Credit Management Policies and the Success of Microfinance Institutions

CREDIT MANAGEMENT POLICIES AND THE SUCCESS OF MICROFINANCE INSTITUTIONS

A CASE STUDY OF BRAC UGANDA

BY

KULE JOSAM

07/U/4954/EXT

A RESEARCH REPORT SUBMITTED TO MAKEREREUNIVERSITYCOLLEGE OF BUSINESS AND MANAGEMENT SCIENCES IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE AWARD OF BACHELORS DEGREE OFCOMMERCE

JULY, 2011

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DECLARATION

I KULE JOSAM, declare that this research report is my own work, and has never been submitted by anyone to any institution for any award. Any other author’s work has been clearly acknowledged.

Signed: ………………………………………….. Date:……………………………

KULE JOSAM

07/U/4954/EXT

APPROVAL

This report has been submitted for examination with my approval as the university supervisor

Signature………………………………… Date…………………………..

MR. TUSUBIRA NYENDE FESTO

(SUPERVISOR)

DEDICATION

I dedicate this research report to my dear parents Yoana and Jorolin, my wife Ester and to my children Judith, Keith and Faith

ACKNOWLEDGEMENTS

Thanks are due to a number of people for their input into the production of this work. Firstly to Mr. Mumbere Idine of Barclays Bank Fort portal Branch for the advice given in coming up with this work.

Gratitude goes to the staff and customers of BRAC Uganda Kasese branches for giving me time and willingly gave information that was necessary to come up with this work.

The Head Teachers of Katwe Sec. School and Nyabugando Bapt.Voc.SS, Students and staff of the two schools for the time they allowed me off duty while carrying out this research work. Without your help, I would not have managed to carryout this research work. I thank you very much.

The major debt of thanks is due to my family who supported me in this venture. My parents Yoana and Jorolin for their words of encouragement, wife Ester and children Judith, Keith and Faith for their tolerance while I was moving up and down in coming up with this work.

Lastly to my supervisor Mr. Tusubira Nyendo Festo for he was always there for me and for his guidance in producing this work. God shall reward you accordingly.

TABLE OF CONTENTS

DECLARATION

APPROVAL

DEDICATION

ACKNOWLEDGEMENTS

TABLE OF CONTENTS

LIST OF TABLES AND FIGURES

ABBREVIATIONS AND ACRONYMS

ABSTRACT

CHAPTER ONE

1.1 Background to the study

1.2 Statement of the problem

1.3 Purpose of the study

1.4 Objectives of the study

1.5 Research questions

1.6 Significance of the study

1.7 Scope of the study

1.8 Operational definitions

CHAPTER TWO: LITERATURE REVIEW

2.0Introduction

2.1.0Credit policy management

2.1.1Credit standards

2.1.2Credit terms

2.2.0Evaluating the success of microfinance institutions in Uganda

2.2.1Measure of outreach

2.2.2Measures self-sustainability

2.2.3The Subsidy Dependence Index (SDI)

2.2.4Performance and success of Brac Uganda

2.3Credit policies and success of microfinance institutions in Uganda

CHAPETR THREE

RESEARCH METHODOLOGY

3.0 Introduction

3.1 Research design

3.2 Area of study

3.3 Sampling design

3.4 Study population

3.5 Sample size

3.6.2 Questionnaires

3.6.3 Interviews

3.6.4 Secondary data

3.7 Data quality control

3.8 Study variables

3.9 Procedure for data collection

3.10 Data processing, presentation and analysis

3.11 Limitations to the study

3.12 Delimitations

CHAPTER FOUR

PRESENTATION OF THE FINDINGS

4.0 Introduction

4.1 Biographic characteristics of the respondents

4.2 Credit management policies used by Brac Uganda

4.3 Success aspects realized by Brac Uganda

CHAPTER FIVE

DISCUSSION OF FINDINGS, CONCLUSIONS AND RECOMMENDATIONS

5.0 Introduction

5.1 Discussion of the findings

5.2 Conclusions

5.3 Recommendations

REFERENCES

APPENDIX I: RESEARCH QUESTIONNAIRE FOR THE STAFF OF BRAC UGANDA

APPENDIX II: RESEARCH QUESTIONNAIRE FOR THE CUSTOMERS OF BRAC UGANDA

LIST OF TABLES AND FIGURES

Table 1: Composition of the sample size...... 23

Table 2: Status...... 28

Table 3: Sex distribution of the respondent Brac staff and customers...... 29

Table 4: Age distribution of the respondents Brac staff and customers...... 30

Table 5: Marital status the respondent staff and customers...... 31

Table 6: Educational status the respondent staff and customers...... 32

Table 7: Period of time spent with Brac Uganda by respondent customers...... 34

Table 8: Collateral security is a requirement before granting a loan...... 35

Table 9: Clients' age and gender are considered for credit worthness...... 36

Table 10: Clients ability to pay can be determined by his or her occupation...... 36

Table 11: Referees are a good source of a customer's credit worthness ...... 37

Table 12: One's credit history is a base for further lending...... 37

Table 13: Land titles and motor vehicle/cycle cards are accepted as security...... 38

Table 14: Group lending is used as a major tool to mitigate default rate...... 39

Table 15: There should be a strong legal framework for debt recovery...... 39

Table 16: Customers should be insured to ensure optimum recovery of loss...... 40

Table 17: Giving short term loans is most suitable for low income earners...... 41

Table 18: The client's business capital is key aspect for loan consideration...... 41

Table 19: Giving incentives to loan clients motivates them to repay in time...... 42

Table 20: Clients need to be recommended by other clients to qualify for a loan...... 43

Table 21: It's risky to give multiple loans to low income earners...... 43

Table 22: BRAC Uganda now offers a variety of products to customers...... 44

Table 23: Social responsibility is now among the priority services of BRAC...... 45

Table 24: BRAC has a capacity to give a loan of over 1m shillings...... 45

Table 25: The credit period offered by BRAC Uganda is customer friendly...... 46

Table 26: BRAC gives incentives to customers as a means to reduce default...... 47

Table 27: The annual growth rate of BRAC Uganda is over 50% per annum...... 47

Table 28: Gender sensitivity is now an emphasis in service for BRAC ...... 48

Table 29: The success of BRAC is due to the quality of workers...... 49

Table 30: BRAC has greatly improved the social welfare of its clients...... 49

Table 31: Customer satisfaction and profitability are BRAC's goals...... 50

Table 32: Correlation Analysis Table showing the relationship between credit management policies and success of Micro Finance Institutions in Uganda. 51

ABBREVIATIONS AND ACRONYMS

MFIs Microfinance Institutions

AMFIU Association of Microfinance Institutions Uganda

SACCOs Savings and Credit Cooperative Organizations

MDI Microfinance Depositary Institutions

ABSTRACT

The study was undertaken to evaluate the relationship between the credit management policies and the success of MFIs in Uganda using BRAC Uganda. This was based on the fact that despite the provision of finance services by MFIs to large numbers of low income people to improve their welfare (social mission), many MFIs however face challenges in credit recovery which as a result affected their success. While MFIs have in place credit policies to ensure control and minimize losses resulting from bad debts to maximize profits to the Institutions, they still continue to make losses and struggle with sustainability.

Using a cross sectional research design in which both the quantitative and qualitative were utilized to find out the credit management policies of Microfinance Institutions in Uganda, to evaluate the success of microfinance institutions in Uganda and establish the relationship between the credit management policies and the success of microfinance institutions in Uganda, questionnaires alongside face to face interviews were administered to 70 respondent staff and clients of Brac Uganda.

It was found and concluded that though clients are first recommended by other clients to qualify for a loan, financial institutions employ among others the use of referees, the Client’s Age and Gender, his or her occupation, collateral such as the client’s business capital alongside land titles and motor vehicles/cycle cards as one of the key credit management policies. This has helped them succeed in improving customer satisfaction and profitability, improving the social welfare of its customers, improved the lending capacity alongside their annual growth rate.

However as a way of improving the success of MFIs, the study recommends among others the need for microfinance institutions in Uganda to increase outreach by providing cost effective but affordable financial services to the poor and critically improve governance, human resource development, and systems development mainly through internal control, business plan, and marketing strategy and concentrate on their original developmental and social objectives other than exclusively focusing on their financial performance.

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CHAPTER ONE

1.0Introduction

This chapter discusses the background to the study, statement of the problem, purpose of the study, research objectives and questions guiding the study, significance and scope of the study and the definition of key terms.

1.1 Background to the study

Serving the poor does not mean serving poorly. The operations of many microfinance institutions (MFIs) rotate around availing credit to the economically challenged segments of the community. Financial services are a unique business because the items traded are both intangible and homogenous. In a financial market development,one of the tasks is to create an efficient and competitive lending system.

Credit policies refer to the guidelines to the lending process within an organization hence providing a framework of the entire credit management process (Ringtho, 1998). Credit policy is a combination of three decision variables; credit standards, credit terms and collection efforts (Pandey, 2005). These affect the activities of a financial institution.

Contemporary microfinance operations are premise on behalf that credit and other financial services need to be delivered in a professional, profitable and sustainable manner. In her report to MFIs, December 2006, “marking service markets work for the poor,’ Regina Kamuhanda, president of the Association of Microfinance Institutions Uganda (AMFIU), said that following the line of events, MFIs had strategically been compelled to refocus their thinking towards financial and non-financial self sustainability. This implied that they should check how they administer and manage their credit policies.

Microfinance refers to the provision of financial services to small and micro clients. Like any other business, microfinance grows because the opportunity arises for it to fill the gap in the market.

It’s a common knowledge that some sections of the population or areas are avoided by the formal banking sector because they are perceived not to be ‘bankable’. In the early 1990s the government implemented the Poverty Alleviation Program (PAP) in an attempt to increase the delivery of microfinance services. This program sought the participation of Non–Governmental Organizations (NGOs), which were incidentally “absent”. It was at that time that many NGOs were formed, and have been providing microfinance in many legal forms (Ayi and Bugonzya 2005).

In 1995, the government was involved in the direct delivery of microcredit schemes through the “Entandikwa credit scheme”, to promote rural and agricultural financing, targeting the section of the population that could not obtain credit through the traditional commercial lending. However, only 40% of the loans were ever recovered (AMFIU Report, 2006).

“Even though microfinance is a recent industry in Uganda, it has been growing at a rate of more than 70% over the past fiver years.” (Mugwanya, 2001). He attributed this to an increase in the range of financial services and loan management portfolio. David Baguma, AMFIU’s Executive Director in the microfinance Banker, December 2005, said that the challenge facing MFIs was to ensure that the process of credit management supported growth needs of the institution while maintaining sufficient control over risks.

The main microfinance networks in Uganda are ACCION, AMFIU, AMT, BRAC International, FINCA International, INAFI, MFN, Opportunity international and Vision Fund.BRAC is a lending development organizationfromBangladesh also functioning in Afghanistan, Srilanka and in 2006 launched the microfinance programme in Tanzania and in Uganda. It entered Africa with the purpose to achieve the Millennium Development Goals along with the campaign of ending poverty. During its intervention in Africa, BRAC comes across the following challenges;

• Reaching the poorer communities in critical mass number.

• Balancing the objectives of poverty alleviation and that of achieving sustainability.

• Poor infrastructure especially in rural areas to facilitate easy accessibility to remote areas.

• Low population densities thus slowing sustainability and limiting impact. (

BRAC works with people whose lives are dominated by extreme poverty, Illiteracy, disease and other handicaps. With multifaceted development interventions, BRAC strives to bring about positive changes in the quality of life of poor people. BRAC Uganda reached 100,000 borrowers in less than 3.5 years with an average annual borrower growth rate of 139%. R Ariful Islam, the country programme coordinator personally disbursed Sarah Mukama’s loan and congratulated her for becoming BRAC Uganda’s 100,000th borrower. (The microfinance News, November 8th, 2009).

1.2 Statement of the problem

Although Microfinance is required to provide finance services to the large numbers of low income people to improve their welfare (social mission), it must provide these financial services in such a way that it exists for a long period of time as a sufficient institution (commercial mission).

MFIs have in place credit policies to ensure control and minimize losses resulting from bad debts to maximize profits to the Institutions (MDI ACT, 2003). Amidst this, MFIs continue to make losses and struggle with sustainability as evidenced with BRAC Uganda. Concern to provide financial services to the economically challenged segments of the society undermine the drive to profitability just like the drive to profitability undermines the mission to serve many clients in this segment (Bugonzya 2005).

It is for this therefore that the researcher sought to find out how the credit management policy helps MFIs balance between their dual mission.

1.3 Purpose of the study

The study evaluated the relationship between the credit management policies and the success of MFIs, the case study being BRAC Uganda.

1.4 Objectives of the study

The specific objectives of the study were;

1. To find out the credit management policies of Microfinance Institutions in Uganda.
2. To evaluate the success of microfinance institutions in Uganda
3. To establish the relationship between the credit management policies and the success of microfinance institutions in Uganda.

1.5 Research questions

The study was guided by the following Questions;

1. What are the credit management policies of microfinance institutions in Uganda
2. How successful are microfinance institutions in Uganda
3. What is the relationship between the credit management policies and success of microfinance institutions?

1.6 Significance of the study

The research findings were meant to provide information to the stakeholders of MFIs on how to improve their credit policy to eliminate the persistent loss of resources through irrecoverable debts.

The study findings were also meant to provide information that may be used by policy makers especially AMFIU, MCC, MFN and BRAC International about proper credit policies particularly in this era of commercialization of microfinance.

Lastly the study findings were meant to act as a benchmark for future studies about similar topics of study such as banking culture.

1.7 Scope of the study

The study covered the credit management policy and the success of MFIs with credit management policy being the independent variable that influences MFIs success (dependent variable).

Credit management policy involves the components of credit standards, Credit terms and Collection efforts as the major indicators of performance.

The study covered the company’s financial years 2005 to 2010.

Geographically, the study was carried out at their eight branches in Kasese district, western Uganda.

1.8 Operational definitions

Credit- Refers to money lent to a customer

Credit risk - Is potential that a borrower will fail to meet his/her obligation in accordance to the agreed terms.

Management – Professional administration of business concerns.

Success – The achievement of desired aim, or of fame, wealth or social position.

Yield – Is the return on an asset, expressed as a percentage per year.

AMFU – Is the Microfinance umbrella championing quality assurance in delivery of microfinance services in the industry and adherence to best practices in Uganda.

Cost per borrower – Is the total number of operating expenses divided by the average number of actual borrowers.

Return of Assets =(Net Operating Income – Taxes)

Average Total assets

Return on Equity =(Net Operating Income – Taxes)

Average Total Equity

Operational Self – Sufficiency = Financial Revenue

Financial Expenses + Net Impairment Loss + operating expenses

Profit margin=Net operating income

Financial Revenue

Yield on Gross Portfolio = Financial Revenue from Loan Portfolio

Average Gross loan Portfolio.

Portfolio at Risk = Outstanding balance, portfolio overdue + Renegotiated portfolio

Gross loan portfolio

Loan loss rate = (Write – offs – Value of loans recovered)

Average Gross loan Portfolio

Write off Ratio = Value of loans written off

Average Gross loan Portfolio.

Risk Coverage = Impairment loss allowance

Portfolio at Risk greater than 30 days

Impairment = Provision to cover-up for bad debts

Unpaid back loans advanced customers.

Portfolio A set or group of investments held by an organization or a person.

CHAPTER TWO: LITERATURE REVIEW

2.0Introduction

This chapter contains existing literature on credit policy as expressed by other researchers. It is divided into sections according to the research objectives and the general purpose of the study.

2.1.0Credit policy management

Credit policy is the essence of MFIs daily operations since a proportionately large amount of sales in MFIs is credit extension. Ringtho (1998) defines credit policy as a framework guideline formulated by the organization to be followed in the process of credit extension to borrowers. All lending institutions set credit policies to ensure control and minimize losses.

Credit policy can also be defined as an organization’s method of analyzing credit requests and its decision criteria for accepting or rejecting applications (Administer 1980). It is significant to note that the credit policy is a key element in the control of cash flow since many business sales depend on how well the credit policy is designed to realize maximum inflow and minimize the level of bad debts.

By its very nature, granting credit is intrinsically risky, some borrowers are not able to pay back causing a firm losses. Pandey (2005) notes that credit policy is a combination of three decision variables that is; Credit standards, Credit terms and Collection efforts.