ST.

MARY'S UNIVERSITY COLLEGE

FACULTY OF BUSINESS
DEPARTMENT OF MANAGEMENT

FACTORS THAT AFFECT THE SIZE OFNON-

PERFORMING LOANS ON THE CASE OF DASHEN
BANK SHARE COMPANY

BY
HIBRET TEREFE

JUNE 2010
SMUC
Addis Ababa

FACTORS THAT AFFECT THE SIZE OFPERFORMING

LOANS ON THE CASE OF DASHEN BANK
 SHARE COMPANY

A SENIOR ESSAY SUBMITTED TO THE DEPARTMENT OF

MANAGEMENT FACTULTY OF BUSINESS
ST. MARY UNIVERSITY COLLEGE

IN PARTIAL FULFILMENT OF THE REQUIREMENT FOR THE

DEGREE OF BACHELOR OF ARTS IN MANAGEMENT

BY
HIBRET TEREFE

June 2010
SMUC
Addis Ababa

ST. MARY'S UNIVERSITY COLLEGE

 FACTORS THAT AFFECT THE SIZE OFPERFORMING
LOANS ON THE CASE OF DASHEN BANK
SHARE COMPANY

BY
HIBRET TEREFE

FACULTY OF BUSINESS DEPARTMENT OF MANAGEMENTS

APROVED BY THE COMMITTEE OF EXAMINES

_____________ _______________
Department Head Signature

______________ _______________
Advisor Signature

______________ ______________
Examiner Signature

______________ ______________
Examiner Signature
 ACKNOWLEDGMENT

First of all, I would like to pass my sincere thanks to the Almighty God and his mother
St. Marry for their assistance and guidance in completing this degree program. Secondly,
my heartfelt gratitude goes to my advisor Ato Ephrem Admassu for his guidance and
follow-up while preparing this paper. My deep appreciation also goes to employees of
Dashen bank who actively participated in this research project by providing me all
relevant information in the questionnaire as well as during interviews.

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 TABLE OF CONTENTS
LIST OF TABLES ......................................................................................................... iv
ACRONYMS .................................................................................................................. v
ABSTRACT................................................................................................................... vi
CHAPTER ONE: INTRODUCTION .............................................................................. 1
1.1 Background of the study ........................................................................................ 1
1.2 Background of the organization ............................................................................. 2
1.3 Statement of the problem ....................................................................................... 3
1.4 Research Questions ................................................................................................ 5
1.5 Objectives of the study........................................................................................... 5
1.6 Significance of the study ........................................................................................ 6
1.7 Scope of the study.................................................................................................. 6
1.8 Limitation of the study……………………………………………………….……..6
1.9 Research Design and Methodology ....................................................................... 7
1.9.1 Research Design……………………………………………………………….7
1.9.2 Population and Sampling Techniques…………………………….…………...7
1.9.3 Types of Data Collected ………………………………………………………8
1.9.4 Methods of Data collection …………………………………………...………8
1.9.5 Methods of data analysis ……………………………………………………...8
1.10 Organization of the study ..................................................................................... 9
CHAPTER TWO: LITRATURE REVIEW ..................................................................... 9
2.1 Concepts of Non-Performing Loan (NPl) ............................................................. 10
2.2 Classification of non-performing loans (NPLs) .................................................... 10
2.3 Credit Risk .......................................................................................................... 11
2.4 Causes of bad loans ............................................................................................. 12
2.5 Preventing and handling of bad loans ................................................................... 13
2.6 Principles of good lending ................................................................................... 16
2.7 Steps in the process of commercial and industrial (C&I) loans ............................. 18
2.8 Collateral Security ............................................................................................... 20
2.9 Evaluation of a Credit request .............................................................................. 22

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CHAPTER THREE: DATA PRESENTATION ANALYSIS &INTERPRETATION .... 25
3.1 Major Types of Credit Facilities........................................................................... 25
3.2 Opinions of staff members and borrowers regarding major factors ....................... 28
3.2.1 Analysis of basic Variables ........................................................................... 30
3.2.2 Assessment made by the bank before granting loans ..................................... 30
3.2.3. Follow-up mechanism of the bank after granting loans to customers ............ 31
3.2.4 The bank’s mechanisms when borrowers failed to pay their debt regularly .... 34
3.2.5 Procedures to get loan from the bank............................................................. 34
3.2.6 The causes of NPLs from borrowers’ side ..................................................... 36
3.2.7 The causes of NPLs from the bank side ......................................................... 41
3.2.8 Staff members’ and borrowers’ opinion about other factors ........................... 45

CHAPTER FOUR: SUMMARY,CONCLUSION AND RECOMMENDATION .......... 47

4.1 Summary of major findings ................................................................................. 47
4.2 Conclusion........................................................................................................... 49
4.3 Recommendation ................................................................................................. 52
REFERENCES.............................................................................................................. 53
ANNEXES………………………………………………………………………….……54
Annex I: Questionnaire .............................................................................................. 55
Annex II: Interview questions .................................................................................... 59

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LIST OF TABLES

Table 1.1: Outstanding Loan Vs NPL…………………………………………………..4

Table 3. 1: Demographic characteristics of the respondents……………………………28

Table 3.2: Assessment made by the bank before granting the loan to borrowers…… 30

Table 3.3 Causes of NPLs from borrowers’ side…………………………………….. 35

Table 3.4 Causes of NPLs from the bank side ………………………………………...40

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 ACRONYMS

1. NBE National bank of Ethiopia

2. NPL Non-performing loan

4. FY Fiscal Year

5. S.C Share Company

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 ABSTRACT

As it is known, lending is the principal function of banks through extending of loans out
of the deposit they collected from depositors. In the course of their operation however,
banks may face the risk of getting loss because of uncollectible loans. Due to this, the
loan portfolio will be dominated by non-performing loan (NPLs).Therefore, the main
purpose of this study is to identify factors that contribute to increase the size of non-
performing loans in banks.
The study used both primary and secondary data collection methods to answer its
research questions. Among primary ones, 51 self-administered questionnaires were
distributed to the staffs who are engaged in loan processing and approving at head office
and branch level of Dashen bank. The response rate of the questionnaire is 94 %( 48). In
order to make the study complete, 60 questionnaires were also distributed to borrowers
of the bank at different branches. The response rate is 42 %( 25), due to the customers
not coming regularly. In addition, some selected loan officers and branch managers were
interviewed to justify the answers given in the questionnaire. Secondary data also
gathered from publications of the bank, loan procedure manuals, journals, websites and
books. Then, the data collected from questionnaire was analyzed using descriptive
statistical method such as percentages in order to make the paper simple to understand.
In addition, tables were used to present the results of the study.
The result of the study indicates that diversion of the borrowed fund to other purpose,
lack of adequate knowledge and experience on how to use the granted loan by the
borrower, un-planned and ambitious business expansion, unwillingness and carelessness
of borrowers to pay their debt and providing falsified financial statements to the bank
are considered by the staff members of the bank as significant factors to make borrowers
in default and increase the balance NPLs in the bank. In addition to these factors,
borrowers reveal that lack of adequate market to sell their goods and services, economic
and political environment of the country are the major causes of the problem. On the
other hand, not taking timely action by the bank when borrowers start to default,
competition among banks to attract borrowers and lack of strict follow-up and loan
workout procedure, are regarded as significant factors that contribute to increase the
size of NPLs from the bank side.
To conclude, the study identifies various factors that contribute to increase the size of
NPLs in the bank, and hence most of the reasons emanate from the borrowers’ side. By
strengthen the existing loan processing procedures together with creating credit
awareness to borrowers; the bank can reduce the chance of loan loss to the large extent.
Therefore, in order to improve its credit processing quality, the bank should have
competent and trained staffs by providing adequate and up to date training as a
continuous basis.

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 CHAPTER ONE
INTRODUCTION

1.1 Background of the study

Banks are financial institutions licensed by a government and play a very

important role in the economic development of every nation. They are
mainly engaged in mobilizing idle funds from the public in the form of
saving and demand deposit and deploy the fund back to the public in the
form of loans and there by earn income in the form of interest and charges.
They have control over a large part of the supply of money and circulation.

Non-Performing Loan (NPL) is a loan that is default or close to being in

default. Many loans become Non-performing after being in default for 3
months, but this can depend on the contract terms.” A loan is non -
performing when payments of interest and principal are past due by 90 days
or more, or at least 90 days of interest payments have been capitalized,
refinanced or delayed by agreement, or payments are less than 90 days
overdue, but there are other good reasons to doubt payments will be made
in full”(www.wikipedia.com).

Dashen Bank is one of the oldest private banks in Ethiopia specifically

designed to further the capital formation process through the attraction of
deposits and extension of credit. However, there are several challenges that
the bank have been facing in its day to day activities. One of the main
challenges facing Dashen Bank is the problem of Non- performing Loan
NPL. Even though, the bank can collect more than 95% of its outstanding
loans each year, currently it has categorized about 90 million birr as non-
performing loan (Dashen Bank Audit Financial Result from year 2004-2008).
 The accumulation of non-performing loans creates a problem by making
provisions for them out of the profit earned by the bank. At the extreme case,
when the value of NPLs becomes greater than the capital of the bank, the
bank will face a series liquidity problem that could be turned out to solvency
problem. Therefore, it is essential for banks to identify the various factors
that can increase the size of non-performing loans and take corrective
measures to drop the balance.

1.2. Background of the organization

The new economic policy introduced in November, 1991 G.C caused the
culmination of the command economic heralding the establishment of a market
oriented one. This policy change created an opportunity and a conducive
environment for the emergence of private financial institutions aimed at the
bringing a meaningful economic role in the development efforts of the country
(www.dashenbanksc.com).

Dashen Bank was established as per the intent of the new policy and the
Ethiopian investment code. It came into existence on September 20, 1995 G.C
according to the commercial code of Ethiopia, 1960, and the licensing and
supervision of banking business proclamation No. 84/1994
(www.dashenbanksc.com).

The first founding members were 11 businessmen and professional that agreed
to combine their financial resources and expertise to form this new private bank.

"Ras Dashen" is the highest mountain of Ethiopia. It is also the habitat of rare
wild animals such as the” Wali Ibex” and Gelada Baboon. These unique

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characteristics of the mountain coincided with the interest of the founders of the
Bank and prompted them to adopt this great name and epitomize their
aspiration. Rightly, reaching the top of banking business in dynamic and
competitive business environment symbolized the highest peak, while the
unique and efficient services the bank caters for the public through state -of-the-
art computer technology and carefully selected and trained man-power equated
with the rare wild animals. Today, indeed, reliability, efficiency and modernity
are the hallmark and the bank's distinguishing features which make them
synonymous with Dashen Bank as much as the rare animals are synonymous
with Ras-Dashen Mountain (www.dashenbanksc.com).

Vision of Dashen Bank

“In as much as mount Dashen excels all other mountains in Ethiopia, Dashen
bank continues to prove unparalleled in banking service.”

Mission of Dashen bank

“Provide efficient and customer focused domestic and international banking

services/overcoming the continuous challenges for excellence through the
application of appropriate technology.”

1.3. Statement of the problem

In order to be competitive and profitable in the banking industry, for any bank,
the balance of NPL should be kept at minimum level as much as possible.
The Dashen Bank’s audit financial result from year 2004-2008 demonstrates that
the percentage proportion of Non-performing Loans NPL with that of
outstanding loans has been decreasing. This shows that among the total
outstanding loans granted, the bank has collected more than 95% of them each
year. However, the bank on average could not collect about 3.28% of its
outstanding loans each year during the last five years period. Therefore,

3
identifying the root causes for the uncollected money is very crucial in order to
increase the profitability of the bank.

There may be so many reasons for customers not to pay their debt timely as they
promised. The reasons may be from borrowers’ side or creditors’ side or from
both of parties. Therefore, this study identified and analyzed various causes for
the amount of NPL in Dashen Bank and provides constructive suggestions to
minimize the balance.

Table 1.1: Outstanding Loan Vs NPL

Year Outstanding Total NPL Percentage

Loan proportion

2004 1,627,369,234 95,908,208 5.89 %

2005 2,160,632,436 99,853,270 4.62 %

2006 3,080,263,248 105,582,459 3.42 %

2007 3, 889, 003, 61 102,839,781 2.64 %

2008 4,291,704,476 89,715,336 2.09 %

Source :(Dashen Bank Audit Financial Result from year 2004-2008)

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 1.4. Basic Research questions

The current study is intended to answer the following research questions

 What are the types of credit facilities offered by Dashen bank?

 How the bank follows up its borrowers after granting the loans?
 To what extent the bank’s loan processing steps contribute
towards the customers’ failure to pay?
 What are the major causes of non-performing loans (NPLs) from
borrowers’ (customers) side?
 What are the major causes of non-performing loans from
creditors’ (bank) side?

1.5. Objectives of the study

General objective

The primary objective of the study is to identify various factors that determine
the size of non-performing loans in the bank.

Specific objectives

Specifically, the current study has the following detailed objectives:

 To describe how Dashen bank S.C offers the different types of credit
facilities for its customers.
 To evaluate the loan granting procedures of the bank.
 To assess the bank’s follow-up effort regarding loan settlement.

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1.6. Significance of the study

This study identified several causes for the existence non-performing loans in
banks. Therefore, the study will inform the bank’s credit department on how to
minimize the balance of non-performing loans in the loan portfolio. It will also
contribute some knowledge to the existing loan management practices of the
bank. Moreover, this study will serve as an input to further study in the area of
bank’s credit management.

1.7. Scope of the study

The study focused on identifying different factors that contribute towards the
borrowers to default. To this effect, the study will only request staffs who work
in loan processing activity and some branch managers who are engaged in
approving loans. In addition, the study will be conducted on few branches of the
bank that are found in Addis Ababa and at the head office credit department.
These branches have been selected based on their rank in loan amount. The
branches are Dashen Main, Messalemia , Golla, Tana, Tikur Anbesa , and Kera
which are ranked them on up to seven. Furthermore, the study will be conducted
based on the NPL data provided by the bank that covered 2004-2008.

1.8. Limitation of the study

Wholly conducting study, the student researcher has faced same problems
regarding to obtain the right information. to this effect, the absence and
unwillingness of borrowers to fill the questioner, the response of staff numbers of
the bank and borrowers as ‘neutral for most of the questions are sum of them

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1.9. Research Design and Methodology

1.9.1. Research design

The researcher will use descriptive approach, because even though the study
will be conducted on the case of Dashen bank it will not analyze each factor in
detailed manner.

1.9.2. Population and Sampling Techniques

There are 25 branches of Dashen bank S.C in Addis Ababa. In each branch, there
are on average six employees who work in the loan sections as loan officers, loan
clerks, loan section heads, and credit follow-up personnel and one branch
manager. From the total 25 branches, 6 branches will be selected based on the
rank in loan amount, which is 25%. At head office level, there are about 15
employees who are engaged in handling, processing and approving the loan
requests of customers, all of them will be candidates for this study.

The study will used purposive /Judgmental sampling technique which is one
type of non probability sampling method. This method allows the researcher to
select targeted employees that can provide relevant information to answer the
research questions. Therefore, the total target population of the study is
estimated to be fifty one employees. To this end, from six branches, 36
employees and form head office, 15 employees will be candidates for this study.
Thus, staffs who are currently working in loan processing activities will be good
candidates for the study.
In order to make the study complete and meaningful, the student researcher
will also gather opinions of borrowers regarding the causes of their delay to pay
their debt on the agreed time. In the selected six branches, there were about 612
customers on overage. Since it is very difficult to get customers in the bank’s
premises and collect their opinion as they come once in a month to pay their

7
debt or for some other reason, questionnaires will be distributed to only 10% of
them randomly to borrowers, i.e., 60.

1.9.3. Types of Data collected

The study will use both primary and secondary data collection methods to meet
its objectives. The primary data includes questionnaire and interview. The
secondary data includes annual reports of the bank, Loan procedure manuals,
magazines, book etc.

1.9.4. Methods of data collection

Among primary ones, the study will mainly use apply self administered
questionnaire using five point likert- scales. The questionnaires will be
distributed to the fifty one employees and sixty borrowers to be completed
individually on the questionnaire, respondents will be asked to express their
opinion regarding the level of significance each factor contribute to increase the
size of NPLs in the bank as very relevant, relevant, average, irrelevant and very
irrelevant. In addition, some selected staffs will also be interviewed un
structurally to fill the gap of answers provided in the questionnaire.
Secondary data also gathered from publications of the bank and other financial
institutions, the bank’s loan management manuals, journals, magazines,
websites and books.

1.9.5. Methods of data analysis

The data collected from questionnaire will be analyzed using descriptive
method such as percentages in order to make the paper simpler to understand.
In addition, tables were used to present the results of the study.

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1.10. Organization of the study

The study will have four chapters. The first chapter will state background
information, problem statement, objectives of the study and method of data
collection and analysis. The second chapter will reveal sufficient literatures that
are relevant to the study. The third chapter will show the analysis of data
collected and findings of the study. Finally, the last chapter will conclude the
paper by summarizing the major findings of the study and forwarding
constructive recommendations.

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 CHAPTER TWO

LITRATURE REVIEW

2.1 Concepts of Non-Performing Loan (NPL)

The lending function is considered by the banking industry as the most important
function for the utilization of funds. Since, banks earn their highest gross profits from
loans; the administration of loan portfolios seriously affects the profitability of banks.
Indeed, the large number of non-performing loans is the main cause of bank failure.

According to Wikipedia definitions, a non-performing loan is a loan that is in default or

close to being in default. Many loans become non-performing after being in default for 3
months, but this can depend on the contract terms. “A loan is nonperforming when
payments of interest and principal are past due by 90 days or more, or at least 90 days of
interest payments have been capitalized, refinanced or delayed”

As per the National Bank of Ethiopia (NBE) directive no. SBB/32/2002, a loan is
identified and segregated as non-performing loan depending up on the number of days
the repayment is delayed or if discontinued at least for ninety days. Accordingly, a loan is
categorized as NPLs if its repayment is delayed or discontinued for at least ninety days.

A loan whose repayment is not discontinued /delayed is included either in pass or special
mention category. Loans and advances under pass category are those being repaid
regularly as per the agreement made between the borrowers and the bank. In addition,
loans and advances secured against cash or cash substitutes are also classified under this
category regardless of the past due status. Special mention category includes any loans
and advances that past due 30 days or more but less than 90 days (NBE directive no.
SBB/32/2002).

2.2 Classification of non-performing loans (NPLs)

According to the NBE directive mentioned above, non-performing loans (NPLs) are
classified under three categories: as substandard, doubtful and loan loss. The substandard

10
category includes any loans and advances that past due 90 days or more but less than 180
days with a 20% minimum provision to be maintained against the outstanding principal
amount. Other than this criteria, sufficiency of cash flow to meet current maturing debts,
adequacy of financial information and collateral documentation are also considered to
categorize the loan
The doubtful category consists of any loans and advances that past due 180 days or more
but less than 360 days with a 50% minimum provision to be maintained. In addition, this
group includes loans that have insufficiency of cash flow to meet short- term liabilities,
insufficiency of capital, unbalanced security defect and deterioration of the financial
position of the borrower.

The third category of non-performing loan is loan loss. This category comprises any
loans and advances whose repayment is delayed or discontinued for more than 360 days
and overdue loans. A 100% provision is to be maintained against the outstanding
principal amount under this category.

In trucking out loan losses, the presence or absence of one or more of the following
conditions needs to be considered. The first condition might be if the borrower is
bankrupted and has no other resource to cover the debt. The second condition could be if
the security offered for the loan has no value or very small to settle the debt. The last
situation may be if the proceed from disposing collateral is insufficient to cover the debt
and the balance of the loan is thought to be not covered by other means (NBE directive
no. SBB/29/2002).

2.3 Credit Risk

Credit risk is a risk where the borrower may not be able or willing to repay the debt
owed to the bank, or to honor other contractual commitments. Credit risk factors include
various factors which may affect the ability of borrowers to repay loans in full as well as
factors which affect the bank’s ability to resolve non-performing loans. As a result of
these factors, actual losses incurred toward the end of the problem debt recovery process
may also affect the bank’s capital adequacy. The significant credit risk factors are the size
of Non-performing loans, economic growth of the country, problems of political

11
uncertainty and violence sensitivity of export businesses where there is intensifying
competition in international markets as well as exchange rate volatility. All these factors
may affect businesses and the debt repayment capacity of the Bank’s customers
(Bangkok Bank annual report, 2006)

For most banks, loans are the largest and most obvious source of credit risk.
However, there are other pockets of credit risk both on and off the balance sheet, such as
the investment portfolio, overdrafts, and letters of credit. Many products, activities and
services such as derivatives, foreign exchange, and cash management services also
expose a bank to credit risk (Comptroller’s Handbook, 1998)

The risk of repayment, i.e., the possibility that an obligor will fail to perform as agreed, is
either lessened or increased by a bank’s credit risk management practices. A bank’s first
defense against excessive credit risk is the initial credit-granting process-sound
underwriting standards, an efficient, balanced approval process, and a competent lending
staff. Because a bank cannot easily overcome borrowers with questionable capacity or
character, these factors exert a strong influence on credit quality. Borrowers whose
financial performance is poor or marginal, or whose repayment ability is dependent upon
unproven projections can quickly become impaired by personal or external economic
stress. Management of credit risk, however, must continue after a loan has been made, for
sound initial credit decisions can be undermined by improper loan structuring or
inadequate monitoring (Comptroller’s Handbook, 1998).

2.4 Causes of bad loans

If a bank fails to collect its outstanding loans because of bad loans, it may encounter
liquidity problem and loans might be written off as un-collectibles. This will reduce the
reserve, profit and capital of the bank. This is also may erode public confidence & lead
the bank to be closed due to excess abnormal withdrawals of money by customers (Koch
and W.Timothy, 1995, p137).

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Whenever a loan is not paid accordingly to the terms of the initial agreement or in an
otherwise acceptable manner, it is classified as bad loan. Loan losses are natural by
products of extending credit. Loans become problem credit as a result of controllable &
uncontrollable factors. Controllable factors are those that reflect through the overall bank
credit policy as well as inadequate credit analysis, loan structuring, and loan
documentation. Uncontrollable factors typically reflect adverse economic conditions;
adverse changes in regulations globalize changes surrounding the borrower’s operations
& catastrophic events (Koch and W.Timothy, 1995, p137).

While there is little that can be done to prevent uncontrollable problems, effective credit
granting can significantly reduce other sources of losses. Sometimes the credit analyst
may have been faulty because it was based on inadequate information or incomplete
analytical procedures. Economic conditions may change adversely after the loan is
granted so that the borrower cannot meet debt service requirements (Koch and
W.Timothy, 1995, p138).

2.5 Preventing and handling of bad loans

Safety is the watchword in commercial bank lending activities. Bankers want to feel
reasonably sure that the principals of their loans will be repaid, even though they may
have to be satisfied with relatively low rates of interest because of their selection of only
the better risks.

Banks deal with problem loans in a variety of ways. The eventual path to collect problem
loans depends on how early the problems are discovered. Problems that are discovered
early enough can frequently be corrected by restructuring the borrower’s operations and
repayment schedule. As cited by Rose (1999, p243) there are useful warning signals of a
weak loans and poor bank lending policies. The signals of weak loans include irregular or
delinquent loan repayment, frequent request for alternations in loan, rising debt to net
worth and not fulfilling documents like financial statements. In addition, requests for
reappraisal of assets to increase net worth and applying for loan on poor quality collateral

13
are signal of problem loans. The customer may also rely on non-recurring sources of
funds, such as selling of buildings and equipment to meet loan repayments.

On the other hand, poor selection of risks among borrowing customers, lending money on
contingent future events, lending money because a customer promises a large deposit,
failure to specify a plan for liquidation of each loan are indicators of poor lending
policies. In addition to this, substantial loans to insides including employees, directors, or
shareholders, tendency to overreact to competition, like making poor loans to keep
customers from going to other banks is dangerous attitude. Lending money to support
speculative purchases and lack of sensitivity to conditions are also good indicators of
inadequate or poor bank lending policies (Koch & W.Timothy, p 157-58).

Lending difficulties can be reduced if management establishes and adheres to loan policy
guidelines that restrict unacceptable activity. Such guidelines specify quantitative goals.
The procedures document, the format for obtaining loan application, grading loan,
approving loans and systematically reviewing loan performance and quality
(Daniela.et.al, 1996).

Once the bank comes to the realization that it has a problem loan on its books, the first
thing it should do is to contact the debtor. This helps to assess the attitude of the borrower
and to find solutions to the problem. If the bank expects a debtor’s cooperation, it is
usually necessary to give him assurance that the bank wishes to cooperate with him and
that is advantageous to both the bank and the debtor. At this instance, the bank must
hope to achieve a two-fold effect. It must be forceful enough to convince the debtor that
the situation is serious and those positive steps of correction must be taken immediately.
But it must also be reasonable and conciliatory enough that the debtor will believe that all
is not lost, and that cooperating with the bank in instituting plan for correction may be
beneficial to him. In no case the bank’s officer should make unrealistic demands for
immediate payment, unless obvious fraud or gross misrepresentation exists, nor should
they threaten legal action at this time (Daniela.et.al, 1996).

14
The second step in handling the problem loan, as described by the same author is
searching solutions. Achieving workable solution is rarely easy, and in some cases
impossible. Where a workable solution can be found, the bank has no alternative but to
collect the loan, either through the voluntary liquidation of assets by the debtor or by
forced liquidation. The benefits that accrue to the debtor, if the plan for correction is
successful are rather obvious. For the bank as well, if it can help the borrower solve his
problems and become a successful businessman, it will have a loyal customer for many
years to come. The bank ordinarily gains the goodwill of the customer, as well as the
business community as a whole. Remedial actions should be sought to recover problem
loans using various workout strategies. Each problem is different, and no routine is
universally applicable. Some of the most common approaches to be considered include:
- Developing a debt structuring program
- Agreeing on additional documentation and guarantees
- Calling on a guarantees
- Arranging for joint partnership and capital contribution
- Working with management to define problems and potential solution
- Developing a retrenchment program with closely monitored budgets
- Arranging the sale of the operating company to a third party
- Replacing management
When all the above methods fail to be effective in the recovery process, the bank has no
option but to forego the dues by writing them off. Write off should, however, be
permitted as the last resort after exhausting all other opportunities (Daniela.et.al, 1996).

As a solution, the creditor may seek to solve the borrower’s problem of inadequate cash
flow to meet loan obligations through the extension of loan terms. Extensions and
renewals however; should be considered only after a thorough examination of a cash flow
projection, and only if there is adequate evidence that repayment will actually materialize
at a later time. Any renewals should be for a short period of time, & the bank should
carefully re-examine its position before granting additional renewals or extension. There
are several dangers involved in the granting of an extension. The debtor may fell relieved
from the pressure, and may reduce his efforts to repay the debt, or divert available cash to

15
the repayment of other debts, which are more pressing. Therefore; when dealing with
prospective renewal request, the lender should carefully analyze the credit in the same
manner as would analyze a new application (Daniela.et.al, 1996).

2.6 Principles of good lending

When evaluating loan requests, bankers can make two types of errors. The first is
extending credit to a customer who ultimately defaults; the second is denying a loan
request to a customer who ultimately could repay the debt. In both cases, banks lose a
customer and its profits (Koch & Timothy, 1995, p101).
To minimize such errors and to prevent problem loans before their occurrences, there are
few general principles of good lending that should be noted while considering an advance
proposal. These include safety, liquidity, and purpose of loan proceeds, profitability and
diversification (Rose, 1999).

“Safety First” is the most important principle of good lending. When a banker lends, he
must feel certain the advance is safe. That is the loan is undoubtfully collectable. If for
example the borrower invests the money in unproductive or speculative venture or if the
borrower himself is dishonest, the advance would be in problem. Similarly if the
borrower suffers loss in his business due to his incompetence, the recovery of the money
may become difficult. The banker ensures that the money advanced by him goes to the
right type of borrower and is utilized in such a way that it will be safe at the time of
lending but will remain so throughout and after serving useful purpose in the trade or
industry where it is employed, and is repaid with interest (Rose, 1999).

The other important task faced by bankers is ensuring adequate liquidity. It is simply
defined as the ability of a bank to convert to a sufficient amount of assets in cash readily
and at favorable price to satisfy at any time both the normal and abnormally high
withdrawal demand of its operation. A bank is said to be liquid if it has immediate access
to funds at reasonable cost at precise time as the funds are needed. In order to ensure
liquidity of the bank, it is necessary to check liquidity of the loan to be granted.
Therefore, it is not enough that the money will come back, it is also necessary that it must

16
be collected on demand or in accordance with agreed terms of re-payment. The borrower
must be in a position to repay within a reasonable time after a demand for repayment is
made. This can be possible only if the money is employed by the borrower for short-term
requirement and not locked up in acquiring fixed assets, or in schemes that take long time
to pay back (Rose, 1999).

The source of repayment must also be definite. The reason why bankers attach much
importance to liquidity as to safety of their funds in that bulk of their deposits is
repayable on demand or at short notice. If the banker lends a large portion of his funds to
borrowers from whom repayment would be coming in but slowly, the ability of the
banker to meet the demands made on him would be seriously affected in spite of the
safety of the advances (Rose, 1999).

Assessing liquidity of the borrower is measuring his repayment ability without disrupting
to normal operation of his business (Daniela et, al, 1996 p345)

Another principle of good lending that must be looked into is the purpose of the loan
proceeds. The range of business loan needs is unlimited. Firms may need cash for
operating purpose to pay overdue suppliers, to make a tax payment or pay employees
salary. Similarly they may also need funds to pay off debt obligations or to acquire new
fixed assets. Frequently a firm recognizes that it is short of cash but cannot identify why.
The first issue facing the credit analyst is what the loan proceeds are going to be used for
legitimated business operating purposes, including seasonal and permanent working
capital needs, for the purchase of depreciable assets, physical plant expansion, acquisition
of other firms, and extra ordinary operating expenses. Speculative asset purchases and
debt substitutions should be avoided. The true need and use determines the loan maturity,
the anticipated source and timing of repayment, and the appropriate collateral (Rose,
1999).

Profitability is also equally important principle in bank activities as other commercial

institutions, banks must make profits. Firstly they have to pay interest on the deposits
received by them. They incur expenses on establishment, rent, stationary, etc. they make

17
provision for depreciation of their fixed assets and also for any possible bad or doubtful
debts. After meeting all these items of expenditure, a reasonable profit must be made,
otherwise it will not be possible to carry anything to be reserved or pay dividends to
shareholders. It is after considering all these factors that a bank decides upon its lending
rate (Rose, 1999).

Another important principle of good lending is the diversification of advances. An

element of risk is always present in every advance whatever security might appear. In
fact, the entire banking business is one of taking calculated risk and a successful banker is
an expert in assessing such risks. He/she is keen on spreading the risks involved in
lending over a large number of borrowers, over large number of industries and areas, and
over different types of securities. For example if he or she has advances of large
proportion of his funds against only one type of security he will run a big risk if that class
of security steeply depreciates. If the bank has numerous branches spread over the
country, it gets a wide assortment of securities against the advances (Rose, 1999).

2.7 Steps in the process of commercial and industrial (C&I) loans

The activities in the process of commercial and industrial (C&I) loans follow eight steps.
These steps are application, credit analysis, decision, document preparation, closing,
recording, servicing and administration, and collection (Wei-Shong and Kuo-Chung
(2006)).

The first step of the C&I loan process is the application, which is conducted by a loan
officer. This step covers the initial interview and screening of a loan request. Initially, the
loan officer obtains as much information as possible about the situation of the borrower,
for example, his or her previous credit history, current outstanding loans, and current
financial statement. The loan officer gathers company information, including legal status,
principal employees, main products or services sold, production techniques employed,
important competitors, and directors of the company.

The second step is the credit analysis conducted by the credit department. First, the
analyst in the credit department receives the financial information of the borrower
gathered by the loan officer; then he or she conducts a comparative and historic analysis

18
of the company's financial data. After finishing the financial comparative analysis, the
analyst prepares a recommendation report for the loan officer about whether the loan
should be granted, rejected, or qualified.

In the third step, the loan officer obtains the credit analysis report and determines
whether the report accurately describes the borrowing capacity and characteristics of the
borrower. The loan officer then grants the loan with or without considerations of
collateral. The loan officer notifies the borrower of his or her decision and proceeds to
negotiate loan terms if the loan is to be granted.

When the loan officer and the borrowing company are in agreement, the fourth step is
the loan operation. Here it is necessary to prepare primary notes, agreements, collateral or
non-collateral agreements. If collateral is required, the amount of collateral and additional
collateral documentation are indicated.

In the fifth step, the loan officer obtains the borrower's signatures and receives
collateral; then the loan operation is closed and the loan proceeds.

The sixth step is the recording of the loan conducted by the loan operation and credit
department staff. A loan operation clerk classifies and codes the loan for entry into the
commercial loan system, and he or she reviews the loan for compliance with the bank's
loan policies. Finally, the loan operation clerk and credit department staff member file the
loan notes, authorization, and receipts in designated files.

The seventh step is loan servicing and administration conducted by a loan operation
operator, a loan officer, a credit department staff member, and a financial analyst. The
loan operation staff person prepares the loan payment notices to notify the borrower and
is responsible for receiving periodic payments. The loan officer makes periodic visits and
customer calls to obtain new financial statements from the borrower and provides that
information to credit department and reviews the loan for compliance with the loan
agreement. A credit department financial analyst also receives and reviews the borrower's
periodic financial statements.

19
In the eighth stage, the loan officer may receive periodic delinquency information and
need to follow up on this with borrowers. The loan officer also needs to adjust loan terms
and conditions as deemed necessary, and to take legal action if non-collectible procedures
and foreclosure on the loan are required.

2.8 Collateral Security

In the employment of funds, a banker generally attaches great significance to the

consideration of security. Collateral is the security a bank has in assets and pledged by
the borrower against a debt in the case of default. Banks look to collateral as a secondary
source of repayment when primary cash flows are insufficient to meet debt service
requirements. Banks can lower the risk of loss on a loan by requiring back up support
beyond normal cash flow. This can take the form of assets held by the borrower or
explicit guarantees by a related firm or key individuals (Koch &W.Timothy, 1995, 116)

Virtually any asset can be used as collateral. From lenders perspective however, collateral
must exhibit three features. First, its value should always exceed the outstanding principal
of the loan. Any lender that must take possession of the collateral can then sell it for more
than the balance due, and losses are reduced. Let us assume lending for the purchase of
an automobile, where the value the car is less than the outstanding loan balance. The
borrower may have a financial incentive to default on the loan. Second, a lender should
be able to easily take possession of collateral and have a ready market for sale. Highly
liquid assets are worth for loss because they are not portable and often are of real value to
the original borrower. Third, a lender must be able to clearly move collateral as its own.
This means that the claim must be legal and clear (Koch&W.Timothy, 1995, 116-117)

It is incorrect, however, to consider an advance proposal from the point of view of

collateral alone. An advance is granted by a good banker on its own merits, that is to say,
with due regard to it’s safely, likely purpose etc, and after looking in to the character,
capacity and capital of the borrower and not because the collateral is good
(Koch&W.Timothy, 1995, 117).

20
In explaining the advantage of having collateral behind a loan, Rose (1999, p 214) puts
two purposes as follows.

If the borrower cannot pay, the pledge of collateral gives the lender the right to seize and sell
those assets designated as loan collateral, using the proceeds of the sale to cover what the
borrower did not pay back. Secondly, collateralization of the loan gives lender a psychological
advantage over the borrower. Because specific assets may be at states (such as the borrowers
automobile or home), a borrower feels more obligated to work hard to repay his loan and avoid
losing valuable assets.

Even though collateral serves as secondly source of repayments, in general loan shouldn’t
be approved on the basis of collateral alone. Liquidating collateral is clearly a second best
source of repayment for three reasons. First, there will be significant transaction costs
associated with foreclosure so banks must often allocate considerable employee time and
pay large legal expenses that reduce the collateral net value above the anticipated loan
amount. Second, bankruptcy laws allow borrowers to retain possession of the collateral
long after they have defaulted. During that time the collateral often disappears or
deteriorates in value. Third, when the bank takes possession of the collateral, it deprives
the borrower’s opportunity to salvage the company. The bank must hire new managers or
manage the firm temporarily with its own personnel until sale, which is poor alternative
(Rose, 1999, p 215).

Different types of assets can be used as collateral to guarantee repayments. Some of them
are accounts receivable; inventories, share certificates, plant and machinery, motor
vehicles, building property, life insurance policies and personal guarantees. Normally, all
properties movable or immovable held, as security for advances must be insured against
fire, unless the risk has been generally or specifically waived. Sometimes the securities
should also be insured against strike, riot, theft, flood, earthquake, explosion, storm and
tempest in addition to the risk of fire (Bedi & Hardikar 1993.p.235).

In considering assets for loan securities, there are certain qualities which a good tangible
security should posses. The attributes such as its marketability, easy ascertainment of its
value, stability of its value, its storability, the cost and labor of supervision, its

21
transportability, its durability, the ascertainment of title, easy transfer of title, the absence
of contingent liabilities with the asset and its yield (to be source of repayments) are
important in collateral consideration (Bedi & Hardikar 1993 p. 235). The need for
security in lending is understandable. There is always an inherent risk in credit extension,
especially over a relatively long period of time. Besides, no bank can claim that all its
loans and advances will be performing portfolios. Therefore, the need for security to
safeguard a bank against risk is almost always a must.

Bank loans generally should be well secured by pledge or mortgage or properties

.However, sometimes clean (unsecured) advances are granted for short periods after
proper consideration of the net liquid resources of the borrowers. Since there is no
security to fall back upon, credit, capital and capacity should be carefully assessed before
granting clean loan granting facilities. The extent of free resource of the borrowers has to
be examined and the reasons for not furnishing security also must be examined (Bedi &
Hardikar 1993 p. 236). Generally collateral supports bankable credit requests. Non-
bankable credit requests could be rejected even if it is supported by high value of
collateral relative to the amount of loan requested. The safety of an advance, when on a
secured basis, depends to a considerable extent on the quality of the security in question.

2.9 Evaluation of a Credit request

The basic objective of credit analysis is to assess the risks involved in extending credit.
When evaluating loans, bankers consider the four “C”s namely, character, capital,
conditions and collateral. These determine to meet obligation and willingness to
cooperate with the lender. The banker should have complete confidence in the integrity
and ability of the customer to use the money to advantage and to repay it within a
reasonable period. In the absence of such confidence, it is preferable to decline to lend,
no matter how much security is available. Confidence in the borrower is the first essential
and one can lend happily to another borrower without security instead of feeling
uncomfortable about lending to a dishonest man with much security (Robinson R, 1962,
p 309).

22
Capital and net worth is the amount of funds the individual borrower or owner has
invested to support both fixed asset (permanent capital) and the day-to-day operation of
the business working capital. The equity position is the best single indicator of the
strength of the business and the commitment of its owners. A business with sufficient
equity has the ability to change adverse situations or to take advantage of growth
opportunities (Robinson R, 1962, p 309).

Capacity is the ability of the borrower to generate cash and the customer requesting credit
must have the legal standing to sign a binding loan agreement. The customer who is
requesting the loan is representative of a corporation; he must have a proper authority
from the board of directors. The recent trends in the borrower’s line of work or industry
shows how changing economic condition might affect the loan and evaluated under
condition study. In assessing the collateral aspect of loan request, the quality, value and
market ability is considered (Robinson R, 1962, p 310).

While evaluating credit request collecting status report of credit information about a
customer is important, banks get information on borrowers from income tax statements,
trade and other reports in the press, interview from banks etc. (Robinson R, 1962, p 310).

Although banks are business competitors in the granting of credit, they recognize their
interdependence in making credit judgments. The credit information is used to evaluate
the honesty, ability, stability, managerial capacity, operation efficiency and financial
history of the prospective borrower (Robinson R, 1962, p 310).

Financial ratio analysis also helps to evaluate loan request. The purpose of financial
statement analysis is to determine the ability of the borrower to meet the credit
obligation. The purpose of applying analytical technique however is not necessary to
calculate a definite answer rather it is to provide a more informed basis on which to make
a decision. There are at least four commonly used categories of ratios as stated by Koch
and W.Timothy (1995, p 169)

23
 I. Liquidity ratios: - indicate the firm’s ability to meet its short term
obligations and continue operation.
II. Activity ratios: - it is a signal how efficient a firm is using its assets to
generate sales.
III. Leverage ratios: - indicate the needs of the firms financing between debt
and equity, hence potential earnings volatility. The greater a firms
leverage volatility, the higher its net profit (loss).
IV. Profitability ratios: - provide evidence of the firm’s sales and earnings
performance.

A credit analyst should evaluate these ratios with a critical eye and try to identify the
firms’ strengths and weaknesses. All these ratios should be compared with the `industry
average` or related business lines or typical competitor and its own historical facts
(EAFS, 2008)

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 CHAPTER THREE

DATA PRESENTATION ANALYSIS AND INTERPRETATION

3. 1. Major Types of Credit Facilities

Overdraft (For Working Capital)”:-An overdraft (O/D) is a credit facility by

which customer can withdraw in excess of her/his its current account balance up to the
limit approved by the Bank. The loan is intended to finance the day-to-day operational
needs of a viable business. Lending Rate=7.5%

Term Loan ( Short & Project Finance):- A term loan is a loan granted to
customers to be repaid with interest within a specific period of time.
 The loan can be repaid in periodic installments or in a lump sum on the due
date of loan, as the case may be.
 The loan is granted in three forms, i.e.,short-term, medium term and long term
loan. Lending Rate=7.5% -9.5%
Short term loan: - is a loan that has a maturity period of one year or twelve months
from the date the loan contract is signed. The loan is extended to finance the working
capital needs and/or to meet other short term financial constraints of customers.
Medium-and Long –Term Loan ( Project Loan)
A medium – term loan is a loan which has a maturity period exceeding one
year but less than or equal to five years from the date the loan contract is signed.

A long –term loan is a loan that has a maturity period of five to fifteen years.

The purpose of the loan is to finance new project, support the expansion of
existing projects, investment and meet working capital needs.

Merchandise Loan:-is a credit facility provided by the Bank against which the
merchandise is held as collateral for the loan. Lending Rate=8%
The purpose of the loan is to overcome the cash –flow problem of customers when
money is tied up in merchandise. The loan is approved for a period of three months ( 90
days) or it may be approved on renewable basis.

25
Letter of Credit Facility
A Letter of Credit is a credit instrument issued by a bank at the request of an importer
through which the bank commits itself to a payment undertaking to an applicant
(importer) to pay a seller (exporter) a given amount of money upon presentation of
specified documents representing the supply of goods within specific time limits, the
documents conforming to the terms and conditions agreed by the importer and exporter.
 Advance on import bills
 Revolving overdraft (for export bills)
 Trade bills discounted
 Export credit guarantee scheme
 Letter of guarantee (Advance, Performance and Bid Bonds)

Typical Loan Catagories

Dashen Bank grants loans and advances to various sectors of the economy on the strength
of assessment of concentration risk. Thus, all loans of all types and terms need to be
spread among the categories of loans recognized by the bank. Economic sectors which
are beneficiaries of Dashen’s credit assistance are:

Domestic Trade and service loans:- Include wholesale trade, retail trade,
services other than transport such as hotels, schools, hospitals, tour agencies, etc.
Financing trade and services helps in the smooth flow of goods and services in the
economy and serve as an intermediary between producers and consumers. Therefore,
trade in essential goods whether imported or locally produced is to be encouraged by
Dashen Bank through working capital financing. Among others, goods traded include
outputs of manufacturing industries, cottage and handicraft, mining activities and
agricultural products.

International Trade (Import/Export loan):- Foreign Trade plays a key role in

the development of an economy and has always been the major force behind the
economic relations among nations. In view of its paramount importance and the bank’s

26
role to promote the growth of the Ethiopian economy, international trade financing in the
form of import and export transactions is one of the priority areas of the bank.

Manufacturing Loan ( small, medium & large )

 Loans availed to facilitate the manufacturing activities of small, medium and

large-scale industries are classified under this category
 Enterprises utilizing agricultural inputs (agro-based industries and other local
raw materials)
 Business establishments producing commodities that will improve agricultural
productivity
 Enterprises producing consumption goods.
 Small scale industries owned by individuals and cooperative ventures.
 Industries engaged in the production of capital goods.
 Industries geared to export market and import substitution.
 Labor-intensive industries.
 Industries producing goods having value added.
 Expansion programs of already existing establishments.

Agricultural Loans:- Agricultural loans include loans granted for purchase of

agricultural inputs like selected seeds, fertilizers, agro-chemicals, rental or purchase of
agricultural machinery and equipment; for crop collection, processing and marketing of
agricultural products, projects aiming at producing exportable products like flowers,
fruits, and vegetable and agro-industry developments like dairy farming, cattle fattening
etc.

Transport: - All loans to be availed for the purchase of transport vehicles like trucks,
tankers and public transport buses to licensed transport operators are to be classified here.
Additionally, loans availed to facilitate smooth operation of trucking companies or loans
to cover custom duty charges or modification costs are also included.

Building & construction loan:- Dashen Bank avails loan to this category for
building contractors, investors engaged on road and water projects under construction,

27
civil workers and business persons who seek financial assistance to construct commercial
or residential buildings.

Loans can be provided to license building contractors to cover working capital

shortages i.e. to mobilize materials required to construct buildings, roads, dams etc.
Based on contracts conclude with employer.

3.2. Opinions of staff members and borrowers about the major

factors

The student researcher collected relevant information from staff members of the bank
who have relevant work experience in loan area and borrowers of the bank through
questionnaire and interview methods. These groups of individuals were selected because
their opinion was found to be essential to analyze the root causes of the problem.
Accordingly, self administered questionnaires were prepared and distributed to six city
branches and head office to be filled by the selected staff members of the bank. Interview
was also conducted with few chosen branch managers and loan officers to fill the gap of
answers given in the questionnaire.
A total of 51 questionnaires were distributed to the staff members but only 48
questionnaires were properly filled and returned, i.e, the response rate is 94%. In order to
make the study complete and meaningful, the student researcher also gathered opinions
of borrowers regarding the causes of their delay to pay their debt on the agreed time. It
was very difficult to get customers in the bank’s premises and collect their opinion as
they come once in a month to pay their debt or for some other reason. During the period
of this study, 60 questionnaires were distributed to the selected branches of the bank in
Addis to be filled by their borrowers. However, only 25 questionnaires were filled and
returned properly due to the customers not come to the bank regularly i.e., 42%.
Demographic characteristics of the respondents

As it can be shown in the Table 3.1, a total of 48 staff members of the bank who are
engaged in loan handling, processing and approving activities were participated by filling
the questionnaire. From the total respondents, about 65% of them are male employees
and the rest are females whereas, majority of customers are males (23) from the 25.

28
When we see age category of respondents, 79.17% of staff members are found in the age
category of 26 to 35 years. This result demonstrates that the bank has many young
professionals who are engaged in loan processing and approving activities. On the other
hand, majority of customers are more than 36 years old (Table3.1).
Table 3. 1: Demographic characteristics of the respondents
No. Factors Number of Percentage
Respondents
Staffs Borrowers Staffs Borrowers
1 Sex
Male 31 23 64.58% 92%
Female 17 2 35.42% 8%
Total 48 25 100% 100%
2 Age
Below 25years 4 0 8.33% 0
26 to 35 38 6 79.17% 24%
36 to 45 4 12 8.33% 48%
46 above 2 7 4.17% 28%
Total 48 25 100% 100%
3 Service year
Less 2 years 4 8.33%
3 to 5 years 19 39.58%
6 to 10 years 21 43.76%
11 years and above 4 8.33%
Total 48 100%
4 Educational back
ground
Grade 12 and below 0 15 0 60%
Diploma 5 7 10.42% 28%
Degree 42 3 87.5% 12%
Masters and above 1 0 2.08% 0
Total 48 25 100% 100%

The study also gathered information about the work experience of staff members in
banking industry. As a result, majority of the respondents have worked more than two
years in bank industry. Table 3.1 shows that 19 employees are found in 2 to 5 years
category, 21 of them have worked for about 5 to 10 years and only 3 of them have work
experience of less than 2 years. This result shows that the bank has relatively many
experienced workers who can process and follow up loan activities.

29
Attempt was also made to see whether the staffs have the necessary educational back
ground or not. Accordingly, Table 3.1 shows the educational back ground of staff
members, to this effect, majority of the respondents have bachelor degree (42) and there
is one Credit analyst who has masters’ degree as well and only 5 employees are diploma
holders. This result shows that the bank has assigned qualified personnel to process and
approve loan requests of customers to achieve its objectives. On contrary to this, majority
of borrowers are found in the age category above 36 years.

3.2. 1 Analysis of basic variables

There were five questions in part II of the questionnaire that include open ended
questions. Majority of the respondents wrote their opinions briefly. The following
paragraphs and tables summarize the answers for each question.

3.2.2 Assessment made by the bank before granting loans

Table 3.2 summarizes the responses on the level of assessment that the bank has been
done towards the borrower’s financial strength and credit worthiness before providing the
loan to borrowers.

30
Table 3.2: Assessment made by the bank before granting the loan to borrowers
To what extent the bank assess borrower’s Frequency Percent Cumulative
credit worthiness before extending the loan?
Percent

Very strong 22 45.83 45.83

Strong 24 50.00 95.83
Average 2 4.17 100.00
Weak 0 0
Very weak 0
0

Total 48 100.00

From the Table 3.2 one can confirm that, the bank strongly assess the borrower’s past
financial history, credit worthiness and perform detailed financial analysis before
extending the loan. As it can be seen from the table, about 96% of the respondents
replied as very strong and strong, only 4% of the respondent, said average, and even no
employee replied as weak or very weak.

This fact demonstrates that the bank strictly assess the borrower’s loan request before
disbursement. The implication of this result is that the bank strongly assesses requests of
borrowers whether the customers fulfill the necessary requirements or not before issuing
the loan amount. Through such types of assessment the bank could minimize the size of
NPLs as it enables to select prominent customers who can pay their debt.

3.2.3 Follow-up mechanism of the bank after granting loans to customers

All respondents confirm that the bank have its own follow up mechanism after granting
loan to customers. The following paragraphs explain the major methods of controlling
borrowers after disbursement, which the loan section staffs wrote in the questionnaire.

31
Some respondents indicated that the follow-up mechanism is dependent on the type of
loan. If it is for construction, the loan shall be granted phase by phase up on the bank’s
engineering assessment. If it is for the purchase of items or machinery, the loan proceed
is directly paid to the suppler. If it is for working capital, the bank’s staff will visit the
customer’s business premises.

After disbursement of the loan, the branch manager and the loan section head committee
visit the borrower’s business premises spontaneously. Visiting is done to make sure that
the availed fund has properly been spent for the targeted purpose or as per the approval of
the bank. Employees of the loan department together with internal auditors might visit
the borrower’s business site at any time so as to have adequate information to control and
direct the customers.

In addition to visiting, the staffs checks whether the granted loan is being repaid as per
the loan agreement. If the borrower failed to pay as a regular basis, different actions will
be taken since one month’s default. Some of the reminding mechanisms are. Telephone
call, formal letters, fax, email, contact in person, etc. When needed discussion with
customers also made to look for normalizing mechanisms when there is a delay in
periodic loan repayment or potential for default is observed. The discussion might
include advices on how to develop their business in order to generate much cash that
enable them paying their debt.

Sometimes, depending on the type of loan, the bank will require customers to offer
different reports that reveal their day to do day business operations, balance sheet,
monthly activities etc to assess the condition of the customer.
If the various actions that have been described before can not regularize the loan
repayment, the case will be transferred to legal department of the bank for further follow
up and legal actions. Therefore, the bank can get its money by selling the collateral
pledge.

32
During the interview also, some loan section heads revealed that the bank has its own
credit follow up mechanisms to control borrowers and minimize the banks’ NPL, some of
them are described below.

In practicing proper follow up, once funds are disbursed the concerned loan officer
cannot afford to rest and expect that all repayment will be collected as scheduled.
Therefore, the loan officer prepare schedule which contain the repayment date and
telephone address of the borrowers in order to make the follow up task easy. After this,
the officer is expected to call when payment delay. Even if the payment is done regularly,
follow-up by visiting customers’ business or factory is necessary to create long lasting
friendly relationship. Sometimes borrowers seem to ignore repayment for one reason or
another. In such case, Dashen bank undertakes the following activities to follow-up.

 Giving verbal reminder after calling the customer and discussing the matter. If
this fails and no payment is made then the bank choose to the second step.
Personal visit is more productive than telephone calls. This should be performed
within one week after the installment is due.

 Sending first written reminder using language of general persuasion and

explaining that the bank is accountable. This should be done if installment is over
due by a month.

 If the first reminder fails, second written reminder will be sent that shows the
bank is legally and morally bound to collect the debt would follow. The reminder
will be worded in such a way as to show the bank’s determination to proceed with
further measures if repayments are not forth coming. It is very important that the
bank use every mean to make the borrower come up with alternative proposal
until the bank make fairly certain that payments will be made.

As it can be seen from the explanations so far, the bank has its own procedures that
enable itself to follow up its borrowers after providing the loan. Reminding of customers

33
starts when installment payment overdue by one month, this should be appreciated. Thus,
if the bank staffs strictly follow the bank’s procedures after granting the loan, they can
minimize the chance of loan loss or the size of NPLs in the bank.

3.2.4 The bank’s mechanisms when borrowers failed to pay their debt regularly

According to the responses given on the questionnaire, when borrowers failed to pay their
loan as per the agreement, the bank might apply one of the following methods depending
on the condition of the borrower, structure of the loan and the nature of the problem.
- Extending the life of the loan
- Injection of additional loans
- Rearrangement of loan repayment structure
- Waive of arrears and repayment
- Foreclosure the collateral pledged, if any

Most of the respondents revealed that the bank has been using all of the above methods
depending on the specific situation of the borrower. This usually done through discussion
with the customer, but extending the life of the loan, rearrangement/rescheduling of loan
repayment structures and foreclosure are the most common methods to re-collection.
Arranging such kinds of repayment mechanisms is very important for those borrowers
who failed to pay their debt as per the agreement. In addition, the bank could collect its
money with the consent of the borrower, this in turn enable the bank to minimize the size
of NPLs in its loan portfolio.

3.2.5 Procedures to get loan from the bank.

Almost all respondents replied this question with brief writings, the summary of their
words is discussed in the following paragraphs.
First of all the customer who wants to borrow money from the bank should make
preliminary interview with concerned body such as branch manager, loan section head or
loan officer. If the clients’ interview makes him/her as prospective borrower, first the

34
customer must open an account in Dashen bank and then he/she will come up with the
written application letter accompanied with pertinent documents.

The borrower should offer various documents such as, renewed trade license to confirm
whether the business is legal or not, company profile, business plan, feasibility study if
any, NBE credit status reports, financial statement etc. Presenting audited financial
statements is necessary if the loan amount is above 5 million birr if not, the applicant can
get the loan by filling the credit form. If the customer or borrower is private limited
company, credit information is gathered to assess the past financial history of the
applicant. To summarize, the customer loan request should pass through the following
five steps, from initiation to disbursement of the loan.
1. Initiation: Applicants should first approach the bank in person with their requests
for loans.
2. Screening The bank discuss with the applicant the types of loans that the bank
provides and the kind of loan the applicant asks for I If the bank finds the
applicant’s request eligible form their discussions visit the business premises and
will require the potential borrower to present the necessary documents for loan
processing.
3. Processing: the bank will process the request via loan approval form (LAF)
4. Approval The loan approval committee, depending on the size of the loan request
and the potential of the applicant’s business transaction, approves the loan with
justification for only variation form recommended request. Loan amount up to
150,000 birr can be approved at branch level, but above this limit, the loan must
be approved on the read office level.
5. Disbursement As per approval and fulfillment of the required conditions, the
amount approved will be disbursed or credited to the customer account from
borrower’s side

As it can be explained so far, the customer loan request should pass through the five
stages from initiation to disbursement. These procedures, if applied fairly and strictly, the
bank could minimize the amount of sick loans in its balance.

35
3.2.6 The causes of NPLs from borrowers’ side
The study collects opinions from staff members of the bank and borrowers concerning
the level of relevance each factor contributes to increase the balance of NPLs in Dashen
bank. The responses of staffs and borrowers presented together for ease of analysis by
showing the percentages of each group responded to each of the factors in Table 3.3.
Table 3.3 Causes of NPLs from borrowers’ side

Very Very
Relevant Average Irrelevan

Total for each group

Relevant Irrelevan
(%) (%) t (%)
(%) t (%)

Description of factors
Employees

Employees

Employees
Borrowers

Borrowers

Employees

Employees
Borrowers

Borrowers

Borrowers
Lack of adequate
knowledge and experience
on how to use the loan 38 20 48 52 12 12 2 16 0 0 100
amount

Diversion of the borrowed

fund to other purpose 34 40 56 56 8 4 2 0 0 0 100

Failure of the investment

project to generate enough
11 48 58 40 31 0 0 12 0 0 100
cash to settle their debt

Un-planned and ambitious

business expansion 32 24 56 48 10 20 2 8 0 0 100

Death, disability or insanity

of borrowers 9 0 15 0 21 0 42 60 13 40 100

Unwillingness and
carelessness of borrowers 17 40 46 52 37 8 0 0 0 0 100
to pay their debt
Unwillingness of the debtor
to disclose truthful 20 0 63 32 17 20 0 40 0 8 100
information
High interest rate on loans
0 32 6 40 10 0 67 28 17 0 100

36
Lack of adequate knowledge and experience on how to use the loan amount

According to the perception of employees of the bank, lack of adequate knowledge and
experience on how to use the granted loan by the borrower is the significant factor that
makes them in default, i.e., a cumulative percentage of 86. Table 3.3 reveals that only 2%
of the staff members said this factor irrelevant but the majority of them (86%) give their
opinion as very relevant (38%) and relevant (48%). The result indicates that knowledge
and experience of the borrower about better management of the borrowed funds is very
crucial to repay his/her debt on the agreeable time. Furthermore, borrowers of the bank
strengthens this fact, about 72% of them categorized this factor as very relevant (20%)
and Relevant (52%).
In addition, employees during the interview discussion uncover that most of the
borrowers are uneducated enough and unwilling to hire professionals to run their
business. Due to this problem, they lack the necessary skill on how to manage the
borrowed funds and this might make them in default.

Diversion of the borrowed fund to other purpose

As the employees’ opinion in the questionnaire, diversion of the borrowed fund to other
purpose is the major significant factor that contributes to increase the size of NPLs in the
bank. Table 3.3 shows that there is only one employee who said this factor is irrelevant
but, majority of them making it the major determinant or cause of the problem. About
90% of the respondents categorize this factor as Very relevant (34%) and Relevant
(56%).In addition, about 96% of borrowers regarded this factor as very relevant(40%)
and relevant(56%).

This answer also supported by few selected employees while conducting interviews. The
bank has been made its effort to control the end use of the loan or pay loan proceed to the
intended purpose especially for loans other than working capital loans. However, most of
the time customers invest the borrowed fund in to another project by diverting the
original purpose of the loan. For instance, they invest the business purpose loan to

37
purchase automobile, house or any luxury goods. This situation shrinks their capacity to
pay their debt including the interest of the loan.

Failure of the investment project to generate enough cash to settle their debt

Failure of the investment project to generate enough cash is also regarded as the
significant factor that makes borrowers in default according to the employees’ opinion.
Table 3.3 demonstrates that about 69% of the employees considered this factor as Very
Relevant (11%) and Relevant (58%). There is no any employee that said this factor
irrelevant or very irrelevant. This result indicates that even though the investment project
established with high capital, the borrower can not pay his or her debt if the project
doesn’t generate enough cash during its operation. Thus, according to some interviewees,
poor quality project and lack of market study by the borrowers before they invest are
some factors that create shortage of cash. This fact also supported by majority of
borrowers (88%), i.e., about 48% of them regarded as very relevant and 40% as relevant.

Un-planned and ambitious business expansion

As it can be seen from Table 3.3, majority (88%) of the employees gave their opinion that
un-planned and ambitious business expansion of the borrower is the major factor that
makes them retard to return their loan amount. Only 2% of the respondents who
considered this factor as irrelevant but, 32% of them take it as Very relevant and 56% of
them regarded it as relevant. In connection to this, about 72% of borrowers considered
this factor as very relevant (24%) and relevant (48%). From this result one can infer that
if borrowers expand their business with out plan or ambitiously, they would face
bankruptcy problem and they cannot pay their debt.

Death, disability or insanity of borrowers

On the other hand, contingencies on the part of the borrowers like death, disability or
insanity were made very little contribution to make the balance of NPLs to increase.
Table3.3 demonstrates that only 25% of staff members considered this factor as Very
relevant (9%) and Relevant (15%) among the total of 48 employees. However, about

38
55% of borrowers regarded this factor as irrelevant (42%) and very irrelevant (13%).On
the other hand, there is no any employee who said this factor as relevant. This result
demonstrates that such factors like death disability or insanity of borrowers have no
significant contribution towards the increment in NPLs since the collateral pledge will be
sold to cover the outstanding loan balance when it happens.

Unwillingness and carelessness of borrowers to pay their debt

The study also attempts to collect opinions of staff members regarding the payment
behavior of borrowers after they receive the money from the bank. Accordingly, Table3.3
describes that about 63% of the employees believe that unwillingness and carelessness of
borrowers to pay their debt is a significant factor that contributes to increase the balance
of NPLs in the bank. In addition, there is no any respondent who considered this factor as
either irrelevant or very irrelevant. In relation to this, majority of borrowers (92%)
regarded this factor as very relevant (40%) and relevant (52%).

To this connection, some loan officers described during the interview is that few
borrowers are careless or unwilling to settle their debts and they believe that they have
good collateral that can cover their entire debt if they are in default. This is a bad
behavior of borrowers and increases the balance of NPLs in the bank.

Unwillingness of borrowers to disclose truthful information

In order to get maximum amount of loan, customers might provide falsified financial
statements and other documents to the bank. This leads the bank to release large amount
of money that might not be collected with in agreeable time. According to the opinions of
staff members, about 83% of them consider this factor as very relevant (20%) and
relevant (63%) to increase the balance of NPLs. On the other hand, only 32% of
borrowers considered this factor relevant but, the majority (48%) of them take it as
irrelevant.

39
In connection to this problem, some branch managers and loan officers gave their opinion
regarding the financial statements provided by their customers. To this end, they said that
most of the borrowers’ business are small and do not have proper accounting records by
hiring trained or qualified accountant. In addition, most borrowers maintain two types of
financial statements one is for tax purpose the other one is for bank credit, therefore it
may be unreliable document. Further, the financial statements provided by majority of
borrowers are un-audited because the law forces only financial statements of share
companies to be audited. All these reasons forces the bank to rely on the financial
statements provided by borrowers whether falsified or not. Consequently, this situation
may create credit risk of non-performing loans.

The interest rate of the bank

The study also attempted to collect opinions of employees concerning the effect of the
current interest rate of the bank on borrowers’ repayment capacity. In viewing this,
majority of employees give their opinion as irrelevant (67%) and only 6% of them
regarded this factor as relevant to make borrowers in default (Table3.3).According to
employees’ opinion, the interest collected by the bank is very small when compared with
the money released to customers. If customers do their business wisely, the interest
payment is not that much big issue. On the other hand, about 72% of borrowers perceived
that the current interest rate charged by the bank has significant effect on the repayment
capacity of borrowers.
From the above detailed presentation of facts, the student researcher ranks the causes of
NPLs at the borrowers’ level .To this end, diversion of the borrowed fund to other
purpose, un-planned and ambitious business expansion, lack of adequate knowledge and
experience on how to use the granted loan and unwillingness of borrowers to disclose
truthful information are ranked first to fourth respectively. Because they are regarded as
relevant and very relevant factors by more than 83% of the respondents. On the other
hand, interest rate on loans and contingencies on the part of borrowers like death,
disability or insanity are considered as irrelevant factor to increase the size of NPLs in the
bank. However the effect of interest rate is considered as very significant factor to
increase the size of NPL as it increases be loan outstanding balance to paid

40
3.2.7 The causes of NPLs from the bank side

Only staff members of the bank were asked to put their perception about the level of
significance each of the following factors contributes to increase the size of NPLs in the
bank. The results of the analysis are shown below in the following table and descriptions.

Table 3.4 Causes of NPLs from the bank side

No. Description of items

Irrelevant
Relevant

Relevant

Average

irrelevant
Very

Very

Total
1. Lack of strict follow- up and 16.67% 20.83% 45.83% 8.33% 8.34% 100%
loan workout procedure
2. Not taking timely action by the 33.33% 35.42% 20.83% 8.34% 2.08% 100%
bank when borrowers start to
default
3. Management/owner 0 43.75% 39.58% 14.59% 2.08% 100%
intervention in loan processing
and approval
4. Unreliable and overstated 8.33% 31.25% 12.50% 39.58% 8.34% 100%
estimation of collateral
5. Competition among banks to 6.25% 52.08% 31.25% 8.34% 2.08% 100%
attract borrowers
6. Lending to affiliated parties of 2.08% 14.58% 41.67% 41.67% 0 100%
the bank such as share holders,
board members, managers
etc...
7. Violations of the existing 0 4.17% 41.67% 52.08% 2.08% 100%
credit policies of the bank by
employees
8. Poor credit/risk assessment of 8.33% 12.5% 50.00% 20.83% 8.34% 100%
the bank

41
Lack of strict follow- up and loan workout procedure
Lack of strict follow- up and loan workout procedure regarded by most of the
respondents as neutral or average (45.83%) and a total of 37.5% of them consider this
factor as relevant(20.83%) and very relevant(16.67%). This result implies that employees
of the bank do not feel that there is lack of strict follow-up and loan workout procedure in
the bank that makes borrowers relax to settle their debt on the agreeable time. Dashen
bank has strict follow-up and loan workout procedure that enable to control its borrowers
after disbursed the loan. However, these procedures sometimes might not be respected
depending up on the customers’ situation.

In connection to this, the student researcher interviewed few loan officers concerning
their follow- up effort when customers delay in paying the loan. According to their
response, the bank has been using its full effort to follow-up and collects the granted
loans on time. The follow -up is done by reminding customers through telephone and
written letters repeatedly and physical observation.

Not taking timely action by the bank when borrowers start to default

Not taking timely action by the bank when borrowers start to default is also the major
factor to increase the size of NPLs in the bank. As it can be shown in Table 3.4 , majority
(69%) of the respondents considered this factor as very relevant (33.33%) and relevant
(35.42%).The implication of this result to the management of the bank that when
borrowers start to default ,the bank should take timely action in order to get its money as
early as possible.

In connection to this, during the interviews made with few loan officers, they revealed
that the bank has done actions step by step. Firstly, when borrowers start to default,
repeated calls and written warnings has been made for a short period of time (up to three
months). If the customers do not start payment during this period, the loan officers
transfer the case to the legal department of the bank for further actions. According to their
opinion they said that after the case is transferred to legal department, it is difficult to
guess when the loan will be settled.

42
Management/owner intervention in loan processing and approval

Management or owner interventions in loan processing and approval of desiring to

acquire fast profit may also result in lending to poor quality borrower. According to the
result, 43.75% of the respondents consider it as relevant factor, 39.58% of them take it as
average and only 14.59% of them take it as irrelevant. As per the interviews conducted
with some selected staff members, there is no that much intervention of management in
loan processing and approving in this bank and therefore this factor may not contributed
much for NPL.
Unreliable and overstated estimation of collateral
A total of 47.92% of the respondents feels that unreliable and overstated estimation of
collateral in the bank is irrelevant fator, i.e, 39.58% said irrelevant and 8.34% said very
irrelevant. Cumulative of 39.58% of the respondents regarded this factor as relevant.

To fill the gap of answers in the questionnaire, the student researcher also conducted
interviews .As a result, the bank has skilled and experienced proffesionals that can
estimate the collateral values with in the reasonable accuracy. If the borrower being in
default, the bank can get its money by selling the assets secured as collateral.

The implication of the result might be overestimation of the collateral or the falls in its
value upon its sale would result in loss of some income to be covered by the collateral in
the event of default. This in turn leads to increase the balance of NPL. A more serious
problem is lack of well developed second hand market or saturation of the market for
properties pledged as collateral.

Competition among banks to attract borrowers

Competition among banks to attract borrowers also might have adverse effect of lending
to non-promising borrowers. Table3.4 shows that 58.33% of the respondents consider this
factor as very relevant and relevant, only a total of 10.42% of them regard it as irrelevant.
While conducting interviews with employees, some of them said that even though there is
swift competition among banks, Dashen bank has been disbursed loans to customers who
fulfill the necessary requirements.

43
Lending to affiliated parties of the bank such as share holders, board members,
managers etc...
Lending to affiliated parties of the bank such as share holders, board members, and
managers is not considered by the respondents as a significant factor to increase the
balance of NPLs in Dashen bank. Only one person (2.08%) regarded this factor as very
relevant and 14.58% of them as relevant. Rather majority of them take this factor as
irrelevant (41.67%) and the same percentage of employees said average. This result has
an implication that lending money to these parties did not have a negative effect on the
profitability of the bank until now in this bank. Because the bank provide loan service to
shareholders and board members based on their limited amount.

Violations of the existing credit policies of the bank by employees

About 4% of respondents believe that violation of the existing credit policies of the bank
by employees is the relevant factor to create poor quality borrower. On the other hand a
total of 54% of the respondents consider it irrelevant (52.08%) and very irrelevant
(2.08%) factor. From this result one can infer that few employees might violate the tight
credit policy of the bank while processing and approving loan requests from customers.
In contrast, as majority of employees’ perception, employees who are engaged in loan
handling activities respect the existing credit policies of the bank. Consequently, if
employees strictly follow the bank’s policies and procedures while granting loans, this
situation enables the bank to reduce the size of NPLs to the large extent.

Poor credit/risk assessment of the bank

According to the respondents’ perception in table 3.4, only 20.83% of them considered
this factor as relevant and about 29 % of them regard it as irrelevant. The rest 50 % said
average impact. To fill the gap of answer given in this factor, interviews also made to few
selected employees. As a result, the bank has been strictly assessing the customer’s loan
requests and has strong loan procedure manual that every employee should abide by.

44
As can be seen from the detailed presentation of responses about the causes of NPLs at
bank’s level, most of the respondents regarded the factors as neutral or said average. But,
the student researcher tried to analyze the factors with the answers given during interview
to rank them. Accordingly, not taking timely action by the bank when borrowers start to
default, competition among banks to attract borrowers and lack of strict follow- up and
loan workout procedure are ranked first to third respectively. On the other hand, lending
to affiliated parties of the bank such as share holders, board members, managers,
violations of the existing credit policies of the bank by some employees and poor
credit/risk assessment of the bank are regarded as irrelevant factors in Dashen bank to
increase the size of loans.

3.2.8. Staff members’ and borrowers’ opinion about other factors that might
increase the size of NPLs in the bank

There are few other factors that are not specified in the questionnaire either from
borrowers’ side or creditors’ .According to the answers given in the questionnaires and
from the conducted interviews; the following are some of the factors that might increase
the balance of NPLs in the bank.
Unfavorable macro economic conditions that lead to large scale failures of enterprises of
a country may create problem to banks. Since most enterprises are interconnected with
banks as a borrower-lender relationship, failure of these enterprises in large scale would
make them unable to repay their loans. Similarly, sudden changes in market conditions,
interest rate, exchange rates etc would make firms unable to service their loans and
resulting in large NPLs.
Unstable prices and substantial variations in prices may cause problems of loan losses
because; firms for whom the change in price is unfavorable will get difficulties to pay
their debts.
The overall economic performance of the country will affect banks in their loan provision
and collection activities. The weak performance of the economy due to prolonged
recession and occurrence of recurrent draught decreases profit of business firms and
incomes of households, consequently loan repayment would might be difficult.

45
Absence of market study by debtors before they invest is also one of the significant
factors that retard customers to pay their debt as they cannot cope with the current
situation in the market. While conducting interview with few branch managers of the
bank, majority of the borrowers are not willing to hire professionals that can study the
market in a better way before they invest large sum of money. They simply start a
business around them, which they seem profitable without analyzing the current and
future situations thoroughly. After they enter in to the business, they cannot compete with
their rivals competently. Due to this reason, they may face business failure and cannot
pay the borrowed fund on time.
Lack of enough market to sell their goods and services as they want in order to generate
sufficient amount of money for running their business together with covering the loan.
Moreover, the respondents believe that unrealistic forecast of borrowers’ revenue and
profit generation affects their repayment condition by inflating the loan size or borrowed
fund.
Damages to the project
Delay of payment for the work executed
Lack of constructive training with regard to credit and loan processing to employees of
the bank.

46
 CHAPTER FOUR

SUMMARY OF THE FINDINGS, CONCLUSION AND

RECOMMENDATION

4.1 Summary of Findings

According to the information posted on the bank’s website, Dashen bank provides many
credit facilities to its customers, the major loan categories are: Agriculture,
Manufacturing, Import/Export Loans, Trade and Services, Building & Construction ant
Transport loans.

According to the responses given by the employees, the bank strongly assesses requests
of borrowers to check whether the customers fulfill the necessary requirements or not
before issuing the loan amount. This is done by analyzing the documents provided and
physically observing the borrowers’ business premises. In addition, the customer loan
request should pass through five stages namely, initiation, screening, processing,
approval and disbursement.

As the staff member’s opinion, the bank also has its own procedures that enable itself to
follow up its borrowers after providing the loan. This has been accomplished through
reminding customers in telephone, letters and physical observation and the like since
installment payments overdue by one month.

As per the responses given on the questionnaire, when customers starts not to pay
regularly, the bank has been using different methods depending on the condition of the
borrower, structure of the loan and the nature of the problem. This is usually done
through discussion with the customer, but extending the life of the loan,
rearrangement/rescheduling of loan repayment structures and foreclosure are the most
common methods to re-collection.

According to the perception of majority of staff members and borrowers, among various
causes of NPLs from borrowers’ side, diversion of the borrowed fund to other purpose,

47
un-planned and ambitious business expansion, lack of adequate knowledge and
experience on how to use the granted loan and unwillingness of borrowers to disclose
truthful information by the borrowers are regarded by most of the respondents as relevant
factors. On the other hand, interest rate on loans and contingencies on the part of
borrowers like death, disability or insanity are considered as irrelevant factor to increase
the size of NPLs in the bank.

As per the opinions of employees of the bank, among various causes of NPLs at the
bank’s level, not taking timely action by the bank when borrowers start to default,
competition among banks to attract borrowers and lack of strict follow- up and loan
workout procedure are ranked first to third respectively. On the other hand, lending to
affiliated parties of the bank such as share holders, board members, managers etc,
violations of the existing credit policies of the bank by some employees and poor
credit/risk assessment of the bank are regarded as irrelevant factors in Dashen bank to
increase the size of loans.

According to the opinions of both employees and borrowers regarding other factors,
unfavorable macro economic conditions, the overall economic performance of the
country, absence of market study by debtors before they invest are some of the significant
factors that retard customers to pay their debt as they cannot cope with the current
situation in the market.

48
4.2 Conclusions

The main purpose of this study is to identify factors that might increase the size of non-
performing loans (NPLs) in banks .After analyzing opinions of staff members of Dashen
bank and its borrowers including the bank’s annual reports, loan procedure manuals and
various literatures , the student researcher forwards the following concluding remarks.

 Dashen bank S.C offers various credit facilities to its customers the major loan
categories are: Agriculture, Manufacturing, Import/Export Loans, Trade and
Services, Building & Construction ant Transport loans. Each loan category has its
own requirements that customers should fulfill to be granted. Therefore the bank
should strengthen its controlling mechanism in order to collect its money form
varies loan categories on time

 The bank has its own procedures that enable itself to follow up its borrowers after
providing the loan. Reminding of customers starts when installment payment
overdue by one month, this should be appreciated, however, some borrowers
failed to pay by their own reason. Thus, if the bank staffs strictly follow the
bank’s procedures after granting the loan, they can minimize the chance of loan
loss or the size of NPLs in the bank.

 The bank has clear loan processing steps that every borrower should follow and
abide by, from initiation to disbursement. If the employees disburse loans based
on these procedures without distortion, there is no such big gap that makes
borrowers failed to pay their debt and increase the size of loan.
 Among various factors that contribute to increase the size of NPLs in Dashen
bank S.C, majority of the reasons comes from the borrower’s problem, weakness
and behavior.

49
 Diversion of the loaned fund to other purpose by borrowers is the first and major
determinant factors that contribute to increase the size of NPLs in the bank. Most
of the time, customers invest the borrowed fund in to another project by diverting
the original purpose of the loan, for instance, they invest the business purpose
loan to purchase automobile, house or any luxury goods. This condition shrinks
their capacity to pay their debt including the interest of the loan with in agreeable
time.

 Lack of adequate knowledge and experience on how to use the granted loan by
the borrower is another significant factor that might increase the balance of NPLs
in the bank. Most of the borrowers are uneducated and unwilling to higher
professionals in running their business. Due to this problem, they lack the
necessary skill on how to manage the borrowed funds and this might lead them in
default.

 Lack of proper business plan and ambitious business expansion of borrowers is

regarded as the third significant factor that affects the borrowers’ capacity to settle
its arrears. Due to this factor, the borrowers might miss opportunities of getting
benefit in business that can build up its capacity to run their business competently.
From this result one can infer that if borrowers expand their business without plan
or ambitiously, they would face bankruptcy problem and cannot pay their debt at
the time specified by the bank, this in turn make the balance of NPLs to grow up.

 In order to get maximum amount of loan, customers might provide falsified

financial statements and other documents to the bank. This leads the bank to
release large amount of money that might not be collected within agreeable time.
In connection to this, most of the borrowers maintain two types of financial
statements one is for tax purpose the other one is for bank credit; therefore it
might not be a reliable document. Further, the financial statements provided by
majority of borrowers are un-audited, because the law forces only financial
statements of share companies to be audited. All these reasons force the bank to
rely on the provisional financial statements provided by borrowers whether it is

50
 truthful or not. Consequently, unwillingness of the debtor to disclose truthful
information might be one of the reasons to increase the size of non-performing
loans in the bank.

 From various causes of NPLs at the bank’s level, not taking timely action by the
bank when borrowers start to default, competition among banks to attract
borrowers and to some extent lack of strict follow- up and loan workout
procedure are considered to be the relevant factors.

 Some factors are beyond the control of the borrowers as well as the bank.
Unfavorable macro economic conditions that lead to large scale failures of
enterprises of a country may create problem to banks. Since most enterprises are
interconnected with banks as a borrower-lender relationship, failure of these
enterprises in large scale would make them unable to repay their loans. Similarly,
sudden changes in market conditions, interest rate, exchange rates and substantial
variations in prices may cause problems of loan losses because; firms for whom
the change in price is unfavorable will get difficulties to pay their debts resulting
in large NPLs in the bank.

51
4.3 Recommendation
Based on the findings, the present study recommends the following points to minimize
the balance of non-performing loans in the bank.

 In order to reduce the diversion of loan funds by borrowers, the bank should make
its maximum effort to control the end use of the loan or pay loan proceed directly
to the intended purpose. For amounts granted to working capital loans, the bank
should assign its staffs to make regular business visit and follow-up the
performance of the borrower continuously.
 Since most of the borrowers lack experience and knowledge regarding how to use
the loan granted, the bank should provide sufficient credit awareness to the
borrower and support them to some extent by giving advices.
 Even though there is lack of organized information about each sector of the
economy in our country, the chance of loan loss would have been reduced if the
bank has made market study about the viability of the investment project through
hiring professionals before it releases huge amount of money. Alternatively, if the
bank cannot do this, it should teach borrowers to do so before they invest large
sum of money on different projects.
 Even if the bank cannot urge borrowers to provide audited financial statements, it
should inform governments about its bad consequence and hence to enforce all
formally established businesses to maintain accounting records like that of share
companies.
 The bank should strengthen its existing loan follow- up and disbursement
procedure in order to increase its credit-processing quality.

 In general, the bank should update its credit policies continuously according to the
borrowers need and in line with market, political and economic conditions. In
doing this, the bank should have competent and trained staffs to assess the
possible credit risks. Therefore, the bank staffs working in loan section should get
adequate and up to date training as a continuous basis.

52
 REFERENCES
H.L. Bedi & V.K. Hardikar, 1993, “Practical Banking Advances”. Available at:
blackwellsynergy.com
Caprio, Gerard and Klingebiel, Daniela. 1996. “Bank Insolvencies: Cross-country
Experience.” Policy Research Working Paper 1620. World Bank, Washington, D.C
Koch W. Timothy, 1995, “Determinants of profit in the commercial banking industry”
Peter S. Rose, 1999 “Bank management and financial services” available at:
http//www.emeraldinsight.com
Robinson R.”The Management of Bank Funds”, 2nd ed, Mc Graw-Hill Book Company,
1962 U.S.A.
Lin Peter Wei-Shong, Mei Albert Kuo-Chung (2006) “The internal performance
measures of bank lending: a value-added approach”, Research paper, pp 272-289
available at: http//www.emeraldinsight.com

“Loan Portfolio Management” Comptroller’s Handbook April 1998 available at:

http//www.occ.trees.gov.
National bank of Ethiopia (2002), “Licensing and Supervision of Banking Business
Directive No SBB/29/02”, Addis Ababa
National bank of Ethiopia (2002), “Licensing and Supervision of Banking Business
Directive No SBB/32/02”, Addis Ababa
Ethiopian Academy of Financial Studies (EAFS) “Credit Analysis and Processing”,
Training Manual, 2008.
Annual Report (2006) of Bangkok Bank, “Risk factors and risk management”
available at: http//www.bangkokbank.com.
Dashen Bank Audit Financial Result from year 2004-2008

53
ANNEXES

54
Annex I: Questionnaire

St, Mary’s University College

Faculty of Business Management Department

Dear respondents, I am a prospective graduate student in the department of management

st, Mary’s university college degree program this year. I am conducting a research project
in titled “Factors that affect the size of non-performing loans (NPLs) in Dashen
banks” in partial fulfillment of BA degree in Management. The purpose of this paper is
to identify various factors that increase the size of non-performing loans (NPLs) in banks.
Therefore, your willingness and cooperation in giving reliable information is extremely
important. The information you provide is strictly used for academic purpose and will be
kept confidential .I would like to thank you in advance for sacrificing your valuable time.
This questionnaire is to be completed by the employees of the bank who are currently
engaged in loan processing activities, such as loan officers, loan clerks, branch managers,
loan section heads, credit follow-up personnel etc.
Part I: Personal Information

The following questions are about your self; put a tick mark (√) on the box given.

1) Sex
Male Female 
2) In which age category are you?

Below 25  26 to 35 years 
36 to 45 years 46 and above 
3) Service year in the banking industry

Less than 2 years 3 to 5 years

6 to 10 years 10 years or more
4) Educational background

Diploma Degree Masters and above 

5) Job position or title………………………………………………………….

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Part II: Assessment of the Bank’s Loan Procedures

1) Does the bank assess borrower’s past financial history , credit worthiness and perform
detail financial analysis before extending the loan?

 Yes, definitely
 Yes to some extent
 Not at all
 I am not quite aware of it
2) Is there any follow-up mechanism of your customer after granting a loan?

Yes  No

3) If your answer for Q.No.2 is yes, please specify how often?

-----------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------
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-------------------------------------------------------------

4) When the borrower faces a certain problem and unable to pay the loan, what mechanism do
you apply in order the loan to be collected?

 Extension of the life of the loan

 Injection of additional loans
 Rearrangement of loan repayment structure
 Any other-------------------------------------------------------------------------------------------

5) What steps customers should follow in order to borrow money from the bank?
-----------------------------------------------------------------------------------------------------------------
----
-----------------------------------------------------------------------------------------------------------------
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6) To what extent the bank’s loan processing steps contribute towards the customers’
failure to pay?--------------------------------------------------------------------------------------
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-----------------------------------------------------------------------

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Part III: Causes from Borrowers’ side

The following items are considered to be factors that might increase the size of non-
performing loans (NPLs) in Dashen banks from borrowers’ side. Please put a tick (√) on
the appropriate space about the relevancy of each factor contributes to make borrowers
failed to pay their debt.

No. Description of items

Relevant

Relevant

Average

irrelevant

irrelevant
Very

Very
1. Lack of adequate knowledge and experience on
how to use the loan amount

2. Diversion of the borrowed fund to other

purpose

3. Failure of the investment project to generate

enough cash to settle their debt

4. Un-planned and ambitious business expansion

5. Death, disability or insanity of borrowers

6. Unwillingness and carelessness of borrowers

to pay their debt
7. Unwillingness of the debtor to disclose truthful
information
8. High interest rate on loans

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Part IV: Causes from Creditor’s (Bank) side

The following items are considered to be factors that might increase the size of non-
performing loans (NPLs) in Dashen banks from creditor’s (bank) side. Please put a tick
(√) on the appropriate space about the relevancy of each factor contributes to make
borrowers failed to pay their debt.

No. Description of items

Irrelevant
Relevant

Relevant

Average

irrelevant
Very

Very
1. Lack of strict follow- up and loan workout
procedure
2. Not taking timely action by the bank when
borrowers start to default
3. Management/owner intervention in loan
processing and approval
4. Unreliable and overstated estimation of
collateral
5. Competition among banks to attract borrowers
.
6. Lending to affiliated parties of the bank such
as share holders, board members, managers
etc...
7. Violations of the existing credit policies of the
bank by employees
8. Poor credit/risk assessment of the bank

Part V: Other Factors

Please specify other factors that you think relevant, which are not listed on the above
tables
………………………………………………………………………………………………
………………………………………………………………………………………………
………………………………………………………………………………………………
………………………………………………………………………………………………
………………………………………………………………………………………………
………………………………………………………………………………………………
………………………………………………………………………………………………

58
 Thank you for taking your time to complete this questionnaire!

Annex II: Interview questions

1. What are the major causes that make borrowers being in default?
2. Do employees stick on the bank’s credit policy while permitting loans to
customers?
3. Are the employees, who engaged in loan processing and approving, competent
enough to handle the work?
4. Does the bank have strict loan follow-up and workout procedure?
5. How much follow-up effort the bank has put to collect its money on the agreeable
date?
6. What actions the bank has done when the borrower starts to being in default?
7. What do you think as a solution to reduce the balance of non-performing loans
(NPLs) in the bank?

59