CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

This chapter reviews literature related to the study variables that is, understanding the
concept of Micro Finance Institutions, nature of loan products and services, loan recovery
concepts and performance of MFIs, techniques for loan recovery, possible measures to improve
loan recovery and performance and existing gaps in the literature.

2.2 Understanding the concept of Micro-Finance Institutions

Germany was the first country in the world to apply the principles of cooperation in the field of
credit. Herr F.W. Raffeisen (1818-1888) and Herr Franz Schulze (1809-1883) were the two
pioneers in this field who took initiative and started introducing various measures of relief.
They started their schemes at about the same time but their field of operation was entirely
different. Raffeisen tried to reduce the sufferings of the people living in the rural areas while
Schulze adopted the new measures for giving relief to the people living in the urban areas (ibid).

Microfinance institutions are new and at the moment are regulated by Bank of Uganda
(Financial Institutions Act 2004). Currently, it is estimated that there are over 500
microfinance institutions in Uganda (microfinance forum, 2001). MFIs were introduced in
Uganda as a means of improving savings, mobilization and financial resource allocation
institutions (Olokoyo, 2011). They have grown to be vital parts of most economies as they
aid growth and development across the various sectors and improve the human capacities as
well. They play the role of mobilizing funds to avail these funds in form of loans which have
become the major contributing asset in the bank in terms of profitability. Granting of loans is an
important service rendered by MFIs to individuals, small and medium businesses, large
corporations, blue chip companies and governments for various purposes like covering for cash
flow shortages, acquiring capital equipment, market expansion, making the most of suppliers’
discount offerings in different sectors of the economy.
According to (Micro Finance Information Exchange- MIX 2010), Microfinance Institution is
defined as an entity that lends small in the terms of the amount of money involved. They extend
loans to every sector operated mainly by the poor people. United States Agency for
International Development (USAID) in their study found out that by this approach, MFIs do
achieve strong outreach in terms of depth (reach very poor) extent (significant scale) and service
quality (USAID,1995). They provide social intermediation services including group formation,
financial literacy training and management capacity of group members (Ledge wood, 2004). The
government’s commitment to eradicating poverty through private sector led development
have culminated into increased number of MFIs to enable provision of low interest small loans to
individuals, small and medium, large business enterprises.

MFIs are normally organized and operated by non-governmental organizations with initial
capitalization from “donors” interested in development through micro-enterprise credit to
the poor and in MFIs are active in most districts of Uganda with their operations offices
located mainly in the trading centers. These institutions include both international and
indigenous non-governmental organizations. Organizations active in community micro
financing include PRIDE Uganda, Letshego, FINCA Uganda, FAULU, World Vision, Mango
Fund, Action Aid Uganda, Uganda Women Finance Credit Trust, UGAFODE, Vision Fund,
FOCCAS, ORUDE, ADD, UWESO and VEDCO. Other micro finance programs are
BUCADEF, Youth Entrepreneurs Scheme (YES) and Platinum credit, which have a wide
coverage countrywide.

Evidence from Ministry of Finance Planning and Economic Development (MoFPED, 2000)
shows that only 0.9% of the country’s population utilize the services of MFIs and this is still very
low representing only approximately 2% of the population of those living below the poverty line
regardless of their gender. Although female clients have highly benefited from microfinance
services, women are the most vulnerable group. MFIs include banks, Non Government
Organizations (NGOs), private company’s building societies and credit cooperatives that
provide savings and minor loans not exceeding US$1000 for projects of the poor so as to
engage in viable economic activities (Directory of MFIs in Uganda, 2000).
2.3 Loan facilities (products and services) offered by MFIs

According to the Association of Micro Finance Institutions Uganda Brochure, (2002), MFIs and
non bank financial institutions extend credit or loans to selected groups of population the
“active” and “very poor’ in order to lift them. Examples of MFIs that provide credit or
loans private business include Uganda Agency for Development (UGAFODE), Foundation
For International Community Association (FINCA), Uganda Microfinance Union (UMU),
Pride Africa , Pearl Micro Finance Ltd

2.4 Relationship between loan recovery and performance of microfinance institutions

2.4.1 Loan recovery

Borrowers of microfinance are mostly rural poor women (Yunus, 2007, 2017). However,
microfinance envisages that women are more trustworthy as well as willing to repay the
loan than men (Kropp, Turvey, Just, Kong, & Guo, 2009). But, these assumptions seem
contravening some other hypotheses, such as poor women generally lack business skills
a n d market information. Since they are mostly deprived of formal education, they
usually possess low or no knowledge of accounting. Besides, they have less control over
the borrowed money once they hand it over to the male members of their family and remain
detached from the business operations (Hassan, 2010). So, the conjecture on women’s
repayment performance deems void. Furthermore, income depends on individual’s
physical and intellectual capabilities (Chowdhury & Mukhopadhaya, 2012). Male
members may fail to generate enough income due to lack of skills in running businesses.
Therefore, the rate of repayment is supposed to be very low in microfinance. But, the
practical scenario is just opposite. Repayment rate in microfinance is as high as 98%
(Aydin, 2015; Yunus, 2017). This lucrative achievement has been possible due to
installing a hybrid mechanism that combines, women-focused lending, group guarantee,
peer monitoring, peer pressure, weekly-meeting and strict supervision of the loan officers.
Notwithstanding, most of the microfinance institutes (MFIs) reportedly exert some kind of
‘pressure’ or ‘force’ on the borrowers in order to optimize repayment (Kassim, Salina, &
Rahman, 2008). This non-statutory malpractice of MFIs c o m p e l s the borrowers

seeking for auxiliary l o a n s from various other sources while pushing them into hardly
escapable ‘loan-trap’ (Diop, Hillenkamp , & Servet, 2007; Jain & Mansuri, 2003; Karim,
2011). Multiple borrowings consequently increase the size of weekly-installment or the
frequency of multiple repayment dates. Hence, it becomes burdensome to the poor
borrowers. Reportedly, in most of the cases if any borrower fails to maintain the due
repayment schedule, they are forced by the loan officers and group members to sell out their
tangible assets or household belongings (Kassim et al., 2008). As a result, they turn into
impecunious poor.

Default effect or credit risk is assumed an internal measurement factor of the performance of
banks. The higher the level of bank’s exposure to credit risk, the higher the possibility of the
bank to likely experience financial crisis and so on. Credit risk is the most formidable amongst
the numerous risks faced by banks and the profitability of the banks is highly affected since a
greater aspect of banks’ income accrues from granting credit facilities from which interest is
generated. However, credit risk is found to be linked with interest rate risk by implying that
interest rate increment enhances loan default possibilities. Interest rate risk and credit risk are
related intrinsically to one another and not separately (Drehman, Sorensen &Stringa, 2008).
According to Ahmad and Ariff (2007), the credit portfolio with greater non- performing assets
limits the banks’ ability in achieving its stated objectives. Therefore, loans that are non-
performing are expressed as the percentage of loan values which has not been service for 90
days and above. Consequence upon the huge rate of non- performing loans, credit risk
management practices is highly emphasized by Basel II Accord.

It is quite unfortunate that in spite the degree of carefulness, skillful, experience or tact of a
loan officer, most of the loan facilities granted to borrowers sometimes go bad. The
introduction of the Prudential Guideline in 1990 for banks licensed in Nigeria enable banks
to properly classify bad and doubtful debt. These guidelines made it compulsory for
licensed banks to at least in a quarter, have their credit portfolios reviewed and credit classified
(into non-performing loans and performing loans) appropriately (Mora, 2011).The introduction
of these guidelines has assisted the banks to promptly identify the deterioration of loans held
by banks. For a credit facility to be considered as non- performing, both the principal and
accrued interest is unpaid for three months and more; or this interest payment must have been
interest of 90 days or more may have been rescheduled, rolled-over or capitalized into a new
credit facility (unless these facilities have reclassified and the borrower have made cash
payment to the effect that interest payment outstanding does not exceed three months).

MFIs have adopted various strategies of recovering their money, some orthodox, some
unorthodox. It has been found that most borrowers are always willing to pay, but certain
situation like economic recession, inflation, political instability, poor investment makes them
not able to pay. According to Ojiegbe (2002), there are also the existences of bad borrowers in
the banking industry whose primary assignment is to abandon their loan obligations in most
banks and enter into new loan contracts with another bank. This low credit standard of
borrowers along with poor management of portfolio and changes insensitivity in the economic
environment by the bankers led to the banks witnessing rising non-performing credit portfolio.
This ultimately causes many banks to fail and become insolvent.

Furthermore, the recovery agent of banks has not helped matters as most of them report on the
uncompromising attitude of the debtors to repay the loan without actually carrying out proper
investigation. This is probably after they have accepted some form of gratification from the
debtors in question. This situation made the Nigerian government to establish the Asset
Management Corporation of Nigeria (AMCON). The setup of AMCON in July 2010 which
was basically to solve the problem of the frequent and alarming degree of non-performing loans
that affected banks in Nigeria (Mora, 2011). Thus, the creation of loan recovery machineries
like the AMCON became relevant as a means of alleviating the menace of increasing non-
performing debt portfolio in Nigerian banks.

2.4.2 Performance of MFIs

Financial performance can be defined as a subjective measure of how well a firm can use
assets from its primary mode of business and generate revenues (Mills, 2008). This term is
also used as a general measure of a firm's overall financial health over a given period of time,
and can be used to compare similar firms across the same industry or to compare industries or
sectors in aggregation. The performance measurement concept indicates that employees can
increase the value of the firm by; increasing the size of a firm’s future cash flows, by
accelerating the receipt of those cash flows, or by making them more certain or less risky
(Cadbury, 1992).

Carreta and Farina (2010), argue that use of financial performance could still be justified on the
grounds that it reflects what managers actually consider to be financial performance and, even if
this is a mixture of various indicators like accounting profits, productivity, and cash flow.
Financial performance is determined by the following indicators; profit or value added; sales,
fees, budget; costs or expenditure and stock market indicators (e.g. share price) and autonomy.
Management accounting is thus fundamentally involved with the processes of organizational
practice. It must be noted that the major practice system in most organization is the budget.

According to Arega (2007), improving access to financial services is an important development

tool, because it helps in creating employment opportunities for the unemployed and increases
their income and consumption, which would in the final analysis reduce poverty. Access to
financial services to the poor also facilitates economic growth by easing liquidity constraints
in production, by providing capital to start-up new enterprises or adopts new technologies, and
by helping producers to assume production risk, a gap MFIs has provided link to in Uganda.

Measures of Financial Performance

Return on Equity (ROE)
Ross et al (1996) noted that return on equity is a measure of how the shareholders money
fared during the year. They further assert that ROE is, in an accounting view the true bottom-
line measure of performance. ROE is a measure of profit on investment in equity. Helfert (1991)
call this ratio, return on net worth and states that it is the most common ratio used for measuring
the return on the owners investment. The ratio of net profit after taxes to common equity
measures the rate of return on the stockholders investment (Brigham, 1980).

According to Banker et al (1993) the Du Pont formula has long been used to measure the
financial performance of companies. They are of the opinion that due to the way in which the
profitability ratio is constructed, it provides only a gross aggregate measure and does not
easily capture the impact that the micro-attributes of the operations of companies have on
profitability.

Net Profit
In the business world, profitability refers to the extent to which an organization has added
value in its line of activities. Profitability is most often used to assess the ability of an
organization to continue in business. The main issue in evaluating profitability of an
organization is its profit performance. The term Profit has several definitions, an investor
view it as a measure of return on his money. Economists look at it as reward for
entrepreneurship for taking risk. An accountant is of the opinion that profit is the excess of
income/revenue over expense incurred in producing that revenue.

In the lending relationships many times small scale entrepreneurs have a weak bargaining power
to influence the terms (Mugisa, 2002). This subjects them to unfair consumption of financial
products due to the inappropriateness of product terms. Most institutions set terms for clients and
without necessarily meeting what the clients need. Many times this has also limited the impact of
businesses funded by MFIs. Another area that supports this argument is the high dropout rate of
loan clients as based on survey carried out in five major finance providers that put at an average
of 5-10% per year (Bernard, 2005)

MFIs are developed to fill the gaps in the financial sector as commercial banks were not
accessible by SSEs (Rutherford, 2000). In Uganda most micro finance finding goes to
commerce, processing and provision of services, yet livestock and agricultural production
still attract fewer funding due to their risky nature. The USAID report 1997 observed that the
nature of financial products offered by MFIs, that is, very short term, with no grace periods, their
products are not appropriate for financing of investments and agricultural production which
makes them limited.

Bibangambah, (1995), also noted that MFIs judge borrowing of individual as an indicator
that credit is beneficial. They don’t have sufficient methodology to assess whether their loans
are beneficial or not. They are unable to connect activities and ensure that are not abused by
clients hence MFIs fails to determine whether the major issue of lenders is that many loans are
obtained or that borrowers pay less attention while receiving loans to loan charges, output,
effects, and impact and its general condition.

Its is argued by Marguerite, (2001) that borrowers main sources of loan repayment are not
different from their uses which narrows to their various investments to earn and increase incomes
while at the same time they use their loans for buying assets like land, personal houses.

2.5 Loan recovery techniques/ practices

Bank loans recovery rates have been analyzed both by Bikker and Metzemakers (2007) and
Ayuso, Perez and Saurina (2004). Dermine and Neto de Carvalho (2003) in a more recent study
analyzed loss-given default rates’ determinants using credit portfolio of Portuguese largest
private bank, Banco Commercial Portuguese. They used 371 samples of defaulted loans SME
size firms granted originally between June, 1985 and December, 2000. The recovery rate
estimates are based on the recovered discounted cash flow as an aftermath of the default event.
They stated three concrete empirical results that conform to previous empirical findings: there
exists a negative but statistically significant effect of loan size and recovery rate. The
frequency distribution of loss-given loan default is bimodal, with some having 100 per cent
recovery rate and others zero per cent. Collateral type is significant statistically in recovery
determination while the relationship between bank-company ages was not.

Group-guarantee is a commonly used lending technique in the microfinance industry.

This technique complements the collateral while acting as an effective tool to attain
optimum repayment (de Quidt, Fetzer, & Ghatak, 2016). This mechanism also addresses the
problem of information asymmetry, adverse selection and moral hazard. Group members
usually encourage each other to invest the money wisely as well as discourage to take
excessive risks. Furthermore, group pressure works as an effective device for due
repayment (Armendáriz & Morduch, 2005). Arguably, microfinance institutes utilize the
peer-group as their ‘pressure-group’ (Siwale & Ritchie, 2012) and most of the time this
method turns into an obsessive enforcement that works for ensuring regular repayment
(Besley & Coate, 1995; Churchill, 1999; de Quidt et al., 2016; Velasco & Marconi,
2004). Overall, by means of aforesaid practices, MFIs tend to maximize loan repayment,
profit and growth while staying far behind the objective of poverty alleviation. But, these
types of demeaning treatments presumably bring about adverse realities to the borrowers’
lives. So, investigating borrowers’ consequences because of ‘forced loan recovery’
technique has a practical importance.

Many reasons have been advanced as factors deterring loan collection in MFIs and this reasons
for which the loan recovery of MFIs is still now defective in most cases, may be raised
from sanctioning procedures of loan, investigation of the project, and investigation of the loans
etc. that is, the problem in loan recovery proves the outcomes of the default process in loan
disbursement. This undoubtedly becomes non-performing loans (NPLs) recently has become
vital debating matter in the new frontiers of finance and management of credits. The main
reasons of poor loan recovery are categorized in the following broad types:

A. Problems created by economic environment:

i) Changing in the management pattern: Changing of management patterns may delay the
recovery of mature loan. ii) Changing in industrial patterns: The banks sometimes sanction
loan to the losing concern for further improvement of the respective sector, but in most cases,
they fail to achieve progress. iii) Operation of open market economy: In our country mainly
industries become sick and also close their business on account of emerging of open market
economy. The cost of production is high and the quality of goods is not of required of
standard. As a result, they become the losing concerns and the amount of bad loan increases.
iv) Rapid expansion of business: There are many companies which expand their business.

Fama, Eugene and Kenneth (2002) assessed the effect of the economic environment on the
rates of recovery. Just as any class of asset, defaulted debt is also affected by the factors
affecting the economy. For instance, recovery and default rates have been correlated
negatively. Other macroeconomic factors may be responsible for recovery rates and these may
cause the impact of default rates on recovery rates to disappear.

B. Problems created by government:

The accumulation of non-performing loans to include high interest rate, macroeconomic
volatility, moral hazard, economic downturns, deterioration of terms of trade, insider
lending and over dependent on inter-bank borrowings that is overly high-priced (Goldstoin &
Turner, 1996). Just as liability, asset and interest rate management have been pronounced in
the last 15 years, NPLs according to deServigny and Renault (2004) has taken a new
dimension.

These are mainly due to External pressure which MFIs face in the loan recovery process as a
part of continuous pressure from various interested groups. ii) Legal problems: Existing rules
and regulations are insufficient to cover the legal aspects of loan recovery. As a result,
defaulters can get release easily from all charges against them. iii) Instability of Government
policy: Frequent changes in government policies in regard to recovery of loan.

C. Problems created by the bank:

The following problems are created by the banks themselves-

i) Lack of analysis of business risk: Before lending, Sometime MFIs fails to properly analyze
the business risk of the borrowers and the bank cannot forecast whether the business will
succeed or fail. If it fails to run well, the loan becomes classified. ii) Lack of proper valuation
of security or mortgage property: In some cases, bank fails to determine the value of security
against the loan. As a result, if the loan becomes classified, the bank cannot recover its
loan through the sale of mortgage.

Some of the root causes of non-performing loans were suggested by Kassim (2002) to include:
Fraudulent activities, Inadequate credit analysis, Political instability, Documentations errors,
Regulatory and policy inconsistencies, Poor management, Weak real sector, Negligence of loan
quality for undue profitability, Unsound credit framework, Economic depression, Social and
political pressure on the operators of banks, Abnormal competition, pest and disease outbreaks
e.g. (COVID-19).

Elaine (2007) adds that potential loss is encapsulates by credit risk or NPLs in the
instance of a borrower’s default or credit deterioration. Thus, what is critical for the creditor is
the soundness of loan credit appraisal. Greene (2005) argued that, the understanding of the
analytical process of credit structure and worthiness, credit standards, negotiations, resolution of
problems, techniques of decision-making, follow-up must be a bank’s top priority for credit risk
to be managed effectively.

Altman (2001) posited that there exists a correlation between recovery and default rates.
The Merton’s models were used and its posited that, the simple link between liability
responsibility and value of asset will determine when default time and probability will occur,
also that, if the level of liability of an asset is closer to default, then recovery rates should be
extremely high. Again, if the values of these assets are independent of the level of aggregate
default, recovery rates and probabilities of default should be relatively independent. For
example Salas and Saurina (2002), Ali and Daly (2010) and Nkusu (2011) found that GDP per
capita had an inverse relationship to non- performing loans in their respective studies while
Beck, Demirhuc-Kunt and Levine (2013), found that there exist appositive relationship between
non-performing loans and GDP.

Kargi (2011) in his study, examined the effect of credit risk on Nigerian banks’
profitability and using financial ratios collected from the financial books of the selected banks
and analyzed using regression, correlation and descriptive statistical techniques. His findings
showed that there was a significant effect between credit risk management and bank
profitability in Nigeria. The study concluded that the degree of loans and advances, deposits
and NPLs was inversely related to bank profitability, thus, exposing the banks to the possibility
of distress and illiquidity.

A similar study by Epure and Lafuente (2012) revealed that regulatory changes improves bank
performance and that risk revealed NPLs and differences in banks to have affected the return
on asset negatively while the ratio of capital adequacy has a positive effect on net interest
margin. Kithinji (2010) who examined the impact of credit risk management on commercial
banks profitability in Kenya showed that, NPLs and amount of credit does not influence the
level of commercial bank profitability, therefore the recommended that variables other than
NPLs and credit do affect profits.

Debt recovery or realization process is one of the important things in a bank lending activity.
This is because if the processes of recovery are unruly protracted or a bank is negligent, there
will be huge losses. When this happens, the level of arrears on loan portfolio of banks would
very high, which will affect the capital ratios of banks in turn. According to Ojo (2008), capital
adequacy is the basis for the Basel framework for managing risk, where the models for internal
risk are suggested in a way of capital augmentation is to make for the penalties of taking risk.
Hence, the requirement for capital adequacy is the root base of prudential supervision and
regulation. Legally, capital adequacy is defined as the aggregate adequate capital of a bank in
relation to risk emanating from common banking operations, asset portfolio, off-balance sheet
activities, and other business associated risks.

The recovery process is often legal and long drawn and in the meantime, MFIs is continuously
deprived of the opportunity to earn from such funds. Added to this, is the question of MFIs
status and reputations which could be altered with an excessive portfolio of problem loans.
Excessive problem loans have been compared to a problem bank which is dying slowly from
several small wounds. It has been said that: one is reminded of a form of torture and death
known as “death of a thousand cuts” seen in American South- West among the Native
Americans (Guo, 2007).
The bank bleeds from all these small cuts and has a very hard, slow time recovering from the
problems. The very essential thing is to create a good environment for debt recovery
process. Debt recovery process requires different mechanisms to be employed. Nigerian
commercial banks adopt different ways of recovering non- performing loans. These methods
are one or the combination of the following: Settlement, Reschedule/Renewal, Foreclosure,
Write- off and Litigation.

Secure NPLs requires MFIs to handle them themselves, use courts to enforce their rights or
auction them in Asset Management Companies (AMCs), which is common in countries where
NPL is not widespread. This AMC in Nigeria is known as the Asset Management Corporation
on Nigeria (AMCON). Every business activity is risk-possessed ranging from crop failure,
inability to market an expensive new item, to non-payment of a trade debtor. However, the
situation for MFIs is quite different because they are exposed to business risks associated with
commercial borrowers, financial market systematic failures, and the impact of economic
downturn. When these risks occur, banks resort to debt recovery mechanisms.
2.6 Measures to improve loan recovery and performance

As a bank’s capital diminishes, the incentives, which its owners have to preserve
solvency, are reduced because with limited liability, they would have to bear only a
proportion of the losses incurred to creditors. If the problem grows out of hand and regulators
begin to question a bank’s ability to lend, it will threaten its existence (Blaz & Schiffman,
1996).

The consequence of inordinate delays in recovering debts can be severe. Borrowers may be
encouraged to disregard their payment obligations, and take advantage of the weakness in
the debt recovery process. Willing defaulters may obtain loans with deliberate intention of
avoiding payment, and may dispose of their assets beyond the reach of lenders because of the
tedious pace of debt recovery suits. In short, delays breed a credit culture of deliberate non-
payment by defaulters (Dickinso, David & Yixin, 2009).Banks have to incur substantial costs in
terms of man power, legal and other administrative expenses to service and realize the problem
loans. Though it is often difficult to quantify these costs, a bank with large portfolio of
problem loans could be experiencing a decline in profitability arising from loss of interest,
income and rising costs in terms of legal and other expenses.

MFIs often during recovery sanctions loans and advances to its customers, they clearly state the
repayment pattern in the loan agreement. But some credit holders do not pay their credit in due
period. The international and indigenous micro financial institutions have to face this sort of
problems. This situation is also found in PRIDE Micro finance institution.

The study of Al-Khouri (2011) on the effect of the characteristics of bank’s specific risk and
the operating environment on banks performance in the Gulf Cooperation Council (GCC) used
the fixed effect regression techniques and concluded that, capital risk, liquidity risk and credit
risk are the dominants elements that affects the performance of banks when measured using
ROA, and only liquidity risk has an effect on the performance of the banks in terms of ROE.

Ahmed, Takeda and Shawn (1998) revealed that increase in the provision for loan losses
reflects increased deterioration in loan quality and credit risk, hence, adversely impacting the
performance of MFIs. The strategies for managing credit risk are the mechanisms applied by
banks to escape or reduce the negative effect of credit risk. A sound framework for managing
credit risk is critical for the survival of banks and attainment of set goals.

Chen and Pan (2012) pointed out major principles in the process of managing credit risk to
include: setting precise structure, responsibility allocation, disciplined and prioritized processes
should be properly defined, communicated and evaluated. Credit risk hedging strategies
include: i. Credit derivatives, ii. Securitization of credit, iii. Basel accord compliance. iv. Credit
bureau. v. Adoption of internal sound lending policy.

Ahmad and Ariff (2007) in their investigation revealed that, for banks that specialize in multi-
services and products, regulation is quite critical; while the quality of management is critical
for banks that are loan-dominants in an emerging market. According to them, increase in the
provision for loan losses is a major factor in facilitating potential credit risk. They
concluded that the credit risk in developed markets is lower than that of the emerging
markets.

Defaults are often caused during periods of ensuing downturns and financial crisis especially
in the real corporate and financial sectors. This study examined critically, the efficiency of loan
recovery rate as it affects deposit money bank performance in Nigeria. The result suggested
that, the rate of recovery relied mostly on industry wide and systematic factors. It is assumed
very difficult to determine precisely which factor is most suitable in the drive to recovering
risk. Notwithstanding, fewer cases can be made in support of the fact that, the state of business
cycle do have substantial influence on recoveries and at least, some of this transmission parts
showed up through industry distress indirectly and persistence with loan defaults.

To overcome the problem of overdue loan, the institution has taken particular loan recovery
programs which includes but nor limited to;- ensuring that credit defaults are successfully
documented in a robust recovery database, setting in motion a recovery rate model that uses
inputs that can be reasonably estimated, using internal loss-given default estimates as well as
regulatory version in estimating losses as well as projected risk and regulatory requirements,
establishing standards for credit policies and conforming with institution overall objectives
and regulatory requirements so as to minimize the degree of exposure to credit risk.

The above can be adopted through use of the following;-

i) Persuasive Recovery: The first step in recovery procedure is private communication that
creates a mental pressure on borrower to repay the loan. In this situation bank can provide
some advice to the borrower for repaying the loan.

ii) Voluntarily: In this method, some steps are followed for recovering loan. These are for
Credit Department for MFIs; Building Task Force; Arranging Seminar; Loan Rescheduling
Policy and Waiver of Interest Rate.

iii) Legal Recovery: When all steps fail to keep an account regular and the borrower does
not pay the installments and interests then the bank take necessary legal steps against the
borrower for realization of its dues. In this case “Artha Rin Adalat Law 2003” plays an
important role for collecting the loan.

2.7 Gaps in the literature

Loan officers are assigned for loan disbursement, business proposal evaluation,
performance monitoring and loan collection. But, allegedly they behave with the
unsuccessful borrowers like tyrannous debt collectors. They use unconventional and
seemingly obnoxious methods, such as scolding or verbally abusing, insulting in front
of other members and even compelling them to sell out their tangible assets to repay the
loans (I. Ali, Hatta, Azman, & Islam, 2017; Dixon, Ritchie, & Siwale,2007).

The review of literature shows that, there were theoretical and empirical gaps. There was direct
link between higher interest rates, repayment and the demand for credit by SMEs. Also, the
literature does not establish how the interest rates on loans/credit, repayment period of the loans,
repayment pattern and levels of penalties imposed for non-compliance with the set credit terms
directly or indirectly affect the performance of the SMEs. Therefore, there is the need to close
the gap and this is what this study aimed at.

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