2011 MBL3 Research Report WN Geletta

Determinants of Non Performing Loans
The case of Kenyan Banks

A RESEARCH REPORT
Janary !"#!
W. N. Geletta Research Report
ABSTRACT
This study intends to assess determinants of nonperforming loans. The mixed research
approach was adopted for the study. Survey was conducted with professionals engaged in both
private and state owned Banks in Kenya holding different positions using a self administered
questionnaire. In addition the study used structured review of documents and records of banks
and in!depth interview of senior bank officials in the Kenyan banking industry.
The findings of the study shows that poor credit assessment failed loan monitoring
underdeveloped credit culture lenient credit terms and conditions aggressive lending
compromised integrity weak institutional capacity unfair competition among banks willful
default by borrowers and their knowledge limitation fund diversion for unintended purpose
over"under financing by banks ascribe to the causes of loan default.
#owever the study outcome failed to support the existence of relationship between banks si$e
interest rate they charge and ownership type of banks and occurrences of nonperforming
loans.
The study suggests that banks should put in place a vibrant credit process that ensures proper
customer selection robust credit analysis authentic sanctioning process proactive monitoring
and clear recovery strategies for sick loans% formulate a clear policy framework that
addresses issues of conflict of interest ethical standard and check and balance in credit
process% organi$ational capacity enhancement of banks% deliberate effort to develop culture
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of the public towards credit and its management by banks and ensuring prudent policies that
govern bank loans.
ACKNO$LED%E&ENTS
It gives me a great pleasure to extend my sincere gratitude for the help I received to complete
this project.
First of all, I would lie to !han God for his divine strength.
"y sincere thans go to my supervisor #r. Wollela $%ehodie for her unreserved assistance,
suggestions and guidance.
I would lie to express my gratitude to my wife, &elamawit Woru for her continuous support
and encouragement, my son Nathan for creating conducive environment where I can focus on
my study and wor at a time and to all my friends and family for their moral support.
"y thans also go to the staff and management of the studied %ans in 'enya for completing
the research survey (uestionnaire and providing financial data. &ome of whom have spared
their valua%le time for personal interview.
Finally, I would lie to than $to )halachew $rega for his assistance in statistical wors and
my previous employer, !he )ommercial *an of 'enya for the financial sponsorship of the
"*+ program.
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Ta'(e of Contents
&BST'&(T...............................................................................................................................ii
$)'N,W+-#G-"-N!&.......................................................................................................iii
+I&! ,F !$*+-&...................................................................................................................vii
+I&! ,F $)R,N."&/$**R-0$!I,N&
.............................................................................................................................................
viii
)1$2!-R ,N-.......................................................................................................................1
,RI-N!$!I,N........................................................................................................................1
3.3. &tatement of the pro%lem.....................................................................................................4
3.4. ,%jectives of the study........................................................................................................6
3.5. Research 6uestions 7R68....................................................................................................6
3.9. "ethods adopted................................................................................................................7
3.:. &cope the study..................................................................................................................7
3.;. +imitation of the &tudy.......................................................................................................7
3.<. &ignificance of the study.....................................................................................................8
3.=. #efinitions........................................................................................................................8
3.>. ,rgani?ation of the Research Report.....................................................................................9
)1$2!-R !W,
.............................................................................................................................................
11
!1-,R-!I)$+ F,@N#$!I,N ,F !1- &!@#. $N# *$N'ING IN '-N.$
.............................................................................................................................................
11
4.3 !heoretical review of %aning
.............................................................................................................................................
11
4.3.3 *aning
..........................................................................................................................................
11
4.3.4 Role of *ans
..........................................................................................................................................
12
4.3.5 *an +ending
..........................................................................................................................................
14
4.3.9 )redit "ethodology
..........................................................................................................................................
16
4.3.9.3 )redit Information
......................................................................................................................................
16
4.3.9.4 )redit $ssessment
......................................................................................................................................
18
4.3.9.5 )redit $pproval
......................................................................................................................................
27
4.3.9.9 +oan Follow up
......................................................................................................................................
29
4.3.: *aning Riss
..........................................................................................................................................
31
4.3.:.3 )redit ris
......................................................................................................................................
32
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4.3.:.4 +i(uidity ris
......................................................................................................................................
33
4.3.:.5 "aret ris
......................................................................................................................................
33
4.3.:.9 ,perational ris
......................................................................................................................................
34
4.3.:.: )urrency ris
......................................................................................................................................
34
4.3.:.; .)apital or &olvency ris
......................................................................................................................................
34
4.3.:.< Interest rate ris
......................................................................................................................................
35
4.3.:.= )ountry ris
......................................................................................................................................
35
4.3.; )redit Ris "anagement
..........................................................................................................................................
36
4.3.< Nonperforming +oans 7N2+8
..........................................................................................................................................
38
4.4 *aning Industry in 'enya
.............................................................................................................................................
49
4.5 )onclusion
.............................................................................................................................................
54
)1$2!-R !1R--
.............................................................................................................................................
55
+I!-R$!@R- R-0I-W
.............................................................................................................................................
55
5.3. #eterminants of Nonperforming +oans
.............................................................................................................................................
55
5.4 "acroeconomic #eterminants of Nonperforming loans
.............................................................................................................................................
56
5.5 *an &pecific Factors causing Nonperforming +oans
.............................................................................................................................................
64
5.5.3 Rapid +oan Growth
..........................................................................................................................................
64
5.5.4 1igh Interest Rate
..........................................................................................................................................
65
5.5.5 +enient )redit !erms
..........................................................................................................................................
66
5.5.9 )redit ,rientation
..........................................................................................................................................
67
5.5.: *an &i?e
..........................................................................................................................................
68
5.5.; )ost -fficiency
..........................................................................................................................................
68
5.5.< ,wnership structure
..........................................................................................................................................
69
5.5.= 2oor +oan FollowAup 7"onitoring8
..........................................................................................................................................
69
5.5.> 2oor Ris $ssessment
..........................................................................................................................................
72
5.5.3B +ac of &trict $dmittance -xit 2olicies
..........................................................................................................................................
73
5.9 )onclusions and identification of nowledge gap
.............................................................................................................................................
76
R-&-$R)1 "-!1,#,+,G.
.............................................................................................................................................
78
9.3. Research pro%lem, %road o%jective, research (uestions
.............................................................................................................................................
78
9.4 Research $pproaches
.............................................................................................................................................
79
9.4.3 6uantitative research approach
..........................................................................................................................................
80
9.4.4 6ualitative research approach
..........................................................................................................................................
81
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9.4.5 "ixed research approach
..........................................................................................................................................
82
9.5 Research "ethod $dopted
.............................................................................................................................................
84
9.5.3 6uantitative aspect of the study
..........................................................................................................................................
84
9.5.4 6ualitative aspect of the research
..........................................................................................................................................
90
9.5.4 0alidity, relia%ility and ethical issues
..........................................................................................................................................
91
9.5.4.3 0alidity
......................................................................................................................................
91
9.5.4.4 Relia%ility
......................................................................................................................................
93
9.5.4.5 -thical Issues
......................................................................................................................................
93
)1$2!-R FI0-
.............................................................................................................................................
95
R-&@+!&
.............................................................................................................................................
95
:.3 &urvey results
.............................................................................................................................................
95
:.3.3 RespondentsC profile
..........................................................................................................................................
96
:.3.4 Factors that affect %an lending
..........................................................................................................................................
99
: .4 #ocument study
............................................................................................................................................
112
:.5 InAdepth interview
............................................................................................................................................
119
:.5.3 Factors %elieved to cause occurrences of N2+ %y the interviewees
........................................................................................................................................
120
:.5.3.3 *ans internal factors
.....................................................................................................................................
120
:.5.3.4 )ustomer related factors
.....................................................................................................................................
121
:.5.3.5 -xternal factors
.....................................................................................................................................
122
:.5.4 "ost critical factors for loan default as per interviews
........................................................................................................................................
122
:.5.5 Factor that are uni(uely associated to 'enyan %aning context
........................................................................................................................................
123
:.9 &ummary of Results
............................................................................................................................................
124
)1$2!-R &ID
............................................................................................................................................
127
#I&)@&&I,N, ),N)+@&I,N& $N# R-),""-N#$!I,N&
............................................................................................................................................
127
;.3 #iscussion of the research findings
............................................................................................................................................
127
;.4 )onclusions
............................................................................................................................................
134
;.5 Recommendations
............................................................................................................................................
136
R-F-R-N)-&
............................................................................................................................................
138
$22-N#ID-&
............................................................................................................................................
149
6uestionnaire 7$ppendix 38
........................................................................................................................................
149
Instrument for InAdepth interview 7$ppendix 48
........................................................................................................................................
156
$ssets and N2+ ratio of *ans &urveyed 7$ppendix 58
........................................................................................................................................
157
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L)ST O* TABLES
!a%le 9.3 'enyan *ans that have started operation %efore the year 4BB</=EEEEEE.=<
!a%le 9.4 +in %etween R6s and data sourcesEEEEEEEEEEEEEEEEEE...>9
!a%le :.3 &urvey response rateEEEEEEEEEEEEEEEEEEE...EEEEE.>;
!a%le :.4 -mployment of respondentsEEEEEEEEEEEEEEEEEEEEE..>;
!a%le :.5 2osition of the respondents in %anEEEEEEEEEEEEEEEEE..E..><
!a%le :.9 RespondentsC experience in the %aning sector EEEEEEEEEEEE..E...>=
!a%le :.: *an lending experience of the respondentsEEEEEEEEEEEEE.EE.>=
!a%le :.; Factors affecting occurrences of N2+ are o%vious EEEEEEEEEEE.E...>>
!a%le :.< Factors considered causing occurrences of N2+ in 'enyan %ansEEEE..E.3BB
!a%le :.= Raning of factors affecting occurrence of nonperforming loansEEEEEEE.3B4
!a%le :.> Factors indicating relation %etween credit assessment and loan defaultEE.E.E.3B5
!a%le :.3B Factors indicating credit monitoring and loan defaultEEEEEEEEE.E.E.3B:
!a%le :.33 Relation %etween collaterali?ing loans and occurrence on N2+EEEEE.EE..3B;
!a%le :.34 Relation %etween %orrowerCs orientation and occurrence of N2+EEEEEE....3B<
!a%le :.35 Relation %etween cost of loan and loan defaultEEEEEEEEEEEEEE.3B=
!a%le :.39 )redit terms and loan performanceEEEEEEEEEEEEEEEEEE...3B>
!a%le :.3: )redit growth relation with N2+EEEEEEEEEEEEEEEEE.EE.33B
!a%le :.3; *an si?e and occurrence on N2+EEEEEEEEEEEEEEEEE.E...333
!a%le :.3< *ans ownership type and N2+EEEEEEEEEEEEEEEEEEE....334
!a%le :.3= N2+ ratio of *ansEEEEEEEEEEEEEEEEEEEEEEEE....335
!a%le :.3> !otal $ssets of *ans EEEEEEEEEEEEEEEEEEEEEE..E.339
!a%le :.4B #escriptive &tatisticsEEEEEEEEEEEEEEEEEEEEEEE..E.339
!a%le :.43 )orrelation "atrix EEEEEEEEEEEEEEEEEEEEEEEEE..33; vii
!a%le :.44 "ean N2+ ratio of 'enyan %ans esta%lished %efore 4BB</=EEEEEEE...33=
L)ST O* ACRON+&S,ABBRE-AT)ONS
I"F International "onetary Fund
N*- National *an of 'enya
F#R- Federal #emocratic Repu%lic of 'enya
&&$ &u%A&aharan $frican
)*, )ooperative *an of ,romia
R6 Research 6uestions
$)* $utomatic )learing *ureau
'.) 'now .our )ustomer
2# 2ro%a%ility of default
+G# +oss given default
-$# -xposure at default
N2+ NonA2erformance +oans
#*- #evelopment *an of 'enya
)** )onstruction and *usiness *an
-!* 'enyan *irr
G#2 Gross #omestic 2roduct
0$R 0alue at ris
"I& "anagement Information &ystem
vii
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ix
CHAPTER ONE
OR)ENTAT)ON
*ans role in the economy of any country is very significant. !hey play intermediation
function in that they collect money from those who have excess and lend it to others who need
it for their investment. $vailing credit to %orrowers is one means %y which %ans contri%ute to
the growth of economies.
+ending represents the heart of the %aning industry. +oans are the dominant asset and
represent :BA<: percent of the total amount at most %ans, generate the largest share of
operating income and represent the %ans greater ris exposure 7"ac #onald and 'och, 4BB;8.
"oreover, its contri%ution to the growth of any country is huge in that they are the main
intermediaries %etween depositors and those in need of fund for their via%le projects 7creditors8
there%y ensure that the money availa%le in economy is always put to good use. !herefore,
managing loan in a proper way not only has positive effect on the %ans performance %ut also
on the %orrower firms and a country as a whole. Failure to manage loans, which mae up the
largest share of %ans assets, would liely lead to the episode of high level of non Aperforming
loans.
1
$ccording to the International "onetary Fund 7I"F, 4BB>8, a nonA performing loan is any loan
in which interest and principal payments are more than >B days overdueF or more than
>B days worth of interest has %een refinanced .,n the other hand the *asel )ommittee
3
74BB38
puts non performing loans as loans left unpaid for a period of >B days.
@nder the 'enyan %aning %usiness directive, nonAperforming loans are defined as G+oans or
$dvances whose credit (uality has deteriorated such that full collection of principal and/or
interest in accordance with the contractual repayment terms of the loan or advances in
(uestionH National *an of 'enya 7N*-, 4BB=8.
In the case of 'enya, %ans, insurance companies and microAfinance institutions are the major
financial institutions. !he sector is closed for nonA'enyan citi?ens. 2roclamation No.:>4/4BB=
7F#R-, 4BB=8 does not permit foreigners to own and operate %ans in 'enya.
!here is a relatively favora%le environment for %aning industry and other financial
institutions in 'enya. $s of Iune 5B, 4B33 the num%er of %ans operating in the country were
sixteen, of which thirteen were private and the remaining three stateAowned 7N*-, 4B338.
#uring the same period there were a total of =93 commercial %an %ranches in the country
7N*-, 4B338. ,ne %ranch of a %an on the average is estimated to serve >:,349 people in
'enya as at #ecem%er 4B3B 7N*-, 4B338.
1owever, the high people to %an %ranch ratio indicates that 'enya still remains as one of the
under %aned economies even %y &u%A&aharan $frica 7&&$8 countries standard 7!he World
*an, 4B3B8. ,wing to this and significant profits operating %ans in the country earn,
3
*asel )ommitteeJ is a committee of %aning supervisory authorities that provides a forum for regular cooperation on
%aning supervisory matters. Its o%jective is to enhance understanding of ey supervisory issues and improve the (uality
of %aning supervision worldwide.
2
there are more entrant %ans in the pipeline to join the sector and the existing %ans are
expanding their %ranch networ .With this also comes the need to put in place a strong
institutional framewor to regulate and monitor the %ans in order to eep health of the
financial sector.
$n efficient and wellAfunctioning financial sector is essential for the development of any
economy, and the achievement of high and sustaina%le growth. ,ne of the indicators of
financial sectors health is loan (ualities. "ost unsound financial sectors show high level of
nonA performing loans within a country.
!he causes for loan default vary in different countries and have a multidimensional aspect
%oth, in developing and developed nations. !heoretically there are so many reasons as to why
loans fail to perform. &ome of these include depressed economic conditions, high real interest
rate, inflation, lenient terms of credit, credit orientation, high credit growth and ris appetite,
and poor monitoring among others. *ercoff et al. 74BB48 categori?es causes of nonperforming
loans to *an specific and "acroeconomic conditions.
!his thesis attempts to explore %an specific determinants of nonperforming loans in 'enya. !he
remaining part of this chapter is organi?ed into seven sections. &ection 3.3 presents pro%lem
statement, while sections 3.4 and 3.5 show the %road o%jectives of the study and research
(uestions respectively. &ection 3.9 presented the methods adopted in the study. !he scope
/delimitations of the study are highlighted in sections 3.:. +imitation, significance of the study
and definitions are discussed in sections 3.;, 3.< and 3.= respectively. Finally, the outline of the
research is presented in section 3.>.
3
#.#. Statement of the /ro'(em
*ans exist to provide financial intermediation services while at the same time endeavor to
maximi?e profit and shareholdersK value. +ending is considered the most important function
for fund utili?ation of )ommercial *ans as major portion of their income is earned from
earned from loans and advances 7Radha , 3>=B8.
#espite the fact that loan is major source of %ans income and constitutes their major assets, it
is risy area of the industry. !hat is also why credit ris management is one of the most critical
ris management activities carried out %y firms in the financial services industry. In
fact of all the riss %ans face, credit ris is considered as the most lethal as %ad de%ts would
impair %ans profit. It has to %e noted that credit ris arises from uncertainty in a given
counterpartyCs a%ility to meet its o%ligations.
If the uncertainties materiali?e they would lead to deterioration of loan (ualities. #eterioration
in %ansC loan (uality is one of the major causes of financial fragility. 2ast experience shows
that a rapid %uildup of %ad loans plays a crucial role in %aning crises 7#emirgLM'unt and
#etragiache, 3>>=, and Gon?Nle?1ermosillo, 3>>>8. !he solidity of %anCs portfolio depends
on the health of its %orrowers. In many countries, failed %usiness enterprises %ring down the
%aning system 7$lemu, 4BB38. $ sound financial system, among other things, re(uires
maintenance of a low level of nonA performing loans which in turn facilitates the economic
development of a country.
1igh level of nonperforming loan is lined with %ans failures and financial crisis. Failure in
one %an might lead to run on %an which in turn has contagious impact affecting the whole
%aning industry as has recently %een experienced in the @&$ and other parts of the world.
4
!hough the recent financial crisis %egan with Fannie "ae and Freddie "ac, @& %ans, it
rapidly spread from Wall &treet to the rest of world economies 7Ionathan *atten and 2eter G.
&?ilagyi, 4B338.
Regular monitoring of loan (uality, possi%ly with an early warning system capa%le of alerting
regulatory authorities of potential %an stress, is thus essential to ensure a sound financial
system and prevent systemic crises. In line with *asel II accord asset (uality is regularly
monitored %y supervisory authoritiesA central %ans to ensure their well %eing. Impaired assets
or non Aperforming loans signal failures and calls for rapid intervention to protect the pu%lic
fund the %ans mo%ili?ed.
In 'enyan context, the *ans in the country are re(uired to maintain ratio of their non performing
loans %elow five percent 7N*-, 4BB=8. @npu%lished data from the N*- shows that the industry
average is %elow the set threshold. #espite this, ratio of nonperforming loans for )ooperative *an
of ,romia 7)*,8 stood at 33.:9O on "arch 53, 4B3B which is relativity very high when compared
with the set threshold or the industry average. !hough there seem to %e some improvements during
recent (uarters, the ratio still remains higher. For example the ratio stood at <.;4O and ;.<:O on
Iune 5B, 4B3B and #ecem%er 53, 4B3B respectively. &howing
slight improvement the ratio was ;.3O on "arch 53, 4B33. ,n the other hand, during the same
period %ans that are relatively new and small as )*, 7lie +ion International, Pemen
,,romia International, *irhan International and *una International %ans 8 have had an
average of less than 5.B=O nonperforming loans ratio 7N*-,4B338. !he deviant o%servation at
)*, caught the attention of the researcher of what the causes of nonperforming loans are not
only in the this %an %ut also in all the %ans in 'enya for a thorough examination.
5
!his pro%lem along with the nowledge gap in the literature 7to %e esta%lished in chapter three8
calls a research to investigate the causes for the existence of high level of nonperforming
loans.
#.!. O'0ecti1es of the st2y
NonAperforming loans proportion is one of the determinant factors that depict soundness of the
%aning sector. !hus, identifying and investigating the determinants of nonperforming loans is
very vital to minimi?e loan default.
).To determine bank specific determinants of non!performing loans
*. To determine relationship between credit admittance policy loan underwriting and risk
assessment and level of nonperforming loans
+. To determine whether credit monitoring determines loan default
,. To determine whether there a relationship between collaterali$ed lending and non
performing loan
-. To determine the impact of credit culture on loan default
.. To determine credit terms and price affect loan performance
/. To determine rapid credit growth and greater risk appetite lead to non performing
loan
0. To determine any relation between bank ownership structure and si$e and loan default
#.3. Research 4estions 5R46
!he following eight specific research (uestions were formulated to help achieve the %road
o%jective stated in section 3.4.
'1). 2hat are bank specific determinants of non!performing loans3
'1*. Is there a relationship between credit admittance policy loan underwriting and risk
assessment and level of nonperforming loans3
'1+. 4oes credit monitoring determine loan default3
'1,. Is there a relationship between collaterali$ed lending and non performing loans3
'1-. 2hat is the impact of credit culture on loan default3
'1.. 4o credit terms and price affect loan performance3
'1/. 4oes rapid credit growth and greater risk appetite lead to non performing loans3
'10. Is there any relation between bank ownership structure and si$e and loan default3
6
#.7. &etho2s a2o/te2
!he purpose of this study is to identify and examine factors that determine the occurrence of
loan default. $s can %e seen from the research pro%lem it is more of explanatory type and tries
to assess the relationship %etween occurrence of N2+ and some %an specific factors. In order
to %enefit from the advantage of (uantitative and (ualitative approaches, the mixed method
was used for this study.
#.8. Sco/e the st2y
!his study was limited to %an specific factors though macroeconomics has a huge impact on
(ualities and performance of loans. !hus the study did not explore macro economic factors
determining loan defaults. *esides, the data used in the documentary study covered the period
4BB:A4B3B only for eleven %ans that were registered %efore 4BB</B=.
#.9. Limitation of the St2y
#ue to the confidential policy of %ans, access to customer and %ans information, except
officially disclosed financial information, was not possi%le. !he study was also limited to %an
employeesC and officialsC personal perception and officially disclosed financial data of %ans.
7
#.:. Significance of the st2y
!he recent glo%al financial crisis and the su%se(uent recession in many developed countries
have increased householdsC and firmsC defaults, causing significant losses for %ans. !his calls
for regular monitoring of loan (uality, possi%ly with an early warning system capa%le of
alerting regulatory authorities of potential %an stress to ensure a sound financial system and
prevent systemic crises.
2rudent ris management, with a special emphasis to credit ris is pivotal. !o put in place
ade(uate credit management tools, understanding factors that contri%ute to the occurrence of
%ad loan play a crucial role.
!his study thus would help 'enyan %ans get insight on what it taes to improve their loan
(ualities and the central %an 7N*-8 to examine its policy in %aning supervision pertaining to
ensuring asset (uality %ans maintain. In addition the study would also contri%ute to the
existing %ody of nowledge regarding the determinants of nonperforming loans and motivate
further research on 'enyan *aning context and more specifically on macroeconomic
determinants of nonperforming which is not studied under this research.
#.;. Definitions
Nationa( Bank of Kenya 5NBE8JA It is the reserve or central %an of 'enya. *esides licensing
and supervising %ans, insurers and other financial institutions, N*- fosters a healthy financial
system and undertaes other related activities that are conducive to rapid economic
development of 'enya. 72roclamation No.:>4/4BB=, F#R-, 4BB=8
8
Loans an2 A21ances < means any financial assets of a %an arising from a direct or indirect
advance or commitment to advance funds %y a %an to a person that are conditioned on the
o%ligation of the person to repay the funds, either on a specified date or on demand, usually
with interest 7N*- #irective, &&*/95/BB=8.
Borro=erJ A is the one who %orrows money from the lender 7*an8.
Len2ing< > is the provision of resources 7granting loan8 %y one party to another party where
the second party doesnCt reim%urse the first party immediately there %y generating a de%t, and
instead arranges either to repay or return those resources a later date.
Non/erforming (oans A loans or advances whose credit (uality 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 (uestionF or when principal and/ or interest is due and uncollected
for >B 7ninety8 consecutive days or more %eyond the scheduled payment date or maturity 7N*-
#irective, &&*/95/BB=8.
Cre2it risk A it is the ris that a financial contract will not %e concluded according to the
agreement. It is the ris that the counterparty to an asset will default.
#.?. Organi@ation of the Research Re/ort
!he research report is organi?ed according to following chapters. )hapter one discusses
orientation of the study that would give a %rief overview of %aning industry in 'enya. !he
chapter also discusses research (uestions, o%jectives, scope, and significance of the study and
definition of important terms. In chapter two theoretical foundation of the study is presented.
9
!his chapter covers important issues related to the %aning and lending, theoretical review of
nonperforming loans, 'enyan %aning system and regulations. )hapter three shows an
exhaustive literature review conducted on relevant studies. !he review included previous
research, surveys and studies. )hapter four descri%es the research methodology. It explains the
research design, the sample population, data collection method, measuring instruments, and
data analysis techni(ues. &imilarly, result of the study and summary thereof is presented. !he
last chapter discusses interpretation of the research results and %ased on the results conclusions
and recommendations are given.
1
0
CHAPTER T$O
THEORET)CAL *OANDAT)ON O* THE STAD+ AND BANK)N% )N KEN+A
*acground information with respect to the research pro%lem, o%jectives, research (uestions
and scope of the study were discussed in chapter one. !his chapter presents the theoretical
foundation of the study along with the %aning industry in 'enya and issues pertaining to
credit ris management and nonperforming loans. It is organi?ed into three sections. &ection
4.3 deals with general theoretical review of %aning and nonperforming loans. !his is followed
%y a discussion of the *aning industry in 'enya in section 4.4.Finally %rief conclusion to the
chapter is presented under section 4.5.
!.# Theoretica( re1ie= of 'anking
!his section discusses the theory of %aning with major focus on role of %ans and their
lending activities.
!.#.# Banking
*ans are financial institutions that accept deposits from the general pu%lic and o%tain money
from such other sources as may %e availa%le to them 7theC havesC8 in order to extended loans to
those in need of the money 7theC haveAnotsC8 . $s Goosen et al.73>>>8 put it, %ans provide
channel 7financial intermediation8 for lining those who have excess funds with those who are
in need of funds, thus ensuring the money availa%le in economy is always put to good use. In
so doing %ans earn income when they lend money out at a higher interest rate than they pay
depositors for use of their money. $ *anKs main source of income is
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interest. $ %an pays out at a lower interest rate on deposits and receives a higher interest rate
on loans. !he difference %etween these rates represents the %anKs net income. *ans and other
financial institutions exist in order to earn a profit and to ensure that shareholdersC value is
maximi?ed.
)urrently in most jurisdictions commercial %ans are regulated %y government entities such as
central %ans and re(uire a special %an license to operate. !he re(uirements for the issue of a
%an license vary %etween jurisdictions %ut typically includeJ "inimum capital, "inimum
capital ratio 7how do we arrive at this ratioQ8 , KFit and 2roperK re(uirements for the %anKs
controllers, owners, directors, or senior officers, approval of the %anKs %usiness plan as %eing
sufficiently prudent and plausi%le.
!.#.! Ro(e of Banks
!he %aning sector maes a meaningful contri%ution to the economic growth of every country.
*ans contri%ution to the growth lies in the role they play in mo%ili?ing deposits and
allocating the resources efficiently to the most productive uses investment in the real sector. &o
maing credit availa%le to %orrowers is one means %y which %ans contri%ute to the growth of
economies. *ans pool resources together for projects that are too large for individual
shareholders to undertae 7*agehot, 3=<58. !hey are also considered the most important
ena%ler of financial transactions in any countryCs economy and are the principal source of
credit 7Rose, 4BB48. *an finance is the primary source of de%t funding. )ommercial %ans
extend credit to different types of %orrowers for many diverse purposes, either for personal,
%usiness or corporate clients 7&aunders R )ornett, 4BB58. *esides, %ans
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are also the custodians of nationCs money, which are accepted in the form of deposits and paid
out on the clientCs instructions 7&iney, 4BB4F 1arris, 4BB58.
$ %anCs role has expanded considera%ly and is no longer limited to the taing of deposits and
providing credit. *ans also perform the following activities 7Fourie et al., 3>>=F 0alde?,
4BBB8J
"oney creatorsJ )ommercial %ans create money %y way of deposit lia%ilities. In
contrast to lia%ilities of other %usinesses, %an lia%ilities 7che(ues8 are generally
accepted as a means of payment.
"anagers of the payment systemJ !his refers to the payment of che(ues through the
$utomatic )learing *ureau 7$*)8. It also facilitates payments of credit and de%it
cards, internet and cell phone %aning and automatic teller machines.
)reators of indirect financial securitiesJ )ommercial %ans hold assets that are su%ject
to specific riss, while issuing claims against them in which these riss are largely
eliminated through diversification.
Information agentsJ )ommercial %ans developed sound data%ases of client
information and the information is not pu%licly availa%le 7asymmetric information8.!he
information is only shared with other %ans %y way of a %an code or a full general
%an report.
Financial Cspectrum fillersCJ !he capital maret cannot supply the full range of
instruments re(uired %y %orrowers. )ommercial %ans assist in this regard %y
supplying specific instruments to fill the gap.
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#ealers in foreign currencyJ #ue to the glo%ali?ation of the worldCs economies this has
%ecome a very important function. )ommercial %ans assist in the conversion of
currencies, transfer of funds and negotiate foreign financing.
Notwithstanding all other activities, %aning industry considers lending as their most important
function for utili?ation of funds. &ince the major portion of gross profit of the industry is
earned from loansF the administration of loan portfolios seriously affects the profita%ility of
%ans 7WeiAshong and 'uoAchung, 4BB;8.
!.#.3 Bank Len2ing
Investment on a productive sector is the precondition for achieving the economic growth from
a country perspective. )apital formation positively supports this investment function. ,nce a
satisfactory level of capital is formed, the option of sound investment comes, that ultimately
leads to flow of capital in the future. Financial institutions, mainly %ans do these functions
through different mechanisms such as loans 7Islam, 4BB>8. 2rovision of resources 7granting
loan8 %y one party to another is termed as lending. +ending presumes the fact that the second
party doesnCt reim%urse the first party immediately rather arranges either to repay or return
those resources at a later date, maing it a de%t.
!o ena%le them function as financial intermediaries, %ans collect funds from savers in the
form of deposit and then supply it to %orrowers as loans. !hus %ans accept customer deposits
and use those funds to give loans to other customers or invest in other assets that will yield a
return higher than the amount %an pays the depositor 7"c )arthy et al., 4B3B8. It follows that
customersC deposit is the primary source of %an loan and hence, increasing or guaranteeing
deposits directly has a positive effect on lending. )ommercial %ans extend
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credit to different types of %orrowers for many diverse purposes, either for personal, %usiness
or corporate clients 7&aunders R )ornett, 4BB58.*an finance is the primary source of de%t
funding. !his intermediation functions %enefit %oth the %ans and the %orrowers.
!he principal profitA maing activity of commercial %ans is maing loans to its customers. In
allocating funds, the primary o%jective of %an management is to earn income while serving
the credit needs of its community 7Reed and Gill, 3>=>8. +ending represents the heart of the
industry. +oans are the dominant asset and represent :BA<: percent to total amount of assets at
most %ans, generate the largest share of operating income and represent the %ans greater ris
exposure 7"ac #onald and 'och, 4BB;8.
+oans and advances are defined in the respective laws of different countries. In 'enya, under
$rticle 35 7F#R- :>4/4BB=8 and 7N*-/4BB=8 $rticle 79.:8 loans and advances are defined asJ
G5 any financial assets of a bank arising from a direct or indirect advance 6i.e.
unplanned overdrafts participation in a loan syndication the purchase of loan from
another lender etc.7 or commitment to advance funds by a bank to a person that are
conditioned on the obligation of the person to repay the funds either on a specified
date or on demand usually with interest. The term includes a contractual obligation of
a bank to advance by the bank on behalf of a person. The term does not include
accrued but uncollected interest or discounted interest.8
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!.#.7 Cre2it &etho2o(ogy
)redit methodology encompasses every activity involved in lending including sales,
customer selection and screening, the application and approval process, repayment
monitoring, and delin(uency and portfolio management. It is also lined with the
institutional structure pertaining to the credit process. 6uality of credit methodology is one of
the most determinant factors for the efficiency, impact and profita%ility of the institutions.
!hus getting the credit methodology and product mix right is therefore one of the most
demanding as well as rewarding challenges of every financial institutions 7%ans8. !he
sections that follow discuss major issues in credit methodology that include credit
information, credit analysis process, credit approval and credit monitoring processes.
Getting these well significantly affect loan performance.
!.#.7.# Cre2it )nformation
-ngagement in financing %egins with customer recruitment. $n issue of nowing the customer,
customarily nown as '.) 7'now .our )ustomer8 is so vital %efore proceeding to details.
*ans use various means to o%tain such information a%out the existing or potential customer.
@se of financial statement, credit report from credit %ureau, customersC history if not new is
the potential sources of information 7Ross et al., 3>>=8.
$ccording to !he Federal Reserve 74BB98 a credit report is the organi?ed presentation of
information a%out an individualCs and/or companyCs credit record that a credit %ureau
communicates to those who re(uest information a%out the credit history of an individualCs
and/or companyCs experiences with credit, leases, nonAcreditArelated %ills, collection agency
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actions, monetaryArelated pu%lic records, and in(uiries a%out the individualCs credit history.
Further according to Ferreti 74BB<8, credit information is usually integrated with data from
other sources such as court judgments, electoral rolls and other private information provided
%y other organi?ations, which compile additional information referring to a consumer. !his
naturally is ideal source of input for credit analysis.
!he purpose of information sharing is to communicate relationship information from existing
lending relationships to outside lenders 7Gehrig and &ten%aca, 4BB<8. )redit providers use
credit information to conduct credit ris analysis of prospective %orrowers in order to mitigate
credit ris. 'all%erg and @dell 74BB58 highlight that information sharing is useful %oth at the
origination stage and after credit has %een extended. -specially at the origination phase,
information sharing reduces the pro%lems of adverse selection.
In fact the exchange of credit information improves nonAperforming loan ratios, leads to fewer
losses through write offs and decreases interest rates for good credit riss 7Ient?sch, 4BB=J
:5=8. Ient?sch 74BB=8 further supports that sharing credit information %etween lenders
intensifies competition and increases access to finance. Iappelli and 2aggano 74BB:8 indicate
that credit information sharing results in improved %anCs nowledge of applicantCs character,
easing adverse selection and reduce the informational rents that %ans could otherwise extract
from their customers. )redit information also acts as a %orrower disciplining device, %y cutting
insolvent de%tors off from credit and eliminates or reduces the %orrowerCs incentive to %ecome
overAinde%ted %y drawing credit simultaneously from many %ans without any of them
reali?ing it.
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Further, Gehrig and &ten%aca, 74BB<8 highlight that information sharing reduces adverse
selection pro%lems and there%y promotes financial sta%ilityF it serves as a %orrower
disciplining device and it reduces the informational rents that %ans can extract within the
framewor of their esta%lished customer relationships. $ccording to 'hu?wayo 74BB=8, greater
information sharing of trade credit data, particularly in the informal sector, could greatly
expand credit access for small and medium enterprises.
In addition, *arth, +in, +in R &ong 74BB=8 show that information exchange will assist in
minimi?ing lending corruption in %ans %y reducing information asymmetry %etween
consumers and lenders, improving the %ri%ery control methods and reducing informational
rent, and hence the %argaining power of lenders. !he exchange of consumer credit information
disciplines %orrowers to repay loans %ecause %orrowers do not want to damage the good report
which can mae it difficult for them to get credit 7&wiss National *an, 4BB=8.
,nce credit information on the loan re(uest is o%tained %an officers precede with credit
assessment. !he next section would thus discuss process involved in credit analysis or
assessment.
!.#.7.! Cre2it Assessment
)redit analysis is the first step in the process to tailorAmae a solution to fit the customerCs
needs. !he assessment starts with an understanding of the customerCs needs and capacities to
ensure there is a good fit in terms of the financing solution. )redit assessment is the most
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important safeguard to ensure the underlying (uality of the credit %eing granted and is
considered an essential element of credit ris management 7)ade, 3>>>8.
!he credit (uality of an exposure generally refers to the %orrowerCs a%ility and willingness to
meet the commitments of the facility granted. It also includes default pro%a%ility and
anticipated recovery rate 7&aunders R )ornett, 4BB58. )redit assessment thus involves
assessing the riss involved in financing and there%y anticipating the pro%a%ility of default and
recovery rate.
$ credit analysis is used %y the credit official to evaluate a %orrowerCs character, capital,
capacity, collateral and the cyclical aspect of the economy, or generally referred to as the five
)Cs 7&trische, 4BBB8. #etailed discussion of this model, also referred as the five )Cs is done
the next section.
The Five Cs of Credit
!he credit analysis process, traditionally employed %y the first %ans, does not differ
fundamentally from the processes used today 7)aouette et al, 3>>=F Rose, 4BB48. !he five )Cs
are considered the fundamentals of successful lending and have %een around for approximately
:B years. Initially only character, capacity and capital were considered. 1owever, over the
years collateral and conditions were added. !hese provided an even more comprehensive view
and clearer understanding of the underlying ris and resulting lending decision 7*ecman R
*artels, 3>::F Reed, )otter, Gill R &mith, 3><;F &iney, 4BB48. $ccording to "urphey
74BB9a8, these principles should %e the cornerstone of every lending decision. !he five )Cs are
discussed as followsJ
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Character<
)haracter refers to the %orrowerCs reputation and the %orrowerCs willingness to settle de%t
o%ligations. In evaluating character, the %orrowerCs honesty, integrity and trustworthiness are
assessed. !he %orrowerCs credit history and the commitment of the owners are also evaluated
7Rose, 4BBB8. $ companyCs reputation, referring specifically to credit, is %ased on past
performance. $ %orrower has %uilt up a good reputation or credit record if past commitments
were promptly met 7o%served %ehavior8 and repaid timely 7Rose, 4BB4F 'och R "c#onald,
4BB58. )haracter is considered the most important and yet the most difficult to assess 7'och R
"ac#onald, 4BB58.
*aners recogni?e the essential role management plays in a companyCs success. )ritically
analy?ing (uality of management has %een one of the ways of assessing character. !he history
of the %usiness and experience of its management are critical factors in assessing a companyKs
a%ility to satisfy its financial o%ligations.
!he (uality of management in the specific %usiness is evaluated %y taing reputation, integrity,
(ualifications, experience and management a%ility of various %usiness disciplines such as
finance, mareting and la%or relations into consideration 7&iney, 4BB4F Nathenson, 4BB98.
!hese factors can %e regarded as a ris mitigants if a %aner views these positively. "uch of its
success can in fact %e attri%uted to competent leadership. )ompanies with strong and
competent management teams tend to survive in an economic downturn.
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,n the other hand privately owned companies are generally managed %y its owners. In this
instance, succession planning must %e in place, as the role of management remains vital to the
success of the company 7'och R "ac#onald, 4BB58.
Ca/acity
)apacity refers to the %usinessCs a%ility to generate sufficient cash to repay the de%t. $n
analysis of the applicantCs %usinesses plan, management accounts and cash flow forecasts
7demonstrating the need and a%ility to repay the commitments8 will give a good indication of
the capacity to repay 7&iney, 4BB4F 'och R "ac#onald, 4BB58.
!o get a good understanding of a companyCs capacity evaluating the type of %usiness and the
industry in which it operates is also vital .It plays a significant role since each industry is
influenced %y various internal and external factors. !he factors that form the %asis of this
analysis includesJ !ype of industry, "aret share, 6uality of products and life cycle, whether
the %usiness is la%or or capital intensive, the current economic conditions, seasonal trends, the
%argaining power of %uyers and sellers, competition and legislative changes 7'och R
"ac#onald, 4BB5F Nathenson, 4BB98. !hese factors lead the %aner to form a view of the
specific company and industry. !he %aner would regard this as a potential ris mitigant if
he/she is confident a%out the company and industry and prospects for %oth appear to %e
positive.
*esides, the financial position is also a critical indication of a %usinessC capacity. !he
companyCs financial position is evaluated %y assessing past financial performance and
projected financial performance. $ companyCs past financial performance is reflected in their
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audited financial statements 7'och R "ac#onald, 4BB58. Financial projections consist of
projected cash flows demonstrating the need for the facility and the a%ility to repay the facility
7&iney, 4BB48. In this regard at least three years audited financial statements 7%alance sheet
and income statement8 are re(uired for data analysis. $ financial spreadsheet is used to
undertae the analysis.
)ommercial %ans utili?e the financial spread 7i.e. audited financial statement analysis and
ratio calculations A #u2ont8 and it is applied through the "oodyCs Ris $dvisor. !he model
also performs a peer comparison and calculates the pro%a%ility of default 7'och R
"ac#onald, 4BB58. !he following financial ratio analyses are very critical in assessing
%usinessC position 7'och R "ac#onald, 4BB58J
LiBi2ity ratios A reflect the companyCs a%ility to meet its shortAterm o%ligations.
$ccording to )onradie and Fourie 74BB48, the current ratio is calculated %y dividing the
current assets %y the current lia%ilities.
Acti1ity ratios> indicate whether assets are efficiently used to generate sales.
Le1erage ratios> indicate the companyCs financial mix %etween e(uity and de%t and
potential volatility of earnings. 1igh volatility of earnings increases the pro%a%ility that
the %orrower will %e una%le to meet the interest and capital repayments.
Profita'i(ity ratiosA supply information a%out the companyCs sales and earnings
performance.
!he cash flow analysis need to %e done once the ratio analysis has %een evaluated. !he cash
flow analysis allows the %aner to distinguish %etween reported accounting profits 7net
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income8 and cash flow from operations 7cash net income8. )ash flow from operations gives an
indication of how much cash is generated from normal %usiness activities. !he cash flow
generated must %e sufficient to service the %aning facilities 7&iney, 4BB4F 'och R
"ac#onald, 4BB58.!hese assumptions are evaluated against the companyCs past performance,
industry averages and expected economic trends 7Nathenson, 4BB98.
$n assessment of the financial capacity of a company should always include an evaluation of
trends. -valuating trends over a three to five year period gives a clear picture of the direction a
firm is heading. Ratio results should always %e compared to a peer group of or an industry
comparison. Is the firm collecting faster or slower than the rest of the industryQ Is this
company more profita%le than other companies just lie themQ In this regard maing a
maximum use of ratios %y comparing the firm to its peers using esta%lished %enchmars is so
vital. )omparison of the company to firms in the same line of %usiness, geographic area and
employee si?e provides a more accurate comparison.
!he projections also reveal the purpose, amount and type of finance re(uired. It also provides
insight into the companyCs a%ility to generate sufficient cash flow to service the de%t
7"urphey, 4BB9%F Nathenson, 4BB98. *ans must ensure that the type of financing is aligned to
the purposed of finance 7Rose, 4BBB8.
$nalysis of the financial capacity of the organi?ation should also %e carried out in order to
determine a %orrowerCs a%ility to meet financial o%ligations in a timely fashion. Its a%ility to
pay may %e much more important. It is critical to understand the difference. Watching
customer payment ha%its over time is an excellent indication of cash flow. $lso, checing %an
and trade references, as well as any pending litigation or contingent lia%ilities are
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pivotal. Further checing for a parent company relationship is important as a parent companyKs
guarantee may %e availa%le. Intercompany loans might affect financial solvency. $gency
ratings that predict slow payment or default should %e carried out %efore completion of
investigating capacity of a %orrower.
Ca/ita(
)apital refers to the ownerCs level of investment in the %usiness 7&iney, 4BB48. *ans prefer
owners to tae a proportionate share of the ris. $lthough there are no hard and fast rules, a
de%t/e(uity ratio of :BJ:B would %e sufficient to mitigate the %anCs ris where funding
7unsecured8 is %ased on the %usinessCs cash flow to service the funding 71arris, 4BB58. +enders
prefer significant e(uity 7own contri%ution8, as it demonstrates an ownerCs commitment and
confidence in the %usiness venture.
Con2itions
)onditions are external circumstances that could affect the %orrowerCs a%ility to repay the
amount financed. +enders consider the overall economic and industry trends, regulatory, legal
and lia%ility issues %efore a decision is made 7&iney, 4BB48. ,nce finance is approved, it is
normally su%ject to terms and covenants and conditions, which are specifically related to the
compliance of the approved facility 7+eply, 4BB58.
*ans normally include covenants along with conditions when credit facilities are granted to
protect the %anCs interest. !he primary role of covenants is to serve as an early warning
system 7Nathenson, 4BB98. )ovenants can either %e negative or positive 7&iney, 4BB48.
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Negative covenants stipulate financial limitations and prohi%ited events 7Rose, 4BBBF 'och R
"ac#onald, 4BB58. &ome examples of negative covenants areJ
)ash dividends cannot exceed :BO of the net profit after tax 7financial limitation8.
No additional de%t may %e o%tained without the %anCs prior approval 7prohi%ited
event8.
2ositive or affirmative covenants stipulate the provisions the %orrower must adhere to
7Rose, 4BBBF 'och R "ac#onald, 4BB58. &ome examples of positive covenants areJ
$udited financial statements must %e provided within >B days of the companyCs
financial yearAend.
!he %orrower must maintain the following financial ratiosJ Interest cover ratio of 9J3
7defined as earnings %efore interest and tax divided %y interest paid8, Gearing ratio of
4J3 7defined as total lia%ilities divided %y owners e(uity8.
)onditions normally stipulate that all the security relevant to the loan should %e in order %efore
any funds will %e advanced.
Co((atera(
)ollateral 7also called security8 is the assets that the %orrower pledges to the %an to mitigate
the %anCs ris in event of default 7&iney, 4BB48 .It is something valua%le which is pledged to
the %an %y the %orrower to support the %orrowerCs intention to repay the money advanced.
&ecurity is taen to mitigate the %anCs ris in the event of default and is considered a
secondary source of repayment 7'och R "ac#onald, 4BB58.
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&upporting of the aforementioned, Rose and 1udgins 74BB:8 define secured lending in %ans
as the %usiness where the secured loans have a pledge of some of the %orrowerCs property
7such as home or vehicles8 %ehind them as collateral that may have to %e sold if the %orrower
defaults and has no other way to repay the lender.
!he purpose of security is to reduce the ris of giving credit %y increasing the chances of the
lender recovering the amounts that %ecome due to the %orrower. &ecurity increases the
availa%ility of credit and improves the terms on which credit is availa%le. !he offer of security
influences the lenderCs decision whether or not to lend, and it also changes the terms on which
he is prepared to lend, typically %y increasing the amount of the loan, %y extending the period
for which the loan is granted and %y lowering the interest rate 7Norton and $ndenas, 3>>=J
3998.
$ccording to #e +ucia and 2eters 73>>=8, in the %aning environment, security is re(uired for
the following three reasonsJ
to ensure the full commitment of the %orrower to its operations,
to provide protection should the %orrower deviate from the planned course of action
outlined at the time credit is extended, and
to provide insurance should the %orrower default.
!he security value of an asset is %ased on the estimated reAsale value of the assets at the time
of disposing of it 7"c"anus, 4BBB8 !he specific type of property is valued %y the %an to
determine the propertyCs maret value for security purposes 7Rose, 4BBB8.
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*esides the physical collateral a third party can provide a suretyship for the de%t of the
%orrower. &hould the %orrower not %e in a position to repay the de%t, the %an will then call on
the surety for repayment 7'och R "ac#onald, 4BB58. It is normal %aning practice for the
%ans to tae the suretyships of the shareholders/directors when funds are advanced to a
company 7Rose, 4BBBF 0ance, 4BB98.
)CsH are wellAnown credit assessment principles, commercial %ans have developed their own
(ualitative credit ris assessment models to assess whether the %an will agree to lend to a
specific %usiness 7&iney, 4BB48.
*ased on the credit information o%tained a%out the %orrower and credit assessment carried out,
either %y (uantitative or (ualitative model 7through the use of the five )Cs8 or com%ination of
%oth, credit sanctioning is done. !he section that follows discusses the credit sanctioning or
approval process.
!.#.7.3 Cre2it A//ro1a(
-xtending credit is the careful %alance of limiting ris and maximi?ing profita%ility while
maintaining a competitive edge in a complex, glo%al maretplace. *ans go through a
thorough process in approving credit to hit the %alance. )redit approval is the process of
deciding whether or not to extend credit to a particular customer. It involves two stepsJ
gathering relevant information and determining credit worthiness 7Ross, Westerfield and
Iordan, 3>>>8.
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$s has %een discussed in the preceding section, the credit analysis process consists of a
su%jective analysis of the %orrowerCs re(uest and a (uantitative analysis of the financial
information provided. !he individual steps in the credit approval process and their
implementation have a considera%le impact on the riss associated with credit approval.
!he (uality of credit approval processes depends on two factors, i.e. a transparent and
comprehensive presentation of the riss when granting the loan on the one hand, and an
ade(uate assessment of these riss on the other. Furthermore, the level of efficiency of the
credit approval processes is an important rating element. #ue to the considera%le differences in
the nature of various %orrowers and the assets to %e financed as well the large num%er of
products and their complexity, there cannot %e a uniform process to assess credit riss.
!he (uality of the credit approval process from a ris perspective is determined %y the %est
possi%le identification and evaluation of the credit ris resulting from a possi%le exposure. !he
credit ris can %e distri%uted among the following ris componentsJ 2ro%a%ility of default
72#8, +oss given default 7+G#8 and -xposure at default 7-$#8. 7,esterreichische National
%an )redit $pproval 2rocess and )redit Ris "anagement, 4BBB, *luhm, ,ver%ec
RWagner, 4BB58J
Pro'a'i(ity of 2efa(t 5PD6
#efault pro%a%ility is the lielihood that the %usiness will default on its repayment over the
term of the facility. Reviewing a %orrowerCs pro%a%ility of default is %asically done %y
evaluating the %orrowerCs current and future a%ility to fulfill its interest and principal
repayment o%ligations.
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Loss gi1en 2efa(t 5L%D6
-xposure at default is the magnitude or exposure that would %e materiali?ed in the event of a
default. It addresses what fraction of the exposure may %e recovered through %anruptcy
proceedings or through some other form of settlement in the event of a default. !he loss given
default is affected %y the collaterali?ed portion as well as the cost of selling the collateral.
!herefore, the calculated value and type of collateral also have to %e taen into account in
designing the credit approval processes. 7ibid8
EC/osre at 2efa(t 5EAD6
In the vast majority of the cases descri%ed here, the exposure at default corresponds to the
amount owed to the institution. !hus, %esides the type of claimF the amount of the claim is
another important element in the credit approval process. 7ibid8
,nce information has %een gathered, the firm faces the hard choice of either granting or
refusing credit. "any financial managers use the Sfive )Ks of )reditS as their guide 7Ross,
Westerfield and Iaffe, 3>>>8 as discussed earlier and identify and evaluate the credit ris
resulting from a possi%le exposure to sanction the credit.
!.#.7.7 Loan *o((o= /
+ending decision is made on sound credit ris analysis /appraisal and assessment of
creditworthiness of %orrowers. *ut past records of satisfactory performance and integrity are
no guarantee future, though they serve as useful guide to project trend in performance. $
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loan granted on the %asis of sound analysis might go %ad %ecause of the %orrower may not
meet o%ligations per the terms and conditions of the loan contract. It is for this reason that
proper follow up and monitoring is essential. "onitoring or followAup deals with the following
vital aspectsJ
-nsuring compliance with terms and conditions
"onitoring end use of approved funds
"onitoring performance to chec continued via%ility of operations
#etecting deviations from terms of decision
"aing periodic assessment of the health of the loans and advances %y nothing some
of the ey indicators of performance that might includeJ profita%ility, activity level and
management of the unit and ensure that the assets created are effectively utili?ed for
productive purposes and are well maintained.
-nsuring recovery of the installments of the principal and interest in case of term loan
as per the scheduled repayment program
Identify early warning signals, if any, and initiate remedial measures there%y averting
from possi%le default.
*asically there are three types of loan follow up systems. !hese areJ 2hysical follow up,
financial follow up and legal follow up. -ach is discussed in section that follows.
Physical Follow -up
2hysical followAup helps to ensure existence and operation of the %usiness, status of collateral
properties, correctness of declared financial data, (uality of goods, conformity of financial data
with other records 7 such as taxes ,register %oos8, availa%ility of raw
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materials, la%or situation, mareting difficulties o%served ,undue turnover of ey operating
personnel, change in management set up among others.
Financial Follow- up
Financial follow up is re(uired to verify whether the assumptions on which lending decisions
was taen continues to hold good %oth in regard to %orrowersC operation and environment , and
whether the end use is according to the purpose for which the loan was given.
Legal Follow- up
!he purpose of legal follow up is to ensure that the legal recourse availa%le to the *an is ept
alive at all times. It consists of o%taining proper documentation and eeping them alive,
registration, proper follow up of insurances. &pecific issues pertaining to legal follow up
includeJ ascertaining whether contracts are properly executed %y appropriate persons and
documents are complete in all aspects, o%taining revival letters in time 7revival letters refer to
renewal letter for registration of security contracts that have passed the statutory period as laid
down %y the law8, ensuring loan/mortgage contracts are updated timely and examining the
regulatory directives, laws, third party claims among others.
!.#.8 Banking Risks
&hareholder value maximi?ation re(uires a firm to engage in ris management practices only if
doing so enhances the value of the firm and, %y implication, its value to shareholders 7$li,
4BB;8
3
1
$ volatile economy and recent credit crisis show the importance of %ans to increase attention
on how riss can %e measured and ept under control. *essis 74BB4J338 defines %aning riss
as Gadverse impacts on profita%ility of several distinct sources of uncertaintyH. "any riss are
common to all financial institutions that includeJ credit, li(uidity, maret, operational,
currency, solvency, and interest rate, country riss among others. !he sections that follow
discuss the ey riss that %ans are exposed to.
!.#.8.# Cre2it risk
$ccording to 0alsamais et al 74BB:8, credit ris is the ris that a financial contract will not %e
concluded according to the agreement. It is the ris that the counterparty to an asset will
default. In other words it is the ris to earnings or capital due to %orrowersC late and nonA
payment of loan o%ligations 7reference8. )redit ris encompasses %oth the loss of income
resulting from the sector ina%ility to collect anticipated interest earnings as well as the loss of
principal resulting from loan defaults. )redit ris arises %ecause the possi%ility that the
expected cash flows from advances and securities held, might not %e paid in full. )redit ris is
considered the most lethal of the riss %ans face 7)ade, 3>>>8. )redit ris includes %oth
transaction ris and portfolio ris. 7Ris "anagement, G!P, 4BBB8.
@nder credit ris are also transaction and portfolio riss. !ransaction ris refers to the ris
within individual loans transaction ris is mitigated through %orrower screening techni(ues,
underwriting criteria and (uality procedures for loan dis%ursement, monitoring, and collection.
2ortfolio ris refers to the ris inherent in the composition of the overall loan portfolio.
3
2
2olicies on diversification 7avoiding concentration in a particular sector or area8, maximum
loan si?e, types of loans, and loan structures lessen portfolio ris.
!.#.8.! LiBi2ity risk
+i(uidity ris is the possi%ility of negative effects on the interests of owners, customers and
other staeholders of the financial institution resulting from the ina%ility to meet current cash
o%ligations in a timely and costAefficient manner. +i(uidity ris occurs when there is a sudden
surge in lia%ility withdrawals resulting in a %an to li(uidate assets to meet the demand
7*essis, 4BB48. It usually arises from managementCs ina%ility to ade(uately anticipate and plan
for changes in funding sources and cash needs. $ccording to Rose and 1udgins 74BB:8 %aners
and other financial institutions are concerned a%out the danger of not having enough cash to
meet payment or clearing o%ligations in a timely and cost effective manner.
-fficient li(uidity management re(uires maintaining sufficient cash reserves on hand 7to meet
client withdrawals, dis%urse loans and fund unexpected cash shortages8 while also investing as
many funds as possi%le to maximi?e earnings 7putting cash to wor in loans or maret
investments8 5Ris "anagement, G!P 4BBB8.
!.#.8.3 &arket risk
"aret ris is the ris incurred in the trading of assets and lia%ilities when interest rates,
exchange rates and other asset prices change 7&aunders R )ornett, 4BB58. It is the current and
potential ris to earnings and shareholdersC e(uity resulting from adverse movements in
3
3
maret rates or prices. It arises from interest rate, e(uity and foreign exchange riss 7'och and
"acdonald, 4BB58. $ccording to *essis 74BB48 due to increased competition the interest
income of %ans is declining and %ans are concentrating more on nonAinterest income in order
to mitigate this ris.
!.#.8.7 O/erationa( risk
It is the ris of loss resulting from inade(uate internal processes, people and systems or from
external events 7'och and "acdonald, 4BB58. ,perational ris is the possi%le ris that existing
technology or support systems will fail or malfunction. It also includes human errors, fraud
and nonAcompliance with an institutionCs procedures and policies 7*essis, 4BB48.
!.#.8.8 Crrency risk
)oncerns the possi%le impact which fluctuations in exchange rates may have on the foreign
exchange holdings or the commitments paya%le in foreign currencies %y %usiness
organi?ations 70alsamais, et al., 4BB:8. It is the possi%ility that exchange rate fluctuations can
adversely affect the value of a %anCs assets and lia%ilities held in foreign currencies 7*essis,
4BB48. )urrency ris is one of the maret riss %ans face.
!.#.8.9 .Ca/ita( or So(1ency risk
It is the ris that a %an may %ecome insolvent and fail 7'och and "acdonald, 4BB58. It isnCt
considered a separate ris %ecause all of the riss a %an faces, in one form or another, affect a
%anCs capital.
3
4
!.#.8.: )nterest rate risk
$ %an is exposed to interest rate ris when the maturities of the %anCs assets and lia%ilities
are mismatched 7&aunders R )ornett, 4BB58. Interest rate ris arises from the possi%ility of a
change in the value of assets and lia%ilities in response to changes in maret interest rates. If
interest rates rise and a mismatch occur in maturities %y holding longerAterm assets than
lia%ilities, the maret value of the assets will decline %y a larger amount than the lia%ilities.
$lso nown as asset and lia%ility management ris, interest rate ris is a critical treasury
function, in which financial institutions match the maturity schedules and ris profiles of their
funding sources 7lia%ilities8 to the terms of the loans they are funding 7assets8. *essis,74BB48
states that interest rate ris could result in economic losses and insolvency. Interest rate ris is
also one of the maret riss.
!.#.8.; Contry risk
It is associated with the ris that foreign %orrowers cannot repay the de%t due to foreign
currency shortages, adverse political and economical conditions or interference %y the foreign
government 7&aunders R )ornett, 4BB58.
*esides the aforementioned riss Rose and 1udgins 74BB:8 state that %ans are also exposed
toJ )ompliance ris, Reputation ris, &overeign ris, &trategic ris, and +egal and regulatory
riss.
3
5
Financial institution managers 7and regulators8 review these riss in light of i8 the institutionCs
potential exposure to loss, ii8 the (uality of internal ris management and information systems,
and iii8 the ade(uacy of capital and cash to a%sor% %oth identified and unidentified potential
losses. In other words, management determines whether the ris can %e ade(uately measured
and managed, considers the si?e of the potential loss, and assesses the institutionCs a%ility to
withstand such a loss 7Ris "anagement Framewor, G!P 4BBB8.
!.#.9 Cre2it Risk &anagement
+oan is a major asset, income source for %ans, and risy area of the industry. "oreover, its
contri%ution to the growth of any country is very clear. *an credit is the primary source of
de%t financing availa%le for most customers in the personal, %usiness or corporate maret. !he
underlying need for credit varies across these marets. *ans generally also want to increase
the %ase of their income and use credit extension as an opportunity to cross sell other fee
generating services when a customer applies for credit facilities 7'och R "ac#onald, 4BB58.
$ny successful %usiness must meet its customer needs and mae a profit. +iewise, successful
financial institutions must meet the desperate needs of depositors and %orrowers. #epositors
loo for high rates, short terms and no ris, while %orrowers see low rates and long terms.
Financial institutions are therefore, in the ris intermediation %usiness. !o %e successful,
financial institutions, %ans in particular, must properly underwrite ris, manage and monitor
the ris assumed 7*arricman, 3>>B8.
3
6
)redit ris can %e defined as the potential for a %orrower or counter party to fail to meet their
o%ligations in accordance with the terms of an o%ligationCs loan agreement, contract or
indenture 7&o%ehart, 'eenan R &teyn, 4BB58.
)redit ris is considered the oldest form of ris in the financial marets. )aouette, $ltman R
Narayanan 73>>=J 38 state that Gcredit ris is as old as lending itselfH, dating %ac as far as
3=BB *.). !he first %ans, which started in Florence seven hundred years ago, faced very
similar challenges that %ans face today. $lthough managing credit ris is their core
competency, many %ans failed due to overAextension of credit 7)aouette et al, 3>>=8.
!he most prominent ris assumed %y %ans is credit ris. !his is due to the various factors that
influence a %orrowerCs a%ility to repay the credit facility. !he %orrowerCs a%ility to repay is
closely lined to the general economic conditions of a country. In favora%le economic
conditions the a%ility to repay increases, which could %e due to a favora%le interest rate
environment, low inflation, increased income levels or a com%ination of these factors. !he
opposite is however true in poor economic conditions. !he %orrowerCs a%ility to repay is
adversely effected under these conditions due to a reduction in disposa%le income 7'och R
"ac#onald, 4BB58.
)redit ris arises from uncertainty in a given counterpartyCs a%ility to meet its o%ligations. !he
increasing variety in the types of counterparties 7from individuals to sovereign governments8
and the everAexpanding variety in the forms of o%ligations 7from auto loans to complex
derivatives transactions8 has meant that credit ris management has jumped to the
3
7
forefront of ris management activities carried out %y firms in the financial services industry
7*asel committee,3>>>8.
!he ris profile of %ans is fundamentally different from that of other financial institutions,
lie stoc%roers and insurance industry. $n integral part of %aning is the management of
credit ris and it is done through wellAdiversified portfolios of exposure. "ost %ans fail
%ecause of poorly managed credit ris 7Rose, 4BB48.
)redit ris management primarily focuses on loss avoidance and the optimi?ation of return on
ris. Financial institutions in the world are facing two major challenges. Firstly, they need to
deliver increasing returns and value to shareholders and secondly, they need to determine how
to capitali?e on the New )apital $ccordCs 7*asel II8 minimal capital re(uirements 7*elmont,
4BB98.
!he need to put a strong credit ris management in place cannot overemphasi?ed as failure
which lead loan default and there%y crisis on %ans. !he section that follows discusses non
performing loans.
!.#.: Non/erforming Loans 5NPL6
+oans and advances constitute the primary source of income %y %ans. $s any %usiness
esta%lishment a %an also sees to maximi?e its profit. &ince loans and advances are more
profita%le than any other assets, a %an is willing to lend as much of its funds as possi%le. *ut
%ans have to %e careful a%out the safety of such advances 7Radha .", et al, 3>=B8. *aners
naturally try to %alance the issue of maximi?ing profit %y lending and at the same time manage
ris of loan default as it would impair profit and there%y the very capital .!hus a
3
8
%an needs to %e cautious in advancing loans as there is a greater ris which follows it in a
situation where the loan is defaulted.
In other words loan loss or defaulted loans puts a %an in a difficult situation especially when
they are in greatest amount. #espite the fact that %ans hold security for the loans they grant
they cannot %e fully %e certain as to whether they are paid or not. It is when such riss
materiali?e that loans turn to %e nonA performing.
!he concept of nonAperforming loans has %een defined in different literatures. $ccording to
2atersson and Wadman 74BB98, nonA performing loans are defined as defaulted loans which
%ans are una%le to profit from. !hey are loans which cannot %e recovered within stipulated
time that is governed %y the laws of a country. $ccording to the International "onetary Fund
7I"F, 4BB>8, a nonA performing loan is any loan in which interest and principal payments are
more than >B days overdueF or more than >B days worth of interest has %een refinanced.
NonAperforming loans generally refer to loans which for a relatively long period of time do not
generate incomeF that is the principal and/or interest on these loans has %een left unpaid for at
least >B days 7Fofac, 4BB>8. NonA performing loans are further defined as loans whose cash
flows stream is so uncertain that the %an does not recogni?e income until cash is received,
and loans those whose interest rate has %een lowered on the maturity increase %ecause of
pro%lem with the %orrower 7"achiraju, @ndated8. 1R "achiraju expresses nonAperforming
loans as a leading indicator of credit (uality.
3
9
Non 2erforming +oans 7N2+8 or %ad loans arise in respect of the loans and advances which are
given %y %ans to the whole range of different projects including %ut not exclusively retail or
wholesale, personal or corporate or short, medium or long term projects. N2+s are a very
sensitive element of a %anCs operations.
$ccording to *rown, "allett and !aylor, the losses %ad loans 7N2+s8 cause, %y reducing the
capital resource of the %an, affects its a%ility to grow and develop its %usiness 7!aylor, 3>>58.
#isclosure of the extent of these losses in its financial statements may lead to a loss of
confidence in the %anCs management and a reduction in its credit ratings. !his will in turn
increase the %anCs cost of %orrowing in the wholesale maret and mae it more expensive or
more difficult to raise capital. In extreme cases, it can leads to a loss of deposits, the
withdrawal of the %anCs authori?ation and ultimately insolvency 7".G. !aylor, 3>>58. !hus
N2+ is one of the concrete em%odiments of credit ris which %ans tae. !hey have greater
implication on the function of the %ans as well as the overall financial sector development.
1istorically, the occurrence of %aning crises has often %een associated with a massive
accumulation of nonAperforming loans which can account for a si?a%le share of total assets of
insolvent %ans and financial institutions, especially during episodes of systemic crises.
#eterioration in %ansC loan (uality is one of the major causes of financial fragility. 2ast experience shows that a rapid %uildup of %ad loans
plays a crucial role in %aning crises 7#emirgLM'unt and #etragiache, 3>>=, and Gon?Nle?1ermosillo, 3>>>8.
4
0
It is widely accepted that the (uantity or percentage of nonAperforming loans 7N2+s8 is often
associated with %an failures and financial crises in %oth developing and developed countries.
In fact, there is a%undant evidence that the financial/%aning crises in -ast $sia and &u%A
&aharan $frican countries were preceded %y high nonAperforming loans. !he current glo%al
financial crisis, which originated in the @&, was also attri%uted to the rapid default of su%A
prime loans/mortgages. In view of this reality it is therefore understanda%le why much
emphasis is placed on nonAperforming loans when examining financial vulnera%ilities 7&orge,
4BB98.
It is apparent that insolvency of %ans is costly to the macro economy per se, %ut this cost can
%e increased or decreased %y the regulators and the policies they use in resolving the
insolvencies. !he faster %ans can %e resolved %efore their economic capital turns negative, the
smaller are %oth losses to depositors and costs to the macro economy 7G. 'aufman, 4BB98.
!his is why most countries provide their own rules regarding N2+s and its classifications.
!he classification of a loan as %ad or dou%tful may result from a specific act %y the %orrower,
for example, petitioning for %anruptcy, or from circumstances that have the potential to place
the loan at ris. For example, the %orrower may have defaulted on one or more of the terms of
the loan, or a su%stantial part of its assets may %e in an industrial sector or country that is
suffering from an economic recession 7".G. !aylor, 3>>58. Nonperforming loans could %e
recogni?ed early from the violation of the terms of agreement %y the %orrower.
4
1
When we see the context of $frica, the criterion for identifying non performing loans varies.
&ome countries use (uantitative criteria to distinguish %etween GgoodH and G%adH loans 7e.g.,
num%er of days of overdue schedule payments8, while others rely on (ualitative norms 7such
as the availa%ility of information a%out the clientCs financial status, and perspectives a%out
future payments8. 1owever, the *asel II )ommission emphasi?es the need to evolve toward a
standardi?ed and internal ratingA%ased approach. $ccordingly, the *asel committee puts non
performing loans as loans left unpaid for a period of >B days as has %een mentioned in the
preceding paragraphs.
@nder the 'enyan %aning %usiness directive, nonAperforming loans are defined as Gloans or
advances whose credit (uality has deteriorated such that full collection of principal and/or
interest in accordance with the contractual repayment terms of the loan or advances in (uestion
7N*-, 4BB=8.H It further provides thatJ
5 loans or advances with pre established repayment programs are
nonperforming when principal and" or interest is due and uncollected for 9:
6ninety7 consecutive days or more beyond the scheduled payment date or
maturity 6;B< *::07.
In addition to the a%ove mentioned category of nonA performing loans, overdrafts and loans or
advances that do not have preAesta%lished repayment program shall %e nonAperforming whenJ
!he de%t remains outstanding for >B 7ninety8 consecutive days or more %eyond the
scheduled payment date or maturityF
4
2
!he de%t exceeds the %orrowerCs approved limit for >B 7ninety8 consecutive days or
moreF
Interest is due and uncollected for >B 7ninety8 consecutive days and moreF or For the
overdrafts, 7i8 the account has %een inactive for >B 7ninety8 consecutive days or
7ii8 deposits are insufficient to cover the interest capitali?ed during >B 7ninety8
consecutive days or 7iii8 the account fails to show the 4BO of approved limit or less
de%it %alance at least once over 5;B days preceding the date of loan review.
!his is in accordance with the *asel rules. If a loan is past due for >B consecutive days, it will
%e regarded as nonA performing. !he criteria used in 'enyan %aning %usiness to identify nonA
performing loan is a (uantitative criteria %ased on the num%er of days passed from loan %eing
due.
!he economic and financial costs of these impaired loans are significant. 2otentially, these
loans may negatively affect the level of private investment, increase deposit lia%ilities and
constrain the scope of %an credit to the private sector through a reduction of %ansC capital,
following falling saving rates as a result of runs on %ans, accumulation of losses and
correlative increased provisions to compensate for these losses. !hese loans also have potential
for reducing private consumption, and in the a%sence of deposit guarantee mechanisms to
protect small depositors, can %e a source of economic contraction, especially when coupled
with declining gross capital formation in the context of a credit crunch caused %y erosion of
%ansC e(uity and assets 7Fofac, 4BB>8.
4
3
Generally, in developing and underdeveloped countries, the reasons for default have a
multidimensional aspect. 0arious researchers have concluded various reasons for loan default.
+iterature categori?es determinants of N2+ to macroeconomic and %an specific factors. !he
paragraphs that follow discuss determinants of nonperforming loans.
George G 74BB98 states the fact that large num%er of the literatures indicates the linage
%etween the phases of the %usiness cycle with %aning sta%ility. "acroeconomic sta%ility and
%aning soundness are inexora%ly lined. -conomic theory and other evidences strongly
indicate that insta%ility in the macroeconomic is associated with insta%ility in %aning and
financial marets and vice versa.
!he relation %etween the macroeconomic environment and loan (uality has %een investigated
in the literature lining the phase of the %usiness cycle with %aning sta%ility. In this line of
research the hypothesis is formulated that the expansion phase of the economy is characteri?ed
%y a relatively low num%er of N2+s, as %oth consumers and firms face a sufficient stream of
income and revenues to service their de%ts. 1owever as the %ooming period continues, credit is
extended to lowerA(uality de%tors and su%se(uently, when the recession phase sets in, N2+s
increase 7Fisher 3>55, "insy 3>=;, 'iyotai and "oore 3>><, Geanaoplos, 4BB>8.
$ccording to &alas and &aurina 74BB48 there is a significant negative contemporaneous effect
of G#2 growth on the N2+ ratio and infer a (uic transmission of macroeconomic
developments to the a%ility of economic agents to service their loans. !he other
macroeconomic varia%les, aside from G#2 growth, such as unemployment and interest rates
4
4
have got an impact on household and firms that they have a relation with N2+ ratio. "ore
specifically, an increase in the unemployment rate should influence negatively the cash flow
streams of households and increase the de%t %urden. With regards to firms, increases in
unemployment may signal a decrease production as a conse(uence of a drop in effective
demand. !his may lead to a decrease in revenues and a fragile de%t condition.
When we see the impact of interest rate, it affects the difficulty in servicing de%t, in the case of
floating rate loans. !his implies that the effect of the interest rate should %e positive, and as a
result the increasing de%t %urden caused from rising interest rate payments should lead to a
higher num%er of N2+s.
!he choice of G#2, unemployment and interest rate as the primary determinants of N2+s may
also %e justified from the theoretical literature of lifeAcycle consumption models. +awrence
73>>:8 examines such a model and introduces explicitly the pro%a%ility of default, explained
earlier. !he model implies that %orrowers with low incomes have higher rates of default. !his
is explained %y their increased ris of facing unemployment and %eing una%le to pay.
$dditionally, in e(uili%rium, %ans charge higher interest rates to risier clients.
Further, Rinaldi and &anchisA$rellano 74BB;8 extend +awrenceCs model %y including the
possi%ility that agents can also %orrow in order to invest in real or financial assets. $fter
solving the optimi?ation pro%lem of an agent, they derive the pro%a%ility of default which
depends on current income, the unemployment rate 7which is lined to uncertainty regarding
future income8 and the lending rate.
4
5
"acroeconomic insta%ility would have conse(uences for the loan (uality of %ans in any
country. 1igh inflation increases the volatility of %usiness profits %ecause of its
unpredicta%ility, and %ecause it normally entails a high degree of varia%ility in the rates of
increase of price of the particular goods and services which mae up the overall price index.
!he pro%a%ility that firms will mae losses riseF as does the pro%a%ility that they will earn
windfall profits.
&tudies conducted on %ans in different economies also depict the correlation %etween
macroeconomic factors lie inflation, unemployment and interest rate and loan defaults.
Generally looing, the effect of macroeconomic insta%ility on the financial sector and %aning
in particular maes it a cause for nonA performing loans.
"acroeconomic factors which are viewed as exogenous forces influencing the %aning
industry should not %e sought exclusively in determining N2+s. In contrast, the typical nature
of the %aning sector along with the specific policy choices of a particular %an with regard to
its efforts to maximi?e efficiency and improve in its ris management are expected to exert a
vital influence on the evolution of N2+s. !hus %an specific factors also ascri%e to the causes
of nonperforming loans.
#ue to the nature of their %usiness, %ans are exposed default ris from %orrowers. $ccording
to *rown%ridge 73>>=8 many of the %ad de%ts were attri%uta%le to moral ha?ardJ the adverse
incentives on %an owners to adopt imprudent lending strategies, in particular insider lending
and lending at high interest rates to %orrowers in the most risy segments of
4
6
the credit marets. 1e further o%served that second major factor contri%uting to %an failure
were the high interest rates charged to %orrowers operating in the highAris segments of the
credit maret. !his involved elements of moral ha?ard on the part of %oth the %ans and their
%orrowers and the adverse selection of the %orrowers.
'eeton and "orris 73>=<8 indicated that commercial %ans with greater ris appetite tend to
record higher losses. !his also leads to leniency. &alas and &aurina 74BB48 attri%ute the
leniency to disaster myopia, herd %ehaviour and agency pro%lems that may entice %an
managers to lend excessively during %oom periods of economic expansion.
&iney and Greenwalt 73>>38 also indicated that there is significant positive relationship
%etween the loanAloss rate and internal factors such as high interest rates, excessive lending,
and volatile funds. 'eeton 73>>>8 also indicated a strong relationship %etween credit growth
and impaired assets. &pecifically, 'eeton 73>>>8 shows that rapid credit growth, which was
associated with lower credit standards.
&alas and &aurina 74BB48 reveal that rapid credit expansion, %an si?e, capital ratio and maret
power explain variation in N2+s. "eanwhile, Rajan and #hal 74BB58 indicated that favoura%le
macroeconomic conditions 7measured %y G#2 growth8 and financial factors such as maturity,
cost and terms of credit, %ans si?e, and credit orientation impact significantly on the N2+s of
commercial %ans in India.
4
7
Fofac 74BB:8 also indicated that the real interest rate, net interest margins, and interA%an
loans are significant determinants of N2+s. "ore recently 1u et al 74BB;8 analysed the
relationship %etween N2+s and ownership structure of commercial %ans and found that %ans
with higher government ownership recorded lower nonAperforming loans.
Generally ro%ustness and prudence of the credit process largely contri%ute to loan (ualities
%ans maintain. In this regard, appropriateness of customer selection process, (uality and
depth of credit assessment, thoroughness of the sanctioning process, and mechanisms of post
dis%ursement follow up will have a significant role in determining where a specific %an
stands i when it comes to loan performance. In other words the credit ris management frame
wors %ans set and live A%y is very crucial in eeping loan default to minimum level. !hus
failing in any one of the issues discussed under section 4.3.9 will liely to lead to occurrences
of N2+. InA depth review of the relevant literature on determinants of N2+ is made in the
chapter three.
*ans should use various mechanisms to recogni?e early warning signs regarding their loans.
!he regulation and monitoring process will %e successful when there is strong legal as well as
institutional framewor of the %aning %usiness. !his is why most countries need to provide
strict regulation regarding nonA performing loans. In order to put mechanisms that help to
recogni?e early warning signs, to need to examine the root causes of loan default is of
paramount importance as discussed in chapter three.
4
8
!.! Banking )n2stry in Kenya
&ources from the National *an of 'enya 7N*-, 4B3B8 indicate that modern *aning in
'enya dates %ac to the year 3>B: when the *an of $%yssinia was esta%lished. *an of
$%yssinia was formed under a fiftyA year franchise agreement made with the National *an of
-gypt, which was owned %y the *ritish %y then. !o widen its reach in the country the *an
had expanded its %ranches to #ire #awa, Gore and #essie. It also had an agency and a transit
office in Gam%ella and at the port of #ji%outi respectively. $fter its formal li(uidation on
$ugust 4>, 3>53 the *an of $%yssinia was replaced %y the *an of 'enya.
$ccording to N*- 74B3B8 *an of 'enya, which was also nown as *an(ue National
-thiopienne , was a national *an and one of the first indigenous %ans in $frica. !he *an of
'enya operated until 3>5: and ceased to function %ecause of the Italian invasion. #uring the
five years of the Italian occupation 73>5;A938, many %ranches of the Italian *ans such as
*anco dCitalia, *anco deARoma, *anco #iANapoli and *anco Na?ianali del lavoro were
operational in the main towns of 'enya.
$fter evacuation of Italians, the &tate *an of 'enya was esta%lished on Novem%er 5B, 3>95
with a capital of one million "arian !reasury of the "inistry of Finance. 2ursuant to the
"onetary and *aning +aw of 3>;5 the &tate *an of 'enya that had served as %oth a central
and a commercial %an was dissolved and split into the National *an of 'enya and
)ommercial *an of 'enya &hare )ompany. $ccordingly, the central %aning functions and
the commercial %aning activities were transferred to the National *an 'enya and the
)ommercial *an of 'enya &hare )ompany respectively.
4
9
Further, as per N*- 74B3B8, due to change of government in 3><9, and the command
economic system which had prevailed in the country, the )ommercial *an of 'enya &.).
and other %ans and financial institutions were nationali?ed on Ianuary 3
st
, 3><:. !he
nationali?ed %ans were reAorgani?ed and one commercial %an, the )ommercial *an of
'enyaF two speciali?ed %ansA the $gricultural and Industrial *an 7$I*8, renamed as the
#evelopment *an of 'enya 7#*-8 and a 1ousing and &avings *an 71&*8 currently named
as the )onstruction and *usiness *an 7)**8F and one insurance company, the 'enyan
Insurance )orporation were formed.
#uring the era of state socialism 73><9A3>>38, 'enyaCs financial institutions were charged with
executing the national economic planF state enterprises received %an finance in accordance
with the planCs priorities. !his system %ased on the template of the &oviet @nion, saw little
need to develop the tools and techni(ues of financial systems 7N*-, 4BB=8.
Following the change of Government in 3>>3 and the change of economic policy directions,
financial institutions were reAorgani?ed to operate towards a maret oriented policy
framewor. 2roclamation No. =5/3>>9 which had allowed the esta%lishment of private %ans
has mared the %eginning of new era in the 'enyan %aning sector development. )ommercial
*ans %oth pu%lic and private are currently operational in line with *aning 2roclamation No.
:>4/4BB=.
Following the enactment of the %aning legislations in the country in the 3>>Bs, a fairly good
num%er of private %ans have %een esta%lished. For example, in the 4B3B/33 fiscal year the
total num%er of %ans already operational in the country reached sixteen. ,f these %ans,
thirteen were private and the other three were government owned. #uring the same period
5
0
there were a total of =4> commercial %an %ranches in the country 7N*-, 4B338. ,ne %ranch
of a %an on the average is estimated to serve >:,349 people in 'enya as at #ecem%er 4B3B
7N*-, 4B338. !here still is also a sign of interest in esta%lishing other new %ans %y different
individuals and groups. &ources from the national %an indicate that, at present, there are over
ten %ans under the process of esta%lishment. )urrently commercial %ans wor for profit and
the role of licensing and supervision is entrusted to the N*-.
+ooing into performance of the %aning sectorF the deposit mo%ili?ed %y the %ans as at Iune
4B3B was registered to %e 'enyan *irr 7-!*8 >=.; *illion and its average growth rate since
4BB:/B; was 44 percent. ,n the other hand, the level of outstanding loans for the same period
was -!* ;4.4 *illion, which is ;5 percent of total deposit. !otal deposit in relation to total
G#2 was noted to %e a%out 34 percent. &oundness indicators of the %aning system in 'enya
show thatJ
)apital ade(uacy ratio is well a%ove the minimum re(uirement of =O of risAweighted
assetF
!he level of nonAperforming loans has su%stantially declined and is less than :O for
most of the %ans, in line with the N*- directivesF
Return on e(uity which is to the tune of 5BO is steadily improvingF
-xposure to foreign lia%ilities is very minimalF and
$ll *ans register a positive profit after tax 7N*-, 4B338.
$lthough the %aning industry in 'enya has a%out hundred years of experience, the sector is
yet to develop and is still in its infancy or growing stage. !he %aning sector in 'enya
provides the most %asic %aning products including deposit facilities, loans and advances,
5
1
fund transfer 7local /glo%al8 , import/export facilities, and guarantees. Recently, most of the
%ans are striving to improve their service delivery through introducing different I! solutions.
Recent trends also indicate that %ans are competing in the maret on the %asis of %ranch
expansion, advertisements, raising capital %ases, improved service delivery, and investment on
I! software and infrastructure. 1owever, these technological innovations are at their infant
stage and the sector is re(uired to do much more to meet its customer expectations 7N*-,
4B3B8
*aning %usiness is done in accordance to G*aning *usiness 2roclamation No. :>4/4BB=H
and different directives on %aning %usiness operations issued %y the central %an, which is the
National *an of 'enya.
$ll the %ans are now regulated %y the central %an which is the National *an of 'enya. $
central %an plays the most influential role in a countryCs economic and financial development.
Generally, the primary role of a central %an is the same in all countries. It acts as a %aner and
financial advisor to the government as the nationCs monetary authority, and is responsi%le to
the government for promoting monetary sta%ility in the country. !o improve the sta%ility of the
financial system further, a central %an will act as a %aner to the %aning and other financial
institutions in the country. )onse(uently, a central %an can influence the lending policy of
commercial %ans and thus their de%t recovery.
*aning is a highly regulated industry in 'enya for a num%er of reasons. &ome of the reasons
include protecting depositorsC fund, ensuring safety and sta%ility of the %aning system,
protecting safety of %ans 7that means to limit credit to a single %orrower8, and
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2
limiting or encouraging a particular ind of lending %ecause of expected impact on the
economy. For these and other reasons, the 'enyan government issued the following *an
proclamations.
!he first *aning proclamation is for the reAesta%lishment of N*- 7F#R-, :>3/4BB=8. !he
proclamation sets out the purpose, powers and duties of the central %an. $ccording to Federal
#emocratic Repu%lic of 'enya 7F#R-, 4BB=8 proclamation No :>3/4BB=, the functions of
N*- includeJ
+icense and regulate %ans, insurance companies and other financial institutions in
accordance with the relevant laws of 'enya,
#etermine on the %asis of assessing the received deposit, the amount of assets to %e
held %y %ans. 7Reserve re(uirement8,
Issue directive governing credit transactions of %ans and other financial institutions,
and
#etermine the rate of interest.
!he &econd proclamation is %aning %usiness proclamation 7F#R-, 4BB=8 proclamation No
:>4/4BB=.!he proclamation sets the following %aning %usiness issuesJ
Re(uirement for o%taining license for %aning %usiness in 'enya,
2rohi%it foreign nationals or organi?ations fully or partially open %ans or %ranch
offices, &u%sidiaries of foreign %an in 'enya or ac(uire the shares of 'enyan %ans,
+imitation of the ac(uisition of shares,
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3
$ppointment of %an directors and officers,
"aintenance of re(uired capital, legal reserve and ade(uate li(uidity and reserve
%alance,
+imitations on certain transaction 7investment8,
Inspection of %ans, and
Revocation of license.
!.3 Conc(sion
!his chapter discussed the roles %ans play in an economy along with %an lending. It also
covered the processes %an pursue in their credit methodology from customer selection to loan
sanctioning and followAup. !he various riss the %aning sector face with special emphasis on
credit ris was also discussed. In addition, definition, impact and how nonperforming loans
occur were discussed in detail.
!he chapter also presented the historical %ac ground and development of the %aning industry
in 'enya. It had further indicated the fact that the 'enyan current %aning system is dominated
%y pu%lic %ans and the private %ans are entering to the industry in recent years and the
various types of services given %y 'enyan %ans that also include lending. With regard to
regulating %ans, it was stated that two %aning proclamations were issued in the year 4BB= %y
the 'enyan government.
5
4
CHAPTER THREE
L)TERATARE RE-)E$
!he focus of chapter two was to give theoretical and conceptual foundation of the study. !his
chapter presents the literature review focusing on the empirical evidence on determinants of
nonperforming loans. $ccordingly, the first su%section, 5.3 presents determinants of
nonperforming loans in general. !he second su%section 5.4 discusses review of literature on
the macroeconomic determinants of nonperforming loans. !he next su%section 5.5 discusses
studies made earlier on %an specific determinants of nonperforming loans. Finally su%section
5.9 present previous studies in 'enya. &ection 5.: is dedicated to conclusion and nowledge
gap.
3.#. Determinants of Non/erforming Loans
#eterioration in %ansC loan (uality is one of the major causes of financial fragility. 2ast experience
shows that a rapid %uildup of %ad loans plays a crucial role in %aning crises 7#emirgLM'unt and
#etragiache, 3>>=, and Gon?Nle?1ermosillo, 3>>>8. In recent years, the glo%al financial crisis and the
su%se(uent recession in many developed countries have increased householdsC and firmsC defaults,
causing significant losses for %ans.
#efault culture is not a new dimension in the arena of investment. Rather in the present
economic structure, it is an esta%lished culture. !he redundancy of unusual happening %ecomes
so fre(uent that it seems people prefer to %e declared as defaulters 7&onali, 4BB38.
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5
Generally, in developing and underdeveloped countries, the reasons for default have a
multidimensional aspect. 0arious researchers have concluded various reasons for loan default.
!he literature reviewed concentrate on two grand factorsA macroeconomic and %an specific
factors. &tudies in the @& and the rest of the world provide this result. For instance, *ercoff et
al 74BB48 examine the fragility of the $rgentinean *aning system over the 3>>5A3>>;
periodsF and came up with a finding that N2+s are affected %y %oth %an specific factors and
macroeconomic factors.
!he rest of this section discusses determinants of nonperforming loans %eginning with
macroeconomic and then %an specific factors.
3.! &acroeconomic Determinants of Non/erforming (oans
!he macroeconomic determinants of the (uality of %ansC loans have %een area of various
researchers during the past two decades. !he literature on the major economies has confirmed
that macroeconomic conditions matter for credit ris. !hese literatures among others have
investigated the linage %etween macroeconomic factors lie G#2, inflation, real interest rates,
unemployment etc. and loan performance. !he paragraphs that follow critically review the
existing literature on the major macroeconomic factors that have %earing on Nonperforming
loans 7N2+8.
5
6
George G 74BB98 states the fact that large num%er of the literatures indicates the linage
%etween the phases of the %usiness cycle with %aning sta%ility. "acroeconomic sta%ility and
%aning soundness are inexora%ly lined. *oth economic theory and empirical evidence
strongly indicate that insta%ility in the macroeconomic is associated with insta%ility in %aning
and financial marets and vice versa.
!he researches indicates that the expansion phase of the economy is characteri?ed %y a
relatively low num%er of N2+s, as %oth consumers and firms face a sufficient stream of
income and revenues to service their de%ts. 1owever as the %ooming period continues, credit is
extended to lowerA(uality de%tors and su%se(uently, when the recession phase sets in, N2+s
increase. 7Fisher 3>55, "insy 3>=;, 'iyotai and "oore 3>><, Geanaoplos 4BB>8.
&tudies conducted %y 'eeton and "orris 73>=<8 on a sample of nearly 4,:BB @& commercial
%ans using simple linear regressions indicate that large portion of loan losses recorded %y the
%ans ascri%e to adverse local economic conditions along with the poor performance of certain
sectors. &imilar study %y &iney and Greenwalt 73>>38 on large commercial %ans in the
@nited &tates from 3>=9 to 3>=< %y employing simple logAlinear regression model and data
also indicates that depressed regional economic conditions explain the lossArate of the
commercial %ans. ,ther authors who looed at assetAprice evidence also found a linage
%etween credit ris increases and adverse macroeconomic conditions 7"ueller, 4BBBF
$nderson and &undaresan, 4BBBF )ollinA#ufresne and Goldstein, 4BB38.
5
7
&tudy made on $ustralian %ans %y 'ent and #C$rcy 74BBB8 suggests that, riss peaed at the
top of %usiness cycle. Rajan and #hal 74BB58 looed at Indian %ans and uncovered a similar
relationship. "arcucci and 6uagliariello 74BB=8 studied the Italian %aning system %y
employing a reducedform value at ris 70$R8 to assess, among other things, the effects of
%usiness cycle conditions on %an customersC default rates over the period 3>>BT4BB9 found
out that the default rates follow a cyclical pattern, falling during macroeconomic expansions
and increasing during downturns.
@sing a dynamic model and a panel dataset covering the period 3>=:A3>>< to investigate the
determinants of pro%lem loans of &panish commercial and saving %ans, &alas and &aurina
74BB48 reveal that real growth in G#2 is among the factors that explain variation in N2+s.
"eanwhile, Rajan and #hal 74BB58 utili?ed panel regression analysis to report that favora%le
macroeconomic conditions 7measured %y G#2 growth8 is among the factors that have
significant impact on the N2+s of commercial %ans in India. -mpirical studies tend to
confirm the aforementioned lin %etween the phase of the cycle and credit defaults.
6uagliarello 74BB<8 find that the %usiness cycle affects the N2+ ratio for a large panel of
Italian %ans over the period 3>=: to 4BB4. Furthermore, Iimene? and &aurina 74BB:8 who
examined the &panish %aning sector from 3>=9 to 4BB5F provided evidence that N2+s are
determined %y G#2 growth, high real interest rates among others. &alas and &aurina 74BB48
estimate a significant negative contemporaneous effect of G#2 growth on the N2+ ratio and
infer a (uic transmission of macroeconomic developments to the a%ility of economic agents
to service their loans.
5
8
Furthermore, )ifter et al 74BB>8, using neural networ %ased wavelet decomposition, find a
lagged impact of industrial production on the num%er of nonAperforming loans in the !urish
financial system over the period Ianuary 4BB3 to Novem%er 4BB<. *ercoff, Giovanni and
Grimard 74BB48 analy?ed $rgentinaCs %aning system using an accelerated failure time model
and found that the money multiplier, reserve ade(uacy among other are factors affecting N2+s.
Further macroeconomic insta%ility which is mostly manifested %y high inflation rate also
maes loan appraisal more difficult for the %an, %ecause the via%ility of potential %orrowers
depends upon unpredicta%le development in the overall rate of inflation, its individual
components, exchange rates and interest rates. "oreover, asset prices are also liely to %e
highly volatile under such conditions. 1ence, the future real value of loan security is also very
uncertain 7"artin *rown%rigde, 3>>=8 We also see that %ans do poorly %oth when product
and asset price prudential policy, inflation accelerates unexpectedly and when inflation
decelerates unexpectedly, unemployment increases, and/or aggregate output and income
decline unexpectedly. @nexpected accelerations in inflation adversely affect %ans that, on
average, lend longer term at fixedArates than they %orrow %ecause nominal interest rates will
raise more than expected. !his will increase their cost of deposits more than their revenues
from loans.
$n increase in the unemployment rate could influence negatively the cash flow streams of
households and increase the de%t %urden. With regards to firms, increases in unemployment
may signal a decrease production as a conse(uence of a drop in effective demand. !his may
lead to a decrease in revenues and a fragile de%t condition.
5
9
!he interest rate affects the difficulty in servicing de%t, in the case of floating rate loans. !his
implies that the effect of the interest rate should %e positive, and as a result the increasing de%t
%urden caused from rising interest rate payments should lead to a higher num%er of N2+s.
"acroeconomic insta%ility would have conse(uences for the loan (uality of %ans in any
country. 1igh inflation increases the volatility of %usiness profits %ecause of its
unpredicta%ility, and %ecause it normally entails a high degree of varia%ility in the rates of
increase of price of the particular goods and services which mae up the overall price index.
!he pro%a%ility that firms will mae losses riseF as does the pro%a%ility that they will earn
windfall profits.
&tudies conducted on %ans in different economies also depict the correlation %etween
macroeconomic factors lie inflation, unemployment and interest rate and loan defaults. &ome
of the studies would further %e pinpointed in the paragraphs that follow.
&tudy %y Fuentes and "a(uieira 74BB58 on )hilean %ansF indicates that interest rates had a
greater effect on N2+s than the %usiness cycle. ,ther macroeconomic varia%les, in particular
the exchange rate, unemployment, and asset and house prices are also important factors
affecting N2+ 7I"F, 4BB;8.
1oggarth et al. 74BB:8 employed @' (uarterly data for the period 3>==T4BB9 to evaluate the dynamics
%etween %ansC writeoff to loan ratio and several macroeconomic varia%les found out that %ansC write
off ratio also increases after increases in retail price inflation and nominal interest rates. &imilarly,
*a%ouUe and IanUar 74BB:8 (uantify the effects of macroeconomic shocs on the loan (uality of the
)?ech %aning sector for the period 3>>5T
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4BB; and report evidence of a positive correlation of nonperforming loans with the unemployment rate and consumer price inflation.
Gam%era 74BBB8 assesses the impact of state and nationwide macroeconomic varia%les on the (uality
of different types of loans 7agricultural, commercial, industrial and residential8 using @& (uarterly data
for 3>=<T3>>>. !he author reports that the unemployment rate, farm and nonfarm incomes, %anruptcy
filings and car sales, among various explanatory varia%les, were significant predictors of %an asset
(uality.
Filosa 74BB<8, estimating three distinct 0alue at Ris 70$R8 models over the period 3>>BT
4BB: with different indicators of %ansC soundness, finds a somewhat weaer relation %etween
macroeconomic developments and %ansC soundness. ,n the other hand, he finds that
deterioration 7improvement8 in the (uality of loans weaens 7reinforces8 real activity and
inflation.
&tudy %y 'alirai and &cheicher 74BB48 who employed a simple linear regression to examine
the interdependence of credit ris for $ustrian %ans during the period 3>>BT4BB3 concluded
that the loan (uality was influenced in particular %y the short term nominal interest rate,
industrial production, the stoc maret return and a %usiness confidence index .
$rpa et al. 74BB38 assess the effects of macroeconomic developments on ris provisions
7calculated as the ratio of total provisions for loans to the sum of total loans and total
provisions for loans8 of $ustrian %ans for the period 3>>BT3>>> %y the use of a single
e(uation time series model indicating that, ris provisions rise when real gross domestic
product growth declines, real interest rates fall and real estate prices increase.
6
1
&hu 74BB48 used a singlee(uation time series model to examine the impact of macroeconomic
developments on loans (uality in 1on 1ong for the period 3>>:T4BB4. !he results show that
the ratio of %ad loans to performing loans falls with higher real gross domestic product growth,
higher consumer price inflation rate and higher property prices growth, whereas it rises with
increases in nominal interest rates.
*ercoff et al 74BB48 examined the fragility of the $rgentinean *aning system over the 3>>5A
3>>; periodsF they argue that N2+s are affected %y %oth %an specific factors and
macroeconomic factors.
@sing a pseudo panelA%ased model for several &u%A&aharan $frican countries, Fofac 74BB:8
finds evidence that economic growth, real exchange rate appreciation, the real interest rate, net
interest margins, and interA%an loans are significant determinants of N2+s in these countries.
!he author attri%utes the strong association %etween the macroeconomic factors and nonA
performing loans to the undiversified nature of some $frican economies.
"acro and %aning sta%ility are closely lined, so that what happens in one affects the other.
!he evidence for most countries suggests that, except where the %ans are state owned or
heavily state controlled, insta%ility generally starts in the macro economy and spills over into
the %aning sector. !he resulting %aning insta%ility, in turn, feeds %ac and amplifies the
macro insta%ility. !hus, to enhance overall sta%ility in the economy, it is necessary %oth to
pursue successful contra cyclical macroeconomic policy and to reduce the fragility of %aning
relative to the magnitude of macro shocs that may %e expected in the particular economy
7!andon )ommittee, 3>>=8.
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2
Generally looing, the effect of macroeconomic insta%ility on the financial sector and %aning
in particular maes it a cause for nonA performing loans. *ecause financial institutions
%asically deal in forward contacts, whose profita%ility hinges greatly on the a%ility to predict
future prices, they do not do well in volatile environments that increase uncertainty and mae
forecasting more difficult. !o reduce their ris exposure, the %ans collaterali?e their loans
with either the %orrowersC estimated future income and/or the estimated future value of
specified assets. If either the reali?ed income or reali?ed asset prices fall sufficiently short of
the projected values, the %orrower may default and generate losses for the %an 7 "achiraju,8.
!he choice of G#2, unemployment and interest rate as the primary determinants of N2+s may
also %e justified from the theoretical literature of lifeAcycle consumption models. +awrence
73>>:8 examines such a model and introduces explicitly the pro%a%ility of default. !he model
implies that %orrowers with low incomes have higher rates of default. !his is explained %y
their increased ris of facing unemployment and %eing una%le to pay. $dditionally, in
e(uili%rium, %ans charge higher interest rates to risier clients. Rinaldi and &anchisA$rellano
74BB;8 extend +awrenceCs model %y including the possi%ility that agents can also %orrow in
order to invest in real or financial assets.
&umming up, the existing empirical evidence shows, (uite convincingly, that favora%le
macroeconomic conditions, such as sustained economic growth, low unemployment and
interest rates, tend to %e associated with a %etter (uality of %an loansF under favora%le
economic circumstances, %orrowers receive sufficient streams of income and meet their de%t
6
3
o%ligations more easily. Furthermore, these results are ro%ust to different empirical
methodologies and hold across countries.
3.3 Bank S/ecific *actors casing Non/erforming Loans
"acroeconomic factors which are viewed as exogenous forces influencing the %aning
industry should not %e sought exclusively in determining N2+s. In contrast, the typical nature
of the %aning sector along with the specific policy choices of a particular %an with regard to
its efforts to maximi?e efficiency and improve in its ris management are expected to exert a
vital influence on the evolution of N2+s. $ few literatures have examined the connection
%etween %anAspecific factors and N2+s. +iterature on %an specific determinants of
nonperforming loans are reviewed in the section that follows.
3.3.# Ra/i2 Loan %ro=th
&tudies indicate that loan delin(uencies are associated with rapid credit growth. 'eeton 73>>>8
who used data from commercial %ans in the @nited &tates 7from 3>=4 to 3>>;8 and a vector
auto regression model indicate this association %etween loan and rapid credit growth. &iney
and Greenwalt 73>>38 who have also studied large commercial %ans in the @& and found out
that excessive lending explain loan Tloss rate. &alas and &aurina 74BB48 who studied &panish
%ans found out that credit growth is associated with non performing loans. *esides, study %y
*ercoff, Giovanni and Grimard 74BB48 shows that asset growth explains N2+s.
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4
&imilarly Wein%erg 73>>:8 uses data on the growth rate of total loans and loan chargeAoffs in
the @nited &tates from 3>:B to 3>>4 to show a pattern of increases in lending preceding
increases in loan losses .Wein%erg 73>>:8 hypothesi?es that risAneutral lenders increase
lending during periods of economic expansion %ecause the expected returns from investment
projects improve, and therefore, the expected returns from all loan customers rise.
&upplyAside explanations of the expansion of %an loans fre(uently suggest a relaxation of
underwriting standards, whereas loan contractions are said to suggest a tightening of standards.
&o with growth of loan si?e comes poor loan performance ascri%ing to the relaxed
underwriting standard.
3.3.! High )nterest Rate
*ans that charge high interest rate would comparatively face a higher default rate or non
performing loans. &tudy %y &iney and Greenwalt 73>>38 on large commercial *ans in @&
depict that a high interest rate charged %y %ans is associated with loan defaults. Rajan and
#hal 74BB58 who used a panel regression analysis indicates that financial factors lie cost of
credit has got significant impact on N2+s. &tudy %y Waweru and 'alini 74BB>8 on the
commercial %ans in 'enya using statistical analysis indicates that high interest rate charged
%y the %ans is one of the internal factors that leads to incidence nonAperforming loans.
*esides, studies %y *erger and #e.oung, 3>><, for the @&F Iimene? and &aurina, 4BB;, for
&painF 6uagliariello, 4BB<, for ItalyF 2ain, 4BB5, for the @'F and *ier and 1u, 4BB4,7 for 4>
,-)# countries8 %ans profit margin exhi%ited %y high interest rate affects occurrence of
N2+s.
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3.3.3 Lenient Cre2it Terms
)redit sanctioning that has not duly considered the credit terms would potentially lead to
occurrence of poor loan performance. Iimene? and &aurina 74BB:8 in their study conducted on
the &panish %aning sector from 3>=9 to 4BB5 evidence that N2+s are determined %y lenient
credit terms. )ause for the lenience is attri%uted to disaster myopia, herd %ehavior, moral
ha?ard and agency pro%lems that may entice %an managers to tae ris and lend excessively
during %oom periods as per this study. Rajan and #hal 74BB58 who studied the Indian
commercial %ans also found out terms of credit determines occurrence of Nonperforming
loans.
Rajan 73>>98 hypothesi?es that %an managers have shortAterm decision hori?ons %ecause their
reputations are strongly influenced %y pu%lic perceptions of their performance, as evidenced
%y shortAterm earnings. "anagersC reputations suffer if they fail to expand credit when the
economy is expanding and %an earnings are improving. !his herd %ehavior will result in
some loans going to customers with higher default ris than would occur otherwise. Wein%erg
73>>:8 also suggests that %an managers adjust lending standards as maret conditions change,
seeing to smooth overall lending ris.
!he ,ffice of the )omptroller of the )urrency 7,)), 3>==8 concludes that the dominant
reason for %an failure in the early 3>=Bs was poor %an management, which encompasses lax
lending standards. $n F#I) study of the causes of the %aning crises of the 3>=Bs and early
3>>Bs 7F#I), 3>><8 finds that a com%ination of factors T economic, legislative, managerial,
and regulatory T led to the %aning crises.
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6
Importantly, the F#I) study finds that %an managers adjusted lending practices as economic
conditions changed, increasing lending into economic and sectoral %ooms and reducing
lending during economic contractions. In addition, the F#I) study suggests that %an
managers reacted to competition from other %aners and that this competition might have
encouraged a weaer lending standard that leads to loan defaults.
*esides study %y Waweru and 'alini 74BB>8 indicates lac of proper sill amongst loan
officials, speedy process of evaluating loans mainly due to external pressure, are among the
factors that lead to huge concentration non performing loans.
)ommercial %ans and other financial institutions experienced an increase in competition in
the @nited &tates during 3>=B and early 3>>B. !his resulted in a change in lending practices.
#ue to the competition and the pressure to deliver increasing returns, %ans increased the
granting of credit facilities to marginal %orrowers. !hese facilities were aggressively priced to
compensate for the increase in ris. $lthough the strategy delivered shortAterm results, credit
losses followed and in many cases caused %ans to fail 7'och R "ac#onald, 4BB58. !he
failure of %ans can therefore, not only %e lined to unfavora%le economic environments, %ut
also to the nature of the credit policies they employ.
3.3.7 Cre2it Orientation
Financial sector development goes hand in hand with orientation of the pu%lic. &tudy
conducted %y Rajan and #hal 74BB58 indicate that credit orientation significantly affects loan
default rate as per their panel regression analysis conducted on commercial %ans on India.
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7
3.3.8 Bank Si@e
&tudy %y )ole et al. 74BB98 used data o%tained from the 3>>5 Federal Reserve National &urvey
of &mall *usiness Finance and %an financial reports, suggest that smaller %ans adopt small
%usiness loan underwriting practices that are risier than those of larger %ans, risier in that
small %ans prefer to lend to small firms that lac hard financial data to support the lending
decision and risier to the extent that the failure rates of small %usinesses are higher than those
of larger, esta%lished firms.
In their study of commercial %ans in India, %y use of panel regression analysis Rajan and
#hal 74BB58 indicates that , %ans si?e have significance on occurrence of N2+s . &alas and
&aurina 74BB48 indicated that %an si?e, is among the factors that explained variations in N2+s
for &panish %ans. &tudies %y *erger and #e.oung, 3>><, for the @&F Iimene? and &aurina,
4BB;, for &painF 6uagliariello, 4BB<, for ItalyF 2ain, 4BB5, for the @'F and *ier and 1u,
4BB4, for 4> ,-)# countries8 also shows that *an si?e is significantly related rate of
occurrence of loan default.
3.3.9 Cost Efficiency
1ughes et al. 73>>:8 lin ris taing to %ansC operating efficiency. !he argument is that risA
averse managers are willing to trade off reduced earnings for reduced ris, especially when
their wealth depends on the performance of the %an. In order to improve loan (uality, they
will increase monitoring and incur higher costs, affecting the measure of operating efficiency.
!herefore, a less efficient %an may in fact hold a low ris portfolio. *ercoff, Giovanni and
Grimard 74BB48 also showed that operating efficiency helped explain N2+s.
6
8
3.3.: O=nershi/ strctre
1u et al 74BB;8 analy?ed the relationship %etween N2+s and ownership structure of
commercial %ans in !aiwan with a panel dataset covering the period 3>>;A3>>>. !he study
shows that %ans with higher government ownership recorded lower nonAperforming loans.
Walter and Werlang 73>>:8 found that stateAowned financial institutions underperform the
maret, %ecause their portfolios concentrate on the nonAperforming loans inde%ted %y the state.
Iang and )hou 73>>=8 adopt the ratio of nonAperforming loans to total loan as the measure of
ris %y using 3>=;A3>>9 data of 35 !aiwanese %ans for empirical study. !he average risA
adjusted cost efficiency of the four provincial governmentAowned %ans was the lowest among
the sample %ans.
3.3.; Poor Loan *o((o=>/ 5&onitoring6
regulatory authorities of potential %an stress, is essential to ensure a sound financial system
and prevent systemic crises. 7$gresti et al.,4BB=8.
!he need to give due attention to %orrower thus need not %e overemphasi?ed in order to ensure
loan performance. !here is a tendency %y %orrowers to give %etter attention to their loans when
they perceive they got %etter attention .&ome of the loans defaults ascri%e to lower level of
attention given to %orrowers. It is advised that %ans eep up with their loans timely 7"ayers,
undated8.
6
9
*ans rarely lose money solely %ecause the initial decision to lend was wrong. -ven where
there are greater riss that the %ans recogni?e, they only cause a loss after giving a warning
sign 7"achiraju8. "ore %ans lose money %ecause they do not monitor their %orrowerCs
property, and fail to recogni?e warning signs early enough. When %ans fail to give due
attention to the %orrowers and what they are doing with the money, then they will fail to see
the ris of loss. !he o%jective of supervising a loan is to verify whether the %asis on which the
lending decision was taen continues to hold good and to ascertain the loan funds are %eing
properly utili?ed for the purpose they were granted.
In order to meet these o%jectives %ans need to see whether the character of the %orrower, its
capacity to repay the loan, capital contri%ution, prevailing maret conditions and the value of
the collateral that was taen during loan approval time continues to remain the same 7George
G, 4BB98.
$s has %een mention under section 5.3.9 a %an can use different ways to monitor the
%orrower. Follow up the financial sta%ility of a %orrower can %e done %y periodically
scrutini?ing the operations of the accounts, examining the stoc statements and ascertaining
the value of security. 0isiting the %orrower periodically to have understanding of the progress
of the %orrowerCs %usiness activity and there%y give advice as necessary is also among the
methods *ans adopt to follow up their loans.
It is clear that effective credit monitoring involves looing into various operations of the
company including operations of the loan, checing whether the company is properly
managed, and the environment in which the company is carrying out its %usiness is
satisfactory.
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0
)onstant monitoring increases the chance that the company will respond to a %anCs concern
and provide information more willingly. $ %an which always closely follows a companyCs
standing can often point out danger or opportunities to the company, as well as (uic
agreement to re(uest for credit. It thus esta%lishes that monitoring is %asically constructive,
and not a panic reaction and carries more weight when it expresses concern 7#onaldson,
undated8
$ %an should have clearly defined continuous procedures for identifying potential %ad and
dou%tful loans. !hese procedures should include regular independent reviews of the loan
portfolio. Within this system, there should %e formal procedures for the continuous review of
all large loans and all areas of lending concentration. !hese reviews should place particular
emphasis upon the %orrowerCs continuing a%ility to service the loan. Failure to do these
continuous reviews and monitoring will lead to loss to %ans or increases the ris of such
losses.
From the regulatory point of view, 'enyan %ans are re(uired to mae continuous review of
their loan and su%mit reports to the central %an. !his function of %ans has a legal as well as
contractual %ase. *ut the detail as to the fre(uency of visiting the %orrowerCs premises,
verifying the use of the loan and other related circumstances is left to the discretion of
individual %ans. !he legal %ase for %ans to do the review is provided under $rticle : of
#irective No.&**/95/4BB=.
7
1
3.3.? Poor Risk Assessment
Ris, and the ways, in which it can %e identified, (uantified and minimi?ed, is ey concerns for
a %anCs management and its auditors when they are considering the need to provide for %ad
and dou%tful loans. No loan is entirely without ris. -very loan, no matter how well it is
secured, and no matter who is the %orrower, has the potential to generate loss for the lender. It
is the degree of ris to which a loan is suscepti%le and the pro%a%ility of loss that varyF these
should normally %e reflected in the interest margin and other terms set at the inception of the
loan 7*rown, 3>>58.
$ %an, in considering whether to lend or not, taes into account the (uality of a %orrower
which is reflected in, inter alia, its past and projected profit performance, the strength of its
%alance sheet 7for example, capital and li(uidity8 the nature of and maret for its product,
economic and political conditions in the country in which it is %ased, the (uality and sta%ility
of its management and its general reputation and standing. It is important for the %an to now
the purpose of the loan, to assess its validity and to determine how the funds re(uired for the
payment of interest and the repayment of capital will %e regenerated.
!he %orrowerCs a%ility to repay a loan is of paramount importance. Ideally, the loan will %e
selfA financing in that it will %e repaid from the cash flow that the %orrower is a%le to generate
from employing the proceeds of the loan. $ %an will often re(uire security for a loan in the
form, say, of a guarantee or mortgage, in which case it will %e concerned a%out the value and
title of that security. !he decision to grant loan, however, should %e %ased on the prospects and
solvency of the %orrower and a careful analysis of how the funds to repay the loan will %e
generated.
7
2
In general, %ans lac effective measures to identify, (uantify and control the regional and
industrial ris, constrained %y o%taining historical data, decentrali?ed information systems and
immature portfolio management sills. &o they have to mae judgment mainly %ased on
personal experience and conse(uently have wea management measures on concentrated and
systemic ris 7Ning, 4BB<8.
*asically, the nonA performing loans are a result of the compromise of the o%jectivity of credit
appraisal and assessment. !he pro%lem is aggravated %y the weaness in the accounting,
disclosure and grant of additional loans. In the assessment of the status of current loans, the
%orrowerCs credit worthiness and the maret value of collateral are not taen into account
there%y rendering it difficult to spot %ad loans 72atersson, 4BB98. )ompromise in (uality of
ris assessment thus leads to occurrence of nonperforming loans.
3.3.#" Lack of Strict A2mittance ECit Po(icies
@nder the influence of idea of pursuing maret share excessively, %ans do not esta%lish
detailed and strict maret admittance policies, which undermine the first ris to prevent gate
and weaen the orientation effect of admittance policies to maret 7 &hofi(ul Islam,4BB:8.
#uring preAloan investigation, %an officers put little emphasis on authenticity and integrality
review on related materials. !hey donCt clarify the true intended usage of the loan 7especially
when extending shortAtermed credit8 and the review is too optimistic, which does not analy?e
the potential influence of changes in related factors. !here is also no deep review on the
maret, no enough understanding on enterprisesC operation management situation, no thorough
ris revaluationF inaccurate assessment, the ris of loans is not fully covered and
7
3
the ris on group customers and affiliated enterprises are not identified effectively. !he factors
a%ove damage the loans at the early stage 7*rown%rige, 3>>=8.
Furthermore, some %ans neglect the fact that the loan procedures are not completed or
detailed and the review materials are not enoughF some operate in different procedures than the
review materials, for instance, signing loan contract %efore approval of the loan, issuing letter
of credit or %an acceptance %efore approvalF consolidated credit is not fully reali?ed, and
credit to some group mem%ers is not included in the consolidated credit management. &ome
extend credit against the rules, i.e. exceeding authority to offer loans, splitting one %ig num%er
into several small pieces to avoid the authority constraint, issuing %an acceptance to fund
enterprises on a rolling %asis, or discount without actual trade %acground.
"ost pro%lems in this case relates with accepting guaranty from un(ualified institutions, high
loanAtoAvalue ratio, providing loans without property registration and transfer of collateral,
guaranty for each other %etween enterprises and legally flawed credit procedures etc. $nd there
are also pro%lems in which that the conditions of the loans are not satisfied and the contracts of
loans are not completed.
!hough the primary role lies on %ans to evaluate their admittance and exit policies, they are
su%jected to the general laws of a country on %aning %usiness. In the 'enyan *aning context
%ans are also re(uired to su%mit reports to N*- on their loan dis%ursement as well as their
outstanding and collected loans showing whether their lending procedure is according to the
regulatory guidelines and laws.
7
4
!hus failure to include strict admittance and exit policies and there%y provisions for
accounta%ility in the credit manual of %ans would create a loop hole that would eventually
lead to occurrence of loan default.
!he heart of any successful commercial lending function is credit discipline written in loan
policy, structured loan approval process and strong loan administration function 7*arricman,
3>>B8.
$s discussed a%ove, efficient %ans and financial marets promote macro development. !his
development leads to growth in overall economy and most countries wor towards ensuring
that development. $ccordingly, ensuring sound financial system and creating efficient %ans
%y reducing nonA performing loans %ecomes important. @sually giving solutions to nonA
performing loans arises from identifying the pro%a%le causes for its creation.
regulatory authorities of potential %an stress, is thus essential to ensure a sound financial
system and prevent systemic crises. In this regard, the analytical tools currently under scrutiny
in the context of macroprudential regulation do in fact assign great emphasis to indicators of
asset (uality 7$gresti et al. 74BB=8.
*efore preceding to issues pertaining to research methodology in the next chapter, the
paragraph that follows touch upon earlier studies made in 'enya on the su%ject of N2+.
#espite the fact that several studies were conducted %y different researchers on the 'enyan
*aning sector, empirical studies on determinant of nonperforming loans could hardly %e
7
5
traced with exception of Pewudu 74B3B8 who has indicated the relations %etween %ans health
7N2+8 and lending. Pewudu also indicated in the study that N2+ is also among the factors that
are used as performance measurement of the sector in 'enya. 1owever, the study was focused
on performance measurement of %ans that it laced empirical evidence as to what caused
occurrences of N2+. ,n the other hand !ihitina 74BB>8 who studied legal pro%lems in reali?ing
nonperforming loans of 'enyan *ans also highlighted major pro%lems in reali?ing non
performing loans in 'enyan %ans and solutions thereof. !ihitanCs study also concentrated on
resolving N2+ and as such issues of factors that %ecause it was not su%ject of the research
though theoretical review of some of the factors causing N2+ were discussed.
3.7 Conc(sions an2 i2entification of kno=(e2ge ga/
!his chapter reviewed literatures relevant to determinants of nonperforming loans and
previous research in 'enya.
$mple researches were conducted on determinants of nonperforming loans of *ans. !hese
studies that showed that macroeconomic and %an specific factors determined occurrence of
nonperforming loans. !he empirical evidence shows, (uite convincingly, that favora%le
macroeconomic conditions, such as sustained economic growth, low unemployment and
interest rates, tend to %e associated with a %etter (uality of %an loans.
!he studies in general depicted the association %etween G#2, inflation, effective interest rate,
unemployment and loan (ualities. Further %an specific factors lie, %an si?e, credit terms,
interest margin, rapid loan growth, credit orientation, operating efficiency, policies on
7
6
%orrower admittance, ris assessment and monitoring are found to %e having significance on
the occurrence of N2+.
"ost of the literature reviewed covered studies %oth in developed and developing countriesC
%aning sector. 1owever, there were only limited literatures availa%le for this research on
$frican %ans, with the exception of one study on &u% &ahara $frica and another on 'enyan
commercial %ans.
2revious study in 'enya directly related to this research i.e. %an specific determinants of
nonperforming loan, to the nowledge of the researcher, is not found though there are other
researches done on %aning sector in 'enya. !herefore, this researcher will contri%ute towards
filling the gap %y examining the factors that affect occurrence of nonperforming loans.
!he next chapter presents the research methodology used to meet the o%jective of this research
project.
7
7
CHAPTER *OAR
RESEARCH &ETHODOLO%+
)hapter three has presented the review of the existing literature on the determinants of
nonperforming loans and identified the nowledge gap. !his chapter discusses the research
design. !he chapter is organi?ed in four sections. !he first su%section 9.3 presents the research
pro%lem along with the %road research o%jective and research (uestions. &u%section 9.4
discusses the research approaches while su%section 9.5 presents the methods planned to %e
used in the study.
7.#. Research /ro'(emD 'roa2 o'0ecti1eD research Bestions
*ans provide financial intermediation services through their lending. +ending is considered
the most important function for %ans fund utili?ation as major portion of their income is
earned from loans and advances. ,n the other hand it is also one of the risy areas of the
industry. In fact of all the riss *ans face, credit ris is considered as the most lethal as %ad
de%ts would impair %ans profit.
)redit ris arises from uncertainty in a given counterpartyCs a%ility to meet its o%ligations. If
these uncertainties materiali?e they would lead to deterioration of loan (ualities. Impaired or
NonAperforming loans proportion is one of the factors that depict soundness of the %aning
sector. !hus identifying the determinants of nonperforming loans is very vital to minimi?e loan
default. NonAperforming loans proportion is one of the determinant factors that depict
soundness of the %aning sector. !hus, the %road o%jective of this study was to identify and
investigate the determinants of nonperforming loans in the context of *ans in 'enya.
78
In the context of the a%ove %road o%jective the following specific research (uestions 7R68
have %een developedJ
7.! Research A//roaches
$ccording to 'ot?ar et al., 74BB:8, research design is defined as the plan and structure of
investigation and the way in which studies are put together. )ooper et al. 74BB58 also define
research design as the process of focusing on the researcherCs perspective for the purpose of a
particular study. +eedy and ,rmrod 74BB:8 define a research methodology as a means to
extract the meaning of data.
!here are three types of research approaches namely, (uantitative, (ualitative and mixed
methods research approach 7+eedy and ,rmrod, 4BB:8.!he following discussions %riefly
present the %asic features of these research approaches.
7
9
7.!.# 4antitati1e research a//roach
!his approach is used to answer (uestion a%out relationships among measured varia%les with
the purpose of explaining, predicting and controlling phenomenon. 6uantitative research
approach has two strategies of in(uiry. !he first is survey design which provides a (uantitative
or numeric description of trends, attitude or opinion of a population %y studying a sample of
that population. From the sample the researcher generali?es a%out the population. !he second
type of design is experimental design used to test the effect of intervention on an outcome,
controlling all other factors which may influence that outcome. In experiment design
researcher may also identify a sample and generali?e to a population 7)reswell, 4BB>8.!he
analysis is made %ased on deductive reasoning, %eginning with certain theory or hypotheses
and drawing logical conclusions from it.
!his approach has advantage of stating the research pro%lem in very specific and set terms
7FranfortANachmias R Nachmias, 3>>48F eliminating or minimi?ing su%jectivity of judgment
7'ealey R 2rotheroe, 3>>;8F following firmly the original set of research goals, arriving at
more o%jective conclusions, testing hypothesis, determining the issues of causalityF achieving
high levels of relia%ility of gathered data due to controlled o%servations, la%oratory
experiments, mass surveys, or other form of research manipulations 7*alsley, 3><B8 and
allowing for longitudinal measures of su%se(uent performance of research su%jects among
others.
#espite this, the (uantitative approach has the following shortcomingsJ failure to provide the
researcher with information on the context of the situation where the studied phenomenon
occursF limited outcomes to only those outlined in the original research proposal due to
8
0
closed type (uestions and the structured formatF ina%ility to control the environment where the
respondents provide the answers to the (uestions in the surveyF to mention a few.
7.!.! 4a(itati1e research a//roach
$ccording to +eedy and ,rmrod 74BB:8 this approach is used to answer (uestions a%out the
complex nature of phenomena and its purpose is descri%ing and understanding the phenomena.
@nlie (uantitative research, (ualitative research consists of a %ody of research techni(ues that
do not attempt to measure, %ut rather see insight through a less structured and more flexi%le
approach 7Gray, 4BB98. -xploratory research is conducted when there are few or no earlier
studies, which can %e referred to. In exploratory research the focus is on gaining insight into
the su%ject and to %ecome familiar with the su%ject area for more rigorous investigation later
7)ooper R &chindler, 4BB58. -xploratory research can %e conducted %y using multiple
methods to achieve triangulation and can consist of a com%ination of the following 7&aunders,
+ewis R !hornhill, 4BBBF Gray 4BB98J $ literature search, taling to experts in the field,
interviews, )ase studies, surveys.
!he (ualitative research process is more holistic with specific focus on designF measuring
instruments and interpretation developing possi%ly change along the way. !he approach
operates under assumption that reality is not easily divided into discrete and measura%le
varia%les.
8
1
6ualitative research approach has five common strategies of in(uiry. !he strategies include
case study, ethnography, phenomenological study, grounded theory and content analysis
7 +eedy and ,rmrod,4BB: 8 .!he approach maes considera%le use of inductive reasoning.
@nder this approach, many specific o%servations will %e made to draw inferences a%out larger
and general phenomenon while personal and literary style language will %e used when
reporting the findings.
!he (ualitative method has twofold advantagesJ First, it focuses on phenomena that occur in
natural settings in that it involves studying those phenomena in the context of complex socioA
economic settings. &econd, (ualitative research is often used to generate possi%le leads and
ideas which can %e used to formulate a realistic and testa%le hypothesis, to gain deep insights
a%out the phenomenon. $ny hypothesis can then %e comprehensively tested and
mathematically analy?ed with standard (uantitative research methods. !he major weaness of
this approach is that findings may %e so specific to particular context that they cannot %e
generali?ed to other context.
7.!.3 &iCe2 research a//roach
!he mixed methods research approach is used when the researcher com%ines elements of %oth
(uantitative and (ualitative approaches. 6uantitative and (ualitative research approach
7mixed8 is appropriate for answering different inds of (uestions. When mixed approach
method is in use there is a tendency to learn more a%out the research pro%lem. Researchers are
given permission to use all of the tools of data collection availa%le rather than %eing restricted
to the types of data collection typically associated with (ualitative research or (uantitative
research
82
$ccording to )reswell, I. W. 74BB58 mixed methods research provides strengths that offset the
weanesses of %oth (uantitative and (ualitative research. !his has %een the historical argument
for mixed methods research for the last 4: years 7Iic, 3><>8. !he argument goes that
(uantitative research is wea in understanding the context or setting in which people tal.
$lso, the voices of participants are not directly heard in (uantitative research. Further,
(uantitative researchers are in the %acground, and their own personal %iases and
interpretations are seldom discussed. 6ualitative research maes up for these weanesses. ,n
the other hand, (ualitative research is seen as deficient %ecause of the personal interpretations
made %y the researcher, the ensuing %ias created %y this, and the difficulty in generali?ing
findings to a large group %ecause of the limited num%er of participants studied.
"ixed methods research encourages the use of multiple worldviews or paradigms rather than
the typical association of certain paradigms for (uantitative researchers and others for
(ualitative researchers. It also encourages us to thin a%out a paradigm that might encompass
all of (uantitative and (ualitative research, such as pragmatism, or using multiple paradigms in
research
#espite its value, conducting mixed methods research is not easy. It taes time and resources
to collect and analy?e %oth (uantitative and (ualitative data. It complicates the procedures of
research and re(uires clear presentation if the reader is going to %e a%le to sort out the different
procedures.
)onsidering the research pro%lem and o%jective shown in the first su%section and fill the gap
that might occur due to usage of only one of the captioned approach, mixed research
8
3
approach is appropriate for this study. !he following section presents the method to %e adopted
in the study.
7.3 Research &etho2 A2o/te2
!he purpose of this study is to identify and examine factors that determine the occurrence of
loan default. $s can %e seen from the research pro%lem it is more of explanatory type and tries
to assess the relationship %etween occurrence of N2+ and some %an specific factors. In order
to %enefit from the advantage of (uantitative and (ualitative approaches, the mixed method
will %e in use for this study. !he su%se(uent discussions hence present the (uantitative and
(ualitative aspects of this proposed study.
7.3.# 4antitati1e as/ect of the st2y
!he purpose of the (uantitative aspect of this proposed study is to see information that can %e
generali?ed a%out the relationship %etween N2+s and %an specific factors. !he study will use
survey design with a structured self administered (uestionnaire and structured record reviews.
!o gather data which will %e used in the study, self administered (uestionnaires will %e
distri%uted to research participants and for structured record reviews 7documentary analysis8
financial information will %e collected from N*-, annual reports of the %ans and other
relevant sources. !he following discussions present the survey design 7%oth survey of %anersC
opinion and documentary studies8 as planned to %e used in this proposed study.
8
4
Survey design
&urvey design is concerned with the issue of sample and instrument design, and also actual
conduct of the survey. +eedy and ,rmond 7 4BB: p.3=58 state that survey research involves
ac(uiring information a%out one or more group of people perhaps a%out their characteristics,
opinions, attitudes, or previous experiencesA%y asing them (uestions and ta%ulating their
answers. !he ultimate goal is to learn a%out a large population %y surveying a sample of that
population.
)reswell 74BB>8 also states that the purpose of survey research is to generali?e from the sample
to the population in order to %e a%le to mae inferences a%out some characteristic, attitude or
%ehavior of the population.
$ccording to "itchell and Iolley 74BB<8 a survey design is relatively inexpensive way of
getting information a%out peoplesC attitude, %eliefs and %ehaviorF with a survey one can collect
a lot of information on a large sample in a short time.
$ccording to +eedy and ,rmord 74BB:8 survey research is a common method used in %usiness
research. &urvey design is selected for this research %ecause of %udget and time constraint i.e.
economy of the design.
&urvey design is concerned with the issue of sample and instrument design, and also actual
conduct of the survey. !he su%se(uent discussions present these aspects of the survey design in
respect of the proposed study and the data analysis methods.
8
5
Saple design
&ample design deals with the sample frame/ population, sample si?e, sampling techni(ues.
2aragraphs that follow discuss issues pertaining to sample frame, sample si?e and sampling
techni(ues respectively.
$ccording to #iamantopoulos 74BB98, a population is a group of items that a sample will %e
drawn from. $ sample, on the other hand, refers to a set of individuals/companies/ selected
from an identified population with the intent of generali?ing the findings to the entire
population. $ sample is drawn as a result of constraints that mae it difficult to cover the entire
research population 7+eedy and ,rmord, 4BB:8.
For this research the target population was all %ans registered %y the National *an of 'enya
7N*-8 and under operation %efore the fiscal year 4BB</4BB=. !he cut off year was set due to
the importance of experience in the industry to understand factors that would cause occurrence
of loan default. In line with this eleven %ans fall in the sample frame.
Further, %ecause of time and %udget constraint to survey all the aforementioned %ans, a
representative sample was selected randomly from among the %ans. &election of sample was
%ased on stratification of %ans according to their si?e, measured in terms of their total asset as
at &eptem%er 5B, 4B33. $ccordingly, six %ans constituted the sample to %e selected.
For this study %ans were stratified in to three levelsJ )omparatively %ig in the 'enyan
%aning industry 7with total assets amounts more than 3B %illion %irr8, medium 7:A3B %illion
%irr8 and small 7%elow : %illion %irr8. !o mae proportional representation two third of %ans
from each stratum was selected randomly %ased on their alpha%etical order of names of
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6
respective %ans. $ccordingly, $wash International *an and )ommercial *an of 'enya
from the %ig category, *an of $%yssinia, #evelopment *an of 'enya and Ni% International
%ans from the medium, and )onstruction and *usiness *an and )ooperative *an of
,romia from the low category were selected 7&ee !a%le 9.38.
Ta'(e 7.# Kenyans Banks that ha1e starte2 o/eration 'efore the year !"":,;
Tota( AssetE
Staff Sam/(e
+ear of
Category in engage2 in
Bank terms of cre2it 579F of staff
Esta'(ishment 5Se/tem'er
tota( Asset re(ate2 engage2 in cre2it
3"D!"##6
acti1ities re(ate2 acti1ities 6
$wash *an 3>>9 33,:BB *ig 9B
3>
)ommercial *an of 3>;5 339,BBB *ig 33B
'enya :3
#ashen *an 3>>: 3<,5B4 *ig A
*an of $%yssinia 3>>; <,<BB "edium 9B
*an 3>
#evelopment *an of 3>
Ni% *an 3>>> <,4<> "edium 9B 3>
@nited *an 3>>= =,5BB "edium A
Wegagen *an 3>>< =,343 "edium A
)onstruction and 3><: 9,3BB &mall 5B
*usiness *an 39
)ooperative *an of 4BB: 4,=;< &mall 4B
,romia >
+ion *an 4BB; 4,;B: &mall A
!otal sample 3:B
V"illion 'enyan *irr 7-!*8
&ourceJ &urveyed %ans
87
"oreover, due to the fact that %an lending process is practiced %y few employees, not all
%an employees and officials, the sample frame was confined to those involved in credit
analysis and appraisalF credit monitoring, ris management and credit sanctioning team
mem%ers of the selected %ans.
$lthough it is difficult to generali?e from project to project %ecause of resource availa%ility in
terms of time, money and personnel availa%ility, as the rule of thum% the sample should %e
large enough so that there are 3BB or more units in each category of major %readown and a
minimum of 4BA:B in minor %readown 7#iamantopoulost and &chlegelmich, 4BBB8.
$ccording to Fowler 73>>58 the appropriateness of any sample design feature can %e evaluated
only in the context of the overall survey o%jectives. !he important point for the researcher is to
%e aware of the potential costs and %enefits of the options and weigh them in terms of the main
purpose of the study.
For this research the sample si?e was 3:B which were a%out 9;O of the total population of
staff involved in credit related activities in the selected %ans. Forty six percent of staffs
engaged in credit related activities were randomly selected from each %an included in the
study for the (uestionnaire survey.
!nstruent design and data collection ethod
!he survey was conducted using a structured (uestionnaire and structured record reviews of
selected %ans. !he (uestionnaire was prepared in -nglish language and it was classified into
three sections. !he first part of the (uestions 3A: were designed to collect participantsC profile
7%acground information8. !he second part, (uestions ;A59 in the (uestionnaire were related
8
8
to factors that determine loan default or occurrence of nonperforming loans. 6uestion ; was
designed in such a way that respondents rate factors that determine non performing loans in
order of their importance when compared with other factors in the list. 6uestions <A55 show a
rating 7a fiveA point scale8 in each factor that determine occurrence on N2+. $ rating 3
indicates a strong agreement, 4 agreement, 5 neutral 7donCt tae position8, 9 disagreement and
: strong disagreement. !he self administered (uestionnaire was delivered to the selected
experts engaged in loan related activities. In order to provide feed%ac, clarification and ensure
response a follow up calls were carried out.
In addition, the study used documentary review. &pecifically, the financial statements of %ans
surveyed along with their annual report and central %anCs report were used. In this regard
financial data of the %ans from the year 4BB: to 4B3B was in use. &pecial emphasis was given
to data sources that provided the total assets, total loans and advances, deposits and respective
non performing loan ratio of the %ans surveyed.
!he purpose was to review whether there is a relationship %etween %an si?e 7measured in
total asset, deposit and loans and advances8 and N2+ ratio. *esides, %ans data was reviewed
if %ans ownership type 7private/state owned8 has got a %earing on loan default expressed in
N2+ ratio.
!he documentary review is %elieved to augment findings in the (uestionnaire survey and the
deep interview to %e carried out.
8
9
"ata analysis ethod
!he data collected from survey (uestionnaire were carefully coded and checed for
consistency and entered into the &2&& spreadsheet. !he analysis was performed with &2&&
ver. 3;. #escriptive statistics was employed to analy?e data and the results were tested with
nonAparametric tests of significance. *esides, measures of central tendency 7mean, standard
deviation8 were used to analy?e the (uestionnaire survey result.
!o conduct documentary analysis &2&& ver. 3; was in use to run the 2earson correlation
%etween the independent factors and dependent factor. "easures of central tendency 7mean
and standard deviation8 were also used to analy?e the varia%les.
7.3.! 4a(itati1e as/ect of the research
!o augment the gap that might not %e captured %y the (uantitative survey and to o%tain deeper
understanding of the %an specific factors that would determine occurrence of nonperforming
loans, unstructured interviews were conducted with senior %an officials in the industry.
$ccording to Gray 74BB98, interviewing is an ideal method to o%tain data relating to peopleCs
views, nowledge and attitudes.
$ccordingly, six experienced %aners who were assumed to have a deeper understanding of
credit dynamics in the 'enyan financial industry were interviewed. !hese were from %ans
that were covered and uncovered %y survey and experts from the N*-. !he researcher
followed same interview protocol.
9
0
$ccording to &traus and )or%in 73>>=8, some researchers %elieve that (ualitative data should
not %e analy?ed and that it should merely %e presented. $s the information o%tained were
(ualitative in nature and a detailed analysis was not made rather the (ualitative data were
organi?ed thematically and content analysis was carried out.
7.3.! -a(i2ityD re(ia'i(ity an2 ethica( isses
0alidity and relia%ility of the research measurement instruments influence, first the extent that
one can learn from the phenomena of the study. &econd the pro%a%ility that one will o%tain
statistical significance in data analysis and third the extent to which one can %ring meaningful
conclusion from the collected data. "ost ethical issues in research fall into one of the four
categoriesJ protection from harm, informal consent, right to privacy and honesty with
professional colleagues 7+eedy and ,rmrod, 4BB:8.
7.3.!.# -a(i2ity
$ccording to +eedy et al 74BB:8, validity is the a%ility of an instrument used to measure what it
is designed to measure. !hey further explained two %asic (uestionsJ does the study have
sufficient control to ensure that the conclusions the researcher draw are truly warranted %y the
data and can the researcher use what he/she has o%served in the research situation to mae
generali?ation to the population %eyond that specific situationQ !he answers to these two
(uestions address the issues of the content validity, internal validity and external validity.
9
1
Content validity
In order to chec content validity for the descriptive survey studies, +eedy et al., 74BB:8
suggests three tacticsJ using multiple sources of evidence, esta%lishing chain evidence and
having ey informants reviewing draft of the study report. !o ensure content validity the target
groups included in sample represented were those who now %etter a%out the issue %eing
investigated.
!nternal validity
!he internal validity of a research study is the extent to which its design and the data it yields
allow the researcher to draw accurate conclusions a%out the relationships within the data. In
this case, itCs less liely that there will %e a 1awthorne effect since the respondents have
professional %acground and nowledge a%out %an lending and credit management and those
who were involved in the interview were not expected to change their %ehavior during
interview. !hey were also ased to give their consent and they were given all the right not to
answer any (uestions if they did not wish to.
#$ternal validity
-xternal validity is related to the extent to which the findings from one research can %e applied
to other similar situations. In other words, how the conclusions drawn can %e generali?ed to
other contexts 7+eedy et al., 4BB:8. $ccording to +eedy et al, these three strategies areJ a real
life setting, a representative sample and replication in different settings +eedy et al 74BB:8.
!o ensure face validity the researcher performed multi method approach i.e. two or more
different characteristics measured using two or more different approaches.
9
2
7.3.!.! Re(ia'i(ity
$ccording to +eedy and ,rmrod 74BB:8 relia%ility of a measurement instrument is the extent
to which it yields consistent results when the characteristic %eing measured has not %een
changed. Furthermore, )ameron et al., 74BB<8 states that in order to increase relia%ility, the
researcher should use the same template as far as possi%le and use static methods. !o ensure
the relia%ility of measurement instrument the researcher performed first standardi?e the
instrument from one person or situation to another.
*esides, the researcher also %elieves that this study is relia%le since the respondents were
selected %ased on their past experience on credit management and their answers were expected
to %e credi%le. Given the credi%ility of selected respondents, the same answers would pro%a%ly
%e given to another independent researcher. Furthermore, am%iguous terms were not used in
interviews to avoid confusion.
7.3.!.3 Ethica( )sses
#ue consideration was given to o%tain consent from each participant a%out their participation
in the study. It was strictly conducted on voluntary %asis. !he researcher tried to respect
participantsC right and privacy. !he findings of the research were presented without any
deviation from the outcome of the research. In addition, the researcher gave full
acnowledgements to all the reference materials used in the study.
In general, to help address all the research (uestions with the methods discussed so far,
attempts to show the linage %etween research (uestions and the different data sources were
made. !he lin %etween research (uestions and different data sources is presented in ta%le
9
3
9.4. &elfAadministered (uestionnaires, structured review of financial information collected
from each %an and deep interviews were used to address the research (uestions.
Ta'(e 7.! Link 'et=een R4s an2 2ata sorces
Research 4estion Data Sorce
Relationship %/n credit admittance policy, loan
underwriting and ris assessment and N2+ 5R4#8
Survey % &-'(
Relationship %etween N2+ and credit
monitoring 5R4 !6 Survey % ''-')
Relationship %etween collateral and non performing
loans 7R438 Survey % '*-'&
-ffects of credit culture on loan default 5R476 Survey % '+-,'
-ffects of credit terms and price on loan default
5R488
Survey % ,,-,&
Survey % ,+--'. "ata fro
Relations %etween rapid credit growth and great ris /an0s financial stateent and
appetite and N2+ 7R498 interviews
Survey % -,--*. "ata fro
/an0s financial stateent and
Relation %etween %an ownership and si?e 7R4:8 interviews
*an specif factors affecting N2+ 5R4;6 Survey % -1. !nterview
Smmary
!his chapter has presented the research design %eginning %y discussing the research pro%lems
along with the research (uestions. #iscussion of the three research approach was also made
with a special emphasis on the approach to %e employed for this study. !he types of
instruments used to collect data and analysis method conducted thereof was also discussed.
Issues pertaining to validity, relia%ility and ethical matter were also presented. !he next
chapter presents the research result.
94
CHAPTER *)-E
RESALTS
!he previous chapters presented orientation of the study, theoretical foundations, literature
review and the research methods adopted in the study. !his chapter presents the results. $s
discussed in the preceding chapter this study is aimed at exploring %an specific determinants
of nonperforming loans. !his chapter tries to present the results of the different sources of data.
!he chapter is organi?ed into three sections. !he first section :.3 discusses survey results and
the second section, :.4 presents documentary analysis. &ection :.5 is devoted for presentation
of the interview results. !he last section :.9 summari?es the results.
8.# Sr1ey res(ts
!he (uestionnaire was distri%uted to credit related professionals 7including relationship
managers, credit analysts, recovery officers, credit managers, loan officers, credit committee
mem%ers, and ris officers8 in seven %ans selected randomly from all %ans that are
operational in 'enya and registered %efore the fiscal year 4BB</B=.
!he (uestionnaire was physically distri%uted to 3:B employees 7whose positions are related to
%an lending8. ,ut of 3:B (uestionnaires 35< were completed and collected. $s the result the
response rate was >3.5 percent. In light of the poor response culture in 'enya this is
impressive. $ccording to Fowler 73>=;8 researcher or survey organi?ation differ considera%ly
in the extent to which they devote time and money to improve response rate. !hus, there is no
agreedAupon standard for a minimum accepta%le response rate.
>
:
Ta'(e 8.# Sr1ey res/onse rate
&ample si?e 3:B
)ompleted and returned (uestionnaires 35<
Response rate >3.5O
Source= Survey outcome and own computation
!he sections that follow present profile of respondentsC lie ownership of the %ans they wor
for, their %aning experience, exposure in %an lending and the positions they hold in the
%aning industry.
8.#.# Res/on2entsG /rofi(e
In respect of employment, 95.= percent of survey respondents were employed in private %ans.
!he rest :;.4 percent were employed in state owned %ans 7!a%le :.48.
Ta'(e 8.! Em/(oyment of res/on2ents
Em/(oyment *reBency Percent
2rivate %ans ;B 95.=
&tate owned %ans << :;.4
!otal 35< 3BB
&ourceJ &urvey outcome and own computation
+ooing at the positions of survey respondents revealed that 53.= percent were %an
customer relationship managers while 3<.= percent were recovery/monitoring officers and
34.9 percent were credit directors. *esides, a%out 5.> percent of the respondents were %an
vice presidents 7!a%le :.58.
9
6
Ta'(e 8.3 Position of the res/on2ents in 'ank
Position *reBency Percent
+oan ,fficer : 5.>
Relationship manager 93 53.=
)redit analyst < :.9
Recovery/ monitoring officer 45 3<.=
)redit #irector 3; 34.9
0ice president : 5.>
,thersV 54 49.=
V,thers includeJ Ris officers, credit committee mem%ers and the related
In terms of experience, 5:.5 percent of survey respondents indicated that they had 33A3: years
of %aning experience. !he second larger num%er of respondents, 4>.9 percent, had %aning
experience of a%ove 3: years. !he remaining 733 percent8 respondents had %aning experience
of 3A: years only. !his clearly depicts that respondents had rich experience in providing
response that naturally contri%uted to the data (uality of the survey 7!a%le :.98.
97
Ta'(e 8.7 Res/on2entsG eC/erience in the 'anking sector
+ears of eC/erience *reBency Percent
+ess than 3 year B A
3A: years 3: 33.B
;A3B years 54 45.:
33A3: years 9= 5:.5
$%ove 3: years 9B 4>.9
,n the other hand, :3 percent of respondents had 3A: years of experience in %an lending
while 99 percent had lending experience for ;A3B years. ,nly four percent of the respondents
had less than one year of %an lending experience .!he fact that majority of the respondents
had many years experience in %an credit operations helped capture a good (uality of data
7!a%le :.:8.
Ta'(e 8.8 Bank (en2ing eC/erience of the res/on2ents
+ears of eC/erience *reBency Percent
+ess than 3 year 9 9
3A: years :3 :3
;A3B years 99 99
33A3: years 44 44
$%ove 3: years 3: 3:
9
8
8.#.! *actors that affect 'ank (en2ing
!he study tried to assess the factors that affect %an lending in the context of 'enya. !he study
re(uired respondents to show their agreement or disagreement to certain statements dealing
with %an specific factors affecting occurrences of nonperforming loans. -xamining the results
of the study in this connection reveals that a%out <: percent of respondents agreed to the
statement Gfactors affecting %an lending are o%viousH while the rest disagreed and were
neutral a%out it.
Ta'(e 8.9 *actors affecting occrrences of NPL are o'1ios
Ot(ook *reBency Percent
$gree 738 3B5 <:.4
Neutral 748 39 3B.4
#isagree 758 3: 3B.>
!otal 354 >;.5
"ean 3.55
&tandard deviation 3.B;
In addition to the a%ove, respondents were ased to identify the causes of nonperforming
loans in 'enyan *ans. !he responses in this regard are summari?ed and presented in
!a%le :.<.
9
9
Ta'(e 8.: *actors consi2ere2 casing occrrences of NPL in Kenyan 'anks
CBB "B# CB2
Total
Factor3Ban0 4i/ Awash A/yssinia CB#5 4o of
5 5 5
/an0s
Fund diversion <
2oor customer selection 3
2oor portfolio diversification 5
Wea governance 5
@nfair competition among %ans :
@nforeseen *usiness riss 5
*orrowers poor %usiness nowledge 5
and management sill
)ompromised integrity ;
Willful default 9
,ver/under financing ;
Natural disaster affecting agriculture 3
)redit operators capacity limitation 5
"acroeconomic factors 5
Inade(uacy of credit policies 5
"acroeconomic policies 9
"anagement pro%lems 3
!ype of %usiness ownership 3
-xternal influence on sanctioning 5
@navaila%ility of data for analysis 5
2oor regulatory and supervisory 4
frame wor
V)**J )onstruction and *usiness *anF #*-VJ #evelopment *an of 'enyaF )*,VJ )ooperative *an of
,romiaF )*-VJ )ommercial *an of 'enya
&ourceJ &urvey and own computation
*ans specific determinants of nonperforming loans naturally vary across %ans due to the
uni(ueness of each %an. ,ne %an might have strength or weaness on particular aspect. !hat
particular issue may or may not %e the case in other %ans unlie the macroeconomic
100
factors that is typical for all operators in particular geography or so. 1owever, in the su%jective
(uestion in the survey respondents from the seven surveyed %ans gave various responses.
&ome of the responses to cause for occurrences of N2+ were all shared %y some participants in
all the %ans surveyed. !a%le :.< indicates factors thought to contri%ute to the occurrences of
nonperforming loans. !he last column shows in how many %ans a particular factor was
%elieved %y respondents to have association with the occurrences of N2+. !he fact that a
particular factor is pinpointed %y all surveyed %ans indicates how prevalent that cause could
%e in the 'enyan %aning industry though a further study might %e re(uired to examine it.
6ost prevalent factors indicated to cause occurrence of 4PL
$ thorough loo into response to the su%jective (uestion indicate that some of the factors lie,
fund diversion, over/under financing, compromised integrity, credit operators capacity
limitation, %usiness failures, willful default, poor diversification of portfolio, changing policy
environment are commonly shared view %y respondents from all the surveyed %ans staff
ascri%ing to cause occurrence of nonperforming loans. *esides, respondents from %oth private
and state owned %ans staff have so much in common.
$naly?ing the response in depth indicates that fund diversion was thought to cause
occurrences in all the %ans surveyed while compromised integrity and over/under financing
were the factors rated %y respondents from six %ans. ,ther factors lie unfair competition
among %ans, willful default and macroeconomic conditions were %elieved to cause
occurrences of nonperforming loans %y respondents from five and four %ans respectively.
!his in fact had helped capture respondentsC views in their own terms as to what cause
occurrences of loan default in their own context.
10
1
Respondents were also ased to ran factors causing nonperforming loans in 'enyan *ans in
order of importance 7from one to eight8. !he results in this regard indicated that 44 percent of
respondents raned %an si?e and poor monitoring /follow up as the top raning factor causing
occurrences of nonperforming loans while credit culture /orientation is raned third factor %y
4> percent of the respondents. !hus poor credit monitoring %y %ans, %ans si?e, poor ris
assessment, credit culture/orientation were the top four factors raned to cause occurrences of
nonperforming loans. ,n the other hand, charging high interest rate and rapid loan growth
were factors that were raned seventh and eighth 7!a%le :.=8.
Ta'(e 8.; Ranking of factors affecting occrrence of non/erforming (oans
*actors
#
st
!
n2
3
r2
7
th
8
th
9
th
:
th
;
th
F F F F F F F F
Rapid +oan growth %y %ans
9 4 ; 4= 5 49 4 :3
1igh interest rate
4 4 33 35 3 5< : 4<
+enient /+ax credit terms
9 : 3< 53 3 45 ; 33
)redit culture / ,rientation
39 ; 4> 35 : < 34 9
&i?e of the *an
44 3< 43 < 33 9 3B 3
2oor monitoring/follow up
44 43 3B 9 49 3 39 3
,wnership type of %an
3: 3> : 5 4> 4 3< 3
2oor ris assessment
5;
3<
5 55 4 93 5
&ourceJ &urvey and own computation
102
!a%le :.> shows responses on factors indicating the relation %etween credit assessment and
occurrence of the nonperforming loans. ,nly 99 percent of the respondents agree that easily
admitted %orrowers usually default the average response has a mean 4.<> and standard
deviation of 3.B>. ,n the other hand ;>.5 percent of the respondents strongly agree 7mean 3.55
and standard deviation B.:3;8 that having in place now your customer 7'.)8 policy lead to
high loan (uality. With regard to good loan underwriting, ;>.9 2ercent of the respondents
agree that it ensures loan performance. 2oor ris assessment is perceived to lead to loan default
%y ><.= percent of the respondents 7!a%le :.>8.
Ta'(e 8.? *actors in2icating re(ation 'et=een cre2it assessment an2 (oan 2efa(t
Strong(y Agree Netra( Disagree Strong(y &ean Stan2ar2
Agree 5#6 5!6 536 576 Disagree 2e1iation
F F F F 586
F
-asily admitted 33.4 54.= 4;.> 45.> :.4 4.<> 3.B>B
%orrowers
usually default
'now your customer ;>.5 4=.: 4.4 A A 3.55 B.:3;
7'.)8 policy
,f *ans lead to high
loan (uality
Good loan 3>.: :B.9 3= >.= 4.5 4.4: B.>:<
underwriting ensures
+oan performance
2oor ris assessment ;:.9 54.9 A B.< 3.: 3.9 B.;=4
would lead to loan
default
10
3
From the a%ove result respondents strongly agree that %ans that employ a ro%ust '.) policy
in recruiting their customers and also do good ris assessment would have a %etter loan (uality.
,n the other hand when the loan underwriting is poor, the loans would %e prone to default.
Respondents view was nearly neutral to the statement Geasily admitted customers usually
defaultH. In general the outcome indicates that poor credit ris assessment cause occurrences of
nonperforming loans.
&trict loan monitoring is %elieved to ensure loan performance %y >4.< percent of the
respondents. ,n the other hand 95.< percent of the respondents 7mean 3.<9, standard deviation
B.<98 disagree with the assertion that loan might perform well if properly monitored despite
poor assessment during sanctioning. !his indicates that loan followAup can never su%stitute
proper credit assessment.
1owever, ;3.5 percent of the respondents 7mean 4.:=, standard deviation B.3>98 agree that
occurrence of nonperforming loan is directly related loan follow up. ,n the other hand only
9B.3 percent of the respondents agree that %ans with higher %udget for loan monitoring have
lower nonperforming loans, the average response %eing neutral 7mean 5.B;, standard deviation
4.:;8. &ee !a%le :.3B
10
4
Ta'(e 8.#" *actors in2icating cre2it monitoring an2 (oan 2efa(t
Agree 5#6 5!6 536 576 Disagree 586 2e1iation
F F F F F
&trict monitoring 5=.< :9 4.4 :.3 A 3.<9 B.<9
ensures loan
performance
2oorly assessed and 9.9 4<.< 49.3 54.= 3B.> 5.3= B.B>5
advanced loans may
perform well if
properly monitored
+oan follow up is 3;.5 9:.4 >.; 44.4 ;.< 4.:= B.3>9
directly related to
occurrence of
nonperforming loans
*ans with higher 5.; 5;.: 55.; 44.; 4.> 5.B; 4.:;5
%udget for loan
monitoring have
lower non performing
loans
From the foregoing discussion it can %e concluded that credit monitoring is directly related to
loan performance. #espite this the respondents didnCt support the argument that loan would
perform well only %y proper monitoring if proper assessment is not carried out while
advancing the credit. !his indicates that follow up would never su%stitute credit analysis or
assessment.
,n the other hand though loan monitoring re(uires %udget, allocating higher %udget might not
ensure loan performance as a good num%er of respondents are neutral to the assertion.
105
With regard to the relation %etween collaterali?ing loans and occurrence of nonperforming
loans, only 55.= and 49 percent of respondents agree with statement that collaterali?ing loan
protect loan default and non collaterali?ed loans would %e defaulted respectively. 1owever,
respondents are of the view that %orrowers would service their de%t if they have pledged
collateral, the response had mean 4.94 and standard deviation B.>>< 7!a%le :.338.
Ta'(e 8.## Re(ation 'et=een co((atera(i@ing (oans an2 occrrence on NPL
F F F F F
)ollaterali?ed loans 9.9 4>.9 4;.: 59.; :.3 5.B< 3.B35
perform well
)ollaterali?ing loans 3B.> :>.> =.= 3<.: 4.> 4.94 B.>><
help protect loan
default
"ost of the time 5.; 4B.9 53.9 5= ;.; 5.45 B.><4
non collaterali?ed
loans are defaulted
!he fact that only small portion, 49 percent of 7mean 5.45, standard deviation B.><48 the
respondents concur with the argument that non collaterali?ed loan are defaulted or only 55.=
7mean 5.<, standard deviation 3.B38 percent only agree with the assertion that collaterali?ing
loans help loan performance indicates that the relation %etween collaterali?ing loans and loan
default is not strong. 1owever, the respondents are of the view that %orrowers would service
the loan if they have pledged collateral lest it would %e foreclosed in case of default.
106
With regard to the relation %etween %orrowersC orientation/culture and loan performance,
almost only less than five percent of the respondents disagree with the assertion that loan
performance is affected %y orientation /culture of a society and its development. !hus the
result indicates strong relation %etween culture/orientation and occurrence of nonperforming
loans. $ll of the factors relating to culture indicated agreement. &ee !a%le :.34
Ta'(e 8.#! Re(ation 'et=een 'orro=erGs orientation an2 occrrence of N2+
Agree 5!6 536 576 Disagree 2e1iation
5#6 F F F 586
F F
*orrowerCs 5B.> ;5.4 :.> A A 3.<: B.::9
orientation/culture is
related to loan
performance
!here is a relationship 4>.9 ;9 :.3 3.: A 3.<> B.;B3
%etween loan default and
%orrowerCs culture
#efault in some area is 3>.< ;5.: 34.9 9.9 A 4.B3 B.<B<
ascri%ed to the culture of
the %orrowers
&ocietyCs cultural 53.9 :9.< 3B.> 4.> A 3.=: B.<45
development leads to good
loan performance
,nly 45.: 7mean 5.43,standard deviation B.=:;8 percent of the respondents agree with the
statement that loan with %ig interest rate tend to turn to N2+ .In a lie manner only 3>.>
107
percent 7mean 5.4:,standard deviation B.=:8 of the respondents concur with the argument that
charging %ig interest rate leads to loan default. ,n the other hand, a%out 9:.3 7mean 4.=3,
standard deviation B.=>8 percent of the respondents agree that loan price might affect loan
performance. 1owever, the average responses to all the factors were close to neutral. &ee !a%le
:.35
Ta'(e 8.#3 Re(ation 'et=een cost of (oan an2 (oan 2efa(t
F F F F F
+oans with %ig B.< 44.= 55.= 5>.< 4.> 5.43 B.=:;
interest rate tend to
turn to N2+
)harging %ig 4.4 3<.; 5:.5 94.; 4.4 5.4: B.=:B
interest rate leads
to loan default
+oan price affects 4.5 94.> 4<.3 4<.3 B.= 4.=3 B.==>
loan performance
With regard to factors relating to credit terms 7+ax /lenient credit terms, poorly understood
terms and /or negotiated credit terms8 as to whether they lead to occurrences of loan default
responses are in indicated under !a%le :.39.
10
8
Ta'(e 8.#7 Cre2it terms an2 (oan /erformance
F F F F F
+enient / lax credit 39.= <4.; <.9 :.4 A 4.B5 B.;:<
term cause loan
default
*orrowers default 9.9 5>.B 59.; 3>.> 4.4 4.<; B.=>;
%ecause they donCt
understand credit
terms well
2oorly negotiated 3;.4 <4.3 <.9 9.9 A 4.BB B.;99
credit terms lead to
loan non
performance
From the !a%le :.39 it can %e concluded that respondents agreed with the fact that there is a
relation %etween loan default and credit terms set %y %ans upon loan approval.
When we see to the response on the relation %etween credit growth and occurrence of
nonperforming loansF almost <=.< percents of them agreed to assertion that aggressive lending
leads to occurrence of large magnitude of N2+. &imilarly ;B.9 7mean 4.9;, standard deviation
B.=<8 percent of the respondents thought that %ansC greater ris appetite would %e cause for
occurrence of nonperforming loans. !he response on the relation %etween compromised
integrity and N2+ reveals that almost =5.; percent are in agreement. &ee !a%le :.3:.
109
Ta'(e 8.#8Cre2it gro=th re(ation =ith NPL
F F F F F
$ggressive lending 4B.; :=.3 33 3B.5 A 4.33 B.=9>
leads to large N2+
volume/ratio
*ans whose 9.9 5B.< 5=.< 4;.5 A 3.=< B.=:>
credit growth is
rapid experience
huge N2+ level
*anCs great ris >.< :B.< 45.> 3:.< A 4.9; B.=<4
appetite is cause
for N2+
)ompromised 4;.> :;.< >.< ;.< A 3.>; B.<>>
integrity in lending
leads to loan
default
&o it can %e stated that when %ans pursue aggressive lending strategy and there%y experience
rapid credit growth they might heap up large volume of nonperforming loans. Not only this %ut
also compromised integrity in sanctioning credit is also %elieved to %e cause for occurrence of
loan default %y respondents.
!he survey response on the relation %etween having large num%er of %orrowers and %ansC si?e
indicates that it is not the cause for the occurrence loan default. Responses to (uestions relating
to %an si?e and occurrences on N2+ are inclined towards disagreement. &ee !a%le :.3;.
110
Ta'(e 8.#9 Bank si@e an2 occrrence on NPL
F F F F F
1aving large 4.4 ;.; 54.= :3.= ;.; 5.:9 B.=B:
num%er of
%orrowers
causes loan
default
+oans default 4.4 :.3 49.5 :=.= >.; 5.;= B.=B:
rate is directly
related to
%ansC si?e
With growth in 3.: 33.< 49.= ::.: ;.; 5.:9 B.=9B
%ans si?e
comes growth
on N2+
,n the other hand a%out :=.3 7mean 4.:, standard deviation B.3B8 percent of the respondents
agree that loan default is associated with %an ownership type. Note also that :;.4 percent of
the respondents are staff of state owned %ans. &ee !a%le :.3< and !a%le :.4
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1
Ta'(e 8.#: Banks o=nershi/ ty/e an2 NPL
Agree 5!6 536 576 Disagree 2e1iation
5#6 F F F 586
F F
+oan default is not related 3=.9 5>.< 3=.9 4B.; 4.> 4.: B.3B4
%ans ownership type
7private/state owned8
8 .! Docment st2y
In order to assess factors affecting nonperforming loans, data on the total assets, total loans
and advances, deposit and nonperforming loan ratio of selected %ans were used. !he relevant
data on %an si?e, %an ownership type, N2+ 7from the year 4BB: to 4B3B8 was collected from
eleven %ans that were registered %efore the year 4BB</B=.
-xamination of the trend in respect of N2+ over the period covered %y the study reveals that
the mean N2+ ratio has %een decreasing since 4BB:. In light of %ansC ownership type the ratio
has %een decreasing for two of the state owned %ans 7)*- and )**8 though the trend was
erratic for private %ans. )omparisons of respective N2+s of %ans against the mean N2+ ratio
depicts no direct relationship %etween si?es of %ans 7relatively %ig, medium and small8 and
N2+ ratios. &ee 7!a%le :.3=8.
112
Ta'(e 8.#; NPL ratio of Banks
Bank +ear
!""8 !""9 !"": !""; !""? !"#"
)ommercial *an of 'enya 4<.:4 44.9: 39.:4 :.55 5..94 3<.B; 3:.:; 33.BB ;.:B
#ashen *an ;.<4 ;.43 :.>: :.=> <.5 4.>
$wash International *an 34.B4 >.:; <.5; =.;; : <
*an of $%yssinia 34.9 9.>9 3B.:9 34.=< :.4: 5.>:
Wegagen *an =.93 9.=: :.4: =.5> <.< 5.:
@nited *an =.9: 9.3= 9.:> 5.>= 5.<; 5.5:
)ooperative *an of ,romia B B B.3< 3.B> 4.: <.;4
Ni% International *an 33.44 =.9< :.:; ;.<5 39.3 <.9
+ion International *an N$V N$V B B.33 B.4< ;.:5
#evelopment *an of 'enya 53.9 5:.: 5;.5 5<.B9 44.< 33.;<
&ean 3;.43 33.:; >.<: >.; <.; :.;:
Stan2ar2 2e1iation >.<9 3B.>4 3B.4; 3B.3< ;.;> 4.=<
VN$ Not availa%le
&ourceJ Financial data of %ans and own computation
!he data also indicate that a total asset of all the %ans covered %y this study, which shows
the si?e of the %ans, was growing for the years under consideration. !he mean total asset
depicted an increasing trend though the standard deviation had also %een so %ig throughout
the years in consideration indicating varia%ility of the means. &ee !a%le :.3>. "oreover, the
113
total deposits and net loans showed an increase from the years 4BB:A4B3B, with exception of
deposit of the #evelopment *an of 'enya that depicted a steady trend as the %an is not
directly engaged in mo%ili?ing deposit from the pu%lic .&ee 7$ppendix 58.
Ta'(e 8.#? Tota( Assets of Banks 5in mi((ions ETB6
Bank +ear
!""8 !""9 !"": !""; !""? !"#"
)ommercial *an of 'enya 55,3;> 5:,=9> 95,9:; :B,93; :>,933 <9,45B
)onstruction and *usiness *an 3,=54 3,<>< 3,==> 4,5>4 4,:>4 5,3;4
#ashen *an 5,94B 9,:9; ;,B93 <,=4> >,<55 34,5:5
$wash International *an 4,44; 4,>:9 5,=5B 9,=4B ;,945 <,>9:
*an of $%yssinia 4,B:< 4,=59 5,5>; 9,4 5,9=B 9,34: :,33= :,<94
@nited *an 3,B<5 3,:>> 4,3=5 5,4:B 9,;:4 :,=>;
)ooperative *an of ,romia 34> 449 949 ;<= 3,B45 3,<;=
Ni% International *an 3,<54 4,B4< 4,;B< 5,;:B 9,=B< :,><3
+ion International *an N$ N$ 4;; :<9 >:4 3,5;9
#evelopment *an of 'enya 9,:9; 9,>:= :,::> :,;:= ;,9B= 3:,4BB
"ean :,3=B :,>B: ;,;9= <,;>< >,;>3 34,<3>
&tandard deviation >,>B= 3B,;34 34,594 39,593 3;,;=5 4B,=4B
114
!otal asset, total deposit and loans advances %eing indicators of %an si?e, their correlation
with the ratio of nonperforming loans were analy?ed. !he outcome is presented as follows.
!a%le :.4B %elow show the mean and standard deviation the total asset, net deposit, net loan
and N2+ ratio of the eleven %ans selected for this study for the period 4BB:A4B3B.
Ta'(e 8.!" .Descri/ti1e Statistics
N &inimm &aCimm &ean St2. De1iation
Tota( AssetE ;9 34> <9,45B =,B>; 39,5:;
Net De/ositE ;9 3: :;,B:5 :,<B; 3B,==>
Net LoanE ;9 5B 44,3:: 5,3<3 9,3==
NPL Ratio ;5 .BB 5<.B9 >.=9 >.B5
V0alue of asset, deposit and net loan is in million -!*
!he %ig standard deviation indicates the varia%ility from "eans under consideration as has
also %een o%served from the minimum and maximum values.
11
5
Ta'(e 8.!# Corre(ation &atriC
Tota( Asset Net De/osit Net Loan NPL Ratio
Tota( Asset 2earson )orrelation 3.BBB B.>=>VV B.>:;VV B.B45
&ignificance
B.BBB B.BBB B.=:;
Net De/osit 2earson )orrelation B.>=>VV 3.BBB B.>3=VV AB.B95
&ignificance B.BBB B.BBB B.<5:
Net Loan 2earson )orrelation B.>:;VV B.>3=VV 3.BBB B.B:B
&ignificance B.BBB B.BBB B.;>=
NPL Ratio 2earson )orrelation B.B45 AB.B95 B.B:B 3.BBB
&ignificance B.=:; B.<5: B.;>=
VV )orrelation is significant at the B.B3 level 74Atailed8.
$s can %e o%served from !a%le :.43 at the B.B3 level of significance there were statistically
significant relationship %etween net deposit and total asset of %ans studied. &ame was true for
the relationship %etween net loan and total asset at B.B3 level of significance. &o as total
deposit or net loans of %ans increased the total asset had also increased. *esides, the
correlation %etween deposit and net loans at B.B3 level of significance was strong. &o with
increase in %ans deposit there was also growth in net loans %ans advanced.
11
6
,n the contrary at B.B: level of significance there were no statistically significant relationships
%etween the total asset and N2+ ratio as the 2earson correlation was only B.B45 i.e. very wea.
!he 2earson correlation %etween net deposit and N2+ ratio was also AB .B95 i.e. very wea
negative correlation.
)onsidering the 2earson correlation %etween net loans and N2+ ratio at B.B: level of
significance was B.B: indicating that there was no statistically significant relationship %etween
the net loans and N2+ ratio. &o, though there was growth on si?e of loans of the %ans studied
during the period 4BB:A4B3B, the N2+ ratios had an erratic trend indicating that N2+ of %ans
are not explained %y loans si?e.
$s has %een indicated earlier the total assets of the %ans, which indicate si?e of %ans, have
shown growth throughout the period under consideration. 1owever, the outcome of the
analysis depict that at B.B: level of significant, there were no statistically significant
relationship %etween N2+ ratio and total assets, which is the indicator %anCs si?e. &o the study
fails to support earlier studies that indicated the relation %etween %ans si?e and
Further, comparatively %igger %ans, )ommercial *an of 'enya, $wash International and
#ashen *ans had N2+ ratios of 3.<O, <O and 4.>O respectively during the year 4B3B for
example. In a similar manner other relatively midsi?ed or smaller %ans had N2+ ratios of
more or less similar to that of $wash *anCs or #ashen *an. !he raw data itself depict that
the association %etween %an si?e and their N2+ ratio is wea or rather nil.
11
7
#espite the fact that the total asset of all the %ans have %een growing throughout the period
under consideration the %ans respective N2+ ratio was not growing rather the trend is erratic
in some of the %ans while it was a decreasing trend. *ut in general the mean N2+ ratio has
%een decreasing indicating the fact that %ans growth in si?e has not lead in growth in N2+
ratio 7&ee !a%le :.3= and !a%le :.448.
Ta'(e 8.!! &ean NPL ratio of Kenyan 'anks esta'(ishe2 'efore !"":,;
NPL ratio,year !""8 !""9 !"": !""; !""? !"#"
"ean N2+ 3;.43 33.:; >.<: >.; <.; :.;9
N > 3B 33 33 3B 33
$s has %een discussed earlier deposits, loans and advances and total assets are indicators of a
%an si?e. !he 2earson correlation %etween these %alance sheet items and N2+ indicates a very
wea correlation. !hus the data fails to support the fact that %an si?e affects or determines
occurrences of nonperforming loans.
In terms of %an ownership typeF for example )*-, the %iggest %an in the industry has seen a
tremendous decrease of N2+ from 4<.:O in the year 4BB: to 3.<O in 4B3B. !he data also
depict that %oth )** and #*- are on same path. #*- though on the right path still
maintained the %iggest ratio. !hat might ascri%e to the development %aning it is engaged in
due to the ris natures of projects financed.
11
8
&eeing to their current positions on N2+ there as such is no direct relationship %etween %an
ownership and occurrences of nonperforming loans. For example )ommercial *an of 'enya
had one of the least nonperforming loan ratios during recent years as do other private %an lie
#ashen. ,n the other had )onstruction and *usiness *an have had comparatively %igger
N2+ ratio than some of the private %ans. &o the data donCt depict relationship %etween %an
ownership type and N2+ ratio.
!hough the literature also indicates the fact that there is association %etween credit growth and
N2+, despite the fact that net loan for all the %ans and the respective mean thereof have %een
growing the mean N2+ has %een decreasing for the period 4BB:A4B3B. !hus the data fails to
support the literature though it re(uires a depth study.
8.3 )n>2e/th inter1ie=
In order to get deep understanding a%out the factors affecting nonperforming loans, inAdepth
interview was conducted with senior %an officials. $ll of the interviewees have had over 39
years credit experience in addition to their several years of %aning experience. In terms of
profile, a president, credit vice presidents, senior credit committee mem%ers participated. !he
interviewees were from private, state owned and central %ans. &ome of the interviewees were
not from %ans that were covered %y the survey conducted. !he respondents have so many in
common as to what they %elieved cause occurrence of nonperforming loans.
11
9
!he section that follows present factors %elieved to cause occurrences of N2+ %y the
interviewees. *esides, the factors that are thought to %e most critical for the occurrences on
N2+ are pinpointed. In addition, factors that ascri%e to the very nature of the 'enyan %aning
industry contri%uting to the N2+ occurrence are specifically presented.
8.3.# *actors 'e(ie1e2 to case occrrences of NPL 'y the inter1ie=ees
Respondents indicated that several factors contri%ute to loan default. $s per the outcome of the
interview the factors can %e categori?ed as %ansC internal situations, the external environment
and %orrowers related. !he factors are organi?ed and presented under the respective su%titles.
8.3.#.# Banks interna( factors
!hese are factors relating to internal inefficiencies due to systems, governance, human
resource issues and the related. @nder theme this most of the interview participants raised the
following issuesJ
*aners lac of integrity,
!erms and condition not %eing set properly,
)redit analysts capacity limitation,
*ans aggressive lending to maximi?e profit,
Not conducting 'now your customers 7'.)8 principles properly %efore lending,
,ver trading/over financing,
12
0
Not understanding and seeing critically the macroeconomic environment,
-xcessive lending %y %ans on a particular sector T poor portfolio diversification,
2oor collateral valuation,
In ade(uate institutional capacity T in terms of ris selection,
2olicies that failed to consider the macroeconomic environment,
2oor monitoring and follow up,
!he credit approval process not %eing prudent and failing to comply with the
existing %an policies,
Inade(uacy of credit ris managementAfrom identifying, measuring and monitoring
Governance pro%lems,
2oor or no management information system 7"I&8,
$%sence chec and %alanceAin loan processing, follow up and monitoring/ follow up
8.3.#.! Cstomer re(ate2 factors
!hese are factors that emanate from %orrowers and have strong %earing on occurrences of
loan default. @nder this ground the following were raisedJ
Fund %eing directed to unintended purpose,
*orrowers not maing competitive analysis %efore engaging in a particular sector,
*usiness management pro%lemsA most of family owned %usinesses donCt have good
management and they also suffer from succession,
2oor record eeping %y %usinesses,
Intentional or willful default,
12
1
8.3.#.3 ECterna( factors
!hese are factors that were %eyond the influence of %ans and %orrowers. !hey are presented follows.
Intervention of external %odies in credit decision maing %oth in private and state
owned %ans,
&ocietyCs culture T one doesnCt %uy foreclosed properties of others in same village
in some society,
2oor credit culture,
"acroeconomic factors lie inflation, maret pro%lems etc.
@navaila%ility of data to conduct project analysis,
Inade(uacy of the supervisory authorities policesA loan classification methodology
adopted for %oth development and commercial %ans were similar,
)apacity limitation of the supervisory organ
8.3.! &ost critica( factors for (oan 2efa(t as /er inter1ie=s
!he interviewees were re(uested to rate the factors they %elieved are rated top in causing
occurrences of nonperforming loans. !heir responses are organi?ed as followsJ
2oor credit analysis %y %ans,
*orrowers lac of nowledge Tentrepreneurship sill gap, engaging in unstudied
%usiness, management capa%ility limitation,
Inade(uacy in the competence of credit operators,
Not eeping apt with national and glo%al %usiness environment %y %ans
)ompromised integrity of credit operators,
12
2
2oor monitoring and follow up,
2olicy environment 7 )entral %anCs and others8
8.3.3 *actor that are niBe(y associate2 to Kenyan 'anking conteCt
Responses of the interviewees on factors they %elieved were very peculiar to the 'enyan
*aning environment and have significant %earing on occurrences of loan default are
organi?ed in the following manner.
Inade(uacy in the capa%ility of employees remain one of the main challenge of the
'enyan *aning industry which as a result would lead to compromise on loan
underwriting standard that in turn have a huge %earing on loan performance,
Regulatory environmentA introduction of credit cap earlier %y the central %an F
%orrowers thin they may not get %ac a loan and fail to perform,
-xternal influence T the change of the national economic policy from command to
maret led had impact earlier,
$%sence of %laclisting of defaulters at a national level. !his would have served
as a deterrent factor helping protect loan default,
-xcessive dependency on collateral T if financing is %ased on the %usiness of the
company %orrowers may not default as source of repayment would %e properly
ascertained %efore advancing loans,
)ultural under developmentA wea credit culture. !here is an 'enyan prover% that
says G$ %orrower or a lender might dieH which would encourage loan default.
!he environment %eing unsupportive T 2olicy, rules and regulation
7macroeconomic policy8.
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3
@nfair industry competition among %ansA endangering %ans not select good
customers. &ometimes non performing loans of other %ans are %ought %y other
%ans.
@nderdevelopment of the %aning system,
+imited capacity of the central %anCs supervision capa%ility,
Interventions and influencesA operators at times lac professional independence,
@nderdevelopment of institutional capacity of %ans in general and human
resource in particular
In an endeavor to ascertain the survey response through interview, the interviewees were ased
of their view on the relations %etween loan price, %an si?e and ownership type of %ans and
occurrences of loan default as indicated in the literature. 1owever, all of the interviewees
indicated that they saw no relation %etween loan price and occurrence of N2+. Nor did they
%elieve association %etween %an si?es or ownership type and loan default.
8.7 Smmary of Res(ts
!he study conducted survey of %ansC employees 7using self administered (uestionnaires8 and
structured survey of documents and unstructured interview. !he survey had a response rate of
ninety one percent. Fifty six percent of the study respondents were from state owned %ans
while the remaining were private %ansC employees. &eventy five percent of respondents were
directly engaged in credit related activities. -ighty nine percent of the respondents had over
ten years of experience in %aning and sixty percent over five years lending experience.
12
4
In response to a su%jective (uestion as to what cause occurrences of N2+ in view of survey
participants, the result indicated that fund diversion, compromised integrity, over/under
financing were the most fre(uently mentioned factors followed %y unfair competition among
%ans, willful default and macroeconomic conditions among others.
In a (uestion where the respondents were re(uested to rate factors they %elieved cause
occurrences of nonperforming loans in order of importanceF poor monitoring %y %ans, %ans
si?e, poor ris assessment, credit culture/orientation were rated to %e the top four factors
causing loan default. ,n the other hand charging high interest rate and rapid loan growth were
rated among the least factors causing occurrences of nonperforming loans.
In a +iert scale measure average response indicated that respondents agreed that credit
assessment is related to loan default. !hey also agreed with the fact that loans follow up
/monitoring is related to occurrence of nonperforming loans. ,n the other hand the response
on relation %etween collateral and loan default indicated disagreement. $verage response on
impact of credit culture /orientation was agreement. !he response on the relation %etween loan
price /interest rate/ and occurrence of loan default depicted disagreement. $verage view of the
respondents on impact of credit terms on loan default was agreement. Respondents were of the
view that aggressive lending and compromised integrity lead to occurrences of N2+. !he
response on the relation %etween %an si?e and occurrences of loan default indicates
disagreement. Finally the response to a (uestion relating %ans ownership type to occurrences
of nonperforming loans was neutral.
12
5
From financial data of %ans, the correlation of independent varia%le such as deposit, loans,
and total asset and dependent varia%le N2+ ratio was tested. !he result showed that at B.B:
level of significant, there were no statistically significant relationship %etween all independent
varia%les and N2+. &ame test carried out at the same level of significance %y categori?ing
%ans in terms of ownership type and si?e indicated that there were no statistically significant
relationship %etween deposit, loan, total asset and N2+.
$n inAdepth interview wherein senior executives in the 'enyan %aning sector were
interviewed indicated that the critical factors causing occurrences of nonperforming loans
include J poor credit analysis %y %ans, %orrowers lac of nowledge entrepreneurship gap
7 engaging in unstudied %usiness and management capa%ility limitation8, lac of competency
of credit operators, not eeping apt with national and glo%al %usiness environment %y %ans
and %orrowers ,compromised integrity of credit operators, poor monitoring and follow up of
loans %y lending %ans and limitations in the policy environment 7 )entral %anCs and others8.
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6
CHAPTER S)H
D)SCASS)OND CONCLAS)ONS AND RECO&&ENDAT)ONS
!he previous chapter presented the results while this chapter is dedicated for the discussions of
the research findings, conclusions and recommendations. $ccordingly, section ;.3 shows the
discussion in the context of literature while sections ;.4 and ;.5 try to present conclusions and
recommendations respectively.
9.# Discssion of the research fin2ings
$s has %een stated in chapter one the %road o%jective of this study was to identify %an
specific determinants of nonperforming loans. Further, the following specific (uestions were
formulated to contri%ute to meeting the general o%jective of the researchJ
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7
!he study analy?ed each factor that has impact on occurrences of nonperforming loans.
*ercoff et al 74BB48 indicated that N2+s are affected %y %oth %an specific factors and
macroeconomic factors. Focus of this study %eing %ans specific determinants of N2+, the
findings in light of the literature are discussed.
In respect of the factors affecting N2+, the su%jective (uestion in the survey and inAdepth
interviews identified factors such as poor credit assessment, failed loan monitoring,
underdeveloped credit culture, lenient credit terms and conditions, aggressive lending,
compromised integrity, wea institutional capacity, unfair competition among %ans, willful
default %y %orrowers and their nowledge limitation, fund diversion for unintended purpose,
over/under financing %y %ans ascri%e to the causes of loan default. !he study tried to
investigate these factors further.
Custoer Adittance and Ris0 Assessent and 4PL
@nder this study 99 percent of the respondents agreed that easily admitted %orrowers usual
default 7!a%le :.>8. !he outcomes of the inAdepth interview support this view. !he fact that
%ans pursue a loose '.) 7now your customer8 %efore admitting a new customer indulge
them to recruiting a %orrower with poor trac record, inade(uate %usiness management,
excessively risy and/or unvia%le venture that would eventually lead to poor credit
performance. !he result supports *rown%rige 73>>=8 who stated that easily admitted
customerCs loan would %e damaged at the early stage.
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8
!he survey also indicated that ><.4 percent of the respondents agree with fact that poor ris
assessment greatly affects occurrences of loan default. $lmost all of the %aners interviewed
concurred with this view. )redit assessment deals with a thorough analysis of the five )s, to
help indicate whether to lend or not and how much, under what term and conditions, at what
price to lend, to mention a few. !hus failing to carry out proper ris assessment would lead to
missing any or all of the captioned issues, which has a potential for the occurrence on N2+.
Ning 74BB<8 indicated the impact of poor ris assessment on loan (uality.
Credit 6onitoring and 4PL
&tating the essentiality of regular monitoring of loan (uality, $gresti et al. 74BB=8 stated that it
would help ensure a sound financial system and there%y prevent systemic crises that otherwise
would lead to loan default. !his survey also confirmed the stated study as >4.< percent of the
respondents indicated agreement 7!a%le :.3B8. +ac of loan followAup was also one of the top
factors rated to contri%ute to the occurrences of N2+ %y the survey and interview participants.
Naturally the o%jective of monitoring a loan is to verify whether the %asis on which the lending
decision was taen continues to hold good and to ascertain the loan funds are %eing properly
utili?ed for the purpose they were granted. !here is also tendency %y %orrowers to give more
attention to repaying loans if they are properly given attention %y %ans. ,therwise %orrowers
would %e tempted to divert the fund to other purposes, as was also learnt through the inAdepth
interview. !hus failing to monitor loans would lead to default.
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9
*ercoff, Giovanni and Grimard 74BB48 showed that operating efficiency helped explain N2+s.
i.e. %ans that incur %ig cost for loan followAup would have a comparatively lower
nonperforming loan. Respondents had a neutral view to the statement that %ans which
allocate higher %udget for loan monitoring would have a lower N2+. !he essence seems to %e
having a proper system in place to proactively follow up loans than magnitude of %udget
allocated.
Collateral and 4PL
&ecurity is taen to mitigate the %anCs ris in the event of default and is considered a
secondary source of repayment 7'och R "ac#onald, 4BB58. $ccording to #e +ucia and 2eters
73>>=8, in the %aning environment, security is re(uired among others, to ensure the full
commitment of the %orrower, to provide protection should the %orrower deviate from the
planned course of action outlined at the time credit is extended, and to provide insurance
should the %orrower default.
!hough <B percent of the survey respondents are of the view that collaterali?ing loan may
protect loan default lest the %orrowers lose their pledged properties, the respondents were
neutral with the assertion that collaterali?ed loan perform well or non collaterali?ed loan are
usually defaulted. &o the relation %etween N2+ and collateral is neutral 7!a%le :.338 in view of
the respondents.
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0
Credit 2rientation 3Culture and 4PL
&tudy conducted %y Rajan and #hal 74BB58 in India indicated that credit orientation
significantly affects loan default. Response to four of the (uestions posed to ascertain the
relations %etween credit orientation and N2+ in the survey indicates average agreement 7!a%le
:.348. !he inAdepth interview also confirmed the outcome of the survey and earlier studies.
!he socio economic underdevelopment of the country which is also associated with poor
access to the formal %aning, as depicted %y higher %an %ranch to population ratio 7N*-,
4B338 meant that credit culture is yet to develop in 'enya. !hat was also why 'enyan %ans
had comparatively %ig N2+ ratio. !here is an 'enyan prover% Geither a %orrower or a lender
might dieH indicating a %orrower shouldnCt %other to repay %orrowings. !hus cultural
development has got huge %earing on loan performance.
Credit Ters 7Price and 4PL
!he study indicated that =<.9 percent of the respondents agree that lenient / lax credit terms
cause loan default 7!a%le :.398. +imitation in capacity of credit operators is the cause for poor
assessment. &hallow assessment would fail to indicate terms and conditions of loan properly,
among others. !his might mean loan dis%ursement might not %e made timelyF grace period
may not %e given properly, repayment amount set wrongly without considering the cash flow.
-ither of these or related would lead to poor loan performance. !hus the failure to put
appropriate terms and conditions would lead to loan default. Rajan and #hal 74BB58 who
studied the Indian commercial %ans also found out that terms of credit determines occurrence
of nonperforming loans. Iimene? and &aurina 74BB:8 also indicated that N2+s are determined
%y lenient credit terms.
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1
!he study %y Iimene? and &aurina 74BB:8 conducted on the &panish %aning sector from 3>=9
to 4BB5 evidence that N2+s are determined %y lenient credit terms caused moral ha?ard and
agency pro%lems. !his is one of the top rated factors %y respondents from six %ans out of the
seven surveyed %ans in su%jective (uestions of the survey. *esides, =5.; percent of the
respondents agreed that compromised integrity would cause occurrences of N2+ 7!a%le :.3:8.
&ame has %een confirmed %y interviewee participants. *an managers at times indulge in a
moral ha?ard that they grant loans to those who donCt meet the criteria set. &uch loans would
hardly %e repaid.
&tudy %y &iney and Greenwalt 73>>38, Rajan and #hal 74BB58, Waweru and 'alini 74BB>8,
*erger and #e.oung,7 3>><8, Iimene? and &aurina 74BB;8, 6uagliariello,7 4BB<8 2ain, 4BB5,
*ier and 1u, 74BB48 indicated that high interest rate charged %y %ans is associated with
loan defaults. !his study fails to support this finding in that average response to the assertion
that loans with %ig interest rate would turn to %e defaulted was neutral 7!a%le :.358. None of
the interview participants %elieved that interest rate is related to occurrences of loan default in
the 'enyan context. ,ne line of argument could %e that the interest rate charged is
comparatively smaller. For example according to N*- 74B338 the price index for non energy
commodity was 4>O higher than a year %efore at the %eginning of the year 4B33, whereas the
average lending rate was only 34.4:O for the year 4B3B/33. ,n the other hand, %usiness might
also have %ig profit margin that interest they payment on loans couldnCt %e an issue to cause
loan default 7this re(uires a further study8.
13
2
Rapid Credit 8rowth and 4PL
&alas and &aurina 74BB48 who studied &panish %ans found out that credit growth is associated
with non performing loans. ,f the survey participants 5=.< percent had a neutral view of the
idea that credit growth is related to N2+ 7!a%le :.3:8. !he documentary analysis also depicted
that 2earson correlation at B.B: level of significance %etween credit si?e and N2+ is very wea.
Nor did the inAdepth interview confirm the literature in this line.
Ban0 si9e 7 ownership type and 4PL
In their study of commercial %ans in !aiwan, 1u et al 74BB;8 found out those %ans with
higher government ownership recorded lower nonAperforming loans. !he survey indicates that
:=.3 percent of the respondents agree that loan default is not related to ownership type of
%ans 7!a%le :.3<8. Interview response %y few indicate that willful defaulters might hesitate to
default at state owned %ans while others did not see of any association %etween loan default
and ownership type.
&udy %y Rajan and #hal 74BB58, &alas and &aurina 74BB48, *erger and #e.oung, 3>>< and
others indicated that %ans si?e have significance on occurrence of N2+s. !he survey however,
did not confirm the earlier studies in other countries 7!a%le :.3;8. !he documentary analysis
that analy?ed factors that indicate %an si?e 7deposit, loans and total asset8 and N2+ ratios
depict a very wea correlation 7!a%le :. 438.
13
3
#espite the fact that the survey result supported earlier studies on some factors, the su%jective
(uestions in the survey and inAdepth interview conducted revealed more findings which also
might provide insights for further future studies. !he factors thought to contri%ute to
occurrences of N2+ in this light includeJ fund diversion for unintended purpose, over /under
financing, unfair competition among %ans, compromised integrity, willful default, inade(uacy
institutional competency, credit operators low level of competence, %orrowers sill gap, policy
environment 7supervisory8 among others.
In fact some these findings might %e categori?ed as part of result of earlier studies. For
example, categori?ing fund diversion, over/under financing under poor credit assessment and
categori?ing others in a similar manner. 1owever, studying each of the aforementioned factors
independently would shade more light on understanding factors that determines occurrences of
9.! Conc(sions
!he %road o%jective of this research was to identify %an specific determinants of
nonperforming loans. *ased on the %road o%jective a num%er of specific research (uestions
were developed.
!o achieve this %road o%jective, the study used mixed research approach. "ore specifically,
the study used survey of employees of %ans, structured survey of documents of %an reports
and unstructured interview of senior %aners. !he results showed that, %ased on the
respondentsC view it was evident that most liely factors that affect occurrences of
nonperforming loans in 'enyan %ans are presented in the paragraphs that follow.
13
4
!he study indicated that poor credit assessment ascri%ing to capacity limitation of credit
operators, institutional capacity draw%acs and unavaila%ility of national data for project
financing that had also led to setting terms and conditions that were not practical and/or not
properly discussed with %orrowers had %een the cause for occurrences of loan default.
*esides, despite the fact that credit monitoring/ followAup plays pivotal role to ensure loan
collection failure to do this properly was also found to %e causes for sic loans. !he research
also indicated that over financing due to poor credit assessment, compromised integrity of
credit operators were cause for incidences of N2+. In fact cases of under financing loan
re(uirement that meant shortage of woring capital or not %eing a%le to meet planned targets
were associated with defaults.
In addition the study also found out that due to underdevelopment of credit orientation /culture
%orrowers engaged in %usiness that they had no depth nowledge, diverted loans advanced for
unintended purpose and at times made a willful default.
!he study also depicted that unfair competition among the %ans along with the aggressive
lending pursued added to the poor customer selection made in a motive to maximi?e profit %y
the %ans and/ or due to the moral ha?ard or compromised integrity were the other causes for
the loan defaults.
InAdepth interview also indicated that underdevelopment of supervisory authority competence
in formulating policies, monitoring capa%ility also ascri%e to occurrences of nonperforming
loans earlier.
13
5
,n the other hand the study did not support the existing literature that state occurrences of
N2+ is related to %anCs si?e, interest rate %ans charge and ownership type of %ans
7 private/state owned8.
9.3 Recommen2ations
$fter close examination and analysis of the research findings, the following recommendations
are suggestedJ
*ans should put in place a vi%rant credit process that would encompass issues of
proper customer selection, ro%ust credit analysis, authentic sanctioning process,
proactive monitoring and follow up and clear recovery strategies for sic loans.
*ans should put in place a clear policy framewor that addresses issues of conflict of
interest, ethical standards, chec and %alance in decision maing process for all those
involved in the credit process ensure its implementation thereof.
*ans should pursue a %alanced approach of profit maximi?ation and ris management
lest they engage in aggressive lending and unhealthy competition that would lead to
selecting %orrowers that would default.
*ans should give due emphasis it taes to developing the competency of credit
operators, information system management pertaining to credit and efficiency of the
credit process.
13
6
$s loans would contri%ute to the development of an economy and its default leads to
episode of huge loss on %ans and a countryF deli%erate effort should %e exerted in
developing culture of the pu%lic towards credit and its management %y individual
%ans, 'enyan *aners $ssociation, 'enyan 2u%lic Financial Institutions $gency,
N*- and others.
2rudence of policies that govern %an loans should continuously %e ensured in light of
international %est practices, macroeconomic situations, level of development of %ans
and the economy in general %y N*-.
Recommen2ations for frther st2ies
"acroeconomic determinants of nonperforming loans
!he focus of this study was %an specific determinant of nonperforming loans, it is,
therefore, recommended that a similar study %e conducted on macroeconomic
determinants of nonperforming loans.
*an specific determinants of N2+
In addition, assessing the statistical relationship %etween all %an specific factors and
nonperforming loans in 'enya could %e a future research agenda.
13
7
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&aunders "N', +ewis 2 R !hornhill $. 4BBBJ 'esearch @ethods for Business Students, 4
th

edition. +ondonJ 2renticeA1all
&hofi(ul Islam, "ohammed, Nihil &hil R "annan $%dul. 4B33. NonAperforming
+oansJ Its causes, conse(uence and some learning, $merican International @niversity,
*angladesh, -ast West @niversity, &tamford @niversity.
14
6
$vaila%le at httpJ//www.mpra.u%.muenched.de/<<B=, accessed on 33/B;/4B33.
&trische #. 4BBBJ !he 6uota%le Five )Cs, Bournal of Dending H (redit 'isk
@anagement, =47<8J 9<A9>.
&hu ). 4BB4. !he Impact of "acroeconomic -nvironment on the $sset 6uality of 1ong 'ongKs
*aning &ector. 1ong 'ong "onetary $uthority Research "emorandums.
&iney IF. 4BB4J (ommercial Bank Ainancial @anagement in the Ainancial!Services Industry,
;
th
edition. New IerseyJ 2rentice 1all.
&o%ehart IR, 'eenan &) R &tein R. 4BB5J (omplexities and Galidation of 4efault 'isk @odels.
7In Frontiers in )redit RisJ )oncepts and techni(ues for applied credit ris measurement.8
&ingaporeJ Wiley
&onali $%eyratne, 4BB3 .Banking and 4ebt 'ecovery in <merging @arketsJ The law reform
(ontext, -nglandJ #artmouth pu%lishing )ompany.
&orge ". 4BB9.&tress!esting Financial &ystemsJ $n ,verview of )urrent "ethodologies. *an for International &ettlements, Woring paper, no. 3;:.
&iney, Ioseph. Fowler. R "ary *. Greenwalt. 3>>3. +oanA+oss -xperience and RisA!aing
*ehavior at +arge )ommercial *ans. Bournal of Ainancial Services 'esearch -= ,+!-9.
&trauss $+ R )or%in I". 3>>=J Basic of 1ualitative 'esearch, 4
nd
edition. !housand ,asJ
&age 2u%lications
&wiss National *an. 4BB=. The <mergence of Information Sharing in (redit @arkets. Purich,
&wit?erlandJ &wiss National *an.
!andon )ommittee. 3>>= .TannanIs Banking Daw and ?ractice in India, 3>
th
edition, New
#elhi, India +aw 1ouse, 2. 3B59.
!he World *an, 4B3B. "easuring Financial $ccess around the World, 2olicy
Research Woring 2aper, :4:5
0alde? &. 4BBBJ &n Introduction to Elobal Ainancial @arkets, 5
rd
edition. +ondonJ
"acmillan 2ress +td.
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0alsamais, $.)., 0ivian, R.W. R #u !oit, G.&. 4BB:. 'isk @anagement= managing enterprise
risks. 5
rd
edition. &outh $fricaJ 1einemann 2u%lishers
0ance !#. 4BB9J From "e to .ou, Reflections on a )areer in +ending. The '@& Bournal,
=<798J 5BA5<.
Waweru, N.". R 'alani, 0. ". 4BB>, )ommercial %aning crises in 'enyaJ causes and
remedies, &frican Bournal of &ccounting, -conomic -conomics, Finance and %aning research,
9798J 34A54
Wein%erg, I. $. 3>>:. )ycles in lending standardsQ <conomic 1uarterly, Federal Reserve
*an of Richmond, =3758, 3T3=.
WeiA&hong ,+in 2eter, "ei $l%ert 'uoA)hung. 4BB; !he internal performance measures of
%an lendingJ a valueAadded approach, *enchmaringJ &n International Bournal )+6+7.*/* !
*09
Walter, N. and Werlang, &. 3>>:. Inflationary *ias and &tateAowned Financial Institutions.
Bournal of 4evelopment <conomics, 9<, 35:A:9
14
8
APPEND)HES
4estionnaire 5A//en2iC #6
4AEST)ONNA)RE
"y name is Wondimagegnehu Negera and I am currently woring with the research
component of the "asterCs #egree in *usiness +eadership 7"*+8 at the @niversity of &outh
$fricaCs &chool of *usiness +eadership 7&*+8.
!he purpose of my study is to identify and examine factors affecting Nonperforming loans in
'enya. !o this end, the study intends to gather information from selected credit related
practitioners 7credit managers, analysts, recovery 7monitoring8 officers, credit committee
mem%ers, ris officers etc8 through a self administered (uestionnaire. !he participation is
fully voluntary and responses will %e confidential. !he results will %e also reported without
compromising the anonymity of respondents.
!he (uestionnaire taes a%out 3: minutes to complete. I would appreciate your favora%le
consideration in completing the enclosed (uestionnaire and assisting me in the research
endeavor.
In case you have any (uestions please call B>33:B:5BB or email wondin\yahoo.com.
!han you in advance
Wondimagegnehu Negera
14
9
4AEST)ONNA)RE
72lease tic appropriate %oxes8
SECT)ON ONE I BACK%ROAND )N*OR&AT)ON
1. +or crrent /osition in the Banking in2stry
+oan ,fficer 3 Relationship manager 9
)redit analyst 4 .Recovery/ monitoring officer :
)redit #irector 5 0ice president ;
,ther, please specify ZZZZZZZZZZZZZZZZZZZZZ
2. )n2icate yor eC/erience in the 'anking in2stry
+ess than 3 year 3 ;A3B years 9
3A: years $%ove 3: years 4 :
33A3: years 5
3. )n2icate yor eC/erience in 'ank cre2it /rocesses
+ess than one year 3 ;A3B years 9
3A: years $%ove 3: years 4 :
4.
33A3: years 5
)n2icate o=nershi/ of the Bank yo =ork for
5.
3. 2rivate 4. &tate owned
Determinants of non/erforming (oans are o'1ios.
3. $gree 4. Neutral 5. #isagree
SECT)ON T$O I 4AEST)ONS ON THE DETER&)NANTS O* NON
PER*OR&)N% LOANS
9. $hat 'ank s/ecific factors 2o yo think are casing the occrrence of
non/erforming (oans in Kenyan 'anksJ
15
0
:. P(ease rank the factors that case occrrence of non/erforming (oans in
Kenyan 'anks
N.* Ran the factors in order of their importance in contri%uting to the occurrence of
nonperforming loans from 3A=
*actor that cases occrrence of Rank
non/erforming (oans
#Khighest LL;K(o=est
Rapid +oan growth %y %ans
1igh interest rate
+enient credit terms
)redit culture / ,rientation
&i?e of the *an
2oor monitoring/follow
,wnership type of %an
2oor ris assessment
,thers, 2lease specifyZZZZZZZZZZZZZZZZZZZZ
ZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZ
ZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZZ
151
P(ease in2icate yor 2egree of agreement or 2isagreement to the statements /ertaining
to cre2it assessment an2 the occrrence of NPL
Strong(y Agree Netra( Disagree Strong(y
Agree
5!6
536 576 Disagree
5#6 586
< -asily admitted %orrowers
usually default
= 'now .our )ustomer 7'.)8
policy of %ans lead to high
loans (uality
> Good loan underwriting
ensures loan performance
3B 2oor ris assessment would
lead to loan default
to cre2it monitoring an2 the occrrence of NPL
Agree
5!6 536 576
Disagree
5#6 586
33 &trict monitoring ensures
loan performance
34 2oorly assessed and
advanced loans may
perform well if properly
monitored
35 +oan follow up is directly
related to occurrence of
nonperforming loans
39 *ans with higher %udget
for loan monitoring have
lower non performing
loans
152
to Co((atera( an2 the occrrence of NPL
536
Agree 5!6 576 Disagree
5#6
586
3: )ollaterali?ed loans
perform well
3; )ollaterali?ing loans help
protect loan default
3< "ost of the time non
collaterali?ed loans are
defaulted
P(ease in2icate yor 2egree of agreement or 2isagreement to the statements /ertaining to
'orro=erGs orientation an2 the occrrence of NPL
536
Agree 5!6 576 Disagree
5#6
586
3= *orrowerCs
orientation/culture is
related to loan performance
3> !here is a relationship
%etween loan default and
%orrowerCs culture
4B #efault in some area is
ascri%ed to the culture of
the %orrowers
43 &ocietyCs cultural
development leads to good
loan performance
153
Agree 5#6 5!6 536 576 Disagree586
44 +oans with %ig interest rate
tend to turn to N2+
45 )harging %ig interest rate
leads to loan default
49 +oan price affects loan
performance
4: +enient / lax credit term
cause loan default
4; *orrowers default %ecause
they donCt understand credit
terms well
4< 2oorly negotiated credit
terms lead to loan non
performance
to Cre2it si@e an2 the occrrence of NPL
536
Agree 5#6 5!6 576 Disagree586
4= $ggressive lending leads to
large N2+ volume/ratio
4> *ans whose credit growth
is rapid experience huge
N2+ level
5B *anCs great ris appetite
is cause for N2+
53 )ompromised integrity in
lending leads to loan
default
54 1aving large num%er of
%orrowers causes loan
default
55 +oans default rate is
directly related to %ansC
si?e
59 With growth in %ans si?e
comes growth on N2+
5: +oan default is not related
%ans ownership type
7private/state owned
154
39. )f yo ha1e frther comments on the 'ank s/ecific factors affecting
non/erforming (oans of Kenyan Banks /(ease se the s/ace 'e(o=
-nd of the (uestionnaire
!han you for your participation
15
5
)nstrment for )n>2e/th inter1ie= 5A//en2iC !6
3. &ummary of the respondent profile 7 age, education level, %aning experience,
experience on credit, current status and the related 8
4. 0iews of the respondents on the factors that determine occurrence of nonperforming
loans in general and 'enyan %ans in particular.
5. 0iews of respondents on which factors answered in 64 stand at the top and rating of
the factors thereof in relation to the other.
9. ,pinion of respondents on the impact of the 'enyan *aning context that might
have any %earing on the occurrence of loan default.
:. Recommendation/ if any for mitigating occurrence of nonperforming loans proposed
%y the respondents.
15
6
Assets an2 NPL ratio of Banks Sr1eye2 5A//en2iC 36
Bank> CO&&ERC)AL BANK O* KEN+A
5in mi((ions ETB6
S,N Partic(ar !""8 !""9 !"": !""; !""? !"#"
3 Net deposit 4:,5;< 4=,4=; 54,=<5 5<,;55 95,9=> :;,B:5
4 Net +oan <,:55 <,;:5 =,5 5:,=9> 95,9:; :B,93; :>,933 <9,45B
9 #eposit to loan ratio 5.5< 5.5 4.53 4.3: 4.:5
: N2+ Ratio 4<.:4 44.9: 39.:4 :.55 5. CONSTRACT)ON AND BAS)NESS BANK
5in mi((ions ETB6
S,N Partic(ar !""8 !""9 !"": !""; !""? !"#"
3 Net deposit 3,B:; ><5 3,35; 3,9=> 3,=59 4,5:9
4 Net +oan <9< 3,B9; 3,394 3,4B: 3,5>3 3,::=
5 !otal $sset 3,=54 3,<>< 3,==> 4,5>4 4,:>4 5,3;4
9 #eposit to loan ratio 3.93 B.>5 B.>> 3.49 3.54 3.:3
: N2+ Ratio 4<.<; 3>.94 3<.B; 3:.:; 33.BB ;.:B
Bank> DASHEN BANK
5in mi((ions ETB6
S,N Partic(ar !""8 !""9 !"": !""; !""? !"#"
3 Net deposit 4,=55 5,;>4 9,=;3 ;,3:4 <,>4: 3B,39:
4 Net +oan 4,3;B 5,B=B 5,==> 9,4=B 9,59> 9,>5>
5 !otal $sset 5,94B 9,:9; ;,B93 <,=4> >,<55 34,5:5
9 #eposit to loan ratio 3.53 3.4B 3.4: 3.99 3.=4 4.B:
: N2+ Ratio ;.<4 ;.43 :.>: :.=> <.5 4.>
157
Bank> A$ASH )NTERNAT)ONAL BANK
5in mi((ions ETB6
S,N Partic(ar !""8 !""9 !"": !""; !""? !"#"
3 Net deposit 3,>9B 4,:;< 5,334 5,=;4 ;,3B;
4 Net +oan 3,43B 3,<=B 4,9B5 4,;33 4,:;9 4,>><
5 !otal $sset 4,44; 4,>:9 5,=5B 9,=4B ;,945 <,>9:
9 #eposit to loan ratio 3.;B 3.99 3.5B 3.9= 3.>9 4.B9
: N2+ Ratio 34.B4 >.:; <.5; =.;; : <
Bank> BANK O* AB+SS)N)A
5in mi((ions ETB6
S,N Partic(ar !""8 !""9 !"": !""; !""? !"#"
3 Net deposit 3,;4< 4,3<< 4,<43 5,9<= 9,9>9 :,35>
4 Net +oan 3,3<5 3,>B4 4,3>< 4,:;< 4,995 4,>4B
5 !otal $sset 4,B:< 4,=59 5,5>; 9,4 3.39 3.49 3.5: 3.=9 3.<;
: N2+ Ratio 34.9 9.>9 3B.:9 34.=< :.4: 5.>:
Bank> $E%A%EN BANK
5in mi((ions ETB6
S,N Partic(ar !""8 !""9 !"": !""; !""? !"#"
3 Net deposit 3,4== 3,<<= 4,<49 4,>;; 5,<4= 5,>45
4 Net +oan >:3 3,:3; 4,B;B 4,4B= 3,>=9 4,5<;
5 !otal $sset 3,;3; 4,4:> 5,9=B 9,34: :,33= :,<94
9 #eposit to loan ratio 3.5: 3.3< 3.54 3.59 3.== 3.;:
: N2+ Ratio =.93 9.=: :.4: =.5> <.< 5.:
158
Bank> AN)TED BANK
5in mi((ions ETB6
S,N Partic(ar !""8 !""9 !"": !""; !""? !"#"
3 Net deposit =;> 3,44B 3,:93 4,995 5,;3; 9,<4:
4 Net +oan :<: 3,5;= 3,=3B 4,B=; 4,:3=
5 !otal $sset 3,B<5 3,:>> 4,3=5 5,4:B 9,;:4 :,=>;
9 #eposit to loan ratio 3.:4 3.4: 3.35 3.5: 3.<5 3.==
: N2+ Ratio =.9: 9.3= 9.:> 5.>= 5.<; 5.5:
Bank> COOPERAT)-E BANK O* ORO&)A
5in mi((ions ETB6
S,N Partic(ar !""8 !""9 !"": !""; !""? !"#"
3 Net deposit 3: >= 4<< 9>B <=> 3,5<4
4 Net +oan 5 34; 45; 53= :== <B9
5 !otal $sset 34> 449 949 ;<= 3,B45 3,<;=
9 #eposit to loan ratio :.BB B.<= 3.3< 3.:9 3.59 3.>:
: N2+ Ratio N$ B B.3< 3.B> 4.: <.;4
Bank> N)B )NTERNAT)ONAL BANK
5in mi((ions ETB6
S,N Partic(ar !""8 !""9 !"": !""; !""?
!"#"
3 Net deposit 3,445 3,9:4 3,=<> 4,9;
9,34<
4 Net +oan 3,B=; 3,93= 3,<:: 4,B59 4,33=
4,99<
5 !otal $sset 3,<54 4,B4< 4,;B< 5,;:B 9,=B<
:,><3
9 #eposit to loan ratio 3.35 3.B4 3.B< 3.43 3.:;
3.;>
: N2+ Ratio 33.44 =.9< :.:; ;.<5 39.3
<.9
159
Bank> L)ON )NTERNAT)ONAL BANK
5in mi((ions ETB6
S,N Partic(ar !""8 !""9 !"": !""; !""? !"#"
3 Net deposit N$ N$ 344 5<: <B9 3,B3=
4 Net +oan N$ N$ <9 3=B 9;: :<:
5 !otal $sset N$ N$ 4;; :<9 >:4 3,5;9
9 #eposit to loan ratio N$ N$ 3.;: 4.B= 3.:3 3.<<
: N2+ Ratio N$ N$ B B.33 B.4< ;.:5
Bank> DE-ELOP&ENT BANK O* KEN+A
5in mi((ions ETB6
S,N Partic(ar !""8 !""9 !"": !""; !""? !"#"
3 Net deposit ;=4 ;5; :<: :B4 :34 3,;::
4 Net +oan 5,93B 5,:;4 5,=;< 9,45; :,34< >,94;
5 !otal $sset 9,:9; 9,>:= :,::> :,;:= ;,9B= 3:,4BB
9 #eposit to loan ratio B.4B B.3= B.3: B.34 B.3B B.3=
: N2+ Ratio 53.9 5:.: 5;.5 5<.B9 44.< 33.;<
160

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Determinants of Non Performing Loans

The case of Kenyan Banks

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