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BCC- Branch Credit Committee BOD- Board of Directors CAD- Cash against Document CEO- Chief Executive Officer CIC- Credit Information Centre
DLL- Discretionary Lending Limit
EC- Ethiopian Calendar
EPRDF-Ethiopian People’s Revolutionary Democratic Party
FIS- Financial Institutions
GC- Gregorian Calendar
L/C- Letter of Credit
LAF- Loan Approval Form
MCC- Management of Credit Committee
NBE- National Bank of Ethiopia
NOW- Negotiable Order of Withdrawal Account
NPLS- Non Performing Loans
NPTL- Non Performing to total Loan NPTGL- Non Performing Loan to Gross Loan OBC- Outward Bills for Collection
ODBC- Outward Documentary Bills for set for Collection ODBP- Outward Documentary Bills Purchased
OPD- Outward Bills Purchased
PSS- Proportionate Stratified Sampling
SC- Share Company
SBB- Supervision of Banking Business
VP- Vice President
ZBA- Zero Balance Account
1.1 Background of the Study
Banks are financial institutions that are established for lending, borrowing, issuing, exchanging, taking deposits, safeguarding or handling money under the laws and guide lines of a respective country. Among their activities, credit provision is the main product which banks provide to potential business entrepreneurs as a main source of generating income.
While providing credit as a main source of generating income, banks take into account many considerations as a factor of credit management which helps them to minimize the risk of default that results in financial distress and bankruptcy. This is due to the reason that while banks providing credit they are exposed to risk of default (risk of interest and principal repayment) which need to be managed effectively to acquire the required level of loan growth and performance.
The types and degree of risks to which banks are exposed depends upon a number of factors such as its size, complexity of the business activities, volume etc. It is believed that generally banks face Credit, Market, Liquidity, Operational, Compliance /legal/ regulatory and reputation risks among which credit risk is known to have the adverse impact on profitability and growth. Hence, the success of most commercial banks lies on the achievements in credit management mitigating risk to the acceptable level.
Charles Mensah (1999) stressed the importance of credit management as follows: Credit management process deserves special emphasis because proper credit management greatly influences the success or failure of financial institutions.
This indicates that credit provision should be accompanied by appropriate and attractive credit policies and procedures that enhance performance of credit management and protects the banking industry from failure.
Credit management means the total process of lending starting from inquiring potential borrowers up to recovering the amount granted. In the sense of banking sector, credit management is concerned with activities such as accepting application, loan appraisal, loan approval, monitoring, recovery of non-performing loans, etc. (Shekhar, 1985).
According to Hettihewa, 1997, Credit Management is extremely important as granting credit is considered to be the equivalent of investing in a customer.
However, payment of the debt should not be postponed for too long as delayed payments and bad debts are a cost to the company. Thus, Efficiency and effectiveness in performing each steps of loan processing using various parameters has significant effect on performance of credit management.
UBA Share Company is one of the financial institutions engaged in providing short and medium credit like other commercial banks in the country in general and in the region in particular. In the last few years, both public and private sectors in the economy underwent encouraging development in investment and business activities, thus becoming the fertile ground for the banking industry. Since its establishment in 1997 G.C, United Bank of Africa (UBA) has been striving to exploit such and all other opportunities towards achieving its corporate goals. The bank has been providing only short and medium loans and advances to its customers because of its early stage of capital base and liquidity position. The bank has been playing a significant role in providing loans and advances to its customers that enhances the investment need in the country and as means of generating income for its shareholders.
Hence, the purpose of this study is to assess the performance of credit management problems and strengths of United Bank of Africa (UBA) Share Company in Tigray Region from different perspectives in light of the practices of modern credit management in financial institutions.
1.2 Background of the Banking Industry in Ethiopia
As a result of the agreement reached between Emperor Minilik II and Mr.Ma Gillivray, representative of the British owned National Bank of Egypt; modern banking in Ethiopia began in 1905 with the Bank of Abyssinia, a private company controlled by the Bank of Egypt In 1931. It was liquidated and replaced by the Bank of Ethiopia which was the bank of issue until the Italian invasion of 1936. During the Italian occupation, Bank of Italy banknotes formed the legal tender. Under the subsequent British occupation, Ethiopia was briefly a part of the East Africa Currency Board. In 1943; the State Bank of Ethiopia was established, with two departments performing the separate functions of an issuing bank and a commercial bank. In 1963, these functions were formally separated and the National Bank of Ethiopia (the central and issuing bank) and the Commercial Bank of Ethiopia were formed.
In the period to 1974, several other financial institutions emerged including the state owned: The Agricultural and Industrial Development Bank (established largely to finance state owned enterprises); The Savings and Mortgage Corporation of Ethiopia; The Imperial Savings and Home Ownership Public Association (which provided savings and loan services).
Major private commercial institutions, many of which were foreign owned, included the Addis Ababa Bank, the Banco di Napoli, the Banco di Roma.
However, the banking business could not move further because of the nationalization of private investments by the Socialist regime (the Dergue regime) that came into power leaving only three government banks; the National Bank of Ethiopia, the Commercial Bank of Ethiopia and agricultural and Industrial Development Bank.
This was reversed when the Socialist regime was overthrown in 1991. Following the overthrown of the Dergue regime in 1991, the EPRDF declared a liberal economic system. In line with this, Monetary and Banking proclamation of 1994 established the National Bank of Ethiopia (NBE) as a judicial entity, separated from the government and outlined its main function.
Monetary and Banking proclamation No.83/1994 and the Licensing and Supervision of Banking Business No.84/1994 laid down the legal basis for investment in the banking sector (www.nbe.gov.com).
After the proclamation of 1994, the first private bank, Awash International Bank was established in 1994 by 486 shareholders paving a way to the establishment of related private banks such as Dashen Bank ( 1995), Abyssinia Bank (1996), Wgegan Bank (1997), United Bank (1998), Nib International Bank (1999), Cooperative Bank of Oromia (2004), Lion International Bank (2006), Oromia International bank (2008), Zemen Bank (2006), Buna International Bank (2009), Birhan International Bank (2009), and others which are under establishment.
1.3 Statement of the Problem
According to Shekhar, 1985, credit plays an important role in the lives of many people and in almost all industries that involve monetary investment in some form. Credit is mainly granted by banks including to several other functions like mobilizing deposits, local and international transfers, and currency exchange service.
Hence, the issue of credit management has a profound implication both at the micro and macro level. When credit is allocated poorly it raises costs to successful borrowers, erodes the fund, and reduces banks flexibility in redirecting towards alternative activities. Moreover, the more the credit, the higher is the risk associated with it. The problem of loan default, which is resulted from poor credit management, reduces the lending capacity of a bank. It also denies new applicants' access to credit as the bank’s cash flow management problems augment in direct proportion to the increasing default
Problem. In other words, it may disturb the normal inflow and outflow of fund a bank has to keep staying in sustainable credit market.
Hence, credit evaluation decisions are important for the financial institutions involved due to the high level of risk associated with wrong decision. The process of making credit evaluation decision is complex and unstructured. This complex and unstructured decision making process of credit evaluation needs proper credit management by the concerned banks.
Adequately managing credit in financial institutions (FIs) is critical for the survival and growth of the FIs. In the case of banks, the issue of credit management is of even greater concern because of the higher levels of perceived risks resulting from some of the characteristics of clients, business conditions and economic environment in which they find themselves.
The very nature of the banking business is so sensitive because more than 85% of their liability is deposits mobilized from depositors (Saunders, Cornett, 2005). Banks use these deposits to generate credit for their borrowers, which in fact is a revenue generating activity for most banks. This credit creation process, if not managed properly, exposes the banks to high default risk which might led to financial distress including bankruptcy. All the same, beside other services, banks must create credit for their clients following prudent credit management procedure to make some money, grow and survive in stiff competition at the market place.
Even though a preliminary study is made in preparing the master business plan for the opening of branches; little work is done in studying the performance of credit management of the branches that would alleviate the problems encountered and contribute to the growth of market share and income generation of the bank. Hence the researcher is interested to the research area in particular and to the contribution and object of the bank in general in assessing the gaps in credit management performance which is crucial to be studied in the prevailing stiff competition in line of the modern financial measurements.
Therefore, the principal concern of this study is to assess the performance of credit delivery and management in United Bank of Africa (UBA) Share Company in Tigray Regional State.
1.4 Research Questions
1. Does the Bank consistently comply with its policy and procedures in entertaining its loan applicants, loan processing, and collecting?
2. To what extent is the Bank accelerating the performance of credit management in line to its policy and national banks requirement?
3. Do loan customers of the Bank support the prevailing loan policy and procedures that could result long lasting relationship?
4. To what level is the Bank building up quality loans arresting non- performing loans in line to its policy and National Bank’s requirement.
1.5 Justification of the Study
Based on the monetary and Banking proclamation No.83/1994 which laid down the legal basis for investment in the banking sector a number of private commercial banks are under establishment opening their head quarter at Addis Ababa which is the capital city of Ethiopia and striving to stretch their branches to all regions as a strategy to build up market share.
United Bank of Africa (UBA) Share Company is one of the leading private commercial banks playing its role in opening about 48 branches in the country. Of which 23 branches are in Addis Ababa, the major business center and the capital city of the country, and the rest 25 branches are at different regions. (Annual report of 2008/09)
Out of these branches in different regions 7 (seven) branches are opened in Tigray Region. However, though a preliminary study is made in preparing the master business plan for the opening of branches, little work is done in studying the performance of credit management of the branches that would alleviate the problems encountered and
Contribute to the growth of market share and income generation of the bank. Hence the researcher is interested to the research area in particular and to the contribution and object of the bank in general in assessing the gaps in credit management performance which is crucial to be studied in the prevailing stiff competition in line of the modern financial measurements.
1.6 Objective of the Study
1.6.1 General objective
The main objective of the study is to evaluate the performance of credit management of United Bank of Africa (UBA) in Tigray region as compared to National Bank requirements vis à vis its credit policy and procedures.
1.6.2 Specific objectives
1. To evaluate the compliance of the Bank to its policies and procedures in processing loan applications.
2. To evaluate the ability of the Bank in creating credit and collecting its loan on their due date.
3. To assess the perception of the customers towards the Bank’s policy in relation to its loan provision.
4. To evaluate the Bank’s credit quality as compared to National Bank’s requirements and its credit policy.
1.7 Significance of the Study
Loans and advances are known to be the main stay of all commercial banks. They occupy an important part in gross earnings and net profit of the banks. The share advances in the total asset of the banks forms a lion share (almost more than 60 percent) and as such it is the back bone of banking sector. Bank lending is very crucial for it makes possible the financing of agricultural, industrial, construction, and commercial activities of a country. The strength and soundness of the banking system primarily depends upon health of the advances. Therefore the ability of banks to formulate and adhere to policies and procedures that promote credit quality and curtail non-performing loans is the means to survive in the stiff competition. In ability to create and build up quality loans and credit worthy customers leads to default risk and bankruptcy as well as hampers economic growth of a country. However, little work is done to search the ways and means that enable to quality loan creation and growth as well as to determine the relationship between the theories, concepts and credit policies both at country level or regional level.
Hence, this study is assumed to be significant in indicating best practice and concepts for prudent lending to enhance the performance of credit management to all managers and policy makers of the bank as well as to all financial institutions and banks. Moreover, it may help as a benchmark for researchers who are interested in the area to extend it further.
1.8 Scope of the Study
The study is concentrated on United Bank of Africa (UBA) Share Company branches found in Tigray Regional state. This is because; it is one of the private banks working with leading area coverage in the Region yet.
The study covered credit policies, procedures, and credit operations of the Bank. It assessed whether the loan growth and performance is to the required level of the bank or not. In addition, the study is concerned with identifying the major reasons for best practices of credit management, loan growth, and causes of loan default if any in the region. Since the lending rules and procedures of the bank is the same in all its branches, the result obtained taking case study of this specific region is assumed to reflect the situation of all branches of the bank in the country under normal circumstance.
1.9 Limitation of the Study
Though studying at full-fledged level of the bank would have better result, due to the time and finance constraints the researcher is limited to undertake the study in seven branches located in Tigray regional state. The branches are stretched from Mekelle to Humera in the region and this has entailed transportation problem, hardship, and time scarcity. The constraint of time had significant impacts on the study.
1.10 Organization of the Study
The Study is organized into six chapters. The first chapter introduces the background of the study, the research objectives and questions, significance of the study, scope of the study, limitation of the study and organization of the study. The second chapter presents theoretical and empirical review of the related literatures. The third chapter deals with methodology of the study. The fourth chapter is concerned with the background of the organization and the fifth chapter describes the analysis, results and discussions. The sixth chapter presents the conclusion and recommendations drawn from findings of the data in addition with implications for further research.
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