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ACRONYMS
BCC- Branch
Credit Committee BOD- Board of Directors CAD- Cash against Document CEO- Chief
Executive Officer CIC- Credit Information Centre
DLL-
Discretionary Lending Limit
EC- Ethiopian
Calendar
EPRDF-Ethiopian People’s
Revolutionary Democratic Party
FIS- Financial
Institutions
GC- Gregorian
Calendar
L/C- Letter of
Credit
LAF- Loan
Approval Form
MCC- Management
of Credit Committee
NBE- National
Bank of Ethiopia
NOW- Negotiable
Order of Withdrawal Account
NPLS- Non
Performing Loans
NPTL- Non
Performing to total Loan NPTGL- Non Performing Loan to Gross Loan OBC- Outward
Bills for Collection
ODBC- Outward
Documentary Bills for set for Collection ODBP- Outward Documentary Bills Purchased
OPD- Outward
Bills Purchased
PSS-
Proportionate Stratified Sampling
SC- Share
Company
SBB- Supervision
of Banking Business
VP- Vice
President
ZBA- Zero
Balance Account
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Banks
are financial institutions that are established for lending, borrowing,
issuing, exchanging, taking deposits, safeguarding or handling money under the
laws and guide lines of a respective country. Among their activities, credit
provision is the main product which banks provide to potential business
entrepreneurs as a main source of generating income.
While
providing credit as a main source of generating income, banks take into account
many considerations as a factor of credit management which helps them to
minimize the risk of default that results in financial distress and bankruptcy.
This is due to the reason that while banks providing credit they are exposed to
risk of default (risk of interest and principal repayment) which need to be
managed effectively to acquire the required level of loan growth and
performance.
The
types and degree of risks to which banks are exposed depends upon a number of
factors such as its size, complexity of the business activities, volume etc. It
is believed that generally banks face Credit, Market, Liquidity, Operational,
Compliance /legal/ regulatory and reputation risks among which credit risk is
known to have the adverse impact on profitability and growth. Hence, the
success of most commercial banks lies on the achievements in credit management
mitigating risk to the acceptable level.
Charles
Mensah (1999) stressed the importance of credit management as follows: Credit
management process deserves special emphasis because proper credit management
greatly influences the success or failure of financial institutions.
This
indicates that credit provision should be accompanied by appropriate and
attractive credit policies and procedures that enhance performance of credit
management and protects the banking industry from failure.
Credit
management means the total process of lending starting from inquiring potential
borrowers up to recovering the amount granted. In the sense of banking sector,
credit management is concerned with activities such as accepting application,
loan appraisal, loan approval, monitoring, recovery of non-performing loans, etc.
(Shekhar, 1985).
According
to Hettihewa, 1997, Credit Management is extremely important as granting credit
is considered to be the equivalent of investing in a customer.
However,
payment of the debt should not be postponed for too long as delayed payments
and bad debts are a cost to the company. Thus, Efficiency and effectiveness in
performing each steps of loan processing using various parameters has
significant effect on performance of credit management.
UBA
Share Company is one of the financial institutions engaged in providing short
and medium credit like other commercial banks in the country in general and in
the region in particular. In the last few years, both public and private
sectors in the economy underwent encouraging development in investment and
business activities, thus becoming the fertile ground for the banking industry.
Since its establishment in 1997 G.C, United Bank of Africa (UBA) has been
striving to exploit such and all other opportunities towards achieving its
corporate goals. The bank has been providing only short and medium loans and
advances to its customers because of its early stage of capital base and
liquidity position. The bank has been playing a significant role in providing
loans and advances to its customers that enhances the investment need in the
country and as means of generating income for its shareholders.
Hence,
the purpose of this study is to assess the performance of credit management
problems and strengths of United Bank of Africa (UBA) Share Company in Tigray
Region from different perspectives in light of the practices of modern credit
management in financial institutions.
1.2 Background
of the Banking Industry in Ethiopia
As
a result of the agreement reached between Emperor Minilik II and Mr.Ma
Gillivray, representative of the British owned National Bank of Egypt; modern
banking in Ethiopia began in 1905 with the Bank of Abyssinia, a private company
controlled by the Bank of Egypt In 1931. It was liquidated and replaced by the
Bank of Ethiopia which was the bank of issue until the Italian invasion of
1936. During the Italian occupation, Bank of Italy banknotes formed the legal
tender. Under the subsequent British occupation, Ethiopia was briefly a part of
the East Africa Currency Board. In 1943; the State Bank of Ethiopia was
established, with two departments performing the separate functions of an
issuing bank and a commercial bank. In 1963, these functions were formally
separated and the National Bank of Ethiopia (the central and issuing bank) and
the Commercial Bank of Ethiopia were formed.
In
the period to 1974, several other financial institutions emerged including the
state owned: The Agricultural and Industrial Development Bank (established
largely to finance state owned enterprises); The Savings and Mortgage
Corporation of Ethiopia; The Imperial Savings and Home Ownership Public
Association (which provided savings and loan services).
Major
private commercial institutions, many of which were foreign owned, included the
Addis Ababa Bank, the Banco di Napoli, the Banco di Roma.
However,
the banking business could not move further because of the nationalization of
private investments by the Socialist regime (the Dergue regime) that came into
power leaving only three government banks; the National Bank of Ethiopia, the
Commercial Bank of Ethiopia and agricultural and Industrial Development Bank.
This
was reversed when the Socialist regime was overthrown in 1991. Following the
overthrown of the Dergue regime in 1991, the EPRDF declared a liberal economic
system. In line with this, Monetary and Banking proclamation of 1994
established the National Bank of Ethiopia (NBE) as a judicial entity, separated
from the government and outlined its main function.
Monetary
and Banking proclamation No.83/1994 and the Licensing and Supervision of
Banking Business No.84/1994 laid down the legal basis for investment in the
banking sector (www.nbe.gov.com).
After
the proclamation of 1994, the first private bank, Awash International Bank was
established in 1994 by 486 shareholders paving a way to the establishment of
related private banks such as Dashen Bank ( 1995), Abyssinia Bank (1996),
Wgegan Bank (1997), United Bank (1998), Nib International Bank (1999),
Cooperative Bank of Oromia (2004), Lion International Bank (2006), Oromia
International bank (2008), Zemen Bank (2006), Buna International Bank (2009),
Birhan International Bank (2009), and others which are under establishment.
1.3 Statement
of the Problem
According
to Shekhar, 1985, credit plays an important role in the lives of many people
and in almost all industries that involve monetary investment in some form.
Credit is mainly granted by banks including to several other functions like
mobilizing deposits, local and international transfers, and currency exchange
service.
Hence,
the issue of credit management has a profound implication both at the micro and
macro level. When credit is allocated poorly it raises costs to successful
borrowers, erodes the fund, and reduces banks flexibility in redirecting
towards alternative activities. Moreover, the more the credit, the higher is
the risk associated with it. The problem of loan default, which is resulted
from poor credit management, reduces the lending capacity of a bank. It also
denies new applicants’ access to credit as the bank’s cash flow management
problems augment in direct proportion to the increasing default
Problem.
In other words, it may disturb the normal inflow and outflow of fund a bank has
to keep staying in sustainable credit market.
Hence,
credit evaluation decisions are important for the financial institutions
involved due to the high level of risk associated with wrong decision. The
process of making credit evaluation decision is complex and unstructured. This
complex and unstructured decision making process of credit evaluation needs
proper credit management by the concerned banks.
Adequately
managing credit in financial institutions (FIs) is critical for the survival
and growth of the FIs. In the case of banks, the issue of credit management is
of even greater concern because of the higher levels of perceived risks
resulting from some of the characteristics of clients, business conditions and
economic environment in which they find themselves.
The
very nature of the banking business is so sensitive because more than 85% of
their liability is deposits mobilized from depositors (Saunders, Cornett,
2005). Banks use these deposits to generate credit for their borrowers, which
in fact is a revenue generating activity for most banks. This credit creation
process, if not managed properly, exposes the banks to high default risk which
might led to financial distress including bankruptcy. All the same, beside
other services, banks must create credit for their clients following prudent
credit management procedure to make some money, grow and survive in stiff
competition at the market place.
Even
though a preliminary study is made in preparing the master business plan for
the opening of branches; little work is done in studying the performance of
credit management of the branches that would alleviate the problems encountered
and contribute to the growth of market share and income generation of the bank.
Hence the researcher is interested to the research area in particular and to
the contribution and object of the bank in general in assessing the gaps in
credit management performance which is crucial to be studied in the prevailing
stiff competition in line of the modern financial measurements.
Therefore,
the principal concern of this study is to assess the performance of credit
delivery and management in United Bank of Africa (UBA) Share Company in Tigray
Regional State.
1.4 Research Questions
1. Does
the Bank consistently comply with its policy and procedures in entertaining its
loan applicants, loan processing, and collecting?
2. To
what extent is the Bank accelerating the performance of credit management in
line to its policy and national banks requirement?
3. Do
loan customers of the Bank support the prevailing loan policy and procedures
that could result long lasting relationship?
4. To
what level is the Bank building up quality loans arresting non- performing
loans in line to its policy and National Bank’s requirement.
1.5 Justification of the Study
Based
on the monetary and Banking proclamation No.83/1994 which laid down the legal
basis for investment in the banking sector a number of private commercial banks
are under establishment opening their head quarter at Addis Ababa which is the
capital city of Ethiopia and striving to stretch their branches to all regions
as a strategy to build up market share.
United
Bank of Africa (UBA) Share Company is one of the leading private commercial
banks playing its role in opening about 48 branches in the country. Of which 23
branches are in Addis Ababa, the major business center and the capital city of
the country, and the rest 25 branches are at different regions. (Annual report
of 2008/09)
Out
of these branches in different regions 7 (seven) branches are opened in Tigray
Region. However, though a preliminary study is made in preparing the master
business plan for the opening of branches, little work is done in studying the
performance of credit management of the branches that would alleviate the
problems encountered and
Contribute
to the growth of market share and income generation of the bank. Hence the
researcher is interested to the research area in particular and to the
contribution and object of the bank in general in assessing the gaps in credit
management performance which is crucial to be studied in the prevailing stiff
competition in line of the modern financial measurements.
1.6 Objective
of the Study
1.6.1
General objective
The
main objective of the study is to evaluate the performance of credit management
of United Bank of Africa (UBA) in Tigray region as compared to National Bank
requirements vis à vis its credit policy and procedures.
1.6.2 Specific objectives
1. To
evaluate the compliance of the Bank to its policies and procedures in
processing loan applications.
2. To
evaluate the ability of the Bank in creating credit and collecting its loan on
their due date.
3. To assess
the perception of the customers towards the Bank’s policy in relation to its
loan provision.
4. To
evaluate the Bank’s credit quality as compared to National Bank’s requirements
and its credit policy.
1.7 Significance
of the Study
Loans
and advances are known to be the main stay of all commercial banks. They occupy
an important part in gross earnings and net profit of the banks. The share
advances in the total asset of the banks forms a lion share (almost more than
60 percent) and as such it is the back bone of banking sector. Bank lending is
very crucial for it makes possible the financing of agricultural, industrial,
construction, and commercial activities of a country. The strength and
soundness of the banking system primarily depends upon health of the advances.
Therefore the ability of banks to formulate and adhere to policies and
procedures that promote credit quality and curtail non-performing loans is the
means to survive in the stiff competition. In ability to create and build up
quality loans and credit worthy customers leads to default risk and bankruptcy
as well as hampers economic growth of a country. However, little work is done
to search the ways and means that enable to quality loan creation and growth as
well as to determine the relationship between the theories, concepts and credit
policies both at country level or regional level.
Hence,
this study is assumed to be significant in indicating best practice and
concepts for prudent lending to enhance the performance of credit management to
all managers and policy makers of the bank as well as to all financial
institutions and banks. Moreover, it may help as a benchmark for researchers
who are interested in the area to extend it further.
1.8 Scope
of the Study
The
study is concentrated on United Bank of Africa (UBA) Share Company branches
found in Tigray Regional state. This is because; it is one of the private banks
working with leading area coverage in the Region yet.
The
study covered credit policies, procedures, and credit operations of the Bank.
It assessed whether the loan growth and performance is to the required level of
the bank or not. In addition, the study is concerned with identifying the major
reasons for best practices of credit management, loan growth, and causes of
loan default if any in the region. Since the lending rules and procedures of
the bank is the same in all its branches, the result obtained taking case study
of this specific region is assumed to reflect the situation of all branches of
the bank in the country under normal circumstance.
1.9 Limitation
of the Study
Though
studying at full-fledged level of the bank would have better result, due to the
time and finance constraints the researcher is limited to undertake the study
in seven branches located in Tigray regional state. The branches are stretched
from Mekelle to Humera in the region and this has entailed transportation
problem, hardship, and time scarcity. The constraint of time had significant
impacts on the study.
1.10 Organization of the Study
The
Study is organized into six chapters. The first chapter introduces the
background of the study, the research objectives and questions, significance of
the study, scope of the study, limitation of the study and organization of the
study. The second chapter presents theoretical and empirical review of the
related literatures. The third chapter deals with methodology of the study. The
fourth chapter is concerned with the background of the organization and the
fifth chapter describes the analysis, results and discussions. The sixth
chapter presents the conclusion and recommendations drawn from findings of the
data in addition with implications for further research.
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