APPROVAL. Dr. Nyambane David

Transcription

1 DECLARATION I MUGISHA Epaphura do declare that this dissertation is my original work. It has not been presented for any award in any University, college or other institution of higher Learning. Signed Date i

2 APPROVAL "I confirm that the work reported in this dissertation was carried out by the candidate under my supervision and has been submitted with my approval". Dr. Nyambane David Date ii

3 DEDICATION I dedicate this dissertation to my Dear wife Wibabara Joan and my Daughter Mihigo Blessing and my Son Mihigo Dan for the support and the words of encouragement I dedicate this research work also to my mother Mukarusine Miriyeri for support during my education. iii

4 ACKNOWLEDGEMENT This work would not have been a success without the support and guidance of relatives and friends. Therefore, thanks go to them through guidance that could have been directly or indirectly felt. I am greatly indebted to Dr Nyambane David for undertaking the task of supervising the research leading to this dissertation. I gained a tremendous amount of knowledge under his supervision for expertise, time, care and compassion that have made this work successful and complete. May God bless him. I thank KIU for all work done towards my studies at University. I am very thankful to my fellow students in my group for the wonderful moments and learning experience we shared for the last two years. Not of course forgetting my classmates Kizihira Alphonse, Tumwine Venant, Muhire Modest, Nteziyaremye Jerome. I am very thankful to almighty God for the good health during my studies for the last two years. iv

5 TABLE OF CONTENTS: PAGE Declaration i Approval......ii Dedication.. iii Acknowledgement....iv Table of Contents.....v ListofTables...x List of Abbreviations. xii Abstract....xiii CHAPTER ONE 1.0. Introduction Background Historical Perspective Theoretical Perspective Conceptual Perspective Contextual Perspective Statement of the problem Purpose...11 v

6 1.4. Objectives of study Research questions Scope of study Significance of the study CHAPTER TWO 2.0 Literature Review Introduction The structure of Micro Finance interests Key institutional issues The roles of government and the central bank Rational for high MF interest rates Affordability of MF interest rates by the poor Who are the clients of microfinance institution Credit Credit analysis Factors to consider in credit analysis The lending process Check on collateral and preparation of loan agreement Default loans Causes of default loans 35 vi

7 2.7.5 Indicators of default loans Management and control of potential loan losses Prevention of problem loans and loss Handling default loans Conclusion CHAPTER THREE 3.0 Methodology Introduction Research design Target Population Sampling Strategies Data collection methods Data collection instruments Data quality control Administrative Procedure Data analysis Limitations of the study CHAPTER FOUR vii

8 4. 0 Data presentation, analysis and interpretation Introduction MFI interest rate charges in Rwanda The importance of unit cost of lending Limited sources of funds for on-lending The importance of risk The roles of government and the central bank Data interpretation Primary data Questionnaire Secondary data Interview Conclusion..69 CHAPTER FIVE 5. 0 Summary, conclusion and recommendations Summary of findings Conclusion Recommendations Prospects for future research...76 viii

9 5.5 References Appendices...81 ix

10 LIST OF TABLES Table Table 1.1 Dates when some Micro Finance Institutions in Rwanda were established..2 Table 1.2 present savings and loans for the period Table 1.3 Consolidated Financial Statement of Micro Finance Institutions on December 31 st Table 2.1 Comparative interest rates in 6 Asian economies Table2.2 A hypothetical Cost structure of a Commercial bank and Micro Finance Institution Table 4.1 Interest rates of Micro Finance Institutions in Rwanda 50 Table 4.2 Comparative interest rates in Rwanda Table 4.3 Interest rates for Agriculture Projects in Rwanda Table 4.4 Inflation rate Rwanda Table 4.5 Trends of deposits and credits of one Micro Finance Institution in Rwanda Table 4.6 Education level analysis Table 4.7 Analysis of clients with credits Table 4.8 Analysis of credit management literacy...61 Table 4.9 Analysis of economic activities of clients Table 4.10 Analysis of credit repayment period x

11 Table 4.11 Analysis of interest rate per month Table 4.12 Problems encountered during credit repayment period Table 4.13 Presents doubtful debts for the period Table 4.14 Bad debts written off Table 4.15 Recovery of loans written off xi

12 List of Abbreviations MFIs: MF: Rwf: CSS: MDGs: ICT: BNR: BK: BCR: BCDI: BRD: COGEBANK: COOPEC: VFC: MINECOFIN: NGO: UBPR : CGAP: SACCO: Micro Finance Institutions Micro Finance Rwandan Francs Credit and Savings Society Millenium Development Goals Information Communication Technology National Bank of Rwanda Bank of Kigali Commercial Bank of Rwanda Bank of Commerce, Development and Industry Rwanda Development Bank Insurance Bank Savings and credit Cooperatives Vision Finance Company Ministry of Finance and Economic Planning Non Governmental Organization Popular Bank of Rwanda Consultative Group to Assist the Poor Savings, Credit and Cooperative Schemes CEFE SA-AGASEKE: Financial Enterprise Centre Company- AGASEKE UOMB: Urwego opportunity Bank xii

13 ABSTRACT This research aimed at finding out why the Poor People still borrow in Rwanda despite the wide range of high interest rates charged by Vision Finance Company. The problem statement of this research based on several reports of 2008, 2009 and 2010 from Vision Finance Company. The objectives of the research were to determine whether Interest rates in Vision Finance Company are high, to determine whether people continue to borrow from Vision Finance in Rwanda Company and to determine the influence of government policy on interest rates and loan repayment. While carrying out the study, data collection methods were used both primary and secondary sources of data, the methods used were documentation, interviews, questionnaire and direct observation. The study revealed that Poor People still borrow in Rwanda despite the wide range of high interest rates charged by Vision Finance Company. The research found out that, economically active poor are able and willing to pay the high interest rates when right opportunities offer themselves for borrowing and they prefer to pay high interest rates to not getting where to borrow at all. VFC which operate savings are able to reduce their cost of funds which enables them to charge lower interest rates than those which do not have deposits; The cost of funds to the VFC is still high especially because availability of sources of funds for on-lending are limited and the financial sector is neither developed nor well integrated; Although in Rwanda there is no indication at the moment of influencing interest rates xiii

14 by putting in place interest rate ceilings, government should avoid this temptation because as a policy, its negative effects ultimately outweigh its positive effects. It creates distortion which lead to eventual collapse or chronic subsidy which is never sustainable because the MFIs would have to use up its capital to support the subsidy, or get into permanent subsidy support. xiv

15 CHAPTER ONE 1.0 INTRODUCTION 1.1. Background Historical Perspective Micro Finance Institutions are organizations that provide banking services such as savings, credit and money transfers to poorer people who cannot access ordinary mainstream banking services. In 1974, famine struck Bangladesh at the time, Dr Muhammad Yunus was a professor of economics at the University of Chittagong. Disillusioned by the elegant theories of economics that could not explain the thousands of poor people dying of starvation on the streets; he was determined to find a practical way to help the poor. During a visit to the nearby village of Jorba, he was astounded to find that a sum of $27 could radically change the lives of 42 people in the village. This was the sum of money they collectively needed to buy bamboo to make the stools they sold to make a living. He took $27 from his pocket and made 42 loans to the stool makers in this tiny village. They were able to pay him back with interest and take a step towards lifting themselves out of poverty. And now the world Bank estimates that more than 16 million people are served by some 7,000 micro finances all over the world. Consultative Group to Assist the Poor experts mean that about 500 million families benefits from these small loans making new business possible. 1

16 THE CLIENT MARKET POTENTIAL STILL UNSATISFIED Table 1.1: Dates when some MFIs in Rwanda were established Name of MFI Year of establishment RWANDA POPULAR BANK 1975 ZIGAMA-CSS 1997 URWEGO OPPORTUNITY BANK 1997 SAVINGS AND CREDIT COOPERATIVES 1999 VISION FINANCE COMPANY 1999 AGASEKE 2003 UBAKA 2003 INKINGI 2004 UMUTANGUHA 2005 UNGUKA 2005 AMASEZERANO 2006 Source: Capmer.org/new/docs/les conditions de credit au Rwanda. PDF; Table 1.1 shows that out of five MFIs visited by the researcher, apart from the UBPR which started in 1975, four others started between 1997 and 2006; a life span of less 10 years. All the above five MFIs which were visited show characteristics of a young MF industry. Table 1.2: Present savings and loans for the period expressed in million of Rwandan francs Indicators 31/12/ /12/ /12/ /12/2010 Total savings Gross loans Loans as 62% 70% 28% 21% proportional to savings Source: Secondary data 2

17 With reference from the above table, savings for the period were , , and million of Rwandan francs respectively. In calculating the proportion of loans to savings, the results were 62%,70%,28% and 21% respectively. The savings were not stable because it reduced in 2008 increased in 2009, but loans increased from 62% to 70% because microfinance was encouraging the poor to start small business regardless of what someone deposited. The microfinance continued its lending limits because their lending capacity over deposits should not be more than 70%. This is good because over lending is considered as one of the major causes of credit non recovery. East African countries also found it viable to implement MFIs as tool of poverty reduction therefore they signed in 2008 MFIs Capacity Building initiative in East African Countries (Kenya, Uganda, Tanzania, Ethiopia, Rwanda and Burundi) where the strengths and weaknesses of 35 MFIs shall be analyzed, benchmarks, set and measures for the improvement of institutional difficulties implemented. After the completion of these activities, some 12 MFIs are then expected to be rated by an official rating agency as Tier 2.This improved status, thanks to the advancement of their structures and capacities, would allow them to fulfill the basic criteria for accessing commercial financial and this project will end in 2012.For Rwanda perspective the first micro finance began to exist since 1975 with the establishment of the first Popular Bank at NKAMBA (former KABARONDO district). After the 1994 genocide in Rwanda, the micro finance sector has known a dramatic progress through the support of relevant international and Non Governmental Organizations especially humanitarians. According to BNR 2008 report status that significant increased activity in the micro finance sector between December 31 st,2007 and on December 31 st, 2009, outstanding deposits of all MFIs amounted to rwf, and the gross outstanding loans of 50.1billions rwf. The number of beneficiaries of the MFIs was people by June These figures are still heavily influenced by those of Zigama CSS( Credit and Savings society) 3

18 which alone amounted to approximately half of the outstanding deposits and loans of all cooperatives and savings and credit Unions. Table 1.3: Consolidated Financial Statement of MFIs as at December 31 st Description (Million in rfw) 31 st December st December 2009 Variation Total Assets 60, , Total Deposits 38, , Gross outstanding loans 42, , Non-performing loans 2, , Provisions 1, , Source: ( BNR, 2009) By the end of September 2009, there were 100 MFIs and one micro finance bank that were divided as follows: 87 Savings and credit Cooperatives (COOPEC) 11 Limited companies One Micro finance bank ( Urwego opportunity Bank) About Vision Finance Company S.A Rwanda Established in 1999, Vision Finance company(vfc) is an affiliate of World Vision International. Since its founding, VFC has been committed to alleviating poverty in Rwanda by ensuring that poor people have access to credit to support business initiatives that will improve their life circumstances. VFC s mission is to promote economic empowerment and improve the standards of living of the Rwandan population through the provision of financial services to the working poor with an emphasis on women living in rural areas. 4

19 1.1.2 Theoretical Perspective MFIs are expected to recover all the costs and on top earn a profit return to finance their own growth. If all the costs are not accurately and comprehensively computed and recovered by the interest rates when funds are lent out, it will inevitably lead to a distorted interest rate. This will further lead lenders resorting to practices such as hiding costs into other charges to clients or dodging the poor to lend a few well to do rich clients whose costs of lending is lower and matches a lower interest rate(robinson, Marguerite,: 2001 pp142). This simply explains that all costs must be reliably estimated with minimum distortions and it does not matter whether the clients use the funds obtained to finance fixed assets or working capital. The price that reflects all the cost elements comprise the interest rate and how high these costs are, determines how high the interest rate will be and therefore, how easy will be for borrowers to pay lenders the principal amount and interest thereon. Although interest rates depend largely on the cost elements outlined above, it also depends on the following factors; individual institutional competencies and their respective managements, the age and size of the MFI which largely determines the level of efficiency, the nature of products and services offered to clients and the nature of client target market(ledger wood, Joanna,:2000 pp11). Other factors that influence interest rate include the broader macroeconomic environment and the level of social economic infrastructural development that supports the economic activities. Furthermore other factors that influence MFI interest rates include political policies in as far as they influence financial outcomes and psychological factors especially building trust and confidence in the financial intermediation process and managing expectations. There are other non- economic social pressures and groups which may influence interest rate. Rosenberg, Richard, 1996 Ledger wood, Joanna, (2000), pp150, offers a model, outlined below, on approximation of sustainable interest rates. The other method which was suggested is less straight forward because it relies on the internal rate of return which can prove difficult for practitioners of micro enterprises to compute, although it gives a more accurate estimation of interest rate. To manage 5

20 interest rate payments, MFIs can then easily manipulate, differently, the computation of interest rate to be charged. MFIs could achieve this either by ensuring the following: all interest charged is recovered at the beginning; a commission is charged on the total loan amount and recovered at the beginning; payments for interest and principal are paid in weekly installments; that the interest is applied flat on the whole loan throughout the period; a flat interest amount is received upfront; the flat rate and upfront interest in combined with a fee; compulsory savings are retained by the MFI to guarantee the loan, normally subtracted from the loan; it could be a combination of flat, upfront interest rate, fee and compulsory saving all combined. All the above techniques result into different annualized interest rate implications for the client and give different Net Present values. This research has adopted the basic model shown below because it is the one adopted by most MFIs in Rwanda which were visited. The annualized interest rate, R=AE+LL+CF+K/II LL Source; Ledger wood, Joanna, (2000),pp149 Where; R is the annualized rate of interest, CF is the proportion of the cost of funds using the Weighted average cost of capital (WACC- will be defined below), AE is the proportion of total administrative expenses incurred by the MFI, LL is the proportion of loan loss provision, K is the proportion of capitalization and opportunity cost II is the proportion of investment income earned each of the above cost or income elements is expressed as a percentage of the average loan portfolio. In the formula above, the numerator is the sum of the proportion of the costs that go into the interest rate as a cost of financing, while the denominator is the proportion of the loans that are good. In other words, the total financing cost is distributed only over the recoverable loans. The behavior of the numerator is such that as the costs decrease, interest rate 6

21 should decrease, while the denominator is such that as the loan loss decreases (as the good loans increase), the denominator increases and approaches one, consequently making the interest rate to decrease. The Average Weighed Cost of Funds or Capital, WACC(Gitman, J. Lawrence, 2006 pp505), denoted by ka is given Ka=(wi*k1)+(wp*kp)+(ws*kr or n) Source: Gitman, J.Lawrence (2006).pp505 Wi+wp+ws=1 In the formula, Wi=proportion of long term debt in capital structure, Wp= proportion of preferred stock in capital structure, Ws=proportion of common stock equity in capital structure Conceptual Perspective The dependent variable in the study is loan repayment. Loan repayment defined from Wikipedia, the free encyclopedia as A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower. In a loan, the borrower initially receives or borrows an amount of money, called the principal, from the lender, and is obligated to pay back or repay an equal amount of money to the lender at a later time. Typically, the money is paid back in regular installments, or partial repayments; in an annuity, each installment is the same amount. The loan is generally provided at a cost, referred to as interest on the debt, which provides an incentive for the lender to engage in the loan. In a legal loan, each of these obligations and restrictions is enforced by contract, which can also place the borrower under additional restrictions known as loan covenants. Although this article focuses on monetary loans, in practice any material object might be lent. 7

22 Acting as a provider of loans is one of the principal tasks for financial institutions. For other institutions, issuing of debt contracts such as bonds is a typical source of funding. The independent variable which is interest rates defined by Investopedia explains 'Interest Rate' as Interest is charged by lenders as compensation for the loss of the asset's use. In the case of lending money, the lender could have invested the funds instead of lending them out. With lending a large asset, the lender may have been able to generate income from the asset should they have decided to use it themselves. Using the simple interest formula: Simple Interest = P (principal) x I (annual interest rate) x N (years) Borrowing $1,000 at a 6% annual interest rate for 8 months means that you would owe $40 in interest (1000 x 6% x 8/12). Using the compound interest formula: Compound Interest = P (principal) x [ ( 1 + I(interest rate) N (months) - 1 ] Borrowing $1,000 at a 6% annual interest rate for 8 months means that you would owe $ The interest owed when compounding is taken into consideration is higher, because interest has been charged monthly on the principal + accrued interest from the previous months. For shorter time frames, the calculation of interest will be similar for both methods. As the lending time increases, though, the disparity between the two types of interest calculations grows. An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. For example, a small company borrows capital from a bank to buy new assets for their business, and in return the lender receives interest at a predetermined interest rate for deferring the use of funds and instead lending it to the borrower. Interest rates are normally expressed as a percentage of the principal for a period of one year Interest rates targets are also a vital tool of monetary policy and are taken into account when dealing with variables like investment, inflation, and unemployment 8

23 From Wikipedia, the free encyclopedia Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds. When money is borrowed, interest is typically paid to the lender as a percentage of the principal, the amount owed to the lender. The percentage of the principal that is paid as a fee over a certain period of time (typically one month or year) is called the interest rate. A bank deposit will earn interest because the bank is paying for the use of the deposited funds. Assets that are sometimes lent with interest include money, shares, consumer goods through hire purchase, major assets such as aircraft, and even entire factories in finance lease arrangements. The interest is calculated upon the value of the assets in the same manner as upon money. Interest is compensation to the lender, for a) risk of principal loss, called credit risk; and b) Forgoing other investments that could have been made with the loaned asset. These forgone investments are known as the opportunity cost. Instead of the lender using the assets directly, they are advanced to the borrower. The borrower then enjoys the benefit of using the assets ahead of the effort required to pay for them, while the lender enjoys the benefit of the fee paid by the borrower for the privilege. In economics, interest is considered the price of credit. Interest is often compounded, which means that interest is earned on prior interest in addition to the principal. The total amount of debt grows exponentially, and its mathematical study led to the discovery of the number 9

24 1.1.4 Contextual Perspective VISION FINANCE COMPANY SA Profile Mission: Our mission is to provide financial and non-financial services to the economically productive Rwandan poor, especially women, through the development of sustainable and small micro-enterprises Background and Main Challenges: "Vision Finance Co. SA (VFC) was started in 1997 as a Microfinance Department under World Vision Rwanda and later registered as a separate program called Amizero (Hope) Microfinance in It was then incorporated as a limited Liability company (Societe Anonyme) in October 2003 and licensed as a regulated Microfinance Institution by the Central Bank in September VFC is a wholly-owned microfinance subsidiary of World Vision International represented by its program in Rwanda, World Vision Rwanda. World Vision is a Christian humanitarian organization dedicated to working with children, families and their communities worldwide to reach their full potential by tackling the causes of poverty and injustice. World Vision strives to impact poor communities through its remarkable model of utilizing the five arms of development, namely Health, Education, Food, Water and Economic Enterprise. VFC hence fulfills the fifth arm of developing sustainable economic enterprises in Rwanda through targeted and meaningful penetration of Rwandan communities using the most effective and proven methodologies to lift communities out of poverty. VFC currently serves over 22,000 credit and savings clients in eight branches and 20 Site Offices (a total of 28 locations) in all of the administrative provinces of Rwanda, with a loan portfolio of about 10

25 RwF 1.8bn as of end of VFC intends to reach over 40,000 savings and credit clients by 31 December 2012 with a loan portfolio of over RwF 5bn, through its three key lending methodologies of Community Banks, Solidarity Groups and Individual Loans. About 70% of all VFC clients are women. VFC s typical client is usually a mother aged over 45, often widowed, looking after an average family size of seven (some of them orphans) and owns a small business, usually a stall in the market, or a small shop/kiosk by the roadside. VFC targets women because its believed that empowering the women of Rwanda will ultimately lift the nation out of poverty. 1.2 Statement of the problem: Poor People still borrow in Rwanda despite the wide range of high interest rates charged by Vision Finance Company. Many people have accessed credit through Vision Finance Company. A lot of funds have been expensed in the institutionalization of Vision Finance Company for purposes of making it credit intermediary of the poor. Impact created by Vision Finance Company to reduce interest rates assault is less significant as many people have continued to borrow at high interest rates. Information Micro on continuity borrowing from Vision Finance Company is available. The best practices of successful Vision Finance Company have not been well documented. The big proportion of revenue of this country is derived from credit operations and most of the activities are facilitated by credit, despite the failure of the loan to generate income to repay the principal and interest. 1.3 Purpose of the study The main purpose of this research was to establish the reasons why poor people continue to borrow despite the high interest rates charged by MFIs. 11

26 1.4 Objectives of study: i. To determine whether Interest rates in Vision Finance Company are high. ii. To determine why people continue to borrow from Vision Finance in Rwanda Company. iii. To determine the influence of government policy on interest rates and loan repayment. 1.5 Research questions include: i. Are interest rates charged by Vision Finance company high? ii. Do people continue to borrow from Vision Finance company in Rwanda? iii. Does government policy influence interest rates and loan repayment? 1.6 Scope of the study: This study will be carried out in VFC at Head Office based in Kigali and the period under consideration is 2007 to The study will focus on assessing interest rates and loan repayments. 1.7 The significance of the study: The study will provide information concerning why people still borrow in Rwanda despite the wide range of high interest rates charged by Vision Finance Company in addition to existing information. The study will also provide information for policy makers and all those people doing further studies as far as interest rates and loan repayments in Microfinance institutions is concerned. 12

27 CHAPTER TWO 2.0. LITERATURE REVIEW: 2.1. INTRODUCTION According to Ledger wood, Joanna, (2000:pp1), MF has evolved as an economic development approach intended to benefit the poor. In the 1970s, government agencies were the predominant method of providing credit to clients with no credit history. Latter in the 1980s, the subsidized, targeted credit model was the object of steady criticism, because most programs accumulated large loan losses and required frequent recapitalization to continue operating. As a result changes in approach occurred with emphasis shifting from the subsidized approach to building up formal financial institutions based on financial systems (Robinson, Marguerite, 2001 pp52). Varying models have evolved from Grameen Bank model initiated by Dr. Mohammed Yunus of Bangladesh which supports community based lending, to ACCION International of Latin America which supports solidarity groups and other NGOs that emerged later such as K Rep of Kenya, which support individual lending ( Otero, Maria, & Rhyne, Elisabeth, 1994 pp ). According to the World Bank s Development Report 1999/2000: Some 80% of the world s billions living in low and lower middle income economies do not have access to a formal sector offering financial services ( Robinson, Marguerite, 2001 pp 10 ). Again according to Ledger wood, Joanna, (2000), since the 1980s, the field of MF has grown substantially. During the , research on inventory revealed 1,000 institutions with outstanding loans of over USD 7 billion and over USD 19 billion in deposits serving over 500 million people (Robinson, Marguerite,:2001 pp26 ).MF in the 1990s (Robinson, Marguerite,:2001 pp22) was marked by a major debate between two lending views: the financial systems approach, sometimes called the minimalist approach, emphasizes institutional self sufficiency as the only possible means to meet wide spread client demand for convenient and appropriate financial services (Versluysen, Eugene,: 1999 pp58). The poverty lending approach sometimes referred to as the integrated or maximalist approach focuses on reducing poverty through credit, often provided together with complementary services such as skills training, literacy, numeracy, health, nutrition, 13

28 family planning, and other social programs (Versluysen, Eugene,: 1999 pp59). This latter approach provides financial intermediation services below market interest rates. MFIs by definition offer financial intermediation (Versluysen, Eugene,: 1999 pp55), although they often also offer social intermediation. On one hand, financial intermediation includes loan products, savings products, insurance products and payments services. On the other hand, social intermediation is defined as the process of building the human and social capital required for sustainable financial intermediation. They include enterprise development, training, organizational development and skills development. Interest rate is defined as the amount charged for a loan, usually expressed as a percentage of the sum borrowed, conversely, the amount paid by a bank, building society, etc., to a depositor on funds deposited, again expressed as a percentage of the sum deposited(dictionary of Finance and Banking,:1997 pp180). In this study, focus will be on the definition, although in the case of MFIs, deposits affect loans since the cost of funds which is one of the major variables that determine interest rates on loans is influenced by the level and cost of deposits. Economically, interest rate is a required rate of return on money borrowed. According to Rhyne, Elisabeth, (1995) Robinson, Maguerite,(2001)pp24 MF can be sustainable at every level of clientele with even the poor being able to pay the full cost of lending. The advantages with the financial systems approach are obvious; they grow and expand outreach systematically by leveraging additional capital and also escape chronic donor and government dependence and influence. The way MF services will be offered is influenced by the overall political and economic environment. This includes; different macroeconomic country level policies, the level of development of the sector including the suppliers of MF financial intermediation and country contextual factors such as regulation, supervision; and the organization of MF clients. There are five well known ways to deliver MF intermediation (Ledger wood, Joanna, 14

29 2000 pp 82-86). The first approach is the individual lending mainly practiced in urban and production based clients and also rural farmers who may possess some collateral. The second approach is the Solidarity group lending as practiced by the Grameen Bank but also practiced in many other parts of Asia, Africa and Latin America. In this case, the clients are organized into groups whereby group members mutually guarantee each others credit and are legally held responsible for other members loans. No collateral is required and appraisal is jointly performed by group members together with credit officers. The third approach is the Village banking which is a credit and savings associations which offer MF intermediation especially in the rural areas. Membership is on voluntary basis and financing is from members contributions as well as from the MFIs. The fourth approach is the Savings and Loans Associations which offer financial intermediation to members only. The fifth approach is the Latin America Solidarity Group lending mainly tailored to serve small scale market vendors who need small short term working capital loans. MF interest rates pose a very important concern because the target markets served by MFIs are poor people and interest rate being the price of funds charged to this category; it is sometimes assumed that it should be and seen to be fair and trusted by clients. For MFIs to operate on a sustainable basis, however, they need to ensure cost recovery. When interest rates are fixed under market forces, this ensures efficient resource allocation and offers a better and reliable opportunity to grow and to reach poor clients as possible. 2.2 THE STRUCTURE OF MF INTEREST RATES As indicated earlier, the objective of a MFI is to offer financial services for which it must charge an interest rate that covers all costs in order for the institution to be sustainable (The CGAP Occasional Paper No.1:1996). An important factor to consider is to ensure that the borrowers are also able to earn adequate return on their profits and be able to meet both their business commitments and in addition meet the lenders commitments. Funds can only be accessed at a cost for which a price must be charged not only covering the cost of funds (cost of funds includes the risk element, the inflation factor 15

30 plus the opportunity cost of the funds which explain the capitalization rate) for on lending, but also to cover administration expenses such as salaries, staff benefits, rent, utilities, depreciation expenses, training, and other operating expenses which form the largest costs of MFIs. Another cost that enters into the computation of MFI interest rate is the loan loss, which also has to be included since not all loans to clients are recovered. 2.3 KEY INSTITUTIONAL ISSUES The structure of an annualized interest rate as shown above reveals that the major factor which largely influences MF interest rate is the cost of financing. In analyzing the factors that influence the variables indicated above, there are two broad categories of major influences on MF interest rates: On one hand, there are factors internal to the MFIs which can be influenced by their Boards of Directors and Management, while on the other hand there are factors that are environmental and external to the MFIs. These internal factors can be sub categorized as strategic or operational, whereby strategic factors are considered as those determined by the respective Boards of Directors including setting Goals, Mission and Vision of the MFIs. According to Campion, Anita & Frankiewicz, Cheryl,(1999 Occasional Paper No. 3 pp17 30), board decisions are very important because they determine not only the nature of the MFI but also its general orientation and focus. Ledger wood, Joanna, (2000 pp111) states that governance and ownership are critical in directing MFIs visionary whether to adopt business like approach or not, which drives the motivation of management. According to Candace, Nelson, (1996 pp35) such decisions extend to organization structural issues like whether an MFI will be a Limited Company, Non Governmental Organization (NGO), or a Cooperative, and this will imply the extent to which profit will be a major focus or not. Governance will also determine how wide or narrow the organization structure will be, which will also have a direct bearing on how heavy administrative expenses will be. Strategic factors are meant to set strict guidelines within which management must operate which will largely determine the efficiency of the MFI and influence the determination of the interest rate. 16

31 Operational factors include outcomes of management decision making, specifically, issues relating to the variables indicated in the formula of the annualized interest rate above (Campion, Anita & Frankiewicz, Cheryl,:pp31-36). There are examples of tools which have been developed to improve the operational efficiency of the MFIs. One such tool outlined (Ledger wood, Joanna,:2000 pp ) is the operational review tool which assesses 7 readiness indicators, the indicators include: corporate governance; markets and clients; credit methodology; distribution; human resource management; computerization and financial management. A close analysis of these indicators by management of MFIs helps in functional management focus and improves operational efficiency. Another example of a useful tool is the Activity Based Costing (ABC) developed by Cooper, Robin, & Kaplan, S. Robert, (n.d, Second Edition, pp ). This tool goes into detail to identify cost drivers when allocating costs to a product, appropriate interest rate can be better apportioned to specific products to which it relates, or possibly make an average of the total costs for the whole business from a point of knowledge of profitable and less profitable products. The management of MFIs could even take the hard decision to abandon some of the existing un profitable products. Cost apportionment is based on cost drivers such as staff time, offices space, equipment time, transport, security and other overheads. Efficient management is judged by how much they are able to push down these operational costs without affecting negatively the bottom line of the MFI. External environmental factors that influence MF interest rates include macroeconomic factors (Ledger wood, Joanna,:2000 pp11) Such as market supply and demand arising from the general behavior of the economy as a whole, behavior of competitors, inflation and exchange rates which determine the stability of the currency especially when foreign sources of financing are involved. Competitive factors would lead to questions such as whether or not MFIs should compete on interest rate charged, type of products offered, markets where MFIs are operating or through promotion and advertising. It would also raise the question of the quality of services offered to clients and the nature of the uniqueness of the market. 17

32 2.4 THE ROLES OF GOVERNMENT AND THE CENTRAL BANK One of the most important issues facing MF today is regulation and supervision (Robinson, Maguerite,:2001 pp20-30). Regulation is intended to lead to efficiency of markets in allocating resources towards the most productive sectors which will harness economic growth (Churchill, Craig,:1997, Occasional paper No 2). Furthermore, they are intended to minimize moral hazard by opportunistic behavior of some managers, which would otherwise endanger client funds (Mankiw, N.Gregory,:1997 pp581). These two aspects are performed by the Central Bank. Many NGOs providing financial intermediation are not regulated. According to Chavez, Gonzalez Vega(n.d) Otero, Maria,& Rhyne, Elisabeth, (1994), pp55-74, Regulation refers to a body of principles, rules, standards, and compliance procedures that apply to financial institutions. Financial supervision involves the examination and monitoring of organizations for compliance with financial regulations. Prudential regulation and supervision are designed to avoid a banking crisis and maintain the integrity of the payment system, protect depositors and encourage financial sector. Competition and efficiency. Case studies edited by Churchill, Craig,:1997 (Occasional Paper No 2), on regulation and supervision in Indonesia, Bangladesh, Philippines, Bolivia, Colombia, Peru, Kenya, West Africa, and South Africa, offer rich and wide experiences on advantages and disadvantages of regulation. The impact of the legal environment on interest rates need not over emphasized. The role of the government is to put in place policies that promote the MF sector, and to make social and economic development plans on how the sector will contribute to its social and economic goals. Interest rates affect investment as well as consumption decisions on a day to day basis. Government has keen interest on how interest rates are determined because of the broader macroeconomic stability of the economy as influenced by interest rates. The challenge of government is: Creating an enabling environment by offering tax and financial incentives, Establishing social and economic infrastructure, Attracting educated labor force 18

33 Availing technological potential Legislating a conducive legal environment including flexible environmental codes and attractive employment contracts, Establishing a favorable security environment, Ensuring low entry and exit costs and putting in place conducive investment laws plus ensuring political stability. Improving the country risk to attract foreign sources of finance, Encouraging inflow of different financial and human resources relevant to the MF Industry. And, through the Central Bank and other economic institutions, government may influence fiscal policy through taxes which will impact on the MFIs also.the above conditions are intended to create a favorable and attractive environment from both the perspective of the MFIs and the borrowers and are in particular enablers to the establishment of MFIs, improving their performance and efficiency and therefore the interest rates they charge. In Rwanda in particular, effective 2005, all regulated MFIs have a tax relief for 5 years after being licensed. Relief on tax improves the profit position of MFIs which implies that they can afford lower interest rates during the establishment period of the MFI when the start- up costs are high. Interest rate is a basic concern of Central Banks in general because it is one of the primary tools of monetary policy. Interest rates charged by MFIs are of particular concern because the poor who comprise their clients are vulnerable which, to the Central Bank, makes it more vital concern. In executing the monetary policy, the Central Bank (Schiller,R. Bradley, 1994 pp ), performs different roles which impact on interest rates: It ensures a stable and progressive economic environment which enables borrowers to invest and spend and lenders to have trust and confidence in the financial intermediation process. Economic activity is essential in determining supply and demand for funds and therefore, impacts on interest rates; 19

34 The Central bank controls inflation in order to ensure that those lending do so with confidence that they will not lose value of their assets over time because of inflation. Furthermore, the central bank maintains a stable exchange rate regime and manages a foreign exchange reserve which facilitates stabilization of the currency, which also directly influences interest rate determination; The Central bank also regulates money supply through open market operations by controlling liquidity in the economy which directly impacts on supply and demand for money in circulation, and thus on interest rates as well; To set and review the monetary policy as a tool to stimulate and stabilize the economy. The Central Bank institutes prudential regulation especially to protect depositor s funds. The respective roles of the government and the central bank in influencing the environment that affects the determination of interest rate are expected, especially given the fact that the central bank acts also as an advisor to the government on financial and monetary issues including interest rates. This does not necessarily mean that they interfere with the market forces which would inevitably lead to interest rate distortions. Instead, they endeavor to build the necessary physical, social and economic infrastructure that creates an enabling environment within which different economic entities can safely and freely operate to their advantage. The BNR policy in Rwanda on MFIs and the monetary policy stipulate a number of guidelines that include the following: MINECOFIN,(2006) pp8-11 Putting in place incentives that promote Investment opportunities through favorable legislation and tax incentives to MFIs that meet specified minimum eligibility criteria; Promoting professional, transparent and a participatory approach in the management and operations of the MFIs; Promoting professional training, capacity building and standards of practice; Promoting sustainability policies and principles of MFIs by promoting a free market environment and eliminating any market distortions where they exist; Encouraging long 20

35 term finances and partnership focusing on MFIs. For example, through the Central bank, MFIs can access guarantee funds established by government. These guarantee funds are meant to bring the risk of borrowing down and therefore the cost of lending and consequently, the interest rates; Promoting gender dimensions of MFIs by encouraging development of special services and promoting other alternative appropriate approaches to cater for other vulnerable groups. This is done through offering economic and other incentives to cooperatives and other organizations willing, and ready to serve un privileged populations without compromising the sustainability principles; Ensuring a stable and progressive economic environment conducive to borrowing and investment, and for lenders to have trust and confidence that lending is profitable. One important thing BNR has done to improve stability, is to establish insurance deposit funds to protect MFIs during risky and uncertain periods. Economic activity is essential in determining supply and demand for funds and therefore, to influence interest rates; Ensuring stability and predictability of the currency within a flexible exchange rate system that responds to market forces in allocation of economic resources. It has so far maintained a stable exchange rate regime and manages foreign exchanges reserves. This role facilitates stabilization and therefore demand for the currency which influences interest rates; Ensuring that MFIs lend with confidence that they will not lose value of their assets over time. That is the reason why inflation targets are integrated in the cost of funds. The BNR targets inflation not to exceed 10% which it hopes to achieve by close supervision and monitoring of monetary and fiscal policies; Encouraging MFIs to face challenges of continuous quality improvement of service delivery. For example it has increased the minimum initial capital requirements of MFIs registered as private companies from 100 million francs to 300 million francs. It has also regulated delinquency should not exceed 10% of the loan portfolio and portfolio at risk should not exceed 5%. The biggest MFI in 21

36 Rwanda, UBPR is in the process of being transformed into a Commercial bank in order to offer a wider range of products so as to improve its profitability; Encouraging and stimulating MFIs to take initiatives that promote product development, and in fine-tuning improvement of access to financial systems through a well developed action plan to be approved by the BNR Board of Directors soon. The main aim is to integrate the MFI sector in the financial and monetary system. 2.5 RATIONAL FOR HIGH MF INTEREST RATES MFIs serve the poor and may be expected to charge low interest rates compared to commercial banks which lend the relatively richer clients. On the contrary, interest rates charged by MFIs are generally higher than those charged by Commercial Banks. The high interest rates charged by MFIs generally attract not only criticism but also concern. However it should be understood from economic logic that interest rate is nothing but a cost of financing which must be carefully and comprehensively analyzed in order for it to be recovered. Table 2.1: Comparative interest rates in 6 Asian economies. Country Commercial Bank MFIs APR Informal sources (eg money APR lenders) Indonesia 18% 28-63% % Cambodia 18% 45% % Nepal 11.5%(priority sectors) 18-24% % 15-18(other sectors) India 12-15% 20-40% % Philippines 24-29% 60-80% 120+% Bangladesh 10-13% 20-35% % Key: APR- Annual interest Percentage Rate. Source: Helms, Brigit(2004) 22

37 Table 2.1 confirms that in Asia like elsewhere, MFI interest rates are higher than those charged by Commercial banks. However, it is also evident that the MFI rates are much lower compared to those of the informal sector. The interest rates charged by MFIs can be as high as double those charged by commercial banks while those charged by the informal sector can be as high as over 10 times those of the MFIs and 20 times those of Commercial banks. According to Rutherford, Stuart, (2003 pp76), the presence of the informal sector teaches three important lessons. First, that some poor people enjoy financial services not available universally, and are able and willing to pay for them highly; second, that the informal sector is tailored to specific client needs in terms of the variety they offer; third, that the informal sector offers their services at a price (Rutherford, Stuart:2003 pp76). This explains the fact that borrowers are underserved and are ready to pay a high price as long as they are happy with the product. In other words, they would avoid the informal lenders if they had enough MFIs that would offer cheaper funds. Research done in India where the operating costs have been brought down to about $ 0.25 per interaction with a customer indicate that MFI interest rates have been steadily falling as a consequence. Administrative costs associated with the high number of interactions per borrower continue to be the main determining factor to push MFI interest rates high (Helms, Brigit,: 2004, Occasional Paper No. 9). The challenge is to strive to stimulate innovations that improve the productivity of MFIs, but even then, interest rates charged by MFIs are likely to remain proportionally higher. The point is that the unit cost of lending by MFIs is higher than that of commercial banks because operating costs of MFIs per unit are higher; which is largely attributed to the small sized loans they give, the remoteness of areas where they operate and the unique characteristics of the target markets which they serve as compared to Commercial banks (Robinson, Maguerite,:2001 pp30). The above point can be illustrated by comparing two hypothetical lenders, a big commercial bank which is to lend one big client, and an MFI lending the same amount to 1000 borrowers; 23

38 Table 2.2: A hypothetical Cost structure of a Commercial bank and MFI. Type of financial Institutio n Commercial Amount Number Amount of Cost per available for lending of clients individual loan borrower Estimated Estimated total cost interest of lending rate $1,000,000 1 $1,000,000 $20,000 $20,000 14% Bank MFI $1,000,000 10,000 $100 $20 $200,000 31% Source: CGAP Occasional Paper No.9: Tabulated and adjusted from Box 1 September,2004 In table 2.2, the cost of capital and loan loss risk is taken to vary proportionally with loan size and have been assumed to be constant in both cases. With the same source of capital, both are assumed to pay 10% for the money and 1% is assumed to default on repayment. Administrative expenses are assumed at 3% for the commercial bank since they are expected to meet the borrower once because he makes his repayment once at the end of the month. On the contrary, the micro lenders may be required to pay weekly and at the same time, the MFI staff may be required to meet them more often which would make annual real interest rate even higher. This is because they have no credit history, no collateral, are often illiterate and have to be advised regularly, they have no records and if left alone may be tempted to divert the loan to other urgent social uses. This pushes the administrative costs much higher for the MFI to administer the same amount of loan portfolio. To understand the above comparison better, the question to ask would be, what the operating expenses would be for the Commercial banks if they were to operate in the same environment and to serve the same category of clients as the MFIs? The answer would be that the operating costs in the same environment would most likely be much higher for the Commercial banks because they pay higher levels of operating expenses which would automatically imply higher interest rates. This partly explains why the commercial banks are not attracted to those specific markets in the first place. The other question to ask would be, how high should the MFI interest rates be to be 24

39 judged fair?. High interest rates charged by most MFI are not unscrupulously high but because their unit operating costs are high, ceteris peribus. This does not exonerate inefficient MFIs; the challenges faced by MFIs in having a low interest rate lie efficiently managing the variables in the interest rate model seen earlier, that determine the interest rates. However, there are also factors such as limited product variety and limited supply of cheap capital which, if favorable, would influence interest rate downwards. Therefore, the constant criticism against high rates charged by MFIs may be misleading in many cases. 2.6 AFFORDABILITY OF MFI INTEREST RATE BY THE POOR According to Rosenberg, Richard,(1996), Robinson, Maguerite,(2001) pp32 there is overwhelming evidence that huge numbers of poor borrowers can indeed pay interest rates at a level high enough to support MFI sustainability. He advances three reasons: first, one typically finds lower income borrowers taking and effectively paying repeated informal loans whose interest rates are much higher than any formal MFI would charge; second, in all countries and regions, borrowers pay high interest rates and demand always continues to outstrip supply; Third, there is no single MFI which has ever been reported chasing away clients because of charging high interest rates. Rosenberg, Richard, (1996) says that the highest interest rate which he ever came across was in Mexico where an MFI charged 10.1% per month, yet money lenders charged between 25-30% per month!. Small enterprises provide high returns and the challenge is to make available funds to them at the right time. The poor referred to in this research are those who, for different motives, are able and willing to save and borrow, however little the amounts may be. In other words, the poor who are economically active need financial services and there, are able and willing to pay for them. There is ample evidence in Asia, Africa, South America, and in many other parts of the world that the poor borrow and pay, and borrow again and pay successfully. The high 25

40 interest rate is therefore not a hindrance to the economic advancement of the economically active poor, but rather a necessary financial intermediation that the poor need and benefit from (Helms, Brigit,:2004, CGAP Occasional Paper No.9). The very poor and the destitute would not benefit from financial intermediation. They need other socially oriented institutions and NGOs offering social programs that pull them out of poverty before offering economic programs. The financial systems approach to financial intermediation must wait for them to graduate from the poverty lending approach (Versluysen, Eugene,:1999 pp59). In Rwanda, apart from what is explained above, there are four factors that can be considered to justify that the poor can afford to pay high MFI interest rates. Firstly, evidence shows that existing MFIs are registering new members in existing branch offices. Secondly, existing MFIs are opening new branches in new locations. Thirdly, existing members are increasing the size of their loans and fourthly, MFIs are introducing new products. The fact that well performing MFIs are increasing their overall portfolio implies that the poor in Rwanda are able and willing to pay for the financial services. 2.7 WHO ARE THE CLIENTS OF MICRO FINANCE INSTITUTION ( The typical client base of any micro finance institutions is poor people who do not have access to formal financial institutions. Microfinance clients are typically self-employed, micro entrepreneurs. In rural areas, they are usually farmers and others are engaged in small income generating activities such as food processing and petty trade. In the urban areas, microfinance activities are more diverse and include shopkeepers, services providers, artisans, street vendors etc. Microfinance clients are poor and vulnerable, non poor who have a relatively stable source of income that may include granting credit without interest and without repayment, potentially damaging the merging culture of credit in Rwanda. 26

41 2.7.1 CREDIT Credit borrowed fund with specific terms for repayment. When there are insufficient accumulated savings to finance business and when the return on borrowed funds exceeds the interest rate charged on the loan, it makes sense to borrow rather than postpone the business activity until sufficient savings can be accumulated. Credit should be based on the cash patterns of borrowers and designed as much as possible to enable the client to repay the loan without undue hardship. This helps the bank to avoid potential losses and encourage borrower to manage their funds prudently. The appropriate loan amount is dependent on the purpose of the loan and ability of the client to repay the loan. When determining the debt capacity, it is necessary to consider their cash flow as well as the degree of risk associated with this cash flow and other claims that may come before repayment of the loan. The willingness and ability of borrowers to repay may change after loans are made. This may be responsible for many loans which are not recovered. Moreover, non recovery may arise with some loans because of the inability of bankers to make proper credit analysis a hasty decision to lend without adequate information or failure on their part to accept the results of a credit analysis. The important thing to note is that banks can not grant loans and forget them because the necessity of their lending function is to be kept informed about loans outstanding so that the loan granted should be recovered and the situation proves the contrary, the cause should be identified and overcame CREDIT ANALYSIS The principle purpose of credit analysis is to determine the ability and willingness of a borrower to repay a request loan in accordance with the terms of the loan contract. A bank must determine the degree of risk involved. Moreover, if a loan is to be made it is necessary to determine the conditions and terms under which will be granted. 27

42 FACTORS TO CONSIDER IN CREDIT ANALYSIS(Tamar Midgal 2006 pp ) Bank credit agents in analyzing a loan request consider many factors. They are ingredients that determine the lending officer s ability and willingness to pay the obligation in accordance with the terms of the loan agreement. For many years agents considered only five C s but now they consider six C s by controlling the already existing factors and these are: CHARACTER In order to make payment the applicant must have both funds to pay as well as willingness to pay. The concept of character, as it relates to credit transactions means not only the willingness to repay debts but also the a desire to settle all obligations within the terms of the Contract(Edouard W. Reed and Edouard K. Gill pp83) The loan officer or credit analyst must be convinced that the customer has a well defined purpose of requesting bank credit and a serious intention to repay. For this purpose the credit analyst must investigate the history of the applicant with regards to the payments business the firm s operating records, labor relations experience in development and marketing of new products, sources of growth in sales earnings, nature and operating if the business types of products. This must be done through the contact with other banks with which the firm or an individual borrower has done business as well as its or his suppliers and customers. CAPACITY There are two dimensions of capacity; there is managerial capacity and plant capacity. Managerial capacity refers to the competence or ability of the potential applicant to make proper use of debt and to be in a position to repay the debt and pay interest while plant capacity tells us about the earning capacity of the potential applicant. Banks are interested not only in the borrower s ability to repay but also in his or her legal capacity to borrow. For the reasons mentioned above loan officer must be sure that the customer requesting credit has the authority to request a loan and the legal 28

43 standing to sign a loan agreement because a loan agreement signed unauthorized persons could prove to be uncollectible and therefore result in substantial losses for the bank. When loan is made to a minor, a parent, guardian or other person of legal age is usually asked to cosign the note. In lending to a partnership, it may be advisable to require that all members of the partnership sign for the loan. If that is not possible the lending officer should determine whether the signing partners have authority to borrow for the partnership. Then verified copy of the agreement or power of attorney may find it difficult to collect from non signing partnership if they establish that borrowed funds were not use to further the business of the partnership. In lending to corporation it is advisable to examine the character and bylaws to ascertain who has the authority to borrow on its behalf. In many cases, banks also follow the practice of requiring corporate resolution signed by members of the Board to have the authority and designing the person or persons who have the authority to negotiate for the loans and to execute borrowing instruments. CAPITAL Analysis of capital of an applicant refers to the analysis of financial position of potential customer, the credit agent must analyze the applicant s application forms, financial stability. The net worth of a firm or the capacity supplied by borrowers is one measure of its financial strength and it is one of the principle determinants of the amount of credit a bank is willing to make available to a business borrower. In general, borrowing customers only have three sources to draw upon to repay tier loans, cash flows, sales or liquidation of assets and funds raised by issuing debt or equity securities. Any of these sources may provide sufficient capacity to repay a bank loan. To assess the capital dimension the credit analyst considers the data obtained from the applicant s financial statements but the usual procedure is to perform extensive ratio analysis and it with the previous trends or records with the industry. 29

44 COLLATERAL The amount and quality of the assets held by a firm reflect the prudence resourcefulness if its management. Some of these assets may serve as security for a loan and thus insurance that the loan will be repaid or in case of bankruptcy the debt can be recovered by liquidating that security. Technology also plays an important role here as. If the borrower s assets are technologically obsolete. They will have limited value as collateral because of the difficult of converting those assets into cash if the borrower s income falters. CONDITIONS The general economic conditions of the industry of the applicant have the influence on the paying capacity. If the economy is in recession, failure is more likely. If the competition is tough possibility of default is high. Therefore before extending credit, the loan officer and credit analyst must also be aware of recent trends in the borrower s line of industry and how changing economic conditions most banks maintain files of information, newspapers, magazines articles and research reports on industries represented by major borrowing customers. CONTROL Control is additional factor assessing a borrower s creditworthiness which centers on such questions as whether changes in law and regulation could adversely affect the borrower and whether the loan request meets bank s and the regulatory authorities standards for loan quality THE LENDING PROCESS( Filling out a loan application Most banks loan individuals arise from a direct request from a customer who approaches a bank and asks to fill out a loan application. Business loan requests on the other hand often arise from contacts the bank s loan officers and sales representatives make as they solicit new accounts from firms operating in the bank s market area. 30

45 Sometimes loan officers will call on the same business firm for months before the customer finally agree to give the bank a try by report when they visit a potential new customer s place of business. This is updated after each subsequent visit giving the next loan officer crucial information about a prospective client before any other person contacts is made. SUBMISSION OF THE REQUIRED DOCUMENTS In case all is favorable to this point, the customer is asked to submit several crucial documents needed by the bank to fully evaluate the loan request, including complete financial statements and for a corporation board of directors resolution authorizing the negotiations of a loan with the bank. SITE VISIT Where a business or a mortgage loan is applied for, a site visit usually will be made by an officer of the bank to assess the customer s location and condition property and ask clarifying questions. The loan officer will contact other creditors who have previously loaned money to this customer to see that their experience has risen. The customer s previous payment records often reveals much about his or her character, sincerity of purpose, and sense of responsibility in making use of bank credit. FINANCIAL ANALYSIS (Windy Wilkins 2006 pp21-25) Once all documents are on file, the credit analysis division of the bank a thorough financial analysis of those documents aimed at determining whether customer has sufficient cash flow and backup assets to repay the loan. DECISION ON THE LOAN REQUEST The credit analysis division then prepares a brief summary and recommendation, which goes to the loan committee for approval. Members of credit analysis division will on larger loans give an oral presentation and discussion ensure between credit analysis and the loan committee over the strong and the weak points of the loan request. 31

46 CHECK ON COLLATERAL AND PREPARATION OF LOAN AGREEMENT After the approval of the customer s request the loan officer or credit committee usually will check on the property or other assets to be pledged as collateral in order to ensure that the bank has immediate access to the collateral or can acquire title to the property involved if the loan agreement is breached. This is often referred to as perfecting banks claim to collateral. Once the loan officer and the bank s loan committee are satisfied that both the loan and the proposed collateral are sound, the other documents that make up a loan agreement are prepared collateral and signed by all parties to the agreement MONITORING The loan agreement must be monitored continuously to ensure that the terms of the loan are being followed and that all required payments of principle and interest are being made as promised. For larger commercial loans, the loan officer will visit the customer may need if customer does encounter serious problems in repaying a loan, a workout plan must be developed that allows the bank to recover as high as proportion of its committed funds as possible. Other prefer to send all such problems to separate workout department, believing that this procedure brings more objectivity to the loan recovery process DEFAULT LOANS (Ledger wood, J 1999 pp59-62 ) Default is failure of the borrower to repay the principle and interest as agreed in the loan agreement. Both the value of payments in arrears and value of outstanding balance of loans in arrears refer to loans that have an amount that has come due and not been received. The value of payments in arrears includes only the amount that has come due and not been received while the value of outstanding balance of loans in arrears includes the total amount of loans outstanding, including the amount that has not yet become due of loan that have an amount in arrears. This is commonly referred to as the portfolio at risk. The term arrears means late payments overdue past due delinquent and default are often used interchangeably generally; loans that are in arrears, past due and overdue 32

47 have become due and have not been paid. These are also that the loan is delinquent when has an amount that is in arrears, past due, overdue and has not been paid. Loans are default is also referring to delinquent loans but most often to loans that have been or are about to be written off. Defaulted loans are also called such if there is little hope of ever receiving payment. Some financial institutions determine that a loan is delinquent if no payment was received on the due date. However, many loans are paid within few days of the due date and other financial institutions allow a short period for late payments and do not consider a loan delinquent until one or two weeks on payment periods have passed. Some financial institutions fail to consider the amount of time a loan is in arrears and base the like hood of default more on the term of loan in other words; a loan is reported as overdue when the loan term ends. Generally they should consider the entire outstanding amount as delinquent because this is the amount that is actually at risk, that is if the borrower has missed a payment, chances are he or she may miss more payments or will simply stop repaying the loan all together. A delinquent loan becomes a defaulted loan when the chances of recovery become minimal. Default loans result in loan write offs. Write offs should be considered after a certain period of time has passed and the loan has not been repaid. The decision to write off a loan and timing of doing so are based on the policies of the institution. Some financial institutions choose to write off loans relatively quickly so that their balance sheets do not reflect basically worthless assets. Others choose not to write off loans as there is a remote possibility of collecting the quality of the loan portfolio. Managers can determine what percentage of the loan is likely to default based on analysis of the quality of the loan portfolio. To reflect this risk and the corresponding 33

48 true value of the loan portfolio accurately it is necessary to create a balance sheet account called the loan loss reserve. LOAN LOSS RESERVE A loan loss reserve is an account that represents the amount of outstanding principle that is not expected to be recovered. It is the amount reserved to cover losses of the loan portfolio. The loan loss reserves reduce the net portfolio outstanding amount of the loan reserve should be based on historical information regarding loans defaults and the amount of time loans have been delinquent. To determine an adequate loan loss reserve an aging analysis should be performed periodically. Aging analysis refer simply to the classification of delinquent loans into the periods of time that they have been in arrears and the choice of aging category depends on the frequency of payments and the loan terms. LOAN LOSS PROVISION (BNR 2005 pp33-37) Loan loss provision is the amount expensed a period to increase the loan loss reserve to an adequate level to cover expected defaults of the loan portfolio. It is based on the difference between the required loan loss reserve and the current outstanding loan loss reserve. WRITE-OFF Write offs are only an accounting entry; they do not mean that the loan recovery should not continue to be pursued if it makes economic sense. Once it has been determined that the likelihood of a particular loan being repaid is remote(borrower has died, left the area, simply will not pay) a write off occurs. Writing off a loan mean the institution has replenished its legal claim to cover the loan. Write offs reduce the loan loss reserve the outstanding loan portfolio by equal amounts. If the loan that was previously written off is recovered, then full amount recovered is recorded as revenue. This is because the principle amount written off was recorded as an expensive, and therefore, if recovered it is as revenue not as decreased in outstanding loan portfolio. 34

49 2.7.4 CAUSES OF DEFAULT LOANS(Dunn, E. and Arbuckle JG 2001 PP5-7 ) Loan problems and loses are results of many factors, they are basically the result of unwillingness of the borrowers to repay the loan or of their inability to realize sufficient income to reduce or to repay loans as agreed. Many lenders including some commercial banks insist that only an infinite small percentage of borrowers become unwilling to repay obligations once loans are granted. They contend that most loans are entered into in good faith and with good intentions. The unwillingness to pay varies with the economic fortunes of some borrowers. In the periods of prosperity, the willingness to repay is greater than the periods of adversity. Unwillingness to repay is closely associated with economic depression, periods of unemployment and declining profits. It is during such periods that credit character is placed under severe strain. It seems that the major reason by far for problem loans and possible losses in the inability of borrowers to realize income from normal business operations, employment or the sale of the assets INDICATORS OF DEFAULT LOANS (FP JOHNSON and RD Johnson.) Early detection of loan problem increases the possibility that the loan will be repaid. The longer a loan goes undetected the more difficult it becomes to resolve. Certain early warning signs should indicate to the loan officer that problems exist or are about to develop. According to Smith indicators are: Delayed submission of financial statements. Slowness in the ability to arrange plant visit and deterioration in the report that has existed between the personnel of the bank and the borrower, deterioration in the atmosphere of mutual trust and confidence.change or resignation of key personnel, employees problem and change in social behavior. Natural disasters such as flood, fire and unfavorable weather conditions A recession in economy Marital problems especially divorce Illness or death of principal Slow or delinquent loan repayment to the bank 35

50 2.7.6 MANAGEMENT AND CONTROL OF POTENTIAL LOAN LOSSES(Dunn, E and Arbuckle JG 2001 PP11-14) It is said that banks never make bad loans; at least they are not bad at the time they are made. However, banks find that invariably a small portion of their loans become delinquent and eventually must be written off. The loan review process is therefore a crucial tool in reducing losses and in monitoring loan quality. It consists of a periodic audit of ongoing performance of some or all the active loans in a bank loan portfolio. Frank Johnson observer the loan review serves to detect, as early as possible credit weakness, documentation discrepancies and violation of lending regulation and policies and to initiate prompt corrective action. It also involves classifying loans according to quality. Loans fall into certain classes require continual monitoring and follow- up whereas other require only minimal monitoring. The grading process in ongoing activity over life of loan and changing conditions force continual review. They also added that the loan review might be conducted on priority basis and as a result of focusing on these loans; certain are placed on a watch loan list. The list may include loans so classified by regulatory examiners or internal examiners loans that have been place on non accruing status, loans whose principle and interest payments are past due 15 days or more and those loans deserve special attention because of other possible weakness. The procedure of loan review should be set forth in the loan policy. In general all the material needed for loan review should be in the credit files set up for each loan made. The scope of banks loan review operations depends on the size of the bank. Some large banks establish loan review staff directly under executive management to ensure its independence from bank personnel. While medium size banks tend to make review operations an additional duty of credit department or assign it to their audit department. The smallest banks often do not have a loan program or they depend on loan officers to conduct the loan review as their time permits. But loan officers should not review their own loans because he/she cannot review his/her work. 36

51 BASIC POINTS INLOAN REVIEW PROCESS Financial condition and repayment ability of the borrower Perfection of security interest Apparent profitability Completeness of documentation PREVENTION OF PROBLEM LOANS AND LOSS(Smith and AI. New Jersey 1984 pp16-19) Because of the costs involved in supervision and collection as well as the impact of losses that should occur on their financial structure, that s why as soon as it is evident that a borrower has encountered a problem in repayment steps and measures to correct and protect the banks interests are taken. One of the following steps or combination might be taken to rescue the borrower and restore financial shape: Reduction of expansion plans When expansion plans are on the drawing board, the borrower might be advised to drop them if possible until the firm has improved its financial position. Such plans might be diverting needed funds from current operations. Encourage the collection of slow receivables Encouraging an improvement in the collection program might do this and the addition of personnel specialized in this area. It might also involve an examination of credit policy of the firm. 37

52 Improve inventory control It is usual for some business to have excess inventories sometime during the business cycle. The firm might be encouraged to offer some items at a discount and thus increase sales. This would increase the cash flow and place the firm in a position to meet its loan payments. Obtaining additional collateral Although the borrower may be skeptical of this move, it may be advantageous to both parties. The bank is less likely to call the loan and in fact may be in a better position to restructure the loan and thus make it easier for the borrower to make repayment and this is advantageous also to the bank because their financial position is strengthened. Obtaining guarantees If the borrower cannot raise additional funds, guarantee from a major stockholder a supplier or a purchaser of the final product might be possible. Debt restructuring The bank might restructure the loan by lengthening its maturity and reducing the monthly payments or even eliminate principle payments for period of time. The bank may also recommend a long term lender or participate with another lender and thus reduce its risk. MERGER The bank might encourage the borrower to merge with another. This would be recommended only after careful study and evaluation of all the influencing factors. If the business is single proprietorship then a partnership might be suggested HANDLING DEFAULT LOANS(Smith and A1. New Jersey pp23-30) The initial steps involved identifying the cause of customer difficult. If the customer is cooperative, the officer may take a wait and see attitude and closely monitor progress. However the progress is not forthcoming the officer must take aggressive actions. 38

53 LIQUIDATION (Tamsin Wilson March 2002 pp61) Liquidation is the process of forcing the borrower to comply with the terms of loan contract and is employing and exhausting every legal means to accomplish this objective. It becomes obvious to as bank that a workout arrangement is not feasible, liquidation which may take one of several forms may be decided upon as the best way of handling a loan that has become a collection problem. When this method is selected it means that the bank has decided after careful weighing all of the factors mentioned that the possibility of the borrower improving his/her financial condition is remote that an extension of the loan contract or advancement of addition funds be hazardous and that the bank will recoup a larger percentage of the funds advanced by this move than by other. Liquidation in many cases is pursued only after a workout arrangement of form has been tried but has proved successful. Liquidation is usually entered into quickly only in those cases where the unwillingness to repay is obvious fraud or some dishonest act has been detected, an act of bankruptcy has been committed, the financial condition of the borrower is hopeless or the will to repay is not present. Furthermore, there are several ways of carrying out liquidation. Banks personnel may do it with help of the banks legal counsel or the department that is concerned with problem loans, which is found in larger banks and has personnel or the staff with expertise in this area. Another method is to sell the company as a going concern. If this is not possible a bulk sale of certain assets or piecemeal liquidation may follow. The liquidation process is lengthy and the important consideration in liquidation is that the bank gains control of the assets to ensure that the sale proceeds will be used to liquidate debt. Legal remedies( In this case the bank decided to use every legal means to collect on unsecured loan, a judgment would be secured from a proper court. This would permit the seizing and selling of a property belonging to the holder to the debtor in the amount sufficient to satisfy the borrower or the garnishment is not entirely satisfactory arrangements, the 39

54 employer does not welcome the role of collector and the employee may lose his or her consequently and this process may be futile. Although the borrower haven t sufficient assets to pay the indebtedness at the time of foreclosure the judgment is a recorded claim that must be paid in the event sufficient assets are ever accumulated. If the bank is one of number of creditors, all of which want their money and are in as strong as relative position as the bank, a creditor committee may be formed. In addition, if a bank calls a loan, it has several rights that it may exercise. The right to set off allows the bank to use the borrowers deposits to satisfy a loan obligation to the extent that security instrument are perfected accounts received of the borrowers may be directed to the bank rather than to the borrower. The account of debtors must be notified. Sometimes the debtor requires written authorization from the borrower before turning over payments directly to the bank. Inventory, plant and equipment may be seized under the provisions of the uniform commercial code. Importantly the decision to seize these should be made when the company is shut down or the lender is prepared to liquidate the company. A WORK OUT(Smith and A1 New Jersey pp40) This is the process of working with the borrower until the loan is repaid in part or in full and not relying on the legal means to enforce collection. When bank borrowers are financially embarrassed, bank can afford to and usually do enter into a work out arrangement assuming the course that the borrower is honest and his or her attitude towards the debt and repayment is satisfactory. This is possible when the borrower has a sizeable equity in the business, some valuable fixed assets, and an organization that is capable of creating income sufficient in amount to repay the loans that are questionable, as well as other loans that may be necessary to keep the firm in the business and has indicated in the past evidence of sound management. In addition most loans that become a problem in commercial banks are handled on a workout basis that is borrowers are permitted to work out of their financial problems 40

55 difficulties and repay their obligations to the bank as possible. For the productive loans, such as business and agricultural the payment on the loans should not be sufficient size to reduce the borrower s ability to create income. In the consumer loans the payments should not be so larger that the borrower s productive efficiency would be impaired. Figuratively speaking, the borrower should not dispossessed and thrown into street. In a sense, the work out method of handling problem loans might be described as a rehabilitation or austerity program imposed upon borrowers with their consent and cooperation. Since work out arrangement is not a legal device it may take several forms may vary from one loan to another. The bank pays by year and adopts a program that best suits a particular situation. REHABILITATION(Joanna ledger wood 1999 pp ) This is the transformation of weak company into stronger one, with loan performance being the end product. Rehabilitation involves significant time and effort. The decision to rehabilitate must take into consideration how involved the bank will be as well as costs and benefits. Another consideration is that the bank may not have sufficient qualified personnel to assign to a rehabilitation effort. An alternative is to bring in a management consultant to assist. This process may involve: Reduce every expensive possible Analyze debt structure and plan cash flow to service debt. This may involve postponing payments and gaining the cooperation of other creditors. Seek additional equity capital Reduce inventory and analyze accounts receivables regarding collection Find a merger or purchase candidate The rehabilitation might also involve modification ot terms of the loan or debt restructuring or modification of terms if two positive factors exist. 41

56 There must be a market for the customer s product or service. There must be sufficient amount or numbers of viable assets to work with in liquidating the borrowers various liabilities. If the lender has confidence in the lender s integrity and long viability a restructuring or modification can be acceptable. A moratorium in principle and interests, may assist the borrower in overcoming a short-cash flow problem. A more definite arrangement may include the lengthening of the repayment schedule converting from a full amortization loan to one with a substantial balloon payment at the end of the original term, obtaining guarantors taking a lien or additional collateral or converting from a non recourse to a recourse obligation. The important consideration is that the lender maintains the continuity of security interest and liens granted and perfect before the date of the modification. Another alternative is to consider consolidation the borrower s debt to concentrate cash flow to the overall reduction of debt CONCLUSION In Rwanda, little has so far been written on MF in general and on their interest rates in particular. It is evident that this is an area to be studied if MF is a strategy to be relied upon as an economic development strategy to achieve vision 2020 for Rwanda and the MDG goals. There is need to fill the knowledge gap regarding; what factors influence interest rates charged by MFIs in Rwanda, how high the interest rates are by establishing whether or not they are determined by market forces and how high they should be. In order to answer those questions, it is important to conduct a research using a suitable research design and methodology. This study attempts to fill this knowledge gap. The researcher used a qualitative research methodology to interview MF regulators and policy level implementers who have expert knowledge and experience. 42

57 CHAPTER THREE: 3.0 METHODOLOGY 3.1 Introduction Research methodology is the science of how to make a research decision and it includes the practice of evaluating the positive or negative impact on decision made in the course of doing research. It has been observed that research is of extensive use of a manager or organization in planning, coordinating, motivating and controlling and forecasting and decision making etc. The research methodology includes design method and techniques of data collections used in conducting the research study. It facilitates the process of thinking, analyzing, evaluation and interpretation of the data obtained from the field. The researcher first read background information from books, some published and un published articles on MF and interest rates and from the monetary policy of the BNR(The Governor, BNR, February 2007, Kigali)issued in February 2007 and from the policy on MF in Rwanda published in 2006(MINECOFIN). From the literature review, a good understanding of the macroeconomic, environmental and other independent variables influencing interest rates were reviewed. On the basis of the above background, it was possible to identify the right questions to ask and relevant interviewees, and also to prepare for the right analysis in order to adequately achieve the research objective. Managers of a few MFIs were sampled as key informants and their responses recorded descriptively. Also interviews with a senior official of the Central Bank and one commercial bank were requested. In addition, three money lenders were carefully sampled. Sampling was purposeful because the interviewees are experts and experienced in this specific field of study, both as regulators or policy implementers. Their responses included views regarding contextual analysis of the prevailing situation. A qualitative approach was applied using open ended one on-one in-depth interviews to get a deep understanding of interest rates and MFIs. Questions were formulated and 43

58 asked to seek answers on the issues in question. Other questions would arise from the discussions during the interviews. This enabled the researcher to get in depth understanding of the factors that affect interest rates charged by MF. The one-on-one method also enabled the researcher to observe the attitude and ease with which key informants responded to the questions. However, no audio recording was done. Two note books were used to write down responses from the experts. Collected information was categorized into recurrent themes which were later analyzed for consistency and divergence of opinions. The identified themes will be discussed under different sub sections in chapter four. 3.2 Research Design This research is an analytical case study, aimed at analyzing and explaining the causes and impacts of credit non recovery to MFIs in Rwanda. However due to limited time and funds, a case study approach was used in carrying out research in Vision Finance Company microfinance as a case study. 3.3 Target Population The population taken was 8 Microfinance institutions based in Kigali but due to time and financial shortages the employees and clients of Vision Finance Company were considered as population of the study because Vision Finance Company microfinance is not highly computerized among other microfinance institutions. 3.4 Sampling Strategies Due to limited resources in terms of money and time it would be impossible to make a study of the whole population. Sample as a small group of cases drawn from and used to represent some larger group thus a sample was selected from the population from Vision Finance Company and this helped the researcher to obtain the reliable information needed. 44

59 Purposive sampling technique: This is a method of sampling where by the researcher used his or her own judgment about which respondents to choose who best meet the purpose of the study. Purposive sampling was used in the sample selection in order to enable the researcher pick respondents who meet the purpose of the study. Therefore the respondents were selected basing on their knowledge and experience of the phenomenon under study. Example cashiers and cleaners did not meet this criterion but management and credit department met the purpose of the study. 3.5 Data Collection methods Both primary and secondary data will be gathered Primary data The primary data are those which are collected for the first time and happen to be origin in character. This is collected either by the researcher or someone else for the purpose of the study. Primary data was collected using interviews, questionnaires and direct observation. Interview Interview is regarded as purposeful observation between the researcher and the respondent and its aim is to get accurate information from the respondent. There are two types of interview namely: structure and unstructured interview. The structure interview is where the researcher prepares and types the questions to be asked and reserves the space where answers are recorded. The structured interview was prepared for the bank manager of Vision Finance Company, the interview questions were prepared in English but translation in any language was done where necessary to facilitate communication between the researcher and the respondents. 45

60 Questionnaire The questionnaires were used to collect data from Vision Finance Company microfinance staff and clients. There are two types of questionnaires: structures and unstructured questionnaires. Unstructured questionnaire is one made of multiple choice questions while structured questionnaire is one made of questions with specific answers or reserves the space to answer in or both. Both open- ended and closed ended questions were applied. The questionnaires were detailed in English but translated in Kinyarwanda for easy understanding. Direct observation In this method, the researcher went on the field to see whether what he was told is in existence, to prove out what he may have heard from the respondents. It was an advantage to this study as the researcher collected first hand data. It also helped the researcher to get data from people who cannot reveal detailed information but can show really what is on the ground. 3.6 Data Collection Instruments Secondary data The secondary data for the present study was required in case where the primary data could not explain better or give adequate information on the variables under the study included published, unpublished and printed sources mostly quantitative nature. Documentation: Documents were reviewed to obtain secondary data information. This include the review of published and unpublished documents report from microfinance institutions alliance, libraries were closely consulted for different books and other publications for obtaining secondary data information. 46

61 Desktop research: The desktop research includes a review of documents obtained from the internet since MFIs are worldwide and the alliance owns an efficient website, much of the information pertaining to the MFIs was obtained from the website 3.7 Data Quality Control Interpretation means explanation of findings; here it involved drawing inferences from analysis of data. In order to get quality information, there was a need for standard checking so that the research ends up with realistic data, which clearly reflect the situation. Standard checking was done up with through edition, coding and tabulating. 3.8 Administration Procedure The procedure involved preparing the proposal and its defense, the researcher sort permission from school of post graduate studies to continue with the study. Then the proposal was approved and research went ahead until the final process of submitting the report. 3.9 Data Analysis Data processing Data collected were analyzed and interpreted in reference to the established objectives. Then, the results were presented in the form of tables and texts. When data is processed, the relevant data to the objectives of the study was considered and transformed into meaningful information for interpretation and understanding. 47

62 3.10 Limitations of the study The main problems faced by the researcher were: Some respondents were suspicious about the study and were reluctant to give the needed information. Others completely refused to respond some of the questions. The researcher managed to interpret the data obtained to reach the objective of the study. It had taken long to reach staff in order to respond to interview questions which caused delays in the completion of this work the research had to work under pressure in order to complete this study. Limited access to reports and financial statements which delayed the researcher in the completion of this work. In as far as literature review is concerned unavailability of the books in KIU library, particularly in the of banking and financial institutions which significantly hindered the research work but the researcher consulted internet in order to obtain information. 48

63 CHAPTER FOUR 4.0 DATA PRESENTATION OF RESULTS, ANALYSIS AND INTERPRETATION 4.1 Introduction In this chapter the researcher used the data collected, transforming it into some useful, clear and understandable patterns. The whole exercise involved editing, tabulation and analyzing the data statistically to enable the researcher draw conclusions in relation to the study problem. Presentation was made in form of figures, charts and tables. 4.2 MFI INTEREST RATE CHARGES IN RWANDA Table 4.1 shows that the range of annual interest rates of MFIs in Rwanda lie between 13% and 48%. These interest rates favorably compare with what was seen earlier in Asia (Table 2.1). However, what is not revealed by the interest rate is whether they are charged on a flat rate or on declining balance, which have implications on annualized interest rates. It is also not indicated whether the recovery is monthly, weekly, or fortnightly which all translate into different interest rate implications. As regards how the interest rates are fixed, there is no doubt among the interviewees that the MFIs fix the interest rates though their own market forces decision process. The other revelation from the interviewees was that in Rwanda, the interest rate is stable. 49

64 Table 4.1: Interest rates of MFIs in Rwanda Name of MFI Rate of Interest POPULAR BANK OF RWANDA 13-15% UBAKA 24% UMUTANGUHA % ZIGAMA-BICUMBI 16% INKINGI 18-27% SAVINGS AND CREDIT COOPERATIVES 13-20% UNGUKA % CEFE SA-AGASEKE 14-24% VISION FINACE COMPANT 15-20% URWEGO OPPORTUNITY BANK 36% ZIGAMA-CREDIT SAVINGS SOCIETY 13-16% Source: Capmer.org/new/docs/les conditions de credit au Rwanda. PDF; 4.3 THE IMPORTANCE OF UNIT COST OF LENDING All of the respondents interviewed concur on the fact that the cost of doing business in Rwanda is high which raises operating costs. All respondents attribute the high costs on high product and factor prices reflected mainly by high fuel, labor and other overhead costs which help explain the high interest rates. In addition, infrastructure and other fixed costs are high. Rwanda being a land locked poor country, is a net importer of equipment across many boarders and long distances which raises fixed overheads. The unit cost of lending incurred by MFIs remains the single most important factor that explains the high interest rate charged by MFIs to their clients. They further reveal that since the main revenue of MFIs comprises mainly operating interest income, cost recovery pushes interest rates high. This is especially because the cost of lending is spread over many but low value operations. The main driver of interest rates in Rwanda remains operating costs. According to the MFI managers interviewed therefore, if costs were lower, the interest rates would also be lower. However, it is important to note that overall operating costs and expenses paid by MFIs are relatively much lower than those paid by commercial banks. Commercial banks are able to have their interest rates down 50

65 because they distribute their revenue beyond interest income alone to include fees, commissions and other non interest income. They also spread interest over a few high value operations which lower the unit cost of lending. Table 4.2: Comparative interest rates in Rwanda Nature of Institution Commercial Banks MFIs Informal Lenders Annual Interest rate 15-19% 13-48% % charged Source: From primary data. Table4.2 shows that in Rwanda, some MFIs can sometimes charge interest rates lower that commercial banks. These are cases when government specifies loan products which it fully guarantees or sometimes subsidizes. Products which have so far been offered on such terms have been agricultural or animal husbandry related. Table 4.3: Interest rates for Agriculture Projects in Rwanda Serial Number Name of Institution Interest rate 1 Bank of Kigali 12-17% 2 Rwanda Commercial Bank 13-16% 3 Bank of Commerce and Development 7-14% 4 Insurance Company Bank 13-16% 5 Rwanda Development Bank 11-13% 6 Zigama-Credit Savings Society 13-16% 7 Cooperative Savings Society 13-15% Source: BNR(2005) Only the last two institutions in table 4.3 are MFIs while the rest are commercial banks and one of them a Development Bank. Table 4.3 also shows that some MFIs charge interest rates lower than some Commercial Banks. However, some of the interest rates charged do not reflect real interest rates considering both the macroeconomic variables at play such as inflation but also the real cost of Capital. Even in such cases, there is no indication that the BNR interferes with the respective MFIs in determining the final interest rate on their respective products. As regards the influence of the subsidy on 51

66 interest rate, the fact is that risk is fully covered by BNR and that is why the interest rate is low. The shortcoming reported by the managers of MFIs has been that the subsidized interest rate ends up hurting the other related products offered by the MFIs especially because the subsidized or guaranteed funds are neither adequate nor available in a sustainable way. The researcher did not establish the impact of the subsidy on the client market. The high interest rate charged by MFIs in Rwanda does not result into high returns to the MFIs. If this was the case, it would translate into profits with the business becoming attractive, since there are neither restrictive controls on entry nor interest rate ceilings. The nature of small sized loan or deposit products and their distribution over wide geographical area makes the unit costs of lending high and when factored in the price of the financial service results into high interest rates but not high profits. Moreover, the small sized loans to poor people earn small margins. 4.4 LIMITED SOURCES OF FUNDS FOR ON-LENDING All the respondents from VFC interviewed by the researcher revealed that they have two main sources of finance for lending to their clients. These sources comprise equity and deposits. None of the managers interviewed mentioned borrowing as one of the sources of funding to the VFC. Its that as a result of limited sources their ability to withstand client demand is limited. According to the BNR, this is the main reason why they raised capitalization of the MFIs from frw100 million to frw300 million in order to finance more client projects and on a long term basis. the Central bank has also opened the external financing for residents and will soon operationalize the capital markets to open more opportunities for investment finance(no.06/2002, Kigali,BNR). Limited sources of financing for the MFIs in Rwanda are an indication of a young financial sector with no capital markets in place yet, and the scope of internal sources of funds for on-lending remains limited. VFC largely depend on donor equity finance, whose sustainability depends largely on their financial strength and the focus those donors will continue to put on Rwanda. 52

67 Limited supply of funds implies that the cost of borrowing remains high. More sources of funds would force down the cost of borrowing and therefore, interest rates. The VFC officials the researcher interviewed attribute their low rates of interest to deposits from members which lowers cost of borrowing. For a VFC to take deposits, however, it must be regulated and supervised. Such VFC is required to have a safe, secure, accessible and convenient place fit for the purpose of keeping the savings. Because savings offer cheap sources of funds, this implies also that with a lower cost of funds, operational and financial sustainability can be achieved at a lower interest rate. So far, no dividends have been paid or are even anticipated in the near future for VFC company. Cheap funds which are easily accessible are critical for realizing low and stable interest rates. However, with a low interest rate paid on deposits of between 4-7% by VFC, the potential to attract savings on a sustainable basis remains limited and therefore is counterproductive in the long run. This rate is lower than the rate of inflation which is reported at between 7.8%-12.4% in the years between 2004 and Moreover, in Rwanda, revenue on deposits is taxed at 15% per annum, which implies that deposits earn a negative nominal and real return. This poses a risk of undermining sustainability. However, Rutherford, Stuart, (2003 pp58) argues that even with a negative return, some savers are willing to continue saving if they get a safe place where to save and are prepared to pay for it because it is difficult to save at home. Table:4.4 Inflation rate Rwanda Year Annual average inflation rate Source: BNR(2007) 12.4% 7.8% 10.2% With a high Central bank base rate of % and interbank rate of % (source :BNR 2007), the market sources of financing are at high rates, if the MFIs were to borrow from the market sources. With an economy which is largely subsistence and a population with low incomes, few would probably afford to borrow at much higher rates(no.06/2002, Kigali, BNR). 53

68 Table 4.5: Trends of deposits and credits of one MFI in Rwanda. Year 1975 million 1980 million 1990 million 2000 million 2007 million frw frw frw frw frw Amount of ,351 11,509 51,289 deposits Amount of ,6736 6,679 51,293 credits Source: Primary data Table4.5 shows that the growth of both deposits and credits of one of the MFIs in Rwanda which depicts enormous growth rate, just as was indicated by all the MFIs visited by the researcher. The number of borrowers has increased from 3 in 1975 to 81,777 in 2007 while the number of depositors has increased from 2,016 in 1975 to 589,089 members in It was not possible to get any indication as to who of the depositors receive interest on savings and those who do not. Being a SACCO, the depositors are cooperative members whose only benefit may be limited to borrowing. The Government has recently decided to sell 35% of the ownership of that MFI to Ribbon, a European bank to form a joint venture commercial bank which will continue to offer MF services. The aim of the sale is to enhance its operational effectiveness, efficiency and its profitability. The new venture is expected to be operational by the beginning of Interviews with officials of another MFI show enormous growth of loan portfolio from 5.3 billion frw in 2003 to 13.2 billion frw in 2006 while deposits grew from 8.7 billion frw in 2003 to 16 billion frw in The figures another MFI which the researcher saw were only for a short period but the potential for growth over three months from January to March 2006 registered a growth rate of about 2.5% on their loan portfolio. The above findings indicate three important points. The first revelation is that the poor are in need of financial services explained by the existence of a high market potential. The second revelation is that the poor are willing and able to pay for financial services. 54

69 Consistent growth of both deposits and credit over the years is a clear indication that there is both willingness and ability on part of the clients of MFIs to pay for services offered. This also implies that the MFIs register portfolio growth with old clients, paying off old loan cycles and operating new and larger amounts for successive cycles and for new products. It also clearly shows that there is opportunity for new MFIs because the industry is growing. The third revelation is that demand is still far from being satisfied; on the part of the MFIs a young industry is evident which is characterized by few operators, inexperienced management, low level of operation and a market in which business opportunities still exist with demand generally still greater than supply. A young industry also means high operating costs and therefore, high interest rates. Although the industry is young, MFIs do not enjoy a monopoly. Another piece of evidence that suggests a young MF industry in Rwanda is when eight MFIs collapsed in 2006 soon after they got started. The main reason for their collapse according to the Central bank was because the MF investors went into a delicate industry without adequate preparation, resources, and know how. What the BNR did was to liquidate them. The managers of MFIs need experience in planning, investment and management. The financial business is a highly sensitive industry that requires both business and financial know-how. Only a few MFIs are resourced with experienced managers, yet it is a requirement to understand the factors that affect the MFI s efficiency in their day-to-day decision making which in turn affects interest rates since they affect how high or low the costs will be. MFIs must also be able to face the challenges of competition through design of the right products, the right prices, and appreciate the quality aspects of the industry. Competition affects not only survival of the MFIs, but also the level of interest rate in the short line and long run (Porteus, David: 2006 pp1). Although the researcher did not interview any borrowers, there is need for them to understand how markets function, how to keep business records, how to record and track their costs an how to integrate interest rates in their product prices. Only when borrowers are able to recover their costs and pay back to the MFIs, can the MFIs also 55

70 make profits and be sustainable. With more experience among MF practitioners, borrowers and regulators, more and better technical and market knowledge will be accumulated which will inevitably lead to better product and pricing techniques and consequently, improve the interest rates. 4.5 THE IMPORTANCE OF RISK ASSESSMENT VFC is regulated and required to attain certain operational benchmarks or be penalized by the Central Bank. The main reason for the benchmarks is to reduce the level of risk and to protect depositors savings. The Central Bank has the responsibility to protect borrowers. The VFC interviewees were concerned with the risks relating to borrowers who may eventually default. They explained that this credit risk is caused by two main factors; firstly, money being fungible implies that borrowers may divert money borrowed for enterprises to other social needs and consequently fail to pay (Wright, A. Graham, et al., 2000 pp2). This means that the loan loss will be high and the interest rate will be pushed high. The risk of loan loss occupies special significance because it affects both the numerator and the denominator in the interest rate formula shown above. Of course some borrowers default especially when the loan amount is big for them, when the borrower diverts a big portion of the loan to unproductive uses or when he or she is simply unwilling to pay. The second manifestation of the credit risk for the VFC arises from trying new clients who have never been exposed to financial services before, and have no culture of paying for them. According to the VFC interviewees, trust is built slowly when the borrower repays the principal and interest of the first loan which implies that on the second cycle, it follows that some trust has accumulated and dealings therefore, are much easier both for the client and for the VFC. However, literature reveals that from the perspective of the depositors, trust may be accumulated when the deposits are left with the VFC; which should also pass the test of access, safety, security, and convenience to the depositors. When this is done on as sustainable basis, it is expected to attract new and more deposits just as when the lending is responsive and convenient to the needs of borrowers. In general therefore, high risk increases cost of funds and lower risks reduce it which directly influences interest rate determination by VFC. On the part of clients of the VFC, trust increases the scale of 56

71 operations as MFIs attract more clients which results into economies of scale that lowers costs of lending and results into lower interest rates. 4.6 THE ROLES OF GOVERNMENT AND THE CENTRAL BANK VFC has been supported by the government through the MINICOFIN and BNR in creating an enabling environment legally, economically and in building institutional strength of VFC. For example legislation of five years of tax relief to VFC after registration implies that VFC can plough back profits as equity if they wish, bringing cost of funds down and consequently, interest rates. However, two of the VFC managers interviewed complained that taxes imposed on upcountry branches by local governments on monthly and annual basis are considered high which eats away their profits. Other examples of support highlighted which are offered to VFC include training for capacity building programs promoted by government through BNR. The interviewees also added that the Government has established guarantee funds especially to benefit Agriculture and the Trade sectors although VFC have not shown enthusiasm in taking advantage of them. When the VFC managers were asked why, their response was that those funds carry with them conditions which are not attractive to VFC, for instance, pressure on MFIs benefiting from those funds not to charge high interest rate to the clients borrowing those specific funds. In a bid to raise capitalization, the BNR raised minimum capital requirements for MFIs registered as private companies from 100 million frw to 300 million frw. This raises equity and provides financing on a more long term nature. In another direct intervention, in 2006, when the eight MFIs collapsed because they failed to manage the assets of their respective institutions. The Government through the Central Bank started the process to liquidate them by appointing a commission to implement the liquidation. In the meantime, it was decided to refund 50% of clients deposits while that commission was charged to recover the remaining 50%. If the BNR had not reacted fast, the collapse of those MFIs risked threatening the stability of all new MFIs in a temporary way. According to the VFC interviewees, this gesture was appreciated by all MFIs because it strongly contributed in enhancing trust in the MF industry as a whole. Another example given by the central bank in the way the government has strengthened its role in the financial sector is its attempt to diversify sources by fostering the development of 57

72 capital markets as one of the incentives to attract domestic savings for financing long term investments. The formation of capital markets and bond market are in advanced stages and with these additional sources of financing, it is envisaged, supply of funds will increase which will consequently lower costs of borrowing. Furthermore, the central bank has been given responsibility of regulating and supervising non-bank financial services including insurance companies, private and public pension funds and mutual investment funds which have hitherto, not been under the regulation and supervision of BNR. This will improve diversification and increase reliability of sources of funds and consequently reduce the cost of borrowing. The central bank intends to develop framework to reduce transaction costs associated with payment systems through a modernization program and use of ICT. In this respect, it has started the process of establishing a national payment council to coordinate development of actions related to payments and other convenient forms of payments. Cash payment operations will be limited to amounts not exceeding US $20,000. This has the effect of indirectly increasing money supply which is expected to contribute to a decrease of interest rates. The BNR regularly (normally quarterly), publishes average monthly interest rates in the macroeconomic monetary policy framework. Although this is relevant mainly to Commercial Banks, its influence extends to the MFIs because it sets a base for the overall cost of funds. Interviews also revealed that BNR, in its regular reports submitted by MFIs and through routine reviews by BNR staff, makes validation checks on a number of performance standards with specific ratios; on liquidity, solvency, delinquency and different aspects of risk exposure. Different administrative controls are also obligated regarding internal controls, financial reporting, conflict of interest guidelines and other prohibitions. Other initiatives the central bank is considering include authorizing capital account operations by residents transacting in foreign currencies and in foreign markets with a ceiling benchmarked by LIBOR and a marked-up margin to be developed by BNR. This is a form of interest rate which may attract funds from the foreign sources, which increases local money supply. The central bank also hopes to manage the high indebtedness facing the banking system by redirecting it to productive investments. This action is hoped to discourage 58

73 inflation and encouraging lending which impacts positively on the interest rate from the lenders perspective. The Managers interviewed revealed that BNR is strict in implementing MFI instruction No 06/2002 and SACCO instruction No 05/2003, which is close to a duplicate of the earlier instruction. These two instructions establish control rules of practice for SACCOs and MFIs. Furthermore, they establish benchmarks or standards against which good performance will be measured. Both instructions ensure that the assets of the MFIs are protected and management and operational risks are minimized. All the roles and initiative above contribute to increase money supply, improve diversification and reliability of sources of funds, reduce financial rigidities and are intended to lower transaction costs, which lead to lowering the cost of lending and therefore interest rates. 4.7 DATA INTERPRETATION This chapter is primarily intended to present findings using tables, graphs as to facilitate their analysis, interpretation and discussion. It also presents two different but interrelated data sources (primary and secondary data). It has been necessary to combine both in order to present strong information and in addition they support each other in analysis and interpretation Primary data Questionnaire Table 4.6: Education level analysis Educational level analysis Number of respondents Percentage None 20 50% Primary 10 25% 3 years post primary 10 25% Secondary and above 0 0% Total % Source: Field Work 59

74 The table above shows us that 25% of respondents have primary education level, 25% represents respondents who do not have secondary and above level education. The reason for the 50% of the respondents to have no level of education is due to the fact that developing countries especially sub- Saharan countries are characterized by low education level due to many factors but mostly poverty. For the case of Rwanda culture contributed to the Rwandan illiteracy. Table 4.7: Analysis of clients with credits Credit Number of respondents Percentage Never % Annually % Quarterly 0 0% Twice a year 0 0% Once a month 0 0% Total % Source: Field Work The table above shows us that 62.5% of the respondents have got credit from the company and 37.5% of respondents have not got credit. Therefore 37.5% of the clients have not obtained credits because for client to acquire a credit needs to be a member of the microfinance for three months and others do not fulfill credit requirement laid down in the microfinance lending policy. 60

75 Table 4.8: analysis of credit management literacy Credit management training Number of respondents Percentage Strongly agreed 0 0% Agreed 0 0% Neutral 0 0% Disagreed % Total % Source: Field Work From the table above it is shown that 100% of respondents have not been trained in credit management literacy. Therefore, the lack of credit management literacy may result into misuse of the borrowed money which in return leads to loans default. Table 4.9: Analysis of economic activities of clients Activity Number of respondents Percentage Agriculture and animal 0 0% raising Small business % Small manufacturing % Construction 10 25% Total % Source: Field Work From the table above, 62.5% of the respondents are involved in small business, 25% of respondents are in construction and 12.5% of respondents are involved in small manufacturing. Small business is the most common activity and this may be due to lack of sufficient capital to start big businesses. The big percentage of the respondents being involved in small business, it is too risky for the microfinance because if something bad happens to small business activities it may lead to difficulties which result into default; so in credit analysis they should motivate clients to go for other activities other than doing small business. 61

76 Table 4.10: Analysis of credit repayment period Repayment period Number of respondents Percentage Short % Long 0 0% Enough 0 0% Total % Source: Field Work The table above shows that 100% of respondents said that the credit repayment period is short since clients complain that the repayment period is short, this contribute much difficulties in repaying the loan as scheduled. This will result into non performing loans, which later become default loans hence loans non recovery. Table 4.11: Analysis of interest rate per month Interest rate Number of respondents Percentages Less than 3% 0 0% Between 4% to 7% 38 95% Above 7% 2 5% Total % Source: Field Work The table above shows that 95% of the respondents are charged interest between 4% and 7% per month, 0% of the respondents are charged interest rates less than 3% and 5% of the respondents are charged interest rate above 7% interests per month. A large number of clients are charged interest between 4% and 7%, this indicates that a huge amount of credits granted involve a high credit risk because the higher the risk involved in the business the higher the interest rates to be charged. It was also observed that many clients run for credit without knowing the money they will pay back which result into problems hence loan default. 62

77 Table4.12: Problems encountered during credit repayment period. Problems Number of respondents Percentages Illness of borrowers 0 0% Family problems 3 7.5% Declining profits 12 30% High interest rate 20 50% Heavy taxes % Total % Source: Field Wok From the table above, 7.5% stated that family problems, 30% said declining profits, 50% high interest rate, 0% pointed out that illness of the borrower and 12.5% said that heavy taxes are the problems they face during repayment problems. As stated in the table above, 30% of the respondents fail to repay due to declining profit while 50% of respondents faced the high taxes problem. In this regard the credit agents should regularly be informed about economic trends and major events in industries and activities in which the banks is a major lender. Therefore this will help them to know how their bank loan activities will most likely be affected by different changes. 63

78 4.7.2 Secondary data Table 4.13: Present doubtful debts for the period (expressed in Million Rwandan francs) Indicator Gross loans Provisions for doubtful debts Percentages 38% 88% 53% 14% Source: Secondary data With reference from the above table, gross loans were , , and millions of Rwandan francs respectively and Provisions for doubtful debts were , , and millions Rwandan francs respectively. Calculating provisions rate as proportion to loans the results were 38%, 88%, 53%, 14% respectively. Provisions for 2008 increased and this affected the amount of loans granted in the following year because the bank was obliged to reduce the loans offered. The reason behind this attitude is that the increase in provision is justified by the increase of clients who do not repay the loan as scheduled and this has an adverse implication on the microfinance s expected revenues and lending capacity and then the rate of credit to be offered. In the year 2008 and 2009 provisions were very high at 88% and 53% respectively; but in the year 2010 provisions greatly decreased to 14% and this is an indicator of loans performance. Important note here is that as the provision for doubtful debt increases, it implies an adverse effect on loan repayment and therefore, the delinquency rate will also be high. 64

79 Table 4.14: Bad debts written off(expressed in million Rwandan francs) Indicators 31/12/ /12/ /12/ /12/2010 Gross loans Accumulated loans written off Source: Secondary data From the above table, loans for were , , and million Rwandan francs respectively. Accumulated written off for the period were , , and millions Rwandan francs respectively. If the above figures are elaborated in percentages, accumulated loans written off over are 17% of the loans offered. This is not a good proportion because it was considered as a loss to Microfinance and it reduced the credits offered every year. Table 4.15: Recovery of loans written off(expressed in Million Rwandan francs) Indicator 31/12/ /12/ /12/ /12/2010 Accumulated loans written off Recovery of loans written off Source: Secondary data From the above table, the accumulated loans written off for the period were , , and millions Rwandan francs respectively. The recovery of loans written off for the period were 8.2, 10.37, 7.0, and 7.1 million of Rwandan francs respectively. 65

80 The recovery of loans written off represented 12.4% of total accumulated loans written off. The accumulated loans written off are in most instances taken as a loss; but sometimes with the efforts of recovery agents some of those written off may be repaid that is why they are taken as a profit to the microfinance INTERVIEW When the operations started The Vision Finance manager said that the microfinance bank started operating in the year Therefore, the cooperative does not have enough experience in saving and lending services. This may be the reason for non performing loans which may result into default and credit non recovery. The types of loans they offer to clients The bank manager said that they offer many types of loans that are: agriculture, small business, ordinary credits, construction. The conditions for acquiring a loan The bank manager said that the following conditions are: To be a member of the bank for at least three months To be of good integrity To have precious good credit records To have a profitable and viable project To present all necessary documents To have sufficient repayment capacity To offer security this largely covers the solicited credit. 66

81 It is necessary to mention that all these conditions should be given equal importance as they are interrelated because by putting emphasis on some of them and not considering others may be cause of default loans. When you give some importance on membership than to the previous good credit records, this may cause non recovery in case the borrower has already failed to honor his or her past obligations. The interest rates charged on loans The bank manager said that the interest rate depend on the type and purpose of the loan. The interest rate charged on ordinary is 4% per month, 8% for overall of loan which is payable is 3 months and 3% to our employees. The factors they consider in credit analysis The bank manager said that they concentrate on the following factors while analyzing the credit files: Capacity, Capital, Collateral, Conditions, Control and Character It is remarkable that all five conditions are given importance. However even if control is introduced by some authors to already existing 5 conditions of credit. It should be somehow considered in a sense that it also contributes to assess a borrower s creditworthiness and centers on such questions as whether changes in law and regulation could affect the borrower and whether the loan meets the bank s and regulatory authorities standards for loan quality. Time they take to visit financial projects The bank manager said that they inspect financed activities once throughout the loan s life. In case the supervision is done once throughout the loan s life it will have a big impact on the credit granted because insufficient inspection may be done of the basis reasons for non performing loans which in turn became default loans. Once borrowers get credit funds and are not supervised, they may misuse the acquired funds and the regular supervision may be one of the different measures to reduce misappropriation of funds. Furthermore, by inspecting on a continuous basis credit 67

82 agents will be able to locate early where it goes wrong and advise to borrowers so as to improve the situation before it is too late. The actions they take when a client fails to repay The bank manager said that the most preferred action is workout arrangement. This is because it does not require long procedures like court action and it is not expensive. In addition, it is one of the courses of action used most frequently by loan officers because they try to predict which course of action is likely to affect the borrower between employees, community and other creditors. The causes of credit non recovery. Incomplete credit information Insufficient loan analysis Bad credit decisions Incompetence of credit agents Lack of supervision Lack of security expertise Environmental factors There are many causes of credit non recovery but the most dominant causes pointed out by the bank manager are insufficient loan analysis, bad credit decisions, lack of security expertise, and lack of supervision, poor selection of risk and unwillingness of borrowers to repay the loan. Some of the credit agents carelessness like insufficient loan analysis. Credit agents have to improve their work given that this attitude has an adverse impact on credit recovery The impact of non recovery to Vision Finance Company The impacts of non recovery are many and very dangerous and these include: 68

83 It hinders the development of the microfinance because its stock reduces due to non recovery. It reduces the budgeted amount for credit to be given to clients It causes delays for other clients to get credits because VFC lose trust in people. It causes poor remuneration of employees because profit is reduced. It causes company not to get stable employees because budget is limited CONCLUSION This study has been able to establish that the MFI sector is critical as a strategy in contributing to economic development by offering financial services to the poor. The sector manifests characteristics of a young industry with a potentially large client base and the management and respective Boards of Directors of MFIs in Rwanda have the traditional role to lead them to success. The key factor in keeping MF interest rate high remains the unit cost of lending which can be reduced through initiatives such as fostering competition, improved productivity of the MFIs and improvement in the macroeconomic and infrastructural frameworks in which the MFIs operate. 69

84 CHAPTER FIVE 5.0 SUMMARY, CONCLUSION AND RECOMMENDATIONS This chapter makes a summary of the main findings of the study. It also indicates the conclusion and recommendations of the study which were made in relation to the findings in line with the objectives of the research. 5.1 SUMMARY OF FINDINGS The table 4.7 above shows that 62.5% of the respondents have got credit from the company and 37.5% of respondents have not got credit. The table above shows that 62.5% of the respondents have got credit from the company and 37.5% of respondents have not got credit. From the table 4.8 above it is shown that 100% of respondents have not been trained in credit management literacy. From the table 4.9 above, 62.5% of the respondents are involved in small business, 25% of respondents are in construction and 12.5% of respondents are involved in small manufacturing. The table 4.10 above shows that 100% of respondents said that the credit repayment period is short since clients complain that the repayment period is short, this contributed much difficulties in repaying the loan as scheduled. The table 4.11 above shows that 95% of the respondents are charged interest between 4% and 7% per month and 5% of the respondents are charged interest rate above 7% interests per month. From the table 4.12 above, 7.5% stated that family problems, 30% said declining profits, 50% high interest rate, and 12.5% said that heavy taxes are the problems they face during repayment problems. In the year 2008 and 2009 provisions were very high at 88% and 53% respectively; but in the year 2010 provisions greatly decreased to 14% and this is an indicator of loans 70

85 performance. From 2007 to 2010 accumulated loans written off were over 17% of the loans offered and only the recovery of loans written off represented 12.4% of total accumulated loans written off. According to the information collected from questionnaires and interviews held in the field, there are three types credits offered at Vision Finance that is ordinary credit, small business and constructions credits. The most important conditions to get a loan are sufficient repayment capacity, to be a member of the bank for at least three months, offer security which covers the solicited credit, previous credit records, good integrity, a profitable and viable project and presentation of all necessary documentation. The most frequently financed activity is small trading. The interest rate to be applied on the next or coming year is determined at the end after considering the current annual results, profitability objectives and needs of the company. In Vision Finance capacity, conditioned character, capital and collateral are the most important factors to consider in credit analysis. Inspection on the performance of the financed projects are done, mostly once thought the loan s life. With regard to action taken when clients fail to repay the loan as scheduled, the most preferred action is the work out arrangement. As far as the problems encountered during repayment period is concerned, the most frequent problems are family problems, declining profits, shift of market and high interest rates. The most dominant causes of credit non recovery are insufficient loans analysis, bad credit analysis decisions, and poor selections of risk, lack of security expertise, lack of supervision and unwillingness of borrowers to repay the loan. The possible solutions suggested to overcome the causes of credit non recovery include collection of all necessary credit information, deeper credit analysis, evaluation of risk involved, verification of revenues, security expertise, good credit decisions, recovery, contact with the borrower, and supervision of financed project and court enforcement of loan agreement. 71

86 5.2 CONCLUSION The sustainability in terms of loan repayments of VFC as a strategy to contribute to economic development depends largely on their ability to cover all their costs from their revenues which are predominantly generated from interest rates. The central bank and the government play a supportive role to promote an enabling environment that promotes and facilitates the VFC sector growth through encouraging a competitive environment. They endeavor to establish necessary physical, social, and economic environment to promote VF sector and positively influence their interest rates. It is true that interest rates charge by VFC are higher than those charged by commercial banks, but the latter have failed to serve the poor. The main reason to explain this notion lies in the fact that the unit cost of lending by VFCis higher for the poor since they get small sized loans, live in scattered patterns, and staff of VFC take a long time to process their loans because of lack of credit history and other factors. All those factors combine to raise the unit cost of lending and therefore, interest rates. Commercial banks would, in any case, charge much higher interest rates if they were to operate in the same circumstances and to serve the same clients as the VFC; The economically active poor are able and willing to pay the high interest rates when right opportunities offer themselves for borrowing and they prefer to pay high interest rates to not getting where to borrow at all. VFC which operate savings are able to reduce their cost of funds which enables them to charge lower interest rates than those which do not have deposits; The cost of funds to the VFC is still high especially because availability of sources of funds for on-lending are limited and the financial sector is neither developed nor well integrated; Problems faced by clients in loan repayment period led them unable to repay the loans as scheduled hence leading to default loans. The most dominant causes of credit non recovery found are insufficient loan analysis and bad credit decisions, lack of security, expertise, lack of supervision and unwillingness of the borrower to repay the loan. These causes mostly result from institutions bad credit management. It is worth noting that Vision Finance company needs effective credit management because it is 72

87 through this department that Vision Finance company can possibly overcome credit non recovery causes. 73

88 5.3 RECOMMENDATIONS In order to reduce the relatively high operating costs, management of VFC need to put in place measures to improve efficiency in their day-to-day operations in order to reduce unit costs. The costs that need to be reduced include cost of funds, administration costs and disbursement costs. Management of VFC need to standardize many procedures and processes which are routine without compromising on prudence or quality. Processes that could be standardized include client screening, credit appraisal, credit processing which leads to lowering of both operational and transaction costs. In order to reduce loan loss arising from clients who are able but not willing to pay, the government needs to enact laws which limit tolerance to clients who refuse or unnecessarily delay to pay their loans. This would improve discipline, reduce credit risk and consequently reduce loan loss and improve profitability which would lower interest rates; the government needs to reduce country risks by encouraging transparency through information exchange and by elimination of process rigidities in VF regulation. Furthermore, there is need to enact laws which attract more and cheaper funds for investments in VF which would reduce the cost at which they would access alternative sources of funds. Both of these initiatives would result into lowering the interest rates; the government needs to continue improving physical infrastructure to facilitate expansion of VF outreach. VF infrastructure is needed in security, IT, communication and transport. Improvement would not only raise economic activity to take advantage of economies of scale but also improve productivity and consequently lead to reduction in unit cost; VF practitioners should take advantage of regulation by ensuring that they meet minimum requirements stated by BNR to attract more savings deposits which would be necessary to reduce the cost of funds. VFC which collect savings indicate that un-served depositors potentially exist; All VF stakeholders should improve transparency through benchmarking, standard reporting and adhering to the profitability and performance ratios: Information and communication exchange among the stakeholders are important initiatives that should be promoted. This will lead VF practitioners to improve trust among clients and 74

89 investors which will promote lessons learned on good management practices that encourage efficiency. It also attracts more and cheaper finance by encouraging competition and promoting efficiency, increased transparency would reduce costs and interest rates; VF practitioners should diversify the scope of their products in order to improve the scope of their profitability and to attract more clients which would directly and positively impact on the interest rates; VF practitioners should improve their external client management and provide them incentives for good performance as regards their products; for instance as regards borrowers, they could reward the best client performers that meet their commitments in a timely and this would have far reaching effects of motivating the client market; The VF management should improve their staff management, who are their internal clients, in the whole process human resource management; this includes recruitment, training, promotion, staff discipline and to encourage continuous improvement in their management approach; Because of change in economic conditions, environmental problems, borrowers may not have money at hand as planned. Therefore debt rescheduling should be done to give these borrowers ample time to pay. Valuation of the security attached to the loan should be done by experts. In case the bank does not have any, it should even hire otherwise it may face an overvaluation of assets pledged as security with disastrous effects on the concerned company when the security should be liquidated to recover loaned amount. Clients should be educated on the importance to honor their obligations can also reinforce the spirit of loan repayment. Because when you repay in time it gives a chance to borrow again its like you are creating a credit worthiness. 75

90 5.4 PROSPECTS FOR FUTURE RESEARCH This dissertation is only a drop in the sea of the knowledge gap that exists on the VF sector in Rwanda in general and on their interest rates in particular. In order to generate more knowledge bases on this study, the following would be interesting topics for further research; What needs to be done by the Government and regulators in Rwanda to improve Competitiveness and reduce interest rates without hurting the sustainability in terms of loan repayments of VFC? What Innovations need to be addressed by VFC in Rwanda to achieve competitive interest rates? Whether the current interest rates in Rwanda are viable in a sustainable way. 76

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94 Versluysen, E. (1999). Defying the odds: Banking for the poor, West Hartford, Connecticut, Kumarian Press Windy Wilkins (2006), Key attributes and characteristics Wright, A. Gr., et al., (2000), Why poor people Want/Need to Save and How they Do it, Micro save-africa Web sites visited /interest rates and loan repayment

95 APPENDICES QUESTIONNAIRE APPENDIX 1 QUESTIONS DIRECTED TO CLIENTS OF VISION FINANCE Dear respondent, Am MUGISHA Epaphura registration number MBA/28781/82/DF-KBL, I am a student in Kampala International University in the final year of Master s degree in Business Administration(MBA), Finance & Banking Option. This questionnaire is intended to facilitate the study on Interest Rates and Loan repayments in Micro Finance Institutions: A case study of Vision Finance company. This study is for academic purposes and is carried out as partial fulfillment of the award of Degree of Master of Business Administration. Your responses also will be treated with utmost confidentiality. In order to accomplish the study, you are requested to complete this questionnaire. Thank you very much for your valuable time. SECTION A 1. What is your level of education? i. Primary ii. iii. iv. Three years post primary Secondary and above None 2. How often do you get credit from Vision Finance? i. Annually ii. iii. iv. Quarterly Twice a year Once a month v. Never 81

96 3. Do you get any credit management training from Vision Finance? i. Strongly agreed ii. iii. iv. Agreed Neutral Disagreed 4. What economic activities do you engage in after getting a loan? i. Small business ii. iii. iv. Small manufacturing Construction Agriculture and animal raising 5. What period do you take to pay the credit? i. Short ii. iii. iv. Long Enough Very long 6. What interest rate do you pay per month? i. Less than 3% ii. Between 4% and 7% iii. Exactly 7% iv. Above 7% 7. What problems encountered during credit repayment period? i. Illness of borrowers ii. Family problems iii. Declining profits iv. High interest rates v. Heavy taxes 82

97 8. What solutions offered for the above problems encountered during credit repayment period?. APPENDIX 2 QUESTIONS DIRECTED TO TOP MANAGERS AND OTHER MANAGERS OF VISION FINANCE Dear respondent, Am MUGISHA Epaphura registration number MBA/28781/82/DF-KBL, I am a student in Kampala International University in the final year of Master s degree in Business Administration(MBA), Finance & Banking Option. This questionnaire is intended to facilitate the study on Interest Rates and Loan repayments in Micro Finance Institutions: A case study of Vision Finance company. This study is for academic purposes and is carried out as partial fulfillment of the award of Degree of Master of Business Administration. Your responses also will be treated with utmost confidentiality. In order to accomplish the study, you are requested to complete this questionnaire. Thank you very much for your valuable time. SECTION B 1. Can you explain when Vision Finance was established? 2. Where do you get funding for Vision Finance?. 3. Why do you think Vision Finance is important in this country?. 4. What products do you offer to your clients? What is the range in amount of your loan products? 83

98 . 5. How big is the market that you serve? Is it saturated yet? 6. What factors determine interest rates? Which factors do you consider most important?. 7. What is the process of determining your interest rates? 8. What is the range of your interest rates? 9. Do you recover all your costs? 10. Is it true that you charge interest rates higher than those charged by other MFIs? Why? 11. Aren t some clients chased away by the high interest rates? 12. What are comparative MFIs interest rate charges in Rwanda? 84

99 13. How do roles of Government and Central bank affect VFC? 14. Do you think depositor s savings are protected from risks?. Thank you for your Cooperation. 85

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