that the saving can be utilized in
economic process. Households should be motivated to save and to deposit the
same so that the idle savings can be used economically. Sometimes, they are
self-motivated. Economists have identified at least three broad reasons for
saving (Frank, Bernanke, 2001); life cycle saving: savings to meet long-term
objectives, such as retirement, college attendance, or for the purpose of a home;
precautionary saving: savings for protection against unexpected setbacks, such
as the loss of a job or a medical emergency; bequest saving: savings done for the
purpose of leaving an inheritance. But, sometimes they require external
inducement that is basically done by the financial institutions or government.
Along with household savings, there is another form of investment that basically
comes from corporation. (Mohammed Islam et al, 2005:6).

Saving can be held in different forms, as financial assets, as stores of value, as


well as informal financial assets such as savings in informal financial
institutions. The financial liberalization paradigm maintains that savings in the
informal sector are as a result of inefficient and repressed financial markets.
The lack of access to financial saving instruments and the market
fragmentation means that people have to resort to non-financial savings.
(Gupta, 1985:7). The prevalence of non-financial savings in rural households of
East African countries, Where financial savings at times constitute only 5-6% of
total household savings. Getting the small savings from the households,
financial institutions form large capital so that it can be invested in the
development of various sectors like industry, business, development and others.
When savings get investing status, it works for the economic development
provided that the investment is rightly done. In an article entitled “The vice of

20
Thrift, Samuel et al, 2001:85 states, “It has become clear that the surge in
investment in East Asia in the 1990s was a sign of weakness, not strength.
Much of the money was wasted on speculative property deals or unprofitable
industrial projects.

The consequences have both positive and negative dimensions to the investing
authority though in the economy it always should have a positive result up to a
limit. If the invested funds can be captured timely, it can again form new
capital creating a good option of reinvestment or consumption. Both of these
reinvestment and consumption functions create a positive impact on the
economy. Because, economy gets some value added jobs to do. But, in case of
non-recovery, the investing party should have to go a long way that is not
expected and sometimes this unexpected happenings cause a great harm to the
economic framework and structure. (Mohammed Islam et al, 2005:7).

Assurance of a timely recovery of the invested fund ensures societal economic


development as these funds again flow into the economy in the form of either
investment or consumption. The fast the loop moves, the fast the economy
develops.

Low Saving and Investment Leads Low Income


Source: (Mohammed Islam et al, 2005:9)
Low Saving and
Investment

Low Average Income Low pace of Capital


Formation

Small size of Low Productivity


Marketing
21
In case of a different consequences, when the loop breaks, economy experiences
a different look like the above where the rate of savings and investment declines
leading to lower the income that hamper the process from both perspective; at
one side, standard of living declines (by lowering the expenditure for living), and
on the other, by saving nothing as the total earnings are expensed to continue
the livelihood. (Samuel et al, 2001:85).

22
CHAPTER THREE
DATA PRESENTATION, ANALYSIS AND INTERPRETATION

This chapter deals with data presentation, analysis and interpretation. The
findings are presented in consideration with the respondents profile and on
each of the investigation questions that the survey sought to answer.
Accordingly, the collected data from employees and customers are analyzed and
interpreted as follows.

Among the questionnaires distributed to 30 employees, all of them were


returned and that makes the response rate 100%. In addition to this, the
questionnaires which were distributed to 15 customers, 12 of them were
returned which makes the response rate 80%.

In addition, interview has been made with 5 employees of the bank to gather
detailed information on the issue.

23
3.1 General Characteristics of Respondents
Table 3.1: Characteristics of Respondents
Employees Customers
Percentage Percentage
No Item Respondents Frequency Frequency
(%) (%)
Male 21 70 - -
1 Sex Female 9 30 - -
Total 30 100 - -
< 30 - - 4 33.33
31-40 - - 6 50
2 Age 41-50 - - 2 16.67
>51 - - - -
Total - - 12 100
12th Grade - - 1 8.33
Certificate - - - -
Diploma 5 16.67 2 16.67
Educational
3 1st Degree 22 73.3 6 50
Background
Above 1 st 3 10 3 25
Degree
Total 30 100 12 100
< 1 year - - - -
Working 1-3 year 14 46.67 - -
4 Experience in 4-6 year 11 36.67 - -
UB 7-9 year 5 16.67 - -
Total 30 100 - -
Credit Mgr. 1 3.33
Credit analyst 5 16.67
Branch 2 6.67
Manager
Asst. Branch 2 6.67 - -
Current
Manager
5 position in the
Loan 1 3.33
UB
Supervisor
Loan Officer 6 20 - -
Loan Clerk 6 20 - -
Clerical Staff 7 23.33 - -
Total 30 100 - -
Domestic - - 10 83.33
Type of trade
6 Foreign - - 2 16.67
you engaged in
Total - - 12 100

Table 3.1 shows the general characteristics of UB employees and customers of


the bank. As indicated in item no. 1, 21(70%) of the respondents were male and

24
4(30%) of them were female. This indicates that most of the respondent
employees working in the bank’s credit area were males.

Item No. 2 shows that, the customer respondents age, 4(33.33%) of them were
young less than 30, 6(50%) of them were between 31 and 40, 2(16.67%) of them
were between 41 and 50 and there is no customer whose age is above 51 years.
This implies that majority of customer respondents are matured and have the
capacity to engage in different businesses in order to repay debts.

Item No. 3 on the other hand shows the educational background of employees
and customers as follows:- 1(8.33%) of the customers has educational
background of 12th grade, neither the employees nor the customers respondents
have certificate, 5(16.67%) and 2(16.67%) of the employees and customers have
diploma respectively. In addition, 22(73.3%) and 6(50%) of the employees and
customers have degree respectively. Moreover, 3(10%) of the employees and
3(25%) of the customers have above 1st degree. This implies that respondents
have well enough knowledge in the area of the study and they are professional
in their respective fields.

Item No. 4 indicates that, 14(46.67%) of the respondents had working


experience of between 1 to 3 years, 11(36.67%) of them have working experience
of between 4 to 6 years and 5(16.67%) of them have between 7 to 9 years
experience. From this data, one can infer that majority of the employees have
long years of experience. As a result, employees have better knowledge in their
professional competency and accordingly they have the ability to discharge their
responsibilities.

As indicated in item no. 5, respondent employees current position in UB, Credit


Manager 1(3.33%), Credit Analyst 5(16.67%), Branch Manager 2(6.67%),
Assistant Branch Manager 2(6.67%), Loan Supervisor 1(3.33%), Loan Officer

25
6(20%), Loan Clerk 6(20%) and clerical staff 7(23.33%). This implies that the
respondent employees current position will have a positive impact on the
information gathered to the student researcher.

On the other hand, item no. 6 shows that 10(83.33%) of the customers are
engaged in domestic while 2(16.67%) in foreign operation. This shows that
most of the customers have experience of domestic trade and fear of risk on
foreign trade.

3.2 Analysis of Major Findings


Table 3.2: Practice of Credit Policy
Percentage
No Item Respondents Frequency
(%)
Very good 13 43.33
Good 15 50
How do you rate the overall
Fair 2 6.67
1 credit policy of the bank?
Poor - -
Very Poor - -
Total 30 100
1 week 4 13.33
2 weeks 5 16.67
How long will it take to
3 weeks 5 16.67
2 process a given loan
One month 9 30
application?
Above one month 7 23.33
Total 30 100
Yes 17 56.67
Does the bank grant loan
3 No 13 43.33
without taking collaterals?
Total 30 100
Do you believe the Yes 23 76.67
procedure followed by the No 7 23.33
4
bank for loan approval is
Total 30 100
satisfactory?
Does the bank assess its Yes definitely 25 83.33
borrowers past historical Yes to some
5 16.67
financial information (i.e. extent
credit worthiness, detailed Not at all - -
5
financial analysis) before I am not quite
extending any loans to - -
aware of it
customers?
Total 30 100

26
Item 1 of table 3.2 concerns about the overall credit policy in UB, 13(43.33%),
15(50%) and 2(6.67%) of the employee respondents rated the overall credit
policy of the bank as very good, good and fair respectively. This assignment
implies that since the respondents are UB employees who are exercising the day
to day operation of loan, there exists a workable policy at the ground which
dwell the credit practice of the bank.

With regard to time taken to process a given loan application, item no. 2 of table
3.2 shows that, of the respondent employees 4(13.33%) of them said 1 week,
5(16.67%) of them said 2 weeks, 5(16.67%) of them said 3 weeks, 9(30%) of
them said one month and 7(23.33%) of them said above one month. From the
majority of the respondents replied as well as the bank’s credit procedure
manual, the time period to give loan is very long and against the bank’s credit
policy and procedure manual. The policy states that the maximum number of
days required to process loan in 15 days. The implication of this is that, the
loan process time needs improvement in order to satisfy customers need and
the banks efficiency.

According to item no. 3 of table 3.2, the majority of the respondents 17(56.67%)
said the bank grant loan without taking collaterals. As per the employees
response in the open ended question, the conditions which the bank grant loans
without taking collaterals for such facilities is based on the type of loan i.e. LC,
export pre-shipment loans, employee emergency loan and employee personal
loan type A are granted without taking collateral. Moreover, for prominent
customers and on borrowers' credit worthiness as well as clean base with the
bank. In contrary 13(43.33%) of the respondents said the bank does not grant
loan without taking collaterals. From the above information one can infer that
granting loan without taking collateral entails the trust that banks have on their
customers. This in turn can reinforce the connection between the bank and the
customers.

27
Table 3.2 of item no. 4 shows that, majority 23(76.67%) of the respondents
believe that the procedure followed by the bank for loan approval is satisfactory.
This shows that most of the staffs or respondents recognized that the procedure
followed by the bank for loan approval is according to order and successful.
But, 7(23.33%) of the respondents believe that the procedure followed by the
bank for loan approval is not satisfactory and reason out that the procedures of
loan process & approval that the bank apply are too long and time taking and
most of the customers are time sensitive so, this will make them dissatisfied.

According to table 3.2 of item no. 5, 25(83.33%) of the respondents believe that
over all the vast majority of the respondents claim that UBSC assesses
borrowers past financial history, credit worthiness and perform detailed
financial analysis frequently before extending any loans. In addition,
respondents indicate in the open-ended question that some of the mechanisms
that the bank used to assess borrowers past experience by requesting the
customer to bring audited financial statements, gathering credit information
from NBE and by observation. This implies that there is a good procedure that
the bank implements to prevent NPL. On the other hand, 5(16.67%) of the
respondents replied that the bank assesses borrowers past historical financial
information to some extent. This implies that there are some cases which
doesn’t need deep assessment of borrowers past financial information (i.e.
which doesn’t use financial statements rather uses its own format which the
bank call it CCR or customer request records.)

On the other hand, interviewees responded that united bank grant a credit
facility in Construction, Hotel & Tourism, Manufacturing, Import, Export and
Domestic Trade sectors. As all interviewees response, the requirements of
borrowers to get loan are loan application letter, License for the business
engaged, TIN certificate, Tax Clearance certificate, Financial Statement
(Audited), Marriage certificate (if married), or unmarried certificate, Company

28
profile, Articles of Association and Memorandum (for Private Limited
Companies), Ownership certificate of a collateral to be held i.e. Carta, Libre.
Moreover, interviewees point out that the bank considers the 5C’s as follows:-
• Collateral:- Consider how strong the collateral offer is to repay the loan in
case of default since it is the last option to recover the loan, even if it is
not advisable for the bank’s image. Thus it has to be carefully checked
and the value has to be assessed.
• Condition:- Considering how profitable & successful the business is in
line with the existing economic conditions of the country and in
competing with other businesses in surviving for long.
• Capital:- Considering the capital that the business initially and currently
has and the extent of needed capital to expand the business.
• Character:- Considering the applicants relationship with the bank and
other areas, pervious history of the borrowers repayment ability and past
settled loans (if any).
• Capacity:- Considering the businesses capacity to run the specified
activity, to overcome its liabilities and to repay bank loans and survive the
business.
As per the information gathered from interview in relation to policy and
procedure of the bank’s estimating collaterals, the bank has its own policy and
procedure of estimating collaterals. This techniques includes Rental Value
Method, Assessing location, material used, insurance estimation, assesses
marketability of the collateral.

29
Table 3.3: Sectors that are Exposed to NPL
Very
High Moderate Low (2) Very Low
No Item High Mean SD
(4) % (3) % % (1) %
(5) %
1 Transportation Sector 16.67 16.66 26.67 30 10 3 1.02

Manufacturing Sector 10 33.33 46.67 6.67 3.33 3.4 0.92


2
Export Sector 6.67 6.66 20 6.67 60 1.93 1.53
3
Domestic Trade &
6.67 6.67 30 33.33 23.33 2.4 1.28
4 Services Sector
Building and
5 33.33 6.67 36.67 3.33 20 3.3 0.93
Construction Sector
6 Import Sector 3.33 3.33 13.34 6.67 73.33 1.57 1.81

Item no. 1 of table 3.3 shows that, with average mean value of 3 and SD 1.02,
(16.67%+16.66) =33.33% of the respondents believe that transportation sector
has a higher tendency of being default loan. In addition, 26.67% of the
respondents have a moderate response. On the other hand (30%+10%) = 40%
of the respondents believe transportation sector has a lower tendency of being
default loan. The average value of mean shows that the majority of the
respondents response lay between moderate(3) and low(2) and their answer
deviate by 1.02. This implies that transportation sector have a medium/low
tendency of being default and customers have the capacity to repay their loans.

On the other hand, table 3.3 of item no. 2 states that with average mean value
of 3.4 and SD 0.92, (10%+33.3%)=43.33% of the respondents think that
manufacturing sector has a higher tendency of being default loan. Similarly,
46.67% of the respondents are in-between higher and lower tendency of
manufacturing sector being default loan. In contrary, (6.67%+3.33%)=10% of
the respondents think that manufacturing sector has a lower tendency of being
default loan. From the above analysis the average value of mean shows that the
majority of the respondents response lay between high(4) and moderate(3) and
their answer deviate by 0.92. This implies that there isn’t sufficient competency

30
in dealing with the manufacturing sector loans which is more complex than
other sectors.

Moreover, item no. 3 of table 3.3 shows that, with average Mean value of 1.93
and SD of 1.53, the majority of the respondents (6.67%+60%)=66.67% of the
respondents believe that export sector have the lower tendency to become
default loan. On the other hand 20% and (6.67%+6.66%) of the respondents
believe that export sector have moderate and lower tendency of being default
loan respectively. From the above analysis the average value of mean shows
that the majority of the respondents response lay on low(2) and their answer
deviate by 1.53 which make the responses very low and moderate. This implies
that export sector isn’t that much exposed to NPL and have the ability to
regulated by both the national regulatory i.e. NBE and the international
regulations such as UCC.

With regard to table 3.3 of item no. 4, with average responses of Mean value
2.4 and SD of 1.28, (33.33%+23.33%)=56.66% of the respondents think that
domestic trade & service sector have a lower tendency of being default loan.
Moreover, 30% of the respondents are in-between that domestic trade and
service sector has neither higher nor lower tendency of being default loan. In
contrary, (6.67%+6.67%)=13.34% of the respondents thinks that domestic trade
and service sector has a higher tendency of being default loan. From the above
analysis the average value of mean shows that the majority of the respondents
response lay between moderate(3) and very low(1) and their answer deviate by
1.28. Thus, one can infer that domestic trade and service sector has a lower
tendency of being default loan so, banks should encourage customer in this
sector in order to prevent the bank’s lending status from having higher NPL
rate.

31
According to item no. 5 of table 3.3, with average responses Mean value of 3.3
and SD of 0.93, (33.33%+6.67%)=40% of the respondents believe building and
construction sector has a higher tendency of being default loan. In addition,
36.67% of the respondents think that building and construction sector has a
moderate tendency of being default loan. In contrary, (20%+3.33%)=23.33% of
the respondents believe that building and construction sector has a lower
tendency of being default loan. From the above analysis the average value of
mean shows that the majority of the respondents response lay on moderate(3)
and their answer deviate by 0.93. Therefore, the bank should create credit
facility in order to encourage its customers to get loan on this sector which have
lower exposure of NPL.

Item no. 6 of table 3.3 shows that, with average responses Mean value of 1.57
and SD of 1.81, the majority of the respondents (6.67%+73.33%)=80% of the
respondents believe that import sector has a lower tendency of being default
loan. On the other hand 13.34% of the respondents think that import sector
has a moderate tendency of being default loan and (3.33%+3.33%)=6.66% of the
respondents think that import sector has a higher tendency of being default
loan. From the above analysis the average value of mean shows that the
majority of the respondents response lay on low(2) and their answer deviate by
1.81 which make the responses very low and moderate. This implies that
import sector is a highly encouraging sector for both the customer and the bank
in order to prevent themselves from default loans.

32
Table 3.4: Factors that Cause NPL
Strongly Strongly
Disagree Neutral Agree
No Item Disagree Agree (5) Mean SD
(2) % (3) % (4) %
(1) % %
Rapid Loan Growth
1 60 20 10 10 0 1.7 1.67
by banks
23.3
High Interest Rate 20 6.67 13.33 36.67 2.5 1.23
2 3
Lenient Credit Terms 13.34 36.67 36.67 6.67 6.67 2.57 1.19
3
Credit Culture 33.3
13.33 26.67 16.67 10 3 1.02
4 /Orientation/ 3
Poor Monitoring
5 16.67 23.33 10 30 20 3.13 0.98
/Follow-up/
6 Poor Risk Assessment 23.33 23.33 16.67 20 16.67 2.83 1.08

Table 3.4 of item no. 1 shows that, with average responses Mean value of 1.7
and SD of 1.67, 80% of the respondents disagreed that rapid loan growth by
banks is one of the factors that cause NPL. In contrary, 10% of the respondents
agreed that rapid loan growth by banks is one of the factors that cause NPL.
10% of the respondents are not taking sides with this regard. From the
majority of the respondents response, one can infer that rapid loan growth by
banks is not the factor that cause NPL.

With regard to item no. 2 of table 3.4, with average responses Mean value of 2.5
and SD of 1.23, (23.33%+36.67%)=60% of the respondents agreed that high
interest rate is other of the factor that cause NPL at large. In addition 13.33%
of the respondents neither agree nor disagree in this view. In contrary, 26.67%
of the respondents disagreed on the view that high interest rate is also factor
that cause NPL. From this analysis and the responses of the majority
respondents one can infer that, high interest rate is one of the factors that
cause NPL and banks should give attention and consider the interest rate while
scheduling repayment period.

33
Table 3.4 of item no. 3 on the other hand shows that, with average responses
Mean value of 2.57 and SD of 1.23, (13.34%+36.67%)=50.01% of the
respondents disagreed that lenient credit terms are factors that cause NPL.
Moreover, 36.67% of the respondents are neutral that lenient credit terms are
factors that cause NPL. In contrary, (6.67%+6.67%) of the respondents agreed
that lenient credit terms are factors that cause NPL. This implies that, lenient
credit terms are not the factor that cause NPL in UB.

Item no. 4 of table 3.4 states that, with average responses Mean value of 3 and
SD of 1.02, (33.33%+10%)=43.33% of the respondents agreed that credit culture
/orientation/ is one of the factors that cause NPL. On the other hand, 16.67%
of the respondents neither agree nor disagree on credit culture /orientation/ is
factor that cause NPL. In contrary, (13.33%+26.67%)=40% of the respondents
disagreed that credit culture /orientation/ is factor that cause NPL. This
implies that, credit culture /orientation/needs to be given to customers in order
to minimize NPL and to make customers get the knowledge about loan.

With regard to item no. 5 of table 3.4, with average responses Mean value of
3.13 and SD of 0.98, (20%+30%)=50% of the respondents agreed that poor
monitoring /follow-up/ is one of the factor that cause NPL. In this view 10% of
the respondents are neutral and (16.67%+23.33%)=40% of the respondents
disagreed on the view which state that poor monitoring /follow-up/ is one of the
factors that cause NPL. Form the majority of the respondents response, one
can infer that poor monitoring /follow-up/ is one of the factors that cause NPL
due to this, to minimize causes of NPL, the bank should follow-up its customers
that they use the borrowed fund to the specified purpose and pay their debt as
per the schedule.

34
On the other hand, table 3.4 of item no. 6 shows that, with average responses
Mean value of 2.83 and SD of 1.08, (23.33%+23.33%)=46.66% of the
respondents disagreed that poor risk assessment is one of the factor that cause
NPL. In contrary, (20%+16.67%)=36.67% of the respondents agreed that poor
risk assessment is one of the factors that cause NPL. In addition, 16.67% of the
respondents are neutral. This implies that poor risk assessment is not the
factor that cause NPL for UB and the bank has its own risk assessment
techniques.

In general, from table 3.4’s over all responses one can infer that the bank
should give emphasis on interest rate, credit culture /orientation/ and poor
monitoring /follow-up/ in order to minimize the factors that cause NPL.

35
Table 3.5: Problems Associated with NPL
Percentage
No Item Respondents Frequency
(%)
Lack of proper 16 53.33
business plan
Diversion of the 20 66.67
borrowed fund to
other purpose
Please specify the major Insufficient credit 10 33.33
1 causes of non performing awareness
loans at borrower side Unwilling customer 3 10
to disclose the
information required
Willful default/ - -
unwillingness to pay
Total 49* 163.33
Please specify your level of Strongly agree 3 10
agreement or disagreement Agree 10 33.33
about mistake on Disagree 9 30
estimation of collateral and Strongly Disagree 6 20
2 evaluation of the borrowers’ Neutral 2 6.67
financial report are one of
cause of non performing Total 30 100
loan in united bank
Please specify your level of Strongly agree 8 26.67
agreement or disagreement Agree 8 26.67
about excessive government Disagree 5 16.67
3 intervention is the major Strongly Disagree 4 13.33
causes of non performing Neutral 5 16.67
loan at economic level Total 30 100
Please specify your level of Strongly agree 3 10
agreement or disagreement Agree 14 46.67
about weak economic plan Disagree 5 16.67
and strategy Strongly Disagree 4 13.33
4
implementation is the major Neutral 4 13.33
cause of non performing
loan at economic level Total 30 100

NB: * Number of respondents became 49(163.33%) due to respondents


chosen multiple choices at a time.

36
According to item no. 1 of table 3.5, 16(53.33%) of the respondents believe that
lack of proper business plan is the major cause of NPL at borrower level.
Moreover, 20(66.67%) of the respondents believe that diversion of the borrowed
fund to other purpose is the major cause of NPL at borrower level. In addition,
10(33.33%) and 3(10%) of the respondents believe that insufficient credit
awareness and unwilling customer to disclose the information required is the
major cause of NPL at borrower level respectively. This implies that diversion of
the borrowed fund to other purpose is the one which needs greater attention by
the bank thus, the bank should follow-up and monitor customers in order to
prevent the bank from higher NPL rate to make customers use the borrowed
fund for the specified purpose.

Item no. 2 of table 3.5 on the other hand shows that, 13(43.33%) of the
respondents agreed that mistake on estimation of collateral and evaluation of
borrowers’ financial reports are one of the causes of NPL in UB. In contrary,
15(50%) of the respondents disagreed that mistake on estimation of collateral
and evaluation of borrowers’ financial reports are one of the causes of NPL in
UB. Moreover, 2(6.67%) of the respondents were neutral in this view. From
the above analysis one can infer that mistake on estimation of collateral and
evaluation of borrowers’ financial reports are to some extent causes of NPL but
there are not the causes of NPL in UB.

With regard to item no. 3 of table 3.5, 16(53.34%) of the respondents agreed
that excessive government intervention is the major causes of NPL at economic
level. In contrary, 9(30%) of the respondents disagreed in this issue. In
addition, 5(16.67%) of the respondents were in-between in the same issue. This
implies that there is a high level of government intervention in the economy and
this has an impact on the bank’s loan default.

37
Respondents indicated that there are several factors that contribute to loan
default. As per the outcome of the interview the causes can be seen from two
perspectives as follows:-

From the customer side:- diversion of borrowed fund to other purpose, lack of
proper business plan, the nature of the business that the customer is engaged,
unexpected economic condition, lack of credit knowledge, financial statements
which are not reliable, and bankruptcy of the business can be the causes of
NPL.

From the bank side: - Lack of proper credit follow-up, poor risk assessment,
improper collateral estimation, and lack of detail data analysis specially the
qualitative information can be considered as causes of NPL that emanate from
the bank side.

Moreover, interviewees’ indication on consequences of NPL for the bank and for
the customers are presented as follows:-

For the Bank:-


• Poor Credit performance
• Liquidity problem
• High level of provision
• Decline in income & profitability
• Government strict interventions
• Reduction in loan provided to customers
• Create bad image of the bank in the society
• When percentage of NPL becomes more than the provision rate of NBE
(more than 5%) the bank will be penalized

For the borrowers:-


• Leads the business to more depression financially;
• The borrower will become banned to entertain loan in to other banks.

38
• The customer will be forced to loose his/her collateral to be sold by the
bank and leads the business man for failure.
• They will have bad historical records at NBE and this will make it harder
for the customer to reestablishment of the business.

For the Government:-


• Cannot get tax and other benefits due to the NPL

From this one can infer that consequences of NPL from both the bank and
borrowers need attention in order to prevent both parties from situations that
cost them.

Meanwhile, item no. 4 of table 3.5 shows that, 17(56.67%) of the respondents
agreed that weak economic plan and strategy implementation is the major
cause of NPL at economic level. Moreover, 4(13.33%) of the respondents are
neutral on the above mentioned issue. Nevertheless, 9(30%) of the respondents
disagreed that weak economic plan and strategy implementation is the major
cause of NPL at economic level. From the majority of the respondents reply one
can infer that weak economic plan and strategy implementation cause NPL and
the bank needs strong economic plan and strategy implementation to become
competitive in the economy.

39
Table 3.6: Procedure that the Bank has used to Reduce the Amount of NPL
Percentage
No Item Respondents Frequency
(%)
Is there any credit follow
Yes 25 83.33
up techniques and
procedures designed and
1 No 5 16.67
implemented by the bank
to reduce the level of
Total 30 100
bank’s NPL
Extension of the life
8 26.67
of the loan
When the borrowers face a Injection of
certain problem and unable 10 33.33
additional loans
to pay the loan, what Rearrangement of
2 procedural mechanisms loan repayment 3 10
does the bank apply in structure
order to collect the loan at Combination of the 30 100
most efficiency above
Total 51 170

NB: * Number of respondents became 51(170%) due to respondents chosen


multiple choices at a time.

The above table 3.6 of item no. 1 shows that, 25(83.33%) of the respondents
believe that there are credit follow-up techniques and procedures designed and
implemented by the bank to reduce the level of NPL. In contrary, 5(16.67%) of
the respondents think that the bank has no credit follow-up techniques and
procedures designed and implemented by the bank to reduce the level of NPL.
From the respondents response one can deduce that the bank has its own
credit follow-up techniques and procedure in order to reduce the level of NPL.
As a result, this will help the bank as a means of competitive edge in line with
NPL.

As indicated in table 3.6 item no. 2, 8(26.67%) of the respondents the life of the
loan is applied by the bank when borrowers face a certain problem and unable
to pay the loan. In addition, 10(33.33%) of the respondents states that injection
of additional source of capital is one of the procedural mechanism applied by

40
the bank when borrowers face a certain problem and unable to pay the loan.
Furthermore, 3(10%) of the respondents state that rearrangement of loan
repayment structure is one of the procedural mechanism applied by the bank
when borrowers face a certain problem and unable to pay the loan. Besides,
30(100%) of the respondents stated that the combination of the above
mentioned mechanisms are used by the bank in order to collect the loan at
most efficiency. From this analysis one can infer that the bank used procedural
mechanisms to prevent NPL and to support borrowers in order to repay their
loan as per the schedule before applying any administrative actions (i.e. sell the
collateral for the repayment of the loan).

Based on their experience and observation, majority of the respondents


suggested that follow “Know your Customer” principle, establish a well
mechanized advisory system for the customers, strict credit analysis techniques
as additional effective mechanism for the bank to implement. The respondents
also indicate measures that can be taken by the bank while borrower stops loan
repayment as per the schedule. These may include:-
• Extension of the life of the loan
• Injection of additional loans
• Rearrangement of loan repayment structure
• Inform via Telephone to clear the arrears
• Issuing 1st, 2nd and 3rd reminder letters if it doesn’t work follow other legal
procedures
• Finally foreclosure /sale/the collateral in order to cover the borrowed
money

Therefore, the credit follow up technique and the other rearrangements used by
the bank should continue and consistently adhered in the future to prevent or
avoid NPL.

41
The respondents also addressed open ended questions and indicate some strong
and weak point about the credit management and practice of the bank as
follows:-
Strong Point
• The bank formulated prudent lending policy
• Each credit organ has its own delegated power
• Look so deeply the loan application and choose the type of loans as per
the market and background of the borrower
• Starts by approving lower amount of loan, then by assessing the progress
of the borrower, will approve higher amount of loan
• Use as many as possible mechanisms to make the borrower pay the
borrowed money before deciding to foreclose the collateral
Weak Point
• The bank heavily relying on collaterals
• Unwilling to finance project loans that have significant impact on national
economy
• Improper estimation of collateral by the bank’s engineers
• Unfair collateral estimation fee
• Lengthy procedures to approve loan to customers
• Focus on limited sectors while approving loans

In an endeavor to ascertain the survey response through interview, the


interviewees were asked of their view on the credit follow-up methods used by
the bank. They deduced that there are credit follow up methods that the bank
use. Some of them are:-
• Field (Business) visit
• Follow up each step that the borrower invests its credit facility to the
intended purpose.
• Communicating the client who have two consecutive outstanding
repayments
• Making portfolio analysis of the loan

42
• Issuing Reminding letters to the borrower … etc

This implies that failure to strictly adhere with the monitoring and follow-up
procedure may lead to the default in the loan which means higher risk of NPL.

On the other hand, the interviewees also indicate mechanisms used by the bank
to minimize NPL and its consequences. Some of them are:-
• Detail review of financial statement
• Evaluate past performance of the applicant
• Site review
• Continuous follow-up
• Assess other source of the business to pay the amount of the repayment,
when business fails.
• Extension of the expiry date of the loan
• Additional short term funding
• Rescheduling the loan repayment such as from monthly to quarterly
• Give advice to customers how to use the loan
• Proper risk analysis
• Knowing the customers very well
• Make detail analysis on the cash flow, sales (growth rate), liquidity,
current and fixed assets, capital, profitability, liabilities, etc prior to credit
facility approval.

Table 3.7: Impact of NPL on the Goal of the Bank

Percentage
No Item Respondents Frequency
(%)
Do you believe that non Yes 23 76.67
1 performing loans affect the No 7 23.33
bank efficiency? Total 30 100
Very high 13 43.33
High 11 36.67
The impact of non
Moderate - -
2 performing loan on the
Low 5 16.67
liquidity of the bank is
Very low 1 3.33
Total 30 100

43
Table 3.7 presents the impact of NPL on the overall goal of UB. As indicated in
item no. 1 of table 7, 23(76.67%) of the respondents believe that NPL affect the
bank’s efficiency. Nevertheless, 7(23.33%) of the respondents did not believe
that NPL affect the bank’s efficiency. From the majority of the respondents’
response, one can infer that NPL has a negative impact on the bank’s efficiency
and this will result dissatisfaction of customers, reduction the bank’s liquidity
through holding more money and this leads the bank to cash shortage.
Furthermore, it increases the provision amount of the bank, retain its
borrowing capacity and tied up the bank’s capital.

Those who believe NPL affect the bank efficiency explain that it affects the
efficiency as follows:-

• Since the lion share of the bank’s profit is generated from loan it has
considerable effect;

• The end result of NPL is collecting the loan disbursed through selling the
collateral held in public market which in turn dim the image of the bank
has in the societies mind;

• NPL increases the provision amount of the bank which can be given to
customers and get interest instead;

• NPL reduces the bank’s liquidity

• Reduce loan provided to customers

• The bank cannot compete with other banks

Item no. 2 of table 3.7 shows that, 23(80%) of the respondents believe that the
impact of NPL in the bank’s profitability is high. Nevertheless, 6(20%) of the
respondents believe that the impact of NPL in the bank’s profitability is low.
From the majority of the respondents’ response, one can infer that the bank’s
profitability is highly affected by NPLs.

44
Respondents also requested open-ended question in relation with the
consequences of NPL on the bank’s credit efficiency and overall performance
and their responses are presented as follows:-

• It spoils the public image of the bank

• It tied up the bank’s capital

• It will lead to unnecessary cost

• It reduce the credit efficiency through late payments and reduce


profitability, liquidity and income of the bank

• It reduces the bank’s credit efficiency

Table 3.8: Relation of the Borrowers in Doing Business with United Bank
No Item Respondents Frequency Percentage (%)
One time 1 8.33
How many times have Two times 8 66.67
1
you got loan from UB? Above two times 3 25
Total 12 100
Short Term Loan 3 25
Medium Term Loan 3 25
Which type of loan
Long Term Loan 1 8.33
2 facility are you in the
Over draft 3 25
bank?
Letter of Credit 2 16.67
Total 12 100

To have a general view about the bank’s clients, customers were asked to give
information about their relationship with UB, the type of loan facility they are in
the bank and for how long they have worked with the UB. Accordingly their
responses were analyzed and interpreted as follows. Table 3.8 of item no. 1
shows that, 1(8.33%) of the customer respondents have got loan from UB one
time. Moreover, 8(66.67%) and 3(25%) of the respondents got loan from UB two
times and above two times respectively. The above information implies that the
majority of the respondents got loan from UB two and above times. This infers
that the borrowers have a significantly positive relationship with the bank and
the bank is encouraging its customers by granting loans repetitively.

45
According to item no. 2 of table 3.8, the type of loan facilities the customers
were engaged with UB are Short term loan, Medium Term Loan, Long Term
Loan, Over draft and Letter of Credit were mentioned by 3(25%), 3(25%),
1(8.33%), 3(25%) and 2(16.67%) of the respondents respectively. From this
analysis one can infer that the bank is encouraging clients who need in short
term, medium term and over draft loan which requires less detailed analysis
and short period of payback. This entails the bank’s ability to reduce the level
of non-performing loans.

Table 3.9: Some Question that Assess about the Loan


Percentage
No Item Respondents Frequency
(%)
During estimation do you Yes 3 25
think the bank give value No 9 75
1
for the collateral you
Total 12 100
presented fairly
Working capital 11 91.67
For what purpose you
Project Expansion 1 8.33
2 borrowed money from the
Other - -
bank
Total 12 100
Does the bank follow Yes 6 50
whether the borrower use No 3 25
3
the fund to their proposal I Don’t Know 3 25
appropriately or not? Total 12 100
Yes 11 91.67
Do you repay the loan
4 No 1 8.33
according to the schedule
Total 12 100
Do you believe that non Yes 11 91.67
performing loans have an No 1 8.33
5
affect on the bank’s Total 12 100
profitability
Do you belive that if the Yes 10 83.33
borrower fails to pay the No 2 16.67
6 loan the bank should sell
the collateral for the Total 12 100
repaymet of the loan?

For the purpose of this study paper customers of the bank were required to
answer their loan status and practice with UB. Thus, the data collected from

46
respondents were analyzed and interpreted as follows. As indicated on table 3.9
item no. 1, some respondents 3(25%) believe that during estimation, the bank
fairly gives value for the collateral they presented. Most of the respondents
9(75%) don’t believe that during estimation, the bank fairly gives value for the
collateral they presented. Mean while, as stated on table 3.5 item no. 2,
13(43.33%) of the employee respondents believe that mistake on collateral
estimation is one of the cause of non-performing loan in UB. Therefore, from
this analysis one can deduce that the bank’s engineering department must
work on this as collateral is the major component in order to assure the debt
recovery method.

Item no. 2 of table 3.9 on the other hand states that, 11(91.67%) and 1(8.33%)
of the customer respondents borrow money from the bank for the purpose of
working capital and project expansion respectively. This implies that, majority
of the respondent, as their loan is considered as NPL, borrowed money from the
bank for working capital purpose. Thus, from this, one can infer that loan
granted by the bank for its borrowers for the purpose of working capital is
highly exposed to NPL.

Accordingly, table 3.9 item no. 3 shows that, 6(50%) of customer respondents
said that the bank follow whether the borrowed fund is used for the specified
purpose or not. Nevertheless, 3(25%) of the respondents said that the bank
doesn’t follow whether the borrower use the fund for the specified purpose or
not. 3(25%) of the respondents doesn’t know whether the bank follow-up or
not. This implies that even if the bank has its own credit follow up techniques,
it’s not applied and this will encourage borrowers to use the fund to other
purpose, which will cause the disability to pay the debt. So, the bank has to
work on this issue so as to prevent the bank from having higher NPLs.

Customer respondents, on item no. 4 of table 3.9 stated that, 11(91.67%) of


them replied that they repay their loan as per the schedule and 1(8.33%) of the

47
respondents doesn’t repay the loan according to the schedule. As customer
respondents status shows NPL, they believe that they are paying as per the
schedule. This implies that majority of the customer respondents doesn’t know
their loan repayment schedule. Therefore, the bank needs to have a better
attachment with its borrowers in order to make them aware in what situation
they are in.

On the other hand, as indicated on item no. 5 of table 3.9, majority of


respondents 11(91.67%) believe that NPL affects the bank’s profitability. In
contrary, 1(8.33%) of the respondents doesn’t believe NPL affect the bank’s
profitability. This implies that, customers also identify that NPL has a negative
effect on both the bank and the customer.

With regard to item no. 6 of table 3.9, 10(83.33%) of the customer respondents
believe that if the borrower fails to pay the loan, the bank should disclose their
securities through foreclosure procedures. Nevertheless, 2(16.67%) of the
customer respondents believe that the bank should not sell their collateral if
they fail to repay the loan, rather needs to use other mechanisms to make them
get the capacity repay. From this analysis one can deduce that customers have
the knowhow about failing to repay will cost them their collaterals to be
disclosed and banks reduce the amount of their NPL through guarantying the
recoverability by getting the proceeds of the asset sold in the foreclosure
procedure. Furthermore, the bank has to use other mechanisms of repayment
before foreclosing customers’ property.

48
Table 3.10: Ratio of Outstanding Loan to Deposit

Deposit by
08/09 09/10 10/11 11/12
Type
Demand 674,005,399 1,106,187,593 1,502,109,946 2,044,020,612
Saving 1,364,415,813 1,984,477,422 2,856,888,878 3,598,373,996
Time 404,930,698 525,087,081 365,856,417 423,432,374
deposit
Total 2,443,351,910 3,615,752,096 4,724,855,241 6,065,826,982
Deposit
OTL 1,859,662,020 2,152,975,918 2,613,609,548 3,276,958,639
Percentage 76.11% 59.54% 55.32% 54.02%
Source: Annual Report 2009-2012 United Bank

The above table 3.10 shows that total deposit in United Bank increased by
about 1.2 million on average every year from 2008/09 up to 2011/12. OTL on
the other hand showed a linear increment during the same period. This implies
that the proportion of the loan and advance increases as the total deposit
increased. More or less the proportion has showed an increasing trend from
year to year.

Graph 1: A Line Graph Showing the Growth Rate of Outstanding Loan and
Deposit in United Bank

7,000,000,000
6,000,000,000
5,000,000,000
4,000,000,000 OTL
3,000,000,000 DEPOSIT
2,000,000,000
1,000,000,000
0
2008/09 2009/10 2010/11 2011/12

Source: Annual Report 2009-2012 United Bank

49
As graph 1 presents on what rate outstanding loans and total deposits have
been growing from year to year. The outstanding loan went up from 1,860
million in year 2008/09 to 3,274 million in year 2011/12 depicting a growth of
76%. Similarly, the total deposit increased from 2,443 million in the year
2008/09 to 6,066 million in the year 2011/12 with a growth of 148%.
According to the annual report of UBSC (2009-2012) total deposit has increased
by over two fold between 2008/09 and 2011/12. The percentage (OTL Vs total
deposit) decreased from 76.1% in 2008/09 to 54% in 2011/12. This implies
that the growth of total deposit is not proportional to the OTL. This also
indicates that the OTL for the bank is not linear implying that the bank needs
to be consistent in the OTL level which have to be proportional to the bank's
deposit.

Graph 2: Growth Rate of Outstanding Loan by Economic Sector

Source: Annual Report 2009-2012 United Bank

As presented above, the growth of loans are classified in to different categories


depending on the economic sector for the period 2009-2012 based on OTL
situation of the bank and disaggregated by economic sector for the period
mentioned. Accordingly, the import sector takes the highest share followed by

50
DTS. Referring to the above graph, the Import sector remained to be
consistently the most significant sector contributions to the bank’s outstanding
loan followed by DTS. These data imply the fact that the bank needs to give
emphasis to borrowers working on the sector of BC, transport and other
economic sectors in the loan processes. Moreover, as employee respondents
states export sector has the lower rate of being exposed to NPL. From this one
can deduce that, granting loans to export sector customers have a better
advantage in order to reduce the banks risk of having growing NPL rate.

Table 3.11: Ratio of NPL to Outstanding Loan


Year OTL NPL % PROPORTION
08/09 1,859,662,020 49,759,183 2.6:1
09/10 2,152,971,919 99,521,901 3.1:1
10/11 2,613,609,548 98,361,604 3.6:1
11/12 3,276,951,786 109,807,619 2.77:1
Source: Annual Report 2009-2012 United Bank

This research also tried to present the proportion of outstanding loans of UBSC
and NPL in the period 2008/09 up to 2011/12. According to table 3.11, with in
the mentioned times period, the proportion showed an increasing trend from
2.6% to 2.7%. This implies that as the outstanding loan increases more or less
the level of NPL increases. Mean while, the loan and advance grants have
grown considerably over the years under consideration. This increment
indicates that bad loan processing and follow-up, weak customer oriented debt
recovery mechanisms can make a favorable condition to higher the level of NPL
position of the bank.

51
CHAPTER FOUR
SUMMARY, CONCLUSIONS AND RECOMMENDATIONS

This chapter is the last part of the study which deals with summary of major
findings, conclusions and recommendations made by the student researcher.

4.1. Summary of the Major Findings

This study tried to address the four basic questions stated earlier in chapter one
of this study. Accordingly, all the necessary information was collected from
respondents by raising specific questions and the major findings are
summarized as follows.

• 21(70%) of the respondents were male and the remaining 9(30%) were
female.

• 5(16.67%) of the employee were diploma holders, 22(73.3%) and 3(10%) have
1st degree and above 1st degree respectively. Whereas 2(16.67%) of the
borrowers have diploma, 6(50%) and 3(25%) of the borrowers have 1st degree
and above 1st degree respectively.

• As per 13(43.33%), 15(50%) and 2(6.67%) of the employee respondents rated


the overall credit practice of the bank as very good, good and fair
respectively. With regard to loan processing time majority the respondents
19(63.34%) claim that it takes from two week to one month and 7(23.3%) of
respondents claim that it will take above one month to process a given loan
application.

• According to the majority of the respondents 17(56.67%), there are loans


granted by the bank without taking collaterals depending on the type of loan
for its employees and reliable customers. The conditions which banks grant
loans without taking collaterals for such facility the borrower credit
worthiness as well as clean base with bank has been key points.

52
• This research also tried to identify the problem associated with the NPL in
UB. Thus, 20(66.67%) of employee respondents specified that diversion of
borrowed fund to other purpose is the major cause of NPL at borrower side.

• According to the majority (50%) of employee respondents of UBSC, lack of


continuous follow-up is the major cause of NPL in UB. In addition, 60% of
the respondents agreed that high interest rate is also the major cause of
NPL. On the other hand, for the majority of the respondents (53.34%) excess
government intervention is the major cause of NPL at economic level.

• According to 13(43.33%) of employee respondents, mistake on estimation of


collateral and evaluation of the borrowers’ financial report are causes for
loan being default. Furthermore, 9(75%) of customer respondents think that
during estimation the bank doesn’t give fair value for the collateral presented
by the customer.

• Majority of employee respondents (56.67%) agrees that weak economic plan


and strategy implementation is the major cause of NPL at economic level.

• One objective of this research was to identify the procedure that the bank
has used to reduce the amount of NPL in the past. UB use different
mechanism to collect loans. These are:- 8(26.67%) of the respondents said
that rearrangement of loan repayment structure, 10(33.33%) extension of the
life of the loan, 3(10%) injection of additional loan and 30(100%) said
combination of the above mechanisms.

• Majority 23(76.67%) and 23(80%) of the employee respondents believe that


NPL affects the bank’s efficiency and have impact on its liquidity respectively.
Moreover, 11(91.67%) of customer respondents believe NPL affect the bank’s
profitability.

53
• From the bank’s customer respondents, 8(66.67%) and 3(25%) of them got
two times and above two times respectively. In addition, those customers
3(25%), 3(25%), 1(8.33%), 3(25%) and 2(16.67%) have got loan facility of
short term, medium term, long term, overdraft and letter of credit
respectively.

• This research also tried to examine the effort that the credit department of
the bank extends to assure the repayment of loans. Both respondents of UB
staff and customers anonymously mentioned that if the borrower stops the
loan repayment as scheduled the bank contacts the borrower with telephone
and personally and then write three consecutive reminders for its customers
and then after goes to foreclosure in stepped procedure.

• As per the annual progress of the bank, the total deposit of the bank
increased by about 1.2 million on average every year from 2009 up to 2012;
the OTL also showed a linear increment during the same period.

• According to the annual report of UB (2009-2012) total deposit has increased


by over tow fold between 2008/09 and 2011/12.

• Within the above mentioned time period, the proportion of NPL to OTL
showed an increasing trend from 2.6% to 2.77%, which implies that as the
OTL increases more or less the level of NPL increases.

54
4.2. Conclusions

Based on the respondents answer and summary of major findings, the student
researcher has drawn the following conclusions.

• The overall credit practice of the bank is in good position.

• The time which takes to process the requested loan almost takes one month.

• The bank grants some type of loans without taking of collaterals to its
employees and customers depending on the type of facility and credit
worthiness of the customer.

• The procedures followed by the bank to approve the loan is believed to be in


a satisfactorily position.

• The bank assesses all the necessary information like financial information
(i.e. credit worthiness, detailed financial analysis) before approving a given
loan.

• From the types of loans granted by the bank, sectors that have higher
tendency of being defaulted or being NPL are: manufacturing sector, building
and construction sector, transport sector, domestic trade and service sector,
export and import sector respectively.

• There are different factors to cause NPL among the major ones the following
have their own impact to default the loan: high interest rate, credit
culture/orientation/, poor monitoring /follow-up/, poor risk assessment,
lenient credit terms, and rapid loan growth from the higher NPL factor to the
lowest respectively.

• The major causes of NPL at the borrower level are highly the diversion of the
borrowed fund to other purpose. In addition, poor business plan and
insufficient credit awareness are some of the causes of NPL at borrower side.

55
• Depending on financial report and collateral evaluation in order to approve
loan, government intervention and implementation of weak economic plan
and strategy are also the cause of NPL in UB.

• United bank has its own credit follow-up techniques and procedures
designed and implemented in order to reduce the level of NPL.

• When the borrower faced certain problem and unable to pay the loan, the
procedural mechanisms the bank apply in order to collect the loan at most
efficiency are combination of extension of the life of the loan, injection of
additional loans, rearrangement of loan repayment structure of the loan are
used to reduce NPLs.

• The impact of NPL highly affects the goal, efficiency and liquidity of the bank.

• Majority of the borrowers get loan from the bank two and above. This means
there is a positive relationship between the borrowers with the bank.

• The bank’s estimation of the collateral is not fair.

• Most of the borrowed fund is for the purpose of working capital.

• The bank follows the borrower proposal and accomplishment of the fund
appropriately.

• NPL have an effect on the bank’s profitability.

• When the borrower fails to pay the loan the bank sell the collateral for the
repayment of the loan.

• The proportion of outstanding loans to the NPL is increased from the period
2008/09 to 2009/10 and decreased to 2010/11.

56
4.3. Recommendations

In light to the outcomes of the data analysis made and conclusion drawn, it
would be sound and convincing to forward the specific recommendations in
order to bring changes for the betterment and prosperity of the bank.

• The overall credit policy of the bank is in good position. But it must be
practical in order to improve its efficiency to avoid dissatisfaction of
customers.

• The time which takes to process the requested loan almost takes one month
so, as much as possible it must decrease the time of loan processing.

• The bank grants some type of loans without taking of collaterals to its
employees and customers depending on the type of facility and credit
worthiness of the customer. But the bank should increase the type of facility
granted to the customer to increase its competitive advantage and increase
loan types.

• The procedures followed by the bank to approve the loan is believed to be in


a satisfactorily position. But to some extent the customer are not satisfied
so it must make some improvements towards the satisfaction of the
customers.

• The bank should encourage sectors which are rarely exposed to NPL in order
to improve the repayment habits or support and advice to take any
important correction actions by the managers of the businesses.

• The bank should consider the factors such as: poor risk assessment, poor
monitoring /follow-ups, lenient credit term and make any necessary
adjustments to solve those kinds of causes.

57
• The bank should follow-up borrowers to minimize the major causes of NPL at
the borrower level which is highly the diversion of the borrowed fund to other
purpose is the main one. In addition, poor business plan and insufficient
credit awareness are some of the causes of NPL at borrower side. So the
bank must try to evaluate the customer reliability to what extent the
disbursed loan is implemented to the intended purpose.

• Even if United Bank has its own credit follow-up techniques and procedures
designed and implemented in order to reduce the level of NPL, its
implementation and practice is not strong enough so the bank must give due
attentions and care.

• When the borrower faced certain problem and unable to pay the loan, the
procedural mechanisms the bank apply in order to collect the loan at most
efficiency are combination of extension of the life of the loan, injection of
additional loans, rearrangement of loan repayment structure of the loan are
used to reduce NPLs. But this should also be practical in full not only be
procedural to decrease the NPLs figure and to improve the image of the bank.

• The impact of NPL highly affects the goal, efficiency and profitability of the
bank. Therefore, the bank should work on decreasing the figure of NPLs due
to the fact that it affects the profitability of the bank.

• The bank’s estimation of the collateral is not fair. So that the bank revise its
estimation procedure depending on the current market situations in order to
satisfy its customers and give collateral a fair value.

• When the borrower fails to pay the loan the bank sell the collateral for the
repayment of the loan. However the selling of collaterals is an impact on the
image of the bank. Therefore, before foreclosing collaterals the bank should
give other opportunities to borrowers to repay their loans and this will
protect the bank from having bad image in the public.

58
BIBLIOGRAPHY

Adriaan M. Blaem and Cornelis N. Gorter (2001), The Treatment of


Nonperforming loans in Macroeconomic statistics, IMF Working
Paper, WP/01/209, P:4-5

Adriaan M. Blaem & Russel Freeman (2005), the treatment of


Nonperforming loans, classification and elaboration of issue
raised by the Deemseel 2004 Meeting of the Advisory Expert Group
of the Inter-secretariat Working Group on National Accounts 8, IMF
BO PCOM-05/29

Frank H. Robert, Ben S. Bernanke (2001), Principles of Economies,


McGraw Hill-Irwin.

Geng Xiaoc 2006, Nonperforming Debts in Chinese Enterprice: Patterns,


Causes, and Implications for Banking Reform, Asian Economic
Paper 4:3, ISSN 61-113

Gupta (1985), Financial Intermidiation, Interest Rates and the


Structure of Savings: Evidence from “Asia”, Journal of Economic
Development, Vol.9. p:7-24
GTZ, Risk Management, 2000

Luis Cortavarria et al (2000), Loan Review, Provisioning and


Macroeconomic Linkage, IMF WP/00/195, p: 11

Mohammed Shofiqul Isalm et al (2005). Nonperforming loans-its causes,


consequences and some learning, Munich personal RePEc
Archive, MPRX Paper No. 7708, Vol. 16, No. 15 ISSN 1:13

NBE (2008), Ethiopian Banking Business Directives P: 2

NBE (2012), Ethiopian Banking Business Directives P: 4-9

Nir Klein (2003), Non-performing Loans in ESSE; Determinants and


Macroeconomic Performances, IMF Working Paper WP/13/72

59
Nobuo et al (2003). Nonperforming loans and the real economy,
London School of Economics, BIS paper No. 22, ISSN 106-107
Peter S. Rose (1983), Loans in a Troubled Economy, The Canadian
Banker Vol 90, No. 3 P. 55
Rajiv Ranjan and Sarat Chandra Dhal (2003). Non-Performing Loans
and Terms of Credit of Public Sector Banks in India: An
Empirical Assessmen, Reserve Bank of India Occasional papers,
Vol.24 No. 3 pp.103
Samuelson, Paul A. and William, D. Nordhaus (2001) Economies,
MCGraw Hill-Irwin, Seventeenth Edition.

St. Mary’s University (2009-2011). Graduated Students Senior Research


paper. Addis Ababa.

United Bank S.C., Annual Progress Report (2008/09), P:8-9


United Bank S.C., Annual Progress Report (2009/10), P:6-8
United Bank S.C., Annual Progress Report (2010/11), P:5-6
United Bank S.C., Annual Progress Report (2011/12), P:6
United Bank S.C., Annual Progress Report (2012/13), P:4-9
United Bank S.C., Credit Procedure, 2010:1-17
UBSC, Weekly Branches Deposit Report (Dec. 2, 2013 – Dec. 7, 2013)

60
Annex I

St. Mary’s University


Faculty of Business
Department of Management

Questionnaires to be filled by Staff of United Bank

This questionnaire is developed by graduate student of St. Mary’s University for


research paper to be done for partial fulfillment of the academic requirements
of B.A degree in Management in order to assess “Causes and Consequences of
Non-Performing Loans”, a case study on United Bank Share Company.

Since none of your response is forwarded to any 3rd party and is kept
confidential, please answer each question with no fear of repercussion.
Moreover, the success or failure of this case study entirely depends on your
responses; hence please respond each question as appropriately as possible.

General Instruction:
 No need of writing your name.
 Put the mark “√” in the box you want to choose.

Thank you in advance for your utmost cooperation!

i
PART I: General Characteristic of the Respondent
1. What is your Position in the United Bank?
Credit Manager Branch Manager Assistant B/Manager
Loan Clerk Credit Analyst Loan Officer
If other, please specify
2. Sex
Male Female
3. Educational Background
Certificate 1st Degree
Diploma Above 1st degree
4. How many years have you work in United Bank S.C?
Less than One Year 7 – 9 Years
1 - 3 Years Above 9 Years
4 - 6 Years

PART II: Questions Directly Related with the Research


5. How do you rate the overall credit policy of the bank?
Very good Poor
Good Very Poor
Fair
6. How long will it take to process a given loan application?
One week One month
Two weeks Above one month
Three weeks
7. Does the bank grant loan without taking collaterals?
Yes No

8. If your answer to Q. 7 is yes, would you please explain it?


___________________________________________________________________________
_______________________________________________________________

ii
9. Do you believe the procedure followed by the bank for loan approval is
satisfactory?
Yes No

10. If your answer to Q. 9 is No, what are the possible reasons?


___________________________________________________________________________
_______________________________________________________________

11. Does the bank assess its borrowers past historical financial information
(i.e. credit worthiness, detailed financial analysis) before extending any
loans to customers?

Yes definitely Not at all


Yes to some extent I am not quite aware of it

12. If your answer to Q. No 11 is yes, how frequently does the bank assess the
borrowers past historical financial information and their credit worthiness.
___________________________________________________________________________
_______________________________________________________________

13. What mechanisms does the bank use to assess borrowers past historical
financial information?
___________________________________________________________________________
_______________________________________________________________

14. Which sectors of loans and advances granted to customer have the
tendency of default loan and advance? Please rate in their priority.

iii
Rate
Sectors that have the tendency to
No. 5=Very High 4=High 3=Moderate
default loan
2=Low 1=Very Low
1 Transportation Sector
2 Manufacturing Sector
3 Export Sector
4 Domestic Trade & Services Sector
5 Building and Construction Sector
6 Import Sector
If Others, please specify it

15. From the listed under, Please specify the major causes of non performing
loans at borrower side.
Lack of proper business plan
Diversion of the borrowed fund to other purpose
Insufficient credit awareness
Unwilling customer to disclose the information required
Willful default/unwillingness to pay
If other, please specify it _______________________________

16. Please rate your level of agreement and disagreement on the causes of
nonperforming loans in United Bank.

No. Strongly Disagree Neutral Agree Strongly


Causes of NPL
Disagree (1) (2) (3) (4) Agree (5)
Rapid Loan growth by
1
banks
2 High interest rate
3 Lenient credit terms
Credit culture
4
/Orientation/
Poor Monitoring/Follow-
5
up
6 Poor Risk Assessment

iv
17. Please specify your level of agreement or disagreement about mistake on
estimation of collateral and evaluation of the borrowers’ financial report is
one of cause of non performing loan in United bank.
Strongly agree Disagree Strongly Disagree
Agree Neutral

18. Please specify your level of agreement or disagreement about excessive


government intervention is the major causes of non-performing loan at
economic level.
Strongly agree Disagree Strongly Disagree
Agree Neutral

19. Please specify your level of agreement or disagreement about weak


economic plan and strategy implementation is the major causes of non-
performing loan at economic level.
Strongly agree Disagree Strongly Disagree
Agree Neutral

20. Do you believe that the level of non-performing loans have a highest
impact on the overall bank’s efficiency?
Yes No

21. If your answer to Q. No 21 is yes, in what form does such non-performing


loans affect bank’s efficiency.
___________________________________________________________________________
_______________________________________________________________

22. What are the effects of non-performing loans in terms of the bank
liquidity?
___________________________________________________________________________
_______________________________________________________________

v
23. The impact of non-performing loan on the bank’s liquidity is
Very high Moderate Low

High Very low

24. What are the consequences of non-performing loans on the bank’s credit
efficiency and overall performance?
___________________________________________________________________________
_______________________________________________________________

25. Is there any credit follow up techniques and procedures designed and
implemented by the bank to reduce the level of bank’s NPL?
Yes No

 If yes, can you please explain about it?


___________________________________________________________________________

_______________________________________________________________

26. When the borrowers face a certain problem and unable to pay the loan,
what procedural mechanisms does the bank apply in order to collect the
loan at most efficiency?
Extension of the life of the loan
Injection of additional loans
Rearrangement of loan repayment structure

Combination of the above


If other, please specify it _________________________________

27. What other procedural mechanism do you advice or suggest for the bank
to implement in order to reduce the level of NPL rate at a minimum level
than before?
_________________________________________________________________________

_____________________________________________________________

vi
28. What measures are taken by the bank if the borrower stops the loan
repayment as per the schedule?
_________________________________________________________________________
_____________________________________________________________

29. If you have any strong or weak point about the credit management &
practice of bank, please specify.

_________________________________________________________________________

_________________________________________________________________________

_________________________________________________________________________

_________________________________________________________________________

_________________________________________________________________________

_____________________________________

vii
A n n e x II

Interview Guideline

These interview questions are developed by a graduate student of St.


Mary’s University for research paper to be done for partial fulfillment of
the academic requirements of B.A degree in Management in order to
assess “Causes and Consequences of Non-Performing Loans”, a case
study on United Bank Share Company.

1) In what sectors does UB S.C entertain credit facility?

2) What are the requirements of borrower to get the loan?

3) How do you consider the Collateral, Condition, Capital, Character and


Capacity when you analyze the loan request?
4) What techniques do the bank’s use to estimate collateral estimation
fairly?

5) What are the causes of non-performing loan?

6) What are the consequences of non-performing loan?

7) What credit follow-up methods does the bank use?

8) What mechanisms does the bank use to minimize NPL and its
consequences?

viii
A n n e x III

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ii
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________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

iii
Declaration

I , th e u n d e r s ig n e d , d e c la r e th a t th is s tu d e n t r e s e a r c h p a p e r is m y o r ig in a l

work, prepared under the guidance of Ato Zelalem Tadesse. All sources of

m a te r ia ls u s e d to th is p a p e r h a v e b e e n d u ly a c k n o w le d g e d .

N am e: B e t h le h e m T a d e s s e

S ig n a tu r e : ___________________

Place of Submission: St. Mary’s University

D a te o f S u b m is s io n : J u n e 2 8 , 2 0 1 4

This paper has been submitted for examination with my approval as

U n iv e r s ity a d v is o r .

N am e: Z e la le m T a d e s s e

S ig n a tu r e : _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

D a te : June 28, 2014

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