Mekelle University

College of Business and Economic

Department of Management

FACTORS DETERMINING LOANS REPAYMENT (In the case of MSEs in Mekelle city
cluster)

A Research Proposal Submitted in Partial Fulfilment of the Requirements for the Master of
Arts degree

In

Business Administration

By

Goitom Berhe Kebebew

Principal Advisor: Doctor Abdulkerim (Phd)

Co- Advisor:

Jan, 2020

Mekelle, Ethiopia
Declaration
I hereby declare that the research proposal entitled as ‘Factors determining loans
repayment in the case of MSEs in Mekelle city’ is approved to be my own work that
was under taken under close supervision of both my principal and co-advisors.
Accordingly I would like to justify that this material was my own work and not
presented or submitted by nobody else for any degree, diploma or fellow ship in other
university and all the materials used for the purpose of developing this proposal have
been duly acknowledged.

Name of the student Signature Date

_______________________ __________________ __________

Name of Principal Advisor Signature Date

_______________________ ___________ ________________

Name of Co- Advisor Signature Date

_____________________ _________________ _________________

Department Signature Date

____________________ _______________ _________________

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Table of contents

CHAPTER ONE ..................................................................................................................................... 1

Introduction ............................................................................................................................................. 1
1.1 Background of the Study .............................................................................................................. 1
1.2 Statement of the Problem......................................................................................................... 5
1.3 Research Questions ....................................................................................................................... 8
1.4 Objectives of the Study ................................................................................................................. 8
1.4.1 General objective ................................................................................................................... 8
1.4.2 Specific Objectives ................................................................................................................ 8
1.5 Significance of the Study .............................................................................................................. 8
1.6 Scope and Limitation of the study ....................................................................................... 9
1.6.1 Scope of the Study ................................................................................................................. 9
1.6.2 Limitation of the Study .......................................................................................................... 9
1.7 Organization of the Study ............................................................................................................. 9
CHAPTER TWO .................................................................................................................................. 10
RELATED RLITERARURE REVIEW ............................................................................................... 10
2. 1 Introduction of the Related Review of Literature ...................................................................... 10
2.2 Definition of Concepts ................................................................................................................ 10
2.3.2 Game Theory of Microfinance ............................................................................................. 13
2.3.3 Financial Sustainability Theory ........................................................................................... 14
2.3.4.2. Determining Factors of MSEs Repayment Performance ..................................................... 18
2.3.4.2.3. Lending Rates ............................................................................................................... 19
2.3.4.2.4 Age of a Firm ................................................................................................................. 19
2.3.4.2.6 Gross Domestic Product................................................................................................. 19
2.4 Empirical Review........................................................................................................................ 20
2.4.2. Empirical Studies in Ethiopian ............................................................................................... 23
CHAPTER THREE .............................................................................................................................. 28
3.8. Data analysis ..................................................................................................................... 33
3.9 Research Validity and Reliability ............................................................................................... 34
3.10 Ethical Considerations .............................................................................................................. 34
3.11. Work Plan. ............................................................................................................................ 35
3.12. Budget breakdown ................................................................................................................ 36

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List of Tables

Table 3.1: Variable Name and measurement………………………………………….32

Table 3.11.1: - Work Plan ……………………………………………………………35

Table 3.12.1: - Supply and Service Expenses ………………………………………..36

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List of Figures

Figure 2:1 Conceptual Framework……………………………………………………27

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Acronyms
ANOVA- Analysis of covariance

CSA- Central statistics agency

DECSI- Dedebit Credit and saving Institution

ILo- International labor organization

MFI- Micro finance institutions

MSEs- Medium and small enterprises

NCBD- Nairobi central bank district

NGOs- None governmental organization

OCSSCO- Oromia credit and saving institution share company

PAWDEP- Poverty reduction and women development empower program

SBP- Sustain able bank project

SPSS- Statistics package social science

SMEs- Small micro enterprise

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CHAPTER ONE

Introduction

1.1 Background of the Study

In the recent decades, Microfinance Institutions are well recognized at worldwide level that
they are very crucial for effective ways of ensuring program implementation through the
provision of finance to micro and small enterprises. The main focus of microfinance
institution is on presenting sufficient loans for micro and small business sector as this is
sector being considered as central components of economic growth and a significant
constituent in the effort to liberate countries from poverty or elevate nations’ development
(Wolfenson, 2007). (Okumadewa, 1998). According to Chossudovsky (1998), the World
Bank Sustainable Banking with the Poor project (SBP) in mid-1996 estimated that there were
more than 1,000 microfinance institutions in over 100 countries, each having a minimum of
1,000 members and with 3 years of experience. In view of this, we can understand that
microfinance institutions are indispensable since they encourage micro and small enterprises
to be flourished throughout a nation by creating a fertile ground and providing sufficient
loans. This in turn creates a wide range of employment opportunity for the youth.
Consequently, there will be a stable development peace and security within a nation.

In line with this point, the roles of microfinance institution may not be restricted only on the
provision of loans to small and micro enterprises, SMEs, groups and individuals but also
gives other financial services such as savings, insurance, and investment guidance including
training program to its customers. Therefore, micro and small business sector is a vital
component to contribute to the transition of industrialization through innovation and
creativity and saving as well (Wolfeson, 2007). The major roles of medium and small
enterprises (MSEs) in developing countries are playing as engines for national economic
growth in developing countries. It is estimated that MSEs’ employ 22% of the adult
population in developing countries (Fisseha, 2006). According to (ILO, 2008), the MSE
sector in developing countries has been helpful in taking about economic transition by
providing goods and services, which are of adequate quality and are reasonably priced, to a
large number of people, and by effectively using the skills and talents of a large number
of people without demanding high-level training, large sums of capital or sophisticated
technology. Similarly, Lara and Simeon (2009) reviewed that the MSE sector creates

1
adequate employment and economic output in many countries. Their share of general
employment tends to be higher in developing countries, which are basically more
concentrated on small-scale production. Despite their potential to improve economic growth,
MSEs in developing countries lack serious attention. They produce largely for the low
income group and employ lower levels of techniques. Many of them are self-employed type
with a low transformation rate into higher size categories and their innovative activities are
inadequate (Gebreeyesus, 2009).

In Kenya, the small and medium enterprises are essentials like many other developing
countries as they employ 85% of the Kenyan workforce. For this reason, the Kenyan
constitution provides a new opportunity to address SMEs related issues through regulatory
and institutional reforms under a new, devolved governance system as well as the Micro and
Small Enterprises Act 2012 (Ong’oloand Odhiambo, 2013). Small and medium enterprises
(SMEs) play a major role in economic development in every country, including in
African countries particularly in Kenya.

The importance contribution of medium and small enterprises also observed to strengthen the
Ethiopian economic plan and open employment opportunities for the adult population. ,
According to the Central Statistics Agency Report of the year 2002 in Ethiopia, there were
974,676 micro and 31,863 small enterprises generating a means of livelihood for about 1.3
million people. Another study conducted in 2003 also reveals that 1863 MSEs had
created employment opportunities for about 97,782 citizens’(CSA, 2008).

The potential of medium and small enterprises (MSEs) is obviously encouraging to improve
economic growth in developing countries; however, they lack serious attention. They
produce largely for the low income group and employ lower levels of techniques. Many
of them are self-employed type with a low transformation rate into higher size categories and
their innovative activities are inadequate (Gebreeyesus, 2009).

In addition, the financial institutions could not provide and deliver adequate credit and
other financial services to the SME sector in the expected way(Chepkorir, 2013).
Regrettably, one of the most crucial and leading factors constraining Small Scale
Enterprises Development in developing countries like Kenya is limited access to financial
capital and credit. This is because on one hand, these enterprises could not fulfill the bans
lending requirements and on the other, financial institutions mostly commercial banks
considers these enterprises as involving high credit risk (Kiliswa, 2012). According to

2
Nene (2014) the main reason for failure of credit repayment by small and medium
enterprises in Kenya is due to loans given out without any form of security to clients and lack
of structure where funds are well projected over the period of repayment and portion money
for such repayments.

However, having their contribution to employment in mind, according to Yordanos,

Gebrehiwot and Wolday (2006), CSA(1995/2003), more than 11,000 MSEs were surveyed
and about 65% of them admitted having main constraints like lack of working space for
production and marketing, shortage of credit and finance, regulatory problems (licensing,
organizing, illegal business), poor production techniques, input access constraints, lack of
information, inadequate management and business skill, absence of appropriate strategy, lack
of skilled manpower, low level of awareness of MSE’s as job area, low level of provision
and interest for trainings and workshops are factors that contribute for the low level
performance and failure for MSEs as compared to other developing nations. In addition
to this studies, Ethiopia as one of sub-Saharan developing countries has also
confronted with several factors that affect the performance of MSEs. The major factors
include financial problems, lack of qualified employees, lack of financial records,
marketing problems and lack of work premises, etc. Besides, environmental factors affect the
business which includes social, economic, cultural, political, legal and technological factors.
In addition there are also personal attitudes or internal factors that affect the performance of
MSE which are related to the person’s individual attitude, training and technological
knowhow (Woretaw 2010).

The overall growth of microfinance institutions may severely affect due to the ineffectiveness
of repayment. In this case, many medium and small enterprises may not repay the money
they borrowed from the financial institutions on the scheduled time. Consequently, these
financial institutions could not strong enough to save capital which in turn seriously affects
the development of medium and small business sectors since they are interwoven.

When we look into the work of many scholars, several factors have been identified such as
interest rates, age, marital status, location, high interest rate, inadequate loan sizes, poor
appraisal, lack of monitoring, and improper client selection are said to impact on the
likelihood of default. However, according to Atsmegiorgis (2013) the factors affecting
repayment performance can be grouped into four factors namely individual/borrowers
factors, firm factors, loan factors and institutional/lender factors. According to Nawai

3
and Shariff (2010), the underlying repayment factors can be also basically classified under
four headings, namely, individual/borrower, firm, institutional/lender, and loan
characteristics affecting repayment performance. Equally, an alternative classification by
Roslan and Karim (2009) identified three broad categories as characteristics of the
borrower, characteristics of the firm, and attribute of the loan. Individual/borrower’s
characteristics include the age of borrower, gender, level of education, business
experience, household size, credit use experience, household income, non- business
income, type of business activity, and amount of business investment (Nawai and Shariff,
2010). Several studies have established the impact of individual factors on loan
repayment. For instance, Nawai and Shariff (2013) established that the factors affecting
the ability of the borrowers to repay their loans are business factors, borrower’s attitude
towards their loans, other debt burden, amount of loan received, business experience,
business formality and family background. A study by Ochung (2013) established that
there was a significant relationship between individual borrowers’ factors and the loan
repayment among customers of commercial banks in Kenya. Further, Njangiru, Maingi
and Muathe (2014) also revealed statistically significant results, for borrowers’
characteristics effect to loan repayment and sustainability. As such, the study established
that due to problems of high risk and high cost of borrowing, uncertainty of repayment
capacity on the rural borrower has been reported high due to irregular income streams. Loan
characteristics include the loan size, repayment period, collateral value, number of
installments, and application costs among others. Past studies have established the influence
of loan factors on loan repayment (Nawai and Shariff, 2010). Atsmegiorgis (2013) revealed
that the loan repayment rate was significantly related with loan size, loan type, and
previous loan experience, purpose of loan, educational level and type of collateral
offered. The study recommended that commercial banks should design loan strategies
giving particular emphasis on these factors while they are giving loans to their
customers. However, most of the time commercial Banks could not be seen in taking risks to
lend money to small and micro enterprises’ owners. In addition, Kibosia (2012) established
that loan defaults by SMEs has significantly been increasing and a number of
determinants affected the loan defaults key among them interest rates, type of loan,
repayment period and economic conditions have also contributed to loan defaults by SMEs.
Firm/Enterprise characteristics are the firm specific factors that influence loan
repayment by small and medium enterprises. Some of the characteristics of the firm/project
include ownership structure, type of firm, and distance between firm location and the

4
lending microfinance institution (Nawai and Shariff, 2010). Kohansal and Manosoori,
(2009) established that the amount of loan approved or received, that is loan size, could have
a positive effect on repayment performance. A study by Ochung (2013) established a
significant relationship between firm/group factors and the loan repayment among
customers of commercial banks in Kenya. Lender/Institutional characteristics are the
factors within the financial institution that may influence loan repayment.
Institutional/lender factors include the time lag between loan application and
disbursement, interest rate, access to business information, access to training on loan use,
cooperative membership and penalty for lateness to group meetings (Nawai and
Shariff, 2010).A study by Kibosia (2012) established that poor credit analysis and
monitoring and economic conditions also contributed to loan defaults by SMEs hence banks
should put more emphasis on credit risk management, training of staff and adopt credit
scoring in selection of SME customers loan requests. Korankye (2014) also established
that the causes of loan default to included inadequate loan sizes, poor appraisal, lack of
monitoring, and improper client selection and recommended that financial institutions should
have clear and effective credit policies and procedures and must be regularly reviewed.
Therefore, if customers are not able to repay the amount of money they borrowed, definitely,
they severely affect the development of financial institutions. This situation also negatively
affect business sector and worsen the living condition of the poor people. So it is very
essential working in this area to find out some solutions.

1.2 Statement of the Problem

The stable development of microfinance institutions depends largely on their ability to collect
their loans as efficiently and effectively as possible. In other words to be financially viable or
sustainable, microfinance institutions must ensure high portfolio quality based on 100%
repayment ,or at worst low delinquency/default, cost recovery and efficient lending.
However of late, there have been complains by the microfinance institutions regarding
high rate of default/delinquency by their clients; which presupposes that most microfinance
institutions are not achieving the internationally accepted standard portfolio at risk of 3%,
which is a cause for concern because of its consequences on businesses, individuals, and
the economy of Ghana at large. Delinquency and hence default have started creeping
deeply into the operations of microfinance institutions in Ghana hence the study into
the causes and control of loan delinquency/default in micro finance institutions in Ghana.

5
In the current time, unemployed youth population increases from time to time due to the
newly graduates of university students and displacement of people from other regions of the
country. In addition, so many students graduate from many technical and vocational training
institutions every year. All these graduated students and displaced people could not get job
opportunities unless they engage in small business by giving due consideration to their
specialization or business interest and organizing them in the form of cooperatives. Due to
this reason, many youth people have no job opportunities since the economic capacity of the
Tigray region in general and Mekelle city in particular could not absorb all these unemployed
population. This situation also aggravates the immigration of youth from the rural dwellers.
For this reason, organizing the youth population into small and micro enterprises based on its
field of study or its business inclination is essential to reduce the problem. In fact, the
regional government has exerted its effort to organize small and micro enterprises help them
to get financial access through microfinance institutions. Although this sever poverty
problems minimized to some extent in the recent years, still it is prevalent the poor living
condition of the people. As a result, the small business sector could not show a significant
level of development and create more job opportunities for the youths.

This problem emanates from poor support system of small business sector and lack of
awareness and training of the people. In addition, the loan procedure is not encouraging and
the customers are not motivated to borrow money and carry out their own business.
Therefore, to liberate these people from the subsistence means of living, there is a need to
encourage investments at macro level in general and at micro level in particular. To address
the poverty reduction throughout the region, it requires raising the income of per household.
Otherwise, it is difficult to improve the standard living of our people and encourage
innovations in the business activities.

Thus, one of the weapons used to fight poverty reduction is to establish micro loans and
implementing in an effective way. To improve this situation, Micro finance Institutions
supports small business, the poor and household who have no access to capital due to the
formal loan bureaucratic procedures practiced in Commercial and Development Banks. In
addition, these big financial institutions have limitations in terms of scope, for example, the
poor youth population who have no fixed assets for collateral agreement.

Professor Muhammad Yunus advises that the contribution of microfinance institutions to the
development of small business firms is unquestionable. The concept of microloans was

6
mainly introduced more than three decades ago in Bangladesh by the Nobel Prize winner
Professor Muhammad Yunus. He commenced Grameen Bank with the aim of reducing
poverty by providing small loans to the country’s poor people who reside in the country side
and to those who had little or no access to capital from financial institutions In line with this
view, initiating microloans throughout the Tigray Regional State is vital to promote small
business activities and make basic financial services accessible to low- income producers
residing in both rural and urban areas since it helps them as components of promoting efforts
and economic growth which leads them to improve their standard ways of life. Investment is
not only the core economic development and poverty reduction, but also an elevator of
innovation and creativity. However, investment needs a source of finance which this can be
obtained from financial loans (WorldBank, 2000).

From this perspective, microloan institutions have pivotal roles in encouraging and
stimulating investments and small business firms and cooperatives by offering financial
credit services. This in turn, paves away for the development and poverty reduction in a
society; in the case of Tigray region and the whole country as well.

In this case, when the microloan institutions facilitate financial credits, it should not be seen
in a single dimension only. Rather, they are seen in multi dimensions as they reduce
unemployment rates, particularly among youths, contribute towards job creation and
provision of low cost goods and services.

In addition, the high growth of investment and economic development enable the
government to collect more revenues. Using the collected revenues, the government can build
infrastructures that attract investment. The expansions of infrastructures in turn have direct
impact on the strengthening of microfinance institutions. These again basically contribute
towards the 2025 nation’s vision that is to place the country in the queue of middle income
countries.

However, the establishment of microloan institutions it is not enough if these institutions are
not effective in assuring profitability and financial effectiveness. So, the microfinance in
Tigray is expected to address the failure of repayment in order to promote itself and the small
business sector and encourage the poor people in improving the economic situation. Related
issues have been studied in Addis Abeba context on the area of use of technology and
consultancy, and establishing good systems to maintain the growth of microfinance
institutions. There is also a study that shows the impact of failure repayments upon the

7
institution. Therefore, this study tries to concentrate on factors determining loans repayment
of Medium and Small Enterprises in the context of Mekelle City

1.3 Research Questions

 What are the borrower’s factors that impede loan repayment rates?

 What are the factors that contribute to the performance of microfinance institutions to
collect repayment rates?

 What are the socio-cultural factors that are related to the impact of loan repayment
rates?

1.4 Objectives of the Study

1.4.1 General objective

Any nation in general and members of a community in a particular seek ways of liberating
from poverty and improve progressively their standard of life. In line with this point, the
general objective of the study is to analyze the key factors affecting clients to repay their
loans and detect main challenges of the institution to collect the money they lent.

1.4.2 Specific Objectives

The study focuses on the following specific objectives:

 Identifying the of borrower’s factors that affect loan repayment rates

 Detecting factors that contribute to the performance of finance institution to collect

repayment rates

 Analyzing and identifying socio-cultural factors related with the impact of loan
repayment rates

1.5 Significance of the Study

It is obvious the necessity of microfinance institutions in strengthening small and micro
enterprises in the business world. They have the lion’s share in presenting adequate loans to
the poor people, providing consultation and training to the people who are engaged in the
sector. By doing so, they greatly contribute to poverty reduction through creation of job
opportunities to the youth population. However, there are various factors that make
demanding the performance of the microfinance institutions and the small and micro
enterprises as well. From this point of view, identifying and analyzing factors that affect the
performance of both the microfinance institutions and borrower is crucial to find solutions

8
and improve the situation in a sustainable way. So, the study has significance contribute to
provide evidence for better understanding and awareness on both the microfinance
institutions and borrowers’ repayment rates. In addition, it provides useful and current
information regarding this business area that help policy makers to review the existing
policies and correct it effectively. Moreover, it enriches the existing literature related to this
issue.

1.6 Scope and Limitation of the study

1.6.1 Scope of the Study

There are tremendous factors that affect the development of microfinance institutions and
borrowers who are engaged in small and micro enterprises. For this reason, it is very
important to delimit the study in terms of title and spatial context to make it manageable.
Consequently, the study is delimited to determining factors repayment loans in Mekelle
City.

1.6.2 Limitation of the Study

The limitation is mostly encountered at the end of the research will be evaluated specially I
have time constraints and work load in my office.

1.7 Organization of the Study

The study is organized in five chapters. The first parts presents chapter one; which consists
background, statement, objectives, key questions, scope, limitation and organization of the
study. The second chapter deals with the relevant literatures that explore world experiences
and review the work of scholars in the study area. The third chapter shows the methodology
of the study. The fourth chapter presents the analysis and interpretation of the collected data.
The final chapter indicates the major findings, summary and recommendations.

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CHAPTER TWO

RELATED RLITERARURE REVIEW

2. 1 Introduction of the Related Review of Literature

This part deals with definition of concepts, historical development of microfinance

institutions, theories, conceptual frame works and factors that influence the effectiveness of
repayment loans. In addition, it overviews the empirical studies of both internationally and
locally related to factors that could determine repayment loans.

2.2 Definition of Concepts

Theoretical Framework is important so as to lay down the frame of study. In this case,
Liberalization theory has been integrated with study as liberalization theory demand-
following and finance extends as economy grows. The Game theory also relates with action
of customers and in groups. A customer acts individually but he/she has group responsibility.
When we define financial sustainability, it is the provision of finance for customers in a
sustainable way to ensure the growth of both the customer and the financial institutions. So,
this theory helps to maintain the economy, social and natural environment for investment.

2.3. Historical Development of Microfinance Institutions

Microfinance is a new business area which is evolved from project related work done by NGOs. They
also developed in the form of formal, informal and semi-formal finance institutions (World Bank,
2002). The definition of microfinance institutions that was coined by some authors and
organizations are apparently different from one another. However the essence of the
definition is usually the same in which micro finance refers to the provision of financial
services primarily savings and credit to the poor and low income households that do not have
access to commercial banks (Arsyad, 2005).Legerwood (1999) defines it as the provision of
financial services (generally saving and credit) to low income clients. Robinson (2001)
defines it as small scale financial services primarily credit and saving provided to people who
farm or fish or herd, who operate medium and small enterprises or microenterprises where
goods are produced, recycled, repaired or sold; who provide services; who work for wage and
commission; who gain income from renting out small amount of land, vehicles, draft
Animals, or machinery tools; and other individual and groups at the local level of developing

10
countries both rural and urban area. Microfinance institutions consist of agents and
organizations that engage in relatively small financial transactions using specialized,
character "based methodologies to serve low " income households, micro" enterprises, small
farmers, and others who lack access to the banking system. They may be informal, semi
"formal (that is, legally registered but not under central bank regulation), or formal financial
intermediaries. The Bank's strategy emphasizes incorporating these activities into countries'
financial development 9 strategies to expand the scope and raise the efficiency of financial
intermediation. The intention is to ensure that access to financial services by poor
households, micro-entrepreneurs, women, a nd farm households improves sustain ably over
time, rather than on a one-time project basis (Pitamber, 2003). The above argument implies
that traditional banking sector cannot reach millions of poor for whom small loans could
make huge differences. There are several reasons for this. Most of the poor live in rural which
have much dispersed settlements. They have low education levels, if at all. As a result,
administrative cost of supplying loans to the poor population is extremely high. Another issue
that makes it difficult to serve these customers through traditional banking is that the poor do
not have any assets to use as collateral. As a result, the poor had access to loans only through
local money lenders at exorbitantly high interest rates. As Helms (2006) indicated, during the
micro credit era of the 1970s the goal was to put these 'moneylenders' out of business because
they often charges in excess of 10 percent per month on their lo a ns. Originally when
financing the poor was referred to microcredit in the 1970s, the informal institutions were
rarely regulated and the borrowers could use their funds for whatever nee d they sought. This
meant that moneylenders or pawnbrokers were the dominant source of capital for villages.
Some of the time, the loan was used for a micro enterprise much like how micro finance is
used today. However, micro credit was also used for other reasons like school fees, health
care, or food. Today, money lenders are used for the same purpose and are supported by the
financial systems approach mentioned previously but are simply providing loans for credit
needs. Modern micro finance is a n approach in addition to informal lending that operates as
a source of funds focused on micro enterprise with the objective that people create a good or
service that will allow them to repay the loan. Microfinance has broadened the breadth of
microcredit in that MF is provided services. Usually these include savings, insurance, and
housing loans.

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2.3.1 The Finance Liberalization Theory
The origin of financial liberalization theory dates back to the influential paper of McKinnon
(1973) and Shaw (1973). Sometimes, this paper referred to as McKinnon and Shaw or
Financial Repression Theory. The theory proposes two way of evaluating the tie between
finance and development. One of the ways is “demand-following” and this happens when
finance extends as economy grows (Ahmed, Abdullahi, Islamand Sardar 2009); the other is
“supply leading” and help growth of firm allows to its financial expansion. Reinhart, Ostry,
Jonathan and Carmen (2003), explains that financial liberalization improves the rate of
growth as interest rates move towards market average value, and resources are properly
utilized. Consequently, removing controls on interest rates and letting interest rise could
inspire increased saving rates. On the one hand, the assumption that increased savings leads
to reduced interest rates. On the other hand, increased rates are expected to raise financial
intervention (Reinhart et al., 2003). Rigorously, with the above assumptions, it is probable
that financial liberalization produces increased savings which ultimately increases economic
development through allowing efficient financial allocations and investment quality. Exerting
effort to adopt policies of financial liberalization theory will lead to improved productivity
and boost growth in the economy. Ahmed et al., (2009) states that designing strategies based
on this assumption is central to increase savings. The increased savings of investors in turn
lowers the interest rates. The scheme here is that interest rates are retained below the market
rates under the repressed financial system with the purpose to achieve sufficient capital for
SMEs. The result is that there will lead to improved productivity and boost growth in the
economy. The suggestion here is that interest rates are retained below the market rates under
the curbed financial system with the purpose to achieve sufficient capital for SMEs. The
result is that there will be reduced investment and savings leading to increased discrepancy
among borrowing and SME's rates, and this can lead to low business. However, Ahmed et al.
(2009) state that financial liberalization is expected to take remedial measures upon the
aforementioned disparities by letting market determination of all SME’s interest rates and
stabilization of inflation. This research considers this theory crucial since it also leads to
increased efficiency and improved performance of the investment. It is through financial
liberalization that SMEs can initiate various mechanism to ensure that there is sufficient flow
of credits to borrows and creditors (SMEs) as well and get optimal value for their
investments (Ahmed et al., 2009). Among the measures include quantifiable credit strategies,
the concessional interest rate to specific SMEs, restricted liquidities and cash reserve ratios.

12
Financial liberalization also entails removing all non-market strategies of interest rate control,
leaving market system pricing and fund allocations. The economic reforms enacted through
financial liberalization improve the investment effectiveness via the efficient use of available
resources, and this ultimately boosts the performance of SMEs.
2.3.2 Game Theory of Microfinance

As Avinash Dixit and Nalebuff (2008) indicates the pioneer of game theory was Prince to
Mathematician called Neumann. In its starting stages, the emphasis was placed on games of
pure conflict. The contrary was regarded as a cooperative one and the participants were
required to select and jointly enact their own actions. Nevertheless, Avinash Dixit and
Nalebuff (2008) affirm that recent research has discovered game theory is not based on
cooperation. The views of these authors with regard to these games is that the participants are
just responsible for their actions which they take actions individually, but their connections to
other members in the group involve elements of both competition and cooperation. The game
theory of finance supports the idea of group lending among small, medium enterprises.
According to this theory, Mbithe (2013) maintains that various mechanisms depend on group
borrowers to cooperatively regulate and enforce contracts themselves. This theory is based on
Grameen lending model that is founded on group (peer pressure) in which credits are given to
groups of between four to seven members. The member of a particular group jointly
guarantee their fellow members’ loan settlements and access to succeeding credit facilities
base on successful repayments by all members of the group (Mbithe, 2013). The lending
model supports weekly repayments. The model assumes that the team is efficient in
discouraging loan nonpayers as revealed by the low rates of absentees in companies like
Grameen Bank,which employ this model. So, the game theory is used in this research as it is
helpful to arrange mutual trust among the entire group. Game theory issued in understanding
how group borrowers play microfinance game with creditors for example SMEs. From the
theoretical point of view, the starting positive outcome from group lending experience is
mystifying. Yunus (1998) describes group lending as defenseless from danger moral
problems. Particular, he highlights the possibility of the existence of free-riding by particular
individuals and possibility of collusion behavior by the entire group against the creditor.
Additionally, Ledge wood (1999) also states that the group typically becomes a building
block for the bigger social network. Though Grubes (2005) contradicts the theory to have a
lot of riding and collisions, and various efficiencies, the fact that the theory has been
successfully applied in different organizations makes it reliable and thus its applicability.

13
2.3.3 Financial Sustainability Theory

Sustainability refers to operations that build and maintain sustainable economic, social and
natural environments. Thus, the concept of sustainability links to the economic performance
of an organization, to the health of employees and to the stock of natural resources in the long
term (Dunphyet, 2003). SME that supports these three principles is termed sustainable
organization. Economic sustainability implies the application of various organizational
strategies that lead to utilization of available resources to the best advantage. This is done in
the most efficient responsible way in order to ensure long-term benefits (Grant, 2009).

Financial sustainability of SMEs and organizations in other sectors is doubtless the key
dimensions of microfinance sustainability. Due to its significance in micro economic
performance, most often, in microfinance the term “financial sustainability” has been used to
define organizational sustainability. It can be measured using two stages: financial self-
sufficiency and operational sustainability of the SME. Operational Sustainability is the ability
for an organization to support all its operations using the generated income (Thapa,
Chalmers, Taylor and Conroy, 1992). Self-sufficient is the ability for the organization to cater
for their individual generated income, financing and operating and other forms of subsidy
valued at market price. That is, its ability to cover its costs suppose its activities are not
funded and suppose it raised funds at commercial rates (Balkenhol, 2007). The ability for an
organization to sustain itself in a long-term is essential for SMEs to reach their clients and
also to be able to have sufficient funds to take care of operational costs (Wells, 2010). Even
though SMEs should have the objective to reach poverty-stricken and poor communities, the
ability for them to remain sustainable should be their first priority. The sustainability for the
SMEs has external and internal implications. The financial sustainability theory is applicable
in this research in two key areas. The first area is to help the researcher focus on human
sustainability (Dunphy, 2003). Any SME can achieve this by setting up a system for
providing continuous services to the target group. Secondly, the theory is applicable in
manifesting principles of sustainability by focusing on the economic sustainability of SME
(Dunphy, 2003).

This involves ensuring that SME’s capital used as inputs are economically recycled.
SME upholding this principle becomes an active promoter of ecological sustainability values.

14
2.3.4. The Importance of Microfinance Institutions’ for Development

The theorist Lysander Spooner was stated that the historical initiation of Micro financing
service was traced back in the middle of 1800s. Consequently he wrote the impact of the
credit schemes on the target entrepreneurs and farmers while targeting the poor peoples to get
out of the poverty. Meanwhile, the modern industry of microfinance service has been
initiated since 1970 by Grameen Bank of Bangladish and pioneer Mohammed Yunus. Shore
bank was the first microfinance and community development bank founded 1974 in Chicago.
According to Prof. Mohammed Yunus and Grameen Banks phrases, an improvement in the
economy and social welfare could partly realized through delivering micro-credits to the poor
people (Microfinance and Micro-credit, 2016). HorKimsay (2011) reported that microfinance
institutions were established originally as anon-for- profit making financial schemes that had
particularly serves the poor (low-income groups of the society) at rural areas. As it was
reported on this module, through time it was believed by some peoples in Cambodia that
serving those poor peoples as non-profit making institute has its own impact on the financial
sustainability of these MFIs to realize that the services would address a wide range of poor
peoples in the country. As a result MFIs in the Cambodia has reviewed their credit scheme
and tried to marginalize the services by commercializing their credit schemes at lower
interest rates than commercial banks. The reason for transforming the MFIs service into
commercial is to bring the transparency of the financial services, increasing the confidence of
donors and investors and to ensure that MFIs are financially sustainable to serve wide range
of poor societies which demands financial services. Moreover, the author stated that the
average loan sizes of MFIs were steadily increased from time to time based on the repayment
experience of borrowers. However through periods an increase in number of clients served
and average loan sizes experiences some defaulted loans over couple of few years that leads
the microfinance practitioners to review their implementation mechanisms and needs of new
credit assessment methodologies that emphasizes on the micro and small scale Enterprises
(MSE). The assessment was focused on the cash flow assessment of borrowers rather than the
collateral requirements which may fulfill the needs of MSE‟s. An increase in the average
loan size and change of loan approach to MSEs was the result of the increased capacity of
lending larger loan size by MFIs (HorKimsay, 2011). Microfinance institutions in developing
countries have a great contribution in reducing poverty. It has been proved that microfinance
service can be viewed as a developmental strategy implementer that intended to empower
poor women entrepreneurs, to initiate their businesses and providing them awareness on how

15
to manage their assets and its related risks (Abdulfettah, 2013). Furthermore, the availability
of these micro-credits schemes and other financial schemes increases the number of enabled
young poor groups which have been organized in the form of micro & small scale enterprises.
This in turn will creates a great employment opportunities for the poor young societies which
have been lacked with financial sources at national level (Abdulfattah, 2013).
Alemayehu (2008) argued that microfinances are considered as a chance for the poor peoples
to promote self-employment through credit and saving service delivery. Microfinances have
been established to support the low income groups of societies by enabling them finance their
start-up businesses and expansion of their low scaled income generating activities.
Moreover, people living in poverty, like in Ethiopia, need a wide range of financial services
for consumption smoothing, running their business and building assets. But due to collateral
13 requirement problems, poor people in most cases have no credit access from formal
financial institutes (Fikirte, 2011). The banking requirements of high collateral valued assets
or material guarantee and intrinsic banking procedures are among the most difficulty cases
that the poor cannot deal with. On the other hand, the volume of loan demanded by small
farmers/poor is not appealing to the bank being there is an assumption that transactions are
costly for small amount (Alemayehu, 2008). Furthermore, some theoretical frameworks also
noted that unlike those microfinance institutions, either government owned or private owned
commercial banks are not willing to serve the poor/low-income group peoples by providing
small financial services due to the fact that their requirements of collaterals. (Yunus, 1994) In
contrast, all microfinance institutions are intended to provide financial services in the absence
of any collateral values unlike the formal commercial banks by delivering various
microfinance schemes such as; micro credits, saving mobilization and provision of insurance
schemes to the poor. The major objectives of these microfinance services are to strengthening
the economic bases of the low-income generating activities of the poor peoples who are
living in the rural and urban areas of the country (Fikirte, 2011).
2.3. 4.1. Loan Repayment Performance of borrowers
According to various researchers, microfinance institutions loan repayment performances can
be influenced by a number of factors identified as borrowers’ characteristics and lenders
lending characteristics. The lending approaches of microfinances can be classified as group
based approach and individual-based approach. A common characteristic of group lending
approach is that the group obtains the loan under joint liability, where each member in a
group is responsible for repayment of loans of his or her peers. Screening of the viable loan

16
applicants, monitoring the individual borrowers’ efforts and enforcing repayment of their
peers‟ loan among the members are listed as the major characteristics of group-based lending
approaches (Zeller, 1996 as cited in Abafita, 2003) Group lending approaches creates better
information on borrowers efforts in settling the loan obligations and have better monitoring
advantages among the members than that of 14 individual borrowers. Members can get
important information like reputation, indebtedness and asset ownership of the loan
applicants at a lower cost. They can also easily monitor individual efforts made towards
ensuring repayment. Moreover, group members appeared to be in a better position to assess
the reason for default and inform to the lending institutes for the shocking experience
exercised by the members which seems beyond their control (Zeller, 1996 as cited in Abafita,
2003). Individuals are supposed to select those whom they trust to form a group with; that is
they are more interested to form group with those whom can make regular repayments and
have a good concern about the possible loss they face in case of non-repayments (Abafita,
2003). In most of the cases, in group-lending approaches the functions of screening,
monitoring and enforcement of repayments are mainly endorsed to the group members than
the lending institutes (Abafita, 2003). Furthermore, in addition to the above benefits from
group-based lending approach, commitment of the borrower to feel indebtedness to the
obligation they entered into is an exemplified character of borrowers for on-time loan
repayment performances (Florence & Daniel, 2014). On the other hand, individual based
lending approach is the other approach that loan contract obligation is endorsed only to the
single individual borrower. According to Reikne (1996) cited in Abafita, 2003), individual
based lending approach may have better repayment performance than that of the group
lending approach. This is due to the possible existence of fragmented geographical locations
and high market share competitions among the group members which in turn affects mutual
indebtedness. Besides, borrowers‟ characteristic that is the ability to repay the loan on- time
can be determined by: 1) the willingness of borrower to repay the loan, 2) capacity (how
much debt a borrower can handle) and 3) the cumulative capital (Assets) owned by the
borrower. Before delivering credit service, identifying and analyzing the characteristics of the
borrowers is an important issues to be considered by the credit managers to judge whether the
borrowers exerts the lowest efforts to honor the credit obligations (Florence & Daniel, 2014).
Repayment performance of borrowers can be affected due to various factors. An economic
theory suggests that a flexible repayment schedule set by the lending institutes can benefits 15
borrowers and potentially enhances their capacity of repaying their debts. On the contrary,
MFIs practitioners believed that high repayment recovery rate can be realized through

17
maintaining the regular repayment time schedules (Abdulfettah Bouri, 2013, Armendariz and
Morduch, 2000 and Morduch, 1999) According to Bayang (2009 cited in Florence & Daniel,
2014), lack of sufficient monitoring and reporting to ensure whether funds are utilized for the
intended purposes are another possible factors that determines repayment coverage.
Furthermore, the repayment rate improved as borrowers get closer to the loan limit, which is
the maximum available loan. In other words, motivation for reaching the maximum loan level
is positively associated to therepayment performance (Seyedmehrdad, Andrea, Giorgio, Paolo
& Emanuele, 2016). Majority of the literatures on repayment performance of the borrowers
have been focused on the group-based lending or joint liability lending category of the credit
schemes. Most of them have revealed that a group-based loan is more effective in minimizing
the default rate than that of the individual based loan (Ghatak, 1999 & 2000). As Greenbaum
and Thakor(1995) and Coyels (2000) had been cited by Mohd Sherif (2012), borrowers
inability and unwillingness to repay the loan amount is considered as causes for high default
rates.

2.3.4.2. Determining Factors of MSEs Repayment Performance

This section explains the factors that affect performance citing the evidence on the proposed
factors. The factors include microfinance loans, managerial skills, and lending rates, age of
the firm, credit accessibility and gross domestic products.
2.3.4.2. 1 Microfinance Loans
Madole (2013) stated that bank loan plays a very crucial role to promote small business
growth. His findings were that the amount of loans is significantly and positively related with
performance of MSEs. Therefore, the government and MFI should enhance the out-reach of
microfinance loans through creating awareness of the activities and operations to SMEs
especially those in rural and semi-urban areas that are yet to appreciate the benefits of the
scheme. Wanambisi(2013) also recommended that amount of loan given by MFIs to MSEs
should be increased to enable the MSEs grow to medium scale enterprises.
2.3.4.2.2. Managerial Skills
Management style plays a key role in the success of every organization. Based on their
leadership characteristics, business leaders use different activities and management tools to
improve financial performance. Bowen and Makarius (2009) in their research concluded that
business success is a consequence of embracing a mix of managerial strategies.

18
2.3.4.2.3. Lending Rates
Accessing low interest credit is considered to be an important factor in increasing the
performance of SMEs Bourke (1989) reports that the effect of credit risk on profitability
appears clearly negative.Kamau and Kalio (2012) proposed that access to low interest credit
further increases SME’s risk-bearing abilities; improve risk coping strategies and enables
consumption smoothing over time. Study by further
indicated that the level of interest rates charged on the loans by the MFIs have negative
correlation with the parameters of business performance. High interest rates do not reduce the
financial cost, improve cash flow as well as increase profitability of the SMEs.

2.3.4.2.4 Age of a Firm

Age of a firm refers to the years a business has been in operation. Madole (2013) found out
that collateral, age or experience of the SMEs owners, and, credit accessibility influence the
access of credit and hence affects performance of firms. Corporate aging could occur for
reasons, consistent with cementation of organizational rigidities, costs rise, margins thin,
growth slows, assets become obsolete, and investment and R&D activities decline as firms
get older. Aging also seems to advance the diffusion of rent-seeking behavior: corporate
governance worsens and CEO pay goes up. Overall, firms seem to face a serious aging
problem.
2.3.4.2.5 Credit Accessibility
Access to credit enables Small and Medium enterprises to enhance their financial
performance. The main objective of microcredit is to improve the performance ofSMEs as a
result of better access to small loans that are not offered by the formal financial institutions. It
is argued that insufficient access to credit by the poor just below or just above the poverty
line may have negative consequences for SMEs andoverall welfare (Kamau&Kalio, 2012).

2.3.4.2.6 Gross Domestic Product

Gross Domestic Product is an indicator of size of an economy in terms of the total dollar
value of all goods and services produced over a specific time period. It is an indicator used to
gauge the health of a country's economy. Ovamba (2014) asserts that on the relationship
between macroeconomic factors and bank profitability had results indicating that
macroeconomic factors (real GDP, inflation and exchange rate) have significant effect on
financial performance of SMEs in Kenya.

19
2.4 Empirical Review
The empirical review discusses the international and local studies on the microfinance loans
and financial performance.
2.4.1 Worldwide Research works

Madole (2013) aimed at examining the impact of microfinance credit on the performance of
SMEs in Tanzania, specifically in Morogoro Municipal. The research design employed was a
case study. Data were collected from 100 respondents. The sample population was selected
using simple random and purposive sampling techniques to arrive at 80 customers as well as
20 Bank staff respectively. Data were collected using interviews, questionnaires, observation
and documentary review. Data were analyzed using descriptive statistics (frequencies and
percentages) using computer package called Statistical Package of Social Science (SPSS)
version 20.0. Results showed that through the credit obtained from a bank in Morogoro,
SMEs have been able to improve businesses in term of: increased business profit, increased
employees, increased sales turnover, increased business diversification, increased business
capital and assets as well as reduction of poverty among customers surveyed. Result also
shows that collateral, age or experience of the SMEs owners, and, credit accessibility
influence the access of credit. The study concluded most of the small businesses depend on
bank loan for business capital growth. Bank loan plays a very crucial role to promote small
business growth.

Wanambisi(2013) investigated the effects of microfinance institutions lending on micro and

small enterprises performance within Kitale Municipality. This study adopted a descriptive
survey research design and the target population was 1,200 MSEs which were registered
within Kitale Municipality and had operated for at least three years. The target population
was stratified into homogeneous categories as wholesalers, retailers, restaurants and service
delivery. A sample of 120 MSEs was used. Data was collected using a semi-structured
questionnaire. Completed questionnaires were verified and coded by the researcher in a
computerized package called SPSS then analyzed and summarized in frequency tables, pie
charts and figures. The association between microfinance lending and MSE performance
variables was established through Chi square and correlation tests at 95% significance level.
A multivariate logistic regression was used for significant bivariate variables. The findings
were that the amount of loans is significantly and positively related with performance of
MSEs in Kitale Municipality.

20
Chibole (2014) seeks to investigate the following research question: how do capital
Microfinance loans, liquidity and ownership affect growth of medium enterprises in Kenya?
The study used cross-sectional descriptive survey. The target population was311 drawn from
medium enterprises located in Nairobi Central Business District (NCBD). The study used
stratified random sampling and involved taking 20% of the target population giving a
respondent base of 62 respondents. Data for the study was collected using the questionnaires
and analyzed using descriptive and regression statistics with the aid of Statistical Package for
Social Sciences (SPSS 21.0). Findings of the study indicated that capital structure, financial
liquidity and ownership structure affect growth of medium enterprises in Kenya. The study
recommended that enterprises need to avoid high Microfinance loans ratios which may
results in high transaction costs resulting in a weakened position to pay higher dividends; for
SMEs to encourage institutions to invest in their enterprises.

Boateng (2015) ascertained the impact of microfinance on poverty reduction in Ghana. The
study employed economic and social variables such as individual income, household growth,
and access to education, housing and participation in social and religious activities as
benchmarks for measuring the impact. Questionnaires were administered to 60 customers and
beneficiaries of microfinance products of two major microfinance institutions in Ghana:
Opportunity International Savings and Loans Ltd. And Sinapi Aba Savings and Loans
Company Ltd. The study found a positive relationship between microfinance and the
benchmark variables and recommended training for beneficiaries to ensure efficient use of
funds and creation of sound political and economic environments so microenterprises can
thrive.

Adama and Agbim (2015) set out to assess the relationship between micro-credit, and self-
employment, education, training and skills acquisition, and economic empowerment.
Regression statistical method was employed to analyze the generated data. The study adopted
survey research design and systematic sampling technique to select the elements that
completed the research questionnaire. It was found that microcredit has significant effect on
self-employment, education, training and skills acquisition, and economic empowerment.
They went ahead and recommended that more awareness on the relevance of micro-credit to
self-employment, education, training and skills acquisition, and economic empowerment
should be created and that microfinance institutions should be encouraged to provide women
entrepreneurs.

21
Ouma and Rambo (2013) assessed the effect of access to microcredit services on the growth
of women-owned enterprises within the Central Business District of Kisumu City. Primary
data was sourced from 190 women entrepreneurs. The study found that access to microcredit
significantly associated with sales, net profit, number of paid workers and liabilities. Thus,
access to microcredit had positive effects on the growth of women-owned enterprises. In
addition, microfinance lending policies were not responsive to financing needs of women and
to changes in the business environment. This undermined the potential of funded enterprises
to achieve sustainable growth. The study recommends the need to review the financial
institution’s lending policies, increase the amount of microcredit funds and encourage other
actors to finance women-owned enterprises. Kimaru (2014) examined the effects of micro
finance institutions activities on the performance of small and medium scale enterprises
owned by women in Mogotio district. The target population was 626 SMEs in Mogotio
district by May 2013 stratified random sampling was used to select the SMEs which were
beneficiaries of 9 existing MFI`s in the district. Simple random sampling technique was used
to select representative sample from every strata. A sample size of 190 respondents, (at
least30% of the target population) was involved in the research study. Questionnaires were
used to collection quantitative data. The instruments of data collection were divided as per
the variables and objectives to ensure that the content would be comprehensive and
representative. Data was presented using frequency tables, pie-charts and histograms. Data
analysis was done using both descriptive and inferential statistics. Specifically, chi-square,
ANOVA, regression and correlation analysis was used with the aid of statistical package for
social sciences computer software package (SPSS) version 21.0. The findings indicated that
Repayment period, Premium and Interest rate had a significant effect on profits at 5% level of
significance.

Muiruri (2014) sought to investigate the role of microfinance institutions on growth of micro
and small enterprise (MSE) in Thika Municipality, Kenya. A cross-sectional survey was
carried that analyzed both secondary and primary data. Through random sampling technique,
285 MSEs and sixteen MFIs were selected. Data collection was done using questionnaires
and interview schedules to the different respondents. Questionnaires were used to collection
quantitative data on MSEs Owners and MFI managers. This data then was analyzed using the
statistical packages for social sciences software (SPSS windows version 13.0). The findings
were presented using both tabular and graphical presentation. The findings on the statistics in
the study demonstrate that MFIs offer services to customers who are majorly (MSEs) and had

22
contributed growth which has been rapid over the years. Finally the businesses that received
MFI services reported growth in sale, revenue and number of employees employed. Bichanga
and Njage (2014) attempted to investigate the effects of MFIs on poverty reduction. The
study focused on Poverty Reduction and Pamoja Women Development Empower Program
me(PAWDEP) located in Kiambu District as a case study. The study used descriptive survey
design. The target population was 9 staff/administrators and 46clients or recipients of
PAWDEP. The study employed stratified sampling technique to select staff of the selected
MFIs and clients. Both qualitative and quantitative data analysis methods were used. The
study revealed that PAWDEP as a microfinance institution has been providing microfinance
services to different groups of women-productive or active poor and that the institution uses
various strategies to deliver its services such as granting small loans to women to help them
start businesses, growth their businesses and educate their children. Korea et al., (2015)
studied the effect of microfinance services on the performance of small and medium
enterprises in Kenya. The study used explanatory research designed a population of relatively
429 SMEs registered by the Kiambu Municipal council. A sample of 270 enterprises was
used utilizing multiple regression analysis to draw inferences on the study. Data was analyzed
using statistical package for social sciences SPSS. The study found that access to saving
schemes, managerial training and loans grace period to be statistically significant in
determining the performance of SMEs. The study concluded that increasing provision levels
of microfinance will bring about increased performance of micro enterprise.

2.4.2. Empirical Studies in Ethiopian

Abreham (2002) has investigated loan repayment and its determinants in small scale
enterprises financing inEthiopia: a case of private borrowers around Zeway area. Sample of
102 clients were randomly selected. Heshowed that loan diversion is found to be one of the
major determinants adversely affecting the loan recovery rate; borrowers who have other
alternative income source were found to show better loan repayment record; business
experience in related economic activity and education were found to be significant and
positive while repayment period and sex were negatively associated with loan repayment
rate; borrowers who have extensive experience in related activity and educated ones show
better repayment record while male borrowers and projects with long repayment period show
poor repayment record; and borrowers who involved in agricultural sector were found to be
relatively defaulters as compared with other sectors.

23
Jemal (2003) did his study on microfinance and loan repayment performance: a case study of
the Oromia credit and savings share company (OCSSCO) in Kuyu. Using sample size of 203,
his results revealed that loan diversion was found to be one of the important and significant
factors influencing loan repayment performance negatively, i.e., it increases default risk
significantly; suitability of repayment period was found to reduce the probability of diverting
loan to nonproductive uses that ultimately lead to reduced recovery rate; loan size was found
to undermine the repayment performance; and factors like income, value of livestock,
availability of other sources of credit and being female were found to enhance the probability
of repayment.

Micha'el (2006) has done a study on micro-finance repayment problems in the informal
sector in Addis Ababa. A sample size of 225 clients was randomly selected. His result
indicated that better repayment performance is strongly and directly associated with
educational level of the borrower; insufficiency of the loan granted and unplanned
engagements in the business activity do also reduce repayment performance; and government
owned and not-for-profit non-government microfinance institutions were found out to face
relatively larger non-repayment due to credit attitude of borrowers towards the loan, as if it
were grant, instead of a liability at the time of difficulty.

Fikirte (2011) under took a study on determinants of loan repayment performance: a case
study in the Addis Credit and Saving Institution, Addis Ababa, Ethiopia. Based on a sample
of 200 randomly selected clients, she analyzed the socio-economic factors that influence loan
repayment. A total of twelve explanatory variables were included in the regression. Out of
these, six variables were found to be significant for the probability of being defaulter. Age
and five business types (baltina and petty market, kiosk and shop, services providing,
weaving and tailoring, and urban agriculture), sex, and business experience of the
respondents were found to be significant determinants of loan repayment performance.

Tnsue (2011) has analyzed determinants of loan repayment in microfinance institution: the
case of DECSI QUIHA sub branch. A cross-sectional data were collected from randomly
selected 140 (87.7% response rate) sample borrowers and key informant interview was held
in the study area. His analysis showed that age, educational status, full disbursement of loan
requested by borrowers, supervisory visit, and income from the loan activities financed by
DECSI were significant factors that enhance the probability of loan repayment, while

24
violation of loan agreement, distance of the borrowers dwelling from the lending agency, sex,
occupation and number of dependents with borrowers were found to significantly increase
loan default.
Based on the above review, it can be concluded that most of the empirical studies done in
other countries (other than Ethiopia) reported that screening, monitoring, and enforcement
activities among group members improves the repayment performance of groups. Whereas,
most of the empirical studies made in Ethiopia focus on factors of individual/borrower
characteristics. Accordingly, education, income, loan supervision, suitability of repayment
period, business experience in related economic activity, and age have significant and
positively determine the loan repayment performance. However, unplanned engagements in
the business activity, loan diversion, loan amount, and number of dependents with borrowers
have significantly and negatively determine the loan repayment performance. Moreover, the
number of weeks the borrower had to wait before receiving loan and the variables measuring
regular group members’ peer monitoring and social ties were found insignificant in terms of
loan repayment performance.

Achamyeleh (2011), conducted, study to identify the impact of Microfinance on income and
non-income indicators of poverty in the rural areas of the Tigray region of Ethiopia by
usingtwo rounds of regional representative household survey data that were collected in
2006, and more recently in 2010. In particular, the researcher studies whether microfinance
credit is reducing poverty, helps the poorest of the poor and the amount of malnutrition
reduced because of microfinance credit. In order to consistently identify the causal effect of
participation in Microfinance and compare the results, the researcher uses two new estimators
called Klein and Vella (KV) and minimum biased estimator along with the standard
Heckman bivariate normal (BVN) selection model. The researcher finds consistent evidence
of causal effect of participation in microfinance on reducing child malnutrition and increasing
annual per capita consumption expenditure when applying the three estimators. More
importantly, the study has shown that the poorest of the poor are benefiting more from
Microfinance credit program than the moderate poor rural households in Tigray. Findings
also suggest that around 3% of the reduction in the gap of sever poverty in Tigray is made
possible by program credit. Results show how Social Welfare programs aimed at poverty
alleviation among those living in severe poverty can affect child malnutrition outcomes,
which goes beyond the standard poverty measures of consumption and income.

25
2.4.3 Summery of the Related Literature Review
Microfinance is a key development strategy for promoting poverty reduction, increasing
financial performance of firms and empowerment of people economically. This is because of
its potential to effectively address poverty by granting financial services to households who
are not served by the formal banking sector. MFIs provide loans for businesses and mobilize
rural savings and using simple and straight forward procedures that originate from local
cultures and are easily understood by the population. These funds are used to finance the
informal sector Small and Medium Enterprises (SMEs) in developing countries and it is
known that these SMEs are more likely to fail. Some Microfinance Institutions (MFIs)
provide social intermediation services such as the formation of groups, development of self-
confidence and the training of members in that group on financial literacy and management
(Bichanga&Njage, 2014).Financial sustainability theory links the ability of a business
withstand all challenges to the economic effectiveness of that organization, to the health of
employees and tothe stock of natural resources in the long term. Microfinance loans offer
funds to start or maintain companies so that they can withstand encounters in the business
world (Dunphy, 2003). Muiruri (2014) demonstrated that microfinance establishments offer
services to customers who are majorly SMEs and has contributed to growth which has been
rapid over the years. He added that businesses that received micro finance services reported
growth in sale, revenue and number of employees employed. Adama and Agbim (2015)
found that micro-credit has significant effect on self-employment, education, training and
skills acquisition, and economic empowerment. The increased involvement of entrepreneurs
especially youth and women in the major markets in Nairobi Kenya in the activities of
microfinance banks, NGOs, associations, cooperatives, rotating savings groups, self-help
groups and savings mobilization groups suggest that further investigations on the relationship
between microfinance loans and financial performance should be conducted to validate the
more generalized results
2.5. Conceptualizations
The conceptual model for the study is to identifying and analyzing factors such as customers’
personal, institutional and socio-cultural factors that can influence the loan repayment
performance of MSEs in Mekelle City. In the literatures reviewed, various empirical studies
were focused on the probable factors that can determine repayment performances. To carry
on the empirical studies to investigate the probability of variables that can affect
repayment performance of borrowers, the study mainly focused on three categories like
identifying and analyzing borrowers personal variables socio-economic variables and
financial institutional variables.

26
 Figure 2:1 Conceptual Framework

Conceptual Frame Work

Personal Variables

Independent  Gender
 Age
variables  Marital statutes
 Household size
 Level of Education
 Business Knowledge ,Skills ,experience, capacity
 Talent, attitudes, capability, innovation skills
 Information & communication
Compon Component 1  Personal Commitment
 Awareness creation & analysis
 Working capital ,machinery, inputs
 Source of income & others
Dependent
\ variables
Institutional variables

 Loan screening & disbursement,

 Flexible & seasonal loan demanding system
 Credit & saving management
 Loan collateral
 Business experience, supervision & monitoring activities Loan repayment
Compon Component 2
 Loan size
 Fully Repaid
 Contract loan agreement terms & payback period  Progressively repaid
 Business policy, strategies & plan Determinant
 Past due
 Interest rate & profitability  defaulted
 Financial & operational management system
 Company procedures, principles guide lines rules &
regulations
 Employee & staff management system
 Training & supervision
 Financial sustainability & productivity
 Delivery quality service & cost reduction competition Strategy

Sociocultural variables
 Infrastructures
 Cultural factor
 Religion factor
Compon Component 3  Marketing factor
 Inflation, hard currency, import & export factors
 living conditions and societal norms
 Government policy, strategy, rules & regulations
 Technology, economy, social, political, environmental

(Source: Adopted by Florence & Daniel (2014), modified by researcher)

27
CHAPTER THREE
Chapter 3: Research design, strategy and methodology
3.1. Site selection and description
3.1.1 Site selection
Mekelle city is selected by its convenience for the researcher and due to the more
concentration of large and MSEs relative to other smaller towns in Tigray region. The city is
found about 780 K.ms far to the north of Addis Abeba, the capital city of Ethiopia. The
Mekelle is the capital city Tigray regional state.
3.1.2 Description of the study area
The socioeconomic a large commercial, industries, manufacturing, transportation and
different service delivery institutions which is found a large factories such as Mesobo cement
factory, an international airport, Aider referral hospital, the educational status from
kindergartens, elementary schools, high schools, government and none government colleges
and the most popular mekelle university, as well as so many financial institution to provides
credit loans and saving that has an alternative opportunity for MSEs for borrowing money in
the reduction of poverty.
The geographical location city is subdivided in to seven sub cities namely: Kuha, Ayder,
Semien, Hawelti, Adihaki, Hadnet and KedemayWoyane. According to Ethiopian Central
statistical agency (2019), the population of the city is estimated about 310,436.
The temperature situated an average attitudes of 2,254 meter (7,395) fit above sea level and
the climate change 180c, 64.40f the average of rainfall minimum 140c maximum 360c
“weynadega” air temperature two main rain and dray season.So mekelle is a favorable
condition to live in this town by use this opportunity to reduce the default repayment loans of
MSEs in mekelle city.
3.2. Research design and strategy
3.2.1 Research design
This study will be employed mixed methodology mainly it uses Correlational design in a
Cross sectional survey. It will use both quantitative and qualitative data. The quantitative data
will be collected by Questionnaire and the qualitative data will be collected using interview
and document analysis distributed to MSEs Consumers so as to have wider and representative
sample of respondents. Structured, Semi structured, and interview will be conducted with
selected medium and small enterprise loans be fisheries DECSI managers, loan officers, and

28
Mekelle MSEs development agency representatives. Moreover, organizational manuals will
also be used.
3.2.2 Research strategy and data type
The type of research is both quantitative and qualitative combining data through
questionnaire survey, in depth interviews with selected MSEs and DECSI sub city managers
and borrowers. Descriptive research involves for the collection of information from all the
sampled individuals through their responses to questions (Mugenda and Mugenda, 2006).
According to Cooper & Schindler (2008), a descriptive design ensures complete
description of the situation, making sure that there is minimum bias in the collection of data
and will be allowed data collection from sizeable population in an economical way.
Thus, a descriptive research design will helpful in collecting data from the small and
medium scale enterprises using questionnaires in an economical way. Therefore: the
quantitative methodology is the main study and the qualitative methodology as explanatory
or supporting method. Data obtained from open ended and interview, focuses group
questions will be analyzed using content analysis technique.

3.3. Source and type of data

Data will be obtained from primary and secondary sources. Primary sources will be obtained
through survey from MSEs and large enterprise authorities. Secondary sources will be
company policies and procedures. Thus, both primary and secondary type of data will be
used.
Instrumentation
The tools that will be used to collect data include questionnaire, interview and organizational
document analysis. Questionnaire will be distributed to selected MSEs by going to their work
place. Questionnaire is preferred over the other methods so as to have wider coverage while
conducting interview or any other method for large size sample is difficult. But interview will
be conducted with the company managers and Mekelle MSEs development agency
representatives and DECSI micro finance institutions. In this case as the number of credit
beneficiaries is, interview is preferable in order to conduct deep discussions. Moreover
organizational manuals will be assessed whenever become available. This will help to
triangulate the findings.

29
3.4 Target Population of the study

A population is a well-defined set of people, services, elements, events, and group of things
or households that are being investigated (Mugenda and Mugenda, 2003). Population refers
to the entire group of individuals or objects of which the researcher is interested in
generalizing the conclusions.

For this study the population of interest will be comprised of all the SMEs in found in
Mekele city. According to the Mekelle city, beneficiaries’ there are 28,564 registered
records on SMEs within the city. The owners and managers of these businesses formed
the population elements of the study.

3.5 Sample size and sampling techniques

The researcher will use simple random and stratified sampling methods will be used to select
the respondents. This sampling method is due to the reason that factors determining loans
repayment and so many challenges affected in there. Stratified sampling method will be
ensured to incorporate and divided the population of all the 7 sub cities found in the city.
Once the SMEs categorize in to sub cities, then simple random sampling will be used to
select the respondents. Simple random sampling will gave each element in the population an
equal chance or probability of getting into the sample and all choices are independent of one
another (Kothari, 2004). Therefore: 395 respondents will be selected from the 7 sub cities.

Sample size determination formula

The sample size will be calculated using Yamane’s formula of sample size.

𝑁
𝑛=
(1 + 𝑁𝑒 2 )

Where:

n= Sample size

N= Size of population

e= the error of 5% points

By using Yamane’s (1967) formula of sample size with an error term 5% and confidence
coefficient of 95% the sample is calculated as follows

30
The total population from which sample is to be drawn is 395. Thus, at 5% error and 95%
confidence coefficient

𝑁
𝑛=
(1 + 𝑁𝑒 2 )

28564
𝑛=
(1 + 28564 ∗ 0.052 )

𝑛 = 394.47~395

Source: http://kb.psu.ac.th/psukb/bitstream/2010/6023/6/260491

Once, the sample size is determined, the next step is to determine the sample size for each
strata type. Since in most of the sub cities the number of credit takers is approximately equal
from each sub city equal number of sample size that is by dividing the total sample size to
number of sub city 57 determined to be taken by giving equal chance to each. Using
proportionate sample allocation so as to make each sampled identical with proportion of
population.

𝑁 = 𝑡𝑜𝑡𝑎𝑙 𝑡𝑎𝑟𝑔𝑒𝑡 𝑝𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 𝑠𝑖𝑧𝑒 395

𝑛 = 𝑡𝑜𝑡𝑎𝑙 𝑠𝑎𝑚𝑝𝑙𝑒 𝑠𝑖𝑧𝑒 57

3.5.1 Economic models

The researcher will use ordinary logistics regression model to test the hypothesis so as to
accept and not to accept the null hypothesis. The dependent variable is loan repayments. This
will be measured in terms of the existence of supplier buyer relationship or volume of
transaction, and/or other loans repayment relationships such as supports in technical training,
provision of credit.

The model developed is given below:

𝑦1 = 𝛼1 + 𝛽11 𝑋11 + 𝛽21 𝑋21 + 𝛽31 𝑋31 … 𝛽818 𝑋818

𝑦2 = 𝛼2 + 𝛽12 𝑋12 + 𝛽22 𝑋22 + 𝛽32 𝑋32 … 𝛽828 𝑋828 + 𝑢

Where:
Y= dependent variable 1(percentage of returned loans repayment)
Y[=dependent variable 2 ( percentage of amount returned loans repayment)

31
 𝑥1 = personal factors to repay

𝑥2 = Institutional factors

𝑥3 = socio-cultural factors

Table 3.1: Variable Name and measurement

Variable name Measurement

personal factors to repay Nominal scales, interval scale, ratio scale

Institutional factors Nominal scales, interval scale, ratio scale

socio-cultural factors Nominal scales, interval scale, ratio scale

Respondents will be asked whether they have MSEs with expected loans repayment rate
response of us to multiple regressions Model.

3.6. Data collection methods and instruments

The study will be employed both primary and secondary. A questionnaire will be used to
collect the primary data. A questionnaire is a form, which is prepared and distributed
for the purpose of securing responses (Mugenda and Mugenda, 2003). The questionnaire
will be contained both structured and semi structured questions. The questionnaires will be
designed such that the respondents could easily comprehend the questions there in.
Structured questionnaires are those questions in which there are definite, concrete and pre-
determined questions while semi structured questions contains questions which do not
require specific answers (Kothari, 2004).

The questionnaires will be self-administered to the sampled respondents. The self-

administering procedure is preferred since it is simpler and the respondents read the

32
questions and fill in the answers by themselves. In addition, the self-administration
technique will appropriate since the researcher is able to rectify any questions at the ground
and make sure all the questions had been responded to. Secondary on the other hand will be
obtained from the office, books, journals, newspapers, magazines and the internet. To
support the data from the questionnaire survey, informal interview with borrowers and
structured interview with MFI’s office managers will be conducted to identify the factors
that affect borrower’s repayment performance.

3.7. Data collection procedures/processing

The method of data collection is a mixed type. The quantitative data will be collecting
through questionnaires to identify the interview and focus group discussion of MSEs,
customers, and loan officers DECSI staff members. To strengthen the quantitative data, a
qualitative data will be obtained to evaluate the process using checklists and data processing
properly designed a questioners and pilot testing sit select retest and gives an orientation for
data collectors daily follow up editing, coding and recording the data entry actual site where
the small and medium business activities take place. The questionnaires will be designed in
terms of multiple choice and likert scale.

3.8. Data analysis

The data will be analyzed in terms of quantitative and qualitative. The data collected will be
classified, summarized analyzed using the descriptive statistical tools and inferential statistics
using A Social Science Statistical Package (SPSS) software version 21 will be applied to
analyze the data. The qualitative data will be organized and tallied according to thematic area
in the study and used to support with additional evidence or compare the perceptions of the
participants in the study
Data was presented using frequency tables, pie-charts and histograms. Descriptive statistics
will be included measures of central tendency like the arithmetic mean, frequencies,
percentages and the standard deviation. Descriptive statistics will be summarized and
described the data in a simple and understandable manner.

Inferential statistics will also be used to draw conclusions particularly correlation, ANOVA
and multiple regression will be employed so that to make interference about the research
questions. According to Kothari (2004) inferential analysis (sampling statistics) is
concerned with the various tests of significance for testing hypotheses in order to

33
determine with what validity data can be said to indicate some conclusion or conclusions.
Additionally, inferential statistics is concerned with the process of generalization and
will be used to estimate the study parameters and the testing of statistical hypotheses.

3.9 Research Validity and Reliability

The Questionnaires will be review by the researcher again and again at different times in
relation to the research gap. In the data collection process, there will be a strict follow up and
monitoring strategies. Thus, it will be tried out in a selected field work which is outside of
study site. Then an amendment will be done based on findings obtained from the pilot study.

3.10 Ethical Considerations

In the research questionnaires, participants will be informing that they do not need to write
their name on a part of the questionnaire. In addition, It will be vividly informed the
participants that their information is to be treating confidentially.

34
 3.11. Work Plan.
Table 3.11.1: Work Plan

Duration, 2020 G.C

No Activities Dec. Jan. Feb. Mr. Ap. May Jun
2-10 1-30 1-30 1-30 10-15
1 Selection of research
Topic and Approval
2 Literature review

3 Proposal writing and

submitting
3 Editing& preparation for
proposal defenses
4 Data collection
5 Data editing

6 Data Analysis and

Interpretation
7 Final thesis submission

8 Preparation and
presentation of paper
9 Submission of post exam
corrected thesis

35
 3.12. Budget breakdown
Table 3.12.1: Supply and Service Expenses

Supply expense
No. Type of Item No. of Item Cost per Item Description Total
expense
1 Office Supply Pen 1pk 4 birr 400
Note pads 1pk average 100
Normal Paper 2pk average 190
USB-Flash Dis 1 Average 16 GB 300
3 Mobile card Card 2 100 birr each 200

Sub total 1190

Service expense
No. Service Cost per No. of pages Description Total in birr
page

1 Photocopying .50 cents 3000 Including company Average 1,500

manuals or reports

2 Printing 2 birr 2000 Average 4,000

3 Transportation 1000 Average 1000

costs

Sub total 6,500

Total 7690

36
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