CHAPTER ONE

INTRODUCTION

1.1       Background to the Study

The financial sector plays crucial roles in economic growth and development by virtue of its

financial intermediation roles which includes savings mobilization, risk management, project

evaluation among others. Channeling of funds from depositors (surplus units) to investors

(deficit units) is a key role played by banks(Negera,2012). Toensure sustainability and

profitability, banks procure cheaper loanable funds from customers‟ deposits, and lend these

funds to borrowing customers at a relatively higher rate of interest (lending rates) than that paid

to the depositors (deposit interest rates) (Warue, 2013). One of the difficulties in lending is the

precise prediction of whether a loan and interest will be paid back in full. This implies that

lending involves credit risk especially default risk. Banks use diverse internal techniques such as

client screening to minimize their l