Factors Affecting Non-Performing Loans: Case Study on Development Bank of Ethiopia Central Region

Abstract

The study aims at identifying the major factors affecting Non-performing loans of Development Bank of Ethiopia, Central Region. To achieve this objective descriptive research design was used and data has been collected mainly through primary source using questionnaire from both borrowers and region’s staffs. Secondary data were also used by reviewing the annual reports, bulletins, manuals, directives and procedures issued by the bank. 43 borrowers and 24 staffs were taken as samples from 77 default loans (Nonperforming loans) and 31 region’s staffs respectively based on stratified random sampling method of sample selection by using mathematical formula. For data analysis, descriptive statistics including mean, frequency and percentages were used and processed through computer loaded SPSS software. The result of the study shows that poor credit assessment and credit monitoring are the major causes for the occurrence of NPL in DBE. Credit size (includes aggressive lending, compromised integrity in approval, rapid credit growth and bank’s great risk appetite); high interest rate, poorly negotiated credit terms and lenient/lax credit terms, and elongated process of loan approval were bank specific causes for the occurrence of nonperforming loans. On the other hand, poor credit culture of customers, lack of knowledge of borrower for the business they engaged in, willful default, loan diversion, and project management problems were identified as the major customer specific causes of NPLs. Hence, to reduce the occurrence of loan default it is suggests that the Bank should strengthen its applicant screening criteria and due diligence assessment to select potential risk taking applicants and adopt appropriate pre and post credit risk assessments. Besides, the bank needs to make sure that borrowed funds are being used for the intended purpose through enhanced credit monitoringThe Development bank of Ethiopia (DBE) is one of government owned financial institutions engaged in providing short, medium and long term development credits by financing viable projects from the priority areas of the government. DBE’s distinguished feature is its “project” based lending tradition. Project financed by the Bank are carefully selected and prepared through appraisal, closely supervised and systematically evaluated. It mobilizes funds from domestic and foreign sources. To achieve the objectives of circulating more and more financial resources to meet the increasing demand for credit and to keep the Bank in sound financial position, the loans extended to various sectors of the economy must be recovered in full. Both the principal which is used for re-lending as well as the interest to meet the operating costs must be recovered. However, for the last many years the Bank’s loan repayment performance has been very low due to various factors. These factors may explain among others the loan repayment behavior of borrowers and lending behavior of the Bank. This has an impact on the sustainable provision of credit to the potential investors and existence of the bank as a financial institution (DBE Annual Report, 2014). Knowing these factors will assist the Bank in its continuous efforts to recover its existing loans and to set ideals for forthcoming ones. Therefore, loan recovery is considered as a crucial factor affecting the liquidity and profitability of the bank. Thus, the present study attempts to identify the determinants of loan repayment performance of projects financed by Development Bank of Ethiopia Central region. The researchers strongly believe that identifying the factors affecting loan repayment performance of projects would enable the bank’s management to tackle and minimize the problems and consequently will enhance its loan recovery performance.