2.2 Evolution of Microfinance in Ghana.
According to Otero (1999), microfinance gained prominence in the 1970s and the 1980s. Prior to that in the 1950s, Canadian Catholic Missionaries had established credit union for the first time in Africa; Northern Ghana (BOG, 2007). Susu, which is one of the key microfinance schemes in Ghana, is also believed to have originated from Nigeria and spread to Ghana in the twentieth century (Stephen, 2012). Ditcher (1999) refers to the 1990s as “the microfinance decade”. Microfinance has now turned into an industry according to Robinson (2001). Microfinance companies seem to be springing up in every nook and cranny in Ghana, providing easy access to financial services to the country’s largely unbanked population. The growth in MFIs saw a change in focus from just the provision of credit facilities to the poor (microcredit) to the provision of other financial services such as savings, pensions and insurance (microfinance) resulting from increase in demand for these other services by the poor (MIX, 2005).
In Ghana, before 2015, committed to the Millennium Development Goals which inspired a focus on poverty alleviation through credit provision. One of her strategies had been establishing a robust and sustainable microfinance industry which addressed poverty reduction, household welfare and women empowerment. Over the years, financial sector programmes and policies undertaken by various governments since independence have facilitated the evolution and thriving of the microfinance sector into its current state (Bank of Ghana, 2007). Some of the financial sector programmes in Ghana have included;
a) Provision of subsidized credits in the 1950s.
b) Introduction of the Agricultural Development Bank in 1965 which was charged to support the financial needs of the agricultural sector.
c) Establishment of Rural and Community Banks (RCBs) in 1970s and 1980s.
d) Liberalization of the financial sector and the promulgation of PNDC Law 328 of 1991, which allowed the establishment of various forms of non-bank financial institutions including savings and loans, finance houses, credit unions etc.
e) This was referred from a Note on Microfinance in Ghana (Working Paper) by the research department of the Bank of Ghana, 2007.
f) According to Bank of Ghana (2007), there are currently three broad types of MFIs operating in Ghana. These are;
g) Formal suppliers of Microfinance (i.e. Rural and Community banks, Savings and Loans companies, Commercial banks).
h) Semi-formal suppliers of microfinance (i.e. Credit unions, Financial Non-Government Organizations (FNGOs) and Co-operatives)
i) Informal suppliers of microfinance (i.e. Susu collectors and clubs, rotating and accumulating savings and credit associations, traders, money lenders and other individuals).
Currently, the regulatory framework has the rural and community banks under the supervision of the Banking Act 2004 (Act 673) while the savings and loans companies are regulated by Non-Bank Financial Institutions (NBFI) Law 1993 (PNDCL 328). On the other side of it is the regulatory framework for credit unions which are still being developed to reflect their dual nature as co-operatives and financial institutions.
Despite the stringent regulatory framework for the aforementioned types of MFIs, there are no explicit legal and regulatory frameworks for these institutional bodies namely Financial Non-Governmental Organisations (FNGOs), Rotational Savings and Credit Associations (ROSCAs), etc. These bodies are largely unregulated.
2.3 Microfinance and poverty alleviation
One major concern to many nations is poverty and most especially is in developing countries. Poverty is defined as a situation where a population or section of the population is able to meet only its bare subsistence, the essentials of food, clothing and shelter, so that their standard of living would be maintained (Balogun, 1988). Poverty was defined by Englama and Bamidele (1997) in both relative terms as a state where an individual is unable to adequately cater for his or her basic needs of food, clothing and shelter, meet social and economic obligations; lacks gainful employment, skills, assets and self-esteem; and has limited access to social and economic infrastructures.
Over the years, a prominent and contemporary development issue has been poverty. The poor is constrained with lack of access to formal sector funds. These constraints disallow them to take advantage of economic opportunities which will enable them increase their level of output thereby fighting the problem of poverty. Hence, microfinance has been identified as a development tool where poor individuals in the society financial sustainability will be promoted. Microfinance revolution in many countries has resulted by helping the poor and lower income groups due to the provision of considerable flow of funds (Weiss et al., 2003). Microfinance has proven to be an effective and efficient mechanism in alleviating poverty all over the world (Morduch and Haley, 2002). However, just like many other development tools, it has inadequately penetrated the poorest unit in the society. In developing countries, the poor people form the vast majority without access to basic education, primary health care and lack of access to microfinance (Adu, Anarfi and Poku, 2014). Just like many other developing countries, Ghana and Bangladesh have recorded relative success in using microfinance as an effective instrument to alleviate poverty in general as well as rural poverty. According to Weiss et al. (2003), lack of access to credit is readily understandable in terms of the absence of collateral that the poor can offer conventional financial institutions, in addition to the various difficulties and high costs involved in dealing with large numbers of small, often illiterate borrowers. Thus, the poor have to rely on loans from friends, relatives or money lenders at high interest rates whose supply of funds will be limited. A report made by Adu et al. (2014) on microfinance and poverty reduction stated that, “Microfinance has broadly and arguably been seen as one of the significant means for improving the lives of poor and also a development tool for alleviating poverty and socio-economic development, particularly in developing and emerging economies”. As an instrument for fighting poverty, microfinance has been prioritised for decades. Ngugi and Kerongo (2014) also stated that, microfinance is very important because of its supporting nature of creating access to formal financial services for low income households, improving living conditions among poor families and fostering economic development. Suitable and affordable instruments for savings, insurance, credit, insurance and payment transfers are very necessary for dealing with economic fluctuations and risks that make the poor vulnerable by taking advantage for opportunities and acquiring productive assets and skills that can generate increased income (Steel and Andah, 2003). For most countries, poverty has become a burden for them most especially households with per capita incomes of less than one dollar per day (Morduch, 1999). The main aim of microfinance is not only providing credit for the poor for fighting poverty alone, but also by creating institutions that will provide financial services to the poor who are ignored by the conventional commercial banks (Otero, 1999).
Boateng, Boateng and Bampoe (2015), observed that in Ghana most micro and small entrepreneurs lack access to financial services and this is a very critical constraint for expanding viable micro-enterprises. According to Aryeetey (1994), for Ghanaian population, only six percent has access to formal financial services while majority of the population are denied access. In Ghana, poverty is identified as a combination of both personal and community life situations. On the personal level, poverty is reflected as inability of gaining access to basic community services (Batse et al 1999) and (Nsiah-Gyabaah, 1998). Poverty is defined by the Ghana Living Standards Survey (GLSS) of 2005 to 2006 using an economic index, where the poor are seen as those ”subsisting on a per capita income of less than two thirds of the national average” (Ghana Statistical Service, 2006).
Studies on poverty levels in Ghana demonstrate that poverty is multidimensional and vary from rural to urban people, the young and old as well as men and women (Nkum and Ghartey, 2000). Poverty means lack of food, insecurity, infertility and inability to participate in social activities for rural dwellers. For urban dwellers, poverty is seen by them as lack of employment, inadequate social services, inadequate capital as well as lack of skills training (Appiah, 1999, Nkum ; Ghartey, 2000). Goldberg (2005) observed that as microfinance has been introduced in Bangladesh, the poor no longer remained as poor. Mawa (2008) also confirmed that microfinance is an innovative step towards poverty alleviation. In Ghana, evidence suggest that the positive impact of microfinance is generally on women empowerment and has increased in respect and decision rights within the family as well as increasing self-esteemed (Cheston and Kulhn, 2002). To other writers, microfinance is a poverty alleviating tool though it cannot alone, fully solve the problem.
2.3.1 Microfinance and Development
According to UNCDF (2004), microfinance plays three key roles in development. It;
a) aids every poor household meet basic needs and protects against risks,
b) helps to empower women by supporting women’s economic participation and so promotes gender equity.
c) is associated with improvements in household economic welfare.
Microfinance creates access to productive capital for the poor, together with human capital, addressed through education and training, and social capital, achieved through local organisation building, enables people to move out of poverty (Otero, 1999). When material capital is provided to poor persons, their sense of dignity is strengthened and this can help to empower the person to participate in the economy and society (Otero, 1999). Otero (ibid.) observes that the provision of capital to the poor to combat poverty on individual level is not the only focus of microfinance, it also has a function at an institutional level. This is because, microfinance seeks to create institutions that deliver financial services to the poor, who are continuously ignored by the mainstream of banking (Conroy, 2003).
According to Littlefield and Rosenberg (2004), the poor are generally excluded from the financial services sector of the economy in the regard of the formal banking so MFIs have emerged to address this market failure. Otero (1999) states that, MFIs by addressing this gap in the market in a financially sustainable manner can become part of the formal financial system of a country and also provide access capital markets to fund their lending portfolios, allowing them to dramatically increase the number of poor people they can reach. In recent times, commentators such as Murduch, Hashemi, Littlefield and Brody (2004) have commented on the critical role of microfinance in achieving the Millennium Development Goals. Littlefield, Murduch and Hashemi (2003) state that, microfinance is a critical contextual factor with strong impact on the achievements of the MDGs. Microfinance is unique among developmental interventions: provision of social benefits on an ongoing, permanent basis and on a large scale. Referring to the various case studies, they show how microfinance has a significant role to play in poverty eradication, promoting education, improving health and empowering women (Littlefield, Murduch and Hashemi, 2003). According to Simainowitz and Brody (2004), microfinancing is a key strategy of reaching the MDGs and in building global financing systems that meet the needs of poorest people.
Devi S. Kavitha (2004) has reviewed on the topic ‘Microfinance and Women Empowerment’. According to her, microfinance gained impetus primarily because it promised the social and economic uplift of women in developing countries across Africa, Asia and Latin America. Countries in these regions have patriarchal societies that harbour gender-biased traditions preventing the liberation of women. She says that, women are empowered when they have the ability to generate and control their own income.
According to the Bank of Ghana (2007), microcredit is thus one of the critical dimensions of the broad range of financial tools for the poor, and its increasing role in development has emanated from a number of key factors. These includes;
a) The fact that the poor need access to productive resources, with financial services being a key resource, if they are to be able to improve their conditions of life.
b) The realization that the poor have the capacity to use loans effectively for income generation, to save and repay loans.
c) The observation that the formal financial sector has provided very little or no services to low-income people, creating a high demand for credit and savings services amongst the poor.
d) The view that microfinance is unable and can become sustainable and achieve full cost recovery.
e) The recognition that microfinance can have significant impact on cross cutting issues such as women’s empowerment, reducing the spread of HIV/AIDS and environmental degradation as well as improving social indicators such as education, housing and health.
Sustainable access to microfinance helps alleviate poverty by generating income, creating jobs, allowing children to go to school, enabling families to obtain health care, and empowering people to make the choices that best serve their needs (Kofi Annan, 2003). Microfinance may not be a panacea for poverty eradication and its related development challenges, but when harnessed can indeed make sustainable contributions through financial investment leading to the empowerment of people hence promotes confidence and self-esteem, particularly for women.
However, not all commentators are as enthusiastic about the role of microfinance in development and it is important to realise that microfinance is not a silver bullet when it comes to fighting poverty. In appreciating the role microfinance can play in helping to mitigate poverty, there came a conclusion in their research on microfinance that “most contemporary schemes are less effective than they might be” (Mosley and Hulme, 1996). They argue that, even to some extent the poorest people have been made worse-off by microfinance, hence microfinance is not a panacea for poverty-alleviation. Rogaly (1996) identifies five major faults with MFIs. He argues that;
a) they encourage a single-sector approach to the allocation of resources to fight poverty,
b) microcredit is irrelevant to the poorest people,
c) an over-simplistic notion of poverty is used,
d) there is an over-emphasis on scale,
e) there is inadequate learning and change taking place.
Much of the scepticism of MFIs emanates from the argument that, microfinance programs fail to reach the poorest, generally have a limited effect on income which then drive women into greater dependence on their husbands and fail to provide additional services desperately needed by the poor (Wright, 2000). Again, Wright (2000) says that many development practitioners do not only find microfinance inadequate, but that it actually diverts funding from more important or pressing interventions such as education and health. Navajas et al (2000) also argue that, there is a danger that microfinance may siphon funds from other projects that might helped the poor more. Therefore, governments and donors should know whether the poor benefit more from microfinance, than from health care or food aid. There is therefore a need for all involved in microfinance and development to deduce what exactly has been the impact of microfinance in fulfilling its aim of combating poverty.
2.4 Causes of Loan Default in Microfinance Institutions.
Balogun and Alimi (1988) also identified the major causes of loan default as loan shortages, delay in time of loan delivery, small business size, high interest rate, age of borrower, poor supervision, non-profitability of business enterprises and undue government intervention with the operations of government sponsored credit programmes. In addition, causes of loan default are because of; lack of willingness to pay loans coupled with diversion of funds by borrowers, wilful negligence and improper appraisal by credit officers (Ahmad, 1997). Moreover, Akinwumi and Ajayi (1990) found out that business size, family size, scale of operation, family living expenses and exposure to sound management techniques were some of the factors that can influence the repayment capacity of customers. According to Olomola (1999), loan disbursement lag and high interest rate can adversely affect repayment performance.
After different MFIs were surveyed in India, it was identified that the main causes of loan default from industrial sector as improper selection of an entrepreneur, deficient analysis of project viability, inadequacy of collateral security/equitable mortgage against loans, unrealistic terms and schedule of repayment, lack of follow up measures and default due to natural calamities (Berger and De Young 1995). Okorie (1986) conducted a study in Ondo state in Nigeria and it revealed that, the nature, time of disbursement, supervision and profitability of enterprises, contributed to the repayment ability and consequently high default rates. Other critical factors associated with loan defaults are: type of the loan; term of the loan; interest rate on the loan; poor credit history; borrowers’ income and transaction cost of the loans. Okpugie (2009) also indicated that, high interest rates charged by the MFIs have been discovered to be the reason behind the alarming default. Vandel (1993), who also found that high interest rates charged by banks tend to facilitate default by borrowers, also confirmed this. According to Gorter and Bloem (2002), an inevitable number of wrong economic decisions by individuals mainly causes non-performing loans and plain bad luck (bad weather, unexpected price changes for certain products, etc.).
Inadequate financial analysis according to Sheila (2011) is another cause of loan default. This is when the loans department officers do not take a careful study of the loan applications to ensure that the applicants have sound financial base such that the risk of loss is mitigated in case of a default. Sheila (2011) again indicated that in Uganda; the issue of inadequate loan support is another cause of loan default. He argues that, it is very important the loan personnel collectively ascertain the position of the customer so that in case he/she needs support, it is availed to him or her. Unfortunately, that is not the case because even when the support is given, it is not adequate which leaves the business crumbling and hence leading to default. The research also pointed out that, causes of loan default can be as a result of illiteracy and inadequate skills. This implies customers do not have enough knowledge about alternative marketable skills that can benefit them when their businesses do not function properly. Secondly, most of them do not know how to read, write and make simple calculations. As a result, they do not know how to account for their businesses even when the lender makes an error, the borrowers are held liable to the loan. Again disappearance of loan clients was seen as another cause.
Another cause of loan default is poor business practice. Kasozi (1998) pointed out that, there are weaknesses of the borrower over which the lender has little control. Bichanger and Aseya, (2013) points out that, some of the factors that lead to loan default include; inadequate or non-monitoring of micro and small enterprises by MFIs, delays by MFIs in processing and disbursement of loans, diversion of funds, over-concentration of decision making
2.5 Non-Performing Loans
As identified in Fofack (2005), the term non-performing loans (NPLs) can be used interchangeable with bad loans, impaired loans of defaulted loans. These types of loans can be described as problem loans (Berger and DeYoung, 1997). In recent times, the literature on non-performing loans has occupied the interest of several authors particularly the attention in understanding of the variables liable to the financial vulnerability (Khemraj and Pasha, 2009). Some researchers observe that, whilst some countries use qualitative criteria such as information about the customer’s financial strength and management judgement about the future payments, others use quantitative criteria such as number of days the credit facility is overdue (Bloem and Gorter, 2001).
According to the International Monetary Fund (IMF, 2009), a non- performing loan is any loan in which interest and principal payments are more than 90 days overdue. The Basel Committee (2001) defines non-performing loans as loans left unpaid for a period of ninety days.
An efficient and well-functioning financial sector is essential for the development of any economy, and the achievement of high and sustainable growth. One of the indicators of financial sectors health is loan qualities. Most unsound financial sectors show high level of non- performing loans within a country.
The causes for loan default vary in different countries and have a multidimensional aspect both, in developing and developed nations. Theoretically, there are so many reasons as to why loans fail to perform. Some of these include depressed economic conditions, high real interest rate, inflation, lenient terms of credit, credit orientation, high credit growth and risk appetite, and poor monitoring among others. Bercoff et al. (2002) categorizes causes of nonperforming loans to institution specific and macroeconomic conditions.
Lending is a risky enterprise because repayment of loans can seldom be fully guaranteed. According to Hoff and Stiglitz (1990), implicit contracts between lenders (financial institutions relationships) and borrowers, can motivate high effort and timely repayments. Besley and Coate (1995) also stated that, long-term relationships are a powerful disciplinary device. They posit that in credit markets dominated by short-term interactions, borrowers may only be motivated to repay if they know that, due to credit reporting, their current behaviour is observable by other lenders. The work of Fehr and Zehnder (2005), indicates that the impact of credit reporting on repayment behaviour and credit market performance is highly dependent on the potential for relationship banking. Therefore, when bilateral relationships are not feasible, the credit market essentially collapses in the absence of acceptable borrower behaviour. As repayments are not third-party enforceable, many borrowers default and lenders cannot profitably offer credit contracts (Brown and Harvey, 2006). The availability of information on past repayment behaviour allows lenders to condition their offers on the borrowers’ reputation. As borrowers with a good track record receive better credit offers, all borrowers have a strong incentive to sustain their reputation by repaying their debt (Orebiyi, 2002). Therefore, by repeatedly interacting with the same borrower, lenders establish long-term relationships that enable them to condition their credit terms on the past repayments of their borrower. As only a good reputation leads to attractive credit offers from the incumbent lender, borrowers have strong incentives to repay.
2.5.1 Relationship between Demographic Characteristics and Loan Performance
There is a relationship between borrower demographic category and accessing loan repayment performance (Berger and Udell, (2006). Thus customer demographic characteristics are important aspect that MFIs consider when advancing loans to their clients. This implies that, the demographic information may show the likely risk level of a particular individual in case of advancing loans. According to Gieseche (2004), the characteristics of borrowers are associated with the creditworthiness of borrowers and these characteristics are also interrelated. Nguyen (2007) identified demographic profiling as a key factor influencing loan advance and the subsequent performance of the loan across the microfinance industry as this provides critical information about the group and individuals to credit officers who then make informed decisions on the suitability or otherwise of the group or individual. This was likewise echoed by Berger, Miller, Petersen, Rajan and Stein (2005) who indicated that MFI customers, as a whole, possess demographic characteristics that put MFIs at a competitive advantage or disadvantage in advancing loans and in loan performance as well. For instance, banks with customers who are: older, less likely to be employed hence have less household income and have less education are likely to default on their loans or have some difficulties servicing their loans. Bank customers having lower income and earnings potential results in them owning investable asset balances.
According to Nguyen (2007) most MFIs consider favourably borrowers who are more educated as they are able to communicate well with the MFI on their status than borrowers with low education level. Indeed, MFI borrowers with high level of education are able to deal with the loan documentation and requirement in an effective manner and to reschedule their loans in cases of change of situations that affect their ability to service their loans appropriately.
It is argued that MFIs are likely to consider comparatively more matured client for a loan relative to the young ones if all the other factors are held constant (Berger and Udell, 2006). Whereas there will be a notable increase in the number of costumers aged 35 to 44 over the next decade, there will be only a slight change in the number of persons aged 45 to 55. It is therefore prudent for MFIs to direct more marketing efforts towards the 35 to 44 age group to share fully in the rapid growth in the market. In fact, differences in the ages of borrowers probably bode well for MFIs. Specifically, male borrowers tend to receive more favourable assessments when compared to women borrowers (Blanchflower, Levine and Zimmerman, 2003). Blanchflower, Levine, and Zimmerman (2003) established that women-owned businesses were about twice as likely to be denied credit even after controlling for differences in creditworthiness and other financial performance factors. However, such effects occur on account of stereotyping, whereby a person is classified as a member of the target group, and inferences are made about that person based on the group’s presumed attributes without the decision maker’s conscious awareness (Wheeler and Petty 2001). Lawrence (1995) examines the theoretical literature of life-cycle consumption model and introduces explicitly the probability of default. This model implies that borrowers with low incomes have higher rates of default due to increased risk of facing unemployment and being unable to settle their obligation. The combination of a customer base that is older with lower earnings potential contributes to higher loan non-performance among MFIs.
The aim of MFIs profiling their customers on the basis of demographic characteristics is to maximize on their client’s repayment performance (Han, 2008). High repayment rates are indeed largely associated with benefits both for the MFI and the borrower. They enable the MFI to cut the interest rate it charges to the borrowers, thus reducing the financial cost of credit and allowing more borrowers to have access to it (Kon and Storey, 2003). Improving repayment rates might also help reduce the dependence on loan subsidies of the MFI which would improve sustainability. Kano, Uchida, Udell, and Watanabe (2006) argued that high repayment rates reflect the adequacy of MFIs services to their client’s needs.
2.5.2 Mitigating Factors of Non-Performing Loans in Microfinance Institutions
Lenders put in place different policies to ensure that credit administration is done effectively. One of these policies is collection policy. This policy is needed because all customers do not pay the firms bills on time. The collection effort should therefore aim at speeding up collections from slow payers and hence decreasing bad debt losses. A collection policy safeguards prompt and regular collection for fast turnover of working capital keeping collection costs and bad debts within limits and hence maintaining collection efficiency. According to Pandey (2004), collection policy lay down clear-cut collection procedures and hence dissuades conflicts arising from loan repayment periods, amounts and loan structure. The policy also examines business viability position and business Management by appraising the financial strength of the applicant, the firm`s quality of management and nature of the customer’s businesses. Management audit is also conducted by the lender to identify weakness of the customer’s business management. If the nature of the customer’s business is highly fluctuating or has financially weak buyers or then it is very dangerous to extend credit to such borrower (Weston, 1982).
Moreover, credit policies also ponder on credit limit (maximum amount of credit which the firm will extend at a point in time). It specifies the extent of risk to the firm by extending credit to a customer. Credit limit is also a function of the character of a customer (customer’s willingness to pay and the moral factor). Various methods are employed to examine credit worthiness. The debt capacity of the applicant is reflected in cash flow projection forming the basis for the decision on the loan conditions and the payment plan. The willingness to pay is assessed either on the basis of his credit history or, if there is none, using statement of suppliers, neighbours on the borrower’s reputation and how promptly. A firm may regulate the credit worthiness of customers by improving its own ad hoc approach of numerical credit. The qualities identify by the firm may be assigned weights depending on their importance and be combined to create an overall- score.
Proper loan allocation
Kay Associates Limited (2005) cited by Aballey (2009) states that bad loans can be restricted by ensuring that loans are made to only borrowers who are likely to be able to repay, and who are unlikely to become insolvent. Credit analysis of potential borrowers should be carried out in order to judge the credit risk with the borrower and to reach a lending decision. Loan repayments should be monitored and whenever a customer defaults, action should be taken. Thus banks should avoid advancing loans to risky customers, monitor loan repayments and renegotiate loans when customers get into difficulties (Ameyaw-Amankwah, 2011). MFIs need a monitoring system that highlights repayment problems clearly and quickly so that loan officers and their supervisors can focus on delinquency before it gets out of hand (Warue, 2012).
Saywer (1998) noted that it is essential for the lender to take an active interest in the borrower and monitor his continuing ability to repay the debt. On monitoring, the lender should focus on the actual sales per month and compare with the monthly budget and reasons for any variance. This regular touch with the borrower will enable the lender to receive early warning of any problem. Bigambah (1997) observed that frequent visits help to ensure that, the client is maintaining the business and intend to repay the loan. Frequent visits allow the loan officer to understand the client’s business and appropriateness of the loan term (amounts, frequency of repayments and repayment period) otherwise, the chances of loan default to occur are high. Mugisha (1995) asserts that non-performing loans in Uganda are usually as a result of weak banking systems. He says that lending institutions in Uganda lack enough skilled loan personnel which become hard to make a follow up of the loan applicants hence they end up defaulting.
Knowledge of borrowers
When borrowers have the knowledge on record keeping and business, it may help them to manage their cash flows and make better business decisions most especially for borrowers who are starting new businesses. Education and training level (Bhatt, 2002) are believed to be affecting the business performing ability of borrowers. However, Bhatt also states that, training for borrowers could prove to be costly for borrowers who need the loans quickly to capture the opportunities since it may cause a delay in receiving the loan.
The nature of loans
Different kinds of investment give different returns. Some farm produce may even give better returns than other produce. Concentration of the nature of a loan may positively affect the performance of MFIs. Investment in high-risk or low earning business ventures may result in a lower repayment rate so MFIs can guide borrowers by specifying the kind of investment for them to limit the higher risks exposure. MFIs should be encouraged to lend to non-farm enterprises and non-farm households in urban communities (Sacay and Randhawa, 1995).
The Schedule and the Amount of Loan Installments
Small and frequent payments may make it easier for small borrowers to manage the cash. Many successful MFIs require small regular repayment from borrowers and this is because, terms of loan repayments are set taking into account the borrowers’ needs (Wright, 2000).
Training of the staff of MFI is considered to affect its performance. Loan collection is therefore affected by the quality of loan officers. Yaron et.al (1997), poor screening and insufficient monitoring of loans affect the quality of the loans.
Management Information Systems
Sacay and Randhawa (1995) states that, management information systems are essential for accurate data and monitoring of customers’ progress. Therefore, there should be an effective management information system in tracking payments, due loans, and overdue loans in order to systematically monitor loan performance (Yaron, et.al., 1997).
Incentives for Borrowers
Incentives provided for the borrowers to pay back may be a determinant of repayment rate. More access to credit after full repayments may be a major incentive for borrowers. Continuing access to loans after previous ones have been repaid is also a critical factor in keeping a low default rate (Wright, 2000). Inadequate incentive for clients to pay back is a factor that affects the quality of loans (Yaron, et.al., 1997). Borrowers need to have a clear signal from the MFIs that loan repayment is serious.
Incentives for loan officers
A loan officers’ incentives system affects the performance of microfinance institutions in terms of loan repayment. Rewards, including monetary incentives and promotion contribute to the efficiency of loan collection in microfinance institutions (Yaron, et al., 1998).
Larger loans have greater risk exposure so if lenders don’t take extra care, there could be more loan defaults (Schreiner, 2001). Greater loan size means less depth of outreach for the borrower, but usually means more profitability for the lender (Schreiner, 2002). Woller (2002), the amount of loans could be a factor causing NPLs, as it directly relates to risk.
Many MFIs have had problems with the repayments of clients whose loans issued exceed their capacity to repay (Wright, 2000). Higher loan size on the average may imply the overestimation of borrowers’ repayment capacity. On the other hand, higher loan size could mean that the borrowers have higher capacity to earn and to repay the loans. Loans too large for business needs may result in the use of loans for personal needs and results in the inability to pay from income (Norell, 2002).
Friends of credit officers or privileged figures are usually the ones who receive large size loans based on favoritism, overlooking the capacity to pay back. Khandker (1998) claims that loan recovery rate for larger loans may be lower than small loans. One of the reasons of the possible relationship between high repayment rate and the small loans could be higher risk distribution. This is because, with a given amount of funds available, smaller loans enable the MFIs to serve more customers (Khandker, 1998).
Bhatt (2002), observes that locations of MFIs affect the transaction costs of the borrowers and lenders. It is easier for lenders to acquire information and provide assistance to the borrowers and easier for the borrowers to travel to the lenders with shorter or more convenient routes of transportation (Bhatt, 2002). In Sharma and Zeller’s study (1999), trying to achieve marginal impact of credit services may be the cause of concentration of branches of MFIs in the area with better access to transport and communication infrastructure where clients’ income covariance seems to be lower. Branches with poor locations may cause inconvenience in communication resulting in inefficiency in consultant services and services related to loan collection hence loan repayments can be delayed of defaulted (Sharma and Zeller, 1999).
Peer pressure may be an essential factor that encourages loan repayment (Khandker, 1998). Dealing with credit groups may reduce transaction costs and risks of lending (Bhatt, 2002). Borrowers tend to be more willing to pay back if pressured by their peers. Ratio of group lending to total lending volume may be related to loan repayment because the groups help take care of the screening and follow up (Bhatt, 2002). Rahman (1999), in his study on Grameen Bank, found that 98 percent of the repayment rate of a local bank was achieved with the help of peer pressure along with institutional and moral coercion. However, many borrowers became vulnerable and trapped by the system with increases in debt liability and recycling of loans (Rahman, 1999).
Flexibility for Borrowers to Use the Borrowed Money
This is an important factor that helps borrowers to take the opportunities of earning better income rather than having to go through the loan application process again. Often loans are diverted because there are better opportunities or emergencies. Wright (2000) points out that successful MFIs do not tie their loans to specific types of projects and where there is a strict policy on providing loans for productive uses, there would be a mechanism to provide facilities to meet other needs.
2.6 Empirical literature review
A lot of researches have been done on the causes and impacts of loan default in micro-finance institutions. Maina and Kalui (2014) conducted a study on the causes of loan defaults by assessing institutional factors contributing to loan defaulting in MFIs in Kenya. Primary data was used for their study where they targeted population comprising 59 MFIs. Because of the small size of their population, a descriptive survey design was used to carry out a census of 59 micro-finance in Kenya.
The data used for their study was collected through a structured questionnaire and was directed to loan officers of MFIs for response. A total of 48 questionnaires were administered out of the 94% response rate. In their findings, they pointed out that, all the three factors had significant impact on their rate of their loan default and these factors are loan recovery procedures, credit policies procedures, and loan appraisal process which are viewed as critical drivers of loan default occurrence.
In a study conducted by Bichanga and Aseyo (2013) on the causes of loan default within MFIs in Kenya, a target population comprising a total of 400 loan borrowers and 200 MFIs were used and out of these, a sample of 150 was picked using simple random sampling for each stratum. In their research, Structured and semi structured questionnaire were used for their data collection where they analysed their data from questionnaires using both quantitative and qualitative techniques and using frequency tables for their tabulation. In their research they found out that, loan delinquency rate was because of MFIs inappropriate supervision to borrowers and lack of adequate training of borrowers on the utilisation of their funds from loans before receiving loans. In their findings also, it was revealed that most borrowers did not spend the amount of their loans on intended and agreed projects.
Mpogole et al (2012) conducted another study where multiple borrowing and its effects on loan repayment were estimated among clients on the sustainability of MFIs in Iringa municipality in Tanzania. In their survey, they added that, a sample of 250 micro-finance clients from 6 MFIs at Iringa municipality. The six MFIs were FINCA, BRAC Tanzania, PRIDE Tanzania, Iringa Development of Youth Disabled and Children Care (IDYDC), Presidential Trust Fund (PTF) and MBF. Results indicated that multiple borrowing frequency at Iringa in Tanzania was very high. Also in their survey, over 70% of the micro-finance clients had at least two loans from diverse MFIs at the same time. About 16% had also borrowed from individual lenders in addition. Insufficient loans from individual lenders, family obligations and loan recycling were the major reasons for multiple borrowing. Also because of multiple pending loans, over 70% of the respondents had setbacks in loan delinquency. Moreover, they found out that what significantly influenced loan contracts were education level and the number of dependants of the respondents.
Alsadek (2009) in his research study investigated the extent to which Libyan retail consumers’ demographic variables influence their attitudes towards potential use of Islamic methods of microfinance. A self-administered survey, covering a random sample of 385 consumers was conducted using phone interviews during the months of December 2007 and January-February 2008 to gather their demographic variables and their opinions towards Islamic methods of microfinance. Descriptive statistics was used to indicate the main characteristics of the sample and potential use of Islamic methods of microfinance. The results indicated that, most of the respondents (85.9%) were potential users of Islamic methods of microfinance. Discriminant analysis is used to indicate which of these demographic variables has much impact on the attitudes of Libyan retail consumers towards Islamic methods of microfinance. This analysis illustrates that professional status, monthly income; age and level of education are the most important variables in discriminating between the two groups of retail consumers (those who are potential users of Islamic methods of microfinance and those who are not).
2.7 Conceptual framework of the study
The framework illustrates the hypothesised relationship between the independent variables (Business characteristics, loan characteristics, borrower’s characteristics and ownership characteristics) and the dependent variable (Loan default). In other words, Business characteristics such as size, age, type, location of business and profits generated from the business may affect loan repayment default by clients. For ownership characteristics, sole proprietors are usually more vulnerable to higher default as compared to ownership types with more members. The kind of collateral that someone possesses has the probability of causing default. For loan characteristics, loan specific factors also influence loan default when the time length to maturity of the loan described by some authors as loan age, or loan term has the probability of causing loan default. Borrower’s characteristics also trigger loan default depending on the kind of relationship the borrower has with the lender. Multiple borrowing increases the stress on the resources of the business thus increasing loan default rate. Hence, loan security can be ensured effectively when appropriate measures are put in place such as proper business screening, proper market analysis, loan polices and follow up. Loan defaults are unavoidable and might be a great challenge for microfinance institutions when effective mechanisms are not put in place. The framework is graphically presented in figure 2.1
Figure 2.1 Conceptual framework of the study
(independent variables) (intervening variables) (dependent variables)