2.

0 LITERATURE REVIEW
2.1 Theoretical review
In this part we are going to show and discuss various concepts used in the report such as the following,
i. Overview of bank loans.
ii. Steps of borrower’s assessment.
iii. Reasons which lead to non-performing loans.

2.1.1 Overview of bank loans

A bank such as National Microfinance bank (NMB) is a depository financial institution that is relatively open
in its ability to disburse loans. Banks are the most important part of all depository institution (Leroy and
Vanhoos, 2006). They do create money, through borrowing to borrowers and purchasing securities
(Thomas, 2006). Many banks especially microfinance and commercial banks tend to extend credit to their
borrowers for number of purposes. One popular task of a bank is to give different types of loans to the
member of society. What bank does is to disburse money from customers who have a lot in their account
and lend to others with the expectation of gaining back the money and earns interests. Therefore, the
intermediary function of a bank is to play an important and central role in the economic activities and also,
acts as the primary basis for financing debts available to most customers. Loans which are productive are
good asset for banks and since they can make profit.

Banks are accepting the deposits which is cash and other forms of money from its different customers and
use those deposited fund in issuing loans and other investment activities that will later on yield a good
return that the actual amount of money the bank gave the borrower (McCarthy et al., 2010) cited in Zewdu
(2010). The principle of banking assumes that, customer deposit is a main root of bank loan and since,
increasing the level of deposits in a bank directly results to a super positive effector outcome . The basic
activity in banks that gives profit is lending loans to customers. During allocation of funds task, the bank
primary goal is to generate income while they serve the credit need which is the main need of its
community (Reed and Gill, 2010). A bank borrower gets to receive a loan from the lender which later on
has to do repayment in a certain period of time, but it can happen that sometimes loan can be paid but not
in regular installments to the lender like it is mostly known to many people.

Above and beyond, credit and loans also comprise of one among of the ways of increasing the supply of
money circulation in the economy (Felix, 2008). Banks loan involves the good relationship between parties
which is borrowers and the lenders. The default risk degree is very high compares to other assets which
bank may own. Loan asset creates a high return rate in compensation time (Thomas, 2006). So, basing on
lending experts, location, size, trade area a composition of a loan mighty varies under these things. The
process of providing or issuing resources is the main role of a bank through loans which has to an
agreement between two parties. During reimbursement time, the second party doesn’t make the process
directly to the other party but instead arrange the date for the repayment of the loan and it’s due whereby
the loan has to all paid when that time reaches. The whole process of lending benefit both parties’ bankers
and also borrowers of the bank.

2.1.2 Steps of borrower’s assessment

Loan purpose is one among crucial things to consider during the assessment of the borrower. By taking a
case when a borrower wants a loan for starting up a business, he or she must show his or her business
plans. Bofondi and Gobbi, (2003) said that the business plan has to be presented in a such way it can give
the giver the confidence of granting you a loan. Also, you have to show them that your business that you
have expressed to them is solid and you are having a strong track record of performance. The summary of
the business, this includes the services and products detailed to be for sale in your business, analyzing the
competitive environment of the business, target of the market and the financial statements. So, when bank
understand you’re the purpose of your loan after reading your plan they will appraise the bank's risks by
using the following C’s such as, conditions, character of the borrower, capacity of the borrower, collateral
that a borrower have and capital.

Importance of character is the issue which has to be observed in earlier stage before lending a loan to a
borrower. Terrazaz (2013) say that, character, is one root qualities and basis of borrower characteristics, it
tells the manner in which borrowers deal with matters in manage all different aspects of their financial lives.
It doesn’t matter, whether your sole proprietor, or a company or corporate, observing your business
tendency is very important. Lender can even decide to check and see the records of the borrower in paying
the loan if he or she had loans before. According to Kohl David (2010), good character comes through
developing a good financial and business plan, and be able to act properly during tough economic period. If
it means to make necessary sacrifices in order to make your image good during loan application system so
as to make lenders be sure that the payment will be done on time so as a bank can keep meeting its

1
objectives. The problem is character is usually tending to be forgotten in good economic times which later
on bank can found itself granting non-performing loans.

Collateral issue has to be adhering whenever a bank wants to issue the loan to the loan applicant.
Collateral helps to show to the bank on how a borrower will be able to repay the loan and if the borrower
fails then a bank will take over collateral in order to repay back their money. According to Corporate
Finance Institute (2015), collateral is a property or a certain type of asset that a borrower offers to the
lender when he or she wants to lend or acquiring a loan. Collateral is to be going a property of the lender if
and only if a borrower fails to do repayment of the given loan, within the actual agreed time for the loan
repayment. So, for the benefit of him or herself a loan applicant must know and understand how collateral
works. For type of borrowers with poor credit, pledging a collateral asset can improve the chances of
getting approved for a loan.

Banks are also checking on the capacity and ability of a loan applicant to pay a loan as schedule says. The
borrowers have to show that he or she can be able to pay back the amount of loan out of the organization’s
or company’s cash flow. If it happens a company wants a loan, a bank will scrutinize a company's debt-to-
income ratio and the amount of its free cash flow. Normally, a lender tends to like these kinds of ratios to
give itself a cushion, if happens the condition of business downturn which is unpredictable. According to
Julia Kagan (2018), a capacity or ability to pay refers to a person financial ability to react good in terms of
making payment of a debt. Specifically, the saying "ability to repay" was used in the year 2010 by Dodd-
Frank Wall Street Reform and Consumer Protection Act in trying to explain the need that mortgage
originators must substantiate so that good borrowers can be able to afford the mortgage which they wish to
get. So, the borrower must demonstrate if he or she has ability to pay.

Capital is known to be important concepts among many in banking sector (Douglas Elliot, 2010.) Banks are
becoming more comfortable if they realize that there is a business that owner has invested money on it.
Lenders tend to like knowing that if the business fails in one way or another the owner also will lose. Lender
can have an assumption that, if the owner is not investing and not ready to invest in his or her business,
then why do they want a bank to do so? Normally, banks likes to lends but not just lending, they like to
lends to different companies which they have proven that they own much amount of business capital. This
means that, the owners of such companies have some "skin in the game." In business environment, when
companies have much actual capital within the business, many banks believe that, those kind of companies
are ready to sacrifice and give all to ensure that they rescue a business and also to make sure that, they be

2
able to repay their debts. When lending your money to these kinds of companies, you are sure of reducing
or removing the presence of non-performing loan.

General economic condition in that particular period where the borrower has applied for loan has to be well
investigated. So during the process of analyzing the loan applicant lenders always are observing overall
economy situation of the country and regional wise, also the industry trends and politics conditions within
the area. Because checking on this issue gives the lender a room to forecast and see where an economy of
the area is headed (Kalen Smith, 2011.) Bank has to think about some factors which are going to be
beyond the power of control of the owner who will be given a loan that will affect performance of him or her
towards success of his or her business or company. The current economic condition can affect the loan
applicant to start a new business, that’s why it is important to understand the condition before issuing a
loan.

2.1.3 Reasons which lead to non-performing loans.

Poor financial analysis process is a reason for non-performing loans (Sheila, 2011). When bank officers
don’t analyze applicants very well to see if applicants have sound financial base so as to mitigate during
default. It is important for a loan officer to be able to ascertain the ability or position the borrowers so that to
be able to give support when he or she needs it, it’s availed to her or him. But it can’t be a case when the
needed support is granted but itis not enough which may leave the business collapse and hence leading to
non-performing loan.

The availability of illiteracy and insufficient level of skills can be another reason for non-performing loans.
Many borrowers have put themselves in traditional and businesses which are lowly paying and therefore
they can lack proper business skills (Sheila, 2011). This implies that there is no quality knowledge in
remarkable skills that can be used for the benefit at times business gone bad and it is function or perform
properly and well. Some can lack knowledge such as, they don’t know how to read and write and make
simple mathematics calculations which are not complex and so on. As a result, account for your business
becomes tough so even if a bank has done an error he or she will be responsible to the loan.

According to Balgova and Plekhanov (2016), economic downturn condition and depression for business is
the major reason for the increase in the volume of non-performing loans. As a result, many financial crisis
are predictable, but the persistence of bad debt is a cause for concern. Balgova and Plekhanov used a
sample of 100 nations so as to compare economic outcomes in three different scenarios following the

3
condition of a rise in non-performing loans. In reducing these non-performing loans, it has seen that there is
an unambiguously positive medium-term effect, with nations that are experiencing an influx of fresh loan
growing the fastest. So, by allowing high levels of non-performing debtors to persist, on the other hand, it
can cost economic growth annually.
Reduced of level buying by customers is also a reason or cause that lead to the problem of non-performing
loans (Annual report on Japan’s economy and Public finance, 2001). Economic resources such as labor,
management resources, capital, and land, are relating to each other. So if labors who are customers, don’t
buy from a business it will cause a low profitability and hence if the businessman or woman has borrowed
the money from the bank, that’s means he or she will fail to pay back the money. The expected role of bank
is, to support businesses financially during trouble and hard time so as they can operate well, through loans
obtained from them.

2.2 Empirical review

2.2.1 Non-performing loans proof in some countries.
According to the study done by Nguta, and Guya (2013) in Kenya said that characteristics of the business
which a borrower has chosen can a cause to non-performing loan. It was found the high cases about the
problem of failing to make loan repayment became common whereby (67.9%) was found in manufacturing
sector. Then it followed service industry whereby it was (64.0%) agriculture sector (58.3%). The trade or
commerce sector was found to be (34.9%). In trade sector whereby they mostly deal with fast moving
offerings there can be good business performance that can increase the revenue which leads to low non-
performing loans. Also, there was a found that the businesses which have been operated for the period of
less than two years had 52.4% of non-performing loans. The highest (78.6%) non-performing loan cases
were found regular in businesses which have been operating between five up to ten years’ period. But, for
the businesses which have survived for more than ten years the non-performing loans is very rare (0.0%).

According to Reuters (2018), bad loans or non-performing loans held by various number of India’s banks
rose up to 10.36 trillion rupees which is equal to ($150.21 billion). The government minister of finance said
with state-backed lenders accounting for more than 86 percent of the total non-performing loans. It was
found that, twenty-one banks whereby majority are owned by the government of India had shown to have
8.96 trillion rupees as non-performing loans, this have been observed from the central bank of India data
says finance minister.

4
In recent years, there has been a lot of literature concerning the issue of non-performing loan. Many
authors and researchers took their time writing and researching issues concerning the investigation of
causes of non-performing loans (Pasha, 2009). In investigation, many explained role which bad debts or
non-performing loans plays which later on leads to bank failures and hence closed. According to Sorge
(2004) argues that it’s too important to investigate on the issue which lead to non-performing loans which
tests the financial systems of the particular bank. Lata (2014) notes that, non-performing loan in
Bangladesh is among the usually raised question mark issue in the country in recent years. The problem
seen to be catalyzed by industrial borrowers who they have create a tendency of loan embezzlement and
later on fail to pay the loan on time. This evil trend has been widening in recent years to the extent that
many banks fail to lend loans Lata (2014).

Ning (2007) found that, the existence of non-performing loan has been a very big mistake the banks take.
Non-performing loans has been a very hard puzzle in China commercial banks, so banks are ought to find
and improve their operations to reduce non-performing loans. So, during making borrowing decisions,
banks are always differing in dealing with non-performing loans above or below the threshold. Banks do
this with the implications knowing that, lending behavior can restrain the economy activities, mostly during
stress period when the existence of non-performing loans is high. Baum, (2002) did the investigation
empirically by showing the link between bank habit of lending and the macro economic difficulties by using
the United States quarterly and annual bank level data. They ended concluding that, in greater
macroeconomic uncertainty banks become conservative and so this narrows the abilities of various banks
in issuing the loans to various applicants.

Evelyn (2011) did an investigation on factors that creates or causes the presence of non-performing loan in
various commercial banks in Tanzania context. She found that, the loan obtained was used contrary to the
reason which leads borrowers to get a loan, and this were the major cause that later on leads to non-
performing loans. Findings observed during the study suggested banks have to be more clinical by making
critical follow-up to the borrowers to see that, if the lending business is been executed accordingly to the
purpose of the loan. Ivana and Vlastimir(2006) did a comparison by investigating between Serbia domestic
banking systems with of the other nations banking systems in transition. They showed that, non-performing
loans are systematic risk generator in real and financial sectors of Serbia. But, according to their
comparative analysis which it showed the same results not only in those countries which are in transition
period, but also in the well-developed ones countries in the world.

5
According to another study conducted by, Kauko (2012) investigated Japanese commercial banks, and
they said that the rapid loan growth in Japan in the year 2000–2005 can be used to project the amount of
money which is non-performing loans if we combine with current deficit situation. Thangavelu and Hu
(2005) suggested that various governments should try their level best to enforce strict and strong budget
constraints on all types of banks in the country in order to be able to prevent the availability of non-
performing loan accumulation. Also, Park (2012) finds data which use as some evidence that sometimes
corruption can distort the allocation process of bank funds from projects which has high returns to bad
projects which later on they fail, resulting into a decrease in the quality of private investments, hence it
creates decreases economic growth in an area.

6
 CHAPTER TWO
RESEARCH METHODOLOGY
3.1 Research Design
In this study we adopted and use a descriptive case type of research design. The case study type or
approach was seen to be preferred by we researchers due to the reason of time constrain and also on the
process of availability and the reliability of data which we wanted from the NMB Bank house branch – Dar-
Es-Salaam. Also one of the researcher works at NMB thus we saw it was easier to make collection of data
from the chosen respondents. This type of research design was aimed at getting a well detailed
information’s regarding the investigation of causes of non-performing loans in a case of NMB bank house
branch – Dar Es Salaam. A descriptive type of study is concerned with finding out the what, where and how
of a phenomenon (Ngechu, 2004). Descriptive type of research design was chosen by the researchers
because it enables the researchers to infer the field findings to a larger population with availability of high
level of accuracy. The focus of this study was qualitative in order to get a better knowledge and more
understanding of the results. According to Schindler and Coopers (2004) descriptive type of studies are
more formalized and they are well structured with more investigative types of questions.

3.2 Location/Site
The research was conducted at NMB Bank House branch in Dar es Salaam city Tanzania. NMB Bank
House branch which is in Dar es Salaam is the biggest branch of National Microfinance Bank and it is the
branch which offers a lot of loans to its customers since 2000. This has proven to us that, there is enough
experience to bank officers and hence we succeeded in getting effective results.

3.3 Research Approach

The research approach which we researchers focused in this research report was the qualitative research
approach, we chose this approach in order to be able to get a well and better knowledge which will help us
with more understanding of the results.

3.4 Population
Our study population was drawn from NMB house branch. In NMB bank house branch, there is 12 loan
officers, 1 experienced branch manager and 2 commercial managers, 2 court brokers officers and 25 other
workers. NMB bank house branch in Dar es Salaam records of December 2018, customers were 4000.

7
3.5 Sampling
This is one of the procedures whereby a targeted population which carries a researcher interests are
designed well and do the selection of a subset of the predetermined size. The sampling technique which
was used in this research report is purposive sampling. This form Cooper and Schindler (2001) define the
sampling frame as a list of elements from which the sample is actually drawn, which is closely related to the
population. The sample was chosen from the top ten banks branch in Dar es Salaam.
Researchers decided to use this sampling because it enabled the researchers to use judgment in selecting
cases that will make answers to the researcher’s questions and to meet the objectives (Saunders et al,
2000).
The sample size was determined using purposive sampling technique. It comprised of officials from various
bank branches in Dar es Salaam. These branches were selected on the basis of the level of capitalization.
The people responding were managers, and two credit analysts from each of the chosen bank branches.
This gave the researchers a sample size of 30 respondents.

3.6 Methods of data collection

Primary data was obtained and collected through questionnaires that were distributed to the respondents.
The respondents were already informed about data collection exercise through their e-mail. The researcher
will rely on referral from senior personal acquaintances in the banks to get to the relevant managers. The
data collected was aimed to provide answers to the research questions as to be able to investigate the
causes of non-performing loans in NMB Bank house branch – Dar es Salaam, the steps bank managers
have taken as a result of the effects of the NPL’s problem and how successful those steps have been.

3.7 Method of data analysis

The collected data was subjected to a process of cleaning to get rid of any overlaps or unnecessary data.
The collected data was analyzed by using the SPSS software package. These included frequencies, total
scores, means and percentages.

8
 CHAPTER FOUR
PRESENTATIONS OF DATA FINDINGS AND ANALYSIS

4.1 Data Presentation and Interpretation

Table 1: General reasons for causes of non-performing loans
Factor Strongly Disagree neutral agree strongly Total
Disagree agree
Fre % Fre % Fre % Fre % Fre % Fre %
a) Economic downturn 0 0 0 0 0 0 17 56.7 13 43.3 30 100
condition and
depression for
business
b) Reduced of level
buying by customers 0 0 0 0 0 0 18 60 12 40 30 100
c) Illiteracy issues 0 0 0 0 3 10 19 63.3 8 26.7 30 100

According to the table I, 43.3 % of our respondents strongly agreed that the economic downturn that led
to depression for business was a cause of NPLs. And so, in addition, 56.7 % agreed. Therefore, the entire
sample agreed with this reason or cause. Furthermore, all of our respondents agreed that the reduced of
level of buying by customers was a very important factor. Forty percent did strongly agree while the
remaining 60% did agree. According to our results many of the respondents (90%) agreed that illiteracy
issues contributed towards increase in the levels of NPLs. Twenty-six point seven percent (26.7%)
strongly agreed and 63.3% only agreed. Ten percent were neutral in their response.

Table 2: Bank specific reasons that causes non-performing loans

Factor Strongly Disagree neutral agree Strongly Total
Disagree agree
Fre % Fre % Fre % Fre % Fre % Fre %
a) Lack of
aggressive
loan collection 0 0 0 0 7 23 17 56.7 6 20 30 100

b) Poor financial
analysis 0 0 3 10 3 10 18 60 6 20 30 100

According to table 2, of the 30 respondents 80% agreed that poor financial analysis is an important cause
of NPLs. Only 10% disagreed while another 10% were neutral. Also the respondents (56.7%) agreed that

9
lack of aggressive loan collection contributed to non-performing loans while 23% neither agreed nor
disagreed. Of those who agreed, 56.7% merely agreed while 20% strongly agreed.

CHAPTER FIVE
SUMMARY, CONCLUSION AND RECOMMENDATION

10
5.1 Summary
The research found out that the main reason which contributes to non-performing loans was the economic
downturn which led to depression for business in general; reduced buying ability of customers, poor
financial analysis, illiteracy and lack of aggressive loan collection. But, researchers suggested what to be
done in order to solve the issue so researchers said major actions such as checking on loan purpose when
issuing loans to borrowers, importance of checking on character of the borrower is the issue which has to
be observed in earlier stage before lending a loan to a borrower, collateral issue, capacity and ability of a
loan applicant to pay a loan as schedule says and capital of the borrower if he or she borrows to expand his
or her business. The improvement in the procedures used for credit risk assessment was reported to be
very successful.

5.2 Recommendation
This study identified causes of NPLs in NMB bank house branch – Dar es Salaam. These include the
economic downturn which led to depression for business in general; reduced buying ability of consumers,
poor financial analysis of the borrower and lack of aggressive loan collection to those who have borrowed
and failed to pay to the bank on time.
Recommendation of this research report is that loan officials or officers must really carefully be granting
loans by basing on their consideration in various issues such loan analysis principles, that borrowers have
to analyzed in a very proper manner by using their discernment as well as experience to verify debtor
credibility.

5.3 Conclusion
Loans form 80% portion of the total assets in commercial banks in Tanzania (BOT annual reports, 2012).
These assets are generating a huge interest income for banks which to a large extent determines their
financial performance. However, sometimes some of these type of loans falls into non-performing status
and adversely affect the actual performance of banks. This is due to the reason that non-performing loans
can be able to affect the ability of banks to play their role in the development of the economy. Findings
indicated that non-performing loans in NMB bank house branch in Dar es Salaam are caused by both
factors related to bank operations and factors related to general conditions and customer operations.

11
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