CREDIT ASSESSMENT PROCESS AND LOAN REPAYMENT: A CASE STUDY OF ATLANTIC BANK, BUEA

Abstract

The purpose of this study was to determine the impact of credit assessment process on loan repayment. The methodology employed in the study was a census survey. The study targeted all the 43 commercial banks registered in Kenya as at December 2013. Data collection was by means of a self-completion questionnaire which was filled by credit assessment officers. Secondary data was obtained from the annual reports from the publications by the Central Bank of Kenya. A response rate of 65.33 % was achieved which was considered adequate for analysis. The parameters considered under the credit appraisal processes were; the 5C’s Process, 5P’s Process, CAMPARI Process, LAPP Process, PACT Process and financial ratios. The factors in the credit assessment process that were analyzed include; policy, screening, appraisal and review. The study revealed that no one credit appraisal technique was used in isolation, with the banks opting to use more than one of each of the credit appraisal techniques. The most commonly used process was the 5C’s followed the use of financial ratios which had means of   1.96 and 2.64 based on a scale of 1 to 5 where 5 used to a very large extent while 5 was used to very little extent. PACT was the least used appraisal with a mean of 3.54 followed by LAPP with 3.14. The CAMPARI and 5Ps techniques had means of 2.89 and 2.96 respectively. A correlation analysis revealed that the use financial ratios was closely related to CAMPARI, PACT and LAPP appraisal processes which had correlation coefficients of 0.923, 0.819 and 0.709 respectively. Banks that used the 5Cs process tended to use the 5Ps as well as this had a correlation coefficient of 0.849. A regression analysis revealed that the main predictors of the credit appraisal process were financial ratios, the personal or corporate profile and the adequacy in staffing. The level of staffing was noted to cause work overload in some of the banks which reduced staff morale and efficiency. Factor analysis applied on the collected data using principal component analysis (PCA) produced three main components which had a cumulative factor score of 93.7%. The component that was related to previous business performance had the greatest weight of 52% while factors related to the future business prediction such as business plans, and the general business profile accounted for less than 30 % in considering the credit worthiness of borrowers. The study revealed there were weaknesses in credit appraisal policies (82%), which allowed rogue bank staff to award loans to non-qualifying applicants. The respondents however agreed the drafting of appraisal policies involved the input of bank staff. The study also revealed that the banks yet to fully integrate computerized credit appraisal techniques to include lie detectors to weed out borrowers who supply false information knowingly

CHAPTER ONE

INTRODUCTION

1.0 Introduction

Banks may either decide to eat well or sleep well. Eating well implies that they grant out more loans to their customers to generate more profits through interest rates. Giving out loans is the most profitable as well as riskiest activity a bank carries out and so certain measures are been put in place to minimize or eliminate these risks but nevertheless, these loans still go delinquent which makes lending difficult. Sleeping well on the other hand means keeping money in the bank to meet up with customer’s withdrawal demands at call and honoring their cheques at maturity. This has always been a bone of contest between management and shareholders as management will always want to maximize profits by granting loans while management will decide to sleep well and remain with the little dividend she receives and not entering into the risk of lending.

1.1 Background of Study

Credit/lending is the most profitable and income generating activity/sector in every commercial bank in particular and banking system in general. Most of the commercial banks that saw the light in the early nineteen centuries are no more today and had closed their doors due to poor credit evaluation before giving out loans which made the loans to go delinquent and eventually defaulted. It should be born in mind that proper credit assessment is key to every successful loan repayment and this assessment can only be carried out with the help of the 5C’s which some other school of thoughts have it as 7, 9, and 12 respectively. These principal 5C’s are: collateral, character, capital, capacity and condition. Cameroon’s financial sector is made up of a central bank, commercial banks, Insurance companies, Pension funds, micro finance institutions as well as self-help groups (njangi) who have roots to the colonial period and were historically oriented towards meeting the financial needs of external trade and large scale commerce. These financial institutions do not therefore have a track record of lending to households and start-up Small Enterprises. Bank lending is guided by credit policies which are guidelines and procedures put in place to ensure smooth lending operations. Bank lending if not properly assessed, involves the risk that the borrower will not be able or willing to honor their obligations.

In order to lend, banks accept deposits from the public against which they grant loans and other forms of advances. Since they bear a cost for carrying these deposits, banks undertake lending activities in order to generate revenue. The major source of revenue comprises margins, interest, fees and commissions. Beyond the urge to extend credit and generate revenue, banks have to recover the principal amount in order to ensure safety of depositor’s fund and liquidity adequacy. Bank lending has to consider interest incomes, cost of fund, statutory requirements, depositor’s needs and risk associated with loan proposals or applications. For these reasons banks have overtime developed credit policies and procedures which stipulate the lending process. These processes include among others; Credit appraisals, documentation and proper information collection, disbursement, monitoring and recovery processes, long term customer relations, collateral and compensating balancing and credit rationing.

Bank lending is also based on international standards. However, banks have continued to face an average of 10 – 20% bad debt written off yearly. However, there have been some improvements with Non-Performing Loans (NPL) improving from 14.1% in 2011 to 13.2% in December 2012and 12% by December 2013.

1.2 Problem Statement

Income from lending constitutes an average of 70 – 80% of all banks incomes (BEAC Report 2012, p.15). Credit policies and procedures are designed to guide lending and ensure prudent lending operations. Despite rigorous credit assessment process, Atlantic bank uses which include among others proof that customer does not have other credit obligations, analysis of their bank account performance, sustainability of their income levels, security and ability to pay, Atlantic bank is faced with problems of its loan portfolio. The financial records show that Atlantic bank’s provisions and bad debts written off increased over the years.

1.3 Research question

1. What are the procedures followed by banks in credit assessment?
2. What is the level of loan default on banks performance?
3. What strategies could be designed to improve credit assessment and repayment of bank loans?
4. Why do loans still go delinquent despite the numerous rigorous strategies put in place for its repayment?

1.4 Objectives of The Study

1.4.1 General objective;

To examine the effects of credit evaluation on loan repayment in Atlantic bank

1.4.2 Specific objectives;

1. To examine the appropriateness of credit assessment process used by Atlantic bank Cameroon and how it can reduce loan default.
2. To analyze the effect of credit assessment on loan repayment in Atlantic bank
3. To establish the level of loan default on Atlantic Bank’s performance.
4. To design and recommend strategies on how credit assessment and repayment of bank loans can be improved.
5. To establish the degree of security in relation to the risk associated with loans.
6. To recommend ways to curb loan defaults and strategies to reduce non-performing loan of Atlantic Bank.

1.5 Hypothesis

H₀: Credit evaluation has no significant effect on loan repayment.

H₁: Credit evaluation has a significant effect on loan repayment.

1.5 Significance of Study

The significance of this basic research is solely to add to already existing knowledge. The study is also to serve as;

Policy makers: provide empirical data for policy makers that assist in formulating appropriate policies for the operations of Atlantic bank

Banks: Provide recommendations on how to assess and recover the loans given to bank customers.

Researchers: To academicians and researchers, they will be furnished with relevant information regarding credit management practices in savings and credit cooperative societies.

Management: To management and directors the study will provide an insight into the various approaches towards credit management techniques and portfolio management in the sector.

Academia: Finally, this will also contribute to the general body of knowledge and form a basis for further research.

CREDIT ASSESSMENT PROCESS AND LOAN REPAYMENT: A CASE STUDY OF ATLANTIC BANK, BUEA