Assessing the effectiveness of credit management practice of

microfinance institutions
(A case study on Somaliland- Saacid microfinance institution)

Submitted to Sheba University College, School of Postgraduate Studies

in Partial fulfillment for the award of MA degree in Accounting and
finance

By: Sahra Hussein Awil

Advisor: Gizachew Yirtaw(Phd)

SHEBA UNIVERSITY COLLEGE

SCHOOL OF POSTGRADUATE STUDIES
DEPARTMENT OF ACCOUNTING AND FINANCE

April, 2020
Mekelle,Tigray

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 DECLARATION

I, Yohannes Desta Hailu, declare that this thesis is the result of my own work and all sources or
materials used for this thesis have been appropriately acknowledged. This thesis is submitted in
partial fulfillment of the requirements for Master of Finance and investment. I confidently
declare that this thesis has not been submitted to any other institutions anywhere for the award of
any academic degree, diploma, or certificate.

Place: Mekelle University, College of business and economics

Submitted by: Yohannes Desta Hailu

Date of Submission: October, 2009

Signature ---------------

I
 CERTIFICATION

This is to certify that this thesis entitled “The Role of tax administration on domestic tax
mobilization: case study of Mekelle City Administration’’ submitted in partial fulfillment of
the requirements for the award of Masters of Finance and investment to the College of Business
and Economics, Mekelle University, through the Department of Accounting and finance done by
Mr. Yohannes Desta Hailu, ID No.CBE/PRI64/06 is an authentic work carried out by him under
my guidance. The matter embodied in this project work has not been submitted earlier for award
of any degree or diploma to the best of my knowledge and belief.

Principal Advisor: Nigus Abera(Assistant Professor)

Signature____________________
Date: October, 2009

Co-adviser: Hiwot Kebede(Assistant Professor)

Signature: _________
Date: October, 2009

Acknowledgments

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First of all, I would like to thank the almighty God for strengthening me in realizing my prayers.
Besides, I would like to express my heartfelt appreciation to my principal advisor-Nigus
Abera(Asst. professor) and my co-advisor-Hiwot kebede (Assistant Professor) for their persistent
advice and constructive comments throughout the steps of this research paper.
Second, I am indebted to Girmay Zeru for his critical support in accomplishing the whole
master’s degree in finance and investment. So, I have nothing to respond but God Bless you.
Thirdly, I would like to thank all respondents for providing the required information throughout
the process of data collection.
Finally, I never forget all those who were sharing their constructive advices like berhane
W/gebreal, Yohannes G/yesus and materials at critical time like Teame Lemlem and my family
Especially my wife Azmera H/Michael.

Yohannes Desta Hailu

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 Table of content
Content Page
CHAPTER ONE: INTRODUCTION----------------------------------------------------------------------1
1.1. BACKGROUND OF THE STUDY-------------------------------------------------------------------4
1.2 Statement of the problem--------------------------------------------------------------------------------3
1.3 General and specific objectives of the study----------------------------------------------------------4
1.3.1General objectives---------------------------------------------------------------------------------------4
1.3.2 Specific objectives--------------------------------------------------------------------------------------4
1.4 Research Question----------------------------------------------------------------------------------------4
1.5. Scope of the study----------------------------------------------------------------------------------------4

1.6. Significance of the study--------------------------------------------------------------------------------5

1.7. Limitation of the study----------------------------------------------------------------------------------5

1.8. Organization of the paper-------------------------------------------------------------------------------5

CHAPTER TWO: RELATED LITERATURE REVIEW------------------------------------------------6

2.1 background of the study area----------------------------------------------------------------------------6

2.2 overview of credit management-------------------------------------------------------------------------
6
2.3 credit management practices----------------------------------------------------------------------------8
2.3.1 Credit risk assessment----------------------------------------------------------------------------------
8
2.3.2 Credit risk monitoring and control-------------------------------------------------------------------9
2.4 credit policy -----------------------------------------------------------------------------------------------9
2.5 credit collection policy ---------------------------------------------------------------------------------10
2.6 credit appraisal policy-----------------------------------------------------------------------------------
11
2.7 credit risk control policy--------------------------------------------------------------------------------
13
2.7.1 Effective approaches to managing credit risk in mfis include----------------------------------13

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2.7.2 Implementing credit risk management-------------------------------------------------------------13
2.8 obstacles to credit risk management------------------------------------------------------------------13
2.9 factors affecting the effectiveness of the credit management practices -------------------------14
2.9.1 Lending company processes-------------------------------------------------------------------------15
2.9.2 Capability ----------------------------------------------------------------------------------------------15
2.9.3 Knowledge & experience----------------------------------------------------------------------------17
Conceptual framework--------------------------------------------------------------------------------------18
CHAPTER THREE: RESEARCH DESIGN AND METHODOLOGY------------------------------16

3.1. Introduction ---------------------------------------------------------------------------------------------19

3.2. Research design and strategy-------------------------------------------------------------------------19

3.3. Data type and source. ----------------------------------------------------------------------------------19

3.4. Data collection method --------------------------------------------------------------------------------20

3.5 Sampling design and procedures----------------------------------------------------------------------20

3.6. Data analysis and interpretation----------------------------------------------------------------------20

Time and budget schedule ---------------------------------------------------------------------------------21

Reference-----------------------------------------------------------------------------------------------------23
Questionnaire-------------------------------------------------------------------------------------------------26

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 CHAPTER ONE
1. INTRODUCTION

1.1. BACKGROUND OF THE STUDY

Global  financial  markets  and  systems  have  experienced  a  very  impressive  growth  over
the  Last  few   decades.  This  has  been  accompanied  by  an  evolution  also  in  the  business
practices  in  countries   around  the  world.  In  the  financial  sector  there  has  been  a
development  of  various  new  financial   instruments  and  techniques  to  meet  changes  in  the
constantly  changing  business  environment.  The   financial  institutions  have  been  able  to
create  various  innovative  products  for  different  sectors  in   the  market.  Through  the
various  capabilities  to  create  innovative  products,  financial  products  have   been  able  to
create  and  maintain  economic  performances  countries  around  the  world.  As  a  result  of  
these  changes  in  the  financial  sector  and  business  world  there  is  an  arising  importance
and  research   interest  in  financial  institutions  in  banking  institution  (Ho,  2002)
The word microfinance refers to small-scale financial services primary credit and savings
provided to people who operate small enterprises, provide services, fish farm or herd, and to
other individuals or groups at local level of developing countries both rural and urban areas
(Robinson, 2001). Degene (2001) also described microfinance based on its main characteristics:
its directing of the poor, promoting small business, building capacity of the poor, extending small
loans without collaterals, combining credit with savings, and charging commercial interest rates.
Based on the above concept of micro financing, it is clear that the primary objective of
microfinance institutions (MFIs) is to provide financial (credit and saving) and non-financial
social intermediation services (such as group formation, development of self-confidence, training
in financial knowledge, and management capabilities among members of a group) to the poor in
order to release financial constraints and help alleviate poverty.
Micro finance provides financial help to the unbanked sections of the society. Since microfinance
is a system that distributes small loans to poor people in order for them to generate income and
start their own small businesses, it has the ability to lessen poverty as well as promote
entrepreneurship, social and economic development in poor communities especially in
developing countries like Somaliland. Microfinance refers to small scale financial services for

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both credits and deposits that are provided to people who farm or fish or herd; operate small or
microenterprise where goods are produced, recycled, repaired, or traded; provide services; work
for wages or commissions; gain income from renting out small amounts of land, vehicles, draft
animals, or machinery and tools; and to other individuals and local groups in developing
countries in both rural and urban areas (Robinson, 2001).
In addition to distributing loans, MFIs also offer a wide range of financial services, such as
savings and insurance options (Premchander 2009). Microfinance is a provision of financial
services like savings, credit, insurance, remittance, etc. in a very small quantity generally to the
poor people (Dasgupta, 2001). It is broadly recognized that lack in credit risk administration and
management policies by monetary establishments have helped altogether to the financial
downturn around the world (Fraser &Simkins, 2010) .As fall out to this emergency, orders
including credit risk administration are currently being given more imperativeness, particularly
in monetary related areas (Horne, 2007). Like banks and other financial institutions. Micro
finance institutions operate in an environment where customers are without credit histories or
necessarily predictable borrowing behaviors (Vincent et al 2014).
Microfinance is a powerful instrument to reduce poverty. To mention some uses Microfinance
provides: it creates financial service access to beneficiaries, it builds beneficiaries assets, it
builds the beneficiaries resistance to different outside and unexpected shocks. However, it is
important to note that Microfinance is an instrument to curb poverty, but this doesn't mean it
works in every place and for all segments of the society (Schwartz, 2013). Moreover, Ideally
Microfinance is thought to always improve its client's capability. However, as different
researches indicate this is not always the case (Orbuch, 2011). In some cases microfinance
contributes negatively and aggravate the poverty of the beneficiaries, this case had been found in
places where there is a surplus microfinance institution (Bateman and Chang, 2012).
Microfinance plays key role in achieving human, physical and social capital to poor people.
Creating access to education, training and productive capital, organizational building, and
providing physical capital contribute to the self-confidence of the poor. The provision of capital
to the poor in order to alleviate individuals' poverty is not the only aim of Microfinance; rather it
creates financial institutions to poor people who are excluded from the formal banking sector
Wreen (2007).

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The concept of credit can be traced back in history and it was not appreciated until and after the
Second World War when it was largely appreciated in Europe and later to Africa (Kiiru, 2004).
Most suggestions were for the evaluation of customer’s ability to repay the loan, but this didn’t
work as loan defaults continued (Modurch, 1999). The concept of credit management became
widely appreciated by Microfinance Institutions (MFI’s) in the late 1990s, but again this did not
stop loan defaults to this date (Modurch, 1999).
Hence, the objective of the study was to assess the effectiveness of credit management practice
of microfinance institutions in Somaliland in relation to credit policy, client's appraisal policy,
credit risk control and collection policy of Saacid credit and saving Share Company using
descriptive statistics.
1.2 Statement of the problem
Credit management is one of the major functions which financial institutions undertake for
proper mobilization of funds. The credit management function includes loans & advances .It also
involves a large number of activities ranging from credit investigation to contract with
borrowers, appraisal, review, follow up, documentation, nursing, recovery & write- offs. Safety
of a financial institutions loan or advance is directly related to the basis on which the decision to
lend is taken, the type and quantum of credit to be provided and the terms and conditions on
which the loan will be made available .Consequently, a two- pronged approach is required to be
followed to ensure the safety of each loan (Shekhar, 2004).
Effectiveness of credit management greatly affects the success or failure of financial institutions
including microfinance institutions. Besides, credit management provides a leading indicator of
the quality of financial institutions (Nzotta, 2004). The biggest risk in microfinance institution is
lending money and not getting it back. Timely identification of potential credit default rate is
important as high default rate leads to decreased cash flow, lower liquidity level (Scheufler,
2002). Sound credit management is a prerequisite for financial institution's stability and
continuing profitability while poor credit quality is the most frequent causes of poor financial
performance (Gitman, 2014).
According to proclamation (No. 40/1996) of the Federal Government of Ethiopia, Micro Finance
Business means an activity of extending credit, in cash or in kind, to peasant, farmers or urban
small entrepreneurs, of loan size of what shall be fixed by the National Bank. Currently there are
many licensed Micro finance institutions in Ethiopia working in both rural and urban areas.

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The above studies have focused mainly on objectives and roles of Microfinance. There is no
known study that has been done on the effectiveness of credit management practice in relation to
lending process, capability and knowledge and experience of microfinance institutions focusing
on Saacid credit and saving Share Company in Somaliland. This study aims at assessing the
effectiveness of credit management practice of microfinance institutions. Hence, this research
will focuses on assessing the effectiveness of lending process, capability and knowledge and
experience using descriptive research method..
1.3 General and specific objectives of the study
1.3.1General objectives:
The general objective of the study is to assess the effectiveness of credit management practices
of Saacid credit and saving Share Company in Somaliland.
1.3.2 Specific objectives
The specific objectives of the study will be:
 To identify the factors that determine the effectiveness of credit management practice of
Saacid credit and saving share company in Somaliland
 To assess the performance the microfinance institution in relation to lending process,
capability and knowledge and experience.
 To identify the cause and effect of the credit management practice f the microfinance
institution.

1.4 Research Question

The research will address the following research questions
 What is the level of effectiveness of credit management practice in Saacid microfinance
institution in Somaliland?
 What are the factors affecting the effectiveness of credit management practice of Saacid
microfinance institution?

1.5. Scope of the study

The scope of the study will be on the effectiveness of credit management practices of Saacid
microfinance institution in Somaliland from the view point of the internal process of the
microfinance institution. Hence, the study will not cover the perspectives of other microfinance
institutions in Somaliland..

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1.6. Significance of the study

A study on the effectiveness of credit management practice of microfinance institution is

significant for several reasons.

First, based on the findings of the study, managers of the microfinance could evaluate their
performance and design strategies to solve their problems

Second: Government policy makers may use the findings of the study to revise government
policies and strategies in relation to microfinance institutions.

Finally, the study could be used as a reference material for those who need to conduct further
research on the topic in other microfinance institutions in Somaliland (Comparative research).

1.7. Limitation of the study

The research method that is planned for this research is descriptive statistics and hence the major
limitation of the study will be that it will not answer the variables that affect the performance of
the credit management and by how much. In addition to the above bottlenecks, reluctance in the
side of the respondents, quality and reliability of data and time and financial shortages may be
other limitations of the study.,

1.8. Organization of the paper

This research paper will be organized in to five chapters. Chapter one is the introduction part of
the study which contains background of the study, statement of the problems, research
questions ,objective of the study, significance of the study, scope of the study and limitation of
the study. Chapter two will contain literature review concerning credit management practice of
microfinance institutions, empirical literatures on the topic and research framework. Chapter
three will cover the research methodology, Chapter four consist results and discussions. And
finally, chapter five includes summary, conclusion and recommendations.

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 CHAPTER TWO
RELATED LITERATURE REVIEW
2.1 background of the study area
Somaliland which was a British Protectorate until 26 June 1960 becomes a part of the Somali
Republic on 1 July 1960 and independent republic of Somaliland on 18 may 1991. It is a
democracy with multi-party system. It is located in the Horn of Africa; it shares its foundries
with the Gulf of Aden in the north, Somalia in the east, the Federal Republic of Ethiopia in the
south-west and the Republic of Djibouti in the North West.
Somaliland has been formed commercial banking and financial institution sector and the
informal financial sector. Saacid microfinance institution is one of the microfinance institutions
in Somaliland formed and licensed on January 2003 by the Central bank of Somaliland with the
main objective of offering finance and saving service to the active poor both in the urban and
rural area to support self employment and income generating activities, to promote rural and
urban micro and small enterprises and to improve the culture of saving by the wider public. The
microfinance provides both financial and non financial services. The financial service includes
provision of credit and mobilization of saving while the non financial service basically deals with
small business training for the client. Saacid microfinance provides financial service Islamic
sector, financial service interest sector and non financial services. Currently, the financial
institution’s customer is 5076 in four branches namely, Hargeisa, Borama, Burco and
berbera(Saacid, 2017).
2.2 Overview of credit management
Credit management is a comprehensive process made up of the monitoring of loan facilities,
extension of credit, distinguishing the market segments as well as delineating the returns
generated. The policy on credit management comprises systems, guidelines and principles that
serve as a blueprint for employees in the credit department in awarding loans and steering the
total collection of credit facilities. The policy on credit management is described as a
combination of principles devised to reduce expenditure connected with loan delivery while
taking full advantage of the gains that can be generated from them (McNaughton, 1996).
Credit management is the process of risk identification, measurement, assessment, monitoring
and control. It involves the identification of potential risk factors, estimating their consequences,

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monitoring activities exposed to the identified risk factors and putting in place control measures
to prevent or reduce the undesirable effects (Richard, 2010).
One critical prerequisite for being able to supervise credit delivery effectively is the capacity to
astutely and competently administer the lines of credit to clients. To be able to reduce the
vulnerabilities associated with uncollectable loans, companies must exercise a better
understanding of economic capacity of clients, history of customers‟ credit rating and varying
repayment arrangements. In order to make an intrusion into new markets as well as enroll more
clients depends on the competence to rapidly and effortlessly make well-informed credit
decisions and set appropriate lines of credit (Hafsa, 2013).
It will be a challenge to enact the most favorable credit policy as the best amalgamation of the
variables of credit policy is quite arduous to acquire. An institution might decide to manipulate
some of the variables within a period and observe the effect. It should be noted that the firm’s
loan guide is greatly influenced by economic conditions (Pandey, 2008). The guidelines of the
firm on credit management may experience a shift as the prevailing conditions of the economy
also metamorphose. The success of lending out credit depends on the methodology applied to
evaluate and to award the credit (Ditcher, 2003)
The issue of giving out credit especially to players within the informal sector comes with a lot of
challenges as asymmetry of information is very high coupled with the lack of collateral to secure
loans. The current blueprint for credit delivery are not well diversified or efficient, and therefore
are not able to completely satisfy the differing demands of the market and different classes of 4
end-users within the savings and loans sector (Asiamah ,2007).
Effective management of credit is essential to the long term success of any microfinance
institution, since they generate most of their income from interest earned on loans extended to
small and medium entrepreneurs. Microfinance Institutions and other finance institutions must
develop a credit policy to govern their credit management operations (Pandey, 2008) and since
microfinance institutions generate their revenue from credit extended to low income individuals
in the form of interest charged on the funds granted (Central Bank Annual Report, 2010). The
loan repayments may be uncertain. The prudent management of credit can minimize operational
risk while securing reasonable returns (IMF, 2010).

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2.3 Credit Management Practices:
2.3.1 Credit Risk Assessment
Credit risk is defined as the change in the value of the asset portfolio of microfinance institutions
due to the failure of an obligor to meet his payment commitments (IMF, 2005). The risk
attributable to loan default leads to high effective borrowing rates, through a risk premium that
varies with the exposure to default. This is because a microfinance institution has to undergo
costs to carefully evaluate and closely monitor the risk, especially in an environment where
probability of default is high (Winton, 2008).
Credit risk encompasses both the loss of income resulting from the MFI’s inability to collect
anticipated interest earnings as well as the loss of principle resulting from loan defaults
(Steinwand, 2000). Omino (2005) puts emphasis on sound development of microfinance
institutions as vital ingredients for investments, employment and to spur the economic growth.
As a result of their flexibility and the way they operate, they are exposed to various risks which
include financial risks, operational risks and strategic risks.
According to Omar (2011), effective credit risk identification and assessment rests on the quality
of the lender’s authorization system. The authorization system should not only enhance the
quality of customer service by reducing the waiting time at the point of sale but should also
reduce the risk of accepting transactions of bad credit. They argue that, credit risk identification,
assessment, and measurement process comprises of credit application approval, credit
authorization, and posting of the advance payment.
Lenders categorize borrowers depending on their assessment of the borrowers’ risk of default,
which is typically based on the borrowers’ income and credit history at the time of the loan
application. Best practice in credit management emphasizes a keen awareness of the customer
base and their credit history, and then, establishing terms prior to the sale (Giacomo, 2009).
According to Mattei(2009),lending officers rely on personal judgment and experience to apply
well-established lending principles. These principles state that borrowers should be assessed in
relation to their character, the purpose of the loan, capacity to repay, and the collateral available
for security.
According to Hemlin (2012), credit authorization acts as a control measure for the credit
approvals. A high-quality authorization process should result in effective credit control (approval
of good credit only) and efficient authorization procedure (minimum waiting time at the point of

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sale). They further provide that, authorizers should be well-trained 11 people responsible for
detecting any bad credit. Managers can impose additional or stringent lending criteria when
granting loans to high-risk borrowers.
2.3.2 Credit Risk Monitoring and Control
Monitoring of borrowers is very important as current and potential exposures change with both
the passage of time and the movements in the underlying variables. It is also a key measure in
dealing with the moral hazards problem. Monitoring, involves, among others, frequent contact
with borrowers, creating an environment that the financial institution can be seen as a solver of
problems and a trusted advisor; developing the culture of being supportive to the borrowers
whenever they are recognized to be in difficulties and in striving to deal with the situation;
regular review of the borrower’s reports as well as on-site visit, updating the borrower’s credit
files and periodically reviewing the borrower’s rating assigned at the time the loan was granted
(Richard,2014).
Wang (2013) points out that, timely review of loan performance is as vital in reducing default as
proper assessment of the initial loan application. Such reviews allow the financial institution to
monitor the repayment behavior of high-risk borrowers and ensure loans in arrears are detected
as early as possible. Timely advise about the potential for loan restructuring, consolidation of
multiple loans and / or short term lowering of repayments may prevent a financially distressed
borrower opting for bankruptcy as a last resort
2.4 Credit policy
Girm` (1996) referred to rejection or acceptance of applications of analyzed credit requests is an
institutional method known as credit policy. Pandey (1995) stated that credit policy helps in the
management of account receivable. . He showed that within the operations of a firm’s activities it
can shape its credit policy due to time flexibility. According to Khandkar and Khan (1998),
policies save time ensuring that people in similar circumstances get similar treatment and that
decisions are consistent and fair. McNaughton (1996), argued that entire practices of
management frame work is provided by credit policy. Majority of financial institutions have
written credit policies for sound credit management. This ensures adherence to uniformity of
sound practices and consistency of operations. A general rule must be designed to guide each
decision, listening to and simplifying each decision making process. Policies should be similar
for all.

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Ahimbishwe (2002) stated that credit policies are procedures, rules and guidelines set to
maximize benefits associated with credit and minimize costs to it. These are objectives, standards
and parameters to guide bank officers granting loans and managing the loan portfolio. These are
rules guidelines and procedure laid down to maximize benefits while minimizing costs
associated with credit.
Hules (1992) found out that the main objective of credit policy is to ensure sustainability and
profitability of MFIs as commercial institutions by keeping an optimal investment in accounts
receivables that minimizes costs while maximizing benefits. The credit policy of a firm depends
on the manager’s regulation of variables for it to be tightened or softened. Credit policy has three
variables: borrowing terms, borrowing standards, and borrowing procedures.
According to Pandey, (2001), financial managers use these variables to evaluate customer’s
borrowing capability, payment time and loan interest, methods of collection and steps to take in
case of loan default. Highly selective cases of credit to customers occur on a tight credit policy.
Tight credit policy target is to collection cost, unnecessary legal costs and bad debts, only clients
who have proved to strong financial base are given loans.
2.5 Credit Collection policy
An effective debt collection strategy starts with a clearly thought out credit policy and credit
management tools to enforce this policy. Success comes from the overall performance of the
whole credit value chain. The collection function within microfinance institutions can make the
difference between a good performance for the business and an excellent performance. By
making use of opportunities to make the collection processes strategically effective,
operationally efficient and customer orientated, an organization can expect the collection
function to add significant value to the business (Benveniste, 2002).The debt collection process
can be defined as a legitimate and necessary business activity where creditors and collectors are
able to take reasonable steps to secure payment from clients who are legally bound to pay or to
repay money they owe (Kitua,2002).Once a loan or credit agreement has been granted and paid
out to a clients, the next phase of the credit provider's tasks will start. The credit agreement has to
be actively managed over its life cycle as payment dates on which the client should pay fall due.
As a result of various reasons, the payment of agreements does not always occur as anticipated,
and some of the payments may become overdue (Benveniste, 2002).
Overdue payments will have a negative impact on the credit provider's financial performance

10
since cash flow targets cannot be met and collection cost increases. Risk is also indicated by
overdue payments, taking into account that overdue payments may become payments that cannot
be collected and inevitably resulting in losses and bad debt. As a result of all of these negative
consequences, the collection of overdue accounts is extremely important to any credit provider
(Harvey, 2005).
2.6 Credit Appraisal policy
The guiding principle in credit appraisal is to ensure that only those borrowers who require credit
and are able to meet repayment obligations can access credit. Lenders may refuse to make loans
even though borrowers are willing to pay a higher interest rate or make loans but restrict the size
of loans to less than the borrowers would like to borrow (Mishkin, 1997). According to Onuko
et. al.,(2015), if borrowers could provide true and complete information regarding their financial
status to the lenders at the time of seeking for credit, then lenders could be at a better position of
making informed credit decisions thereby reducing the risks associated with credit. Similarly, if
lenders could make additional efforts to ensure they obtain all relevant information on credit
applicants during the credit appraisal process, the credit risk associated with such applicants
could be reduced. For this reason, the theory is relevant for the study. This theory was significant
in this study since it inferred that lack of a sound credit appraisal process would result to
increased credit risk due to inability/failure of the microfinance to obtain all relevant information
on credit applicants leading to the possibility of granting credit to undeserving borrowers. This
would in turn lead to deterioration in loan performance. The reverse of this is true implying a
positive relationship between sound credit appraisal and loan performance. This study focused on
credit administration, measurement and monitoring which is very significant sound credit
appraisal process in microfinance
Microfinance institutions need to have credit collection strategies that would make clients
attracted to find it easy to repay their loans without enforcement. An institution that constantly
compels its clients to service their debt reflects weak credit collection policy employed that
ensure timely collection of funds from clients. Palladini (2010) considers credit collection policy
as guidelines that establish set of procedures used to collect accounts receivable getting overdue.
It aims at maximizing rate of return from microfinance loan portfolio in order to increase firms‟
assets value. The rationale of establishing a set of policy is that, not all clients meet their
obligations timely and without enforcement. There are clients who simply forget and the rest

11
don‟t have tendency of paying their dues until persuaded to do so. Lending institutes that
experience gradual repayment of loans from clients, increase bad debts of their loan portfolios.
Therefore, credit collection efforts are directed at accelerating loan recovery from clients.
Microfinance management efforts for making sure strict collection procedures are adhered; helps
to keep debtors alert and reduction of portfolio at risk (Warue, 2012). As such loan portfolio is
the microfinance institutions most important asset that needs to be managed conscientiously
against default risk. Survival of any lending institution depends on successful loan portfolio
performance which results into increasing rate of return on various loan investment products.
Previous studies indicate that, portfolio performance of microfinance institution is influenced by
various factors. Existence of attractive and customer-oriented credit collection strategies
contributes to sound financial performance in microfinance institutions. Emran et al., (2006) in
their study observed that, microfinance institutions that charges high interest rates are likely to
affect quality of loan portfolio due to increasing default rates. Consequently, impacts negatively
on overall financial performance of MFIs. However, studies by Sene, (2010) added that
individual-based microfinance lenders charging higher interest rates are likely to be more
profitable up to a certain level. Beyond which the profitability of microfinance institution tends
to be worse due to an increase in rates of delinquency from their clients. As such, microfinance
need to learn that, charging high interest rates beyond a certain threshold is said to be
unfavorable for the MFIs financial sustainability
Bart (2009) state that Credit risk is the risk that a borrower defaults and does not honor its
obligation to service debt. Vogiazas (2014) define credit risk management as the combination of
coordinated tasks and activities for controlling and directing risks confronted by an organization
through the incorporation of key risk management tactics and processes in relation to the
organization's objectives Generally, the greater the credit risk, the higher the credit premiums to
be charged by banks, leading to an improvement in the net interest margin (Ryu, 2004). .
However, a broader definition of credit risk also includes the risk of default by other financial
institutions, which have payment obligations to MFIs (Bruet,2004). According to Tony & Bart
(2009) Credit risk consists of pre-settlement and settlement risk. Pre-settlement risk is the
potential loss due to the counterpart's default during the life of the transaction (loan, bond,
derivative product One is exposed to settlement risk because the payment or the exchange of
cash flows is not made directly to the counterpart, but via one or multiple bank

12
2.7 Credit risk control policy
Credit risk, the most frequently addressed risk for MFIs, is the risk to earnings or capital due to
borrowers’ late and non-payment of loan obligations. Credit risk encompasses both the loss of
income resulting from the MFI’s inability to collect anticipated interest earnings as well as the
loss of principle resulting from loan defaults.
2.7.1 Effective approaches to managing credit risk in MFIs include:
 Well-designed borrower screening, careful loan structuring, close monitoring, clear
collection procedures, and active oversight by senior management. Delinquency is
understood and addressed promptly to avoid its rapid spread and potential for significant
loss.
 Good portfolio reporting that accurately reflects the status and monthly trends in
delinquency, including a portfolio-at-risk aging schedule and separate reports by loan
product.
 A routine process for comparing concentrations of credit risk with the adequacy of loan
loss reserves and detecting patterns (e.g., by loan product, by branch, etc.).

The importance of a “credit culture” in minimizing problems and increasing operational

efficiencies cannot be overstated. MFI senior managers need to set up systems that compel and
offer incentives to loan officers to prevent, disclose, and respond to problem loans quickly, so as
to limit potential credit-related losses.
2.7.2 Implementing credit risk Management
As MFI’s become larger and more sophisticated, risk management should become a more
conscious part of their management and governance. The goal of good risk management is to
reduce uncertainty and qualify potential financial losses as “reasonable,” in other words to
eliminate surprises. Implementing risk management, however, is both art and science. The
“science” is quantifying risks and probabilities so that an MFI can make informed decisions
about the costs and benefits of risk management options. The “art” is to create an organizational
culture of identifying risks without discouraging prudent risk-taking. Prudent risk-taking
involves understanding the risk the MFI is assuming and recognizing that the upside reward
potential carries the risk of loss. Losses should never come as complete surprises to management.

13
In other words, management should be aware of the risks the MFI assumes and should
understand the extent of the exposure and its potential implications.
To be effective, the MFI must integrate risk management into the organization’s culture. It is the
task of the MFI’s leadership (the directors, CEO and senior managers) to communicate the
importance of risk management and instill a risk management culture at all levels of the
institution. Without a commitment to risk management from the top and resources to support it,
the MFI cannot expect its employees to perform in a manner that mitigates risk.
Second, MFIs should incorporate risk management into the design of its systems, processes, and
methodologies to reduce the frequency and scale of unwanted risk from the outset. Designing
procedures that reduce the chance of human error can improve quality control and significantly
boost productivity and efficiency. For example, the most successful MFIs worldwide have built
excellent credit risk management into their lending methodologies, using screening techniques,
co-guarantees, and other mechanisms to reduce the likelihood of delinquency and default. Lower
delinquency rates elevate loan staff’s efficiency and productivity by reducing their time spent on
collection and increasing time to work with potential and existing customers. MFIs should
evaluate their procedures and information flow to see whether some “re-engineering” (i.e.
systemic alterations) could result in operational improvements and enhanced quality control.
2.8 Obstacles to credit risk management
There are several reasons that microfinance institutions have not thoroughly integrated risk
management into their culture and operations. The primary reason has been a lack of a
framework and understanding of the need to do so, which this publication works to overcome.
However, several obstacles remain that impede the microfinance industry’s ability to maximize
its risk management potential. This chapter addresses the remaining obstacles to effective risk
management on both an institutional and industry level and discusses some of the resources
needed to overcome them.
Successful microfinance institutions often become over-confident of their future based on their
past successes. However, few microfinance institutions have been in existence for more than ten
years. This short-time frame is inadequate to assess an MFI’s long-term ability to survive and
respond appropriately to changing risk environments over time. The /Financial crisis is already
one example of overconfidence impeding an MFI’s effective risk management.
Many MFIs have become leading financial institutions in part because they have faced little or

14
no competition. As competition increases and time passes, some MFIs will inevitably flounder
and lessons will emerge that will emphasize to MFIs the importance of proactive risk
management. Despite short-term successes, MFIs need to prepare for worst case scenarios, such
as a downturn in the world economy, MFIs should use sensitivity analysis to determine how the
institution would fare in face of unforeseen risks, given its current structure and controls, and
implement additional measures to ensure its survival.
Few MFIs employ a comprehensive approach to risk management, seldom integrating risk
management strategies in all areas of operations and in the organizational culture. This
publication should help to convince MFIs of the importance of institutionalized risk
management, but it is up to the institution to create the links between the various levels of
operations and lines of authority.
Since effective risk management begins at the top of the organizational chart, the board must
play an active role in communicating the importance of risk management to the rest of the
institution. Therefore, the real starting point for effective risk management is for the MFI to have
an active and effective board of directors. The Microfinance Network’s Guidelines for Effective
Governance of Microfinance Institutions guides MFIs in the development of more active and
effective board members. Then, the board must ensure the senior management’s commitment to
the risk management process. In MFIs with less effective boards, senior management might have
to take the lead in developing board commitment to risk management
2.9 Factors Affecting the Effectiveness of the Credit Management Practices
This section shall review literature on the effectiveness of credit management systems as well as
the factors that drive that effectiveness. These factors shall be categorized in three broad buckets
on the basis of the various aspects of the transaction, namely lender related factors, borrower-
related factors and other factors related to the business environment.
2.9.1 Lending Company Processes
According to Hafsa (2013), poor financial and credit management practice is actually at the heart
of the late payment problem. Market power or not, certain customers can delay payments or
default on the payment simply because the financial institutions are inefficient. Borrowers take
advantage of inefficient debt collection and / or disputes over loan related charges. Kong, (2014)
assert that, this arises from borrowers /customers who are dominant in relation to the financial
institutions’ exercising market power and obtaining a cheap form of finance, the latter being

15
power-less to impose sanctions. Political interference may be a major obstacle in managing an
effective credit system.
Zhang (2012) asserts that the success of a credit system, in terms of both effectiveness and cost,
is largely determined by policy established within the company. Richard, (2010) argue that a
well-documented credit management policy elaborating the products offered and the respective
credit management activities to be performed as well as a credit manual outlining who, how and
what should be done in assessing, approving, authorizing, monitoring and controlling credit,
should be in place for an effective credit management system. Inefficient systems of credit
management make it questionable on whether they will be able or indeed willing to collect the
interest due to them (Hassan, 2013).
Omar (2011) argue that inefficient data management is a major challenge to the successful
management of credit risk since it affects that ability to access data when it’s needed and cause
problematic delays. According to Richard, (2010), the lack of efficient risk modeling framework
usually limits the lenders’ ability to generate and analyze complex risk scenarios. If not flexible
enough, analysts may not be able to change the model easily to suit the different requirements of
the diverse client base. This results in too much duplication as analysts rework the model and
therefore affecting the efficiency level of the lender.
According to Paul and Boden (2011), insufficient risk tools, too, hinders the successful
management of credit risk since without a robust risk solution, lenders may not be able to
identify clearly any portfolio concentrations or re-grade portfolios often enough to effectively
manage risk. According to Kong, (2014), cumbersome reporting poses a major challenge in the
successful management of credit risk since manual, spreadsheet-based reporting processes may
overburden analysts and cause delays in the credit risk management system. Lending strategies
and a meaningful credit culture affect the effectiveness of credit risk management. The
disciplined origination/ underwriting and strong work out procedures in credit management
determine the effectiveness of the credit management. The primary motivating factors include
refinements of traditional techniques to determine the default likelihood of individual assets, new
analytical solutions to credit portfolio management, larger and improved databases to translate
risk ratings into expected losses, and the dynamics of market mechanism such as credit
derivative and other credit-enhancement techniques (Jin and Yu, 2012).
The extent to which credit risk has been embedded in the decision making process is a key

16
success factor. Failure to appreciate risk issues may give rise to serious consequences. The
effectiveness of firms internal audit function and audit committees in reviewing controls and
corporate governance in general is essential in effective credit management. Management boards
should be reminded of their responsibilities for determining acceptable credit risks and for
managing them. Organizations need to embrace a control culture were credit risk management is
embedded within the organization as part of the day-to-day activities (Hafsa, 2013). However,
since local line managers can only lead risk control effectively, responsibility for risks must be
taken at a variety of levels. Loss control is an operational technique designed to reduce but not to
entirely eliminate losses incurred by a lender.
2.9.2 Capability
McHugh and Ranyard (2012) assert that, transaction volumes, the authorizer in case of manual
processes, and the attitude of the borrowers /applicants also affect the efficiency and
effectiveness of the credit management process. Fluctuations in transaction volumes may lead to
delays and /or undue pressure on the approvers and authorizers. This may lead to the approval of
bad credit. The use of manual authorization procedures as opposed to the use of automatic
procedures (via risk management systems and expert systems) may have a negative effect on
accuracy and hence the effectiveness of credit controls (Hassan (2013). A well-trained and
experienced authorizer will already have developed his own heuristics or methodology to detect
bad credit as opposed to a less experienced one. The credit management process is more
effective where the applicant is willing and ready to provide all the necessary information, and
where the authorizers’ authorization limits (in terms of amount) are clearly defined (Rahman,
2011).
Omar (2011), point out that, the level of computerization affects the effectiveness of the credit
management system in a big way. Computers are useful in credit analysis, monitoring and
control as they make it easy to keep track on trends in credits as well as offer timely, valid and
reliable information. Poor record keeping and lack of effective database systems hinders the
effective management of credit (Richard, 2010). However, Kaijage (2010) and Kong (2009) note
that technology is only a tool and in the wrong hands, it is useless.
2.9.3 Knowledge & experience
Richard, (2010) argue that, the quality of the credit risk management staff is a key success factor
in the management of credit. The staff ensures that the depth of knowledge and judgment needed

17
is always available. Personal judgment and intuition plays a big role in credit assessment. They
ensure that the design and operation of the system is efficient and effective. According to Zhan
(2012) the quality of the loan authorization process depends on the personnel processing the loan
application (Garbage-in-garbage-out) and is a key determinant of the effectiveness of the credit
management system.
Figure 2. 1: conceptual framework

 Lending company
process Effectiveness of
microfinance
 capability
institutions
 Knowledge and
experience

Source; researcher’s own framework based on the existing literatures

18
 CHAPTER THREE

RESEARCH DESIGN AND METHODOLOGY

3.1. Introduction

This chapter deals with how the research will be conducted in order to achieve the objectives of
the study. It will consist of the research design and strategy, source of data, target population,
sampling design, data collection method, data collection procedures and method of data analysis.
3.2. Research design and strategy
Based on the purpose, the research design applied for this study will be descriptive statistics
where the study will be under taken to provide detailed description about the effectiveness of
credit management practices of microfinance institutions. In addition, a quantitative method will
be used in this research. a quantitative approach is a research methodology that sets out to
quantify the data in order to use statistics for analyzing the data set. A quantitative approach
enables a researcher to establish statistical evidence on the strength of the relationship between
variables and test the hypothesis and determine reliability and validity of the variable
measurement,(Malhotra,2004).
On the other hand, qualitative method will be used to analyze the data that will be collected from
the microfinance officials using structured interview. The research design used in this study will
be survey design. A survey is a research technique in which information is gathered from a
sample of population by use of a questionnaire (Zikumnd, 2003).

3.3. Data type and source.

In order to address specific objective, both primary and secondary sources will be employed to
gather relevant information for the study. The primary data will be collected from the sample
population of the four branches of Saacid credit and saving Share Company in Somaliland
through self administrated and close ended questionnaires from the identified respondents. The
secondary data relevant to this study will be collected from publications, documents and reports
of Saacid credit and saving Share Company

19
3.4. Data collection method

The study will use survey method of data collection which will be composed of self administered
questionnaires in the form of close ended questions. Collecting data through questionnaire is
quite popular because it requires low cost. Questionnaires will be distributed to the sample
respondents.

Furthermore, the questionnaires will have two parts; the first part will be intended to solicit data
on the demographic characteristics of the respondents. The second part of the questionnaire will
be designed to evaluate the variables on a 5 point likert scale ranging from 1=strongly disagree,
2= disagree, 3= neutral 4= agree, 5= strongly agree. The researcher will use cross sectional
design because the data will be collected at one point in a time to describe the effectiveness of
credit management practice Saacid micro finance institution in Somaliland. Cross sectional
design is a study in which various segments of population are sampled at a single point in a time
(Zikmend, 2003).

3.5 Sampling design and procedures

The sample is the section of the wider population that will be engaged in the survey and
sampling is the process of identifying who you will aim to contact from that population. A
sampling frame is a list of members of a population from which members of a sample are then
selected. A sampling frame needs to be accurate, complete, up-to-date and relevant to the
purposes of the survey for which it is to be used. Once you have an established sampling frame,
depending on its size you may need to adopt a sampling technique to extract your final sample
(Zikumnd, 2003).
For the purpose of this study, the researcher will use simple random sampling techniques. The
simple random sampling technique will be applied to select the respondents using lottery basis
based on the percentages of number of employees in the four branches. According to the report
of Saacid microfinance institution 2019, the total number of employees in each branch is as
follows: Hargeisa branch 43 employees, Borama branch 38 employees, burco branch 51
employees and Rerbera branch 31 employees.
The total sample size based on yemane's formula at 95% confidence level is:
n= N / 1+N (e) 2 Where: n =sample size N = total population

20
 e =sampling error 5%
n=61/1+61(0.05)2 =54
branch Total population Sample size
Hargeisa 43 31
Borama 38 27
Burco 51 36
berbera 31 22
total 163 116
Source: Saacid report, 2019

3.6. Data analysis and interpretation

The field editing for verification of data and post-coding method will be followed towards data
collected for fulfillment of the objective of the study. Then researcher will analyzes and
interprets the data collected using qualitative and quantitative data analysis techniques.

In line with this, the study will also use descriptive statistics by importing the data from software
called SPSS version 16.00.For presenting data appropriately, the researcher will use different
types of descriptive data analysis methods among others frequency, percentage, and simple
tabulation, cross tabulation, mean and standard deviation.
Time Schedule and Budget Cost

Time schedule
No Activities to be conducted Month/date
1 Proposal Preparation 1-25/6/2012E.C.
2 Feedback and Editing Proposal 26-10/7/2012E.C.
3 Questionnaire Distribution 11-20/7/2012E.C.
4 Data collection & Organization 21-30/7/2012E.C.
5 Data Analysis & interpretation 1-30/8/2012E.C.
6 Report Writing 1-10/9/2012E.C.

Budget cost
No Description/Activity Qty Unit cost Total cost

21
1 Stationary materials;
• Paper 100 pcs 0.50 50.00
• pen 2 pcs 5.00 10.00

2 • Typing manuscript 60 pages 5.00 300.00

• Editing and finalizing 15 hours 10.00 150.00
• Printing 200 pages 1.00 200.00

3 Transportation 50.00
4 Internet 5 hours 10.00 50.00
Grand total 810.00

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Appendixes
Appendix 1 questionnaire for the Saacid Microfinance institution staffs
SHEBA UNIVERSITY COLLEGE

25
 DEPARTMENT OF ACCOUNTING AND FINANCE

QUESTIONNAIRE FOR ACADEMIC RESEARCH

DEAR RESPONDENTS:
My name is Sahra Hussien Awil and I am attending master program in Sheba University college,
department of accounting and finance. Currently, I am conducting a research on the effectiveness
of credit management practice of microfinance institutions for the partial fulfillment of master in
accounting and finance. This questionnaire is developed to collect data from the staff members of
Saacid microfinance institution. Your cooperation in providing genuine answers to the following
questions is highly important for the success of the study. The study is only for academic purpose
and your responses will be kept confidential.
The questionnaire is composed of four parts:
 General information
 Lending company process
 capability
 knowledge and experience

PART-ONE: General information/put tick mark on the space provided/

1. Sex 1.Male ---------- 2. Female----------
2. AGE 1.18-25---------- 2. 26-30 -----------
3. 31-35--------- 4. 36-40------------
5. 41-45---------- 6. Above 45-----.-
3. Educational background
1. Illiterate ------------ 2. Elementary school-----------
3. high school---------- 4. Diploma------------------------
5. First degree---------- 6. Second degree and above---
4. Field of study

26
 1. Accounting and finance--------- 2. Economics----------
3. Management-------------------- 4. Marketing ----------
5. Others-------
5. Work experience
1. Less than three years--------- 2. 3-6 years--------------
3. 7-10 years--------------------- 4. Above 10 years--------
PART TWO: questionnaire related to lending company process
s/n Determinants 5 4 3 2 1
4 The microfinance institution clear credit policy of
credit management
5 The microfinance institution clear credit appraisal
policy of credit management
6 The microfinance institution clear credit risk
identification policy of credit management
7 The microfinance institution clear credit collection
policy of credit management
8 The microfinance institution is effective in its credit
management processes

PART-THREE: questionnaire related to capability

s/n Determinants 5 4 3 2 1
9 The microfinance institution regular review of
borrowers loan accounts
10 The microfinance institution regularly updates the
borrowers’ credit files
11 The microfinance institution is effective in Prompt
implementation of arrears collection procedures
through personal contacts and negotiation
12 The microfinance institution is effective in providing
Constant advice and support to borrowers by the lender
especially during difficult times
13 The microfinance institution is effective in Tracking of
the adherence to term and conditions of the loan

PART FOUR: questionnaire related to knowledge and experience of staff

s/n Determinants 5 4 3 2 1
14 The employees of the microfinance institution are

27
 competent in checking the lending requirements of clients
15 The employees of the microfinance institution are
competent in monitoring of late or non payments by the
clients
16 The employees of the microfinance institution are
competent in documentation their day-to-day tasks
17 The employees of the microfinance institution are well
trained in approval and authorization of loan
18 The employees of the microfinance institution are
competent in customer relations

THANK YOU IN ADVANCE

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