Evaluation Of The Consequences Of Non Performing

Published Date: 02 Nov 2017

A thesis

Presented to

London School of Commerce

In Partial fulfillment

Of the requirements for the Degree

Bachelor of Business Administration

By

Julien Simbi

ID Number: L0561FSFS0211

Date….....…/…......... 2013

Signature.............................

Supervisor

Dr. VIJAY Shenai

DEDICATION

ACKNOWLEDGEMENTS

I would like to thank everyone who has contributed to the achievements of this work. I thank the government of Rwanda for giving me the opportunity to study my primary and high school, and my first university year in the National University of Rwanda.

Deepest gratitude to my parents, for all the love, care, guidance and support through everything, this work is for you too, without you I wouldn’t have made it. A special "Thank you" to all my family, Christian, thank you for the support.

To London School of Commerce, I am very grateful for the opportunity and the knowledge I, to the Strategic Brand management group and especially to my supervisor Dr. Vijay Shenai for his guidance in the entire project research, to my all my friends especially Olivier, Josh, Fatma, Hellen & Wilbert for their great support and friendship during my stay in London, all the lecturers especially Mr David Acquaye for all the support and guidance in my studies.

I extend my sincere thanks to the administration of Access Bank Rwanda for the support they gave me during my research.

May God bless you all.

List of abbreviations

NPLs: Non Performing Loans

BANCOR: Banque a la Confiance d’Or

BNR: Banque National du Rwanda – National Bank of Rwanda (NBR)

IMF: International Monetary Fund

GDP: Gross Domestic Product

HKMA: Hong Kong Monetary Authority

AMC: Asset Management companies

Abstract

This study was mainly carried out to evaluate the consequences of non performing loans in commercial bank in Rwanda, were Access Bank Rwanda was taken as case study.

The objectives of this study were to identify reasons why loan holders fail to pay back their loans, to evaluate the consequences of non performing loans and finally strategies put forward to reduce the level of non perfuming loans in commercial banks.

During the research, data were collected from primary and secondary data, were research techniques like questionnaires and documentations have been used. The population of the study comprises Access staff in credit risk management and customers of Access Bank who had been given loans.

After data were collected and analyzed, they were presented in tables and figures and the interpretation was done accordingly.

The research findings revealed that the level of non performing loans has decreased a lot, but there is still a lot to do by concerned parties namely the central bank, commercial banks and customers of banks to continue reduce even eliminate the problem of non performing loans in commercial banks in Rwanda.

Table of content

List of abbreviations 3

Abstract 3

Table of content 5

LIST OF TABLES 7

List of figures 8

General introduction 9

1.1.Background of the study 9

1.2 Research focus 10

1.3 Purpose of the study 11

1.4 Research questions 11

1.5. The scope of the study 11

1.6. Significance of the study 12

Chapter 2 13

Literature review 13

2.0. Introduction 13

2.1. Definition of nonperforming loans 13

2.2. Different between performing and nonperforming loans 14

14

2.3. Definition of other concepts 14

2.6. Causes of nonperforming loans in commercial banks 22

2.4. Different views on performing loans 27

2.8. The level of nonperforming loans in the East African commercial banks 29

Chapter 3 32

Statement of findings 32

3.1. Research methodology 32

3.1.1 Introduction 32

3.1.2 Research design 33

3.1.3 Population 33

3.2.1. Collection of primary data 33

3.2.2. Collection of secondary data 34

3.2.3. Data analysis 34

3.3. Limitation of the research 35

Chapter 4 37

Chapter 5 47

Summary and conclusion 47

5.1. Introduction 47

5.2. Summary of findings 47

5.2.1. Reasons why loan holders fail to pay back their loans 47

5.2.2. The main consequence of non-performing loans in Access bank 48

5.3. Conclusion 48

5.4 Recommendations 49

5.5 Suggestions for further research 52

BIBLIOGRAPHY 53

1. BOOKS 53

2. REFERENCES 53

3. WEBSITES 53

APPENDICES 55

LIST OF TABLES

List of figures

Figure 1: Age group of respondent 38

Figure 2: The education level of respondents 38

Chapter 1

General introduction

Background of the study

Access Bank Rwanda is one of the commercial banks in the banking sector here in Rwanda. It is a large financial service provider, with an asset base of US$ 12.6 (February 2012).

The bank was first established in Rwanda in 1995, as Bancor S.A by a Ugandan investor. In 2000, it was sold to Tribert Rujugiro, and in 2001 the bank was restructured and other investors of South African nationality were brought on board as part-owners. In 2008, the Nigerian financial services provider, Access bank group took 75% ownership in Bancor S.A and in January 2009, the bank re-branded to Access Bank Rwanda.

Access Bank Rwanda is a member of Access bank group. Other member companies are Access bank plc – NIGERIA, Omnifinance bank – Cote d’Ivoire, Banque privée du Congo – D.R Congo, Access bank Sierra Leone, Access bank Gambia, Access bank United kingdom, Access bank Zambia and Finalease Burundi.

The vision of access bank is to transform the bank into a world class financial services provider, with the mission to go beyond the ordinary, to deliver the perceived impossible, in the quest for excellence. Its core values are excellence, ethics, passion for customers, team work, trust and continuous learning.

Caprio and Klingbiel (1999), non performing loans generally refer to loans which for a relatively long period of time do not generate income; that is the interest and the principal than whether the loan is overdue or not.

Goldstoin and Tunner 2007 noted that Non-performing Loans (NPLs) have become contemporary issues in credit management and undoubtedly the new frontier in finance. The accumulation of Non-performing Loans (NPLs) is generally attributable to a number of factors, including economic down turns and macroeconomic volatility, terms of trade deterioration, high interest rates, excessive reliance on overly high-priced inter-bank borrowings, insider lending and moral hazard.

Access Bank is striving to reduce the non performing loans to increase its profitability and for the best running of the economy of the country. The main area of my study is Access Bank, one of the private institutions in banking sector in Rwanda.

Access Bank grant loans and when those loans are not paid according to terms they result into non performing loans. This is not favorable to an institution like Access Bank as it reduces its profitability.

As conclusion non performing loans are not either good to the bank and to its customers, that’s why the credit risk management unit try to prevent credit risk to the bank but also its customers. Therefore the main objective of this study is to find out the consequences of nonperforming loans on commercial banks in Rwanda.

1.2 Research focus

According to the international monetary fund, global financial stability report (2010), in Rwanda, access to credit in the past, has been complicated due to stringent conditions imposed by commercial banks. In a sense, that is understandable, since Rwandans don’t have a good track record when it comes to paying back loans.

As per the National Bank of Rwanda (BNR 2010 report), few years ago non-performing loans (NPL) made up 40% of all credit given out, an indication that Rwanda’s financial sector was characterized with very high credit risk. In 2010, non performing loans had dropped to 10.8%, even though the ideal level for a thriving financial sector is 5%. This shows that even though the level of non performing loans has reduced it is still at high level. This raises curiosity and calls for an investigation into the evaluation of the consequences of nonperforming loans on commercial banks in Rwanda.

1.3 Purpose of the study

Overall purpose

This study intends to evaluate the consequences of the non performing loans on commercial banks and suggest remedies to overcome the increase of the non performing loans in future for commercial banks in Rwanda.

1.4. Research objectives

Identify reasons why loan holders fail to pay back their loans.

To evaluate the main consequences of non-performing loans in Access bank.

To find out the strategies put forward to reduce the level of non performing loans in Access bank.

1.4 Research questions

What are the causes of nonperforming loans in commercial banks?

What are their consequences on the profitability of commercial banks?

What strategies have been put in place to overcome the problem of non performing loans in commercial banks?

1.5. The scope of the study

The study was conducted in Access Bank where I got information regarding the non performing loans.

1.6. Significance of the study

This study is important to the researcher, other students, Commercial banks, Government and to other researchers, as it provide an insight on how loans can be used effectively and efficiently to borrowers and lenders.

To the researcher: It helps the researcher to improve knowledge and skills acquired in class and help him to come up with his final project.

To general public: : It gives them a clear picture on how loans can be harmful when asked without plan and the consequences they might face if they keep not paying their loans and the bank stops lending to them.

To commercial bank: It helps them to understand the effects of non performing loans to the bank, its borrowers and prospective investors, potential clients and the entire financial sector. Specifically it helps Access bank to improve their controls concerning loans.

To the Rwandan community, London School of Commerce students: This study is of great importance for researches and to improve their knowledge on non performing loans, and mostly how to avoid such cases in the future.

To other researchers: It serves as secondary data to other researchers who may need to use it in their research.

Chapter 2

Literature review

2.0. Introduction

This is a selection and analysis of relevant documents by distinguished scholars about the topic of study. It is an account of what has been published on bank loans by accredited scholars and researchers.

Kombo and Tromp (2006) define it as the works which the researcher consulted in order to understand and investigate the research problem. Amin (2005) is of the view that reviewing literature enables the researcher to know the means of getting to the frontiers of knowledge in the field of research. It also forms the foundation upon which all future work in this area will be built.

2.1. Definition of nonperforming loans

Hennie Van Greuning and Sonja Brajovic Bratanovic (2003), loans are considered to be nonperforming when the principal or interest on them is due and left unpaid for 90 days or even more, but this vary by jurisdiction.

Caprio and Klingbiel (1999) 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. So as the borrower is at default, loans do not produce interest to the lender. A non performing loan is a loan that is not being paid according to terms. In other words the borrower has defaulted or is close to being defaulted in making repayments.

Usually, a loan is non-performing when payments of interest and principal are past due by 90 days or more, or if at least 90 days of interest payments have been capitalized, refinanced or delayed by agreement, or payments are less than 90 days overdue (International Monetary Fund).

A loan is said to be in default when the borrower fails to repay it according to the terms of the promissory note. Typically, a loan is declared to be non-performing after 90 days of default, but this period of time may vary according to the contract terms.

2.2. Different between performing and nonperforming loans

A performing loan is a debt on which the borrower has historically made payments on time. For example, if a homeowner takes out a mortgage and pays his home loan faithfully each month, his mortgage is considered as performing loan. In some cases, loans in which payments are less than 90 days late may be considered performing.

A non-performing loan is a debt on which the borrower is late on making payments or is in danger of missing payments. Loans where the borrower is 90 days late on payments are considered non-performing, but any loan in default or near default may also be called non-performing. Lenders take a variety of steps to avoid and mitigate the impact of non-performing loans, such as denying loans to especially risky borrowers and charging higher interest rates to borrowers with lower credit scores (ehow.com).

2.3. Definition of other concepts

Commercial Bank

Hoggson N.F (1926), the name bank derives from the Italian word banco "desk/bench", used during the Renaissance by Florentine bankers, who used to make their transactions above a desk covered by a green tablecloth. The word traces its origin back in ancient Roman Empire, where money lenders would set up their stalls in the middle of enclosed courtyards called macella on along bench called bancu , from which the word banco and bank are derived.

While the Commercial banks refers to financial institutions which provides different financial services like deposits, loans, money transfer, foreign exchange and so many others with the aim of making profit. It is a type of financial intermediary and a type of bank that provide checking accounts, savings accounts, and money market accounts and that accepts time deposits.

BNR (2009) Commercial banking can also refer to a bank or a division of a bank that mostly deal with deposits and loans from corporation or large businesses, as opposed to normal individual members of the public (retail banking). The aim of commercial banks is to make profit.

Commercial bank raises funds by collecting deposits from businesses and consumers via checkable deposits, savings deposits, and time or term deposits. It makes loans to businesses and consumers. It also buys corporate bonds and government bonds. Its primary liabilities are deposits and primary assets are loans and bonds.

Commercial banks play different roles like: Issuing bank drafts and bank cheques, Lending money by overdraft, installment loan or other different means, Accept money from the public (deposit), Provide documentary and standby letter of credit, guarantees, performance bonds, securities underwriting commitments and other forms of off balance sheet exposures, Large commercial banks also underwrite bonds, and make markets in currency, interest rates, and credit-related securities and Safekeeping of documents and other items in safe custody.

Secured loan

A secured loan is a loan in which the borrower pledges some asset like a property or a car as collateral for the loan.

Unsecured loan

Unsecured loans are monetary loans that are not secured against the borrowers assets which mean no collateral is involved. These types of loans may be available from financial institutions under many marketing packages or guises namely bank over drafts, corporate bonds, credit card debt, credit facilities or lines of credit and personal loans.

Mortgage loan

A mortgage loan is a very common type of debt instrument, used to purchase real estate. Under this arrangement, the money is used to purchase the property. However, Commercial banks are given security – a lien on the title to the house – until the mortgage is paid off in full. And if the borrower defaults on the loan, the bank would have the legal right to repossess the house and sell it to recover sums owing to it.

Credit

A credit is a contractual agreement in which a borrower receives something of value now and agrees to repay the lender at some date in the future, generally with interest. The term also refers to the borrowing capacity of an individual or company. It is granting a loan or the provision of resources by one party to another, where the second party does not reimburse the first party immediately. Credit is in turn dependent on the reputation or creditworthiness of the entity which takes responsibility for the funds.

Ingham (2004).Credit need not necessarily be based on formal monetary systems. The credit concept can be applied in barter economies based on the direct exchange of goods and services, and some should go so far as to suggest that the true nature of money is best described as s representation of the credit –debt relationship that exist in society

Trade credit

Trade credit in commercial trade; refer to the approval for delayed payments for purchased goods. Sometimes, credit is not granted to a person who has financial instability or difficulty. Companies frequently offer credit to their customers as part of the terms of a purchase agreement. Credit manager are recruited for institutions that offer credit to their clients.

Customer credit

Consumer debt can be defined as money, goods or services provided to an individual in lieu of payment. Consumer credit may be in forms of motor or auto finance, credit cards, store cards personal loans or even retail loans (retail installment loans) and mortgages.

2.5. Nonperforming loans in Rwanda’s context

According international monetary fund (global financial stability report, 2010) non performing loans to total gross loans (%) in Rwanda was 10.80 as of 2010; its highest value over the past 8 years was 57.00 in 2002. The national Bank of Rwanda also says that collecting loans rose from Rwf 307.6 million in 1999 to Rwf 837.0 million in 2000 and Rwf 1.8 billion in 2001. And according to The New Times (16 April, 2009) article by John Gahamanyi under the title "Rwanda: Banking industry – non performing loans in banks now at 9.3 Percent".

According to the National Bank of Rwanda, after the 1994 Genocide against Tutsi the banking sector was almost collapsed and in 1995 it was recovering. Before 1994, Rwanda had only three commercial banks namely Bank of Kigali (BK), Commercial Bank of Rwanda (BCR), BACAR and had only one development which is the Development Bank of Rwanda (BRD).

The 1995-2007 BNR report on banking supervision, results from the first reorganization plans have been satisfactory though it has been noted that some banks experienced specific difficulties attributed to poor quality of a substantial number of loans granted after the 1994 genocide.

The audit said that the 1994 genocide strongly weakened the banking activity in the country, leaving a substantial figure of non performing loans on the banks’ balance sheets. Bank losses came in many ways as a result of genocide, clients of banks who had acquired loans were killed and a reasonable number of investments financed through debt were halted.

After the 1994 genocide, investment was one of the things that have been promoted and its facilities increased which attracted numerous investors and it helped in stimulating the local market. This had led financial institutions to regain their business through financing real estate, buildings and residences for rental use.

The audit says that even though some institutions have improved their performance others did not and according to the National bank of Rwanda it was not sufficient since the collected amount were less significant comparing to the total non performing loans.

The BNR noted that several factors were the sources of non reimbursement of loans granted and this is due to the non productivity of some financed projects, bad use of borrowed funds and incompetence of some entrepreneurs. All this was noted when the BNR examined the case of the statement of irregular debtors. Lack of experience, limited financial, human and material resources were some of the causes of this poor performance.

Throughout the year 2002, according to the annual report of the National Bank of Rwanda (Department of banking supervision, 2002), while reinforcing its capacities to this effect, the bank has continued its regular activities of supervising the banking system to which prudential regulations and standards were applied to ensure good and prudential management of risks relating to the banking operations. It is within this framework that the bank undertook the amendment of some prudential regulations to adopt them to international standards.

Moreover, the bank has provided the rehabilitation program of the country financial system, which confronted with a high volume of non performing loans. It is within this framework that an interbank commission on the rehabilitation of the portfolio credits of the Rwandan financial system was created. It suggested short term recommendations in order to accelerate and to maximize the recovery and other medium commitments, and to modernize the legal and regulatory framework, in particular relating to the registration and the realization of banking guarantees and the legal handling of unpaid bank loans. Some banks facing problems drew the special attention of the bank; recovery and restructuring plans were adopted in order to help them find ways of achieving financial profitability.

During the year 2002, the National Bank of Rwanda (BNR) carried out activities of monitoring and these activities followed two methods of monitoring namely; Document-based control and On-site inspection.

Control of supporting document

The control of supporting document was reinforced in order to closely follow up on the document of banks. Some of the improvements in 2002 were the following:

Introduction of a quarterly note of analysis for the whole banking system.

Standardization of the format for the quarterly note of analysis of banks.

Setting up statistical database gathering information obtained from banks on the financial statements, quality of loan, the solvency and liquidity. The statistical report (figures, trends and ratios) is produced quarterly and it presents an information set on each individual bank and consolidated information for the banking system.

On-site inspection

On-site inspection focuses essentially on most serious risks; it is preventive in nature and aims at orienting the decision-making relating to the control and rehabilitation of banks. In 2002, four on-site inspections were carried out; two general inspections and two other inspections in relation to loans, profitability and liquidity.

The main observations made throughout these inspections concern the weakness in the analysis of loans applications, especially on matter related to the analysis of transmitted information and the evaluation of repayment capacity of the borrowers, the absence of policies and procedures for the granting of loans suitably approved by the entitled organs of the banks, the lack of clear management policies of the loans portfolio and the recovery of nonperforming loans, the violation of regulations relating to shareholders and their group’s borrowing.

Taking into account these observations, the bank has made recommendations aiming at improving the situations including: the designing of loans policies and procedures manual, the revision of the system for the analysis and follow up on risks by making sure that the applications are processed and assessed in conformity with international best practices in matters related to loans; the follow up of the registration of guarantees and sticking to the best practices as the evaluation of guarantees when loans are granted and during the future revisions of their commercial value; the necessity of bringing the loans extended to the banks’ management within the regulatory limits; the setting up of a policy for the management of loans portfolio and a strategy for the recovery of nonperforming loans.

According to IMF, improvements were brought throughout the year to the working methodology, especially:

The introduction of planning phase envisaging among other things, selection of loans sample to be revised, analysis of the main area of risk in order to give a better orientation to the inspection and prepare a meeting with committees of internal auditors of banks.

The introduction of an accompanying letter, which once the final inspection report is out, reminds the management of the inspected bank, about the priority aspects on which the National Bank of Rwanda believes action must be taken.

The use of a standardized format for report comprising of a summary table of what has been done and a summary of observation and recommendations. (Emma, 2009).

The introduction of a meeting at the beginning and at the end of the inspection with the management of banks and other financial institutions.

Concerning the restructuring of banks in difficulties, the following recovery plans were designed: Adequacy of their equity capital to the prudential rules published by the National Bank of Rwanda, Compliance with ratios of risk division and the control of the growth of the credit activities, Implementation of a policy for the rationalization of the operating costs, Reinforcement of efficiency in the management of funds, Reduction of nonperforming loans and setting up a recovery plan, Two banks, whose situations were particularly dramatic, were put under temporary administration while the other bank was under a provisory controller, both appointed by the central bank. Finally, an in depth reform program was launched for one of the three banks in Rwanda at that time, which was also one of the important commercial banks in Rwanda whose management was controlled by the government. The objective of this reform was to sell the government actions held in that bank to a strategic investor.

In January, 2002 the government of Rwanda through the central bank intervened in the former BACAR (now FINABANK) whose non performing loans had reached a damage level to the extent that the bank would be closed mainly due to the poor and wrong administration by the management of the bank; and the influence peddling from the shareholders in the wake of this crisis. The central bank of Rwanda dismissed the management of the bank through its appointed representatives. As a result of this, the report indicates a positive and normal recovery.

Also in the same experience, the government in May 2002 took a decision t save the Commercial Bank of Rwanda (BCR) whose non performing loans had reached 35%. The government of Rwanda, which was the biggest shareholder with 61% of shares, decided to recapitulate the bank with 5 billion Rwf. According to the annual report of BCR (2002) they moved to some extent of the non performing loans gap by 40%. Strict measures were taken by the new management to the extent that the bank targets to recover its former glory by the year 2006.

2.6. Causes of nonperforming loans in commercial banks

The root causes of nonperforming loans usually are the absence of proper bankruptcy laws and legal procedures in enforcing security rights, wrong lending decisions as a result of corrupt bank staff and improper credit appraisal system. It has been often reported that some bank officers usually do not follow the basic credit policies in granting loans.

A major portion of bad loans arose out of lending to the priority sector, at the dictates of politicians and bureaucrat. If only banks had monitored their loans effectively, the bad debt problem could have been eliminated. Politicians and bureaucrats force bank’s management to throw good money after bad in case of the unscrupulous borrowers. Many borrowers defaulted only due to the reasons of recession in the economy.

The absence of proper bankruptcy laws and dilatory legal procedures in enforcing security rights, are the root causes of bad debts in banks. One of the primary reasons for non performing loans could be that the decision was incorrect. Therefore, seasoned bankers would scoff at this statement but the reality has to be faced. Appraisal of credit needs of industrial units and business concerns cannot be put into straitjacket and banks have to re-learn the tricks of the trade (Bad loans of banks: causes and remedies. Report by the Hindu paper India).

Banks in developing markets often do not have a well developed plan for managing credit risk. Consequently deficiencies lead to loan portfolio weaknesses, including an over concentration of loans in one industry or sector, large portfolios of nonperforming loans, credit losses, insolvency and liquidity. Diana Mc Naughton (1992). Other causes of nonperforming loans are the following:

Credit culture

Most nonperforming loans are caused by borrower decisions. Sometimes borrowers decide to qualify for loans without thinking enough about the future and what else they need to buy with their income.

When this occurs, a credit culture can develop where borrowers take out large loans not because it is financially wise but because they see others doing it. That can easily result in defaulted loans.

Weakness in credit risk management

Credit risk is defined as the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with the agreed terms (Basel committee on banking supervision, 2000).

According to the Basel committee on banking supervision (2000), the effective management of credit is a critical component of a comprehensive approach to risk management and essential to the long term success of any banking institution. Payments may be delayed or ultimately not paid at all, which can in turn cause among other problems the flows of nonperforming loans.

The basis for an effective credit risk management process is the identification and analysis of existing and potential credit risk inherent in any product or activity.

Measures to counteract these risks normally comprise clearly defined policies that establish the framework for lending and guide the credit granting activities of the bank.

Credit risk management process should cover the entire credit cycle starting from the organization of the credit in a commercial bank’s books to the credit is extinguished from those books. it should provide for sound practices in: credit processing or appraisal, credit approval, credit documentation, disbursement, monitoring and control of individual credits, monitoring the overall credit portfolio, credit classification and managing problem credit/recovery. Bank of Mauritius, guidelines on credit risk management (2003).

Emma, (2009).Deficiencies in credit risk management cause weakness in credit risk identification at the credit origination level and through all the credit life, which result in non performing loans’ accumulation

Sudden market changes

Any sudden market change can change the loan market by affecting how much money people have to take out loans and make payments. If the market suddenly changes and the prices of objects increase due to shortages or greater demands, borrowers will have less money to pay off their loans, which can lead to greater overall nonperformance (ehow.com).

Weakness of the banking supervision in evaluating banks’ credit risk management system

Banking supervision is the process of monitoring banks to ensure that they are carrying out their activities in a safe and sound manner and accordance with laws, rules and regulations. Sinkey J.R (1986) states the goals of regulations as:

The protection of depositors

The protection of the economy from vagaries of the banking systems

The protection of banks customers from monopolistic power of banks.

According to Dale (1986) has classified prudential of banks into three: preventive, protective and supportive.

Preventive regulation is designed to limit the risk undertaken, the protective regulation offers protection in the event of failure, while the supportive regulation is in form of a lender of last resort.

According to the 17th principle for the management of credit risk issued by Basle committee on banking supervision in 1999, supervisors should require that the banks have an effective system in place to identify measure, monitor and control credit risk as part of an overall approach to risk management.

Supervisors should conduct an independent evaluation of a bank’s strategies, policies, practices and procedures related to the granting of credit and the ongoing management of the portfolio (Basel committee on banking supervision, 1999).

Deficiencies in the bank’s credit risk management system increases credit defaults which leads to high level of nonperforming loans. In credit matters, the role of the banking supervision is to evaluate the quality of the bank’s credit risk management system and address with management any weakness detected in the system. Supervisors should ensure the bank to take appropriate actions to improve its credit risk management system. Thus, efficient banking supervision helps commercial banks to reduce flows of nonperforming loans Emma (2009).

Real estate changes

The real estate industry and home loans--one of the staples of the loan industry--are closely connected. If prices in the real estate market fall--if houses sell for less and less--then lenders recoup less and less money from seizing properties in response to defaulted loans. This results in more loans becoming nonperforming, losing the lender money instead of making it.

Bank performance

Bank performance also acts as a key cause of nonperforming loans. An efficient and well-run bank should be able to adjust loan rates and terms to the current market in order to decrease the chance of nonperforming loans. Banks should also be selective as to which borrowers they accept. Banks that do poorly in these areas will create more nonperforming loans.

Rwanda is also not exonerated from the core causes of non performing loans in the banking sector, as in the experiences of other world economies that suffered problems of non performing loans. However, Rwanda has had certain peculiar causes of bad debts and here are the following:

The most strong and stringent cause of non performing loans traces its roots from 1990, was a result of poor and bad governance that featured the country whereby most influential politicians and rich people drew thousands of money in local banks to deposit them in foreign banks without collateral as they were suspecting something strange to hit the country, that is subsequent political wars and later alone 1994 Genocide. These catastrophic events ruined the country basic economic infrastructure including banks that are the major contributors for the well being financial, social and economic sector of the country.

2.4. Different views on performing loans

DeServigny and Renault, (2004), submitted that Non-performing Loans (NPLs) has taken a new dimension in finance just as interest rate and asset and liability management were 15 years ago. Because of mounting pressure of Non-performing loans (NPLs) on bank's balance sheets and incessant bank failures, the Central Bank of Nigeria's Prudential Guidelines (1990) and subsequent reviews include credit facilities into loans, advances, overdrafts, commercial papers, banker's acceptances, bills discounted, leases, guarantees, and other loss contingencies connected with a bank's credit risks.

The activities of these credits in terms of frequency of repayment or inability to repay same have further made it possible to group them into performing and non-performing credit facilities. According to Elaine (2007), Non-performing Loans (NPLs) or credit risk encloses the possibility of loss if things like credit deterioration happens to the borrower of the funds. Therefore a well studied credit appraisal of loans is very vital to the creditor.

In the arguments done by Dorfman (1998), some bankers do need to have a good understanding and be familiar with credits standard, get to know the process that credits worth is measured as well as the analysis of the credit structure. Bankers also should be familiar with decision making techniques, how to negociate, have skills to make a good follow up of credits they gave and skills to resolve problems too so that it gets easier to deal with credit risk management.

According to Abolo (1999) he made an argument in support of Dorfman’s findings by presenting some of his principles of granting less than three headings divided as Safety, Suitability and the profitability of the credit. These also require the bankers to follow the credit granting rules provided.

It has been said by many, whether in social or business reasons that credit often has to do with faith as well. But again in many case the loyalty and trust between two parties involved in the loan does not matter in reducing the importance of analyzing the portfolios of the loans mostly when the good faith the parties had has been violated, resulting in a possibility of a nonperforming loans, whether it had been done intentionally or unintentionally, for such reasons, a good analysis is needed before granting a loan.

This involves sound credit analysis, which Nwankwo (1991) describes as the process of assessing the risk of lending to a business or individual against the benefits to accruable from such investment. The benefits can be direct, such as interest earnings and possibly deposit balances required as a condition of the loan or indirect, such as initiation or maintenance of a relationship with the borrower, which may provide the bank with increased deposits and with demand for a variety of bank services. He argues further that credit risk assessment has two aspects. One is qualitative, and generally the more difficult; and the other are quantitative.

To evaluate the qualitative risk, the loan officer has to gather and appraise information on the borrower's record of financial responsibility, determine his true or correct need for borrowing, identify the risks facing the borrower's business under current and prospective economic and political situations, and estimate the degree of his commitment regarding the repayment. To estimate the financial viability of a portfolio, banks should not only limit their analysis to project evaluation techniques alone, but also by evaluating all credit risks that could become threats to the overall performance of such a portfolio.

Schall and Halley (1980) outlined the key indicators for loan analysis as capacity, collateral, capital, condition and character. He concludes that lending involves the creation and management of risk assets and is an important task of bank management. While being the highest earning asset, the loan portfolio is also the most illiquid and most risky of banks' operation. The fiscal costs of these impaired loans are important as well, and vary with the scope and length of the crisis (Cortavarria Luis, Dziobek, A.KanayaanI, Song, 2000).

Non-performing Loans (NPLs) are the most common causes of bank failures. This has made all regulatory institutions to prescribe minimum standards for credit risk management. The basis of sound credit risk management is the identification of the existing and potential risks inherent in lending activities. Measures to counteract these risks normally comprise clearly defined policies that express the bank's credit risk management philosophy and the parameters within which credit risk is to be controlled.

DeServigny and Renault (2004) argued that specific credit risk management measures typically include three kinds of policies. One set of policies include those aimed to limit or reduce credit risk, such as policies on concentration and large exposure, adequate diversification, lending to connected parties, or over-exposure. The second set includes policies of asset classification which expose a bank to credit risk. The third set include policies of loss provisioning or the making of allowances at a level adequate to absorb anticipated loss-not only on the loan portfolio, but also on all other assets that are sensitive to losses.

2.8. The level of nonperforming loans in the East African commercial banks

Martin Luther Oketch, (2011) noted that the level of non-performing loans (NPL) in East African commercial banks have drastically dropped, which signifies that the banking industry in this region is in a good shape. Banks’ asset quality is a key indicator of the quality of banks’ credit and overall risk of default (credit risk).

Unlike in the 1990s and up to early 2000s when the level of the non performing assets (non-performing loans) in East African commercial banks were at 50 per cent and above. Banks’ performance in the year 2010 was also characterized by strong credit growth to the private sector and, a sharp rise in foreign currency loans during the last half of 2010 across East African region.

The Bank of Uganda Annual Supervision Report for 2010 indicates that the level of non-performing loans in Ugandan banks stood at 2.2 per cent, in Kenya the ratio of non-performing loans in Kenyan banks was 6.2 percent as of end of December 2010, in Tanzania the ratio of non-performing loans closed at 6.7 per cent as of end of December 2010, and Rwanda registered ratio at 11.3 per cent.

     

The Bank of Uganda states in its annual supervision report that overall, bank asset quality in Uganda has improved in the period after the global crisis and continues to be good. The level of banks’ NPLs has since declined to 2.1 percent as at December 2010 compared to 4.4 per cent in 2009. By way of comparison within the East African region Uganda banks have the lowest level of nonperforming loans compared with other countries within the East African Community.

Speaking specifically on Uganda’s banking industry, the governor Bank of Uganda Professor Emmanuel Tumsiime Mutebile explained that during 2010, Uganda’s financial sector registered strong growth, reflecting the rebound in economic growth which took place on the second half of 2010 together with heightened competition in the banking sector. "The performance of the banking industry improved, as manifested in higher asset quality and profitability. The ratio of non-performing loans to total gross loans decreased from 4.2 percent of total gross loans in December 2009 to 2.1 percent in December 2010. Commercial banks remained well capitalized," he said.

Professor Mutebile said aggregated across the banking system, the core capital to risk weighted assets ratio was 17.4 percent as at December 2010, far above the regulatory minimum level of 8 percent. "Profitability also improved, including among the new banks whose operating costs reduced significantly. Earnings grew by 13.8 percent for the year to December 2010," he said.

Bank profitability improved, particularly for the new banks whose operating costs were significantly reduced. For Uganda’s case in particular, Earnings and Profitability, the Bank of Uganda explained in the report that as at the end of December 2010, banks’ earnings had reached Shs.268.7 billion ($134 million) compared to shs.236.1 billion($118 million) in December 2009. The rise in banks’ earnings was due to improved performance during 2010 especially in the quarter ending December 2010.

 

As the level of nonperforming loans in banks continues to drop, the level of credit growth in the East African Community is growing raising hopes that the financial sector in the region is picking up. It also indicates the economies in East African region are growing at higher rate than most economies in the Sub-Saharan African Continent. The financial sector is one the catalysts for high economic growth since the sector acts as conduit for expansion of private enterprises in a particular country.

The International Monetary Fund puts economic growth in the East African Community states at 5.5 per cent for the year 2011 driven by recovery in the global economy leading to increased economic activities in EAC states.

The Bank of Uganda says one indicator of rapid credit growth recommended by the BCBS is the ratio of private sector credit to Gross Domestic Product (GDP. For Uganda, this ratio was 15.7 percent as at end December 2010, up from 7.9 percent in December 2005. Within the East African region, the ratio of private sector credit to GDP for Kenya as at end of September 2010 was 66 percent, Rwanda at 17.3 percent, while Tanzania was at 36.2 percent.

Bank of Uganda officials in Supervision Department points out that from the above perspective, the recent growth in credit, although fairly rapid, may reflect convergence with the levels of the other EAC states.

Chapter 3

Statement of findings

3.1. Research methodology

3.1.1 Introduction

This chapter focuses on describing the methods of investigation used while conducting the present study. It shows lights on, the population with its sample size, data collection and analyzed techniques and also mentions the limitations encountered during the study.

According to Kothari (1990) "Research methodology refers to a way to systematically solve the research problem. It may be understood as a science of studying how research is done scientifically. It includes the various steps that are generally adopted by the researcher in studying the research problem along with the logic behind them. "

As per Richard M. Grinnel research methodology is the way to systematically solve the research problem. It may be understood as a science of studying how research is done scientifically. Thus when we talk of research methodology we do not talk only of the research methods but also consider the logic behind the method we use in the context of our research study and explain why we are using a particular method or technique and why we are not using others so that research results are capable of being evaluated either by researcher himself or by others.

Lastly the chapter indicates the various problems encountered by the researcher during the research and how they were overcome or minimized.

3.1.2 Research design

The researcher used a case study design to collect data on the consequences of non performing loans and Access Bank Rwanda has been used as case study.

3.1.3 Population

According to Grinnell and Williams (1990), population is the "totality of persons or objects with which the study is concerned". Donald et al (1999), defined population as the "total collection of objects about which researchers wish to make inferences".

In this study 3 staffs of Access bank among 5 in risk management unit and 10 customers of Access bank who have been given loans constitute the population and sample size of this study.

3.2. Methods of data collection

These are methods or instruments used by the researcher to collect data from respondents and other sources that are relevant to the study. Data were obtained by the use of primary and secondary data.

3.2.1. Collection of primary data

In gathering primary data the observation and interview methods were used.

Interview method

The researcher conducted an interview on non performing loans to Access bank staff in credit risk management.

Questionnaire

This is an instrument that consists of a set of questions whereby a large number of people are asked to answer in order to provide data to the researcher. Due to the fact that personal interviews were not convenient to all respondents, questionnaires were designed.

The researcher designed both open and closed ended questions. With open ended questions, respondent where asked to give personal opinions whereas with close ended questions respondent were required to select answers from a number of pre-determined alternatives.

Questionnaires technique is advantageous because it enables some respondent like bank managers who are given adequate time to think about the questions and are free from bias of the interviewer. Even to those who are not approachable could be reached, thus saves costs and time since of questions are sent to respondents.

3.2.2. Collection of secondary data

Secondary data was obtained from reading about what others wrote about the research topic. This was obtained from various libraries, banks’ annual reports, local and international news papers, Access bank website, related books and different internet web sites.

3.2.3. Data analysis

After the data collection, the data were processed to obtain meaningful results as data were disorganized. This involves the following steps;

Editing

Editing was done to ensure complete record, accuracy and correct errors throughout the answers collected from respondent.

Coding

It consists of classification of data from different respondent. Symbols were assigned to different categories so as to prepare tabulation.

Tabulation

This is a kind of statistical tables that show the number of occurrences of responses to a particular question, because data is collected and put into some kind of statistical tables.

MOSER and KALTON (1971) noted that "once data is edited and coded is put together in the same kind of tables and, may undergo some other forms of statistical analysis.

3.3. Limitation of the research

These refer to the problems faced by the researcher during the course of research. Those problems (limitations) are:

Some respondent were not willing to disclose some information that would benefit the researcher during his research saying that they can not disclose some of their information.

Also managers were not willing to reveal their most of their confidential information.

Delay in responding to questionnaires by respondents.

Sometimes the researcher received partial response to designed questions.

Hard time reaching managers or getting them to talk to me.

Despite these limitations the researcher put a lot of commitment in his research and tried to use the available information to complete his work. And also the researcher used available information in order to avoid conflicts with managers because of their confidential information.

Chapter 4

4.1 Introduction

This chapter intends to present and analyze the research findings as well as their interpretation. The findings are expected to provide an insight of the assessment of the situation of non-performing loans, as well as their causes and consequences in commercial banks in Rwanda. Data collected are from primary and secondary data from various sources.

Tables and figures were used for better understanding and interpretation of data

4.2 Interpretation of data

Table 1: Age group of respondent

Age

Frequency (N)

Percentages (%)

20-30 Years

6

60

30-40 Years

2

20

40-50 Years

1

10

50-60 Years

1

10

Above 60 Years

0

0

Totals

10

100

Source: primary data

As per table 1, the majority of respondent range from 20-30 years. It constitutes the highest percentage with 60%. The age group of 30-40 years has 20%, while the age group of 40-50 and the one of 50-60 both constitute 10% each of the respondents. This table shows that the age group of above 60 years has no respondent.

Figure 1: Age group of respondent

Table 2: The education level of respondents

Education level

Frequency (N)

Percentages (%)

High school level

2

20

Bachelor’s degree

6

60

Masters degree

3

30

PhD level

0

0

Totals

10

100

Source: primary data

Figure 2: The education level of respondents

According to the table and figure below 60% of respondents have a Bachelor’s degree, 30% have master’s degree and only 20% have a high level.

None of the respondents had a PhD level.

Table 3: Occupation of the borrowers

Occupation

Frequency (N)

Percentage (%)

Self employed

6

60

Civil servant

0

0

Private sector employee

4

40

Totals

10

100

Source: primary data

According to Table 3, most borrowers (60%) are self employed meaning that they are business people, they are their own bosses. This indicates that the loans that they are likely to request are for their business.

From the respondent there was no civil servant.

Also another part of respondents are employees of private sector with 40% of respondents.

Figure 3: Occupation of the borrowers

Table 4: How long have you worked in the loan recovery department?

Time worked

Frequency (N)

Percentages (% )

Below 2 Years

1

33

2-5 Years

2

67

5- 8 Years

0

0

Above 8 Years

0

0

Total

3

100

Source: primary data

This question was addressed to Access Bank staff. The above table shows that one employee form the respondent has less than two years of working experience in this department. Other two employees have between two to five years of experience. We can say that the most employees have good experience in this field.

Figure 4: How long have you worked in the loan recovery department?

Table 5: have you ever requested for loan?

Response

Frequency (N)

Percentage (%)

Yes

10

100

No

0

0

Source: primary data

As per table 5, all respondent requested for loans.

Table 6: Reasons for requesting loans

Reason for requesting loans

Frequency (N)

Percentages (%)

Business

8

80

Health concern

0

0

Education

0

0

Vehicle financing loan

2

20

Totals

10

100Source: primary data

The Table above shows that 80% of borrowers requested loans for their business, while 20% requested vehicle financing loans. These 2 people who requested vehicle financing loan were Access Bank staff. This shows that most clients of Access Bank are businessmen and when they request for loans the major purpose is to carry on their business.

Figure 5: Reasons for requesting loans

Table 7: Have you ever been declared bankrupt by any bank?

Response

Frequency (N)

Percentage (%)

Yes

0

0

No

10

100

Source: primary data

According to table 7, no respondents had been declared bankrupt by their banks. They claimed to have paid their loans as it was supposed but some of them have not yet finished paying it.

Table 8: What may be the causes of non-performing loans in commercial banks?

Major causes of NPLs

Frequency (N)

Percentages (%)

Business failure

10

38.6

Poor credit analysis

5

19.2

Poor assessment and classification of borrowers

5

19.2

Lack of professionalism by employees

6

23.0

Totals

26

100

Source: primary data

Figure 6: What may be the causes of non-performing loans in commercial banks?

As per table 8, according to respondent the major cause of NPLs is business failure. Many people ask for loans to carry their own business. But sometimes, the business plan of some is not well prepared. They start the business and at some point their business stuck or even collapse.

As the business has collapsed they fail to repay their loans and as result their loans become nonperforming. Respondents agree at 38.6 that the business failure is the major cause of nonperforming loans.

The other cause was the poor credit analysis. This happen when the bank does not have well defined procedures of monitoring credits. Respondents said that whenever the bank does not have well defined procedures, they grant loans to people who really do not have all requirements to get loans. The poor credit analysis has 19.2% of the causes.

Poor assessment and classification of borrowers has also 19.2% of the causes. For example borrowers who had long history of loans would still come back and request for more. So when the bank does not have an efficient and effective way of assessing borrowers whether they are qualified to get loans or not, whether they have been defaulted before or not may be the cause of nonperforming loans.

Regarding the non professionalism of employees, respondents said that that sometimes employees of the bank grant loans to customers not because they fulfill the requirements but because those customers are famous like politicians or because of friendship. So this lack of professionalism may harm the well performance of the bank due to the non performing loans rising from that lack of professionalism.

Table 9: what can be obstacles for paying back loans by borrowers?

Major reasons

Frequency (N)

Percentage (%)

Competition from similar businesses

4

19

Poor business management

3

14

High interest rate

7

33

Lack of adequate business skills

2

10

Loss of jobs

5

24

Totals

21

100

Source: primary data

Figure 7: what can be obstacles for paying back loans by borrowers?

As per table 9, respondents argued that high interest rate is the main obstacle when it comes to paying loans. High interest has 33% of all obstacles, loss of jobs 24%, competition from other business 19%, poor business management and lack of adequate business skills 10%.

Chapter 5

Summary and conclusion

5.1. Introduction

This chapter intends to present the summary of findings on questions relating to non performing loans in commercial banks, here in Rwanda, and present recommendations on actions to be taken to reduce that serious burden in the Rwandan banking sector.

5.2. Summary of findings

5.2.1. Reasons why loan holders fail to pay back their loans

According to the research, many loan holders fail to pay back their due to high interest rate of banks (33% of the reasons).

The research revealed also that the loss of jobs (24%) is another big obstacle. This is explained with the fact that when customers get loans while having a job, their income (salary) from that job help them to repay their loans. But when they lose their job it is difficult for them to find another source of revenue to help them pay back their loans so that they do not be declared bankrupt by banks.

Other reasons are competition from similar businesses (19%) and poor business management (10%), where when you are not strong enough to compete or you do not have proper ways to manage your business, you are eliminated and by loosing your revenues you also loose means to pay back loans.

5.2.2. The main consequence of non-performing loans in Access bank

As per observation non performing loans have a great impact on the profitability of the bank. When non performing loans continue to increase, the bank profitability reduces even though the bank preserves a loan loss provision.

So when the bank profitability decreases, it affects shareholders, because they can not put their shares in an institution that is making loss and in the long run the whole bank is also affected.

5.2.3. Strategies put forward to reduce the level of non performing loans in Access bank

According to the research, respondents showed that the bank visit their business like once a month, which is a very good act on the side of the bank but also on the side of the customer as it help the customers to manage well their businesses with the advices of staffs of bank. And this may reduce chance of loan to be declared nonperforming advise the customer how to monitor his business.

5.3. Conclusion

The objective of this research was to evaluate the consequences of non performing loans in commercials banks in Rwanda and suggest remedies to overcome it in commercial banks.

The research revealed that the level of non performing loans is decreasing which is good for commercial bank but also to the national economy of the country; but there is still a lot to do to reduce or even eliminate nonperforming completely.

This was proved by international monetary fund (global financial stability report, 2010) and the National Bank of Rwanda, were non performing loans to total gross loan in Rwanda was 10.80% in 2010 while in 2002 it was 57%.

The research also revealed that Rwandans are getting the culture of paying to pay loans which permitted the decrease in the level of non performing loans in Rwanda.

Even though the level of non performing loans has decreased, there is still a lot to do to continue reducing the level of non performing loans.

This will be a benefit to commercial banks, borrowers and the country in general.

5.4 Recommendations

Based on the findings of the research, the researcher would like to advise all stakeholders concerned namely the National Bank of Rwanda, commercial banks and to borrowers of loans.

The study recommends the strengthening of banking regulation; adequate provisions for Non-performing Loans so as not to distort the true presentation of the banks position in their balance sheets; sound credit analysis; acceptable level of risk-reward and tradeoff for portfolio activities; the institution of bank credit strategy that will take into account.

5.4.1. Recommendations to the National Bank of Rwanda (BNR)

The study recommends the strengthening of banking regulation; adequate provisions for Non-performing Loans so as not to distort the true presentation of the banks position in their balance sheets; sound credit analysis; acceptable level of risk-reward and tradeoff for portfolio activities; the institution of bank credit strategy that will take into account.

These days the competition is tough in the banking industry in Rwanda, so the national bank should encourage commercial banks to work together by sharing information.

The BNR should revise the interest rate charged by commercial banks when granting loans, as borrowers claim that the interest rate charged by commercial banks is very high.

The BNR should advise commercial banks to improve their management capacity.

5.4.2. Recommendations to commercial banks

Bankers should improve their professionalism, as lack of professionalism was mentioned as one of the causes of non performing loans by respondents.

The follow up and advice by banks to their customers in their businesses are necessary to make sure that what the funds were requested for is being done, otherwise impose a regulation on the funds misuse.

Institutions should help students to carry their research by giving them information that would help them in complete their research.

Banks should not emphasize on competition and to work together for their interest.

Banks should improve their credit analysis procedures, grant loans only w