INVESTIGATING THE IMPACT OF CREDIT MANAGEMENT ON FINANCIAL Free Essay Example

CHAPTER kTWO

LITERATURE kREVIEW

2.1 kIntroduction

This kchapter kreviewed kliterature kavailable kon kthe kproblem kunder kstudy kaccording kto kselected kthemes kthat krelate kto kthe kstudy. kIt kfocused kon kliterature kon kcredit kmanagement kand kits kimpact kon kfinancial kperformance kof kindigenous kbanks. kIt kgave kan kappreciation kinto kthe kexisting kliterature kand kresearch kwork kcarried kout krelating kto khow kendogenous kand kexogenous kfactors kon kcredit kmanagement kimpact kfinancial kperformance kin kbanks. kIt kalso kcovered kthe ktheoretical kperspectives kand kempirical kliterature kreview kand kit kended kwith ka kconclusion kthat khighlighted kthe kresearch kgap.

2.2 kTheoretical kperspectives

2.2.1 kDefinition kof kCredit kManagement

There kare kmany kdefinitions kgiven kfor kcredit kmanagement kby kdifferent kscholars. kAmong

these, ksome kare khere kcited kas kfollows: kCredit kmanagement kis kimplementing kand kmaintaining ka kset kof kpolicies kand kprocedures kto kminimize kthe kamount kof kcapital ktied kup kin kdebtors kand kto kminimize kthe kbusiness kexposure kto kbad kdebts k(Churchill kand kCoster, k2001).

According kto k(Abedi, k2000), kCredit kManagement kfrom ka kdebtor’s kpoint kof kview, kis kmanaging kfinances kespecially kdebts kso kas knot kto khave ka ktail kof kcreditors klurking kbehind kyour kback.

kCredit kmanagement kis ka kresponsibility kthat kboth kthe kdebtor kand kthe kcreditor kshould kseriously ktake. kWhen kit kfunctions kefficiently, kcredit kmanagement kserves kas kan kexcellent kinstrument kfor kthe kbusiness kto kremain kfinancially kstable.

2.2.2 kProcess kof kCredit kManagement

The kprocess kof kcredit kmanagement kbegins kwith kaccurately kassessing kthe kcredit-worthiness kof kthe kcustomer kbase kand khis/her kbusiness kviability. kThis kis kparticularly kimportant kif kthe kcompany kchooses kto kextend ksome ktype kof kcredit kline kor krevolving kcredit kto kcertain kcustomers.

kHence, kproper kcredit kmanagement kis ksetting kspecific kcriteria kthat ka kcustomer kmust kmeet kbefore kreceiving kthe kproposed kcredit karrangement. kAs kpart kof kthe kevaluation kprocess, kcredit kmanagement kalso kcalls kfor kdetermining kthe ktotal kcredit kline kthat kwill kbe kextended kto ka kgiven kcustomer. kSeveral kfactors kare kused kas kpart kof kthe kcredit kmanagement kprocess kto kevaluate kand kqualify ka kcustomer kfor kthe kreceipt kof ksome kform kof kcommercial kcredit. kThis kincludes kgathering kdata kon kthe kpotential kcustomer’s kcurrent kfinancial kcondition, kincluding kthe kcurrent kcredit ktrack krecord kthat kdiscloses kthe kcharacter kof ka kcustomer kin kmeeting kobligations kas kwell kas kcollateral kvalue. kThe kcurrent kratio kbetween kincome kand koutstanding kfinancial kobligations kwill kalso kbe ktaken kinto kconsideration. kCompetent kcredit kmanagement kseeks kto kprotect kthe kbank kor kany kfinancial kinstitution kinvolved kfrom kpossible klosses, kand kalso kprotect kthe kcustomer kfrom kcreating kmore kdebt kobligations kthat kcannot kbe ksettled kin ka ktimely kmanner. kWhen kthe kprocess kof kcredit kmanagement kfunctions kefficiently, keveryone kinvolved kbenefits kfrom kthe keffort. kFinancial kinstitutions ksuch kas kbanks khas ka kreasonable kamount kof kassurance kthat kloans kgranted kto ka kclient kwill kbe kpaid kback kwithin kterms, kor kthat kregular kminimum kpayments kwill kbe kreceived kon kcredit kaccount kbalances. kCustomers khave kthe kopportunity kto kbuild ka kstrong krapport kwith kthe kcreditor kand kthus kcreate ka ksolid kcredit kreference k(Michael kand kMiles, k2007)

2.2.3 kFinancial kPerformance kMeasures

Measuring kand kcomparing kthe kperformance kof kbanks khas kbeen kdifficult kdue kto kboth ka

lack kof kpublicly kavailable kfinancial kinformation kand kdifferences kin kreporting k(Michael kand kMiles, k2007) kA kmyriad kof kfinancial kratios kare kavailable kfor kassessing kthe kperformance kof kbanks k(CGAP k2003, kThe kSeep kNetwork kand kAlternative kCredit kTechnologies, k2005) kAlthough kit kis kdifficult kto ksynchronize kthe kdifferent kinterpretations kof kall kthe kratios, kthey kprovide kalternative kperspectives kin kassessing kthe kperformance kof kbank’s kfor keach kof kthe kdomains knamely, kprofitability, kefficiency, kleverage kand krisk. kIn kessence, kinterpreting kthe kdeterminants kof kbank’s kfinancial kperformance kdue kcognisance kshould kbe ktaken kof kthe kprecise kfocus kof keach kratio.

2.2.4 kFinancial kProfitability

Return kon kAssets k(ROA) kfalls kwithin kthe kdomain kof kperformance kmeasures kand ktracks kbank’smability kto kgenerate kincome kbased kon kits kassets. kThe kratio kexcludes knon-operating kincome kand donations. kROA kprovides ka kbroader kperspective kcompared kto kother kmeasures kas kit ktranscends the kcore kactivity kof kbanks knamely, kproviding kloans, kand ktracks kincome kfrom koperating activities kincluding kinvestment, kand kalso kassesses kprofitability kregardless kof kthe kbank’s kfunding structure. kROA kis kexpected kto kbe kpositive kas ka kreflection kof kthe kprofit kmargin kof kthe kbank, otherwise kit kreflects knon-profit kor kloss. kIn kbanks kand kother kcommercial kinstitutions, kthe commonest kmeasures kof kprofitability kare kReturn kon kEquity k(ROE), kwhich kmeasures kthe returns kproduced kfor kthe kowners, kand kReturn kon kAssets k(ROA), kwhich kreflects kthat organisation’s kability kto kuse kits kassets kproductively. k

2.2.5 kEfficiency

Efficiency kof kbanks kis kmeasured kby kthe kshare kof koperating kexpense kto kgross kloan kportfolio kin most kcases. kThe kratio kprovides ka kbroad kmeasure kof kefficiency kas kit kassesses kboth

administrative kand kpersonnel kexpense kwith klower kvalues kindicating kmore kefficient koperations. The kdebt kequity kratio kis ka kmember kof kthe kasset/liability kmanagement kratios kand kspecifically attempt kto ktrack kbanks kleverage. kThis kmeasure kprovides kinformation kon kthe kcapital kadequacy of kbanks kand kassesses kthe ksusceptibility kto kcrisis. kInvestors kmainly krely kon kthis ratio kas kit khelps kto kpredict kprobability kof ka kbank khonouring kits kdebt kobligations. kHowever kits use kshould kalways kbe kcontextualized kas khigh kvalues kcould klead kto kgrowth kof kbanks. The kOperating kExpense kRatio kis kthe kmost kwidely kused kindicator kof kefficiency, kbut kits

substantial kdrawback kis kthat kit kwill kmake ka kbank kmaking ksmall kloans klook kworse kthan ka kbank making klarge kloans, keven kif kboth kare kefficiently kmanaged(Michael kand kMiles, k2007). k

2.3 kThe kimpact kof kcredit kguidelines kon kfinancial kperformance kof kindigenous kbanks.

2.3.1 kCredit kManagement kVariables k

Key kCredit kmanagement kvariables kinclude;

Client kAppraisal k

First kstep kin klimiting kcredit krisk kinvolves kscreening kclients kto kensure kthat kthey khave kthe

willingness kand kability kto krepay ka kloan. kBanks kuse kthe k5Cs kmodel kof kcredit

to kevaluate ka kcustomer kas ka kpotential kborrower k(Abedi, k2000).This kview kis ksupported kby kMcMenamin k(1999), kwho kasserts kthat kthe kbasic kinformation kneeded kto kassess

the kcreditworthiness kof ka kcustomer kis kcaptured kby kthe k5 kC’s kof kcredit: kcharacter, kcapital,

capacity, kconditions kand kcollateral. kKcgodc k(2006) kconcurs kwith kthe kabove kin kthat kcredit kscoring ksystems kutilize kinformation krelating kto kthe ktraditional k5C’s kof kcredit. kThe k5Cs khelp kthem kto kincrease kloan kperformance, kas kthey kget kto kknow ktheir kcustomers kbetter. kThese k5Cs kare: kcharacter, capacity, kcollateral, kcapital kand kcondition.

Character k- krefers kto kthe ktrustworthiness kand kintegrity kof kthe kbusiness kowners. kIt’s kan

indication kof kthe kapplicant’s kwillingness kto krepay kand kability kto krun kthe kenterprise. k

Capacity: kassesses kwhether kthe kcash kflow kof kthe kbusiness k(or khousehold) kcan kservice kloan krepayments.

Capital k- kAssets kand kliabilities kof kthe kbusiness kand/or khousehold. k

Collateral k- kAccess kto kan kasset kthat kthe kapplicant kis kwilling kto kcede kin kcase kof knon-payment, kor ka kguarantee kby ka krespected kperson kto krepay ka kloan kin kdefault. k

Conditions k- kA kbusiness kplan kthat kconsiders kthe klevel kof kcompetition kand kthe kmarket kfor kthe kproduct kor kservice, kand kthe klegal kand keconomic kenvironment. k

The k5Cs kneed kto kbe kincluded kin kthe kcredit kscoring kmodel. kThe kcredit kscoring kmodel kis ka kclassification kprocedure kin kwhich kdata kcollected kfrom kapplication kforms kfor knew kor kextended kcredit kline kare kused kto kassign kcredit kapplicants kto k”good” kor k”bad” kcredit krisk kclasses k(Constantinescu ket kal., k2010). kInkumbi k(2009) knotes kthat kcapital k(equity kcontributions) kand kcollateral k(the ksecurity krequired kby klenders) kas kmajor kstumbling kblocks kfor kentrepreneurs ktrying kto kaccess kcapital. kThis kis kespecially ktrue kfor kyoung kentrepreneurs kor kentrepreneurs kwith kno kmoney kto kinvest kas kequity; kor kwith kno kassets kthey kcan koffer kas ksecurity kfor ka kloan. kAny keffort kto kimprove kaccess kto kfinance khas kto kaddress kthe kchallenges krelated kto kaccess kto kcapital kand kcollateral. kOne kway kto kguarantee kthe krecovery kof kloaned kmoney kis kto ktake ksome ksort kof kcollateral kon ka kloan. kThis kis ka kstraightforward kway kof kdealing kwith kthe kaspect kof ksecuring kdepositors? kfunds.

2.3.2 kCredit kRisk kControls

According kto k(Churchill kand kCoster, k2001) kkey kcredit kcontrols kinclude kloan kproduct kdesign, kcredit kcommittees, kand kdelinquency kmanagement.

k

2.3.3 kLoan kproduct kdesign

Banks kcan kmitigate ka ksignificant kportion kof kdefault krisk kby kdesigning kloan kproducts kthat kmeet

client kneeds. kLoan kproduct kfeatures kinclude kthe kloan ksize, kinterest krate kand kfees, krepayment

schedule, kcollateral krequirements kand kany kother kspecial kterms. kLoan kproducts kshould kbe

designed kto kaddress kthe kspecific kpurpose kfor kwhich kthe kloan kis kintended.

2.3.4 kCredit kCommittees

Establishing ka kcommittee kof kpersons kto kmake kdecisions kregarding kloans kis kan kessential kcontrol

in kreducing kcredit k(and kfraud) krisk. kIf kan kindividual khas kthe kpower kto kdecide kwho kwill kreceive

loans, kwhich kloans kwill kbe kwritten koff kor krescheduled, kand kthe kconditions kof kthe kloans, kthis

power kcan keasily kbe kabused kand kcovered kup. kWhile kloan kofficers kcan kserve kon kthe kcredit

committee, kat kleast kone kother kindividual kwith kgreater kauthority kshould kalso kbe kinvolved. kThe

credit kcommittee khas kthe kresponsibility knot konly kfor kapproving kloans, kbut kalso kfor kmonitoring

their kprogress kand, kshould kborrowers khave krepayment kproblems, kgetting kinvolved kin

delinquency kmanagement.

2.3.5 kDelinquency kManagement

To kminimize ksuch kdelinquency kbanks kcan kuse kthe kfollowing kdelinquency kmanagement kmethods: k

2.3.6 kInstitutional kCulture: kA kcritical kdelinquency kmanagement kmethod kinvolves kcultivating kan kinstitutional kculture kthat kembraces kzero ktolerance kof karrears kand kimmediate kfollow kup kon kall klate kpayments. kBanks kcan kalso kremind kclients kwho khave khad krecent kdelinquency kproblems kthat ktheir krepayment kday kis kapproaching.

2.3.7 kClient kOrientation

A klogical kfirst kstep ktoward kdeveloping ka kzero-tolerance kinstitutional kculture kis kto kcommunicate

this kconcept kto keach knew kclient kbefore kshe kreceives ka kloan.

2.3.8 kStaff kIncentives

Creating kstaff kinvolvement kin kdiscouraging kdelinquency, kthrough ka kstaff kincentives ksystem,

can kbe keffective. kDelinquency kPenalties: kClients kshould kbe kpenalized kfor klate kpayment. kThis

could kinclude kdelinquency kfees kpegged kto kthe knumber kof kdays klate kand klimiting kaccess kto

repeat kloans kbased kon krepayment kperformance.

2.3.9 kLoan kRescheduling

Given kthe kvulnerability kof kthe ktarget kmarket, kit kis kcommon kfor kborrowers kto kbe kwilling kbut

unable kto krepay. kAfter kcarefully kdetermining kthat kthis kis kindeed kthe kcase kit kmay kbe kappropriate

to kreschedule ka klimited knumber kof kloans. kOnly kdone kunder kextreme kcircumstances, kthis kmay

involve kextending kthe kloan kterm kand/or kreducing kthe kinstallment ksize.

2.3.10 kCollection kPolicy

There kare kvarious kpolicies kthat kan korganization kshould kput kin kplace kto kensure kthat kcredit

management kis kdone keffectively, kone kof kthese kpolicies kis ka kcollection kpolicy kwhich kis kneeded

because kall kcustomers kdo knot kpay kthe kfirms kbills kin ktime. kSome kcustomers kare kslow kpayers

while ksome kare knon-payers. kThe kcollection keffort kshould, ktherefore kaim kat kaccelerating

collections kfrom kslow kpayers kand kreducing kbad kdebt klosses k(Kariuki, k2010). kOn kthe kother khand kBerger kand kFrame k(2005) kcontend kthat kfailure kto kmaintain kproper kbooks kof kaccounts, kor khaving kweak kfinancial kstatements kmake kit kdifficult kfor kformal kfinancial kinstitutions kto kassess ktheir kcredit kworthiness. kFurthermore kFeldman k(1997) kagrees kwith kthe kabove kthat kgood kcredit kmanagement kis kthe kprocess kof kassigning ka ksingle kquantitative kmeasure, kor kscore, kto ka kpotential kborrower krepresenting kan kestimate kof kthe kborrower’s kfuture kloan kperformance.

2.4 kImpact kof kstaff keducation kand kexperience kon kfinancial kperformance kof kindigenous kbanks

For kany kcompany kto koperate ksuccessfully, kit kmust khave kmaterials, kmoney, ksupplies, kequipment, kideas kregarding kthe kgood kor kservices kto koffer kthe kindividuals kwho kmay kutilize kits koutputs kand klastly kpeople, kwhich kis kthe khuman kresource, kto krun kthe kcompany. kThe kproper kmanagement kof kindividuals kat kwork kis kHuman kResource kManagement, kand kit khas kdeveloped kto kbe ka kmain kactivity kin kmany korganizations kand kis kthe kconcentration kfor ka kwide k- kranging kdeliberation kconcerning kthe knature kof kthe kcontemporary kbusiness krelationships.