FACULTY OF COMMERCE

DEPARTMENT OF BANKING

IMPACT OF CREDIT APPRAISAL TECHNIQUES ON MICROFINANCES’

LOAN PERFOMANCE (2009-20015)

COMPILED BY:

(P0111791P)

SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTSFOR

BACHELOR OF COMMERCE (HONOURS) DEGREE IN BANKING

2016
DEDICATION

To my beloved parents; you are my pillar of strength and the fountain of my inspiration.

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CONTENTS
DEDICATION………………………………………………………………………………..........i
CONTENTS ……………………………………………………………………………………....ii
ACKNOWLEDGEMENTS ……………………………………………………………………...vi
ABSTRACT ……………………………………………………………………………………..vii
GLOSSARY OF TERMS . ………………………………………………………………………vii
LIST OF ABBREVIATIONS AND ACRONYMS . …………………………………………….ix
LIST OFFIGURES………………………………………………………………………………..x
LIST OF TABLES..…………………………………………………………………………........xi
LIST OF APPENDICES…………………………………………………………………...…....xii
CHAPTER ONE: INTRODUCTORY CHAPTER ........................................................................ 1
1.0 INTRODUCTION ............................................................................................................ 1
1.1 BACKGROUND TO THE STUDY ................................................................................ 1
1.1.1 PERFORMANCE OF MFI SECTOR ...................................................................... 3
1.1.2 STATEMENT OF PROBLEM ...................................................................................... 4
1.2 OBJECTIVES OF THE STUDY ..................................................................................... 5
1.3.1 PRIMARY OBJECTIVES ........................................................................................ 5
1.3.2 SECONDARY OBJECTIVES.................................................................................. 5
1.3 RESEARCH QUESTIONS .............................................................................................. 6
1.4 RESEARCH HYPOTHESIS ........................................................................................... 6
1.5 ASSUMPTIONS .............................................................................................................. 6
1.6 JUSTIFICATION OF THE STUDY ............................................................................... 7
1.7 LIMITATIONS ................................................................................................................ 8
1.8 SCOPE OF THE STUDY ................................................................................................ 8
1.81 CONCEPTUAL SCOPE .............................................................................................. 8
1.82 GEOGRAPHICAL SCOPE .......................................................................................... 9
1.9 ORGANISATION OF THE STUDY .............................................................................. 9
CHAPTER TWO: LITERATURE REVIEW ............................................................................... 10
2.0 INTRODUCTION .......................................................................................................... 10
2.1 DEFINITION OF KEY CONCEPTS ............................................................................ 10
2.1.1 CREDIT RISK .............................................................................................................. 10
2.1.2 CREDIT RISK MANAGEMENT ................................................................................ 11
2.1.3 CREDIT TERMS ......................................................................................................... 12
2.1.4 CREDIT RISK APPRAISAL ....................................................................................... 12
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 2.1.5 LOAN QUALITY ........................................................................................................ 14
2.2 THE CREDIT RISK APPRAISAL AND MANAGEMENT IN MICROFINANCE......... 16
2.2.1 GROUP LENDING MECHANISM ............................................................................ 17
2.2.2 DYNAMIC INCENTIVES........................................................................................... 19
2.2.3 COLLATERAL SUBSTITUTES ................................................................................. 19
2.2.4 REGULAR REPAYMENT SCHEDULE .................................................................... 20
2.3 CREDIT RISK ASSESSMENT/APPRAISAL APPROACHES: THEORETICAL
ASPECTS .................................................................................................................................. 21
2.3.1 STRUCTURAL APPROACH...................................................................................... 22
2.3.2 EMPIRICAL / STATISTICAL APPROACH .............................................................. 22
2.3.3 EXPERT-JUDGMENT APPROACH / SUBJECTIVE-JUDGMENT APPROACH .. 22
2.4 CREDIT RISK ASSESSMENT APPROACHES IN INDIVIDUAL LENDING BY MFIS
................................................................................................................................................... 23
2.5 EXPERT SYSTEMS ........................................................................................................... 26
2.5.1 CAMPARI .............................................................................................................. 26
2.5.2 PAPERS .................................................................................................................. 27
2.5.3 5Cs .......................................................................................................................... 28
2.6 KEY COMPONENTS OF EFFECTIVE CREDIT RISK APPRAISAL AND
MANAGEMENT ...................................................................................................................... 29
2.7 EMPIRICAL EVIDENCE .................................................................................................. 30
2.7.1 THE CASE OF GHANA .............................................................................................. 30
2.7.2 THE CASE OF KENYA .............................................................................................. 31
2.7.3THE CASE OF PAKISTAN ......................................................................................... 32
2.8 CONCLUSIONS ................................................................................................................. 32
CHAPTER THREE: RESEARCH METHODOLOGY ............................................................. 33
3.0 1NTRODUCTION .............................................................................................................. 33
3.1 RESEARCH DESIGN ........................................................................................................ 33
3.2 TARGET POPULATION ................................................................................................... 33
3.3 SAMPLING TECHNIQUES ......................................................................................... 33
3.4 DATA COLLECTION METHODS AND TECHNIQUES........................................... 34
3.4.1 SECONDARY DATA ............................................................................................ 34
3.4.2 PRIMARY DATA .................................................................................................. 35
3.4.3 QUESTIONNAIRES .............................................................................................. 35

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 3.4.4 PERSONAL INTERVIEWS .................................................................................. 36
3.5 VALIDITY AND RELIABILITY OF INSTRUMENTS .............................................. 37
3.6 DATA ANALYSIS PLAN............................................................................................. 37
3.7 CONCLUSION .............................................................................................................. 38
CHAPTER FOUR: ANALYSIS, PRESENTATION AND DISCUSSION OF RESULTS ........ 39
4.0 INTRODUCTION .......................................................................................................... 39
4.1 ANALYSIS OF DATA RESPONSE RATE ................................................................. 39
4.1.1 QUESTIONNAIRE RESPONSE RATE ................................................................ 39
4.2: APPRAISAL TECHNIQUES USED BY MICROFINANCE INSTITUTIONS .............. 40
4.3: EFFECTIVENESS OF CREDIT APPRAISAL TECHNIQUES ...................................... 41
4.3.1 EFFECTIVENESS OF APPRAISAL TECHNIQUES AND PORTFOLIO AT RISK 42
4.3.2 USAGE OF APPRAISAL TECHNIQUES AND REPORTED PORTFOLIO AT RISK
............................................................................................................................................... 43
4.3.3 IPARTS AND PORTFOLIO AT RISK ....................................................................... 43
4.3.4: INTERNAL RATING AND PORTFOLIO AT RISK ................................................ 45
4.4 RELATIONSHIP BETWEEN INTEREST CHARGED AND PORTFOLIO AT RISK ... 47
4.4.1 NON- PERFORMING LOANS AND CREDIT TERMS ............................................ 49
4.5 DISCUSSION OF INTERVIEW RESULTS ...................................................................... 52
4.6 CONCLUSION ................................................................................................................... 53
CHAPTER FIVE .......................................................................................................................... 54
5.0 INTRODUCTION ............................................................................................................... 54
5.1 KEY FINDINGS OF THE STUDY ............................................. ………………………...54
5.2 CONCLUSION ……………………………………………………………………………56
5.2.1 THE APPRAISAL TECHNIQUES USED BY MICROFINANCE INSTITUTIONS 56
5.2.2 IMPACT OF CREDIT RISK APPRAISAL TECHNIQUES ON PORTFOLIO AT
RISK ...................................................................................................................................... 56
5.2.3 THE EFFECT OF CREDIT TERMS ON MFI LOAN PERFORMANCE………….. 57
5.2.4IMPORTANCE OF CREDIT APPRAISAL IN IMPROVING LOAN QUALITY ..... 57
5.3 RECOMMENDATIONS
………………………………………………………………….Error! Bookmark not
defined.

5.4 SUGGESTIONS FOR FURTHER STUDY …………………………………………...60

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REFERENCES ............................................................................................................................. 61
LISTOF
APPENDICES………………………………………………………………………………….69

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 ACKNOWLEDGEMENTS

My paramount gratitude is credited to the Almighty God who afforded me the opportunity to
carry out this research. Personally, I do not have the capacity of being where I am, but the
invisible hand of the Lord has stretched me this far.

I would also like to profoundly express my gratitude to my supervisor, Mr. I.Ndlovu who guided
me throughout the entire project. The knowledge and guidance he imparted to me is priceless and
I am sincerely grateful. I fully appreciate the valiant efforts, assistance and unwavering support
which I received from him as he was always ready to challenge me with a lot of questions which
helped me to remain focused. Special thanks also go to all the firms who responded to my
questionnaires and who provided information which aided to the successful completion of this
project.

Behind every project are the unseen and the unsung people who contribute expertise and advice.
I could not have come this far without my friends’ unconditional friendship, honest critiques,
guidance during high and lows and notable among them are Gilbert Wozhele and Silas Musiiwa ,
I also want to acknowledge the great assistance and support from my best friend Nester Mareya,
who is constantly continuing to play a pivotal role in helping me fulfill my endeavors. Lastly, my
family has always been the backbone of all my accomplishments and I am grateful to them for
the financial and moral support which enabled me to carry out this research.

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ABSTRACT

This research was mainly influenced by the high levels of non-performing loans and increasing
number of defaulting loans being experienced by microfinance institutions in Zimbabwe
resulting in deteriorating loan performance. The Reserve Bank of Zimbabwe and other analysts
attributed this failure to poor credit risk management practices in banks and in most cases the
causes of the failure were also directly related to lax credit risk management controls. Annual
consolidated reports by various micro-finance institutions recently reported deterioration in
aggregate loan quality with gross non-performing loans and defaulting loans increasing. The
principal aim of this study was to analyze the impact of credit appraisal techniques employed by
microfinance institutions in improving loan performance. The research secondary objectives
included the credit appraisal techniques used by micro-finances, impact of the used techniques
on reducing portfolio at risk, effect of credit terms on loan performance and other components of
credit risk management that microfinance institutions can employ to increase loan performance.
Exploratory and descriptive research designs were used that enabled the researcher to organize
the collection of data. In order to make the research effective in achieving its defined objectives,
the researcher mainly targeted loans officers, credit risk analysts, recoveries officers and the
managers. The research was based on a sample of 12 registered and operational Zimbabwean
Micro finance institutions. Simple random sampling and judgmental sampling were used for the
research. Primary data collection methods adopted in this research included questionnaires and
personal interviews while secondary sources of data were also used to compliment primary data.
The research findings revealed that although all microfinance institutions in Zimbabwe use credit
appraisal techniques, one of the major causes of poor loan performance amongst the institutions
is ineffective credit appraisal. Major causes for non-performing loans and defaulting borrowers
which are directly linked to credit appraisal included high levels of non-performing loans, large
exposures to a single borrower or group of related borrowers and high prevalence of connected
loans. This study also found that, most microfinance institutions do not use loan performance
ratios as a benchmark for loan quality. The study therefore concluded that microfinance
institutions in Zimbabwe are experiencing severe deteriorating loan performance thus most of
them are continuously experiencing problems with non-performing loans and defaulting loans
since 2009 due to weak credit appraisal techniques. It was also noted that, most micro-finances
in Zimbabwe undermine the capabilities of credit appraisal techniques to significantly reduce
loan performance problems. This study therefore recommends micro-finances should adopt and
develop effective and efficient credit risk management tools that are in line with international
best practices to prevent exposure and in turn maximize shareholders wealth. Further study
should be carried out to establish the efficiency and feasibility of other credit appraisal
techniques being used by banks in microfinance setup.

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GLOSSARY OF TERMS
Non Performing loan is a loan that is not earning income because full payment of interest or
principal is no longer anticipated or the maturity date has passed and payment in full has not
been made. The non performing loan ratio is our primary indicator of loan quality problems.
Microfinance institution is an organization that offers financial services to low income
populations. Almost all give loans to their members, and many offer insurance, deposit and other
services.
Credit appraisal techniques are methods that are employed by commercial banks when
assessing the credit worthiness of a prospective borrower. These techniques usually vary,
depending on determinants such as the size and maturity of the loan, the operating record of the
business, security offered and previous relations with the borrower.
Credit risk is the current or prospective risk to earnings and capital arising from an obligator’s
failure to meet the terms of any contract with the bank or if an obligor otherwise fails to perform
as agreed. An institution is exposed to credit risk from diverse financial instruments such as
loans, acceptances, inter-bank transactions, trade financing, foreign exchange transactions,
financial derivatives and other off-balance sheet activities.
Credit policy is a guideline on overall credit operations within a banking institution to ensure
the establishment and maintenance of proper credit standards within the bank.

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LIST OF ABBREVIATIONS AND ACRONYMS

RBZ Reserve Bank of Zimbabwe

NPLs Non-performing loans
MFIs Micro-Finance Institution
PaR Portfolio at Risk

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LIST OF FIGURES

FIGURE 1.1 MICROFINANCE PORTFOLIO QUALITY TREND…..........................................4

FIGURE 4.1 EFFECTIVENESS OF APPRAISAL TECHNIQUES……………………………41
FIGURE.4.2 PORTFOLIO AT RISK AND INTEREST CHARGE ……………………………49
FIGURE 4.3 FREQUENCY ON PAYMENT PERIOD………………….……………………..50
FIGURE 4.4 FREQUENCY ON INTEREST CHARGED…….………………………………..51

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LIST OF TABLES
TABLE 1.1 MFI PERFORMANCE INDICATORS…………………………………………..….3
TABLE 2.1CREDIT APPRAISAL PROCESS…..……………………………………………...13
TABLE 4.1 QUESTIONAIRE RESPONSE RATE……………………………………………..39
TABLE 4.2 DESCRIPTIVES ON USAGE OF TECHNIQUES………………………………..40
TABLE4.3 EFFECTIVENESS OF TECHNIQUES AND PORTFOLIO AT RISK…………....42
TABLE 4.4 5CS AND PORTFOLIO AT RISK………………………………………………....43
TABLE 4.5 IPARTS AND PORTFOLIO AT RISK………………………………………….…44
TABLE 4.6 INDEPENDENT SAMPLE TEST …………………………………………………44
TABLE 4.7 INTERNAL RATING AND PORTFOLIO AT RISK………………….……….…45
TABLE 4.8 INDEPENDENT SAMPLE TEST.....................................................................…....46
TABLE 4.9 CHISQUARE TEST ON INTEREST AND PaR……………………………..……47
TABLE 4.10 CROSS TABULATION……………………………………………………….….48
TABLE 4.11 ONE SAMPLE TEST ON INTEREST AND PaR…………………………….….52

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LIST OF APPENDICES
APPENDIX A…………………………………………………...................… QUESTIONNAIRE
APPENDIX B………………………...…………………………………….INTERVIEW GUIDE

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 CHAPTER ONE: INTRODUCTORY CHAPTER

1.0 INTRODUCTION
Microfinance institutions in Zimbabwe for the past few years have been constantly reporting
poor loan performance mainly due to defaulting, non-performing and delinquent loans. In most
microfinance institutions, losses turn from outright default due to inability or unwillingness of
customers or counterparties to meet commitment. Alternatively, losses mainly result from
reduction in portfolio value due to actual or perceived deterioration in loan performance. Since
loans make the main asset of microfinance’s there is also need for sound and good credit
appraisal. Consequently, prudent lending is very necessary if the microfinance wants to retain its
integrity guaranteed in the market and the market to have confidence in it.

This research assesses the impact of credit risk appraisal techniques in establishing the credit
worthiness of a prospective borrower with particular reference to micro finance institutions thus
leading to the success of those institutions. This project identifies various causes and the
debilitating repercussions of poor credit risk appraisal, various credit appraisal techniques, and
implementation of these techniques as well as their impact on loan performance paying particular
attention to micro finance institution
1.1 BACKGROUND TO THE STUDY
Institutions involved in lending, including mortgage lending, carefully assess credit risk, which is
the possibility that borrowers will fail to pay their loan obligations as scheduled. The judgments
of these institutions affect the incidence of delinquency and default, two important factors
influencing profitability. To assess credit risk, lenders gather information on a range of factors,
including the current and past financial circumstances of the prospective borrower and the nature
and value of the property serving as loan collateral. The precision with which credit risk can be
evaluated affects not only the profitability of loans that are originated but also the extent to
which applications for mortgages that would have been profitable are rejected. For these reasons,
lenders continually search for better ways to assess credit risk. (Avery, Bostic, Calem and
Canner 1996)
In 1990s loans given to customers did not perform which called for an intervention. Most
suggestions were for the evaluation of customer’s ability to repay the loan, but this didn’t work
as loan defaults continued (Modurch, 1999). The concept of credit management became widely

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appreciated by Microfinance Institutions (MFI’s) in the late 90s, but again this did not stop loan
defaults to this date (Modurch, 1999).
Some of the loans given out by the MFIs unfortunately are becoming non-performing and
eventually result in bad debts with adverse consequences for the overall financial performance of
the institutions. The issue of loan default (Non Performing Loans) is becoming an increasing
problem that threatens the sustainability of MFIs. The causes of the problem are multi-
dimensional and non uniform among different literatures.
Non Performing Loans are always a source of misery for lenders because if an MFI has too much
of it on its balance sheet, it can adversely affect its operations in terms of liquidity, profitability,
debt- servicing capacity, lending capacity and ability to raise additional capital. The incidence of
non-performing loans in the Zimbabwean banking and non-banking industries including MFIs
has been on the rise in recent years as their loan portfolio increases despite efforts by these
financial institutions to deal with it.
According to the Reserve Bank of Zimbabwe report on Risk Management (2012) microfinance
institutions in Zimbabwe are exposed to a variety of risks including credit, liquidity, market,
price, interest rate among others. The complexity of these risks has been heightened by
technological advancement, financial innovation as well as the economic meltdown in
Zimbabwe. Failure to adequately manage these risks exposes microfinance institutions not only
to the possibility that they may suffer losses, but more importantly to the possibility that they
may not achieve their strategic business objectives. In the worst case, inadequate risk
management may result in circumstances so catastrophic that the institutions cannot remain in
business.
The Financial Services sector and the economy in general has been hit by a series of failing
businesses due to a number of factors which include among them poor credit risk appraisal
practices. Since the introduction of the multicurrency system in 2009 growth of these institutions
has remained stagnant leading to the eventual collapse of some of them notably McDowells in
Masvingo and Capital Base, in Mutare. The MFI industrial report of June 2015 highlights that
the situation has been exacerbated by inadequate credit assessments and high lending rates
charged by some microfinance institutions resulting in over indebtedness by some microfinance
customers leading to inability to service loans. High level of indebtedness among the

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microfinance clients has the undesirable effect of negating the financial inclusion objective of
microfinance.
1.1.1 PERFORMANCE OF MFI SECTOR

The MFI sector is a critical component of the financial sector focusing. The sector has been
providing loans and other financial services to low income groups. Total MFI sector loans
increased by 6.85percent to $173.31 million from $162.20 million during six (6) months ended
30 September 2015. MFI sector’s total loans accounted for 4.33percent of total banking sector
loans of $4.0 billion as at 30 September 2015. Billion as at 30 September 2015.
Table 1.1 MFI PERFORMANCE INDICATORS

31 Dec 2013 31 Dec 2014 30 Jun 2015 30 Sep 2015

No. of Licensed Institutions

143 147 147 155

Total Loans $164.20m $156.99m $162.20m 173.31m

Total Assets $185.73m $202.71m $208.76m 207.74m

Portfolio at Risk (PaR> 30 16.03percent 11.29percent 13.31percent 9.05percent

days)

No. of Clients 150,188 205,282 224,300 198,371

No. of Loan Accounts 162,221 257,542 281,547 224,055

No. of Branches 334 473 495 475

Source: Reserve Bank of Zimbabwe (Microfinance Summer School 4-5 December 2015)

There is high credit concentration in the sector. The top 20 MFIs which controlled 89.12 percent
of total MFI sector loans as at 30 September 2015 .The largest microfinance institution with a
loan book of $32.04 million, commanded a market share of 18.49percent as at 30 September

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2015.The Reserve Bank of Zimbabwe Microfinance Summer School report in December 2015
shows that as at 30 September 2015, MFIs were serving 198 371 clients (with 224,055 loan
accounts) through 475 branches. Portfolio quality, as measured by the Portfolio at Risk (PaR) (30
days) improved to 9.05percent as at 30 September 2015 compared to 13.31percent as at 30 June
2015. The improvement is attributed to a slowdown in lending by some microfinance institutions
and increased focus on collections. However, the current Portfolio at Risk (PaR) of 9.05 percent
is still above the international best practice of 5percent.

Figure 1.1 Portfolio Quality Trend

Source: Reserve Bank of Zimbabwe (Microfinance Summer School Report 4-5 December
2015)

1.1.2 STATEMENT OF PROBLEM

The success of MFIs largely depends on the effectiveness of their credit management systems
because these institutions generate most of their income from interest earned on loans extended
to small and medium enterprises (SMEs).The RBZ Supervision Report, October 5, 2014
indicates high incidence of credit risk reflected in the rising levels of non- performing loans by
the MFI’s in the last 6 years, a situation that has adversely impacted on their loan performance.
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This trend not only threatens the viability and sustainability of the MFI’s but also hinders the
achievement of the goals for which they were intended which are to provide credit to the rural
unbanked population and bridge the financing gap in the mainstream financial sector. A study of
microfinance credit management systems is a topic of considerable interest to many researchers.
However, most studies undertaken in the past few years have focused mainly on poverty
alleviation by MFI’s and rural micro financing (Migiri, 2002).

1.2 OBJECTIVES OF THE STUDY

In carrying out this research, two sets of objectives will be underscored. These are primary and
secondary objectives.

1.3.1 PRIMARY OBJECTIVES

The principal aim of this study is to assess the impact of credit appraisal techniques on the loan
performance of MFIs in Zimbabwe in the post dollarization era.

1.3.2 SECONDARY OBJECTIVES

The following are complimentary objectives the study seeks to encompass and clearly look into:

1. To outline the credit appraisal techniques currently being implemented by microfinance

institutions.

2. To assess the impact of credit risk appraisal techniques in the reduction of Portfolio at Risk
within 30days (Par 30) for microfinance institutions.

3. To establish the effect of credit terms used by microfinance institutions on the performance
of their loans.

4. To determine the components of an effective credit risk appraisal system that can be
employed MFIS

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1.3 RESEARCH QUESTIONS

The main research questions from the research problem can be said to be;

1 What are the credit appraisal techniques employed by microfinance institutions when
assessing the creditworthiness of a borrower?

2 Are the credit risk appraisal techniques outlined effective when assessing the credit
worthiness of a borrower?
3 What is the effect of credit terms of microfinance institutions on loan performance?

4 What are the components of a sound credit risk appraisal system that an MFI can adopt?

1.4 RESEARCH HYPOTHESIS

This research tests the following principal hypotheses

1. Null Hypothesis H0: Credit risk appraisal techniques do not have an impact on the loan
performance of MFIs.

2. Alternative Hypothesis H1: Credit risk appraisal techniques have a positive impact on the
loan performance of MFIs.
1.5 ASSUMPTIONS

In this study the researcher assume

1 Selected interviewees will respond in time.

2 The respondents have a general understanding of credit risk management.

3 Information on credit risk management practices and credit appraisal techniques in MFIs
will be obtainable.

4 Information to be supplied by respondents will be assumed to represent actual facts at

that period in time.
5 The credit risk appraisal policy used will continue to be used throughout the research
period.

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 6 The environment remain unchanged or the same throughout the research period.
7 The project will be completed on time.
8 The limitations to be encountered will not affect very negatively the viability of the
research.
1.6 JUSTIFICATION OF THE STUDY

The researcher consider it necessary to assess the impact of credit appraisal techniques on the
loan performance of MFIs in Zimbabwe with the hope to advise microfinance institutions in
Zimbabwe on sound credit appraisal practices that will revive the deteriorating loan quality. This
research aims to appraise financial institutions on various credit appraisal techniques that they
can employ when assessing a prospective borrower.

The researcher is aiming to contribute to the appreciation and importance of credit appraisal.
This project research also attempts to highlight to all credit managers whether credit
management techniques are effective and can be of assistance and great importance to curb loan
portfolio problems or are of insignificant use and should be ignored when assessing the credit
worthiness of a prospective borrower. This is a critical topic since it hinders the overall
improvement of loan quality in microfinance institutions hence decreased profit earnings
resulting in adverse growth of the Zimbabwe’s microfinance sector.
These research findings are likely to be of great benefit to financial institutions, prospective
individual borrowers and corporate clients as well as all other economic players who are directly
and indirectly beneficiaries of microfinance lending in Zimbabwe.

This study will help the researcher in the partial fulfillment of the requirements of the Bachelor
of Commerce Honors’ degree in Banking at the National University of Science and Technology.
The study will also be an eye opening opportunity for the researcher’s it would enable her to
acquire extensive knowledge of credit risk management and better understand the role of credit
appraisal in addressing issues of non-performing loans in lending business. The study will also
help the researcher to have a laid proper foundation for conducting future research studies.

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1.7 LIMITATIONS

The researcher faced numerous problems and limitations in the process of carrying out his
project. These are outlined below:
a. The need to protect confidentiality- Most microfinance employees were not willing to
divulge the required information due to the need to maintain confidentiality in the
banking industry. The researcher was often required to seek permission from senior
management before she can get responses. A clause was included on the research
questionnaire assuring respondents that the information will be used purely for academics
purpose and that a high degree of confidentiality will be maintained.
b. Financial limitations- The researcher could have done more of the pick and drop method
that which proved to be more effective, but could not because of financial constraints
associated with traveling around to collect the questionnaires Therefore it proved to be
very costly to administer questionnaires and carry out interviews. To supplement the
researcher’s limited financial resources funds were borrowed from friends and relatives.
c. Delayed responses- For several accessions, the researcher was told that the suitable
personnel were not in office, in a meeting or too busy. However, the researcher made
numerous call backs. Consequently the data collection process took more time than
anticipated. In order to obtain desired response rate the researcher had a constant follow
ups persuading the respondents to return questionnaire.
d. Refusals- The researcher did not face outright refusals but micro-finances kept delaying,
sometimes until he/she exclaimed loss of the questionnaire, and had to be sent another
one. To encounter this problem, the researcher therefore resent the questionnaires to the
microfinance institutions.
1.8 SCOPE OF THE STUDY

In this section the researcher defines all parameters of the study.

1.81CONCEPTUAL SCOPE

This research mainly focuses on assess the impact of credit appraisal techniques on the loan
performance of MFIs in Zimbabwe and methods employed by microfinance institutions when

8
assessing a borrower and any other techniques or methods outside credit risk will not discussed
or addressed in detail. This will allow the researcher to clearly focus on the credit appraisal
techniques in accordance to the research topic. The best time frame to analyze the Impact of
credit appraisal techniques and methods used by microfinance institutions is from the advent of
the multicurrency system in 2009 up to 2015.

1.82 GEOGRAPHICAL SCOPE

Although most of the findings of this research will apply to many countries world-wide
especially developing economies, it is to be carried out based on the data from microfinance
institutions in Bulawayo, Zimbabwe.

1.9 ORGANISATION OF THE STUDY

The research was organized in five chapters as follows.

Chapter One: Introductory Chapter: Introduces this research, with the background of the
study, statement of the problem, objectives, significance of the study, assumption, limitations of
the study.
Chapter Two: Literature Review: Reviews both theoretical and empirical literature to gather
the view of other authors on the impact of credit appraisal techniques on loan performance of
microfinance institutions .The process is guided by the identified research objectives and sub
questions.
Chapter Three: Research Methodology: gives an analysis of the research methodology to
indicate how the research was carried out. The chapter looks at the research design, target
population, sampling method, sample size, methods of data collection, data analysis procedures
and the data collection procedures.
Chapter Four: Analysis, Presentation and Discussion of Results: gives a detailed account of
the findings of the data collection exercise from field work and secondary sources.
Chapter Five: Research Findings, Conclusions and Recommendations: Summarises the
results from the previous chapter. Finally, the dissertation concludes with conclusions and
recommendations from research findings and their implication with suggestion for future
research.

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 CHAPTER TWO: LITERATURE REVIEW

2.0 INTRODUCTION

This chapter is aimed at giving the reader an insight and critique to what has been written on the
impact of credit risk management techniques on the success of Microfinance Institutions in
Zimbabwe. This chapter will analyse and make a thorough review of the literature, with regards
to credit risk management techniques being employed by MFIs, credit terms, components of an
effective credit risk management system, expert systems of credit appraisal as well as the
importance of these credit appraisal techniques in loan performance. The literature review will be
mainly based on empirical evidence and theoretical evidence thus it looks at what various
scholars in their textbooks say about the impact of credit risk management techniques in relation
to success of MFI as measured by performance of their loans. Also incorporated is work by
various journalistic writers and published research work in order to identify the impact and
importance of credit risk management techniques employed by MFIs. A conclusion to the
chapter is then given, summarizing briefly the findings of what the chapter has been detailing.

2.1 DEFINITION OF KEY CONCEPTS

The research focuses, as key variables on credit risk appraisal which is a branch of credit risk
management and loan performance and these are now defined from different sources.
Furthermore, working definitions of the same variables have been coined to incorporate all
aspects of the definitions for the purpose of this research

2.1.1 CREDIT RISK

Credit risk is the risk that a borrower or counterparty will fail to meet obligations in accordance
with agreed terms (Chumo, 2011). Credit risk is further defined as risk of a debtor failing to meet
punctually the financial commitments stemming from a credit agreement i.e. he must be able to
service interest and be in a position to repay the capital when it falls due.Greuning and
Bratanovic (2003: p135) also define credit risk as the chance that a debtor or financial instrument
issuer will not be able to pay interest or repay the principal according to the terms specified in a
credit agreement. According to Greuning and Bratanovic (2003) an institution is exposed to
credit risk from diverse financial instruments such as loans, acceptances, inter-bank transactions,

10
trade financing, foreign exchange transactions, financial derivatives and other off-balance sheet
activities.Credit risk is most critical and expensive risk associated with financial institutions and
impact is quite significant compared to any other risk associated to the banking sector as it is
direct threat to solvency of the institution (Chijoriga, 2011). Credit risk is not only directly
associated to solvency but it’s magnitude as well as level of loss is severe compared to other
risks. It may results in loan losses of high level and even failure of financial institution (Richard
et al., 2008; Chijoriga, 2011).

In the recent years, credit risk gained focal importance because of huge financial losses faced by
big international financial organizations (Nikolaidou&Vogiazas, 2014). Since the financial crisis,
financial organizations have taken special measures to mitigate any forthcoming financial losses
caused by mismanagement in loan allocations and credit recoveries

2.1.2 CREDIT RISK MANAGEMENT

SAS.com defines credit risk management as the practice of mitigating those losses by
understanding the adequacy of both a bank’s capital and loan loss reserves at any given time a
process that has long been a challenge for financial institutions. According to Gyamfi (2012), the
basis for an effective credit risk management process is the identification and analysis of existing
potential risks inherent in all products and activities

According to Greuning & Bratonovic (2003) credit provision requires due attention as credit risk
management is one of the critical aspect and hot issue amongst the issues faced by banks. The
two post that the risk management aspect is not only crucial for sustainability but growth of the
banking sector as well and also brings stability to local currency as well as the economy as a
whole. Faisan and Malik (2015) are of the view that poorly managed credit risk may cause
liquidity risk results in insolvency of the financial institutions and presence of risk in financial
sector is also attached to products offered by them. Those include balance sheet products such as
short term and long term loans, as well as off balance sheet such as letter of credits along with
other guarantees. Inspite of all the risks, loans however, constitute a greater proportion of credit
risk as they generally, account for 10-15 times the financial institution’s equity (Kitua,
1996).Hence, business may likely to collapse if there is slight deterioration in loan quality and
credit risk management offers a viable solution to such challenges.

11
Today, credit risk management constitutes a critical component of a comprehensive approach to
risk management in banking sector (Arora& Kumar, 2014). Credit management for a loan deal
does not stop until the full and last installment has been recovered (Moti et al., 2012).As posted
by Soke Fun Ho and Yusoff (2009), the efficient management of credit risk is a vital part of the
overall risk management system and is crucial to each bank’s bottom and eventually the survival
of all banking establishments. It is therefore important that credit decisions are made by sound
analyses of risks involved to avoid harms to bank’s profitability. They held effective
management of credit risk is an essential component of a comprehensive technique to risk
management and critical to the long-term success of all banking institutions.

2.1.3 CREDIT TERMS

This refers to the conditions under which an MFI advances credit to its customers. The credit
terms will specify the credit period and interest rates. Credit period refers to the period of time in
which the credit is granted. The length of the credit period is influenced by Collateral value,
Credit risk, the size of the account and market competition (Ross, Westerfield& Jordan, 2008).
Debt in a particular class will have its own interest rate in accordance with the theory of term
structure. The interest rates charged is a cost on borrowed funds and may affect the loan
performance.

2.1.4 CREDIT RISK APPRAISAL

Credit appraisal is a process to ascertain the risks associated with the extension of the credit
facility. It is generally carried by the financial institutions which are involved in providing
financial funding to its customers (Praband, 2013).Loan appraisal can also be defined as an
application/request for funds, evaluated by financial institution. The aspects to be focused in
appraisal includes: purpose of the client, need genuineness, repayment capacity of the borrower,
quantum of loan and security. Loan appraisal plays important role to keep the loan losses to
minimum level, hence if those officers appointed for loan appraisal are competent then there
would be high chances of lending money to non-deserving customers (Boldizzoni, 2008).

12
TABLE 2.1 CREDIT APPRAISAL PROCESS
Receipt of application from applicant
|
Receipt of documents
(Balance sheet, KYC papers, Different govt. registration no., MOA, AOA, and Properties
documents)
|
Pre-sanction visit by bank officers
|
Check for RBI defaulters list, willful defaulters list, CIBIL data, ECGC caution list, etc.
|
Title clearance reports of the properties to be obtained from empanelled advocates
|
Valuation reports of the properties to be obtained from empanelled valuer/engineers
|
Preparation of financial data
|
Proposal preparation
|
Assessment of proposal
|
Sanction/approval of proposal by appropriate sanctioning authority
|
Documentations, agreements, mortgages
|
Disbursement of loan

Source: Praband (2013) ‘CREDIT APPRAISAL PROCESS OF SBI’

13
Sheila, (2011) is of the view that proper and adequate appraisal is the key to controlling or
minimizing default. This is the basic stage in the lending process. According to Anjichi (1994),
the appraisal stage is the heart of a high quality portfolio. This includes diagnosing of the
business as well as the borrower. Before beginning the process of collecting information on the
client for the purpose of determining credit limits, the loan officer should have specific
information available which will guarantee that the data and figures provided by the client will
have a pro-margin error (Sheila, 2011).

The majority of the information is obtained by the loan officer through direct interaction with the
client in such a way that each loan analysis provides valuable insights for evaluating the
application for the future client.

However, most clients withhold a great deal of information making the evaluation a difficult and
unreliable exercise. Furthermore, the loan officer should visit the home or the work place of the
client with the main objective of determining whether the client needs the loan programs or not.
This information will help the loan officer to assess the ability to effectively utilise the loan.
Hunte (1996) observes that the time to assess the applicant’s credit worthiness also matters. He
argues that the longer it takes to assess the applicant, the better. This is because he believes that a
shorter time is not enough to fully assess the applicant. This is in agreement with Bigambah
(1997) who contends that it is necessary to analyse the client before a loan is issued; the
applicant has to be screened to assess his or her credit worthiness.

2.1.5 LOAN QUALITY

Credit risk variation indicates the change in health of loan portfolio managed by bank (Cooper et
al., 2003) resultantly performance of financial institution would also vary accordingly. Miller
&Noulas (1997) depicted that if financial institutions are exposed more too high risk loans, there
would be accumulation of unpaid loans along with less profits. Achou and Tenguh (2008) also
conducted research on bank performance and credit risk management found that there is a
significant relationship between financial institutions performance (in terms of profitability) and
credit risk management (in terms of loan performance). Better credit risk management results in
better performance.

14
A loan is delinquent when a payment is late (CGAP, 1999). A delinquent loan becomes a
defaulted loan when the chance of recovery becomes minimal. Delinquency is measured because
it indicates an increased risk of loss, warnings of operational problems, and may help to predict
how much of the portfolio will eventually be lost because it never gets repaid. There are three
broad types of delinquency indicators: collection rates which measures amounts actually paid
against amounts that have fallen due; arrears rates measures overdue amounts against total loan
amounts; and portfolio at risk rates which measures the outstanding balance of loans that are not
being paid on time against the outstanding balance of total loans (CGAP, 1999).

Default occurs when a debtor has not met his or her legal obligations according to the debt
contract. For example debtor has not made a scheduled payment, or has violated a loan covenant
(condition) of the debt contract (Ameyaw-Amankwah, 2011). A default is the failure to pay back
a loan. Default may occur if the debtor is either unwilling or unable to pay their debt. A loan
default occurs when the borrower does not make required payments or in some other way does
not comply with the terms of a loan. (Murray, 2011).Moreover, Pearson and Greeff (2006)
defined default as a risk threshold that describes the point in the borrower’s repayment history
where he or she missed at least three installments within a 24 month period. This represents a
point in time and indicator of behavior, wherein there is a demonstrable increase in the risk that
the borrower eventually will truly default, by ceasing all repayments. This definition does not
mean that the borrower had entirely stopped paying the loan and therefore been referred to
collection or legal processes; or from an accounting perspective that the loan had been classified
as bad or doubtful, or actually written-off.

Loan default can be defined as the inability of a borrower to fulfill his or her loan obligation as
at when due (Balogun and Alimi, 1990). According to Ahmad, (1997), causes of loan default
include; lack of willingness to pay loans coupled with diversion of funds by borrowers, willful
negligence and improper appraisal by credit officers of which credit appraisal is the key variable
in this research.

15
2.2 THE CREDIT RISK APPRAISAL AND MANAGEMENT IN MICROFINANCE
The failures of formal banks in rural sector especially the bad repayment rates of agricultural
State banks that had provided subsidized loans to rural farmers have given rise to the innovative
lending institutions that are Microfinance institutions. This type of organization has become an
increasingly popular means that can alleviate poverty by making small, uncollateralized loans to
poor customers. Moreover, what attracted attention to MFIs were its remarkably high repayment
rates.

Microfinance institutions implement multiple mechanisms that overcome the screening and
enforcement problems, which reduce the default risk and improve repayment rates. Armendariz
and Morduch (2005) and Giné et al. (2010), agree that microfinance has become a revolutionary
way to reduce poverty due to the fact that this type of organization and the way that it operates
are better designed to face information problems.

In order to explain the success of microfinance in providing credit to the poor, a large number of
theoretical works uses the principal/agent theory to demonstrate that microfinance contracts
lending to joint-liable groups solve the problems of asymmetric information in the credit market.
They permit the lender to bypass adverse selection and moral hazard and hence help to maintain
high repayment rates. Kono and Takahashi (2010) describe the existing literature and theoretical
models on innovative factors underlying the high repayment rates in microcredit programs. They
present simple models to argue that different elements of microcredit, such as group lending
solve the problems of asymmetric information in the credit market.

According to Armendariz and Morduch (2000), a large part of MFI does not offer group but just
individual loans. Many practitioners of group lending are now turning steadily toward individual
lending. This give rise to a very important question: when MFIs is not associated with joint
liability lending mechanism and offer just individual loans, how MFIs manage their credit risk.
In their interesting theoretical analysis, Armendariz and Morduch (2000) have highlighted
several important mechanisms that allow MFI to generate high repayment rates from poor
borrowers without requiring collateral and without using group lending contracts. These

16
mechanisms include the use of non-refinancing threats, regular repayment schedules, collateral
substitutes, and the provision of nonfinancial services.

2.2.1 GROUP LENDING MECHANISM

One of the major mechanisms that most MFIs employ is group lending. Group lending refers
specifically to arrangements by individuals without collateral who get together and form groups
with the aim of obtaining loans from a lender. According to Kono and Takahashi (2010), in the
typical group lending scheme: (a) each member is jointly liable for each other's loan, (b) if any
members do not repay, all the members are punished (often in the form of denial of future credit
access), and (c) prospective borrowers are required to form groups by themselves. Group lending
model has attracted an enormous amount of public and academic attention mainly after the
success of group lending program in Grameen Bank.

Besley and Coate (1995), Ghatak (1999), Kono and Takahashi (2010), Stiglitz (1990) and Van
Tassel (1999) agree that several economic works on microfinance focus on the incentives
induced by joint liability in group lending contracts and many authors have proven that group
lending enforces joint liability mechanisms, involves borrowers in sharing information and then
reduces asymmetric information). Zeller (1998) uses information on credit groups in Madagascar
and shows that the group effectively generates insurance, transfer screening and monitoring costs
from the MFI to borrowers, providing an effective way for MFIs to overcome adverse selection,
moral hazard, and enforcement problems, which leads to a better repayment performance.

First, peer selection in group lending model provides a screening mechanism for borrower’s
character, the choice of investment project and the proposed loan use, that can help to reduce
adverse selection as agreed by (Ghatak (1999); Morduch (1999); Van Tassel (1999) and Zeller
1998). Ghatak (1999) and Van Tassel (1999) provide original theoretical models to explain how
group lending with joint liability affects the problem of adverse selection. They mentioned that
borrowers in group lending have perfect knowledge of their partners and every individual wants
to form a group with safe borrowers. This peer selection and screening mechanism make the
effective cost of borrowing lower to safer borrowers and hence improve repayment rates and
efficiency. In his study, Wenner (1995) uses information on 25 Costa Rican credits groups and

17
proved that lending groups use private information to select their peers and that this selection
mechanism increases the group repayment performance.

Additionally, joint liability in group lending can reduces the problem of moral hazard by
increasing borrower’s incentives to monitor each other and then to repay the loan. The original
theoretical models dealing with the effect of group lending with joint liability on moral hazard
can be found in Stiglitz (1990).These studies conclude that joint liability may induce borrowers
in a group to monitor each other, thereby alleviating moral hazard problems. However, Kono and
Takahashi (2010) advance that group lending alleviates the problem of moral hazard only if the
group can coordinate its members’ decisions and achieves higher repayment rates only if the
returns are sufficiently high.

Besley and Coate (1995) and Wydick (1999) agree that moral hazard can be reduced also by
social sanctions against defaulting borrowers in group members. For example, Besley and
Coate(1995) construct a model to compare the repayment performance between group lending
with and without the use of social sanctions and argue that social sanctions can improve
repayment rates under group lending. Social penalty function that describes the punishments
implies that members in the community who do not repay their share can be in the form of bad
reputation, lost the trust among group members and can be excluded from the group. The
consequence may be that the delinquent borrower will find it difficult to find partners that would
be willing to co-sign for future loans. Cassar et al. (2007) show that social ties, relations and trust
among members in group lending, which are often being referred to as social capital contribute
to high repayment rates.Wydick (1999) working on 137 Guatemalan credit groups, finds that
social capital affects group performance in terms of repayment rates, group insurance and moral
hazard.

In a nutshell, group-lending mechanism can potentially deal with information asymmetry,

therefore reduces risk-taking and improves the lender’s repayment rate. Armendariz and
Morduch (2005) argue that the secret to the high repayment rates on loans is tied closely to the
use of the group lending contracts. Besides the benefits of group lending in reducing information

18
asymmetry, group lending can be an effective and efficient way to reduce the high transaction
costs in both searching reliable borrowers and ensuring the repayment of credit .
However, group lending in practice suffer from some disadvantages such as domino effect or
risk of contagion if one of the members is unable to meet repayments (Armendáriz and Morduch
(2005) and Churchill (1999).

2.2.2 DYNAMIC INCENTIVES

Lenders may use dynamics incentive as an important incentive mechanism (Besley and Coate
(1995), Kono and Takahashi (2010) and Morduch, 1999). Although group lending mechanism
manages credit risk only in group loans, the mechanism of dynamics incentive or progressive
lending, as named by Armendariz and Morduch (2005), can manage credit risk both in group and
individual loans. Dynamics incentives mechanism boils down to the threat not to refinance a
borrower who defaults on her debt obligations. This incentive has a large effect on microfinance
borrowers’ behavior because they have considerable needs for future loans to develop their
business. Morduch (1999) notes that the repeated nature of the interactions and the credible
threat to cut off any future lending when loans are not repaid can be exploited to overcome
information problems. Indeed, this mechanism allows lenders to build a long-term relationship
with borrowers over time, to generate reputation mechanisms and screen out the worst prospects
before expanding loan scale.

However, as noted by Morduch (1999), competition and increasing mobility of borrowers will
diminish the power of this mechanism against moral hazard since borrowers will have the
opportunity to take a loan elsewhere. Another limitation of progressive lending is related to the
‘finite repeated games’ problem. If the relationship has a clear end, the customer will have an
incentive to default in the final period. Morduch (1999) states that, ‘dynamic incentives are
enhanced further if borrowers can anticipate a stream of increasingly larger loans’.

2.2.3 COLLATERAL SUBSTITUTES

In financing theory, the lender uses a guarantee to reduce the risk attached to the loan. As
mentioned above, one particularity of MFI is that they do not require their clients to provide any
physical collateral that traditional commercial banks do. However, in order to maintain high
repayment rate, MFI can use important mechanism that is collateral substitutes. Collateral
substitutes serve as a means to secure repayment since collateral. For example, following the

19
model of Grameen bank, many MFIs especially during their initial years of operation require
borrowers to pay 0.5 percent of every unit borrowed (beyond a given scale) in order to collect the
emergency fund. The emergency fund serves as insurance against loan default, death or disability
(Morduch, 1999). The borrowers are also required to pay an additional five percent of the loan
that is taken out as a ‘group tax”. These contributions are usually deducted from the members’
loans or form part of weekly contributions in addition to loan amortization and thus are forced
savings. These forced savings can be withdrawn upon leaving, but only after the banks have
taken out what they are owed.

Babu and Singh (2007) noted that the lender may accept the borrower's degree certificate,
driver's license, marriage certificate and such other documents as collateral substitutes in
individual lending. Bank Rakyat Indonesia, a leading name in microfinance, uses this technique
effectively. In Russia, household items may be considered as collateral if they have sufficient
personal value for borrowers (Armendariz and Morduch (2000) and Churchill (1999)).

In rural areas, lender may accept tangible assets such as stocks as collateral substitutes. In
addition, MFI providing individual microcredit may require guarantor agreeing to guarantee the
borrower's loan, Ibtissem and Bouri (2013) the two post that it must be noted that the essential
role of a guarantor is to be a decisive factors for granting the credit and not a secondary
repayment source. The presence of a guarantor primarily acts as an ex ante signal that can reduce
adverse selection problem inasmuch as the request for guarantors requires costly efforts for the
potential borrower to find one or more Guarantors and hence bad borrowers will be discouraged
Ibtissem and Bouri (2013). Moreover, presence of a guarantor is also an ex post sanction
mechanism. Indeed, in case of default of payment, the cosigner who may lose his reputation to
the same extent as the borrower can put pressure on the borrower to meet its obligations. The
guarantor can even apply direct sanctions by revealing his or her bad conduct to neighbors or,
more generally, to members of the community he or she belongs to.

2.2.4 REGULAR REPAYMENT SCHEDULE

Even though economic theory suggests that a more flexible repayment schedule would benefit
clients and potentially increase their repayment capacity, microfinance practitioners believe that
the discipline imposed by regular repayment maintains high repayment rates in the absence of

20
collateral. Although that this feature is less usual than the previous mechanisms, it helps MFI to
maintain high repayment rates (Armendariz and Morduch, 2000; Morduch, 1999). In the MFI,
the repayment starts almost immediately after disbursement and then occurs on a weekly or
monthly basis.
Morduch (1999) points out the different advantages of regular repayment schedules. He argues
that it:
1. Screens out undisciplined borrowers at an early stage
2. Gives early warning to loan officers and peer group members about potential future
problems.
3. Permits the banks to get hold of cash flows before they are consumed or otherwise
diverted.
4. Requires that the borrowers have an additional income source on which to rely since the
repayment process begins before investments bear fruit. This permits a positive selection
of clients for the lender and for diversified households (Armendariz and Morduch
(2000)).
Ibtissem and Bouri (2013) post that regular payment schedule provide clients a credible
commitment device, which enables them to form the habit of saving regularly. They note also
that frequent meetings with a loan officer may improve client trust in loan officers and their
willingness to stay on track with repayments.

However, this early regular repayment schedules may exclude potential borrowers who have a
single source of income from the market. These borrowers are mostly present in areas focused
sharply on highly seasonal occupations like agricultural cultivation. The income generation of
agriculture areas is unstable and regular repayment schedules are difficult to respect.

2.3 CREDIT RISK ASSESSMENT/APPRAISAL APPROACHES: THEORETICAL

ASPECTS
Credit risk evaluation is the process through which a financial Institution assesses the
creditworthiness of prospective loan that exposes the financial institutions to credit risk. The
credit analysis ultimately results in an estimation of the likelihood of customer default (Ibtissem
and Bouri (2013))

21
Outside microfinance, to optimize the credit decision, there exist three main approaches to
estimate borrower’s probability of default: Structural approach or reduced form models,
statistical approach and expert-judgment approach

2.3.1 STRUCTURAL APPROACH

According to Ibtissem and Bouri (2013) the structural approach is based on modeling the
underlying dynamics of interest rates and firm characteristics that can lead to a default event.
These financial dynamics, generally described by stochastic processes evaluate the default
probability. This approach is used in portfolio credit risk models. However, it needs the use of
complex mathematical and stochastic techniques that can be hardly modeled. In addition, a clear
disadvantage of this approach is their limited applicability to public firms because it requires
specific information, e.g. borrower’s stock prices, which are not available for all borrowers.
Hence, MFI and banks offering consumer loans cannot benefit from this approach.

2.3.2 EMPIRICAL / STATISTICAL APPROACH

The second approach is the empirical or the statistical approach. Credit scoring models are used
by some financial institution in their internal rating system. The principle 3 of Basel Committee
(February, 2006) declares, ‘A financial institution’s policies should appropriately address
validation of any internal credit risk assessment models’. ‘Models may be used in various aspects
of the credit risk assessment process including credit scoring, estimating or measuring credit risk
at both the individual transaction and overall portfolio levels, portfolio administration, stress
testing loans or portfolios and capital allocation’ (p. 6). In this approach, credit scoring models
link borrower characteristics, such as financial and non-financial variables to repayment
performance on previous loans in order to estimate the borrower default. Hence, the relationship
of default and information about the borrower is learned from historical data. The major
advantage of credit scoring models is that they can be developed for all types of credit, from
consumer credit to commercial loans. However, one of the credit scoring disadvantages is that
there is no common consensus or rigorous theory on which variables should be included in
scoring model. The choice of the explanatory variables will depend largely on data availability.

2.3.3 EXPERT-JUDGMENT APPROACH / SUBJECTIVE-JUDGMENT APPROACH

Kwan et al., (1986) post that the third approach is the expert-judgment approach or subjective-
judgment approach. In this approach, creditworthiness was estimated purely by credit experts

22
based on their judgment and their intentions. The decision of granting credit is based on adoption
of certain rules or principles of lending carefully build by skilled loan officers themselves. For
example, under the 5C's of credit evaluation criteria, evaluation is based on character, capacity,
and condition, capital and collateral. These principles are drawn from the experience of loan
officers, but should be used generally and not rigidly as laws of lending.

2.4 CREDIT RISK ASSESSMENT APPROACHES IN INDIVIDUAL LENDING BY

MFIS
Evidence regarding the better credit risk assessment approaches in individual lending in MFI is
divergent and the literature highlights two main approaches: Judgmental and Statistical
forecasting methods. According to Agier and Safari (2012), adverse selection is the main
problem faced by the lending industry including microcredit institutions and in order to tackle
this problem, bankers typically combine two mechanisms: subjective-judgment approach and
statistical approach.

In the subjective judgment approach, the decision of granting credit is based on adoption of
certain rules or principles of lending carefully build by skilled loan officers. The loan officers in
MFI are trained to collect and make judgments about information on entrepreneur’s personality,
analyze the risk of potential borrowers and decide to approve or to reject the applicant. This
would typically involve a face-to-face meeting with each applicant where the loan officer -
intentionally or unintentionally - forms judgments about its creditworthiness after interviewing
him. Furthermore, loan officers should consider information about business’ project and business
conditions such as forecasts about market, economic growth, and additional macro-economic
factors. Those indications are essential in order to get a feeling about the management's ability to
handle changes in the environment.

In the literature, different authors argue that subjective approach appears to be very suitable for
MFI as it can mitigate opacity problems and be beneficial where little data exists (Bunn and
Wright, 1991). Armendáriz and Morduch (2000) argue that the success of individual-based
programs is linked to particular methods of gathering information. Loan officers must do a good
job of collecting a host of information at the screening stage. For example, the Russian micro
lending program relies heavily on credit officers visits to applicants' businesses rather than just

23
on business documents (Zeitinger, 1996).Ibtissem and Bouri (2013) demonstrates the relevance
of using loan officer’s subjective judgment in order to predict future default of microenterprise
and concludes that relationship lending technology is the most adequate for MFI because it
makes extensive use of qualitative information. However, subjective judgment for individual
loans has its weaknesses in credit risk management. First, subjective judgment assessment
requires a fair amount of time per applicant and is expensive for the lender.

According to Babu and Singh (2007), evaluating the loan proposal and defining the terms for
each particular client is costly to the MFI resulting in reduced profitability. Second, as written
within the credit scoring literature (Hand, 1998; Lewis, 1992), judgmental approach lacks of
quantification of credit risk. Moreover, borrowers’ characteristics are analysed in this approach
sequentially rather than in combination thereby ignoring their correlation. Finally and more
importantly, loan officer, like other people may seriously have cognitive bias in processing
information that affect his judgments and beliefs, so that he may be a victim of behavioral bias
and appear irrational. Balthazar (2006) notes, ‘studies of behavioral finance usually show that
credit analysts are good at identifying what the main strengths and weaknesses of a borrower are,
but integrating all the information into the final rating is not always done in a consistent way’ (p.
118).

According to Ibtissem and Bouri (2013) in order to reach a greater number of applicants more
efficiently, several MFIs judge repayment risk by the use of statistical tool used extensively in
bank to monitor their credit portfolio. This tool is the credit scoring models. Credit scoring
models represent a methodology accepted by the Basel Committee for Banking Supervision and
the U.S. and European financial systems in the construction of an internal rating system. This
method presents an innovation for microcredit but is not at all new to others credit risk
management techniques.

Credit scoring models have been used successfully with individual loan by a number of
microfinance organizations and thus can be seen as a powerful tool that improves a microfinance
institution’s management of credit risk. For example, Credit Indemnity, a microfinance division
of African Bank in South Africa experienced a decrease in default when they started to use the

24
credit scoring. Indeed, the profit of Bank increases by $2 million the year after implementing
credit scoring (Kuhn and Olsen, 2008). ACCION (in Bolivia, Ecuador, and Peru) and Women’s
World Banking (in Colombia and the Dominican Republic) are also examples of MFIs that have
adopted the credit scoring as a credit risk management technique in their granting decision. Two
WSBI members, Banco BCSC in Colombia and BancoEstado in Chile, have incorporated credit
scoring systems and have found that scoring system is very important tool for making faster and
more accurate credit decisions.

According to the literature by the authors, Dellien (2003), Kuhn and Olsen (2008), Schreiner,
(2003) and Viganò (1993), Crediamigo, the largest Brazilian MFI, used the credit scoring system
as an integral part of credit risk assessment and decision process for new loans and for loan
renewals. Alexandria Business Associations (ABA), a Microfinance Service Provider in Egypt
started full implementation of credit scoring in August 2007. Several researches have highlighted
the usefulness of credit scoring. Credit scoring model automates the credit decision process,
replaces manual loan decision and overcomes the high cost of collecting relevant information on
borrower, leading to minimization of administrative costs. This is very profitable because the
tight margins of microcredit render manual loan decision increasingly unprofitable Different
authors (Berger et al., 2005; Fishelson-Holstine, 2004) show that scoring increases not only
profits but also the number of clients and the number of poor clients. Schreiner (2003, 2005) and
Dellien (2003) conclude that scoring simultaneously increases breadth, depth, and length of
outreach by reducing the high transaction costs, improving the time allocation of loan officers
and hence improving credit decisions and portfolio management. Simbaqueba et al. (2011)
advance that under the pressure of the demand of microcredit, it will be not practical or cost
effective for MFI to train and maintain an adequate staff of experienced credit evaluators and
conclude that ‘credit scoring as a technology meant to improve micro lending significantly’
(p.1).

In addition to the above literature, scoring model allows adjusting interest rates and fees
according to risk (Kuhn and Olsen (2008); Schreiner (2003)). Furthermore, scoring approach
identifies the most important risk explaining factors. This enables to gain more effective
advanced risk management systems, leading to a quantitative risk culture (Schreiner, 2005; Van

25
Goal et al., 2011). More importantly, by making the criteria explicit, credit scoring reduces the
role of subjectivity in the loan decision and then reduce the effects of discrimination and
prejudice by individual loan officers and minimizes human bias in the credit decision process
(Kuhn and Olsen (2008); Schreiner (2005).

However, others advance that credit scoring is vulnerable to several limits. For example,
ignoring qualitative factors and blindly applying a credit scoring in Microfinance context can led
to inaccurate evaluations and hence to high arrears and default. Schreiner (2003) argues that the
installation of the credit scoring models requires an important fixed cost7 at the beginning and
requires periodic updating and persistent training with the loan officers. Cornée (2009) concludes
that transaction-based technologies are not well-suited for MFI and that credit scoring technique
would potentially not be able to give a ruling on a borrower’s creditworthiness if the project is
too innovative. They explained this by two causes. First, the situation in MFI can be referred to
as uncertainty not as risk because microenterprises are characterized by their idiosyncrasy and
this high degree of uniqueness makes impossible to form homogenous classes of instances
difficulty to use the credit scoring models.

2.5 EXPERT SYSTEMS

These are commonly used by most local banking institutions in Zimbabwe. Reel and Gill (1989:
243) outlined that expert systems are basically traditional approaches to credit risk management
and mainly include CAMPARI, PAPERS and 5Cs. The two further outlined that in this approach
the credit decision is left to the local branch lending officer or the account relationship manager.
Implicitly, this manager’s expertise, subjective judgment and weighting of certain key factors are
the most important determinants in the decision to grant credit. Once a client has been visited
and a visitation report complied, the lender should now proceed to prepare a credit proposal
using these traditional approaches.

2.5.1 CAMPARI
The abbreviation CAMPARI stands for:
C-Character
A-Ability
M-Margin

26
P-Purpose and proposed facilities
A-Amount
R-Repayment
I-Insurance
Davies and Kearns (1992: 117) described this approach under the following subheadings below;
i. Character: In this category the lending officer looks at the age as well as health of the
prospective borrower; personal stability of the borrower (thus borrower’s dependents,
marital status, type of employment, duration of current employment and whether the
borrower is a tenant or owner); integrity and honesty; borrowers personal resources or
wealth; borrowers lifestyle as well as connections.
ii. Ability: The borrower’s ability to repay the funds borrowed or to use the borrowed funds
to intended use should be assessed. Under this category Reel and Gill (1989: 246) noted
that it should be insured that the borrowing company is not using borrowed funds to pay
its dividends or repay other loans.
iii. Margin: The microfinance should consider its expected return in all this process and
generally the greater the risk, the higher the interest rate to be charged.
iv. Purpose: The prospective borrower should provide satisfactory proof that the reasons for
intended use of funds are valid and this has to be in the customer’s best interest.
v. Amount: Guidelines should be laid down by the microfinance that will assist to
determine minimum and maximum amounts for certain types of lending.
vi. Repayment: Assessment of the borrower’s commitment to repay the principle amount as
well as interest payment should be made. The client’s cash flows should be looked at to
identify whether the repayments can be serviced without strain.
vii. Insurance: Any security should be easy to value as the microfinance will need to know
the value of the security and the procedures of registering security should be simple, and
easy to realize.
2.5.2 PAPERS
As enunciated by Smithson (1998) PAPERS are the basic cannons of lending which have
traditionally been used. PAPERS stand for;
P-Personality
A-Amount

27
P-Purpose
E-Earnings
R-Repayment
S-Security
Smithson (1998) went on to describe this approach under the following subheadings;
i. Personality: This basically entails honesty, integrity, commitment as well as experience.
Management quality and market perception of management of the company should also
be assessed.
ii. Amount: The Company should have its own funds committed to venture into the new
project that they want to embark on. Thus the micro-finances should not be expected to
provide all the risk capital required. Amount required by the company must also be
proportionate to the company’s turnover thus the loan advanced must be within the reach
of the company to pay back.
iii. Purpose: The purpose of the loan should be consistent with the company’s normal line of
business. On this note Davies et al (1992:113) emphasized that banking institutions
should be aware of financing speculative activities as well as business divergence from
the company’s normal operations.
iv. Earnings: The amount projected by the microfinance must fully justify the risk it is
taking on by any facility available.
v. Repayment: Source of repayment must be evident and feasible thus it must be clearly
defined and should preferably be from proceeds of the transaction financed. An
alternative source of repayment must also be stated if the primary source fails.
vi. Security: On this regard, Reel and Gill (1989:p246) said that “Security is not the sole
standard in judging a facility but rather it is a safety net essential for the protection of the
microfinance against loss, diversion or default by the customer.”
2.5.3 5Cs
According to Davies et al (1992: p121), the most common cannons of lending are the 5Cs
of credit. The two further elaborated on these 5Cs of credit under the following
subheadings;
i. Character: Firm reputation, its willingness to repay as well as repayment history should
be thoroughly assessed.

28
 ii. Capital: Leverage ratios such as owner’s contribution to equity, equity to debt ratio of
the company should be assessed and a higher leverage suggests a greater probability of
bankruptcy.
iii. Capacity: This is mainly the ability of the borrower to repay and the reflective of the
borrower’s volatility of earnings. There should be no significant deviation of company
earnings over time as this can constrain periodic interest and principle repayment.
iv. Collateral: In the event of default, the microfinance has claims on the collateral pledged
by the borrower. The greater the priority of this claim and the market value of the
underlying collateral, the lower the exposure risk of the loan.
v. Cycle: This generally refers to economic conditions. The state of the business cycle is an
important element in determining credit risk exposure especially for cycle dependent
industries.

2.6 KEY COMPONENTS OF EFFECTIVE CREDIT RISK APPRAISAL AND

MANAGEMENT
According to Lepus (2004), effective credit risk management is a critical component of a
financial institution’s overall risk management strategy and is essential to the long-term success
of any financial institution.
Overall, the components of effective credit risk comprise active Board and Senior management
oversight; sufficient policies, procedures and limits; adequate risk measurement, monitoring and
management information systems; and comprehensive internal controls. Lepus sought the
opinions of industry participants on the key components of effective Credit Risk management.
 Robust technology and business processes
Robust technology is a critical component of effective credit risk management. It is thought to
help financial institution identify measure, manage and validate counterparty risk, although it is
of little value without effective credit risk policies and business processes in place.
 Policies
Having a comprehensive and strategic vision for credit policy is vital as it sets guidelines for
businesses, giving rise to effective credit risk management. These guidelines include a set of
general principles that apply to all credit risk situations, as well as specific principles applicable
to some countries and types of counterparties and/or transactions.

29
 Exposures
The ability to measure, monitor and forecast potential credit risk exposures across the entire firm
on both counterparty level and portfolio level is vital.
 Robust analytics
A key component of an effective credit risk management strategy is having robust risk analytics.
Efficient and accurate credit analytics enable risk managers in financial institutions to make
better and more informed decisions. The availability of better information, combined with
timeliness in its delivery, leads to more effective balancing of risk and reward, and the possibility
of higher long-term profitability.
 Other
The other ingredients of effective credit risk management include credit risk transparency,
defined credit decision process, sophisticated risk measurement methodologies, stress testing,
timeliness and accuracy of risk calculations as well as efficient credit risk reporting.

2.7 EMPIRICAL EVIDENCE

This section gives findings by different authors on the variables under study.

2.7.1 THE CASE OF GHANA

The study was carried out by Addae-Korankye (2014) analysed the causes and control of loan
delinquency/default in microfinance institutions in Ghana. Random sampling technique was used
to select twenty-five microfinance institutions and two hundred and fifty clients for the study.
The study found the causes of loan default to include; high interest rate, inadequate loan sizes,
poor appraisal, lack of monitoring, and improper client selection.

Measures to control default were found to include training before and after disbursement,
reasonable interest rate, monitoring of clients, and proper loan appraisal. These factors or causes
confirm the findings of the study conducted by Ahmad, (1997), who found that lack of
willingness to pay loans coupled with diversion of funds by borrowers, willful negligence and
improper appraisal by credit officers are some of the causes of loan default.
It was recommended among others that MFIs should have clear and effective credit policies and
procedures and must be regularly reviewed. It was concluded that the government and hence
Bank of Ghana should regularly monitor and supervise the MFIs so as to ensure safety of clients’
deposits and customers’ confidence.

30
2.7.2 THE CASE OF KENYA
The study was conducted by Gakure et al aiming at measuring the effect of credit risk
management techniques on the performance of unsecured loans by commercial banks in Kenya.
From the study, it was observed that risk identification, risk rating, collateral, credit worthiness
and credit scoring affected the performance of unsecured bank loans to a great extent .The study
sought to find out the level of agreement of the respondents on the effect of credit-
approval/sanctions on the performance of unsecured bank loans. From the findings, the
respondents strongly agreed that clear established process for approving new credits and
extending the existing credits has been observed to be very important while managing Credit
Risks in banks and banks must have in place written guidelines on the credit approval process
and the approval authorities of individuals or committees as well as the basis of those decisions
affect the performance of the bank.

The study also revealed that monitoring of borrowers is very important as current and potential
exposures change with both the passage of time and the movements in the underlying variables
affect the performance of unsecured bank loans .The respondents agreed that prudent credit
practice requires that persons empowered with the credit approval authority should not also have
the customer relationship responsibility, some approval authorities will be reserved for the credit
committee in view of the size and complexity of the credit transaction and that credits to related
parties should be closely analysed and monitored so that no senior individual in the institution is

Another study was carried out by Gatuhu (2011) aiming at establishing the effect of Credit
Management on Financial performance of MFIs in Kenya. The study sought to determine the
extent to which MFIs used client appraisal in Credit Management, from the findings 45.3% of
the respondents indicated to a great extent, 35.8% of the respondents indicated to a very great
extent whereas 18.9 % of the respondents indicated to a moderate extent, this implies that most
MFIs used client appraisal in credit management to a greater extent. The study also revealed that
Client appraisal is a viable strategy for credit management where aspects of collateral character
are considered while appraising clients. According to this study the failure to assess customers’
capacity to repay results in loan defaults.

31
2.7.3 THE CASE OF PAKISTAN
The study was carried out by Ahmed S F and Malik Q A(2015)The main aim of the paper was
to evaluate the influence of credit risk management practices on loan performance while taking
the credit terms and policy, client appraisal, collection policy and credit risk control as the
dimensions of the credit risk management practices. For statistical evaluation, the primary data in
cross sectional form was taken into consideration. The data is collected from the managerial
level credit risk management staff of microfinance banking sector. The results of the analysis are
showed that the credit terms and client appraisal have positive and significant impact on the loan
performance, while the credit policy and credit risk control have positive but insignificant impact
on loan performance. The study is helpful for the management to enhance the loan performance
by focusing on the dimension of the credit risk management practices used in the study. Future
aspects of the research have also been taken into account and elaborated.

2.8 CONCLUSIONS
The chapter looked at the related literature on the effectiveness of credit risk management
techniques on the success of Microfinance Institutions. Various sources were used, which
include journals, textbooks and the internet in order to come up with different and well balanced
views of authors and authorities with regard to credit risk management. The next chapter will
discuss the research methodology.

32
CHAPTER THREE: RESEARCH METHODOLOGY

3.0 1NTRODUCTION
This chapter outlines the methods used to conduct the research and examines the various
techniques used. It gives arguments for the approach that the research adopted in the collection
of data pertaining to the research topic. Research methodology refers to the systematic, focused
and orderly collection of data for the purposes of obtaining information in order to solve research
questions. The chapter also covers the research design, target population of the study, the sample
chosen, sampling techniques, data collection methods, a data analysis plan, and the research
process itself.

3.1 RESEARCH DESIGN

The research employed a causal research design method as it sought to identify the effect of
credit appraisal techniques in relation to reducing portfolio at risk. Causal research involves the
determination of factors that relate to the variables to be analyzed and seeks to establish the
cause of the relationship between or amongst variables. This was used as the researcher seeks to
find if effective credit appraisal result in an improvement in an institutions loan quality.
Exploratory research design was also considered appropriate in this research. This research
design was adopted because it provides the researcher with a better idea and insight about a
broad and vague research problem as the study seeks to identify and evaluate the effect of credit
appraisal techniques on microfinance’s’ loan performance.

3.2 TARGET POPULATION

Target population is defined as the total group of elements and subject taken into consideration.
The target population posses the information sought by the research and about which references
are to be made. In order to make the research effective in achieving its defined objectives, the
researcher focused mainly on Microfinance institutions. The research population was drawn from
the stakeholders who are directly affected by the day-to-day operations of the Micro finances
institutions in Zimbabwe these include loans officers, credit analysts, recovery officers and
managers.
3.3 SAMPLING TECHNIQUES
A sample is a subset of the population under investigation. The sample was based on the non-
random sampling technique through the use of judgmental sampling. The use of judgmental

33
sampling means that the researcher identified elements thought to be representative of the
population. Therefore out of the 155 Micro- finances in Zimbabwe the researcher chose 12
Micro-finance institutions to be representative of the entire population. The researcher chose 12
micro-finances situated in the Bulawayo central business district for they would be easier to
reach given the time constraint associated with the research.

A stratified random sampling method was used in choosing the representative of the entire
population. A stratified random technique is accurate, easily accessible, divisible into relevant
strata; low costly if relevant strata are considered but relatively difficult to explain. A simple
random technique was then applied for the actual selection of the respondents. Simple random
technique is accurate and easily accessible but high costly if there is a large sample and relatively
difficult to explain

The researcher also used judgmental sampling thus the selection of the sampling units was
consciously shaped by the research agenda. Judgmental sampling was used for the selection of
loans officers, credit analysts, recoveries officers and managers. The basis of the target
population was based on the subjective instinct that those members will represent the entire
group. This sampling technique was used because it is convenient, fast and relatively cheaper
and conclusive judgments could be made on the work under the study.

3.4 DATA COLLECTION METHODS AND TECHNIQUES

This research was based on both primary and secondary data sources in order to come up with a
valuable and meaningful conclusion. The study made use of both questionnaires and personal
interviews as methods of gathering the required data. The above-mentioned techniques are easy
to read, understand and interpret to all levels thus they clearly show the variations in the results
of the findings.

3.4.1 SECONDARY DATA

The secondary data sources included the Internet, journals, newspapers, RBZ Reports and others.
These sources are useful in providing important information used during the process of designing
the questionnaires for the survey. Secondary data is less expensive to use than primary data
collection. Secondary data is also useful because less time and effort is expended in analyzing

34
and interpreting data that had been compiled already and due to time constraints, the researcher
required some data quickly and secondary data is the best method to use.

3.4.2 PRIMARY DATA

The primary data sources included self-administered questionnaires with individual and
institutional investors and personal interviews with fund managers. Primary data was used
because the data is very useful and direct, thus meeting the exact needs of this work, data is also
up to date and very recent thus making the research more objective, the data is also presumably
reliable to use, as it was coming directly from the various parties involved and also due to the
nature of the data obtained, which is first hand detail. However, the primary data method of
collection are very time consuming and costly, distribution of the questionnaires, conduction of
interviews as well as obtaining feedback from the various respondents.

3.4.3 QUESTIONNAIRES
The questionnaires constituted of open ended questions and semi-structured questions as shown
in appendix. Some of the questionnaires were physically distributed by the researcher and some
through electronic mail. A total of 5 respondents were targeted from all the micro-finance
institutions selected. Where the targeted person was busy, the questionnaire was left for him or
her to fill in and then later collected.

The questionnaire responses were coded and tallied question-by-question to aid data presentation
in Chapter Four. Questionnaires were chosen because they are relatively cheap, easy to
administer and cover a large number of respondents. Questionnaires also allow respondents to
have enough room to respond to questions at their own time and pace especially in instances
where the respondents are too busy to be interviewed. This eliminated bias as information is
provided in the absence of the researcher. Self-completion of questionnaires also guaranteed
confidentiality. Furthermore, with closed questions, answers are standardized and this help in
interpreting responses.

Despite the merits brought about through the use of questionnaires some respondents did not
return them and some left other questions unanswered, thereby compromising the sample size
and authenticity of the survey. Some questions lacked clarity and vague to respondents thus
feedback was somehow wrong.

35
The researcher counteracts the drawbacks by encouraging respondents to answer all the
questions in utmost good faith as much as possible and structuring questions in the most simplest
and understandable manner as much as possible. Follow ups were made using phone calls to
questionnaire recipients so as to increase the response rate.

3.4.4 PERSONAL INTERVIEWS

Kahn and Cannel (1957) define an interview as a purposeful discussion between two or more
people. The use of interviews can help to gather valid and reliable data that are relevant to the
research objectives (Kahn and Cannel, 1957). It is therefore a primary data collection process
through direct questioning. Interviews can be structured or semi-structured or unstructured
(Saunders et al., 2007).

In a bid to get lucid opinions from different respondents the researcher conducted interviews.
The researcher scheduled appointments with different managers of the microfinance institutions.
The interviews were carried out with the aid of the interview guide. The interviewees were asked
questions and their various responses were recorded in a note book by the researcher. However,
where they were not available loans officers and credit analysts were opted for. The interviewee's
were asked questions and their various responses were recorded in a note book by the researcher.
Interviews helped the researcher to overcome the limitations caused by questionnaires. They
were mainly used for interviewing stakeholders to whom some of the questions were irrelevant
but whose views were crucial to the research. Interviews proved important because they provide
a face to face confrontation with the respondent where he or she was not limited in space or
structure but gave a free opinion in his or her own language.

However interviews are time consuming and provide source of worry due to bias feedback by the
respondent. Some respondents are more concerned about maintaining confidentiality that they
fear the interviews could be manipulated by the researcher to obtain the company secrets which
could either be exploited by competitors or by the regulators. In these scenarios the researcher
convinced the concerned parties that the information would be used solely for academic
purposes.

36
3.5 VALIDITY AND RELIABILITY OF INSTRUMENTS
The questionnaires and interview guides used by the researcher were pilot tested. The researcher
carried out a pilot test administering the questionnaires to a group of 4 staff members from
different microfinance institutions representing stakeholders in the management of credit risk.
Specifically, the researcher was reviewing all of the items for readability, clarity and
comprehensiveness to see whether the respondents will come to some level of agreement that
will help to see items that should be included in the final instrument.

The research used a pilot test used to find out the time it takes to complete a questionnaire,
clarity of questions; whether there are major topical omissions and any other comments from the
respondents. The purpose of the pilot test is to refine the questionnaire so that respondents will
have no problems in answering the questions and there will be no problems in recording the data.
In addition, pilot test enabled the researcher to obtain some assessment of the questions’ validity
and the likely reliability of the data that will be collected. The questionnaire and the interview
guide were also checked by the supervisor for ambiguity, appropriateness and relevance with the
study.
3.6 DATA ANALYSIS PLAN
The data was collected using questionnaires and interviews were analyzed using SPSS and MS
Excel to come up with meaningful information. Data analysis involves reducing accumulated
data to a manageable size, developing summaries, looking for patterns and applying statistical
techniques. The purpose for doing all this will be to present data in a clear, logical and justifiable
manner so that readers will find it easier to interpret data.

The analysis and interpretation of the findings involved, making deductions from the numerical
parameters of the findings that is percentages and degree of agreement, comparing findings with
the existing theory and prior related research findings, suggesting reasons for deviation and
modifications. In analyzing the findings from the study, the researcher employed the use of
hypothesis testing in-order to find out if the statistics found from SPSS were realistic in
accordance to the research questions of the study. In doing this hypothesis testing was used on
results from cross tabulations, Chi-square tests, independent sample tests, and one sample t-tests
to determine the relationship between variables. The researcher also used descriptive statistics to

37
determine frequencies in respondents' views on the variables that were asked in the distributed
questionnaires.
3.7 CONCLUSION
This chapter outlined the research design and the data gathering instruments that were employed
in this research, noting the reasons behind choosing such research instruments. The challenges
faced by the researcher when gathering data and the possible solutions at her exposure are also
explained in this chapter. The sampling technique that was used and the sample population have
been described in this chapter. The next chapter focused on the presentation of data and analysis
of the results of the study

38
CHAPTER FOUR: ANALYSIS, PRESENTATION AND DISCUSSION OF RESULTS

4.0 INTRODUCTION
This chapter looks at the key research findings. The responses obtained from questionnaires and
interviews were ultimately presented, interpreted and analyzed in a descriptive manner. The
research findings were linked to the research objectives and summarized to capture the essence
of this research study.

4.1 ANALYSIS OF DATA RESPONSE RATE

The following information relates to results obtained from questionnaires and interviews
respectively

4.1.1 QUESTIONNAIRE RESPONSE RATE

The researcher distributed five questionnaires to each Microfinance institution targeting the
Loans officers, Recovery officers, credit analysts and management. In total the researcher
distributed sixty questionnaires. The table below illustrates the response rate.

Target population Distributed Questionnaires Responses Response Rate

%
Loans Officers 24 23 95.8%
Recoveries Officer 12 8 66.7%
Credit Analyst 12 7 58.3%
Management 12 6 50.0%
Total 60 44 73.3%

TABLE4. 1: RESPONSE RATE

Source: Primary Data

The researcher therefore attained 95 percent response from targeted loans officers, 66.7 percent
from recoveries officers, 58.3percent from credit analysts and a 50 percent from management. In
overall the response rate was 73.3 percent.

39
4.2: APPRAISAL TECHNIQUES USED BY MICROFINANCE INSTITUTIONS
This section seeks to outline the appraisal techniques used in microfinance institutions and the
extent to which the techniques are used. In the statistics in table 4.2 below, the minimum mean
value of 1 represents usage to a greater extent, mean of 2 represents usage to a lesser extent and
the maximum mean of 3 represents no usage (never used).

TABLE4. 2 :USAGE OF TECHNIQUES’ DESCRIPTIVE STATISTICS

Std.
N Minimum Maximum Mean Deviation

Usage of Internal Rating 44 1.00 3.00 2.4791 .72555

Usage of Credit Scoring 44 1.00 3.00 2.5636 .74991
Usage of 5 Cs 44 1.00 3.00 1.2045 .46152
Usage of IPARTS 44 1.00 3.00 1.4545 .69732
Usage of Compare 44 1.00 3.00 2.4918 .69542
Effectiveness of PAPERS 44 1.00 4.00 2.2045 .76492

Valid N 44

Source: Primary Data

Basing on the results above 5Cs and IPARTS has a mean closer to mean of 1 (Used to a greater
extent) when rounded off thus it is the most used technique. PAPERS have a mean closer to 2
(Slightly used) when rounded off .Internal Rating, Credit Scoring and Compare have got means
that range from being slightly used (mean of 2) to never used (Mean of 3) when rounded off.

Basing from above it can be concluded that the appraisal techniques used by microfinance
institutions are 5Cs (most used) followed by IPARTS (slightly used) and PAPERS (slightly
used).

40
4.3: EFFECTIVENESS OF CREDIT APPRAISAL TECHNIQUES
This section seeks to give an insight in terms of descriptive statistics on the effectiveness of
credit appraisal techniques used by microfinance institutions in Zimbabwe as per respondent’s
point of view. Minimum mean is 1 representing the response (Very Effective), mean of 2
represents response (Fairly effective), mean of 3 represents response (slightly effective) and
Maximum mean is 4 representing response (Not Effective).
Figure 4.1: Descriptive statistics

Effectiveness of CAMPARI

Effectiveness of IPARTS

Std. Deviation
Effectiveness of PAPERS
Mean

Effectiveness of 5Cs Maximum

Minimum

Effectiveness of Credit Scoring

Effectiveness of Internal Rating

0 1 2 3 4

Source: Primary Data

Basing on the results above Campari, Credit Scoring and Internal Rating scored means of 1
(Very effective) when rounded off. PAPERS scored a mean of 2(Fairly effective) when rounded
off .5Cs and IPARTS scored means of 3(Slightly effective) when rounded off. None of the
techniques scored a mean of 4(not effective).It can be concluded that the appraisal techniques
used by microfinance institutions from table 4.2 (5Cs, IPARTS and PAPERS) are not very
41
effective in reducing Portfolio at Risk. The above assertion can be supported by sample tests in
section 4.3.1 below.

4.3.1 EFFECTIVENESS OF APPRAISAL TECHNIQUES AND PORTFOLIO AT RISK

This section seeks to test on the relationship between effectiveness of appraisal techniques and
the portfolio at risk incurred by the micro finance institutions. In this section the researcher tested
the most used techniques which are the IPARTS, 5Cs and PAPERS. To achieve the objective the
researcher conducted a one sample test to determine the relationship between each of the above
mentioned techniques and portfolio at risk as according to the respondents’ views.
TABLE 4:3: EFFECTIVENESS OF APPRAISAL TECHNIQUES AND PaR

Test Value = 1

95% Confidence Interval of the

Sig. (2- Mean Difference

t df tailed) Difference Lower Upper

Effectiveness of 5Cs 14.045 43 .000 1.54545 1.3235 1.7674

Effectiveness of
10.446 43 .000 1.20455 .9720 1.4371
PAPERS
Effectiveness of
15.844 43 .000 1.63636 1.4281 1.8446
IPARTS

Source: Primary Data

Hypothesis
H0: Mean is significantly different from 1(Very effective)
H1: Mean is not significantly different from 1(Very Effective
Basing on the above results we reject H1 and accept H0 since the mean is significantly different
from 1(Very Effective) shows by p-value (0.000) which is less than 0.05.We can then conclude
that the appraisal techniques employed by Microfinance institutions are not very effective in
reducing Portfolio at Risk.

42
4.3.2 USAGE OF APPRAISAL TECHNIQUES AND REPORTED PORTFOLIO AT
RISK
The researcher also conducted an independent test on two of the most used appraisal techniques
(5Cs and IPARTS) and one less used technique (internal rating) to determine the relationship
with portfolio at risk.

TABLE 4.4 GROUP STATISTICS( 5CS AND PaR)

Std.
Usage of 5 Cs N Mean Deviation Std. Error Mean

Portfolio at Risk used to a greater

extent 31 3.4839 .81121 .14570

never used 2 2.5000 .70711 .50000

Source: Primary Data

Hypothesis
H0: 5 Cs is not very effective in reducing Portfolio at Risk
H1:5Cs is very effective in reducing Portfolio at Risk
Basing on the group statistics it can be noted that the a number of MFIs have higher portfolio at
risk (3.50 ≠ 0.81121) regardless of using 5cs to a greater extent as compared to a few MFIs with
lower portfolio at risk(2.500≠0.70711.

From the results we reject H1 and accept H0 and conclude that 5Cs are not very effective in
reducing portfolio at risk since regardless of a greater extent of their usage MFIs still report high
portfolio at Risk.

4.3.3 IPARTS AND PORTFOLIO AT RISK

The researcher also conducted an independent testing to determine the relationship between
IPARTS and portfolio at risk. In this the researcher used the level of usage of IPARTS in testing
its impact on reported Portfolio at Risk and this can be seen in the table overleaf.

43
TABLE 4.5 :GROUP STATISTICS (IPARTS AND PORTFOLIO AT RISK)

Std. Std. Error

Usage of IPARTS N Mean Deviation Mean

Portfolio at Risk used to a greater

59 3.3898 .80979 .10543
extent

never used it 15 2.2000 .41404 .10690

Source: Primary Data

Regardless of the usage of IPARTS to greater extent most microfinance institutions report higher
risk of (3.3898≠ 0.809709) than the lower risk when not used (2.2000≠0.41404).Many
microfinance institutions use IPARTS to a greater extent and their Portfolio at risk is always high
and a few who never used it report lower portfolio at risk thus we conclude that IPARTS is not
very effective in reducing portfolio at risk.
The researcher also conducted a Levine’s test to determine the equality of means and variances
as shown in table 4.6 below.

TABLE 4.6:INDEPENDENT SAMPLES TEST

Levine’s Test
for Equality
of Variances t-test for Equality of Means
95% Confidence
Sig. Interval of the
(2- Mean Std. Error Difference
F Sig. t df tailed) Difference Difference Lower Upper
Portfolio Equal
at Risk variances 17.611 .000 5.491 72 .000 1.18983 .21670 .75786 1.62181
assumed
Equal
variances
not 7.925 44.347 .000 1.18983 .15014 .88730 1.49236
assumed

Source: Primary Data

44
The p-value in table 4.6 overleaf is less than p-0.05 therefore we reject H0 and accept H1 and
conclude that the IPARTS are not very effective in reducing portfolio at risk.

4.3.4: INTERNAL RATING AND PORTFOLIO AT RISK

The researcher also conducted an independent testing to determine the relationship between
internal rating and portfolio at risk. In this the researcher used the level of usage of internal rating
in testing its impact on reported Portfolio at Risk and this can be seen in the table overleaf
TABLE 4.7:GROUP STATISTICS(INTEREST AND PaR)

Usage of Internal Std. Error

Rating N Mean Std. Deviation Mean

Portfolio at Risk used to a greater

extent 6 1.0000 .00000 .00000

never used it 23 3.6087 .72232 .15061

Source: Primary Data

Hypothesis
H0: Internal rating is not effective in reducing portfolio at risk.
H1: Internal rating is effective in reducing portfolio at risk
Basing on the group statistics it can be noted that the a few MFIs have higher portfolio at risk
(1.000 ≠ 0.000) when using internal rating to a greater extent as compared many of them with
higher portfolio at risk(3.6087≠0.72232

The researcher also conducted a Levine’s test in order to check equality of the means obtained in
the usage of internal rating and portfolio at risk as shown in table 4.8 overleaf.

45
The table below shows the Levine’s test on equality of means between portfolio at risk and
internal rating.
TABLE 4.8 :INDEPENDENT SAMPLES TEST(INTEREST AND PaR)

Levine’s
Test for
Equality of
Variances t-test for Equality of Means

95% Confidence

Sig. Interval of the

(2- Mean Std. Error Difference

F Sig. t df tailed) Difference Difference Lower Upper

Portfolio Equal
- -
at Risk variances 11.366 .002 -8.728 27 .000 -2.60870 .29889
3.22197 1.99542
assumed

Equal
variances - - -
22.000 .000 -2.60870 .15061
not 17.321 2.92105 2.29634
assumed
Source: Primary Data

Hypothesis
H0: Internal rating is not effective in reducing portfolio at risk.
H1: Internal rating is effective in reducing portfolio at risk
From the Levine’s independent sample test above we can note that the p-value is less than p-0.05
therefore we reject H0 and conclude that the greater the usage of internal rating has a greater
impact in reducing portfolio at risk. However, basing on the group statistics in table 4.7 only a
few microfinance institutions are employing this technique.

46
4.4 RELATIONSHIP BETWEEN INTEREST CHARGED AND PORTFOLIO AT RISK

The study carried out a Chi-square test to assess the relationship between interest charged and
Portfolio at risk and presented in table 4. It is used to determine whether there is a significant
association between the two variables: interest charged and Portfolio at risk. Below are the
results.

TABLE 4.9:CHI-SQUARE TESTS(INTEREST AND PaR)

Asymp. Sig. (2-

Value df sided)

Pearson Chi-Square 45.743a 9 .000

Likelihood Ratio 48.487 9 .000
Linear-by-Linear Association 22.474 1 .000
N of Valid Cases 105

Source: Primary Data

Hypothesis

H0: There is no significant relationship between interest charged and portfolio at risk

H1: There is significant relationship between interest charged and portfolio at risk

Basing on the results above we reject H0 and accept H1 Since the P-value (0.000) is less than the
significance level (0.05), we cannot accept the null hypothesis. Thus, we conclude that there is a
significant relationship between interest charged and portfolio at risk.

The researcher also cross tabulated the relationship between interest charged and the portfolio at
risk incurred the results are shown by the table 4.10 overleaf. The cross tabulations provide a
way of analyzing and comparing the results for interest charged with the results of Portfolio at
risk. The Y axes of the table is measuring portfolio at risk and X axes measures the interest
charged.

47
TABLE 4.10 PaR AND INTEREST CHARGED (CROSS TABULATION)

Interest Charged
Above
Below 10% 10-20% 21-30% 30% Total
Portfolio at 0-10% Count 1 4 3 0 8
Risk
% within Interest
33.3% 33.3% 5.0% .0% 7.6%
Charged
11-20% Count 0 8 14 6 28
% within Interest
.0% 66.7% 23.3% 20.0% 26.7%
Charged
21-30% Count 2 0 15 2 19
% within Interest
66.7% .0% 25.0% 6.7% 18.1%
Charged
Above Count 0 0 28 22 50
30% % within Interest
.0% .0% 46.7% 73.3% 47.6%
Charged
Total Count 3 12 60 30 105
% within Interest
100.0% 100.0% 100.0% 100.0% 100.0%
Charged
Source: Primary Data

According to the results of the 7.6% of few microfinance institutions that have the least portfolio
at risk, 66.6% charge interest rates below 20%, 5.0% charge interests of 21-30% and none of
them charge exorbitant interest rate of above 30%.
Moreso most of the 47.6% of microfinance institutions that experience portfolio at risk higher
than 30%,73.3% charge interest rates above 30% and 46.7% charge interests higher than 20%
their portfolio at risk is also high above 20%.
From the findings it can be inferred that as interest charged increases chances of portfolio at risk
increases somehow. This can also be shown in figure 4.2 overleaf.

48
FIGURE 4.2: PORTFOLIO AT RISK AND INTEREST CHARGED

30

25

20

15 Portfolio at Risk 0-10%

Portfolio at Risk 11-20%

10 Portfolio at Risk 21-30%

Portfolio at Risk Above

5 30%

0
Below 10%
10-20%
21-30%
Above 30%
Interest Charged

Source: Primary Data

From the figure above it can be noted that low Portfolio at risk is incurred when interest charged
are low and risk increases as interest charged increase since this make it expensive for borrowers
to pay on time. This means that there is a positive linear relationship between interest charged
and portfolio at risk.

4.4.1 NON- PERFORMING LOANS AND CREDIT TERMS

In this section the researcher seeks to give an insight two of the impact of credit terms: interest
charged and repayment period on loan performance in terms of non-performing loans.
The researcher computed the frequencies on loan repayment period employed by each
respondent as shown in figure 4.3 below.

49
FIGURE 4.3: DESCRIPTIVE STATISTICS ON REPAYMENT PERIOD

Repayment Period

Std.
Deviation

Mean

Maximum
Repayment Period

Minimum

0 20 40 60 80 100 120

Source: Primary Data

Minimum is response equal to l (Repayment period =monthly) Maximum response is also equal
to1 (Repayment period= monthly) since none of the respondents indicated any payment period
higher than one month. The figure 4.4 above shows that all respondents use one month as the
loan repayment period.

50
FIGURE 4:4: FREQUENCY ON INTEREST CHARGED

100

90

80

70

60 Below 10%
10-20%
50 21-30%
Above 30%
40

30

20

10

0
1 2 3 4

Source: Primary Data

From the figure 4.2 above it can be noted that a few microfinance institutions charge interest
rates of below 10%, the number of micro-finances increase as interest charged increases. We can
then conclude that most of the microfinance institutions in Zimbabwe charge interest rates
ranging from 21% per month going upwards
The researcher also conducted a one sample test to assess the impact of interest rates charged by
microfinance institutions on the level of nonperforming loans. The impact is therefore deduced
from the relationship between the two variables as shown in table 4.11 below.

51
TABLE 4.11 :ONE-SAMPLE TEST
Test Value = 1
95% Confidence Interval
Sig. (2- Mean of the Difference
t df tailed) Difference Lower Upper
Interest impact on
10.024 104 .000 1.18095 .9473 1.4146
causing NPL
Repayment Period
10.195 104 .000 1.23810 .9973 1.4789
impact on NPL
Source: Primary Data
Hypothesis
H0: Mean is not significantly different from 1(probability of causing NPL is very high)
H1: Mean is significantly different from 1(probability of causing NPL is very high)
From the statistics above it can be noted that the mean of impact of interest rates and repayment
period is significantly different from 1(probability of causing NPL is very high) by p-values
0.000<0.05.Therefore we reject H0 and accept H1 and conclude that the probability of causing
Non-performing loans of repayment period and interest charged is very high.
The study establishes that if microfinance institutions charge high interest rates the portfolio at
risk and non –performing loans increases .The same applies when the repayment period is short
the level of portfolio at risk tends to be high since the clients would not have time to engage in
cash generating projects.

4.5 DISCUSSION OF INTERVIEW RESULTS

According to the findings the majority of microfinance institutions cited the lack of credit
reference bureau as the major hindrance to effective credit appraisal. The microfinance
institutions said the lack of credit bureau cause hardships in verifying whether customer has
borrowed with microfinance or not. The issue results in e microfinance institutions lending to
over borrowed customers thereby increasing their exposure to credit risk. This is also
exacerbated by competition, whereby the institutions are competing for a slim market thereby
causing them to lend to anyone without consulting proper credit appraisal process.

52
The researcher also found out that besides poor credit appraisal techniques there are other factors
that contribute to high portfolio at risk and non-performing loans which are:
a) Salary shocks whereby customers’ salaries are delayed and thereby increasing their
portfolio at risk.
b) Consumption based lending whereby 90% of a microfinance institution’s loan book
consists of consumer loans which do not generate income for the ability of a client to
payback on time.
c) Lack of continuous monitoring of clients business leading to clients defaulting without
the institution expecting or suspecting such a credit event.
d) Economic downturn whereby many companies closed down and retrenched most of their
workers there by causing an unexpected increase in portfolio at risk and non-performing
loans at the same time.
e) Lending to related parties is also a major factor causing high portfolio at risk as the
borrowers default intentionally.

4.6 CONCLUSION
This chapter analyzed and presented the different views and opinions of the respondents. The
researcher found out that credit appraisal techniques have a positive impact on loan quality in
terms of minimisation of portfolio at risk and non-performing. However the techniques
complement each other and if an institution use only one technique the impact is always
insignificant to the extent that the institution may be seen reporting high portfolio at risk whilst
using appraisal techniques. The researcher also found out that besides poor credit appraisal there
are other factors that cause high portfolio risk such as repayment period, interest charged,
economic conditions, poor credit strategies to mention but a few.The next chapter will focus on
summary, conclusions and recommendations using these research findings and also suggestions
for future research.

53
CHAPTER FIVE

RESEARCH FINDINGS, CONCLUSIONS AND RECOMMENDATIONS

5.0 INTRODUCTION

In this final chapter, the researcher will give a comprehensive and analytical presentation on the
findings obtained in the previous chapter. The information obtained, will enable the researcher to
make conclusions and recommendations on the research undertaken. The main aim of this
research was to analyze the effectiveness of microfinance’s’ credit appraisal on loan performance
in terms of reducing portfolio at risk. In the recommendations section suggestions that are
expected to benefit Zimbabwean micro-finances will be made.

5.1 KEY FINDINGS OF THE STUDY

This study reviews that, all micro-finance institutions in Zimbabwe use credit appraisal
techniques when establishing the credit worthiness of prospective borrowers but not all
microfinance institutions are employing effective appraisal techniques. Micro-finance
institutions use appraisal techniques which include internal rating, credit scoring, Campari,
IPARTS, Papers, Campari and 5Cs. It was also noted that only a few micro-finances stick to the
credit appraisal techniques stated above. This therefore reveals that credit appraisal techniques
have a positive impact on loan performance; the more they are used the higher the loan
performance in terms of minimized credit risk.

The research observed that the most effective but least used appraisal techniques by
microfinance institutions are internal rating, Credit scoring and Campari. The least effective but
most used techniques in Microfinance institutions are the 5Cs, IPARTS and PAPERS which are
not very effective in credit appraisal because of their subjective nature.

54
Research findings indicate that, one of the major causes of deteriorating loan performance in
Zimbabwean micro-finance institutions is ineffective credit appraisal. Major causes for non-
performing loans and defaulting borrowers which are directly linked to credit appraisal include
high levels of non -performing loans, large exposures to a single borrower or group of related
borrowers and high prevalence of connected. Micro-finance institutions in Zimbabwe have fairly
high non-performing to performing loans ratios depending on the sizes of their loan books thus
contributing to loan performance problems.

Concentration risk was noted to be skewed to consumer lending instead of being skewed more to
business loans which leads to high levels of portfolio at risk the banking institutions is fairly low.
This leads to the failure of loans in generation of income for the borrowers to be able to pay back
on time and hence leading to high levels of non- performing loans and therefore poor loan
quality.
This study also found that, besides credit appraisal credit terms also have an impact on loan
performance in the sense that the higher the interest rates charged the higher the exposure to
credit risk. More-so the shorter the repayment period the higher the probability of default since
the loans would not have enough time to generate income for the borrower.

It has also been noted that the micro-finance institutions do not have loan performance ratios as a
benchmark for loan quality or as a way to measure loan quality. The key loan performance ratios
that are used by micro-finance institutions in Zimbabwe to measure loan performance include,
portfolio at risk ratios in 30 days, 60days and 90 days, non-performing loans to total loans, sector
distribution of loans to total loans and write- offs to average total loans. The main purpose for
these loan performance ratios is to act as robots signaling when loan performance is deteriorating
thus they are indicators for deteriorating loan performance.

This study also reviews that, the credit appraisal process is very important before availing funds
to a prospective borrower. The researcher also acknowledged that, credit appraisal process is one
of the most important elements in credit lending; hence this process is guided by a company
credit or loan policy which is often reviewed or amended annually. The researcher noted that,
some institutions have efficient and effective credit appraisal techniques that can be used to

55
address loan performance problems whereas other Microfinance institutions’ credit appraisal
techniques are rather ineffective.

5.2 CONCLUSIONS

5.2.1 THEAPPRAISAL TECHNIQUES USED BY MICROFINANCE INSTITUTIONS

Micro-finance institutions employ more of subjective judgment approaches such as the 5Cs
approach where the decision of granting credit is based upon adoption of certain rules or
principles of lending carefully build by skilled loans officers themselves. This agrees with Kwan
et al, (1986), who posts that in this approach, creditworthiness was estimated purely by credit
experts based on their judgment and their intentions. For example, under the 5C's of credit
evaluation criteria, evaluation is based on character, capacity, and condition, capital and
collateral. These principles are drawn from the experience of loan officers, and the same applies
with IPARTS and PAPERS. The institutions use less of statistical approaches such as credit
scoring, Campari and internal rating.

5.2.2 IMPACT OF CREDIT RISK APPRAISAL TECHNIQUES ON PORTFOLIO AT

RISK

Credit risk appraisal techniques have an impact of reducing portfolio at risk when used to a
greater extent .Moreover the impact of risk reduction is greater when different techniques are
used to compliment each other’s weaknesses .The study revealed that the most effective
techniques were internal rating, credit scoring and Campari. This means that credit scoring and
internal rating are more of statistical approaches and they cannot work effectively alone without
some of subjective approaches such as 5cs, IPARTS, CAMPARI and PAPERS .In the literature,
different authors argue that subjective approach appears to be very suitable for MFI as it can
mitigate opacity problems and be beneficial where little data exists (Bunn and Wright, 1991).On
the same note statistical approaches

However, subjective judgment for individual loans has its weaknesses in quantifying credit risk
management and requires a fair amount of time per applicant and is expensive for the lender.

56
Moreover (Hand, 1998; Lewis, 1992), argue that in judgmental approach loan officer, like other
people may seriously have cognitive bias in processing information that affect his judgments and
beliefs, so that he may be a victim of behavioral bias and appear irrational. This is the case with
Zimbabwean MFIs where too much behavioral bias of microfinance customers and biased
judgments by the loans officers are the cause of high credit risk.

However, others advance that statistical approaches such as credit scoring and internal rating
despite their effectiveness they are vulnerable to several limits. For example, ignoring qualitative
factors and blindly applying a credit scoring in Microfinance context can led to inaccurate
evaluations and hence to high arrears and default, Schreiner (2003).In overall micro-finances in
Zimbabwe tend to be biased to one technique therefore the weaknesses of such technique ,ay
overcome its benefits

This method presents an innovation for microcredit but is not at all new to others credit risk
management techniques.

5.2.3 THE EFFECT OF CREDIT TERMS ON MFI LOAN PERFORMANCE

Credit terms (interest and repayment period have an impact on loan performance in the sense that
the higher the interest charged on loans the more expensive it is for customers to pay back and
hence poor performance in terms of high credit risk and non-performing loans. Microfinance
institutions in Zimbabwe charge too high interest rates which is the reason why their default rates
and non-performing loans are too high. The study also found out that microfinance institutions
offer too short repayment period, this does not allow the customers projects to generate income
for timely payment. This is well supported by the research conducted in Pakistan by Ahmed S F
and Malik Q A (2015) where it was established that credit terms and client appraisal have a
significant impact on the loan performance.

5.2.4 IMPORTANCE OF CREDIT APPRAISAL IN IMPROVING LOAN QUALITY

Reed and Gill (1989: 122) highlighted that credit appraisal remains at the heart of the decision
making process leading to the granting of credit to a borrower in many micro-finance
institutions. Consequently, it has been concluded that the credit appraisal process is very
important before availing funds to a prospective borrower and most Microfinance institutions
experience problems with non-performing loans due to weak credit analysis. The researcher also

57
acknowledged that, credit appraisal process is one of the most important elements in lending;
hence this process is guided by a company credit or loan policy which is often reviewed or
amended annually.

From the findings, the researcher acknowledged that, although there are other techniques or ways
that can be implemented or used to address loan performance problems besides the credit
appraisal techniques the latter is the most effective way when addressing deteriorating loan
performance problems

Summing it all up, the researcher concluded that micro-finance institutions in Zimbabwe are
experiencing severe deteriorating loan performance due to a number of problems facing the
Microfinance institutions, the banking sector and the whole economy at large. The researcher
also concluded that credit appraisal techniques are one of the most effective ways of improving
loan performance in micro-finance institutions. However, most Microfinance institutions in
Zimbabwe lack effective credit appraisal techniques and undermine its capabilities of
significantly reducing loan performance problems. Thus, most micro-finance institutions are
continuously experiencing problems with non-performing loans and defaulting loans since 2009
due to weak credit appraisal techniques in their institutions.

5.3 RECOMMENDATIONS
In light of the above conclusions the following recommendations were made for MFIs to have a
sound credit risk management.
a) Most loans officers outlined the need for credit policy manual in-order to give guidelines
on the credit appraisal techniques to be employed on each and every scenario faced when
dealing with a new or existing borrower. The policy should also give a detailed and
formalized credit evaluations and appraisal process, risk acceptance criteria loan
documentation procedure and roles and responsibilities of staff in loan origination.
b) Majority of Credit analysts aired the need for senior management oversight in-order to
ensure that everyone is performing their functions properly towards minimizing credit risk
of the company. The senior management also has a role of defining the risk appetite of the
company for instance the type of customers to be served and forming the credit policies
thereafter.
58
c) A certain manager highlighted the need for credit approval limits that is proper definition
of credit approval authority at various hierarchy levels and authority for approving
exceptions.
d) Management information systems are needed by microfinance institutions for information
management as well as to avoid too high exposure to clients since the system will always
be programmed to give limits and boundaries. More-so it is very difficult to employ other
quantitative appraisal techniques such as credit scoring without usage of an information
system.
e) Microfinance institutions also need employment of credit analytics in discovery,
interpretation, and communication of meaningful patterns in borrowers’ data. This helps in
calculation and interpretation of borrowers’ creditworthiness in order to minimize credit
exposure.
f) Microfinance institutions also highlighted the need for employment of credit grading
system whereby risk associated with each borrower is measured and the rightful decision
taken thereafter
g) There is need for microfinance institutions to charge low interest rates so as to minimize
credit risk; the interest charged should at least be equal to the risk premium and not the
exorbitant figures that they charge.
h) MFIs need to employ both statistical and judgmental techniques so they can complement
each other. More-over proper credit appraisal guarantees lower credit risk and hence there
will not be need for the MFIs to transfer the risk to clients in form of high interest rates.
i) There is also need for the institutions to employ experienced employees and or train the
current employees on how to manage credit risk in-order to reduce credit risk.
j) MFIs should craft their lending products in line with customer needs and demands thus
they should ensure that they understand borrowers’ cash cycles when advancing loans.
The research noted that MFIs tend to experience non-performing loans due to the short
loan tenor of 30days given to borrowers. These institutions should first understand their
borrowers’ asset conversion cycle before crafting loan tenors. Longer loan tenors of 60, 90
or even 120 days where necessary, should be initiated.

59
5.4 SUGGESTIONS FOR FURTHER STUDY
There is need to carry out a study on the efficiency of credit appraisal techniques. Technological
advancements and increased competition has posed new credit risks hence further study should
analyze whether credit appraisal techniques used by microfinance institutions in Zimbabwe are
still efficient and meeting international standards. Further study should also be on the feasibility
in Zimbabwe of some of the new credit appraisal techniques being used in other developed
countries such as the neutral networks, statistical models and other credit metrics models. The
researcher failed to address the issues raised above mainly due to lack of adequate funding and
limited time as the research study was done over a period of six months.

60
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APPENDIX A

RESEARCH QUESTIONAIRE

TO WHOM IT MAY CONCERN

REF: REQUEST FOR ASSISTANCE
My name is Chinduru Patricia, a 4th year student at the National University of Science and
Technology, NUST and my student number is P0111791P I am currently studying for a
Bachelor of Commerce Honors Degree in Banking and as part of my degree requirement, l am
carrying out a research on the evaluation of the impact of credit appraisal techniques on
Microfinance’s Loan performance.
I therefore seek your assistance by way of completing the questionnaire attached to this letter.
Your response will be treated with confidentiality and the findings will be used for academic
purposes only.
Your cooperation will be greatly appreciated.
Yours faithfully
Patricia Chinduru
Email:triciachinduru@gmail.com

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SECTION A:
Responded Profile (Please tick your chosen response where options are provided)
1.1 Name of Microfinance ………………………………
1.2 Position Held
(a)Loans Officer (c) Credit Risk analyst
(b)Credit Recoveries Officer (d) Credit Management
1.3 Working experience
(a) Less than 1 year (c) 1-3 years
(b) -10 years (d) More than 10 years
2.0 SECTION B: RESEARCH DETAILS
(Please make use of additional space on the last page to express and give additional
opinions where given opinion or space is not enough)
2.1 Which year was your institution established? ………………
2.2 Who approves Loans in your organization? …………………………………..
2.3 Which market segment does your microfinance serve? Please tick as appropriate
(a)Business (c) Personal
(b) Both business and personal (d) Others, Specify………
2.4 Before giving out a loan to a borrower, how important is the credit appraisal process?
(a) Very important (c) fairly important
(b) Slightly important (d) not important
2.5 Please tick the appropriate qualities of the credit appraisal process employed in your
institution.
a) Subjective c) Quantitative e) Others……………….
b) Objective d) Qualitative

2.6 Please choose the techniques used in your institution and indicate the degree the techniques
are used.
Technique Used to a greater Used to a lesser extent Never Used
extent

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 a)Internal Rating

b)Credit Scoring

c)5Cs

d)PAPERS

e)IPARTS

f)CAMPARI

g)Others

2.7Please and give the impact of the appraisal techniques used by your institution to loan
performance in terms of preventing or reducing the portfolio at risk within 30 days (PaR30)?

Technique Very effective Fairly Slightly Not effective

Effective effective
(a) Internal Rating
(b) Credit Scoring
(c) 5cs
(d) PAPERS
(e) IPARTS
(f) CAMPARI
(g)Others…………….

2.8 Ineffective credit appraisal has been viewed as one of the major causes for non- performing
loans hence creating loan quality problems. Do you agree?
(a) Yes (b) No
2.9 In your institution, what are the main causes of Loan Portfolio Risk and non-performing
loans besides weak credit appraisal?

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………………………………………………………………………………………………………
………………………………………………………………………………………………………
……………………………………………………………………………

2.10What have been your Yearly Portfolio at risk (Par 30), write offs and Nonperforming loan
ratios since the multicurrency regime?
Year Reported PaR(30) NPL ratio
2009
2010
2011
2012
2013
2014
2015

2.11Please specify your credit terms and their impact in terms of their probability of causing
poor loan performance. Key 1= probability is very high, 2 = probability is fairly high
3=neutral, 4= probability is very low, 5=probability is zero
Repayment monthly Quarterly Half yearly Annually Others
Period
Interest % % % % %
Charged
Impact(12345)

2.12 Please indicate and give your opinion on which components can be adopted by
microfinance’s for sound credit appraisal
Component Reason
Credit policy manual
Senior management oversight
Credit approval limits
Management information
systems
Credit analytics
Credit grading system

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 Risk Measurement

2.13 Give other components of sound credit management that are not given in question above
………………………………………………………………………………………………………
………………………………………………………………………………...................................

APPENDIX B.

INTERVIEW SCHEDULE

This interview seeks for your opinion on the topic: The Impact of Credit appraisal techniques
on Micro-finances’ Loan performance and various other issues.

QUESTIONS
1) Which year was your institution established?
2) Who approves Loans in your organization?

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3) Which market segment does your microfinance serve?
4) Before giving out a loan to a borrower, how important is the credit appraisal process?
5) Is the credit appraisal process guided by a company credit or loan policy and how often is
it reviewed?
6) What are the credit appraisal techniques that you use in establishing the credit worthiness
of a borrower?
7) To what extent do you use the above mentioned techniques?
8) How effective are these credit appraisal techniques in improving the microfinance’s loan
performance?
9) In your institution, what are the main causes of increase in Portfolio at Risk and non-
performing loans?
10) Ineffective credit appraisal has been viewed as one of the major causes for non
performing loans hence creating loan quality problems. Do you agree?
11) What have been your Yearly Portfolio at risk (Par 30), write offs and Nonperforming
loan ratios since the multicurrency regime?
12) Please give your credit terms and their impact in terms of their probability of causing
poor loan performance.
13) Please give your opinion on components that can be adopted by microfinance’s for
sound credit appraisal and credit management system.

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