Han Thesis 1

WOLLO UNIVERSITY
COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF MANAGEMENT
MASTERS OF BUSINESS ADMINISTRATION /MBA/
DETERMINANTS OF NON-PERFORMING LOANS: THE CASE OF

THE ETHIOPIAN COMMERCIAL BANKS
BY: HANAN SEID
ADVISOR: GIRMA TADESSE (PhD)
JANUARY, 2024
DESSIE, ETHIOPIA
I
WOLLO UNIVERSITY
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF MANAGEMENT
MASTERS OF BUSINESS ADMINISTRATION /MBA/
DETERMINANTS OF NON-PERFORMING LOANS: THE CASE OF

THE ETHIOPIAN COMMERCIAL BANKS
A THESIS SUBMITTED TO WOLLO UNIVERSITY COLLEGE OF

BUSINESS AND ECONOMICS, DEPARTMENT OF MANAGEMENT IN
PARTIAL FULFILMENT FOR THE REQUIREMENT OF A DEGREE
IN MASTER OF BUSINESS ADMINISTRATION
BY: HANAN SEID

ID.No: 0043/14
ADVISOR: GIRMA TADESSE (PhD)
JANUARY, 2024
DESSIE, ETHIOPIA
I
DECLARATION
First, I declare that this thesis is my work and that all sources of materials used for this thesis
have been fully acknowledged. This thesis has been submitted in partial fulfillments of the
requirements for a MBA to Wollo University. I also declare that this thesis is not submitted to
any other institution for the award of any academic degree, diploma, or certificate. Brief
quotations from this thesis are allowable without special permission, provided that accurate
acknowledgement of the source is made.
Requests for permission for extended quotation from or reproduction of this manuscript in
whole or in part may be granted by the head of the major department or the dean of the Post
Graduate Studies. In all other instances, however, permission must be obtained from the
author.
Name: Hanan Seid Signature: ………………...
Place: Wollo University, Dessie
Department of Management
Program: MBA Program
Date of Submission: January, 2024
II
APPROVAL SHEET
As members of the Board of Examiners of the Master thesis open Defense Examination, we
certify that we have read, and evaluated the Thesis prepared by Hanan Seid, entitled
“Determinants of Non-Performing Loans: The Case Of The Ethiopian Commercial
Banks’’ and recommend that it be accepted as fulfilling the thesis requirement for the Degree
of Masters of Business Administration (MBA) in Wollo University, College of Busines and
Economics, complies with the regulations of the university and meets the accepted standards
considering originality and quality.
Name of chairman Signature Date
__________ ________________ ____________
Name of Major Advisor Signature Date
Girma Taddese (PhD) ________________ ____________
Name of Internal Examiner Signature Date
____________________ ________________ ___________
Name of External Examiner Signature Date
____________________ ________________ ______________
Final approval and acceptance of the thesis is contingent upon the submission of the final
copy of the thesis to the council of graduate studies (CGS) through the departmental graduate
committee (DGC) of the candidate’s major department.
I hereby certify that I have read this thesis prepared under my direction and recommend that
it be accepted as fulfilling the thesis requirement.
_________________ ________________ _______________
Postgraduate Directorate Date Signature
I
CERTIFICATE
This is to certify that the thesis titled “Determinants of Non-Performing Loans: The Case of
Ethiopian Commercial Banks”, submitted to Wollo University, Department of Management
for the award of Degree of Master of Business Administration (MBA) and is a record of
genuine research work carried out by Hanan Seid, under my guidance and supervision.
Name of Major Advisor Signature Date
Girma Taddese (PhD) ________________ ____________
II
ABBREVIATIONS AND ACRONYMS
AB Abay Bank
AdIB Addis International Bank
AIB Awash International Bank
BOA Bank of Abyssinia
BIB Berhan International Bank
BuIB Buna International Bank
CBB Construction and Business Bank
CBE Commercial Bank of Ethiopia
CBO Cooperative Bank of Oromia
DB Dashen Bank
DBE Development Bank of Ethiopia
DGB Debub Global Bank
ECBs Ethiopian Commercial Banks
LIB Lion International Bank
NBE National Bank of Ethiopia
NIB Nib International Bank
OIB Oromia International Bank
UB United Bank
WB Wegagen Bank
ZB Zemen Bank
CAR Capital Adequacy Ratio
FDRE Federal Democratic Republic of Ethiopia
IMF International Monetary Fund
KYC Know Your Customer
NPLs Non-Performing Loans
ROE Return on Equity
RQ Research Questions
SBB Supervision of Banking Business
III
ACKNOWLEDGEMENTS
It is the grace, mercy, charity, forgiveness, help and kindness of the one almighty lord that
made me still alive, achieve this success and strength and to go through all the difficult times.
I am thankful to all those who, in one way or another, contributed to the successful
completion of this research paper. My heartfelt gratitude goes to my Advisor Dr. Girma
Tadesse, College of Business and Economics, Wollo University, for his meticulous review of
my work as well his earnest encouragement and essential guidance in the course of the
research work.
Many thanks also go to the staff and management of the private and state-owned commercial
banks, on which this study has been conducted, for completing the research survey
questionnaire and providing financial data as well as valid qualitative information in this
regard.
Finally, I would like to extend my gratitude to the Management Department of the Wollo
University in general, and the Graduate Programs Coordinating Office in particular, for their
understanding and special support to get us all successful in our endeavors, amid all the
challenging situations in our respective occupations.
IV
TABLE OF CONTENTS
DECLARATION.......................................................................................................................II
APPROVAL SHEET..................................................................................................................I
CERTIFICATE..........................................................................................................................II
ABBREVIATIONS AND ACRONYMS................................................................................III
ACKNOWLEDGEMENTS.....................................................................................................IV
LIST OF TABLES................................................................................................................VIII
LIST OF FIGURE....................................................................................................................IX
ABSTRACT..............................................................................................................................X
CHAPTER ONE........................................................................................................................1
1. INTRODUCTION..................................................................................................................1
1.1 Back ground of the study.............................................................................................1
1.2 Statement of the problem.............................................................................................3
1.3 Research Questions......................................................................................................5
1.4 Objective of the Research............................................................................................6
1.4.1 General Objective..............................................................................................6
1.4.2 Specific Objectives............................................................................................6
1.5 Research Hypotheses...................................................................................................6
1.6 Significance of the Study.............................................................................................6
1.7 Scope of the study........................................................................................................7
1.8 Organization of the Paper.............................................................................................7
CHAPTER TWO.......................................................................................................................8
2. LITERATURE REVIEW.......................................................................................................8
2.1. Theoretical literature review.......................................................................................8
2.1.2 The Classifications of Loans.............................................................................9
2.2 Empirical Literatures Reviews...................................................................................11
2.3 Conceptual Frame work.............................................................................................13
CHAPTER THREE..................................................................................................................14
3. RESEARCH METHODOLOGY......................................................................................14
3.1 Study area...................................................................................................................14
V
3.2 Research design..........................................................................................................14
3.3 Research Approach....................................................................................................15
3.4 Sampling Techniques and Sample Size of the Study.................................................15
3.5 Data Sources and Method of Data Collection of the Study.......................................16
3.6. Research model.........................................................................................................17
3.7. Data Analysis and Presentation.................................................................................17
3.6. Reliability and Validity Test.....................................................................................18
3.7 Ethical considerations................................................................................................18
CHAPTER FOUR....................................................................................................................18
4. RESULTS AND DISCUSSION..........................................................................................18
4.1 Response Rate............................................................................................................19
4.2 Description of Respondent’s Profile..........................................................................19
4.3 Reliability and Validity Test......................................................................................22
4.4. Descriptive Analysis of Determinants that Affect NPLs..........................................23
4.4.1. General Ranking of factors affecting occurrences of NPLs in the banks......23
4.4.2. Effect of Credit assessment on Non-Performing Loans.................................24
4.4.3. Effect of credit monitoring on Non-Performing Loans..................................25
4.4.4. Effect of collateralizing loans on Non-Performing Loans.............................27
4.4.5. Effect of Borrower’s Orientation and Culture on Non-Performing Loans....28
4.4.6. Effect of Interest Rate on Non-Performing Loans.........................................29
4.4.7. Descriptive analysis of Dependent Variable, Non-Performing Loans...........30
4.4.5 Descriptive Summary of determinants and Non-performing loans (NPLs)....30
4.5 Results on Pearson Correlation Analysis...................................................................31
4.6 Results on Multiple Linear Regression Analysis.......................................................32
4.6.2 Multicollinearity Test Results.........................................................................32
4.6.3. Normality Test Result....................................................................................33
4.6.4. Homoscedasticity Test...................................................................................34
4.6.5. Independence of Errors (Autocorrelation) Test Result..................................35
4.6.6. Linearity test...................................................................................................35
4.6.7. Regression Model Fitting Summary and Coefficients...................................35
4.7. Hypotheses Testing...................................................................................................37
4.8 Discussion on Interview Analysis..............................................................................39
CHAPTER FIVE......................................................................................................................40
VI
5. SUMMARY OF FINDINGS, CONCLUSIONS AND RECOMMENDATIONS..............40
5.1 Summary of Major findings.......................................................................................40
5.2 Conclusion..................................................................................................................41
5.3 Recommendations......................................................................................................42
4.6 Limitations and future research directions.................................................................43
REFERENCE...........................................................................................................................44
APPENDIX A: QUESTIONNAIRE USED FOR THE STUDY............................................48
VII
LIST OF TABLES
Table 3.1:Targeted Banks and Selected Sample Respondent Numbers..................................16
Table 4.1: Response rate..........................................................................................................19

Table 4.2: Respondents Experience in the Bank Industry.......................................................21
Table 4.3: Respondents’ work experiences in Banking Credit Process...................................21
Table 4.4: Reliability Analysis.................................................................................................23
Table 4.5: Ranking of factors affecting NPLs.........................................................................24
Table 4.6: Credit assessment on Non-Performing Loans.........................................................24
Table 4.7: Credit monitoring on Non-Performing Loans.........................................................26
Table 4.8: Collateralizing loans on Non-Performing Loans....................................................27
Table 4.9: Borrower’s orientation on Non-Performing Loans.................................................28
Table 4.10: Interest Rate on Non-Performing Loans...............................................................29
Table 4.11: Descriptive Results of Non-performing loans (NPLs)..........................................30
Table 4.12: Descriptive Statistics on Determinants and Non-performing loans (NPLs).........31
Table 4.13: Results Pearson Correlations................................................................................32
Table 4.14: Checking Multicollinearity in the Regression Model...........................................33
Table 4.15: Multiple Regression Analysis Model Summary Result........................................35
Table 4.16: ANOVA Table of Regression Analysis Result.....................................................36
Table 4.17: Regression Coefficient Analysis of the fitted model............................................37
Table 4.18: Summary of hypothesis testing.............................................................................39
VIII
LIST OF FIGURE
Figure 2.1: Conceptual framework of Determinants and non-performing loans(NPLs)........13
Figure 4.1: Respondents Current Position in the Bank............................................................20
Figure 4.2: Respondent Employees Perception about Determinants of NPLs.........................20
Figure 4.3: Respondent employees working bank ownership.................................................22
Figure 4.4: Histogram of standardized residuals for normality test.........................................34
Figure 4.5: Scatter plots of standardized residuals for homoscedasticity test..........................34
Figure 4.6: p-p plot of residuals to test linearity......................................................................35
IX
ABSTRACT
Loans and advances form a greater portion of the total assets in banks. These assets generate
huge interest income for banks which to a large extent determine the financial performance
of banks. However, some of these loans usually fall into non-performing status and adversely
affect the performance of banks. In view of the critical role banks play in an economy, it is
essential to identify problems that affect the performance of these institutions. Non-
performing loans is one of these problems. Therefore, a research on determinants of non-
performing loans, the case of Ethiopian Commercial banks was conducted on thirteen banks.
The research seeks to find out the determinants of non-performing loans in the Ethiopian
commercial banks. Structured questionnaire was used to collect data for the study from both
private and state-owned banks. The regression analysis showed that credit assessment (CA),
credit monitoring (CM), collateralizing loans (CL), borrower’s orientation (BOC) and
interest rate (IR) significantly affect Non-performing loans (NPLs). The study also found that
poor credit analysis and unsound lending practices, lack of focused loan monitoring and
follow-up, lenient credit terms and conditions, compromised integrity, and fund diversion as
the major factors that contribute to loan default. The findings from the interview result
indicates that, variables such as poor credit risk assessment, focusing on collateral based
lending, poor loan monitoring and follow-up, poor banker’s skill in dealing with lending
matters, undiversified loan products, short loan life and lack of credit advisory practices
were also the bank specific factors that affect non-performing loans of Ethiopian
Commercial banks. The study suggests that focusing on these non-performing loans
indicators could further reduce the probability of default while extending credit in the future.
Further studies were recommended by including macroeconomic and other bank specific
variables; and by increasing the sample size.
Keyword: Non Performing Loans; Credit assessment; Credit monitoring; Determinants; significant
X
CHAPTER ONE
1. INTRODUCTION
1.1 Back ground of the study
It is widely accepted that the quantity or percentage of non-performing loans
(NPLs) is often associated with bank failures and financial crises in both developing
and developed countries. In fact, there is abundant evidence (Fofack, 2005 and Hu,
2006) that the financial/banking crises in East Asia and Sub-Saharan African countries
were preceded by high NPLs. The current global financial crisis, which originated in
the US, was also attributed to the rapid default of sub-prime loans/mortgages. In view
of this reality, it is therefore understandable why much emphasis is placed on NPLs when
examining financial vulnerabilities.
Suryanto (2015) stipulated that, the banking sector in the modern economic system, described
as the heart pumps blood flow in the form of funds to the rest of the economy. To contribute
to the development of the economy of a country, banks play an intermediary role by
transferring excessive funds from the depositors to the borrowers through lending system.
According to Suryanto (2015), this is done so that the collected money in the bank can
continue to operate, because the velocity of money through the bank can earn income from
interest and when the more loans disbursed, the greater bank's revenue earned. In their article
Vatansever & Hepsen (2013), stated that loans generate huge interest income which is a
critical measure of the bank’s financial performance and stability. Therefore, banks are
expected to contribute to the development of the economy through financial intermediation
where, the collected money granted in such a way that earns maximum profit.
Despite of the intermediary role they are expected to play in the economy, banks operate with
the purpose of earning returns without assuming excessive risk. In a study by Alexandri &
Santoso (2015), to investigate the influence of internal and external factors on Non-
Performing Loans and Jolevska & Andovski (2015), to evaluate the Non-Performing Loans
in the Serbia, Croatia and Macedonia banking system concluded that failure to manage loans,
which make up the lion’s share of banks assets, would likely lead to high Non-Performing
Loans, which leads to a low bank health and low economic growth. Therefore, banks should
properly manage Non-Performing Loan to a minimum level that has little or insignificant
effect on its operation.
In the normal operation, all loans granted are not fully subject to collection and free of risk.
Some portions of the loan portfolio have a probability of uncollectable and may threaten the
financial stability of the bank, which leads to increase in Non-Performing Loans. Sizeable
volume of Non-Performing Loans signals the existence of financial fragility and a cause of
worry for banks management and regulatory authorities (Suryanto, 2015). On the other hand,
low Non-Performing Loans suggests relatively a more stable financial system (Adebola,
Yusoff & Dahalan, 2011). Hence, banks need to properly follow and ensure the collection of
the funds they are granted so as not to lose their significant source of income and maintain a
stable financial position. A Non-Performing Loan (NPL henceforth) according to Saba,
Kouser & Azeem (2012), is defined as a sum of borrowed money upon which the debtor has
not made his or her scheduled payments for at least 90 days. NPLs according to Guy (2011),
cited in Joseph, Edson, Manuere, Clifford & Michael (2012), are also commonly described as
loans in arrears for at least ninety days. Therefore, in this study, NPLs are loans that are
ninety or more days’ delinquent in payments of interest and/or principal (Bexley and
Nenninger, 2012, cited in Joseph et al. 2012).
Theoretically, there have been so many reasons why loans fail to perform and the factors
associated with NPLs of banks are numerous and vary across countries. According to Saba et
al. (2012), the factors associated with NPLs of banks can be broadly classified as
macroeconomic and bank specific. The macroeconomic factors according to Suryanto (2015)
are external variables that are not related to internal bank management but reflect the
economic, legal and the surrounding natural environment that can affect the loan quality of
banks in common as operating within the same economic setting. The bank specific factors
on the other hand, refer to those factors which characterized individual banks and usually
associated with the specific policy choices of a particular bank such as loan growth,
performance, the quality of the loan portfolio and operational efficiency (Saba et al. 2012).
Njeru (2012), argue that, for effective management of NPLs, it is very critical for banks in
developing countries to understand and focus more on the management of bank specific
factors which they have more control over and seek practical and achievable solutions to
address NPLs problems. In line with its importance, according to Hassan et al. (2015), it is
worthwhile to study deeply and find out the most important bank specific factors associated
with NPLs of banks in developing countries like Ethiopia.
2
Commercial banks in Ethiopia provide credit facilities and services to various classes of
customers. In the course of their operation, however, they may find themselves with a loan
portfolio in which the risk of the loss is greater than they had anticipated when the loan
was made. That is a position where the risk is greater than the bank would normally be
willing to assume. During this time the loan portfolio will be dominated by NPLs. NPLs or
bad loans arise in respect of the loans and advances which are given by banks to the whole
range of different projects including but not exclusively retail or wholesale, personal or
corporate or short, medium or long term projects. NPLs are, therefore, a very sensitive
element of a bank’s operations.
Thus, an efficient and well-functioning financial sector is essential for the development of
any economy, and the achievement of high and sustainable growth. One of the indicators of
financial sectors health is loan qualities. Most unsound financial sectors show high level of
NPLs within a country.
Theoretically there are so many reasons as to why loans fail to perform. The current study
focuses on exploring the bank specific determinants of NPLs.
1.2 Statement of the problem
In the process of allocation of resources from depositors to borrowers through lending
system, banks while making profits, encounter credit risk. Credit risk is inherent to lenders
and it measures the financial exposure associated with the money lend to borrowers. Ahmad
& Bashir (2013) indicated that whenever financial vulnerability is examined; main emphasis
is placed on NPLs. Among various indicators of financial stability bank’s NPLs assume
critical importance since it contemplates on the asset quality, credit risk and efficiency in the
allocation of recourses to the productive sector (Jameel, 2014). Consequently, banks are
expected to trace deeply the determinant factors that affect NPLs so as to effectively manage
their assets.
Many research works have been carried out around the globe by considering bank specific
factors as important determinants of NPLs. For instance, Shingjergji (2013), found out that
capital adequacy ratio, the loan to asset ratio and interest rate margin as the most important
factors associated with NPLs in the Albanian banking system. Hassan et al. (2015) on the
other hand shows that credit assessment, credit monitoring, rapid credit growth, interest rate
charged by banks and bankers’ incompetence are the most important bank specific factors
associated with NPLs of Pakistani Banking sector.
3
In this regard, very few scholarly works have been carried out in Ethiopian banking sector.
For instance, the study of Wondimagegnehu (2012), Zelalem (2013), Gadise (2014) and
Anisa (2015) need to be worth mentioned. Wondimagegnehu (2012) have tried to identify the
bank specific factors that determine NPLs of Ethiopian banking sector from bank employees
using questionnaire and concluded that, poor credit assessment, failed loan monitoring,
underdeveloped credit culture, lenient credit terms and conditions, aggressive lending,
compromised integrity, weak institutional capacity, unfair competition among banks, willful
default by borrowers and their knowledge limitation, fund diversion for unintended purpose,
over/under financing by banks ascribe to the causes of loan default.
On the other hand, Zelalem (2013) have examined the macroeconomic and bank specific
determinants of NPLs of banks in Ethiopia using a mixed research approach. The study found
out that among the bank specific variables studied: loan growth, financial performance and
operational efficiency are the most important and statistically significant variables affecting
NPLs. Gadise (2014), have also examined the macroeconomic and bank specific
determinants of NPLs of banks in Ethiopia using quantitative research approach and
secondary data. The study found out that, return on equity and capital adequacy ratio has
statistically significant effect on NPLs. Anisa (2015), conducted a study by employing
secondary data and found out that deposit rate, loan to deposit ratio and lending interest rate
had positive and significant impact on banks NPLs.
Though the studies have undeniably contributed to the subject matter, there is a research gap
yet to explore. First of all, the study of Wondimagegnehu (2012) was more of explanatory
and did not show the statistical relationship and significance of bank specific variables and
NPL sufficiently. Moreover, the study did not sufficiently show how the factors studied
correlate with NPLs of banks.
Even if there are so many bank specific variables, Anisa (2015) employed secondary data of
(cost efficiency, deposit rate, loan to deposit ratio and lending interest rate). However, there
are other variables such as return on equity and credit growth rate that can determine banks
NPL. In addition, Zelalem (2013); Gadise (2014) and Anisa (2015) disregarded the
knowledge and experience of credit performers who are actually participating in the lending
process. Hence, it is useful to include and study credit performer knowledge and experience.
An absolute amount of 3.5 billion Birr in loans arrears for an economy such as Ethiopia was
frightening enough and when the bad debt figure is seen in relative terms, it may drive the
4
faint hearted to despair if reports of an up to 40 percent bad debts/loans ratio for at least one
of the three state-owned banks and up to 14 percent for either of the private banks were true.
The question, however, is if the rate in the domestic banking system had reached such a
frightening level, how there has been no major financial crisis in Ethiopia yet is a paradox
that triggered the researcher to take in the study at the outset. Anything above a 5 percent bad
debts ratio in other countries would stir financial panic. It is also worth mentioning the state
owned banks presently claim to maintain their NPLs to a minimum despite the reported
frightening figures.
Currently, there are sixteen private commercial banks and three state owned banks operating
in Ethiopia. Surveyed financial data of the banks as at end of September 2012 indicate that
the ratio of NPLs for Zemen Bank (ZB), Development Bank of Ethiopia (DBE), Bank of
Abyssinia (BOA), Birhan International Bank (BIB), Wegagen Bank (WB), and Oromia
International Bank (OIB) stood at 13.1 percent, 9.4 percent, 6.2 percent, 6.1 percent, 5.7
percent, and 5.3 percent, respectively, which in all cases are higher as compared to the
international standard of 5 percent. Moreover, the NPLs positions of ZB, DBE, and BIB as at
December 2012, stood at 14 percent, 9.5 percent, and 5.5 percent, showing that the non-
performing assets are still high, deserving due attention of the managements and Board of
Directors as well as of the regulatory body, National Bank of Ethiopia.
Thus, the magnitude of the then existing total bad debts of state owned banks, the prevalence
of NPLs that literally triumph in all banks and deviant observation caught the attention of the
researcher for a thorough examination. The researcher, therefore, believes there are perhaps
more important causes that need to be addressed as the first order of banking business is to
identify the real causes behind the unpaid loans in the banking system. Despite such a
prevailing phenomenon of NPLs in Ethiopia, there is little study that investigates the
contributing factors.
There are a good number of studies that examine the factors leading to NPL. However, there
is little empirical study on Ethiopia that has intensively investigated the relationship between
bank-specific factors and NPLs. Thus, the motivation for undertaking this study is to identify
the determinants of NPLs in the case of Ethiopia.
1.3 Research Questions

The study is designed to seek answers for the following research questions related to the bank
determinants of non-performing loans (NPLs).
5
1. What is the effect of credit assessment on the occurrence of NPLs?
2. What is the effect of credit monitoring on the occurrence of NPLs?
3. What is the effect of collateralized lending on the occurrence of NPLs?
4. What is the effect of borrower’s orientation & culture on occurrence of NPLs?
5. What is the effect of interest rates entail loans on occurrence of NPLs?
1.4 Objective of the Research

1.4.1 General Objective
The general objective of the study is to find out the determinants of NPLs in the case of the
Ethiopian banks.
1.4.2 Specific Objectives
 To examine the effect of credit assessment on the occurrence of NPLs.
 To examine the effect of credit monitoring on the occurrence of NPLs.
 To assess the effect of collateralized lending on the occurrence of NPLs.
 To evaluate the effect of borrower’s orientation & culture on occurrence of NPLs.
 To scrutinize the effect of interest rates entail loans on occurrence of NPLs.
1.5 Research Hypotheses
To achieve the specific objectives, the study proposed the following research hypothesis
based on the existing theories and referring to past empirical studies for later testing.
H 1 : Credit assessment has positive relationship and significant effect on non-performing
loans
H 2 : Credit monitoring has positive relationship and significant effect on non-performing
loans
H 3 : Collateralized lending has positive relationship and significant effect on NPLs
H 4 : Borrower’s orientation & culture has positive relationship and significant effect on
NPLs
H 5 : Bank interest rates entail loans have positive relationship and significant effect on NPLs
1.6 Significance of the Study
The current study explored the factors contributing to NPLs in the case of Ethiopian Banks.
As such, the study yields great contribution to research and practice. The research
contribution is attributed to the current contribution to the existing body knowledge and
research regarding factors influencing NPLs. Besides providing further evidence to findings
6
of prior studies, the current study has also identified a few additional factors that worth for
further research and validation. The other contribution of the current research is in relation to
practice. The findings of the current study would help Ethiopian banks get insight on what it
takes to improve their loan qualities and the central bank (NBE) to examine its policy in
banking supervision pertaining to the asset quality banks shall maintain. Finally, this study
can be used as a foundation for other researchers who would like to undertake research on
similar and/or related area of study.
1.7 Scope of the study

This thesis, which is essentially about identifying the determinants of NPLs at both private
and state-owned banks, has focused on Head Office (particularly Credit Department) of each
bank, located in Dessie City. This is premised on the fact that the selected commercial banks
have been operating long enough to give the kind of academic insight the study seeks to
offer. Besides, these banks extend credit facilities to almost all major sectors of the economy.
Again the nationwide credit operation of the banks presents an opportunity for a national
outlook of the issues under study.
1.8 Organization of the Paper
This thesis had been structured in five chapters as follows. Introduction in the first chapter,
chapter two contained a review of literature. The research methodology has been presented in
chapter three showing the targeted population and sampling, research design and approach,
data collection and data analysis methods. In chapter four, the results and findings of the
study were discussed. Finally, the last chapter encompassed the summary of findings,
conclusions drawn and recommendations of the results.
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CHAPTER TWO
1. LITERATURE REVIEW
1.1.Theoretical literature review
2.1.1 The Nature and Definition of Non-Performing Loans
Loans become nonperforming when it cannot be collected within certain stipulated time
period that is governed by some contract. Nonperforming loans generally refers to loans,
which for a relatively long period of time do not generate income; that is the principal and/or
interest on these loans has been left unpaid for at least 90 days.
The definition of NPL varies across countries; there is no global standard to define NPLs at
practical level and previous studies have defined NPLs according to their needs. Saba et al.
(2012) defined NPL in US banking sector as a sum of borrowed money upon which the
debtor has not made his or her scheduled payments for at least 90 days. A NPL is either in
default or close to being in default. Once a loan is non-performing, the odds that it will be
repaid in full are considered to be substantially lower. If the debtor starts making payments
again on a NPL, it becomes a re-performing loan, even if the debtor has not caught up on all
the missed payments. Basha & Ramaratnam (2016), defined NPL (also called Non-
Performing Assets) in India as the assets of the banks which don’t perform (that is – don’t
bring any return) are called Non-Performing Assets (NPA) or bad loans. According to them
bank’s assets are the loans and advances given to customers. If customers don’t pay either
interest or part of principal or both, the loan turns into bad loan.
The recent global financial crisis highlighted the importance of appreciating financial
institutions vulnerabilities in the context of managing credit risk. The key motivation for this
paper is to improve understanding of the determinants of NPLs. However, a lot of research
papers can be found regarding the problem or non-performing loan. Many prudential
researchers intend to work on NPLs because it is perceived as the foremost aspect of bank’s
survival.
8
The question of loan default is related with none recovery/repayment of loans. When a
borrower cannot repay interest and/or installment on a loan after it has become due, then it is
qualified as default loan or non-performing loan (Chowdhury & Adhikary, 2002). It is
known as non- performing, because the loan ceases to “perform” or generate income for the
bank. The default/non- performing loan is not a “uni-class”, rather a “multiclass” concept.
NPL is also defined from institutional point of view. Basel committee cited in Hassan et al.
(2015) defined NPLs as loans which are not paid and their overdue time period is 90 days
after maturity date. More specifically NPL is:
“any loan in which interest and principal payments are more than 90 days overdue;
or more than 90 days' worth of interest has been refinanced, capitalized, or delayed
by agreement; or payments are less than 90 days overdue, but no longer anticipated”.
Under the Ethiopian banking business directive, NPLs are defined as “loans or advances
whose credit quality has deteriorated such that full collection of principal and/or interest in
accordance with the contractual repayment terms of the loan or advances in question”.
Further defined in the directive as:
“Loans or advances with pre-established repayment programs are nonperforming
when principal and/ or interest is due and uncollected for ninety consecutive days or
more beyond the scheduled payment date or maturity”
Therefore, loans become NPL when it cannot be recovered within certain stipulated period of
time that is governed by some respective laws.
Generally, from the above definition NPL is:
a). A loan that is not earning income;
b). Full payment of principal and interest is no longer anticipated;
c). Principal or interest is 90 days or more delinquent or;
d). The maturity date has passed and payment in full has not been made.
2.1.2 The Classifications of Loans
Despite its critical importance, there is no well-recognized international standard for
recognizing and accounting for credit losses by banks. Loan can be classified as performing
and non-performing. Performing loan is loan that payments of both principal and interest
charges are up to date as agreed between the creditor and debtor. Generally, loans those are
outstanding in both principal and interest for a long time contrary to the terms and conditions
contained in the loan contract are considered as NPLs.
9
All banks need a loan classification or grading system to facilitate the monitoring and
management of credit risk in their loan portfolios (NBE, 2018). To identify the loans which
are non- performing and to calculate and determine the amount of provisions under the
current Ethiopian banking regulations, a bank’s loan portfolio can be classified into five
major categories namely, in order of deteriorating status, pass; special mention; substandard;
doubtful; and loss. Each of these categories has, among other things, a time element before
which a loan is transferred to a lower category. To this end, the NBE issued asset
classification and provisioning directive to provide uniform guidelines for banks operating in
Ethiopia. According to the NBE Directive SBB-43-2018, classification of loans and advances
into the five categories:
Pass
Loans or advances in this category are fully protected by the current financial and paying
capacity of the borrower and are not subject to criticism. In general, any loan or advance, or
portion thereof, which is fully secured, both as to principal and interest, by cash or cash-
substitutes, shall be classified under this category regardless of past due status or other
adverse credit factors.
Special mention
Loans and advances classified under this category have the following characteristics;
1. Loans or advances with pre-established repayment programs past due 30 days or
more but less than 90 days.
2. Overdraft and loans or advances that don’t have pre-established prepayment
program, if
a. The debt remains outstanding for 30 consecutive days or more but less than 90 days
beyond the scheduled payment or maturity date.
b. The debt exceeds the approved limit and interest due or uncollected outstanding for
30 consecutive days or more but less than 90 days. And
c. The overdraft account has been inactive (no debit and credit transaction has been
made) for 30 consecutive days or more but less than 90 days.
Substandard
The following non-performing loans and advances at a minimum shall be classified as
substandard:
more but less than 180 days
10
program, if
a. The debt remains outstanding for 90 consecutive days or more but less than 180
days beyond the scheduled payment or maturity date.
Doubtful
The following non-performing loans and advances at a minimum shall be classified as
doubtful:
more but less than 360 days
program, if
a. The debt remains outstanding for 180 consecutive days or more but less than 360
days beyond the scheduled payment or maturity date.
Loss
The following non-performing loans and advances at a minimum shall be classified as loss:
more.
program, if
a. The debt remains outstanding for 360 consecutive days or more.
360 consecutive days or more. And
made) for 360 consecutive days or more.
11
Therefore, as per the above NBE loans classifications, loans are classified as NPL, when it is
classified as Sub Standard, Doubtful and loss.
2.2 Empirical Literatures Reviews
Empirical literature review is to discuss different previous researches in relation to this study.
According to Njeru (2012), for effective management of NPLs, it is very critical for
commercial banks to understand and focus more on the management of bank specific factors
such as, size of the bank expresses in terms of its total asset, operational efficiency (ROA and
ROE), terms of credit (such as interest rate charged), risk profile (measured by several
proxies such as loans to asset ratio and loans to deposit ratio), which they have more control
over and seek practical and achievable solutions to address NPLs problems. Banks that
charge high interest rate would comparatively face a higher default rate or non-performing
loans. Study by Waweru and Kalini (2009) on the commercial banks in Kenya using
statistical analysis indicates that high interest rate charged by the banks is one of the internal
factors that leads to incidence non-performing loans.
Financial sector development goes hand in hand with orientation of the public. Study
conducted by Rajan and Dhal (2003) indicate that credit orientation significantly affects loan
default rate as per their panel regression analysis conducted on commercial banks on India.
Regular monitoring of loan quality, possibly with an early warning system capable of alerting
regulatory authorities of potential bank stress, is essential to ensure a sound financial system
and prevent systemic crises (Agresti et al.,2008).
In Ethiopian context, there appears to be very limited studies on the factors associated with
NPLs of banks. Wonimagegnehu (2012) assessed the bank specific determinants of NPLs in
Ethiopian commercial banking sector and the findings of the study shows that poor credit
assessment, failed loan monitoring, underdeveloped credit culture, lenient credit terms and
conditions, aggressive lending, compromised integrity, weak institutional capacity, unfair
competition among banks, willful default by borrowers and their knowledge limitation, fund
diversion for unintended purpose, over/under financing by banks ascribe to the causes of loan
default. However, the study outcome failed to support the existence of relationship between
financial performance (ROA and ROE), banks size; loan to deposit ratio; regulatory
requirements; loan growth rate and occurrences of NPLs.
The study of Zelalem (2012), examined the bank-specific and Macro-economic determinants
of NPLs of commercial banks in Ethiopia. The study adopts a mixed methods research
12
approach by combining documentary analysis (structured review of documents) and in-depth
interviews. More specifically, the study reviews the financial records of eight commercial
banks in Ethiopia and relevant data on macroeconomic factors considered for the period from
the year 2000 to 2011. The findings of the study show that, loan growth, financial
performance, operational efficiency, effective exchange rate, inflation rate and gross
domestic product have negative and statistically significant relationship with banks’ NPLs.
On the other hand, variables like bank size and state ownership have a positive and
statistically significant relationship with banks’ NPLs. However, the study fails to see bank
specific variables like capital adequacy ratio.
Gadise (2014), examined the macroeconomic and bank specific determinants of NPLs of
commercial banks in Ethiopia using secondary data and quantitative approach. The study
found out that, bank profitability measured in terms of ROE, banks capital adequacy ratio and
lending rate had negative and statistically significant effects whereas bank profitability
measured in terms of Return on Asset(ROA) had positive and statistically significant effect
on NPLs of commercial banks in Ethiopia. However, the study fails to consider some bank
specific variable like cost efficiency, loan growth and size of the bank and their influence on
NPL.
2.3 Conceptual Frame work
The main objective of this study is to investigate the most important bank specific factors
associated with the occurrence of NPL in Ethiopian Commercial Banks using variables that
have been studied by previous researchers. To this end, the researcher developed the
conceptual framework of the study, to better comprehend the most important bank specific
factors associated with the occurrence NPL identified in the theoretical and empirical
literatures, and to understand their relationship with the problem. The framework is
constructed mainly in reference to the studies done by Boudriga et al. (2009); Louzis et al.
(2011); Makri et al. (2012); Messai & Jouini (2013); Wondimagegnehu (2012); Shingjergji
(2013); Vatansever & Hepsen (2013); Jamel (2014); Alexandri & Santoso (2015); and
Suryanto (2015).
The research investigates the bank specific factors. These factors include loan growth rate;
loan to deposit ratio; capital adequacy ratio; cost efficiency ratio; return on equity; and bank
size. Thus, Figure 2.1 which is the conceptual framework summarizes the main focus and
scope of this study in terms of variables included.
Independent variables Dependent Variable
13
Credit assessment
Credit monitoring Non-
Determinants Collateralized lending performing
Borrower’s orientation & culture loans (NPLs
Bank interest rates
Figure 2.1: Conceptual framework of Determinants and non-performing loans(NPLs)

Source: Researchers own design by referring the previous researchers (2024).
CHAPTER THREE
2. RESEARCH METHODOLOGY
This chapter describes the methodology that was used in conducting the research study. The
purpose of this study is to identify and examine innate factors that determine the occurrence
of NPLs. It is more exploratory type and tries to measure the relationship between occurrence
of NPLs and some bank specific factors.
3.1 Study area
The study was conducted at Dessie city. Like other business activities, banks strive to make
profit and grow. Currently, sub-headquarters of all private commercial banks and state owned
banks are located at the Dessie city. The Department that is responsible for provision of loans
and advances to individuals and projects is contained at the Head Offices of the banks.
Therefore, the study was conducted in consultation with staff involved in credit operations at
head offices level using survey design with structured self-administered questionnaires.
3.2 Research design
A research design according to Zikmund, Babin, Carr & Griffin (2009) is a master plan that
specifies the methods and procedures for collecting and analyzing the needed information. A
research design provides a framework or plan of action for the research. It is useful to
determine which research approach is being implemented when conducting a research.
In order to achieve the objectives of the study, the research undertakes descriptive approach,
using both qualitative and quantitative data. In doing so, the study intends to describe,
compare, contrast and interpret the existing facts and puts the status of NPL in relation to
various variables which will help to understand the issue and lead to causal analysis. Further
the research utilizes a survey as a research method.
14
Secondary data are obtained from publications of private banks and other financial
institutions. Besides, relevant information is also grasped from various books, research
papers, magazines, newsletters, websites and the like. Primary data are collected through
questionnaires distributed to respondents that involve Department Managers and Senior
Officers working on loan processing, such group involves Loan Officers, Credit Analysts,
Credit follow-up and Monitoring officers, Credit Directors, Relationship Managers and
Recovery Officers etc.
As the overall purpose of the study is to investigate the determinants that affect NPLs of
Commercial private and state owned Banks in Ethiopia, at Dessie city, and the study is
interested in examining the statistical relationship between the bank specific factors and the
problem, there are perhaps several other factors that influence NPL apart from the variables
identified in the study. Therefore, explanatory research design is appropriate to examine the
relationship between NPLs and the five potential determinants at independent variables.
3.3 Research Approach
In order to investigate the factors that affect NPLs of ECBs, this study employed mainly
quantitative research strategy. In addition, in order to better understand the nature of the
problem and to increase to scope of inquiry of the bank specific factors that were not
addressed by the quantitative part the study also employed qualitative research strategy as
well. Although, the quantitative method was dominantly used to investigate determinants of
NPLs of ECBs Following to this, the qualitative method was used to support the quantitative
findings and to gain additional insight into the factors that may affect NPLs of ECBs.
3.4 Sampling Techniques and Sample Size of the Study
The study is limited to employees that are directly involved in administration of loans at all
head offices level as a sampling frame. Such professionals include, loan officers, credit
analysts, credit directors, relationship managers and recovery & monitoring officers etc.
In order to simplify the study, convenience sampling has been employed followed by
multistage cluster sampling using preexisting clusters as a sampling frame. Accordingly, the
commercial banks were classified into two clusters as private owned and stated owned banks.
Further, all positions and respective tasks were listed involving credit processing, loan
provisioning, monitoring and follow- ups. Furthermore, professionals were classified based
on positions held in the structure of credit department. In doing so each position was
considered strata to carryout proportional sampling to avoid the likelihood of sampling
15
biases.
To conduct the survey, out of seventeen private commercial banks and three state owned
banks, professionals working in eleven private commercial banks (64.7 percent) and two state
owned banks (66.7 percent) located in Dessie City were contacted.
Seven of the private commercial bank branches were in banking operation for a long time
experience, while the remaining four were in the market for less than five years. However,
the two state-owned banks, commercial Bank of Ethiopia, and Development Bank of Ethiopia
were in operation for more than ten and six years, respectively (Table 3.1).
A total sample of 221 professionals working in commercial banks related to credit and credit
related operations were selected as part of the study. On average thirteen professionals were
selected from each private bank, while fifty-two and eighteen were considered from state-
owned bank branches of CBE and DBE, respectively.
Table 3.1:Targeted Banks and Selected Sample Respondent Numbers
S/ N Banks at Dessie district Questionnaire Completed %
State Owned banks
1 Development Bank of Ethiopia 18 8.26%
2 Commercial Bank of Ethiopia 52 23.85%
3 Construction & Business Bank
Private Commercial Banks
4 Awash International Bank 28 12.84%
5 Dashen Bank S.C 12 5.50%
6 Bank of Abyssinia S.C 15 6.88%
7 Wegagen Bank S.C 12 5.50%
8 United Bank S.C 8 3.67%
9 NIB International Bank S.C 7 3.21%
10 Cooperative Bank of Oromia S.C
11 Lion International Bank S.C
12 Zemen Bank S.C
13 Oromia International Bank S.C
14 Bunna International Bank S.C
15 Berhan International Bank S.C 15 6.88%
16 Abay Bank S.C 22 10.09%
16
17 Addis International Bank S.C
18 Tedey Bank S.C 9 4.13%
19 Hijira Bank 12 5.50%
20 Zemzem Bank 8 3.67%
Sample collected 218 98.6%
Non- response rate 3 1.4%
Total 221 100%
Source: Bankers’ Association (2020), Volume 2; Survey outcome and own
computation
3.5 Data Sources and Method of Data Collection of the Study

For realizing on the achievement of both the general and specific objectives of the research,
the researchers used both primary and secondary data are collected and systematically
presented and analyzed in this paper. Primary data are collected through questionnaires
distributed to respondents and Secondary data are obtained from publications of private banks
and other financial institutions.
Out of sixteen private commercial banks and three state owned banks, ten private commercial
banks and two state-owned banks were selected for the survey. Therefore, those commercial
banks currently operating in Ethiopia are considered as primary sample units to conduct this
research.
Primary data are collected through questionnaires (Appendix A) distributed to respondents
that involve Department Managers and Senior Officers working on loan processing. Such
group involves Loan Officers, Credit Analysts, Credit follow-up and Monitoring officers,
Credit Directors, Relationship Managers and Recovery/Monitoring Officers etc.
Secondary Data are directly gathered from records of each commercial bank under sample
study. The data collected include aggregate loans outstanding balances, NPLs as at the
annual closing date, June 30 of each year.
3.6. Research model
The research model for this study was linear regression model. The variables included for this
study are: credit assessment (CA), credit monitoring (CM), collateralized lending (CL),
borrower’s orientation & culture (BOC) and bank interest rates (IR).
Y = β0 + β1(x1) + β2(x2) + β3(x3) + β4(x4) ++ β5(x5) + u
EP = β0+ β1(CA)+ β2(CM)+ β3(CL)+ β4(BOC)+ β5(IR) + u
Y=dependent variable: Non-Performing Loans (NPLs).
17
β0= is the intercept term- it gives the average value of Y when the stated independent
variables are set equal zero.
β1 = the coefficient of credit assessment (CA); β2 = the coefficient of credit monitoring (CM)
β3 = the coefficient of collateralized lending (CL); β4 = the coefficient of borrower’s
orientation & culture (BOC); β5 = bank interest rates (IR).
u = error term
NPLs = Non-Performing Loans, dependent variable.
3.7. Data Analysis and Presentation
The data collected from survey questionnaire were thoroughly coded and checked for
consistency and entered into SPSS version 20 spreadsheet. Descriptive statistics was
employed to analyze the data and the results were tested with non-parametric tests of
significance. As a part of inferential analysis, Bivariate Pearson’s correlation using one-tailed
test was used. The aforementioned analysis is founded on the fact that the study aimed to
investigate the linear relationship between each independent variable with the dependent
variable and to test the direction of effect between the two variables correlated with prior
specific prediction. In addition, the classical linear multiple regression (CLMR) model was
employed to investigate the significant bank specific factors associated with the problem and
the effect of independent variables on the dependent variable. Finally, the study findings are
presented in form of tables that reflect the statistical results.
3.6. Reliability and Validity Test
To ensure the validity and reliability of the data used in the model, the researcher run two
steps multiple linear regression equations. In the first step all the proposed independent
variables were regressed with respect to the dependent variable. Then, only the significant
variables that were found from the first step regressed once again in order to ensure the
reliability and validity of the data used in the model. In addition, to check for the validity of
the study parameters and to guard the study from spurious results, the researcher performed
diagnostic tests for classical linear multiple regression assumptions such as test for
Normality, Multicollinearity, Heteroscedasticity and Autocorrelation.
To ensure the validity of the data obtained from in-depth interview, the target groups to be
included in the study to represent were those who know better about the issue being
investigated. Besides, the researcher assured that this study was reliable in that the
respondents were selected based on their past experience on credit related matters.
18
3.7 Ethical considerations
The research gave due consideration to obtain consent from each participant of the study and
it was strictly conducted on voluntary basis. The researcher also tried to respect right and
privacy of the participants for the study. Furthermore, Participants were informed that the
information they provide would be kept confidential and would not be disclosed to anyone
else including anyone in the bank.
In addition, the researcher assured that the findings of the research presented without any
deviation from the outcome. Finally, the researcher has given full acknowledgements to all
the reference materials used for the study.
CHAPTER FOUR
1. RESULTS AND DISCUSSION
The purpose of this research was to analyze the determinants of non-performing loans. Data
analysis of the findings generated from the results of survey which were conducted through
the questionnaires. This chapter presented a discussion of the final results and the process
through which the results obtained, the statistical methods of analysis were discussed, which
included a descriptive analysis, a correlation analysis, and a regression analysis through SPSS
version 25.
4.1 Response Rate
A structured questionnaire (Appendix A) was distributed to 221 employees, loan officers,
credit analysts, credit directors, relationship managers, recovery/monitoring officers and vice
presidents in eleven private commercial banks and two state owned bank branches that
selected randomly from all banks that are operational in Ethiopia at Dessie City.
Table 4.1: Response rate
Items Response rate
Sample size 221 100%
Collected 218 98.6%
Remain uncollected 3 1.4%
Source: Own Survey Data Computation (2023)
19
From the above table 4.1, 221 questionnaires were distributed and 218 questionnaires (92%)
collected and 8 questionnaires (8%) were remaining uncollected.
4.2 Description of Respondent’s Profile
The first part of the questionnaire consists of five items about the socio-demographic
information of the respondents. Profile of the respondents like ownership of the banks they
work for, banking experience and specific exposure in bank lending and positions held by
respondents are presented and subsequently interpreted.
discussed as follows.
Figure 4.2: Respondents Current Position in the Bank

As shown in the above figure 4.1, 89 (40.83%) of the respondents were customer relationship
managers while 51 (23.39 percent) were credit analysts and 26 (11.93 percent) were loan
officers. The rest of the respondents belonged to other occupations like; credit directors,
monitoring officers and vice presidents.
20
Figure 4.3: Respondent Employees Perception about Determinants of NPLs
The above figure 4.2 demonstrates respondent employees’ perception about determinants of
NPLs are observable. Accordingly, 145(66.51%) of the total respondents were agreed,
24(11.01%) were neutral and only 49(22.48%) were disagreed from the total respondents.
Thus, the findings indicate that majority of the respondents were agreed that determinants of
NPLs are observable
Table 4.2: Respondents Experience in the Bank Industry
Experience category Frequency Percent Cumulative %
Less than 1 year 49 22.5 22.5
1-5 year 37 17.0 39.4
6-10 years 33 15.1 54.6
11-15 years 45 20.6 75.2
Above 15 years 54 24.8 100.0
Total 218 100.0 100.0
In terms of banking experience, the majority (about 55 percent) of the respondents reported to
have served the banking industry for more than 5 years, of which close to 50 percent were
long serving employees, having over 10 years of work experience in the industry. On the
other hand, about 40 percent of the respondents had as short as one to five years of banking
experience.
21
Table 4.3: Respondents’ work experiences in Banking Credit Process
Experiences in Credit Frequency Percent Valid Percent
Less than 1 year 46 21.1 21.1
1-5 year 40 18.3 39.4
6-10 years 20 9.2 48.6
11-15 years 61 28.0 76.6
Above 15 years 51 23.4 100.0
Total 218 100.0 100.0
As shown in the above table 4.3, in terms of bank borrowing experience, the majority (60.6
%) of the respondents had more than five years of experiences particularly in lending (or
credit management) activities, of which 51.4 percent reported to have acquired more than 10
years of exposure in the area. The fact that such a majority of the respondents had ample
experience in credit activities is believed to have impacted the dependability of the data quite
positively.
Figure 4.4: Respondent employees working bank ownership
In terms respondents profile shown in Figure 4.3, 67.89% of survey respondents are
employed in private banks. The remaining 32.11% are employed in two state owned banks.
Since the process of administration of loans and advances both in private and state owned
banks is under taken in compliance with the Ethiopian Commercial Banks, Banking
22
Supervision Directorate, directives results are comparable and similar results may not be
affected variance in the mix of respondents will not have impact on the findings. As depicted
above, more than two-third (about 68 percent) of the respondents belong to the private banks
while slightly above one-third (32 percent) are employees of the state-owned banks.
4.3 Reliability and Validity Test
Testing goodness of data is testing the reliability and validity of the measures. Since the
statements have been generated from an extensive review of academic and practitioner’s
literatures, it is assumed that the construct validity was hold.
Reliability analysis was conducted to check whether a scale used in this paper consistently
reflects the subset it measures. For this study, the Cronbach’s α is used as a measure of
internal consistency. According to Hair (2006), if α is greater than 0.7, it means that it has
high reliability and if α is smaller than 0.3, then it implies that there is low reliability.
Therefore, the result shows that the results extracted from the questionnaire are highly
reliable. The Cronbach’s coefficient alpha was calculated for each field of the questionnaire.
As shown Below in table 4.4, the values of Cronbach’s Alpha for each field of the
questionnaire and the entire questionnaire. Cronbach's Alpha equals 0.887 for the entire
questionnaire which indicates very good reliability of the entire questionnaire. Reliability
scale of the overall variables is 88.7%. Therefore, based on the test, the data collected using
the designed tool are reliable and acceptable.
Table 4.4: Reliability Analysis
Variable Cronbach’s alpha Number of Item
Credit assessment(CA) 0.863 6
Credit monitoring (CM) 0.854 6
Collateralizing loans(CL) 0.721 8
Borrower’s orientation (BOC) 0.723 10
Interest Rate (IR) 0.696 3
Non-Performing Loans (NPLs) 0.765 7
Overall reliability 0.887 40
4.4. Descriptive Analysis of Determinants that Affect NPLs

Descriptive analysis of the observed items for all the independent variables and dependent
variable was done.
23
4.4.1. General Ranking of factors affecting occurrences of NPLs in the banks.
In Table 4.5, the respondents were also expected to rank factors causing NPLs in the
Ethiopian Commercial Banks in order of importance (from 1st/highest to 8th/lowest). The
survey result indicated that Rapid loan growth by banks (35.3%), poor monitoring and
follow-up of loans (34.9%), as the top ranking factors causing occurrences of NPLs followed
by lenient credit term (34.4%) and credit orientation/ culture (30.3%). The survey results
further reflected that the contribution of such factors as size of bank, rapid loan growth of
banks, high interest rates and ownership type of bank to occurrences of NPLs is quite
minimal, varying from as insignificant percentage of ranking in the order mentioned. This
shows us banks should give serious attention to risk assessment, monitoring, and follow up of
loans and advances in order to protect NPLs.
Table 4.5: Ranking of factors affecting NPLs

No. Factor that causes occurrence of 1st 2nd 3rd 4th 5th 6th 7th 8th
NPLs (%) (%) (%) (%) (%) (%) (%) (%)
1 Rapid loan growth by banks 35.3 3.7 3.7 5.5 21.6 6.9 4.1 19.3
2 High interest rate 10.6 33.9 2.8 13.3 11.9 5.5 12.8 9.2
3 Lenient credit term 34.4 7.8 6.0 5.5 15.1 11. 5.5 14.7
0
4 Credit culture /Orientation 30.3 5.0 10. 10.6 12.8 14. 5.5 10.6
6 7
5 Size of the bank 14.7 10.6 15. 25.7 11.5 14. 2.8 5.5
1 2
6 Poor monitoring/follow-up 34.9 15.6 7.8 10.6 15.1 8.3 4.1 3.7
7 Ownership type of bank 10.1 5.5 5.5 16.1 4.6 2.3 37.6 18.3
8 Poor risk assessment 19.7 4.6 16. 2.8 6.4 4.1 12.8 33.0
5
24
4.4.2. Effect of Credit assessment on Non-Performing Loans
In order to measure the effect of credit assessment on Non-Performing Loans, respondents
were assessed with six (6) variables/items measuring this dimension as an aggregate.
Table 4.6: Credit assessment on Non-Performing Loans
Strongly Disagree Neutral Agree Strongly Mean
Items
disagree Agree (SD)
Easily admitted borrowers Freq 6 50 7 112 43 3.2
usually default . (1.13)
% 2.8 22.9 3.2 51.4 19.7
Know You customer (KYC) Freq 5 9 9 127 68 4.6
Policy of banks lead to high . (0.60)
Loans quality % 2.3 4.1 4.1 58.3 31.2
Good loan underwriting Freq 3 22 32 113 48 3.6
ensures loan performance . (0.52)
% 1.4 10.1 14.7 51.8 22.0
Poor risk assessment would Freq 3 22 32 113 48 4.6
lead to loan default . 0.52)
% 1.4 10.1 14.7 51.8 22.0
Our bank assess the overall Freq 17 58 8 109 26 4.2
ability of borrowers for . (0.53)
repayment % 7.8 26.6 3.7 50.0 11.9
Our bank considers the five Freq 63 92 24 28 11 2.5
5cs during credit risk . (1.45)
assessment % 28.9 42.2 11.0 512.8 5.0
The above table 4.6 demonstrates the respondent employees regarding the effects of credit
assessment on occurrences non-performing loans in the Banks. About 51.8 percent (mean 4.6,
standard deviation 0.52) of respondents agree that poor risk assessment would lead to loan
default while, in conformity to this, 58.3 percent (mean 4.6, standard deviation 0.60) of the
respondents share the opinion that proper implementation of know your customer (KYC)
principle leads to high loan quality.
On the other hand, 51.8 percent (mean 3.6, standard deviation 0.52) of the sample
respondents agree that good loan processing ensures conducive loan performance, in
addition, majority (51.4 percent) of the respondents share the opinion that easily admitted
25
borrowers usually default. Therefore, KYC policy and risk assessment needs due attention in
loan process to protect loan default. Based on the results one can easily observe that all
responsible officers involved in credit administration have to carry out comprehensive and
detailed analysis in order to determine the prospective borrowers’ businesses and related
merits prior to providing credit facilities. This would assist the officers and managers to
establish, essentially, the extent to which the borrower is able to service the debt by the
income generated from businesses.
Further, the importance of employment of know-your-customer (KYC) principle cannot be

overemphasized. Respondents agree that banks that employ a stout KYC policy would
maintain better loan quality. Such information includes the prospective borrower’s business
and financial management, organizational setup, credit history or overall track record, and
complete profile. As indicated in the literature part there is nothing important than knowing
potential customer.
Proper review of documents obtained from applicants, including the information inquiry
report is quite essential so as to ensure the extent to which the information collected is
credible. Obviously, when the loan undertaking is poor, the probability of default is high.
Therefore, the bank should conduct due diligence by making every possible examination
available.
4.4.3. Effect of credit monitoring on Non-Performing Loans
In order to measure the effect of credit monitoring on Non-Performing Loans, respondents
were evaluated with six (6) observed items measuring as dimension in composite.
Table 4.7: Credit monitoring on Non-Performing Loans

Items Strongly Disagree Neutral Agre Strongly Mean
disagree e Agree (SD)
Strict monitoring ensures loan Freq 9 25 11 108 65 4.2
26
performance . (0.88)
% 4.1 11.5 5.0 49.5 29.8
Poorly assessed & advanced Freq 17 68 14 86 33 2.8
loans may perform well if . (1.15)
properly monitored % 7.8 31.2 6.4 39.4 15.1
Loan follow up is directly Freq 17 54 12 109 26 3.3

related to occurrence of NPLs . (1.21)
% 7.8 24.8 5.5 50.0 11.9
Bank with higher budget for Freq 63 85 32 27 11
loan monitoring has lower . 3.2
NPLs % 28.9 39.0 14.7 12.4 5.0 (1.05)
Credit monitoring helps our Freq 32 22 3 113 48
bank to track our customer’s . 4.5
credit report and credit scores. % 14.7 10.1 1.4 51.8 22.0 (0.48)
Our bank primarily use loan Freq 12 10 3 135 58
follow up to guard against . 3.4
identity theft % 5.5 4.6 1.4 61.9 26.6 (1.01)
The importance of regular monitoring of loan quality, Agresti et al. (2008) stated that it
would help insure a sound financial system and there by prevent systemic risk that otherwise
would lead to loan default. From the above table (Table 4.7), one can conclude that strict loan
monitoring ensures commendable loan performance as asserted by nearly 49.5% (mean 4.2,
standard deviation 0.88) of the respondents. 51.8% of the respondents agreed with the
assertion that credit monitoring helps our bank to track our customer’s credit report and credit
scores. If loans are not paid as and when due, credit risk is involved on reducing the value of
the bank’s business. In order to continue lending the banks must be able to collect their
outstanding loans on time. Once funds are disbursed the concerned banks cannot afford to
rest on their laurels and expect all payments to come in on the due dates without problem.
Hence, in order to minimize the occurrence of bad loans every effort of follow-up must be
carried to the utmost degree and take timely action when necessary.
The survey results also indicated that, 61.9 percent (with mean of 3.4 and standard deviation
of 1.01) agreed that occurrence of NPLs is directly related to loan follow-up. Should effective
follow-up of loans and advances be in place good asset quality is maintained. From the above
27
data we can infer in loan process it needs a strict and separate work assignments necessary
and proper monitoring cannot cover assessment of loan activities.
4.4.4. Effect of collateralizing loans on Non-Performing Loans

In order to measure the effect of c collateralizing loans on Non-Performing Loans,
respondents were assessed with eight (8) observed items for the dimension in composite.
Table 4.8: Collateralizing loans on Non-Performing Loans
Strongl Disagree Neutra Agree Strongly Mean
Items y l Agree (SD)
disagree
Collateralized loans perform well Freq 9 73 12 75 49 4.4
. (0.48)
% 4.1 33.5 5.5 34.4 22.5
Collateralizing loans help protect Freq 13 71 13 78 43 3.6
loan default . (0.95)
% 6.0 32.6 6.0 35.8 19.7
Most of the time non Freq 54 78 13 43 30 4.5
collateralized loans are defaulted . (0.48)
% 24.8 35.8 6.0 19.7 13.8
My bank provides loan to Freq 32 22 3 113 48 3.6
customer with strong collateral . (1.01)
% 14.7 10.1 1.4 51.8 22.0
Collateralizing loans helps the Freq 12 10 3 135 58 3.8
bank to secure its loans . (0.42)
% 5.5 4.6 1.4 61.9 26.6
The bank can seize the collateral Freq 17 54 12 109 26 3.2
to recoup its losses . (1.0)
% 7.8 24.8 5.5 50.0 11.9
Loans that are secured by Freq 63 85 32 27 11
collateral typically have lower . 4.5
interest rate than unsecured loans % 28.9 39.0 14.7 12.4 5.0 (0.48)
Secured loans are less risky to Freq 9 73 12 75 49 3.4

the lenders . (1.01)
% 4.1 33.5 5.5 34.4 22.5
In the above table 4.8, collateral refers to assets that the Bank holds to mitigate default risk. It
is a security that a borrower gives to a Bank to guarantee repayment of a loan. It depends on
the Bank’s policy that all loans shall be backed by acceptable collateral. It is a second way-
28
out and it should never be a substitute for credit worthiness, which is the existence of
adequate cash flow to repay the loan. In the banking environment, security is required among
others, to ensure the full commitment of the borrower, to provide protection should the
borrower default from the planned course of action outlined at the time credit is extended,
and to provide insurance should the borrower default.
The survey results indicated that 35.8 percent of the respondents are of the view that
collateralizing loans helps protect loan default, while only 38.5 percent and 25.4 percent
agree with the statement that collateralized loans perform well. So the relation between NPLs
and collateral is neutral in view of the respondents. And also the interview discussion
collateral loans are not give full guarantee for NPLs. That is why there are many political and
law sanctions and unexpected accidents. In addition to complete the issue it takes time and
needs extra labor and finance. With regard to relationship between borrowers‟
orientation/culture and loan performance (Table 4.8), about 61.9 percent of respondents agree
with the assertion that collateralizing loans helps the bank to secure its loans . This indicates strong
relation between culture/orientation and occurrences of NPLs.
4.4.5. Effect of Borrower’s Orientation and Culture on Non-Performing Loans
In order to measure the effect of borrower’s orientation respondents were forwarded with ten
(10) variables /items measuring this dimension in composite.
Items Strongly Disagr Neutral Agre Strongly Mean
disagree ee e Agree (SD)
Borrower’s orientation/culture Freq. 6 61 10 98 43 3.2
is related to loan performance % 2.8 28.0 4.6 45.0 19.7
(1.13)
There is a relationship Freq. 42 99 11 40 26 4.6(0.60)
between loan default & % 19.3 45.4 5.0 18.3 11.9
borrower’s culture.
Default in some area is Freq. 5 34 10 117 52 3.2(1.13)
ascribed to the culture of the % 2.3 15.6 4.6 53.7 23.9
borrowers
Society’s cultural development Freq. 25 74 25 70 24 4.6
leads to good loan % 11.5 33.9 11.5 32.1 11.0
(0.60)
performance
Loan with big interest rent Freq. 17 54 12 109 26 3.2
tend to turn to NPLs % 7.8 24.8 5.5 50.0 11.9
(1.13)
Charging big interest rate Freq. 63 85 32 27 11 4.6(0.60)
leads to loan default % 28.9 39.0 14.7 12.4 5.0
Loan price affects loan Freq. 54 78 13 43 30 3.2(1.13)
performance % 24.8 35.8 6.0 19.7 13.8
Lenient /lax credit term cause Freq. 32 22 3 113 48 4.6(0.60)
loan default % 14.7 10.1 1.4 51.8 22.0
29
Borrows defaults because they Freq. 54 78 13 43 30 3.2
don’t understand credit terms % 24.8 35.8 6.0 19.7 13.8
(1.13)
well
Poorly negotiated credit terns Freq. 32 22 3 113 48 4.6
lead to loan non performance % 14.7 10.1 1.4 51.8 22.0
(0.60)
Table 4.9: Borrower’s orientation on Non-Performing Loans
Item table 4.9 demonstrated, 45.0% of respondents have the opinion that their existed
relationship between borrowers’ orientation/ culture and non-performing loans. It could also
be noted that 53.7 percent of respondents believed loan default in some areas is ascribed to
the culture of the borrowers. From this result the culture of borrowers and society needs due
attention in banking sector in order to borrow and collect loans and advances properly. So
understand borrowers culture is taking as pre requisite study. It indicates existence of strong
relationship between each of these factor and NPLs. Similarly, 51.8 % of respondents
believed that poorly negotiated credit terns lead to loan nonperformance . The same percentage of
the respondents showed their agreement, which implies that Lenient /lax credit term cause loan
default.
4.4.6. Effect of Interest Rate on Non-Performing Loans
In order to measure the effect of borrower’s orientation respondents were forwarded with
three (3) variables /items measuring this dimension in composite. Study by Shingjergji (2013)
indicated that high interest rate charged by banks is associated with loan defaults. The
following table (Table 4.10) indicates that only 41.3 percent of the respondents disagree with
loans with big interest rate tend to turn to NPLs, while 46.3 percent disregard the assertion
that loan with big interest rate tend to turn to NPLs. In other words, charging big interest rate
doesn’t necessarily lead to loan default. In contrary from the interview discussion the
respondents raise high interest rate leads to loan default and low interest rate initiate
borrowers as well as easy to repay. Moreover, 47.2% of the respondents were agreed on loan
price affects loan performance.
Items Strongly Disagree Neutral Agree Strongl Mean
disagree y Agree (SD)
Loans with big interest Freq 45 92 6 56 21 4.6
rate tend to turn to NPLs . (1.23)
% 20.6 41.3 2.8 25.7 9.6
Charging big interest rate Freq 38 101 8 57 14 3.5
leads to loan default .
30
% 17.4 46.3 3.7 26.1 6.4 (0.92)
Loan price affects loan Freq 12 64 13 103 26 3.3

performance . (1.45)
% 5.5 29.4 6.0 47.2 11.9
Table 4.10: Interest Rate on Non-Performing Loans
4.4.7. Descriptive analysis of Dependent Variable, Non-Performing Loans

In order to measure the Non-performing loans (NPLs), respondents were assessed with seven
(7) variables/items measuring this dimension in composite.
Table 4.11: Descriptive Results of Non-performing loans (NPLs)
Items Strongly Disagree Neutral Agree Strongly Mean
disagree Agree (SD)
My bank is successful in Freq 5 50 14 94 55 3.7(1.15)
managing non-performing loans
.
% 2.3 22.9 6.4 43.1 25.2
Nonperforming loans are major Freq 8 41 13 93 63 3.7 (1.17)
problems in my bank .
% 3.7 18.8 6.0 42.7 28.9
Nonperforming loans contribute Freq 38 78 6 70 26 2.8 (1.36)
for the emergence of other
.
problems in my bank
% 17.4 35.8 2.8 32.1 11.9
My bank has set clear strategy for Freq 4 33 3 107 71 3.9(1.05)
dealing with nonperforming loans .
% 1.8 15.1 1.4 49.1 32.6
Everyone in my bank is Freq 3 23 16 114 62 3.9 (0.95)
responsible and committed to
.
deal with NPLs
% 1.4 10.6 7.3 52.3 28.4
My bank is aware of causes and Freq 21 36 3 95 63 3.8 (1.07)
effects of nonperforming loans
.
% 9.6 16.5 1.4 43.6 28.9
Loan default is not related banks Freq 19 42 6 86 65
ownership type (private/state . 3.9(1.15)
owned) % 8.7 19.3 2.8 39.4 29.8
31
From Table 4.9 above, Item No. 1 indicates 94 (43.1%) of the respondents are agreed on the
item that my bank is successful in managing non-performing loans. 107(49.1%) of the
respondents are agreed on my bank has set clear strategy for dealing with nonperforming
loans. The majority, 114(52.3%), of respondents are agreed that Everyone in my bank is
responsible and committed to deal with NPLs. These show respondents’ agreements on the
points that set objectives agreed to their best performance in ECBs.
4.4.5 Descriptive Summary of determinants and Non-performing loans (NPLs)

When some concepts are measured by several items (questions), the items can be summarized
to calculate the mean values. This is called calculating total scale scores. To conduct the
analysis and to test the hypothesis, total scale scores is calculated for each variables of the
study as depicted in the below table 4.12.
Table 4.12: Descriptive Statistics on Determinants and Non-performing loans (NPLs)

Variables N Minimum Maximum Mean Std. Deviation
Credit assessment 218 2.17 5.00 3.6175 .58608
Credit monitoring 218 2.00 5.00 3.5598 .60425
Collateralizing loans 218 2.00 5.00 3.3307 .67285
Borrower’s orientation 218 2.00 5.00 3.3862 .72254
Interest Rate 218 2.00 5.00 3.3428 .67466
Non-performing loans (NPLs) 218 2.17 5.00 3.6712 .65558
The above table 4.12 showed the mean and standard deviation of selected determinants and
Non-Performing Loans given by respondents of the study. As it can be seen from Table 4.12,
the mean of NPLs was 3.67 with a minimum of 2.17 and a maximum of 5.0. This indicates
that, from the total loans that ECBs disbursed, an average of 3.67 were being default or
uncollected over the sample period.
Regarding the descriptive statistics results of independent variables of the model there are
some interesting statistics that have to be mentioned. For instance, credit assessment and
credit risk assessment showed the highest mean, which means, it was the least deviated
variable from its mean compared to other variables in the model.
32
4.5 Results on Pearson Correlation Analysis
In determining the strength of the relationship between two variables, the Pearson correlation
coefficient (−1 ≤r ≤ 1 ¿ can be used. The value of the coefficient of correlation between 0 and
1 are interpreted as follows; r = 0.10 to .29 or r = - 0.10 to -29 week, r = 0.30 to .49 or r = -
0.30 to -.49 moderate and r = 0.50 to 1 or r = -0.50 to - 1 strong. The correlation analysis of
the table 4.13 below shows that there is strong positive relationship or correlation between
potential determinants and Non-performing loans (NPLs). Credit assessment (CA) and Non-
performing loans (NPLs) (r = 0.723, sig. < 0.05) has strong positive correlation, credit
monitoring (CM) and Non-performing loans (NPLs) (r =0.725, sig.< 0.05), collateralizing
loans (CL) and Non-performing loans (NPLs) (r = 0.657, sig. < 0.05), borrower’s orientation
(BOC) and Non-performing loans (NPLs) (r = 0.640, sig.<0.05) and Interest Rate (IR) and
Non-performing loans (NPLs) (r = 0.643, sig.<0.05) has also strong positive correlation.
Table 4.13: Results Pearson Correlations

Variables/ Measures CA CM CL BOC IR NPLs
Credit assessment Correlation 1
(CA)
Credit monitoring Correlation 0.637* 1
(CM)
Sig. (2-tailed) 0.000
Collateralizing Correlation 0.589* 0.617* 1
loans(CL)
Sig. (2-tailed) 0.000 0.000
Borrower’s Correlation 0.542* 0.512* 0.531* 1
orientation (BOC)
Sig. (2-tailed) 0.000 0.000 0.000
Interest Rate (IR) Correlation 0.569* 0.508* 0.477* 0.524* 1
Sig. (2-tailed) 0.000 0.000 0.000 0.000
Non-performing Correlation 0.723* 0.725* 0.657* 0.640* 0.643* 1
loans (NPLs)
Sig. (2-tailed) 0.000 0.000 0.000 0.000 0.000
N 218 218 218 218 218 218
*. Correlation is significant at the 0.01 level (2-tailed).
33
4.6 Results on Multiple Linear Regression Analysis
Regression is a technique that can be used to investigate the effect of one or more predictor
variables on an outcome variable. That is, it allows us to make statements about how well one
or more independent variables predict the value of a dependent variable. The variables
considered as determinant factors were entered into regression analysis to determine their
relative importance in contributing to the overall Non-Performing Loans. Regression
Analysis is used to ascertain the extent of credit assessment (CA), credit monitoring (CM),
collateralizing loans (CL), borrower’s orientation (BOC) and interest rate (IR) explains the
dependent variable (Non-Performing Loans: NPLs).
4.6.2 Multicollinearity Test Results
Multicollinearity exists when there is too highly correlation between two or more predictors
in a regression model. Multicollinearity poses a problem only for multiple regressions
because it involves more than two predictors. Perfect Collinearity exists when at least one
predictor is a Perfect linear combination of the others.
The best method of checking Multicollinearity is to produce collinearity diagnostics with the
use of SPSS, and one of which is the variance inflating factor (VIF). The VIF indicates
whether a predictor has strong linear relationship with the other predictor(s). Although there
are no hard and fast rules about what value of the VIF should be a cause for concern,
(Gujarati, 2004) suggests that value of less than 10 is good value and he suggest that if the
average VIF is greater than 1 then there is no Multicollinearity in the regression model.
Table 4.14: Checking Multicollinearity in the Regression Model
Collinearity diagnostics
Determinant variables
Tolerance VIF
Credit assessment(CA) 0.465 2.150
Credit monitoring (CM) 0.485 2.063
Collateralizing loans(CL) 0.520 1.925
Borrower’s orientation (BOC) 0.584 1.711
Interest Rate (IR) 0.590 1.694
In this study as indicated in Table 4.14, the Variance inflation factors (VIFs) for the
independent variables included in the regression equation is greater than 1 and less than 10.
For tolerance statistics, values above 0.1 and below 1 are worthy of concern. Considering the
regression model for this study the tolerance statistics values are greater than 0.1 and below
34
1, VIF are all less than 10 for all predictors as indicated in tables 4.14 as such no
Multicollinearity is observed in this model.
4.6.3. Normality Test Result
Distribution of the data is another issue in this research, whether it is normal or not. Graphical
methods, such as histograms and normality plots, can be conducted to provide a visual
inspection of the normal distribution of a data set prior to further interpretation of the
regression analysis. A useful graph that we can inspect to see if a distribution is normal called
a P–P plot (probability–probability-plot). The normal probability plots were used to test the
normality of data. It is comparatively simple graphical device to study the shape of the
probability density function (PDF) of a random variable is the normal probability plot (NPP).
It uses values of the variable of interest on the horizontal axis and the expected value of this
variable on the vertical axis. If the fitted line in the NPP is approximately a straight line, one
can conclude that the variable of interest is normally distributed.
Hence, Figure 4.4 Histograms can provide important information about the shape of a
distribution. If most of the scores are gathered around the middle of the continuum and a
gradual, symmetric decrease of frequency on either side of the center score occurs, it is
considered a normal distribution.
Figure 4.5: Histogram of standardized residuals for normality test

Nevertheless, no distribution can be considered “perfect”, as most of the scores are gathered
around the middle of the continuum and histogram is a bell-shaped, it is considered a normal
distribution.
35
4.6.4. Homoscedasticity Test
The assumption of Homoscedasticity indicates that the variance of errors is equal and
constant across all levels of the variables. Homoscedasticity is related to the assumption of
normality because when the assumption of normality is met, the relationship between the
variables is homoscedastic. This assumption requires evenly distribution of residual terms or
homogeneity of error terms throughout the data. According to Gujarati (2004) this
assumption can be assured by visual checking of a plot of the standardized residuals by the
regression standardized predicted rate. If the error terms are distributed randomly with no
certain pattern, then the problem is not detrimental for analyses.
Figure 4.6: Scatter plots of standardized residuals for homoscedasticity test

Figure 4.5 above shows that the standardized residuals in this research are distributed evenly
indicating heteroscedasticity is not a serious problem for this data.
4.6.5. Independence of Errors (Autocorrelation) Test Result
This Linear regression assumption refers to that errors in regression are independent; this
assumption is likely to be met if the Durbin–Watson statistic is close to 2 and between 0 and
4. The Durbin–Watson statistic test for this study found to be 0<1.833<4 (see table 4.15
below) which indicate the assumption of independence of errors is met. Thus, the value of
Durbin Watson is close to 2 indicates no violation of independence errors.
4.6.6. Linearity test
Linearity refers to the degree to which the change in the dependent variable is related to
the change in the independent variables.
36
Figure 4.7: p-p plot of residuals to test linearity
From the above figure 4.6 the scatter plot of residuals shows no large difference in the spread
of the residuals as you look from left to right on figure 4.6; This result suggests the
relationship we are trying to predict is linear. Therefore, there is no violation of linearity
assumption.
4.6.7. Regression Model Fitting Summary and Coefficients
Table 4.15: Multiple Regression Analysis Model Summary Result
Model Summaryb
Model R R Square Adjusted R Square Std. Error Durbin-Watson
1 0.850a 0.722 0.716 0.34959 1.833
a. Predictors: (Constant), IR, CL, BOC, CM, CA
b. Dependent Variable: Non-Performing Loans
From the above table 4.15 above, it has been seen that R value is 0.850. Therefore, R value
(85.0%) for the overall selected determinants namely credit assessment (CA), credit
monitoring (CM), collateralizing loans (CL), borrower’s orientation (BOC) and interest rate
(IR) suggested that there is a strong effect of independent variables on the Non-Performing
Loans. From the Table 4.15 above, it can also have observed that the coefficient of
determination i.e. the R-square (R2) value is 0.722, which representing that 72.2% of the
variation in Non-Performing Loans is due to the independent variables, which in fact, is a
strong explanatory power of regression and the other unexplored variables may explain the
variation in Non-Performing Loans which accounts 27.8 % of it. The researcher concludes
that 72.2% of the portion of the Non-Performing Loans is explained by five determinant
37
factors: credit assessment (CA), credit monitoring (CM), collateralizing loans (CL),
borrower’s orientation (BOC) and interest rate (IR) that are included in this thesis.
Table 4.16: ANOVA Table of Regression Analysis Result
ANOVAa
Modelb Sum of Squares Df Mean Square F Sig.
1 Regression 67.354 5 13.471 110.223 .000b
Residual 25.910 212 0.122
Total 93.264 217
a. Dependent Variable: Non-Performing Loans (NPLs)
b. Predictors: (Constant), IR, CL, BOC, CM, CA
F-test is used to test the impact of overall explanatory power of the whole model, or the joint
effect of all explanatory variables as a group. (i.e. testing the overall performance of the
regression coefficients). It measures the statistical significance of the entire regression
equation rather than each individual coefficient as the beta value is designed to do. The
greater the value of F-statistics indicates that the variables included in the model have
together a significant effect on the dependent variable, and the model has a high explanatory
power. From the ANOVA Table 4.16, it is identified that the value of F-statistics is 110.223
and is significant as the level of significance is less than 5% (p=0.00<0.05). This indicates
that the overall model was reasonable fit and there was a statistically significant association
between independent variables (credit assessment (CA), credit monitoring (CM),
collateralizing loans (CL), borrower’s orientation (BOC) and interest rate (IR)) with the
dependent variable.
Table 4.17: Regression Coefficient Analysis of the fitted model

Unstandardized Standardized T Sig.
Model Coefficients Coefficients
B Std. E. Beta
(Constant) -0.091 0.64 -.555 0.580
Credit assessment(CA) 0.275 0.059 0.246 4.627 0.000*
Credit monitoring (CM) 0.312 0.056 0.287 5.526 0.003*
Collateralizing loans(CL) 0.143 0.049 0.147 2.918 0.004*
Borrower’s orientation (BOC) 0.165 0.043 0.181 3.830 0.000*
38
Interest Rate (IR) 0.187 0.046 0.193 4.090 0.000*
a. Dependent Variable: NPLs; * shows that the variables are statistically significant at 5%.
As illustrated in table 4.15 above, the value of adjusted R square is 0.716 which indicated
71.6% of changes in Non-Performing Loans can be accounted for by the five determinants
but the remaining change in Non-Performing Loans may be accounted for variables other
than the variables included in this study.
The above table 4.17 also depicts the extent to which each determinant influences the Non-
Performing Loans. The relative importance of determinants (independent variables) in
contributing to the variance of the Non-Performing Loans (dependent variable) was explained
by the unstandardized Beta coefficient. The beta values of the independent variables i.e.
credit assessment (CA), credit monitoring (CM), collateralizing loans (CL), borrower’s
orientation (BOC) and interest rate (IR) are 0.275, 0.312, 0.143, 0.165 and 0.187,
respectively.
The result obtained from the regression analysis showed that credit monitoring (CM)
followed by credit assessment (CA) is the most significant and statistically meaningful when
compared with the other variables in terms of affecting Non-Performing Loans. This can be
understood as a certain improvement on the credit monitoring (CM) practice to increase Non-
Performing Loans by 0.312 which is significant. Thus, all considered independent variables
were statistically significant positive effect on Non-Performing Loans.
4.7. Hypotheses Testing

Hypothesis testing is based on unstandardized coefficients beta and P-value to test whether
the hypotheses are rejected or not. At this point using this multiple regression coefficient
results (Table 4.17), the proposed 4 hypotheses for this study were tested as follows.
H 1 : Credit assessment has positive relationship and significant effect on Non-Performing

Loans
The result of multiple regression analysis in Table 4.17above clearly indicates that credit risk
assessment has significant effect on Non-Performing Loans, since (sig.<0.05). Besides the
value of beta (β=0.275) shows the positive effect of credit risk assessment on Non-
Performing Loans. The above result is supported by Shahzadi et al. (2014), which credit risk
39
assessment has a positive and significant effect on Non-Performing Loans. Therefore, H 1 is
accepted.
H 2 : Credit monitoring has positive relationship and significant effect on Non-Performing
Loans
The result of multiple regression analysis in Table 4.17 above clearly indicates that Credit
monitoring has significant effect on Non-Performing Loans, since (sig.<0.05). Besides the
value of beta (β=0.312) shows the positive effect of credit monitoring on Non-Performing
Loans. The above result is supported by Lunenberg (2011), which credit monitoring has a
positive and significant effect on effect on Non-Performing Loans at banks. Therefore, H 2 is
accepted.
H 3 : Collateralized lending has positive relationship and significant effect on Non-Performing
Loans.
The result of multiple regression analysis in Table 4.17 above clearly indicates that
collateralized lending has significant effect on Non-Performing Loans, since (sig.<0.05).
Besides the value of beta (β= 0.143) shows the positive effect of collateralized lending on
Non-Performing Loans. The above result is supported by Sara et al. (2004), which
collateralized lending have a positive and significant effect on Non-Performing Loans.
Therefore, H3 is accepted.
H 4 : Borrower’s orientation & culture has positive relationship and significant effect on Non-
performing loans (NPLs) at Ethiopian Banks
The result of multiple regression analysis in Table 4.17 above clearly indicates that
Borrower’s orientation & culture has significant effect on Non-Performing Loans, since
(sig.<0.05). Besides the value of beta (β=0.165) shows the positive effect of Borrower’s
orientation & culture on Non-Performing Loans. The above result is supported by Armstrong
(2007), which Borrower’s orientation & culture has a positive and significant effect on Non-
Performing Loans. Therefore, H4 is accepted.
H 5 : Bank interest rates entail loans have positive relationship and significant effect on NPLs
The result of multiple regression analysis in Table 4.17 above clearly indicates that interest
rates has significant effect on Non-Performing Loans, since (sig.<0.05). Besides the value of
beta (β=0.187) shows the positive effect of interest rates (IR) on Non-Performing Loans. The
above result is supported by Armstrong (2007), which interest rates has a positive and
significant effect on Non-Performing Loans. Therefore, H4 is accepted.
40
4.8 Discussion on Interview Analysis
In order to triangulate data from different sources and tools the researcher employed
unstructured interview with credit administrators and officers. As the respondents’
determinate factors for NPLs in banks were poor credit assessment, poor credit monitoring
and follow up, high interest rate, rapid credit growth, poorly negotiated credit terms, lack of
knowledge of borrower, inflation, money devaluation, profit margin, legal gaps and exist in
procedural laws, and lack of laws protect financial securities such as Financial Guarantee
Bonds and negotiable instruments affect and contribute for NPLs or bad loan. From this we
can conclude that most of the points are directly matched with analysis on documents and
questionnaire. And also it shows the similarity of problem of NPLs in almost head
quarters of selected commercial banks in Ethiopia.
The result of hypothesis testing and decisions can be summarized in table 4.18 below.
Table 4.18: Summary of hypothesis testing
Hypothesis Result P-value
H a 1 : Credit assessment has positive relationship and significant Accepted 0.000*
effect on NPLs
H a 2 : Credit monitoring has positive relationship and significant Accepted 0.003*
effect on NPLs
H a 3 : Collateralized lending has positive relationship and significant Accepted 0.004*
effect on NPLs
H a 4 :Borrower’s orientation & culture has positive relationship and Accepted 0.000*
significant effect on NPLs
H a 5 : Bank interest rates entail loans have positive relationship and Accepted 0.000*
significant effect on NPLs
Source: Own Survey Data Computation (2023); * is significant
41
CHAPTER FIVE
5. SUMMARY OF FINDINGS, CONCLUSIONS AND
RECOMMENDATIONS
This chapter deals with summary of major findings of the study, conclusions and
recommendations and possible solutions for the problems identified.
5.1 Summary of Major findings
By investigating the relationships between selected determinant factors and their effect on
Non-Performing Loans and also by quantitatively testing the effect of variables such as
motivational tools, motivational goal settings, reward & recognition systems and financial/
monetary incentives on performance of the employee, the following findings were obtained.
1. The respondents’ demographic information in this study indicates that 89 (40.83%) of the
respondents were customer relationship managers while 51 (23.39 percent) were credit
analysts and 26 (11.93 percent) were loan officers. The study also indicates the 145(66.51%)
of the total respondents were agreed, 24(11.01%) were neutral and only 49(22.48%) were
disagreed on the idea that determinants of NPLs are observable.
The other result observed from the study shows the majority (60.6 %) of the respondents had
more than five years of experiences particularly in lending (or credit management) activities,
of which 51.4 percent reported to have acquired more than 10 years of exposure in the area.
Moreover, the majority (about 55 percent) of the respondents reported to have served the
banking industry for more than 5 years, of which close to 50 percent were long serving
employees, having over 10 years of work experience in the Bank industry.
2. The respondents were also asked to indicate their opinion about the different determinant
factors affecting NPLs. Accordingly, the majority of the respondents were in favor of credit
assessment (CA), credit monitoring (CM), collateralizing loans (CL), borrower’s orientation
(BOC) and interest rate (IR) practices implemented in the Banks. The overall questionnaire
items score a reliability of 0.887.
3. Descriptive statistics was used to indicate that the means for credit assessment (3.61),
Credit monitoring (3.56), collateralizing loans (3.33), Borrower’s orientation /culture (3.39)
and Interest Rate (3.34). The result also showed that the mean Non-performing loans (NPLs)
form the measured/observed items was 3.67. The lowest mean was observed on
collateralizing loans while credit assessment and monitoring had almost identical averages
from all determinant factors.
42
4. Correlation coefficient was computed for the purpose of determining the relationship
between the independent variables (determinant factors) and the dependent variable i.e. Non-
Performing Loans. There was a positive and statistically significant relationship between the
variables mentioned as independent variables such as credit assessment (r = 0.723, sig. = 0.00
<0.05), credit/loan monitoring (r = 0.725, sig. = 0.00<0.05), collateralizing loans (r = 0.657,
sig. =0.00<0.05), borrower’s orientation/ culture (r = 0.640, sig. = 0.00<0.05) and interest
rate (r = 0.643, sig. = 0.00<0.05) with Non-Performing Loans. Therefore, all variables show
positive and significant relationship with Non-Performing Loans in ECBs.
5. The regression analysis was done to ascertain the extent to which the five determinant
variables mentioned as independent explain the variance in Non-Performing Loans. The
value of Adjusted R2= 0.716 which indicates 71.6% of variance in Non-Performing Loans is
explained by the variables credit assessment (CA), credit monitoring (CM), collateralizing
loans (CL), borrower’s orientation (BOC) and interest rate (IR). The result supports the
hypothesis that the five expected determinant factors have a significant effect on Non-
Performing Loans.
5.2 Conclusion
The main objective of this research was to investigate factors that affect NPLs in Commercial
Banks in Ethiopia. To achieve this objective, the study used mixed research approach. More
specifically, quantitative research approach using secondary data. In addition, to have a better
insight and to gain a richer understanding about the research problem, the qualitative method
also employed. To this end, the collected data from the respondents were analyzed using
descriptive statistics, correlation matrix and multiple linear regression analysis. The analyses
were made in line with the stated hypotheses formulated in the study. As a result, the
empirical findings of the study suggested the following conclusions:
The finding from the study showed that a strong positive correlation and significant effect
with between the variables: credit assessment (CA), credit monitoring (CM), collateralizing
loans (CL), borrower’s orientation (BOC) and interest rate (IR) with Non-Performing Loans.
While observing the extent to which each independent variable influences the dependent
variable i.e. Non-Performing Loans, the result obtained demonstrates that credit risk
monitoring practice is most significant in terms of improving NPLs of bank customers. And
this helps to conclude that the Banks have to create a favorable credit monitoring (CM) since
the beta value of the motivational tool is 0.312, since, the larger value of Beta coefficient that
43
an independent variable has, brings the more support to the independent variable as the more
important determinant in predicting the dependent variable.
Variables such as poor credit risk assessment, focusing on collateral and cash flow based
lending, poor loan monitoring and follow-up, poor banker’s skill in dealing with lending
matters, undiversified loan products, short loan life and lack of credit advisory practices,
providing unreliable information and previous financial performance by the borrower, using
the loan for unintended purposes that are undesirable from the banks' point of view, lack of
borrowers credit worthiness, willful default by the borrowers and borrowers poor credit
knowledge and orientation were found to be the most important bank specific factors that
affect NPLs in ECBs.
5.3 Recommendations
From the findings of this study it was observed that there is a direct and positive relationship
between the determinant factors and Non-Performing Loans. Based on the findings of the
study, the following possible recommendations were forwarded as follows:
 The bank needs to spend more on proper loan monitoring and follow-up, to lower the
level of NPLs and developing sound loan recovery strategies. In addition, it is
recommended for the bank to communicate with the borrowers and make signal on a
timely basis regarding their loan repayment status.
 The bank need to focus on credit information sharing of other banks and exploit the
application of know your customer (KYC) principle, which plays an important role in
reducing the probability of risk associated with poor credit assessment and the
occurrence of NPLs.
 In addition to cash flow and collateral base lending, the bank need to consider other way
outs such as the business viability studies, adequate credit assessment, the trust and
credit worthiness of the borrower, the feasibility of the project and the management and
business experience of the borrower as a lending approach in such a way that minimizes
the probability of default.
 The bank need to provide good and up to date training to the lending officers which
increases the skill and capability of them in dealing with lending matters so that they are
able to make wise loan decision which in turn reduces the level of NPLs. Since,
competent personnel in the loan processing results in quality loan approval, which will
minimize the amount of NPLs.
44
 The bank should put in place diversified loan products to address the need of the
borrowers so that they are able to get the required finance for their intended business on
which they have a better knowledge and experience with a reasonable maturity period
which do not create additional burden on them.
 The bank should provide business advice and financial counseling to the borrowers on
the wise use of loan.
4.6 Limitations and future research directions
The present study has considered limited banking indicators as determinants of NPLs and
was limited to a specific sample. Therefore, future studies should consider more data sets and
variables as determinants of the NPLs to perform more in-depth analysis. Economic factors
can also be used in future studies along with banking variables as elements of NPLs.
Moreover, cross-cultural influences on NPLs can also be checked. The research can be done
in other developing countries to examine the effect of banking factors on NPLs.
45
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49
APPENDIX A: QUESTIONNAIRE USED FOR THE STUDY
WOLLO UNIVERSITY
College of business and economics
Department of management
Masters of business administration program
Dear respondents,
I am a graduate student in the department of management of MBA program at Wollo
University. I am conducting a research on the Determinants of Non-Performing Loans in
the case of Selected Ethiopian banks. To this end, it intends to gather information from
pertinent bank employees involved in credit and related activities (i.e.; credit managers,
analysts, recovery/monitoring officers, risk management officers, credit committee
members ... etc). The participation is fully on voluntary basis, and your accurate and frank
responses are imperative for the successful accomplishment of the study. Please be assured
that your responses will be treated in a strictly confidential manner, and the results will be
used only for the purpose of this research, presented only at aggregate level without focusing
on individual bank. So that, I sincerely request you to give me your precious time and fill up
this questionnaire with regards. Thank you for your cooperation please put ‘X’ mark on the
provided boxes and your answers on the spaces.
Part A: Background information of the respondent employees.
1. Your current position in the Banking industry.
a. Loan Officer d. Relationship manager
b. Credit analyst e. Recovery/monitoring officer
c. Credit Director f. Vice president
2. Indicate your experience in the Banking industry
a. Less than 1 year d. 11-15 years
b. 1-5 years e. Above 15 years
c. 6-10 years
3. Indicate your experience in the Banking credit process
50
a. Less than 1 year d. 11-15 years
b. 1-5 years e. Above 15 years
c. 6-10 years
4. Please, indicate ownership of the Bank you work for. Private State owned
5. Determinants of nonperforming loans are obvious
Agree Neutral Disagree
Part B: Measurements of Determinants of Non-performing loans
6. Please rank the factors that cause occurrences of NPLs in the Ethiopian Banks by
Ranking the factors in order of their importance in contributing to the occurrence of
NPLs from 1 – 8.
No. Factor that causes occurrence of NPLs Rank
1=highest ….8=lowest
1 Rapid loan growth by banks
2 High interest rate
3 Lenient credit term
4 Credit culture /Orientation
5 Size of the bank
6 Poor monitoring/follow-up
7 Ownership type of bank
8 Poor risk assessment
7. Please indicate your degree of agreement or disagreement to the statement pertaining
to the following determinants and the occurrence of NPLs. Using the key below,
please indicate the extent to which you agree with each statement. (1= Strongly
Disagree, 2=Disagree, 3=Neutral, 4=Agree, 5= Strongly Agree)
Items and potential determinant factors
No. 1. Credit assessment 1 2 3 4 5
1 Easily admitted borrowers usually default
2 Know You customer Policy of banks lead to high Loans quality
3 Good loan underwriting ensures loan performance
4 Poor risk assessment would lead to loan default
5 Our bank assess the overall ability of borrowers for repayment
6 Our bank considers the five 5cs during credit risk assessment
No 2. Credit monitoring 1 2 3 4 5
1 Strict monitoring ensures loan performance
2 Poorly assessed & advanced loans may perform well if properly
monitored
51
3 Loan follow up is directly related to occurrence of NPLs
4 Bank with higher budget for loan monitoring has lower NPLs
5 Credit monitoring helps our bank to track our customer’s credit
report and credit scores.
6 Our bank primarily use loan follow up to guard against identity
No 3. Collateralizing loans 1 2 3 4 5
1 Collateralized loans perform well
2 Collateralizing loans help protect loan default
3 Most of the time non collateralized loans are defaulted
4 My bank provides loan to customer with strong collateral
5 Collateralizing loans helps the bank to secure its loans
6 The bank can seize the collateral to recoup its losses
7 Loans that are secured by collateral typically have lower
interest rate than unsecured loans
8 Secured loans are less risky to the lenders
No 4. Borrower’s orientation 1 2 3 4 5
1 Borrower’s orientation/culture is related to loan performance
2 There is a relationship between loan default and borrower’s
culture.
3 Default in some area is ascribed to the culture of the borrowers
4 Society’s cultural development leads to good loan performance.
5 Loan with big interest rent tend to turn to NPLs
6 Charging big interest rate leads to loan default
7 Loan price affects loan performance
8 Lenient /lax credit term cause loan default
9 Borrows defaults because they don’t understand credit terms
well
10 Poorly negotiated credit terns lead to loan non performance
No 5. Interest Rate 1 2 3 4 5
1 Loans with big interest rate tend to turn to NPLs
2 Charging big interest rate leads to loan default
3 Loan price affects loan performance
52
Part C: The questions in this sections deal about the non-performing loans(NPLs)
8. Please indicate your degree of agreement or disagreement to the statement concerning
the occurrence of NPLs. (Using the key below, please indicate the extent to which you
agree with each statement. (1= Strongly Disagree, 2=Disagree, 3=Neutral, 4=Agree,
5= Strongly Agree)
No Dimensions of non-performing loans(NPLs) 1 2 3 4 5
1 My bank is successful in managing non-performing
loans
2 Nonperforming loans are major problems in my bank
3 Nonperforming loans contribute for the emergence of
other problems in my bank
4 My bank has set clear strategy for dealing with
nonperforming loans
5 Everyone in my bank is responsible and committed to
deal with NPLs
6 My bank is aware of causes and effects of
nonperforming loans
7 Loan default is not related banks ownership
type(private/state owned)
9. What other bank specific factors do you think are causing the occurrences of NPLs in
Ethiopian banks?
______________________________________________________________________
______________________________________________________________________
______________________________________________________________________
10. If you have further comments on the bank specific factors affecting NPLs of the
Ethiopian Banks, please use the space provided below:
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
53
11. What is your recommendation in mitigating NPLs problems of commercial banks in
Ethiopia?
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
With regards, thank you for your cooperation!
54

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WOLLO UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DETERMINANTS OF NON-PERFORMING LOANS: THE CASE OF

BY: HANAN SEID

ADVISOR: GIRMA TADESSE (PhD)

DETERMINANTS OF NON-PERFORMING LOANS: THE CASE OF

A THESIS SUBMITTED TO WOLLO UNIVERSITY COLLEGE OF

BY: HANAN SEID

ADVISOR: GIRMA TADESSE (PhD)

Name: Hanan Seid Signature: ………………...

Place: Wollo University, Dessie

Program: MBA Program

Date of Submission: January, 2024

Name of chairman Signature Date

__________ ________________ ____________

Name of Major Advisor Signature Date

Girma Taddese (PhD) ________________ ____________

Name of Internal Examiner Signature Date

____________________ ________________ ___________

Name of External Examiner Signature Date

____________________ ________________ ______________

_________________ ________________ _______________

Postgraduate Directorate Date Signature

Ethiopian Commercial Banks”, submitted to Wollo University, Department of Management

Name of Major Advisor Signature Date

Girma Taddese (PhD) ________________ ____________

Table 4.1: Response rate..........................................................................................................19

1.3 Research Questions

1.4 Objective of the Research

1.7 Scope of the study

Figure 2.1: Conceptual framework of Determinants and non-performing loans(NPLs)

3.5 Data Sources and Method of Data Collection of the Study

Figure 4.2: Respondents Current Position in the Bank

Figure 4.4: Respondent employees working bank ownership

4.4. Descriptive Analysis of Determinants that Affect NPLs

Table 4.5: Ranking of factors affecting NPLs

Further, the importance of employment of know-your-customer (KYC) principle cannot be

Table 4.7: Credit monitoring on Non-Performing Loans

Strict monitoring ensures loan Freq 9 25 11 108 65 4.2

Loan follow up is directly Freq 17 54 12 109 26 3.3

Source: Own Survey Data Computation (2023)

4.4.4. Effect of collateralizing loans on Non-Performing Loans

Secured loans are less risky to Freq 9 73 12 75 49 3.4

Loan price affects loan Freq 12 64 13 103 26 3.3

4.4.7. Descriptive analysis of Dependent Variable, Non-Performing Loans

Source: Own Survey Data Computation (2023)

4.4.5 Descriptive Summary of determinants and Non-performing loans (NPLs)

Table 4.12: Descriptive Statistics on Determinants and Non-performing loans (NPLs)

Table 4.13: Results Pearson Correlations

Figure 4.5: Histogram of standardized residuals for normality test

Figure 4.6: Scatter plots of standardized residuals for homoscedasticity test

Table 4.17: Regression Coefficient Analysis of the fitted model

4.7. Hypotheses Testing

H 1 : Credit assessment has positive relationship and significant effect on Non-Performing

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