ASSESSMENT ON CREDIT COLLECTION MANAGEMENT PRACTICES AND ITS

CHALLENGES, IN THE CASE OF VISION FUND MICRO FINANCE INSTITUTION HAWASSA

CITY, SIDAMA REGIONAL STATE, ETHIOPIA

BY: - BERHAN DEBERO

RIFT VALLEY UNIVERSITY

HAWASSA CAMPUS
MASTERS OF BUSINESS MANAGEMENT
MBA PROGRAM

JUNE, 2023 G.C.

HAWASSA, ETHIOPIA
 ASSESSMENT ON CREDIT COLLECTION MANAGEMENT PRACTICES AND ITS
CHALLENGES, IN THE CASE OF VISION FUND MICRO FINANCE INSTITUTION HAWASSA
CITY, SIDAMA REGIONAL STATE, ETHIOPIA

A THESIS SUBMITTED TO DEPARTMENT OF BUSINESS MANAGEMENT

IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE AWARD OF MASTER’S DEGREE IN
BUSINESS ADMINISTRATION (MBA)

BY:
BERHAN DEBERO
ADVISOR: TELILA BORENA (MBA)

RIFT VALLEY UNIVERSITY

HAWASSA CAMPUS
MASTERS OF BUSINESS MANAGEMENT
MBA PROGRAM

JUNE, 2023 G.C.

HAWASSA, ETHIOPIA
Acknowledgements

I am highly appreciated to my respect advisor Telila Borena for his constructive

comments patience and advice in the preparation of this research paper. Next I would like
to thanks Rift Valley University for designing this program through that students develop
their knowledge. Finally I would like to thank for all my friends and my family who
helped me to do this research paper and conduct my study as such a good manner.

I
 Rift Valley University
Hawassa Campus
Advisor Approval Sheet
This is to certify that student Berhan Debero have conducted her senior essay paper on
the Title credit collection Management and the work is complied with the evaluation of
the Advisor and the examiners as per the Requirement of University

Adviser Name (MBA)--------------------------------Signature----------------------

Date--------------

Examinet Name----------------------------------------- Signature----------------------

Date--------------

Head of Accounting and Finance Department-------------------------------------

Date--------------

II
III
 Declaration
I hereby that the research entitled credit collection management submitted for Award of
MBA from Rift Valley Hawassa campus in my original work and it has not been
presented for the award of any other degree fellowship or other similar titles of any other
University or institution.

Student Name Signature Date

1.Berhan Debero --------------------- ---------------------------

IV
V
 Abstract

This study conducted to spotlight credit collection management of Vision fund Micro
finance institution Hawassa Branch. Credit management is the backbone of an
organization that is built on giving financial services to its clients or customers. Not only
it would help organizations to maintain their sustainability but also help keeps their
profitability. Vision fund Micro finance institution gives financial services for its
customers of which credit is the core one. The study has assessed the strength and
weaknesses of the company in managing its credit collection. The researcher have been
used Qualitative research approach. Descriptive research design has been utilized to
finalize the paper. The collected data were analyzed through a descriptive statistics
method like, frequency, Percentage and tables. The source of data include both primary
and secondary method of data collection. Primary data is collected through
questionnaires and interviews; on the other hand secondary data are collected from
strategic plans. Operational manuals of the company reports and others. Target
populations in the study were includes those personnel’s on the Managements and
member of staffs currently working at credit management directorate. From the total 30
population, only 15 respondents have been selected as a study sample size purposively.
To meet the objective of the study the researcher have used stratified random sampling
method to select relevant respondents from the entire population. In this study descriptive
analysis was used to access the major problems on the credit collection management of
Vision Fund Micro Finance Institution in case of Hawassa branch office. Specifically
loan diversion was found to be one of the important and significance factors influencing
loan repayment performance negatively. That it increases default risk (arrears)
significantly.

Key Terms: - Micro finance, credit management, financial services, etc.

VI
 Table of Content
Title Page
Abstract................................................................................................................................I
Acknowledgements.............................................................................................................II
Abbreviation......................................................................................................................III
Table of Content................................................................................................................IV
List of Table....................................................................................................................VIII

VII
CHAPTER ONE
INTRODUCTION...............................................................................................................1
1.1. Background of the Organization...............................................................................1
1.2. Back Ground of the Study........................................................................................1
1.3. Statement of the Problem..........................................................................................2
1.4. Objective of the Study..............................................................................................4
1.5. Significance of the Study..........................................................................................5
1.6. Scope of the Study....................................................................................................5
1.7. Limitation of the Study.............................................................................................5

CHAPTER TWO
LITERATURE REVIEW....................................................................................................6
2.1. Credit Policy in Ethiopia..........................................................................................6
2.2. Development of Financial Institutions......................................................................7
2.3. Development of Micro Finance Institutions in Ethiopia..........................................9
2.4. The Ethiopian micro – Finance Experience............................................................10
2.5. Establishment Credit Groups (CG).........................................................................11
2.6. The Need for Credit Management..........................................................................11

CHAPTER THREE
3. RESEARCH DESIGN AND METHODOLOGY.........................................................12
3.1. Method of Data Collection.....................................................................................12
3.2. Sample Design & Procedure...................................................................................12
3.3. Data Processing and Analysis.................................................................................12
3.4. Method of Data Analysis........................................................................................13

CHAPTER FOUR
4. DATA ANALYSIS AND INTERPRETATION...........................................................14
CHAPTER FIVE...............................................................................................................21
5. CONCLUSION AND RECOMMENDATION............................................................21
5.1. Conclusion..............................................................................................................21
5.2. Recommendation....................................................................................................22
Appendix........................................................................Error! Bookmark not defined.
References..................................................................................................................23

VIII
 List of Table

Table 1: Educational status of VFMFI’s client of the branch

Table 2: Show the response on the loan repayment of VFMFI’S client
Table 3: Show the response on importance of supervision for loan repayment
Table 4: Show the training given by VFMFI helps to manage their loan
Table 5: Show credit policy of the company

IX
 CHAPTER ONE

INTRODUCTION

1.1. Background of the Organization

Vision fund Micro finance institution Hawassa Branch that will be organized and operated under the Sidama
Region. The scheme was transformed to the company in August 1997 under the proclamation No 40/1996
issued for licensing and supervision of the business of micro–finance. More of this Micro Finance Institutions
in the country have been operating in the direct and indirect supervision of National Bank of Ethiopia to serve
as developmental sectors supporters for economic change impact.
Vision fund Micro finance institution has above 100 branches, from those branches Hawassa branch is the one.
Vision fund Micro finance institution has been delivering the credit service to the poor using group guarantee
mechanisms (peer pressure) that does not require material collateral. Delivering loan to the poor through peer
pressure requires only good character.
The possible impacts expected are:
- Increasing an income and ensuring household food security
- Promoting saving culture
- Alleviating poverty and restoring self – reliance
- Improving social status of the poor
The credit program norms of VFMFIHB are loan size, loan terms and lending rate. The loan size is the amount
of money eligible client takes as loan (credit) in each loan cycle. VFMFIHB average loan size for the 1 st 110,
2nd 1200, 3rd 1500, 4th 1800 5th 2000 and nth 5000.
The loan terms are established at different levels for different activities with maximum loan period being one
year.
Example, Trade loans are given for a period one production cycle and paid back at once at the end of the
production period.
VFMFIHB is currently financing for Trade inputs loans, form, petty trade activities, fattening and animal
husbandry.
It will be to ensure the viability and sustainability of its operations charges 12% AND 10% flat interest rate per
annum on it loan for rural and urban respectively.
Vision, Mission and Value
Vision

10
 We aspire to be a financially self – sustaining model MFI enhancing mainly the livelihood of law income
people in Sidama Region
Mission
To provide need based financial services to strengthen the economic base of the low income urban people in
South through increased access to sustainable and cost efficient financial services.
Values
 Attaining significant outreach and financial self sufficiency
 Transparency
 Commitment to financial discipline
 Commitment to serve the clients
 Good governance
 Consistency
 Enhancing youth and women participation

1.2. Back Ground of the Study

Micro finance is relatively new industry which arose in the early 1980’s after the failure the government
delivery of subsidized credit to poor farmers. Micro finance, therefore, come in as the beginning of seeking
effective market oriented solutions to the provision of sustainable and effective financial resource to poor
groups of people who do not have access to financial service from formal government and private financial
institutions.
Hence micro finance is emerged as the provision of financial services and financial resources to the poor low
income and active group of people living in both urban and rural areas in general. These groups of people face
lack of capital to start up new business or to improve the existing one. Micro fiancé service here refers mainly
to credit provision and saving mobilization. Some micro finance institutions also affairs insurance, salary and
pension management and money transfer service. In addition to financial intermediation, many micro financial
institutions (MFI) provide other social oriented service such as group formation, development of self
confidence and training in financial literacy and management capabilities among members, which serves as a
conduct for developing the sense of cooperation or team work to campaign on the common enemy that means
poverty. The credit collection management in VFMFI Hawassa branch used two mechanisms. These
mechanisms applied prior to deliver loan and offer deliver of loan.
1. Prior to deliver loan is screening target poor clients by using the following eligible criteria. Physical and
mental fitness in terms of the requirement of the specific enterprise intended to be undertaken hard working
11
 willingness to join VFMFI Hawassa br. program. Willingness to adhere to group and center by law and joint
responsibility, good personal conduct residence and prompt loan utilization and repayment.
2. After deliver of loan monitoring and evaluation (supervision methodologies)
 Loan repayment will consist of loan principal and interest. VFMFI Hawassa branch was disbursed loan
amount 362,700 birr in 2002/03 for 479 client amount 1,168,900 birr in 2003/04 for 1.321 client amount
2,029,700 birr in 2004/05 for 1934 client, amount 4055,300 birr in 2005/06 for 2771 clients, amount 5,798,900
birr in 2006/07 for 3,468 clients, amount 13,524,400 birr in 2007/08 for 5969 clients. The loan repayment
coverage from year 2002/03 – 2007/08 was 100% but in 2007/08 was collected 95% (VFMFI 2007/08 annual
report) The majority about 99% of the company has put its clients at different economic status, as compared to
their initial level, refers to impact to the service micro fiancé model has served more effectively in funding
activities such as petty trading small scale agriculture processing operations, small scale dairy production and
other life stock related activities. This is mainly because such activities do not exhibit a pronounced seasonality
and conductive for making small regular loan repayment form the returns.

1.3. Statement of the Problem

A firm’s credit selection activity involves deciding whether to extend credit to a customer and how much credit
to extend.
The management of credit collection strongly depend up on, the credit and collection policy of a firm. The
result of this study helps to make suggestions and recommendation that have contribute towards improving the
performance of credit collection in Vision fund Micro finance institution Hawassa Br (VFMFIHB) on the
above clarification the researcher will raise the following basic questions that should be answered in this
course of study.
 What are the problems and challenges with regards to credit policy and analysis of the
organization?
 What are the sources of credit information and methods that are used to credit policy?
 What impact does the length of credit period has on collection of credit?
 What are the main components of credit policies and analysis?
12
1.4. Objective of the Study
The major objective of the study is to improve credit collection procedures of Vision fund Micro finance
institution Hawassa Branch (VFMFIHB)
The specific objectives of the study are described as follows:
 To assess the credit collection management of Vision fund Micro finance institution Hawasaa Branch
(VFMFIHB)
 To assess loan diversion.
 To assess loan in default and errors.
 To evaluate the facility access to various saving and credit services to the target group.
 To evaluate the awareness and habit of saving among low income earning people.
.

13
1.5. Significance of the Study

A study on assessment of credit collection management of financial institutions will be the vital role, because it
provides information that will enable effective measures to be under taken to improve the credit collection
management by the stock holders (employees) of micro financial institution in general and that of VFMFI
Hawassa Branch in Particular.

1.6. Scope of the Study

The study would be undertaken in Vision fund Micro finance institution Hawasaa Branch (VFMFIHB) office
which found Southern part of Ethiopia, from Addis Ababa 270 km. The collection sample will analyzed for
assessing the credit collection management of the branch.

1.7. Limitation of the Study

While conducting the study they were different limitation
 Financial limitation.
 Time given and budget allocated by university is not sufficient to make this study more effective.
 Misunderstanding of questions by respondents.
 There are some documentations problems that defers from looking more details about a specific loan
file, particularly to refer to previous credit agreement with client.

14
 CHAPTER TWO

LITERATURE REVIEW

2.1. Credit Policy in Ethiopia

The formal and information financial sectors and the principal sources of finance for any investment or
business that can be undertaken a micro small–scale and large–scale levels in an economy. The major
financial institutions in the formal financial sector in Ethiopia are the Commercial Bank of Ethiopia (CBE) and
the Development Bank of Ethiopia (DBE). As Dejene (1993) noted, because of the elaborate paper work,
bureaucratic lending procedures and stringent collateral requirements, the institutions do not deliver credit as
and when needed. Moreover they operate at high transaction costs.

During the imperial regime the banking sector was partly owned by foreigners and the lending policy was
mainly oriented to financing foreign enterprises wealthy clients while domestic small borrowers were rationed
out and forced to seek credit from informal (Mauri, 1997)
More branch concentration was in few urban centers, with Addis Ababa alone, for instance, accounting for 64
percent of branches in the country. Collateral requirements were up to 200%.
The agricultural sector was almost neglected because financial institutions considered agricultural activity as
risky investment (Itana, 1994)
During the Derg regime (1974 – 1991) all financial institutions were nationalized and credit was mainly
channeled to public enterprises, state farms and cooperatives. The provision of credit was not based on
economic rationality but the discrimination against the private sector was not only in credit access but entirely
on government preference also in interest rate, which was for instance 9% for private sectors as opposed to 6%
for public industrial enterprises since July 1986 (Itana, 1994). Abreham (2002) noted that with the downfall of
the Derge, the private sector got equal access to credit with other sectors, banks were also given autonomy to
decide by themselves based on purely commercial criteria and establishment of private banks and insurance
companies was permitted. As a result loan disbursed to the private sector, which was 49% in 1992/93 rose
considerably and reached 87.7% in 2000/01. In fact there is still unsatisfied demand for credit from this sector
of the economy due to inability to meet banks leading requirements.
As Solomon (1996) noted the banks serve big businessmen and disregard poor households as bankable. Many
small, creditworthy businessmen, with their viable investment ventures, are denied access to institutional credit
because they couldn’t afford the required collateral. He also indicate that, “overall, the prevailing operation of
15
the formal financial institution in many low income countries such as Ethiopia is inefficient in providing
sustainable credit facilities to the poor.
Regarding delivery of financial services access to institutional credit was very limited in Ethiopia. Because of
this limited access, the majority of the poor get financial services through informal sources like money lenders,
Iqub, Iddr, merchants, friends and relatives, etc. The formal financial sources have not been interested in
delivering credit to the poor. Even if the banks in the country, which are part of the formal financial sources
decide to give credit to the poor. Even if the banks in the country, which are part of the formal financial
sources decide to give credit to the poor (as in the case some banks have been forced to do so during the Derge
regime) their outreach was also very limited for long. Thus, delivering financial services to the poor requires
an innovative targeting deign and a mechanism of credit delivery that helps identify and target only the poor
who can take the initiative and sustain productive use of loans.
In recent years the informal and Semi – formal lending institutions (such as Iqub, Iddir, money lenders etc.) are
becoming the dominant and important sources of finance for poor households in Ethiopia. According to
Dejene (1993) account for 81% of the agricultural credit.

2.2. Development of Financial Institutions

It is noted that the formal financial markets in developing countries do not provide credit and saving services
to small scale farmers, micro – entrepreneurs and woman. In other words, it is not accessible to the rural and
urban poor. Consequently, government started to fill this gap by establishing development fiancé institutions
since the 1930’s (Hulmle 1997 p.2)

The large and successful micro finance institutions reaching the poor in developing countries have all relied on
the support by donor and government at least during their formation stage. Because of wide spread market
imperfection concerning financial service to the poor, institutional innovation and expansion in micro finance
is rarely market driven, but the process that has been fostered by the public sector or altruistic leaders, private
sectors have contributed little to micro fiancé revolution that we have witnessed in the past fifteen years (Zeller
2001 as cited by Wolday 2002)

The Grameen Bank: In Bangladesh, Professor Mohammed Yunus, 1997 as cited by Zeller 2001, addressed the
banking problem faced by the poor through a program of action research with his graduates’ students in
Chittogong University; he designed in 1976 an experimental credit program to serve the poor. Though special

16
relationship with rural Banks and the Sports of Donors, the Grameen Bank was found 1983 and know serve
more than 3 million of the poor.

The state owned micro Banks in Indonesia; another flagship of micro fiancé movement is the village Banking
units system of the Bank rank at Indonesia (BRI) the largest micro fiancé institution in developing countries.
This state owned bank services about 22 million micro savers with autonomously managed micro banks. The
micro banks of BRI are the product of a successful transformation by the state owned agriculture bank during
the mid 1980’s (AIO, 1973 as cited by Dejene 2000).

The earlier intervention of government in rural credit (i.e. provision of credit with cheap interest rate and
limited saving and deposit facilities) was not successful in financial terms (Hume 1997, p.2). According to a
World Bank study (1975) over half of a sample of 44 development finance institutions known to the World
Bank had arrears rate of more than 50 percent. There was also a problem of high transaction cost (ibid, 1997,
p.22). In addition most of the credit did not reach the intended beneficiaries (Khandker, 1998, p.1)

It seems that many countries in the developing world intervened in the rural credit markets. It is emphasized
that neither financial intermediation nor higher interest rates will solve the problems of imperfect information
and imperfect enforcement that are endemic in developing countries (Humle 1997, p.3)

2.3. Development of Micro Finance Institutions in Ethiopia.

Micro finance involved in the 1980s as development approach that intends to benefit the active poor, largely,
in response to benefit the active poor. Largely in response to the failure of targeted subsidized cheap credit
programs. In such programs benefits went to those having connections and influence rather than target groups.
Large loan losses accumulated and frequent recapitalization were required to continue operating, suggesting
the need for a new approach considers micro fiancé as an integral part of financial system, emphasis as
sustainable institutions operating on the market principles to serve the poor (as opposed to subsidized loans to
the target population) and recognizes the importance of both credit and saving services (Samson, 2003).

In Ethiopia, though savings and credit program were operated for a number years by NGOS, micro finance
operation in regulated form is a relatively new (about 10 years) phenomenon following proclamation 40/96
issued by national bank of Ethiopia (NBE) the early formal micro finance activity is the development Bank
Ethiopia (DBE) pilot credit schemes for years their program that emphasized both credit and saving emerged
17
in 1990s. For examples Relief society of Tigray (RST) to Dedebit credit and saving institution (DECSI). 1993,
Oromo self help organization (OSHO) to OCSSC (Oromia credit and saving share company) 1996 etc.

After Proclamation No 40/96 was issued, NGO where prohibited from directly involving themselves in credit
and saving activities (Wolday, 2002) however, currently NGOs are playing a very important role by initiation
and supporting their own micro financial institution, each improves the financial access to the poor. The
outreach of micro financial institution, each improves the financial access to the poor. The outreach of micro
financial institutions in Ethiopia is estimated to about half a million active client. The objective of all most all
– micro financial institutions in Ethiopia is poverty alleviation (Bekele and Wolday, 2002).

2.4. The Ethiopian micro – Finance Experience

In Ethiopia Micro – financing experience providing credit to rural agricultural households for purchase of
agricultural inputs and tools have been practiced by the country major state owned banks (including
Development Bank of Ethiopia (DBe) and commercial bank of Ethiopia) credit schemes targeted a turban poor
where non – existence until recent years who NGOs, starts providing credit on poor households in some parts
of the country. Befekadu Degefe and Berhanu Nega, 1999/2000 Annual report on the Ethiopian economy
volume 1 p. 381 – 382)
And hence nongovernmental organizations have been active in the prevision of micro fiancé services to the
poor since the drought of 1984/85 and the government of Ethiopia has been keen on putting in place a legal
framework under which micro–fiancé institutions (MFI’s) can be formed. Poverty alleviation being MFI’s top
development agenda, the current government has created suitable policy environment for the formulation of
MFIs. Since the promulgation of proclamation no 40/1996, 19 MFIs have been legally registered. Coring over
a population of more than 427,000 by March 2000, all MFIs in Ethiopia, the majority of the poor are excluded
from MFI services due to a number of factors that are external and internal to MFIs. The other argument is that
micro finance service should not be limited to poverty alleviation alone but should also be a tool for enhancing
economics development at the grass root levels. This implies the need for diversifying the activities and the
products of MFIs to teach those small entrepreneurs that tare not reached by the formal financial services
(Gebrehiwot, 2002 P. 31).
Since the issuance of proclamation No 40/1996, 19 MFIs have been registered and licensed by the House of
peoples. Representatives Even though the development of MFIs started following the drought of 1984/85
recently the industry has shown remarkable growth in terms of outreach among poor rural households. With a
network of about 500 branches and sub branches, the MFIs have spread their operations in the regional
18
(Tigray, Amhara, Oromia and Southern nations and nationalities and peoples region0 where the incidence
poverty is the highest.

2.5. Establishment of Credit Groups (CG)

A group of 10 to 12 people organizes themselves into saving and credit groups (SCG) or modifies their
existing group to accommodate the guidelines of VFMFI. Each group will have the center cent 1 chair person,
secretary, treasure, service period is for one year and if the group wishes they may serve for one additional
year. A member of a group must then step down for one year before he or she is entitled to serve again in the
executive committee for the work to go smoothly, of the elected, at least must be able to read and write.

The zonal social and economic committee takes the overall coordinating responsibilities for facilitating the
form action of saving and credit groups by registering and helping them to solve their problems to take
collective measures and decisions. The committee carefully guides SCG’S until they build up their capital and
capacity.
(Abdesa, 2009 P.11)

2.6. The Need for Credit Management

The management of all assets and liabilities is essential if they are to achieve efficient and effectiveness of
MFI. Mismanagement of these resources, indeed leads institutions to failure.

Proper management of micro – financing service operation means maintaining the quality of work or the
standard of the business or industry. But, failure to maintain the quality or if the quality or loan is poor.
Low loan performance could lead to the liquidity problem if some of the loans are not repaid. Institutions
could able to repay their debts. Unless there is some form of protection, depositors will be at risk and will be
affected. This is turn erodes the credibility of an MFI. An MFI will not be able to earn interest income, which
is a major and largest source of revenue. Profitability is also significantly affected as a consequence.

To minimize possible failure of the program or micro fiancé service operation clear working policies and
procedures should be designed and implemented accordingly. These policies and procedures are in targeting
the clients, loan processing, risk management, client management and supervision and follow up issues.

19
 2.6. Definition and Concept of credit
[

Different scholars define the word credit in accordance with different contexts. Among those scholars Jhibgan
(2002), defines that the word credit is derived from the Latin word Creditum, which means to believe
or trust. In economics, the term credit refers to promises by one party to pay another for money
borrowed or goods or services received. It is a medium of exchange to receive money or goods on
demand at some future date.

The other researcher Donald L. (2008), according to the context of commerce and finance, the term
credit is used to denote transactions involving the transfer of money or other property on promise of
repayment, usually at a fixed future date. The transferor thereby becomes a creditor, and the
transferee, a debtor; hence credit and debt are simply terms describing the same operation viewed
from opposite standpoints

Credit is the power or ability to obtain money, by the borrowing process, in return for the promises to
repay the obligation in the future. Credit is necessary in a dynamic economy because of time elapse
between the production of good and its ultimate sale and consumption Mulugeta (2010).

2.7. Definition of Credit Management

Some of the definitions provided by different researchers and scholars about credit
management are described here under accordingly.

Wise (2014), describe that credit management is the process of making a series of investments
based upon credit relationships and managing the encountered risks involved with these
investments. According to the researcher, credit management encompasses assessing the risk
involved with each loan and analyzing and determines the total amount of risks for all loans. The
major objective of credit management is to enhance health loans through reducing the amount of
loan defaults. Bankers can reduce the loan default risk by considering the credit repayment history of
the client prior to grant loans.

The same with Hempel (1994), point out that Credit management is the efficient control and co-
ordination of loanable funds so as to maintain credit and the investment in credit at optimal level.
According to Hampel banks can’t achieve institutional objectives without following effective credit
20
management strategies. Together with this to establish effective credit management strategies it
must be supported by effective risk assessment, control and follow-up strategies. A strong and
effective credit management process is one that reinforces and compliments its corporate
objectives and goals. The main problem that banks encounter in credit administration is that some of
the granted credit facilities are not re-paid leading to loss of depositor’s funds and emergence of bad
debts.

According to Emmanuel (2012), it is the process of accurately assessing the credit - worthiness of
the customer base. This is important when the company chooses to extend some type of credit
line or revolving credit to certain customers. The researcher also narrates that Proper credit
management calls for setting specific criteria that a customer must meet before receiving the
required credit service. As part of the evaluation process, credit management also calls for
determining the total credit line that will be extended to a given customer.

Pandy (1997), effective credit management is the output of the credit policy that the financing
institution is implemented. According to the researcher, the effectiveness of the credit management
is dependent on formulation of credit policy, evaluation of credit policy, implementation of credit
policy, Administering and controlling the credit policy.

2.8. Credit Management Process

Credit process is the core process adopted by any bank and it has the authorized organ to pass
decisions whether or not lend to the requested loans to the entity or individual borrowers after
assessing the credit worthiness, integrity, financial position, customer identity and repayment
capacity of the entity or borrower. According to Basu and rolfes (1995), they indicate that the success
of credit lending institutions are built on a proper and quality credit management process. To
maintain the health of granted loans managements at each level should be eager in taking relevant
decisions based on the follow up reports received. Ineffective management process is one of the
reasons that led to increase the bad loan ratios of the institution. Coyle (2001), a weak credit risk
management system is a means for many non-performing loans.

The fundamental objective of credit lending institutions is to make profitable loans with minimal
risk Boakye (2015), Management should target specific industries or markets in which lending

21
officers have expertise. The credit process relies on each bank’s systems and controls to allow
management and credit officers to evaluate risk and return tradeoffs.
According to Timothy (1995), the credit process includes three functions: business development and
credit analysis, credit execution and administration, and credit review.

 Business development and credit analysis: Business development is the process of

marketing bank services to existing and potential customers. With lending it involves
identifying new credit customers and soliciting their banking business, as well as maintaining
relationships with current customers and cross-selling non-credit services.
 Credit execution and administration: The formal credit decision can be made
individually or by committee, depending on a bank’s organizational structure. This
structure varies with a bank’s size, number of employees, and type of loans handled.
A bank’s Board of Directors normally has the final say on which loans are approved.
Typically, each lending officer has independent authority to approve loans up to
some fixed dollar amount.
 Credit review: The loan review effort is directed at reducing credit risk as well as
handling problem loans and liquidating assets of failed borrowers. Effective credit
management separates loan review from credit analysis, execution, and
administration. The review process can be divided into two functions: monitoring
the performance of existing loans and handling problem loans.

2.9. Areas of Credit Management

Every financial institution engaged in the credit financing sector is prioritizing the most focusing
areas of the credit management sequentially based on the encountered risks in the loaning process.
According to Edwards (2004), Credit Management process of banks can be summarized in three main
stages, namely Credit Initiation, Documentation and Disbursement and Credit administration or
monitoring. Lenders give due attention for more risky areas in the lending activity. The areas which
need special management concentration are described here under accordingly.

 Credit initiation: - credit initiation is one of the credit management areas of many credit
lending institutions. The credit initiation is a process that starts from a market analysis and
22
 ends at the credit application approval Emmanuel (2012). According to Emmanuel, this
process includes, survey and industry studies, prospect lists, customer solicitation, negation
& presentation, credit committee approval and customer advice. The credit initiation and
analysis process should follow a typical diagnostic process flow, beginning with screening of
potential customers and data collection, followed by identification, analysis and measurement
of risks, and then moving to a series of specific risk evaluation and risk mitigation actions in
preparing for a credit decision.

 Disbursement: - transferring the credit grant to customers through verifying wither

beneficiary is fulfill all terms and conditions that is stipulated on the grant agreement
Michael (2015), point out that Credit disbursement is the act of giving or paying out money
to customers who have been accessed and approved to be given credit. In the loan
disbursement process lenders should make sure does the credit is utilized for the planed
objective as per the contracts signed between the lender and the borrower. The researcher
also recommends lenders to verify the authenticity of the security and other required
documentations are received certified before funds are given out to the qualified customer.

 Credit Monitoring: - According to Emmanuel (2012), credit monitoring refers to the credit
support, control systems and other practices necessary for the effective monitoring of credit
risks taken by the Bank. The researcher point out Control of Credit files, Safekeeping of
credit and documentation files, Follow-ups for expirations of essential documents like CA's
and insurance, Control of credits and excesses over approved lines, Monitoring of collateral
inspections, site visits and customer calls, Monitoring of repayments under term credits are
some of the major credit management areas in the credit monitoring process.
According to Huppi and Feder (1990), concludes that efficient monitoring leads to high repossession
of loans by revealing likely dangers (like loan diversions) and reminding defaulters of their
responsibilities towards the lending institution ,thus calling for redoubling of efforts in the direction
of loan repayments. The same with Robinson (1962), many of the agonies, frustrations and distress
financial institutions can be reduced by good credit monitoring and follow up process.

23
 2.10. Credit Analysis
[

Effective Credit analysis plays a vital role to maintain the credit quality through identifying and
reducing the upcoming credit risks. According to Boakye (2015), credit analysis is important for
deciding the credit worthiness of borrowers, assessing the likelihood of default and diminishing the
risk of non-reimbursement to an acceptable level. The researcher also concludes that credit risk
analysis is basically default risk investigation, in which the loan officers endeavor to assess a
borrower’s capacity and eagerness to reimburse.
To reduce the credit risk on a loan request process conducting a Credit analysis is the most desirable
method. This helps to determining the financial strength of the borrowers, estimating the probability
of default and reducing the risk of non-repayment to an acceptable level. In general, the credit
evaluations processes are done based on the loan officer's subjective assessment (Hagos, 2010).

Once a customer requests a loan, the credit experts analyze all available data’s to determine whether
the loan meets the bank’s risk-return objectives. To ensure this objective every financial institutions,
Bankers and lenders engaged in the loaning sector are most of the time used the 5 C’s of credit to
measure borrowing reliability and credit worthiness. Clearly Understanding the 5 C’s of Credit will
give some insights the bankers or lenders how can they work with the loan applicant following in the
right way. This five C’s are the key denominators of an applicant’s creditworthiness. According to
Lawrence (1997:776-777), identified five C’s of credit accordingly. They include; Character,
Capacity, Capital, Collateral, and Conditions.

1. Character: The applicants record of meeting past obligations, financial, contractual, and
moral. Past payment history as well as any pending or resolved legal judgments against the
applicant would be used to evaluate its character.
2. Capacity: The applicant’s ability to repay the requested credit. Financial statement
analysis, with particular emphasis on liquidity and debt ratios, is typically used to assess
the applicant’s capacity.
3. Capital: The financial strength of the applicant as reflected by its ownership position.
Analysis of the applicant’s debt relative to equity and its profitability ratios are frequently
used to assess its capital.
4. Collateral: The amount of assets the applicant has available for use in securing the credit.
The larger the amount of available assets has the greater the chance that a firm will recover
24
 its funds if the applicant defaults. A review of the applicant’s balance sheet, asset value
appraisals, and any legal claims filed against the applicant’s assets can be used to evaluate
its collateral.
5. Conditions: The current economic and business climate as well as any unique
circumstances affecting either party to the credit transaction. Analysis of the general
economic and business conditions, as well as special circumstances that may affect the
applicant or firm is performed to assess conditions. In other context Matovu & Okumu
(1996), they strongly recommend lenders to apply 5C‟s principle to evaluate the credit
worthiness of borrowers prior to establish contractual agreement.

2.11. Credit appraisal

The term appraisal is the comprehensive and systematic assessment of all aspects of a proposed
project. In other words, it is the professional judgment of value of the asset, property and collateral
based on the recent market value. According to Tekeste (2016), credit appraisal does mean the
evaluation of fresh or enhancement proposals on the basis of futuristic data. The researcher revealed
that when appraising proposals, the banker tries to find out: the financial need of the client, end-
use of funds, viability of operations and risk involved. In case of Proposals involving working capital
finance, the banker can ascertain the aforesaid factors only when he/she is supplied with the business
plan of the borrower for the ensuring period. Business plan is expressed through operating statement,
balance sheet, funds flow, and cash flow statements, all on projected basis. Similarly Rosemary
(2013) sought out client appraisal is one of the major solution to reduce credit risks in the credit
management process. Together with the credit appraisal bankers should clearly understand and
evaluate the collaterals provided by the client on the replacement of the credits received. This idea is
supported by Inkumbi (2009) notes that capital (equity contributions) and collateral (the security
required by lenders) as major stumbling blocks for clients trying to access capital.

Financial institutions engaged in the loaning service should conduct adequate appraisal work before
granting loans to borrowers. That is why project appraisal is usually seen as a major activity of
lending institutions while project feasibility study is normally undertaken by project
promoters/consultants. Project appraisal is one of the crucial stages in the loan processing procedures,
because this stage provides relevant information about the financial strength and creditworthiness of

25
the customer. Some of the factors considered in granting loans include; applicant’s background, the
purpose of the request, the amount of credit required, the amount and source of borrower’s
contribution, repayment terms of the borrower, security proposed by the borrower, location of the
business or project and technical and financial soundness of the credit proposal (ADB Desk Diary,
2008).

Review of appraisal guideline reference with DBE

 Background Information: - Particulars of the project like name of the Appraisal Team,
Applicant, Objective of the Project, Purpose of the Loan, and Status of the Project (New /
Expansion), type and location of the project and form of organization shall be discussed
in this section.
 Success and Risk factors: - Summarize the level of risk with its mitigation mechanisms
and success factors of the project. Present Risk Grade in Tabular form.
 Market and Marketing Strategy: - The findings with regard to the market prospect of
the project in terms of market penetration capability, major advantage, such as location,
quality cost, and etc must be pointed out. Indicate SWOT analysis results.

26
  Technical Feasibility: - The highlights of location, layout, and cost estimates,
appropriateness of technology selected, production capacity, infrastructure, and related
issues will be discussed in brief.
 Organization, Management and Manpower: - Soundness of the proposed
organizational set up and competence of management along with availability of
manpower shall be indicated under this section.
 Financial Viability: - Summary of investment costs, and financing schemes and findings
of the financial analysis made with regard to profitability, liquidity and Sensitivity test
must be pinpointed.
 Socio-Economic Justifications:-Issues like creation of employment opportunities,
utilization of domestic resources, regional development, and taxes revenue to the state,
export earnings and foreign exchange saving capacity should be stated (DBE, 2008).

2.12. Credit Approval

Credit approval is the decision passed by the approval committee by which the lender decides whether
an applicant is creditworthy or not and should receive a loan. Effective approval process is a key
predecessor to favorable portfolio quality, and a main task of the function is to avoid as many undue
risks as possible. The goal of credit review or examination is not only to identify current portfolio
problems, but it also identifies potential problems that may arise due to ineffective policies, irrelevant
trends, lending concentration, or non-adherence to policies.

In banking the approval process plays a great role in managing and controlling credit risks related
with problems happened due to appraisal mistake through conducting deep analysis and review of the
presented document. Every Credit lending institutions should have in their own written guidelines on
credit approval process, approval authorities of individuals or committees as well as decision basis.
The board of directors should always monitor loans. Approval authorities will cover new credit
approvals, renewals of existing credits and changes in terms and conditions of previously approved
credits particularly credit restructuring which should be fully documented and recorded (Jappelli &
Marco, 2007). Prudent credit practice requires that persons empowered with the credit approval
authority should not have customer relationship responsibility. Approval authorities of individuals
27
should be commensurate to their positions within management ranks as well as their expertise
(Mwisho, 2011).

Any decisions passed by the approval process should be based on a system of checks and balances.
Some approval authorities will be reserved for the credit committee depending on the size and
complexity of the credit transaction (Jansson, 2012). Depending on the size of the financial institution,
it should develop a corps of credit risk specialists who have high level of expertise and experience and
who have demonstrated judgment in assessing, approving and managing credit risk. An accountability
regime should be established for decision-making process accompanied by a clear audit trail of
decisions taken and proper identification of individuals/committees involved. All this must be
properly documented (Hoque & Hossain, 2008).

All credit approvals should be at an arm‟s length, based on established criteria. Credits to related
parties should be closely analyzed and monitored so that no senior individual in the institution is able
to override the established credit granting process (Greuning & Iqbal, 2007). Related party
transactions should be reviewed by the board of directors under due processes of good governance.

Mwisho (2011) concludes that related with credit unions approval practice, he recommended that
credit unions to have a written loan policy that is approved by the board of directors of the financial
institutions. The board should review the policy on an annual basis and revise where necessary. The
loan policy should include the policy objective, eligibility requirements for receiving a loan,
permissible loan purposes, acceptable types of collateral, loan portfolio diversification requirements,
loan types, interest rates, terms, frequency of payments, maximum loan sizes per product type,
maximum loan amounts as a percentage of collateral values, member loan concentrations, restrictions
on loans to employees and officials, loan approval requirements, monetary loan limits, loan
documentation requirements and co-signer requirements. Besides the loan policy, credit unions should
also develop lending procedures which are developed by the operational management team who are
responsible to up-to-date and ensure they are indicative of current lending practices (Gestel & Baesen,
2009).

28
Loan concentration limits is one of the critical element of the loan policy. In the practice of
Development Bank of Ethiopia, the bank limits the borrowing capacity of customers by set different
restrictions. Currently the bank issue the maximum of credit up to the banks 1/3 of paid up capital.
This is not workable at the banks district and branch office, when applicants of the banks district &
branch request credit above the districts/branches lending capacity they should be treated through
head office.
The second critical component in the loan policy is the restriction placed on loans to employees,
officials and their immediate families. Muranga (2011) indicated that the board of directors should
approve all loans to these individuals by a simple majority vote. However the official or employee
requesting the loan should not be present during the board discussion and vote. It is essential that the
rates, terms and conditions on loans made to or guaranteed by an official, employee or their
immediate families are not more or less preferential than the rates, terms and conditions of loans
granted to other members of similar credit history subject to specific review. The audit committee or
its designee should review the loan portfolio at least semi-annually. The objective of this review is
to determine the quality of the loan portfolio, discover any loans which have problems and
provide suggestions for loan recovery in order to minimize losses. The committee should also ensure
compliance with loan policy and procedures and present their findings to the board of directors
(Fredrick, 2017)

Powers and Duties of the Approval team reference with DBE

The Team will have the following Powers and duties:

- The Team shall based on the written policies and procedures of the Bank, review and
pass its decision on all loans and project rehabilitation proposals primarily closely
scrutinized and approved at multiple stages down the line and submitted for its
consideration and final approval
- The Team shall ensure that loan and project rehabilitation proposals are in full
compliance with the Bank‟s policy and procedure and loan appraisal guideline/format.
- The Loan Approval Team operates in the belief that the various organs of the Bank
participating within the loan screening and multiple loan approval ladder not only
function properly and efficiently to uphold their designated responsibilities but also to
promote the effective implementation of Bank policy.

29
 - The Team shall from time to time, in connection with the credit policy, loan approval and
project rehabilitation processes and with the overall objectives of improving the loan and
project rehabilitation approval process and system, submits its considered views, on
identified shortcomings and weak points as regards the loan appraisal and approval
process in general.
- The Team thus as a rule continues its work with the firm belief that its recommendations
to management for the improvement of identified shortcomings in the above areas and in
general in relation to the credit relations, loan administration and loan appraisal system
will be taken care of without more ado so as to ensure its normal, continuous and
uninterrupted operation.
- The Credit Process representative or Project Rehabilitation and Loan Recovery sub-
process owner or representative shall submit a particular credit research document or
proposal to the Team for consideration. In such cases he/she shall present, explain and
defend that particular project without having a right to Vote.
- The loan appraiser may be summoned by the Approval Team, as and when appropriate to
explain a credit research document (DBE, 2008).

Project Supervision and Follow-up

To ensure the financed projects are properly implemented and operating, lending institutions should
conduct regular follow up works regularly. Because supervision and follow up in the current dynamic
environment plays a key role the institutions seek to identify associated risks tackled in the financing
process. According to the study of African Development Bank in (2010), describes that the
importance of supervision and follow up work accordingly,

The study revealed that, Supervision can play a key role in achieving development results and impact,
through pro-active problem solving and trouble shooting, a focus on results and long- term
development objectives, in addition to this, it helps through Identifying supervisions, the institution to
invest effective resources where needed, implementation assistance can contribute significantly to
better aid effectiveness. Moreover, effective follow up and supervision provides some insights that
Management is re-considering and redesigning the project supervision system and operations manual
at the Bank. The evaluation is expected to add value to this effort to

30
become more results-oriented by providing key evidence on supervision performance, reasons for
this performance, and best practices.

Among other things, the reason loans to be entered in a bad loan category is due absence of
conducting effective supervision and follow up work after the loan is disbursed. If lenders pay
attention to monitoring and control they can reduce the occurrence of bad debts (Rouse 2009). In
monitoring and control Rouse identified internal records, visits and interviews, audited accounts and
management accounts as some of the ways that help in the monitoring and control process. This can
reduce the occurrence of non-performing loans through ensuring the utilization of the loan for the
agreed purpose, identifying early warning signals of any problem relating to the operations of the
customer‟s business that are likely to affect the performance of the facility; ensuring compliance with
the credit terms and conditions and enabling the lender discusses the prospects and problems of the
borrower‟s business.

In the monitoring and control process, a lending decision can be made on sound credit risk appraisal
and assessment of creditworthiness of borrowers. Though past records of satisfactory performance
and integrity serve as useful guide to project trend in performance they don‟t guarantee future
performance. Aloan granted on the basis of sound analysis might go bad because the borrower may
not meet obligations per the terms and conditions of the loan contract (Norton and Andenas, 2007).
The other researcher Tekeste (2016), revealed that the importance of regular follow up work to ensure
the soundness of the credit management and he conclude lenders must conduct strict follow up works
to the utmost degree to minimize the occurrence of bad loans.

According to the view of different researchers follow up systems are classified in to three basic
categories. These are: physical follow up, financial follow up and legal follow up.

Physical follow up, this is a type of follow up which helps to ensure existence and operation of the
business, status of collateral properties, correctness of declared financial data, quality of goods,
conformity of financial data with other records, availability of raw materials, labor situation,
marketing difficulties observed, undue turnover of key operating personnel and change in
management set up among others McManus (2010).

31
Financial follow up, required to verify whether the assumptions on which lending decisions was taken
continues to hold good both in regard to borrowers‟ operation and environment and whether the end
use is according to the purpose for which the loan was given.

Legal Follow up, the purpose of legal follow up is to ensure that the legal recourse available to the
Bank is kept alive at all times. It consists of obtaining proper documentation through registration and
follows up of insurances to keep them alive Rose (2009).

Once a loan is granted to the client, it is the responsibility of the business units should administer and
manage in collaboration with a credit administration support team, to ensure that the credit is properly
maintained. This includes keeping the credit file up to date, obtaining current financial information,
sending out renewal notices and preparing various documents such as loan agreements.

Given the wide range of responsibilities of the credit administration function, its organizational
structure varies with the size and sophistication of the bank. In larger banks, responsibilities for the
various components of credit administration are usually assigned to different departments. In smaller
banks, a few individuals might handle several of the functional areas. Where individuals perform such
sensitive functions as custody of key documents, wiring out funds, or entering limits into the
computer database, they should report to managers who are independent of the business origination
and credit approval processes.

In developing their credit administration areas, banks should ensure the efficiency and effectiveness
of credit administration operations, including monitoring documentation, contractual requirements,
legal covenants, collateral, etc. in addition to this, the accuracy and timeliness of information provided
to management information systems, adequate segregation of duties, the adequacy of controls over all
“back office” procedures and Compliance with prescribed management policies and procedures as
well as applicable laws and regulations are the key components of credit administration consideration
areas.

In the credit lending process there are common areas that all financial institutions to be focused on.
Before providing credit grantee to borrowers‟ lenders should make adequate pre and post credit
assessments. According to Lamia (2012), the following things are the most common consideration
areas of in the pre and post credit assessment stage.

32
According to the researcher, lenders should assess Project Profile, ration analysis, financial statement
analysis, management capabilities, collateral aspects and fulfillment of the required documents at the
pre sanctioning stage. While, loan monitoring and post loan review assessment works are conducted
at the post sanctioning stage.

Credit Risk
Any financial institutions which are engaged in a credit service always must consider the occurrence
of upcoming risks together with the service they provide. Because the two terms never can‟t see
separately. For every credit service there is often the expected associated credit risk. Different
scholars define the word credit risk using their own words. Credit risk occurs when the debtor cannot
repay part or whole of the debt to the creditor as agreed in the mutual contract (Dam Dan Luy, 2010).
„The potential that a contractual party will fail to meet its obligations in accordance with the agreed
terms‟ Ken Brown & Peter Moles (2016). Default risk, performance risk and counterparty risk are the
basic features of credit risk according to the view of scholars. They also put three basic characteristics
that could define the term credit risk.

 Exposure (to a party that may possibly default or suffer an adverse change in its ability to
perform).
 The likelihood that this party will default on its obligations (the default probability).
 The recovery rate (that is, how much can be retrieved if a default takes place). Note that, the
larger the first two elements, the greater the exposure.

Credit risk is the most common risk which is occurred in the banking industry. The credit quality of
the lenders is directly or indirectly determine by the lenders ability to control such risk. According to
Giesecke (2004) he describe that credit risk is by a long shot the most significant risk confronted by
banks and the accomplishment of their business relies upon exact estimation and productive
management of this risk to a more noteworthy degree than whatever other risk. Chijoriga (1997)
credit risk is the most expensive risk in financial institutions and its effect is more significant as
compared to other risks as it directly threatens the solvency of financial institutions. Fatemi and
Fooladi (2006) characterize credit risk as risk that occurs from the ambiguity in a borrowers‟ capacity
to meet his/her debt. In general credit risk is the most serious issue in the banking industry and it
requires special treatments in the credit financing process.

33
Beyond other things credit risk is the primary factor for many financial institutions failure and reason
to liquidate from the industry. Therefore, to ensure the safety of the organization bankers/lenders
should enforced to establish strong credit risk management strategies.

Credit Risk Management

Lending is the core operational activity of in a banking industry and it is the most profitable asset of
the institution. Banks should ensure the health of the loan they provide to their customer through
establishing strong credit management environment. According to Lillan (2013), the success of Credit
management is mainly determined by the level of risk management in place, policies and procedures,
professionalism and governance. The effectiveness of a bank is measured by its ability to manage the
approaching credit risks properly in the loaning process. Bankers should have correctly formulated,
well designed and clearly understood credit policy that supports to meet the credit risk management
strategies of the institution. At all levels of the bank management should give due attention to avoid
unnecessary risks and correctly assess the opportunities for business development. When financial
institutions have effective credit risk management strategies it creates the comfortable situations to
meet their fundamental objectives. According to the definitions of M.N. Lapteva (2009), Strategic
management is a continuous process of selecting and implementing the goals and strategies of the
organization. The author also describes the basic strategic goals that effective strategic management
depends on; Growth, protection and development are the most ultimate goals of strategic
management.

King (2008), defines the term credit management as the “policies and practices businesses follow in
collecting payments from their customers”. The ultimate goal of credit risk management is to
maximize a bank‟s risk-adjusted rate of return by maintaining credit risk exposure within acceptable
parameters. Banks should manage the credit risk inherent in the entire portfolio as well as the risk in
individual credits or transactions. Banks should also consider the relationships between credit risk and
other risks. The effective management of credit risk is a critical component of a comprehensive
approach to risk management and essential to the long-term success of any banking organization. Poor
credit risk management is the major cause of many business failures. Many small businesses have
neither the resources nor the expertise to operate a sound credit management system (Richardson,
2002).

34
Credit risk management involves the policies and procedures made to assess, identify, measure,
control and monitor the risk that can arise from the potentiality of the loan nonpayment or default.

Controlling for Credit Risk

According to Bernanke (2009b), “one of the lessons learned from the current financial crisis has been
the need for timely and effective internal communication about risks”. This is observed in a study
conducted by the Controller of the Currency where the findings show that the main component to the
failure of financial institutions was the inadequate control over loan quality Apadoford (1988). The
researcher point out some determinant factors that led to affect loan quality. According to the
researcher, factors such as, Inattention to loan policies, over indulgent loan terms and nebulous
standards, Perilous concentration of credit, Weak control over loan administrators, Inadequate
systems to identify loan problems. Excessive growths of loan portfolio are some of the means for
poor control over quality.

Credit Collection Methods

In the credit management process the establishment of adequate credit collection strategy is the
primary task for all lenders. Effective credit collection techniques are one of the necessities for
financial institutions in any economic climate. Knowing how to encourage customers to pay their
outstanding debts to financial institutions like banks on time can increase the cash flow of banks.
Therefore to reduce bad loan ratios across the organization lenders should use different collection
techniques. According to Michael (2015), Timely issuance of reminder letter to defaulters is one of the
relevant steps that facilitate arrears collection. Hagos (2010), under normal circumstances loan clients
are expected to pay in cash or deposit or keep their installment repayment as per the agreement made.
As the loan account becomes past due or overdue the collection effort becomes more personal and
strict. The researcher point out that, telephone calls, personal visits writing reminding letters, using
collection agencies are some of the common techniques used in the loan collection process.
Additionally, taking legal action is the other alternative in the efforts to collect loans. Kariuki (2010),
organization should put their own collection policy to ensure that the credit management is done
effectively maintaining with its soundness. Collection policy is one of the primary tools to assure the
health of loans when customers do not pay the firms bills in time. Some customers are slow payers
while some are

35
non-payers. The collection effort should, therefore aim at accelerating collections from slow payers
and reducing bad debt losses

Empirical Literature

According to Fredrick O.Nyasaka (2017), effective Loan appraisal and subsequent approvals based on
borrower‟s capacity, character, condition, credit history and collateral reduce Non- performing loans
and it has a great contribution that the institution to ensure the health of loans. In addition to this; the
researcher also reaches an agreement, establishing strong controlling and monitoring mechanisms are
the key points of ensuring sound credit services.
Evelyn (2014), by his research concludes that Client appraisal, credit risk control and collection
policy are some of the common factors to be considered in the credit management process. According
to the view of the researcher to ensure the portfolio quality lenders should follow adequate credit
management strategies.

Rosemary (2013), by his study concludes that, credit appraisal; credit risk control and collection
policy had directly affected the lending process of the institution. The study revealed that a unit
increase in client appraisal, credit risk control and collection policy would lead to increase the loan
performance of the institution. This is an indication that there was positive association between those
variables and loan performance.
Spéciose (2016), by his research concludes that, financial institutions can reduce the upcoming credit
risks through conducting detail analysis in accordance with five C‟s criteria. Occupying additional
collateral Substitutes, providing different trainings about loan repayment schedule and other non-
financial services to customers and the staff has appositive contribution in the credit management
process. According to the researcher, following effective credit risk mechanisms influenced the loan
recovery and reduces the level of bad debt.

Michael (2015) was conduct a study about the credit management practice of societies in Obuasi
Municipality credit unions and he point out how poor qualified and staff affects in the credit
management process. In addition to this, the researcher concludes roles of technologies to improve
credit management activities in better way. According to the view of the researcher technology helps
to maintain consistency in credit decision making. These indicate that this

36
department of the credit union is not resourceful as will be expected from a sector that manages the
biggest assets of the societies.

Minh (2013) revealed that establishing effective risk management is the most important tool to control the
bad debt rate; the credit risk management is an important task. According to the view of the researcher
factors such as, Credit analysis is one of the tools the banks use to analyze the customer data in order to
make the loan approval decision. The policies and strategies are the other issues and aims to provide a risk
control techniques for the banks. The last principle of credit risk management is the lending guideline. In
fact, the lending guideline is a combination of many lending policies that issued by the bank for its staff
members when dealing with a loan application.

Yalemzewd (2013), by his study indicate that subjective consideration in the loan approval process
leads to distortion in decision and result inconsistency in decision making. To avoid credit risks
occurred related with this the researcher recommends as bankers should reduce subjectivity
considerations in approving a credit request and develop a sense of accountability and transparency at
each level.

Yohannes (2015) mentions some important factors that lead to establish effective credit managements
in the credit financing process. According to the researcher, improving the credit risk management
practice, improving the quality of credit granting process, establishing appropriate credit risk
environment, recruiting adequate and qualifies credit and credit risk management staffs and experts,
putting a well-documented credit management strategy, policy and procedure, conducting a
comprehensive credit worthiness analysis during credit offering might have a significant effect and
positive effect on the credit management process.

Alebachew (2015), was conduct a study about the credit risk management practice of Buna
International Bank S.CO (BIB) and he point out some internal factors that directly affect the credit
management practice of the bank. According to the researcher, factors such as, poor credit policy,
weak credit analysis, poor credit monitoring, inadequate risk management, lax proper procedures used
for credit risk assessment and lack of trained lending personnel or experts on project loans, and
overestimated of collateralized properties have a significant influence towards the attainment of
successful credit risk management .

37
Hagos (2010), fin out the importance of effective collection techniques in order to ensure the
sustainability of the institution. Banks to meet its financial obligation, they should enhance their
collection capacity through convincing the client to pay their debit in accordance with the agreed terns
with the bank. Without following a proper collection technique, it is difficult the banks to assure its
organizational sustainability. Therefore, collection must be the primary task of all financial institution
which is engaged in the credit financing role. In addition to impacts of collection Hagos also conclude
that, lengthy and reluctant credit analysis and loan approval process has also a negative effect on the
soundness of the credit management.

Tekeste (2016), was tried to assess the credit management practice of Berhan International Bank
S.C (BIB) and he point out some relevant factors to be considered in the credit management process.
According to the view of the researcher, Visiting business on regular basis after disbursement ,
applying due care before granting a loan, establishing payment guideline, considering prompt
payment, writing reminder letter, providing incentive for prompt payment are some of advisable
points to be taken by banks.

Conceptual Frame Work

The main objective of this study is to assess the credit management practice of Development
bank of Ethiopia. Based on the objective of the study, the following conceptual notes are framed. As it
has been explained in the literature review part, the soundness of credit management can be affected
by different organizational factors. Those organizational or bank specific factors are the common
obstacles for the credit management practice of every credit lending institution. Beyond external
factors, internal factors are the major problems for bankers to have high NPL ratio or poor portfolio
quality.
Thus, the following conceptual notes are framed to summarize the main focus and scope of this
study in terms of factors included.

38
  Conceptual Frame Work
Credit Approval

Credit appraisal

Follow up &monitoring
Factors
Organizati Affecting
onal/Bank Loan Disbursement Credit
Specific Management
Factors Practice of
KYC/Due diligence DBE

Credit Risk

Collection

Management & Staff

competency

Summary of Literature Review

The literature review outlined the need to adopt sound credit management practice and to achieve
organizational goals through ensuring the loan portfolio quality. Sound credit management entails
through conducting critical assessments at various stages in the loaning process. It requires a
continues process starting from credit initiation stage to final loan repayment by a borrower.
Litterateurs related with credit analysis, loan approval, credit appraisal, follow up and supervision,
risk management theories and collection methods are described in detail. In addition to the theoretical
aspect empirical facts are also discussed in the chapter. Local studies that have been done by different
researchers on various Ethiopian commercial Banks were not this much enough to fill the gaps in the
knowledge area. Therefore, this research is expected to bridge the existing gaps shown in the
empirical evidence session. Finally, theoretical and empirical expositions described in this chapter by
different researchers on the basic credit management knowledge areas are used as a guideline for this
research.

39
1
CHAPTER THREE
3. RESEARCH DESIGN AND METHODOLOGY
Methodology refers to the overall approach to the research process from the theoretical
underlining to the collection and analysis of data. For the purpose of this study the
methodology that to be used attach the target of the research is described as follows.
3.1. Method of Data Collection
This refers to various means by which data can be collected. These are personal interview
& questionnaires are collected from actual source. These are staff workers of VFMFIHB
and clients.
Primary Data
Primary data source is in which data is collected directly from the employee’s and
customers through questionnaires and interviews.
Secondary data
Secondary data source is obtained from VFMFIHBs written manuals and Ethiopian micro
finance institution annual reports and others. Before using secondary data, the reliability
and relevance of data was insured.
3.2. Sample Design & Procedure
Data sampling technique is used to carry out an investigation about the credit collection
management of VFMFI Hawassa branch for the study using random sampling method.
To determine sample size judgmental sampling technique was used. Because to get
sufficient information in short time.
3.3. Data Processing and Analysis
Data processing
Next to data collection form both sources the responses of respondents to each question is
arranged through tally techniques. Father for data processing,
Which consist editing and classifying the collected data. The raw data was examined to
detect errors and omissions to correct them, if necessary again put responses in a limited
number of categories symbols where assigned to answer. Finally the raw data were
organized in groups on the bases of common characteristics.

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3.4. Method of Data Analysis
The processed data is analyzed using descriptive statistics. Different statistical tools like
percentiles tables are used. Finally a reasonable explanation and the final tasks of
interpretation was accomplished after considering or the relevant factor.
The analysis and tally indicate transformation of raw data in to a form that would make
item easy to understand and interpret it.

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CHAPTER FOUR
4. DATA ANALYSIS AND INTERPRETATION

As included in detail in the methodology part this paper contains both primary and
secondary data. But this section deals with the major results of the whole survey. The
primary data obtained from the respondents thoroughly summarized with the help of
tables. The analysis has two parts.
Part I: Information obtained from clients of VFMFIHB since the stake holders of
(VFMFI) are different as some are clients and other are not client. (Neither take loan nor
save their money in VFMFI) for this matter of heterogeneity was random sampling
technique applied for the selection of 20 clients out of VFMFI Hawassa branch.
Here for the purpose of analysis from prepared questionnaires the responses of the
question were grouped in to categories for the sake of simplification.

Table 1: Educational Status of VFMFI’s clients of the branch

Qualification Certificate 6 – 12 grade < 6 Grade Illiterate
Frequency 2 10 7 1
Percentage 10% 50% 35% 5%
As indicated in the above table the educational level of potential clients was found to be
dominated illiterate (5%) less than 6(35%) complete (almost 50%) followed by certificate
(10%) and diploma holders respectively.
From this figure one can understand that the educational status of many of the stake
holders of the branch is very low. The reason behind is that may micro finances including
VFMFI are working with the poorest of the poor. These poor peoples have no access to
education.
Thus the low educational status of its clients has adverse regarding loan utilization.
Education improves the habit of loan utilization and repayment. The more educated
society is encouraged to repay than less educated society.

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Table 2: Shows the Response on the Loan Repayment
Number of respondents
Response Yes No
Number of clients 18 2
%age 90 10
As indicated in the preceding table 2 most of the respondents have the habit of repayment
(90%) while only (10%) of the respondents have no habit of repayment. Thus clients lack
of knowledge about loan repayment as they don’t know as loan repayment improves their
future wealth.

As can be seen from the table above majority of the clients (90%) has the habit of
repayment. These clients have different repayment mechanism; most of the clients of the
company in the branch are farmers and most of them practice mixed farming system they
repay their loan when they got any income.

The other respondents said that. using the agreement made with the branch (monthly,
quarterly and yearly) in this mechanism some of the clients are repay the loan which have
knowledge about loan repayment schedule clients who have no knowledge are not
repaying on time.

Table 3: Show the response on importance of supervision for loan repayment

Response Number of respondent
Yes No
No of client 17 3
% 85 15%
As it indicated on the above table of the clients understand the importance of supervision
for loan repayment and are less understanding. Most of the clients understand that loan
officers are supervise than and discuss with each other monthly, on monthly meeting and
other center & group meetings prepare themselves for repayment (clients) which have no
understanding of supervision which are absent from meetings has no information and are

5
 not prepare themselves for repayments till the other supervision is done in order to
impose them for the payment both in self-interest or legal procedures.
Table 4: Show the Training given by VFMFI help to manage this loan
No of Respondents
Response Yes No
No of Client 19 1
%age 95% 5%

As it is presented on the above table (95) of the respondents manages their loan according
to training given from the branches credit officers (5) of the respondents has les
management on their loan. Respondent which have les management has peoples which as
no knowledge.
Table 5: Show credit policy of the company
Opinion about the credit policy No of Respondents
Response Yes No
No of client 15 5
%age 75% 25%

Question response No of %age

Respondents
1. Which of the following Collection 5 25%
elements are involving in the policy
credit policy of the company? Credit period 15 75%
Discount 0 0
offered

-75% of the respondent replied that credit is the only major element involving in the
credit policy of the company and cash discount is not included as element of the credit
policy.
Part II Information obtained from staff workers of VFMFI’s Hawassa Branch

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From the survey of credit collection management of VFMFI’s of Hawassa Branch the
workers of the company have replied almost similar ideas and they observed almost the
same ideas on credit collection management if the clients of the branch, which is some
way or another differ for responses of the clients of the Branch is as follows.
To identify the supervision of creditors or clients as they response they have a
supervision schedules between staff (credit officers) and clients accordingly as a
company and also at any time credit officers to direct their clients for preparation of loan
repayment and manage their loan accordingly.

Is there diversion of loan form there loan plan? Most of response they have less loan
diversions, these diversion of loan is made when there is market fluctuation, air
conditions changes their utilization is diversify so as staff respond this cause is risk on
loan repayment.
What types of loan size have taken from the VFMFI in Hawassa Branch?
Loan size is the amount of money eligible client takes as loan (credit) in each loan cycle.
VFMFI’s average loan size for the 1st loan period is 1000 Birr. However this loan size is
subject change every year if the borrower continues as 2 client. i.e. new clients will
always start with the first average loan amount (1000 Birr) and pass to the higher loan
size after the 1st loan. But this does not mean that every client will receive the average
loan. In country VFMFI delivers its loan on actual enterprise demand basis.
Loan cycle 1st 2nd 3rd 4th 5th nth
Average loan size 1000 1200 1500 1800 2000 5000
What types of loan term your have taken from the VFMFI in Hawassa Branch?
Loan terms are established at different levels for different activities with maximum loan
period being one year, i.e. loans are extended for a maximum duration of 12 month. Loan
terms are related to the maturity of enterprises for which the loan is taken and agricultural
loan are given for a period of one production cycle and paid back at once at the end of
that production period. The other activity for which micro – loan extended is petty trade.
This type of trade as the term indicated involves turn over activities. That is, buying and
selling activities in which benefits or profits can be obtained. As a policy, repayment for
petty trade is planned to be in four installments but in actual fact it will be advantageous

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 to use pay as you earn (PAYE) method without waiting unit the last due date. Paying on
an installment base has an advantage both for the clients and VFMFI. Institutionally, the
risk of loan default will be less if a client pays on an installments base than one time
repayment.
Loan terms
Loan purpose Loan terms
1 Farm oxen 1 year
2 Petty trade Installments
3 Agricultural inputs
selected seeds 8 months
Fertilizer
Agro – chemicals
4 Fattening – oxen fattening
Small ruminants 6 month
Is what type of Eligibility criteria to fulfill to enter into the member of VFMFI?
- Physical and mental fitness in terms of the requirement of the specific enterprise intended
to be undertaken.
Have the physical and mental condition necessary of undertaking particular micro
enterprise operation.
- Hard working: have history of being hard working.
- Willingness to join VFMFI program.
- Willingness to adhere to Group and center by–law and joint responsibility.
- Willingness to adhere to solidarity group norms & decisions.
- Willingness to assume joint responsibility for loan repayment.
- Good Personal conduct
Have history of trust worthiness
Responsible person not drunkard & irresponsible
No bad conduct such as theft, robbers, fraud and etc.
- Residence
Permanently reside within the boundary of VFMFI’s operation.

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 Prompt loan utilization and repayment properly use the loan for the purpose for which
loan was taken and repay on due date.
How you identify credit worth clients? Clients are identified through Economic and
Social appraisal process

a) Economic appraisal with local Elders

- Let the local Elders be selected by the general public of the peasant association (PA)
leaders facilitate the selection process.
- Be sure that every village is represented by two local Elders.
- Let local Elders promise to honestly classify the society in to “poor”, medium and rich
categories in line with the local tradition.
- Let local Elders classify PA members and non members into “poor” medium and rich
through wealth ranking.
- Those identified as “poor” are to be clients.
- Have an appointment for general assembly. PA leader takes the
responsibility.
b) Social Appraisal at the client’s level.
- Appear at the meeting place on time.
- Introduce the objective of the meeting.
- Approve the meeting to go on.
- If not, arrange for other day.
- If yes branch staff explain about
o History of VFMFI
o Objectives of VFMFI
o Major Components
 Credit provision
 Saving mobilization
 Micro – Insurance service
 Advisory service
Is there any arrears of loan?

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For this question the response of the staff is there is no arrears according to the branch
because the clients supervised directly and also they have group based loan. When any
member of the group of center cannot pay the other are responsible (repay the loan)

For the case of loan diversion, loan default and arrears supervision is continuously done
from disbursement date to last repayment date for one cycle loan.

Where do you collect the credit (loan)? Any collection without monthly saving collected
at office.
Loan is collected by legal receipt (vouchers) and deposited to safe (cashier) with Internal
with the approval of branch manager and branch accountant.

Also the branch has a credit monitoring guidelines (manuals) and for any of the
company’s duty (work)

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CHAPTER FIVE
5. CONCLUSION AND RECOMMENDATION

5.1. Conclusion
Similar to the rest of developing countries the emerging of micro finance institution in
Ethiopia is a recent phenomenon. The proclamation No 40/1996 which enabled to license
and supervises micro financial institution was first issued in July 1996. Since then about
27 micro financial institutions have licensed and being in operation in the country.

Accordingly VFMFI was initiated by Sidama Regional State to access sustainable

financial service, especially for that financial resource. Poor rural and urban societies
which don’t have access to conventional banks in the region.

The paper is attempted to present general feature of micro financial institutions in

Ethiopia in general and credit collection management of VFMFI in particular. In this
study descriptive analysis was used to access the major problems on the credit collection
management of VFMFI case of Hawassa Branch office.

Specifically loan diversion was found to be one of the important and significance factors
influencing loan repayment performance negatively. That it increases default risk
(arrears) significantly.

This variable itself influenced by many factors of which loan supervision, education and
suitability of repayment period were found to reduce the probability of diverting loan to
non productive uses that ultimately lead to reduce recovery rate.

The paper also conclude that, there is a need for a continuous supervision on loan
utilization and training so as to reduce both problem of using loan for non income
generating activities as well as lack of skill observed because of the wide scale illiteracy
(particularly) in rural areas.

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5.2. Recommendation
Managing of credit (Loan) is the main role of any micro financial institution. Therefore
VFMFI need to further develop workable and realistic strategies to further improve the
collection managements.

Therefore based on over all evaluations, observations and findings the following
strategies recommendations were recommended in order to increase policies for the credit
collection management of the organization.
- Improving office quality and office layout to minimize (savers) creditors’
psychological worry about safety of their money and increase service delivery to
savers.
- Increase the loan size to rural clients.
- Revise and design credit and saving management manuals and strategies in order
to give similar services.
- Encouraging the company’s client to open current account in the company.
- Review the current lending rate and making adjustment.

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 References

 BekeleShiferaw and WoldayAmha, 2001, revising the regulatory supensivion

frame work of micro finance industry in Ethiopia, report No 13.
 Birituu, 2002 Quarter bulletin of NBE. AUGUST – OCTOBER 2004
 BodilDickersin (1998 introduction to financial management 4 th editor me graw
hill co. USA.
 Hulme David (1996, 1997 P.2) the international Transfer of Institutional
Innovation replacing the Grameen Bank in other countries.
 J. Gitman 1997.
 Khandkeretal (1998, p.1) Micro credit program evaluation; A critical review vol.
29 No. 40 ct.
 VFMFI 2ND strategic business plan for 2007/08
 Todaro, M.P 1997 Economic Development 6th Edition, New York zeller M and
Sharma. 2001. Group Based Financial Institution in the rural poor in Bangladesh,
an institutional and Hose hold level analysis, Research report. 20, Washington
DC.

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