THE EFFECTIVENESS OF A CREDIT MANAGEMENT AND BANK LENDING IN THE WORLD
ABSTRACT
Commercial banks in Kenya as per the World Bank report were recording higher non- performance in loans over the study period than the standard globally in spite of Kenya having the most stable and developed banking system in East and Central Africa region. Commercial banks non-performing loans for five years from 2015 to 2018 averaged eleven percent which was higher than the recommended rate of one percent. In Kenya, commercial
banks’ non-performing loans remain higher than the recommended rate which could be due To inadequate credit management practices. The study therefore aimed at examining the
effect of credit management practices on loan performance of commercial banks in Kenya. Specifically, the study sought to establish the effect of debt collection policy, client appraisal and lending policy on the loan performance of commercial banks in Kenya. The underpinning theory of the study was the 5Cs model for credit. The study used explanatory research design and the research philosophy adopted was positivism. The target population was 44 commercial banks in Kenya and a census approach was used. Both primary and secondary data were used. Primary data was collected through structured questionnaires and related to credit management practices while secondary data was obtained from review of existing bank loan records in relation to loan amount advanced and non-performing loans for a period of four years from 2015-2018. The data collected was analyzed using both descriptive and inferential statistics with the help of SPSS version 22. The study found out that debt collection policy and lending policy had a positive significant effect on loan performance of commercial banks in Kenya. However, client appraisal had no significant effect on loan performance of commercial banks in Kenya. Therefore, the study concluded that commercial banks’ loan performance could be largely attributed to the efficiency of the credit management practices put in place at the institutions. The study recommended that commercial banks to regularly evaluate and update practices relating to debt collection policy, client appraisal and lending policy that are capable of ensuring that credit risks are identified and recorded from departmental level to the institution at large. This is vital in light of technological innovations
in the banking sector like mobile lending that may limit commercial banks’ ability to evaluate and manage credit using traditional methodslending policy. Additionally, the commercial banks should establish proper client appraisal
methods in order to mitigate credit risk. Proper customer credit worthiness system should also
be put in place based on their ability to repay back their credit and customer’s loyalty.
Technology, Helsinki
The banks utilize deposits to generate interest revenues making credit
amounts the main component of commercial banks assets and source of the credit risk
compensation is
made in case of incurring of risks (Lalon, 2015).
Non-performing loans remain to be the highest detrimental factor to development of the
financial sector (Doriana, 2015). World Bank (2018) report indicated that there was low
performance of commercial banks in Kenya having a relatively high non-performing loan
rates than the globally set standards at 14.92% and five years average of 11.07%. This raises
great concern and the reason why the study examined credit management practices and loan
performance, taking the case of commercial banks in Kenya. Loan performance constitutes a
huge proportion of the credit risk of a bank as it accounts for more than 10 times of the equity
(Barth et. al., 2001). The total amount of money issued out as loans is referred to as loan
portfolio to different borrowers as different loan products. The loan products could be in form
of individual loans, corporate loans, salary loans or group guarantee loans. Loan performance
accesses the rates of payment, number of borrowing clients, security pledged and rate of
arrears recovery (Basel, 2006).
Performance of loans is determined by the percentage of NPLs to total loans (Petersen &
Raghuram, 2008). Non-performing loans (NPLs) is the sum of money borrowed upon which
scheduled payments have not been made for at least 90 days (Bank for International
Settlements, 2016). Performing loans on the other hand is a loan which both the principal and
interest payments are not more than 90 days overdue and which continued payment of the
loan is anticipated (Petersen & Raghuram, 2008). Hence, banks and other financial
institutions focus on reducing NPLs due to the risk that results in the principal loans and
interests not being recovered (Otieno & Nyagol, 2016). Commercial banks in Kenya have
recorded higher NPLs than the standard globally (World Bank, 2018). According to Montana
(2012), non-performing loans have continued to record sharp upward growth over the years
despite the increasing efforts to curb non-performing loans. For instance, in Kenya non-
performing loans increased from 4.96% in 2013 to 5.9% in 2014, 8.97% in 2015, 9.02% in
2016, 11.38% in 2017 and 14.92% in 2018 (Central Bank of Kenya, 2018). In 2018, the
NPLs in the banks were 14.92% and four years average from 2015 to 2018 of 11.07% which
was higher than the recommended rate of 1% (World Bank, 2018). According to Ekrami and
Rahnama (2009) the high amounts of NPLs acts as an indication of the current high risk in
credits in the banking system which poses both market and liquidity problems. NPLs mainly
occur as a result of inefficiencies in the credit management practices employed by the banks
The lending policies guide the bank on issuing out loans to customers and ensuring proper
credit management (Kithinji, 2010). These should be aligned with the general bank plans and
factors such as existing credit policies and prevailing country’s economy status. Prior to the
establishment of the lending policies, banks mainly issued out credit to anyone who
expressed interest to borrow. This resulted in large volumes of bad credit leading the banks to
be more cautious thereafter (Abor, 2004). Majority of commercial banks have customized
their own lending policies to fit the local market and to gain a competitive edge (Ombaba,
2013). However, they still face from poor lending practices (Altunbas et al, 2009). It thus
sensitizes on the importance of monitoring and providing the necessary steps that are related
to lending both to individuals and corporates (Crowley, 2007). This has seen the CBK to
issue guidelines with each bank being required to prepare Credit Policies Guidelines (CPGs)
for guiding decisions pertaining to lending (CBK, 2017).
2. Statement of the Problem
Poor loan performance remains the highest detrimental factor to development of the financial
sector (World Bank, 2016) and impacts on banks’ ability to lend (Doriana, 2015). There has
been concern on the extent of non-performing loan levels in Kenya which has been higher
than the recommended rate of 1%. In 2018, banks NPLs to total loans were 14.92% and five
years average of 11.07% (World Bank, 2018). Between the year 2017 and 2018 the NPLs to
total loans ratio increased from 11.38 percent to 14.92 percent (Central Bank of Kenya,
2018). Ineffective credit management practices have been identified to constitute a major
reason behind increase NPLs (Basel, 2006). In Kenya, the recent collapse of some
commercial banks shows that the successful utilization of the credit management practices is
yet to be realized (Kinyua, 2017). According to Obiero (2013), 37.8 % of banks collapsed
due to poor lending practices between 1984 and 2013. For example, Chase Bank was placed
into receivership in 2016 due to insolvency. The insolvency was occasioned by huge non-
performing loans and disregard of CBK Prudential Guidelines on minimum core capital to
total risk weighted assets. In October 2015 the CBK put Imperial Bank under statutory
management due to unsafe and unsound credit management practices (CBK, 2016).
3. Research Hypotheses
H01: Debt collection policy has no significance on the loan performance of commercial banks
in Kenya.
H02: Client appraisal has no significant effect on the loan performance of commercial banks
in Kenya.
H03: Lending policy does not significantly affect loan performance of commercial banks in Kenya.
4. literature review
4.1 Theoretical Review
The study was guided by the 5 C’s model. According to Baiden (2011), The 5 C’s Model for
Credit was introduced as a framework through which financial institutions build the policy
for their credit transactions. The 5 C’s details the five important factors that commercial
banks will use in administration of credit which are expected to lead to improved
performance of loans (Mac Donald et al., 2006). This includes; character of the applicant,
capacity of repayment, collateral as form of security, capital and the prevailing economic
condition (MacDonald et al., 2006; Baiden, 2011). The 5 C’s Model for Credit thus provides
an assessment upon which lenders use for both current and future borrowers. Character
entails the level of commitment portrayed by the borrower in fulfilling the loan obligations.
Capacity entails the ability of the borrower to make regular payments and settle the loan
obligation fully without any major constraints. Capital on the other hand describes the wealth
position of the borrower measured by the capital adequacy and market standing (Denis,
2010). Collateral acts as a security to loan issued in case of any defaults.
4.2 Empirical Literature Review
Balgova, Nies and Plekhanov (2016) investigated influence of NPLs on economic
performance. Longitudinal design was used. The study established that reducing non-
performing loans has an unambiguously positive medium-term impact on the economy. The
study failed to examine how credit management practices affected loan performance.
However, the study confirmed the negative consequences of NPLs in an economy and hence
need to manage the same. The current study determined how credit management practices
affect loan performance. Otieno and Nyagol (2016) investigated on CRM practices and
performance. Descriptive research design was adopted by the study.
Figure 1: Conceptual Framework
Source: Author (2019)
As shown by Figure 1, independent variables for the study are the debt collection policy,
client appraisal and lending policy. The debt collection policy is conceptualized by the
collection enforcements, guarantor payments on borrowers’ default and continuous
monitoring and control of loans. Client appraisal is conceptualized by use of the funds,
collateral characteristics, CRB credit score, assessed character of the borrower and ability to
pay the debt. Lending policy is conceptualized to consist of Credit limits, Credit terms and
documentation. The dependent variable for the study is the loan performance that is measured
by the amount of NPLs to total loans.
6. Research Methodology
The study adopted the explanatory research design since it sought to determine causal
relationship between credit management practices (debt collection policy, client appraisal and
lending policy) and dependent variable (loan performance). The research adopted positivism
philosophy because the events of interest were objective and the researcher was independent.
7. Research Findings and Discussion
To establish the relationship that exists between credit management practices and loan
performance, multiple regression analysis was computed. The independent variables were the
various constructs of credit management practices namely debt collection policy, client
appraisal, lending policy and the dependent variable was the loan performance of the
commercial banks. The data used for inferential statistics was both primary and secondary.
8. Conclusions
The study concluded that debt collection policy has a significant effect on the loan
performance of the commercial banks. This implies that an improvement in debt collection
policy would lead to an improvement in the loan performance of the commercial banks. The
study further concluded that client appraisal has an insignificant effect the loan performance
of the banking sector. This shows that an improvement in client appraisal would not
necessarily improve the loan performance of the banking sector. The study also concluded
that lending policy has a significant effect on the loan performance of the commercial banks.
This implies that an improvement in leading policy would lead to an improvement in the loan
performance of the banking sector.
9. Recommendations
The study recommended that all the commercial banks in Kenya should regularly evaluate
and update practices relating to debt collection policy, client appraisal and lending policy that
are capable of ensuring that all credit risks are identified and recorded from departmental
level to the institution at large. This is vital more so because of technological innovations in
the banking sector like mobile lending that may limit commercial banks’ ability to evaluate
and manage credit management using traditional methods. The study also recommended that
commercial banks should have an independent internal control system for conducting
ongoing assessment of the bank’s debt collection policy, client appraisal practices and
lending policy. Additionally, the commercial banks should establish proper client appraisal
methods in order to mitigate credit risk. Proper customer credit worthiness system should also
be put in place based on their ability to repay back their credit and customer’s loyalty.
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