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THE IMPACT OF CREDIT MANAGEMENT ON PERFOMANCE: A

STUDY OF KENYA COMMERCIAL BANK BRANCHES IN LAIKIPIA


COUNTY

PHILIP MISILI MUSYOKA


D53/OL/NYI/24264/2014

A RESEARCH PROJECT PROPOSAL SUBMITTED IN PARTIAL FULFILLMENT


OF THE REQUIREMENTS FOR THE AWARD OF THE DEGREE OF MASTER OF
BUSINESS ADMINISTRATION OF THE KENYATTA UNIVERSITY

NOVEMBER, 2015

Declaration
This proposal is my original work and has not been presented for a degree in any other
university.

Signature_________________________ Date____________________
Name: Philip Musili Musyoka
D53/OL/NYI/24264/2014

Supervisors:
This proposal has been submitted for the review with our approval as University supervisors.
Signature __________________________Date__________________
Name: Dr. .
School of Business

Signature __________________________Date__________________
Name:
Chairman, Department

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TABLE OF CONTENTS
Declaration...............................................................................................................................ii
Dedication................................................................................................................................vi
Acknowledgement..................................................................................................................vii
Abbreviations and Acronyms..............................................................................................viii
Operational Definition of Terms............................................................................................ix
ABSTRACT..............................................................................................................................x
CHAPTER ONE......................................................................................................................1
INTRODUCTION....................................................................................................................1
1.1 Background of the Study.....................................................................................................1
1.1.1 Credit Management...........................................................................................................2
1.1.2 Firm Performance.............................................................................................................3
1.1.3 Financial Services Sector in Kenya..................................................................................5
1.2 Problem Statement...............................................................................................................5
1.3 General Objective of the Study............................................................................................7
1.3.1 Specific Objectives...........................................................................................................7
1.4 Research Hypothesis............................................................................................................7
1.5 Justification of the Study.....................................................................................................8
1.6 Scope of the Study..............................................................................................................8
1.7 Limitation............................................................................................................................9
1.8 Assumptions of the Study...................................................................................................9
CHAPTER TWO...................................................................................................................10
LITERATURE REVIEW......................................................................................................10
2.1 Introduction........................................................................................................................10
2.2 Theoretical Review............................................................................................................10
2.2.1 Transactions Costs Theory.............................................................................................10
2.2.2 Asymmetric Information Theory.....................................................................................11
2.2.3 Theory of Performance...................................................................................................11
2.2.4 Pecking Order Theory....................................................................................................12
2.3 Credit Management Practices............................................................................................13
2.3.1 Credit Scoring.................................................................................................................14
2.4 Financial Performance.......................................................................................................15
2.4.1 Profitability.....................................................................................................................16
2.4.2 Efficiency........................................................................................................................16
2.5 Empirical Literature Review..............................................................................................17
2.5.1 Credit Policy and Bank Performance..............................................................................17
2.5.2 Credit Scoring Mechanism and Bank Performance........................................................18
2.5.3 Credit Monitoring Style and Bank Performance...........................................................19
2.6 Summary of the Research gaps..........................................................................................20
2.7 Conceptual Framework......................................................................................................21
CHAPTER THREE...............................................................................................................22
RESEARCH METHODOLOGY.........................................................................................22
3.1 Introduction........................................................................................................................22
3.2 Research Design.................................................................................................................22
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3.3 Study Population................................................................................................................23


3.4 Sampling Size and Sampling Procedure............................................................................23
3.5 Data Sources and Collection..............................................................................................24
3.6 Data Collection Procedure.................................................................................................25
3.7 Validity of Data Collection Instruments............................................................................25
3.8 Reliability of the Research Instrument..............................................................................25
3.9 Data Analysis and Presentation..........................................................................................26
3.10 Ethical Considerations.....................................................................................................27
REFERENCES.......................................................................................................................28
APPENDICES........................................................................................................................31
Appendix I: Letter of Transmittal............................................................................................31
Appendix II: Questionnaire......................................................................................................32
Appendix III: Budget..............................................................................................................33
Appendix IV: Work Plan..........................................................................................................33

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Dedication
This research work is lovingly dedicated to my dad Daniel Musyoka and my mum Agnetta
Musyoka who have shown me great support in my quest for education.

Acknowledgement
This research project could not have been possible without the valuable input of a number of
groups whom I wish to acknowledge. First and foremost, great thanks to God for His grace
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and the gift of life during the period of the study. Special appreciation goes to my supervisor
Dr. Omagwa. I wish to sincerely acknowledge his professional advice and guidance in the
research project. Thanks to the entire academic staff of the school of business for their
contribution in one way or another.

Abbreviations and Acronyms


CBK-

Central Bank of Kenya

FIs-

Financial Institutions
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GDP-

Gross Domestic Product

GoK-

Government of Kenya

IMF-

International Monetary Fund

MFIs-

Micro Finance Institutions

SACCO-

Savings and Credit Cooperative Societies

SME-

Small and Medium Enterprises

Operational Definition of Terms


Collateral security-

Property or other assets that a borrower offers a lender


to secure a loan.

Commercial bank-

An institution which accepts deposits, makes business loans


and offers related financial services
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Loan:
Micro credit:

Credit facility offered by a financial institution


The lending of small amounts of money at low interest to
small enterprises

ABSTRACT
Credit management is one of the most essential activities in any commercial bank. Lack of
sound credit management practices leads to pitfalls in the banking sector. The general
objective of this study is to evaluate the impact of credit management on financial
performance of KCB Bank Group. The study specifically seeks to determine the impact of
credit policy, credit scoring mechanism and credit monitoring style on financial performance
of KCB bank branches in Laikipia County. The research shall adopt the use of mixed method
approach research design which is the application of both qualitative and quantitative
approaches.The researcher will draw the population from the KCB bank branches in Laikipia
County where the 78 staff members will be targeted. The study will use census survey on
managerial and supervisory staff while simple random sampling (at 30%) will be used on
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other category of staff giving a total sample size of 37. The study will obtain secondary data
through a data collection form that will indicate the profitability and loan sales of the banks.
However, a semi- structured questionnaire will be used to collect primary data from the bank
staff. The researcher will employ self-administration approach of data collection. The pretesting will be carried out on a sample consisting of ten (10%) of the respondents; from
Equity bank, Laikipia town branch. The study will use split-halves and internal
consistency method to measure reliability. Responses in the questionnaires will be tabulated,
coded and processed by use of a computer Statistical Package for Social Science (SPSS)
program to analyze the data. The responses from the open-ended questions will be listed to
obtain proportions appropriately; the response will then be reported by descriptive narrative.
Both descriptive and inferential statistics will be used to analyze the data. Mean and standard
deviations will be used as measures of central tendencies and dispersion respectively. The
relationship between the dependent variable and the independent variables will be tested
using Pearsons correlation.

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CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
The importance of credit management by commercial banks has attracted much attention in
recent years and has become an important topic for economists and policymakers working on
financial and economic development. This interest is driven in part by the fact that
commercial banks account for the majority of buoyant firms in an economy and thus provide
a significant share of employment (Demirguc-Kunt & Huzinga, 2013). Furthermore, most
SMEs usually get funding from commercial banks in order to develop, grow and contribute
to the economic development (Boahene, Dasah & Agyei, 2012). The recent attention on
credit management also comes from the perception among academicians and policymakers
that banks that lack appropriate credit management mechanisms risk making huge losses
(Demirguc-Kunt & Huzinga, 2013). As put in by Nzotta (2004), credit management greatly
influences the success or failure of commercial banks.

Credit management is one of the most essential activities in any commercial bank (Gatuhu,
2013). Therefore, credit management cannot be overlooked by any economic enterprise
engaged in credit irrespective of its business nature. Lack of sound credit management
practices leads to pitfalls in the banking sector. Scheufler (2002) summarizes these pitfalls as
failure to recognize potential frauds, under-estimation of the contribution of current customers to
bad debts, getting caught off guard by bankruptcies, failure to take full advantage of technology,

and spending surplus resources on credit evaluations that are not related to reduction of credit
defaults.

With the rise in bankruptcy rates, the probability of banks incurring losses has risen
(Omboto, 2014). Economic pressures and business practices are forcing organizations to slow
payments while on the other hand resources for credit management are reduced despite the
higher expectations. Therefore it is a necessity for credit professionals to search for
opportunities to implement proven best practices (Gatuhu, 2013). Timely identification of
potential credit default is important as high default rates lead to decreased cash flows, lower
liquidity levels and financial distress. In contrast, lower credit exposure means an optimal
debtors level with reduced chances of bad debts and therefore financial health (Gatuhu,
2013).

1.1.1 Credit Management


Myers and Brealey (2003) describe credit management as methods and strategies adopted by
a firm to ensure that they maintain an optimal level of credit and its effective management. It
is an aspect of financial management involving credit analysis, credit rating, credit
classification and credit reporting. Nelson (2002) views credit management as simply the
means by which an entity manages its credit sales. It is a prerequisite for any entity dealing
with credit transactions since it is impossible to have a zero credit or default risk. Nzotta
(2004) opined that credit management greatly influences the success or failure of commercial
banks and other financial institutions. This is because the failure of deposit banks is
influenced to a large extent by the quality of credit decisions and thus the quality of the risky
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assets. He further notes that, credit management provides a leading indicator of the quality of
deposit banks credit portfolio. A key requirement for effective credit management is the
ability to intelligently and efficiently manage customer credit lines. In order to minimize
exposure to bad debt, over-reserving and bankruptcies, companies must have greater insight
into customer financial strength, credit score history and changing payment patterns. Credit
management is concerned primarily with managing debtors and financing debts (Gatuhu,
2013).
Credit management starts with the sale and does not stop until the full and final payment has
been received. It is as important as part of the deal as closing the sale. In fact, a sale is
technically not a sale until the money has been collected. It follows that principles of goods
lending shall be concerned with ensuring, so far as possible that the borrower will be able to
make scheduled payments with interest in full and within the required time period otherwise,
the profit from an interest earned is reduced or even wiped out by the bad debt when the
customer eventually defaults (Diagne & Zeller, 2001).
1.1.2 Firm Performance
Companies that achieve organizational performance enhance the engagement culture by
decentralizing the decision-making process and allowing employees to contribute thus
benefiting from multiple perspectives (Kungu, Desta & Ngui, 2014). Khan, Farooq and Ullah
(2010) analysis shows that companies with the highest levels of performance also have high
levels of employee engagement. Their employees are visible involved and with a leadership
platform that bolsters the company's mission and involves all employees in developing
strategy (Khan, Farooq & Ullah, 2010).
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The good performance of any company begins to crystallize only after its leaders create an
engagement culture among employees (Kungu, Desta & Ngui, 2014). Turyahebya (2013)
defines financial performance as the ability to operate efficiently, profitably, survive, grow
and react to the environmental opportunities and threats. In agreement with this, Sollenberg
and Anderson (1995) assert that, performance is measured by how efficient the enterprise is
in use of resources in achieving its objectives.

Existing literature on the how to measure organizational performance varies across studies
(Comb, Crook & Shook, 2005). The contradictions between studies are mostly caused by
different concepts and measurement approaches of organizational performance. This is
majorly due to completely different concepts and measurement systems, with each newer
study applying a new construct measurement approach on organizational performance (Khan
et. al. 2010). Consequently, the interest into measurement approaches, construct validation
and conceptual nature of organizational performance is very elusive for most researchers.
However, Combs, Crook and Shook (2005) distinguished between operational and
organizational performance. In their framework, operational performance combines all nonfinancial outcomes of organizations while the conceptual domain of organizational
performance is limited to economic outcomes. But this study combines the two perspectives
of performance and identifies four organizational performance dimensions: profitability and
growth in customer base.

1.1.3 Financial Services Sector in Kenya


The banking sector in Kenya operates in a relatively deregulated environment governed by
the companies Act, the Banking Act, the CBK Act and the various prudential guidelines
issued by the CBK. In Kenya there are a total of 42 banks which are all for the same market
share (CBK Annual Report, 2010). Before 1983, the formal banking system in the country
was dominated by state owned banks that had a monopoly in terms of their spread and
operations (Hinson & Hammond, 2006). Hinson and Hammond (2006) report that, with the
passage of the universal banking law however, all types of banking can be conducted under a
single corporate banking entity and this greatly reorganises the competitive scopes of several
banking products in Kenya. Thus reform and deregulation has brought the banking sector
into the competitive arena in terms of customers and products. This means sound credit
management decisions should take into consideration factors that promote customer
satisfaction, customer retention, customer loyalty, increased market share and firm
profitability.

1.2 Problem Statement


Sound credit management is a prerequisite for a financial institutions stability and
continuing profitability, while deteriorating credit quality is the most frequent cause of poor
financial performance and condition. According to Gitman (1997), the probability of bad
debts increases as credit standards are relaxed. Firms must therefore ensure that the
management of receivables is efficient and effective .Such delays on collecting cash from
debtors as they fall due has serious financial problems, increased bad debts and affects
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customer relations. If payment is made late, then profitability is eroded and if payment is not
made at all, then a total loss is incurred. On that basis, it is simply good business to put credit
management at the front end by managing it strategically.
The excessively high level of non-performing loans in the banks can be attributed to poor
corporate governance practices, tax credit administration process and the absence or nonadherence to credit risk management practices. Thus far, the major cause of serious banking
problems continues to be related to low credit standards for borrowers and as well counter
parties, poor portfolio management, and lack of attention to changes in economic or other
circumstances that can lead to delineation in the credit standing of banks counter parties.
Thus, the biggest problem facing banking and other forms of financial intermediaries is the
risk of customers or counter party default. Recently, the banking sector witnessed rising nonperforming credit portfolios. This has contributed to the financial distress in banking sector.
Also focused has the existence of predatory debtors in the banking system whose Modus
Operandi involves the abandonment of their debt obligation in some banks only to go ahead
and contract new debts in other banks. In literal sense, it is inimical to state that, the
increasing amount of non-performing loans in the credit portfolio hinders banks from
achieving their objectives to operate successfully and profitably, since a large chunk of banks
revenue accrues from loans from which interest in derived.
Matu (2008) carried out a study on sustainability and profitability of banking institutions and
noted that efficiency and effectiveness were the main challenges facing Kenya on service
delivery. Gitau (2010) did a study on assessment of strategies necessary for sustainable
competitive advantage in the banking and microfinance industry in Kenya with specific focus
to Faulu Kenya. Achou and Tenguh (2008) also conducted research on bank performance
and credit risk management and found that there is a significant relationship between
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financial institutions performance; in terms of profitability; and credit risk management.


However, most of the studies reviewed focused more on loan performance and ignored other
aspects of performance; a gap this study seeks to fill by focusing on KCB bank branches in
Laikipia County.

1.3 General Objective of the Study


The general objective of this study is to evaluate the impact of credit management on
financial performance of KCB Bank branches in Laikipia County.
1.3.1 Specific Objectives
The study will be guided by the following specific objectives:
1. To determine the impact of credit policy on financial performance of KCB bank
branches in Laikipia County.
2. To establish the impact of credit scoring mechanism on financial performance of
KCB bank branches in Laikipia County.
3. To evaluate the impact of credit monitoring style on financial performance of KCB
bank branches in Laikipia County.

1.4 Research Hypothesis


The following hypotheses will be tested in this research:
H1- Credit policy has no impact on financial performance of KCB bank branches in Laikipia
County.
H2- Credit scoring mechanism has no impact on financial performance of KCB bank
branches in Laikipia County.

H3- Credit monitoring style has no impact on financial performance of KCB bank branches
in Laikipia County.

1.5 Justification of the Study


The study findings may aid banks, the government, employees and other stakeholders.
Commercial banks will ascertain if the proper lending framework is in place for effective
micro lending from the findings of this study. The study findings will help in analyzing the
existing credit management practices that affect banking institutions.The study findings will
help the policy makers re-evaluate the current methods used to manage credit and possibly
develop other means to improve performance.

Scholars in the field of credit management will use the information to understand the state
of the sector better. They might also use the information as a reference point to research on
the credit strategy formulation and innovations in other industries. Finally, the Government
may find the information useful in diagnosing the problems affecting the banking sector
liquidity and come up with regulative solutions.

1.6 Scope of the Study


The study will focus on performance of the banks for a four year period; 2010-2014.The
study will only focus KCB bank branches in Laikipia County and therefore the findings may
not reflect the perception of the entire country. This study focuses on banks only; but neither
focuses on other financial service businesses which are not necessarily banks; such as MFIs
and SACCOs. The study will focus on three aspects of credit management thereby ignoring

other aspects of credit management. The study further seeks to interview bank staff only
thereby ignoring other stakeholders in credit management.

1.7 Limitation
Staff from KCB bank may decline to give information concerning their credit management
and performance due to the fear of competitors and privacy codes. However, the researcher
will clearly outline the motive of the study to them before embarking on data collection.
Time will also be a limiting factor since businesses operate on very tight schedule. Moreover,
a bigger sample size would have been appropriate were it not for the cost and time
constraints. The researcher will plan to interview the respondents on days when they are not
very engaged.

1.8 Assumptions of the Study


The researcher assumes that the respondents will be sincere and provide truthful information.
The respondents will understand the significance of the study and will be objective in the
responses they give to the researcher.

CHAPTER TWO
LITERATURE REVIEW
2.1 Introduction
This chapter concentrates on reviewing the literature with a view of understanding how other
researchers have contributed and the extent of the findings regarding accessibility of finances
and the performance of Bank. The chapter also reviews the theories relevant to the dependent
and independent variables.

2.2 Theoretical Review


2.2.1 Transactions Costs Theory
First developed by Schwartz (1974), this theory conjectures that suppliers may have an
advantage over traditional lenders in checking the real financial situation or the credit worthiness
of their clients. Suppliers also have a better ability to monitor and force repayment of the credit.
All these superiorities may give suppliers a cost advantage when compared with financial
institutions. Three sources of cost advantage were classified by Petersen and Rajan (1997) as
follows: information acquisition, controlling the buyer and salvaging value from existing assets.
The first source of cost advantage can be explained by the fact that sellers can get information
about buyers faster and at lower cost because it is obtained in the normal course of business. That
is, the frequency and the amount of the buyers orders give suppliers an idea of the client s
situation; the buyers rejection of discounts for early payment may serve to alert the supplier of a
weakening in the credit-worthiness of the buyer, and sellers usually visit customers more often
than financial institutions do.

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2.2.2 Asymmetric Information Theory


Information asymmetry refers to a situation where business owners or manager know more about
the prospects for, and risks facing their business, than do lenders (PWHC, 2002) cited in Eppy
(2005). It describes a condition in which all parties involved in an undertaking do not know
relevant information. In a debt market, information asymmetry arises when a borrower who takes
a loan usually has better information about the potential risks and returns associated with
investment projects for which the funds are earmarked. The lender on the other hand does not
have sufficient information concerning the borrower (Edwards & Turnbull, 1994). Perceived
information asymmetry poses two problems for the banks, moral hazard (monitoring
entrepreneurial behavior) and adverse selection (making errors in lending decisions). Banks will
find it difficult to overcome these problems because it is not economical to devote resources to
appraisal and monitoring where lending is for relatively small amounts. This is because data
needed to screen credit applications and to monitor borrowers are not freely available to banks.
Bankers face a situation of information asymmetry when assessing lending applications (Binks &
Ennew, 1997). The information required to assess the competence and commitment of the
entrepreneur, and the prospects of the business is either not available, uneconomic to obtain or
difficult to interpret. This creates two types of risks for the Banker (Deakins, 1999).
2.2.3 Theory of Performance
The Theory of Performance (ToP) by Elger (2007) develops and relates six foundational
concepts to form a framework that can be used to explain performance as well as performance
improvements: context, level of knowledge, levels of skills, level of identity, personal factors,
and fixed factors. To perform is to produce valued results (Elger, 2007). A performer can be an
individual or a group of people engaging in a collaborative effort. Developing performance is a
journey, and level of performance describes location in the journey (Tomlinson, Kaplan,
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Renzulli, Purcell, Leppien & Burns, 2002). While some factors that influence improving
performance are immutable, other factors can be influenced by the organization or by others
(Elger, 2007). The factors that can be varied fall into three axioms for effective performance
improvements. These involve a performers mindset, immersion in an enriching environment and
engagement in reflective practice (Bradford, Brown & Cocking, 2000). A ToP informs learning
by organizations through the idea of examining the level of performance of the organization
(Bradford et. al. 2000). This theory will go to support the variable on bank performance. This
theory of performance will be tested against the variable on bank performance and how it is
affected by credit management in the study.
2.2.4 Pecking Order Theory
The pecking order theory by Myers and Majluf (1984) focuses on the immediate need for
funding based on the existence of a pecking order and provides a rational explanation for choice
in corporate finance. For a company, this order consists in order to focus on internal sources of
financing before resorting to external investors. Thus, the company follows a hierarchy of
financing, dictated by the need for external funds. In general, financing by internal funds should
be promoted on the financing by external funds, according to the following hierarchy: cash
flow/debt/issue of shares (Myers & Majluf, 1984). At this level, it is necessary to clarify the
hierarchy of funding, driven by the need of external funding that follows any business according
to the theory of the Pecking Order. This theory will go in to support the variables on credit
monitoring style and credit scoring mechanism and how they affects bank performance.

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2.3 Credit Management Practices


Myers and Brealey (2003) describe credit management as methods and strategies adopted by a
firm to ensure that they maintain an optimal level of credit and its effective management. It is an
aspect of financial management involving credit analysis, credit rating, credit classification and
credit reporting. A proper credit management will lower the capital that is locked with the
debtors, and also reduces the possibility of getting into bad debts (Gatuhu, 2013). According to
Edwards (1993), unless a seller has built into his selling price additional costs for late payment,
or is successful in recovering those costs by way of interest charged, then any overdue account
will affect his profit. In some competitive markets, companies can be tempted by the prospects of
increased business if additional credit is given, but unless it can be certain that additional profits
from increased sales will outweigh the increased costs of credit, or said costs can be recovered
through higher prices, then the practice is fraught with danger (Kariuki, 2010).

Most companies can readily see losses incurred by bad debts, customers going into liquidation,
receivership or bankruptcy. The writing-off of bad debt losses visibly reduces the Profit and Loss
Account (Omboto, 2014). The interest cost of late payment is less visible and can go unnoticed
as a cost effect (Knox, 2004). It is infrequently measured separately because it is mixed in with
the total bank charges for all activities. The total bank interest is also reduced by the borrowing
cost saved by paying bills late (Knox, 2004). Credit managers can measure this interest cost
separately for debtors, and the results can be seen by many as startling because the cost of
waiting for payment beyond terms is usually ten times the cost of bad debt losses (Knox, 2004).
Effective management of accounts receivables involves designing and documenting a credit
policy (Gatuhu, 2013). Many entities face liquidity and inadequate working capital problems due
to lax credit standards and inappropriate credit policies. According to Pike and Neale (1999), a
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sound credit policy is the blueprint for how the company communicates with and treats its most
valuable asset, the customers. Scheufler (2002) proposes that a credit policy creates a common
set of goals for the organization and recognizes the credit and collection department as an
important contributor to the organizations strategies. If the credit policy is correctly formulated,
carried out and well understood at all levels of the financial institution, it allows management to
maintain proper standards of the bank loans to avoid unnecessary risks and correctly assess the
opportunities for business development (Omboto, 2014).
2.3.1 Credit Scoring
The first step in limiting credit risk involves screening clients to ensure that they have the
willingness and ability to repay a loan. Banks use the 5Cs model of credit to evaluate a customer
as a potential borrower (Abedi, 2000). The 5Cs help banks to increase loan performance, as they
get to know their customers better. These 5Cs are: character, capacity, collateral, capital and
condition. Character refers to the trustworthiness and integrity of the business owners since its
an indication of the applicants willingness to repay and ability to run the enterprise. Capacity
assesses whether the cash flow of the business or household can service loan repayments. Capital
refers to the assets and liabilities of the business or household. Collateral refers to access to an
asset that the applicant is willing to cede in case of non-payment or a guarantee by a respected
person to repay a loan in default. Finally, conditions refer to a business plan that considers the
level of competition and the market for the product or services as well as legal and economic
environment .The 5Cs need to be included in the credit scoring model.

The credit scoring model is a classification procedure in which data collected from application
forms for new or extended credit line are used to assign credit applicants to credit risk classes
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(Constantinescu, 2010).Inkumbi (2009) notes that capital and collateral are major stumbling
blocks for entrepreneurs trying to access capital. This is especially true for young entrepreneurs
or entrepreneurs with no money to invest as equity; or with no assets they can offer as security
for a loan. Any effort to improve access to finance has to address the challenges related to access
to capital and collateral. One way to guarantee the recovery of loaned money is to take some sort
of collateral on a loan. This is a straightforward way of dealing with the aspect of securing
depositors funds.

2.4 Financial Performance


According to Hermes and Lensink (2007), the financial systems approach, which emphasizes the
importance of financial performance, is likely to prevail the poverty lending approach. The
argument is that finance institutions have to be financially sustainable in order to guarantee a
large-scale outreach to the poor on a long-term basis (Kariuki, 2010). Measuring and comparing
the performance of banks has been difficult due to both a lack of publicly available financial
information and differences in reporting (Michael &Miles, 2007). A myriad of financial ratios are
available for assessing the performance of banks (CGAP, 2003). Although it is difficult to
synchronize the different interpretations of all the ratios, they provide alternative perspectives in
assessing the performance of banks for each of the domains namely: profitability, efficiency,
leverage and risk .In essence, interpreting the determinants of banks financial performance due
cognisance should be taken of the precise focus of each ratio (Kariuki, 2010).
2.4.1 Profitability
Return on Assets (ROA) falls within the domain of performance measures and tracks banks
ability to generate income based on its assets. The ratio excludes non-operating income and
15

donations.ROA provides a broader perspective compared to other measures as it transcends the


core activity of banks namely, providing loans and assessing profitability regardless of the banks
funding structure. ROA is expected to be positive as a reflection of the profit margin of the bank,
otherwise it reflects non-profit or loss (Mix Market, 2011). In banks and other commercial
institutions, the commonest measures of profitability are Return on Equity (ROE), which
measures the returns produced for the owners, and Return on Assets (ROA), which reflects that
organizations ability to use its assets productively (Kariuki, 2010).

These are appropriate indicators for unsubsidized institutions. But donor interventions more
typically deal with institutions that receive substantial subsidies, most often in the form of grants
or loans at below-market interest rates. In such cases, the critical question is whether the
institution will be able to maintain itself and grow when continuing subsidies are no longer
available (Pandey, 2008). To determine this, normal financial information must be adjusted to
reflect the impact of the present subsidies. Three subsidy-adjusted indicators are in common use:
Financial Self-sufficiency (FSS), Adjusted Return on Assets (AROA), and the Subsidy
Dependence Index (SDI) (Turyahebwa, 2013).
2.4.2 Efficiency
Efficiency of banks is measured by the share of operating expense to gross loan portfolio in most
cases (Gatuhu, 2013). The ratio provides a broad measure of efficiency as it assesses both
administrative and personnel expense with lower values indicating more efficient operations. The
debt equity ratio is a member of the asset or liability management ratios and specifically attempt
to track banks leverage (Gatuhu, 2013). This measure provides information on the capital
adequacy of banks and assesses the susceptibility to crisis. Microfinance investors mainly rely on
16

this ratio as it helps to predict probability of a bank honoring its debt obligations (Turyahebwa,
2013). However, its use should always be contextualized as high values could lead to growth of
banks. The Operating Expense Ratio is the most widely used indicator of efficiency, but its
substantial drawback is that it will make a bank making small loans look worse than an bank
making large loans, even if both are efficiently managed (Turyahebwa, 2013). Thus, a preferable
alternative is a ratio that is based on clients served, not amounts loaned. If one wishes to
benchmark a banks Cost per Client against similar banks in other countries, the ratio should be
expressed as a percentage of per capita Gross National Income; which is used as a rough proxy
for local labor costs (Gatuhu, 2013).

2.5 Empirical Literature Review


2.5.1 Credit Policy and Bank Performance
Ghimire & Abo (2013) did a study on Ivorian banks credit policies: constraining factors and
performance. The methodology adopted by the study included descriptive statistics, crosstabulations along with dependency tests of Chi-square and Cramers value. Moreover,
correspondences analyses or joint-plots were computed, displaying the relationships between the
most pertinent variables and bank performance. The study adopted structured questionnaires
which were sent out to respondents in four major commercial banks namely: Bank Internationale
de lAfrique de lOuest, Ecobank, Banque Atlantique and Societe Generale de Banque Cote
dIvoire. The study targeted a total of fifty managers. Out of 50 questionnaires sent in both rural
areas of Abengourou and urban areas of Abidjan, only 36 responses were received. The
computed percentage shows that firms having flexible credit policies and strict credit policies
had achieved loan sale out targets at 100% and 83.3% respectively. The findings revealed that
17

credit policy indeed affect performance of the banks. However, the study focused on loan sale
out targets as the only aspect of performance, a gap the current study seeks to fill.

Azende (2012) did a study on credit management and performance of banks in Nigeria. This
study assessed the impact of credit policy on performance of the banks; using banks in Benue
and Nasarawa States as case study. Mean scores and standard deviation were used to present and
analyze the primary data obtained via questionnaires. Correlation was used to substantiate
whether there was similarity. Simple percentages combined with mean scores were used to test
hypothesis one on credit policy and performance while Chi-square was used to test hypothesis
two on collateral security and performance. The result showed that the banks with strict credit
policies were significantly preferred by corporate clients for loans than those with relaxed credit
policies. Therefore the study concluded that indeed credit policy affects bank performance. The
study recommended that both the government and the banking sector should mutually agree on a
credit policy acceptable to all. However, the study mainly focused on collateral security as an
aspects of credit policy, a gap the current study seeks to fill.
2.5.2 Credit Scoring Mechanism and Bank Performance
A study by Iopev and Kwanum (2012) on how credit scoring mechanism affects financial
performance of banks was done in Nigeria. The study adopted a survey research design. To
achieve the objective of the study, one hundred and ten (110) bank staff from Benue state were
interviewed using an open-ended questionnaire. Data collected was analyzed using descriptive
statistics. The findings revealed that about eighty four percent of respondents agreed that the
credit scoring mechanism affects performance of bank loans. However, the study failed to give a

18

detailed statistical relation between credit scoring mechanism and the performance of the banks;
a gap the current study seeks to bridge.

Muguchu (2013) did a study on the relationship between credit scoring mechanism and financial
performance of MFIs in Nairobi, Kenya. The study sought to find out whether there was
relationship between the two variables. The study focused on the imperfect information theory.
The study used secondary sources of data. Secondary data was sourced from the financial
records from the year 2008 to 2012. The study employed descriptive analysis as well as
regression analysis to analyze the data collected. The target population under study was the
licensed MFIs within Nairobi County. Cluster sampling of Bank in the central business district in
Nairobi was done by clustering the BANK based on the streets where they were located. A
sample of 40 MFIs within the central business district was selected for the survey. Descriptive
analysis as well as regression analysis found that there was a positive relationship between credit
scoring mechanism and return on investment for the MFIs. The study recommended that a
financial institution be set to have special lending structures for Bank to enable them access
credit. However, the study used secondary data only, a gap the current study seeks to fill.
.
2.5.3 Credit Monitoring Style and Bank Performance
Nkuah., Tanyeh & Gaeten (2013) did a study on effect of credit monitoring methods on banks in
Ghana: challenges and determinants of performance. The study focused on the credit rationing
theory propounded by Stiglitz and Weiss (1981). The study employed the quantitative approach
of research in which the probability sampling criteria; specifically the stratified and simple
random sampling; were employed to select eighty bank staff from the Wa Municipality. The
19

major findings for the study indicated that there exist significantly, positive relations between
credit monitoring methods and bank performance. The study also revealed that some monitoring
activities such as business registration, documentation, business planning, asset ownership, and
others also impact heavily on banks financial performance. However, the study only focused on
banks that were within the town location; a gap the current study seeks to fill.

Minh (2012) did a study on the effects of credit monitoring on performance of banks in Vietnam.
Due to the characteristics of data, the study could not aim at in-depth specific problems, but at
general pictures of bank financing including endogenous and exogenous variables. The
binominal logit model was used to assess the influence of credit monitoring style on financial
characteristics of the banks such as credit worthiness and profitability. The study adopted
discriminant and cluster analysis to contribute to the findings. Basing on logistic model, the
study found that besides conclusions that were consistent with other studies, there were also
interesting unprecedented conclusions. The study showed that, banks in Vietnam are largely
affected by credit monitoring styles. However, this did not apply to banks in Central North where
it was extremely easy for small business to access funding.. However, the study concentrated on
predetermined list of banks funded by World Bank, a gap the current study seeks to fill.

2.6 Summary of the Research gaps


Most of the studied reviewed focused on loan performance aspect of the banks only while others
focused more on banks that were within the town location or had a predetermined list of banks.
Other studies used secondary data only thus ignoring primary data. These are the gaps the current
study seeks to fill.
20

2.7 Conceptual Framework


A conceptual framework is a theoretical structure of assumptions, principles, and rules that holds
together the ideas comprising a broad concept (Huberman, 1994). Bank performance is the
dependent variable, while credit management forms the independent variable. The indicators for
the various variables are as illustrated in figure 2.1.

Independent Variables

Intervening Variable

Dependent Variable

Central Bank
Credit policy:
Credit control
Credit risk

Regulations

Credit scoring technique:


Scoring platform
Credit requirements

Bank Performance:
Profitability
Loan sales

Credit monitoring style:


Post loan follow up
Non-performing loans

Figure 2.1: Conceptual Framework


Source: Researcher (2015)

21

CHAPTER THREE
RESEARCH METHODOLOGY
3.1 Introduction
This chapter presents the methodology that will be used to carry out the study. It further
describes the research design, type and source of data and research instruments to be used to
collect data. It also describes the target population and the data analysis method.

3.2 Research Design


According to Kothari (2007), research design is defined as framework that shows how
problems under investigation will be solved. The research shall adopt the use of mixed method
approach research design which is the application of both qualitative and quantitative
approaches. Both qualitative and quantitative data shall be collected and converged in order to
provide a comprehensive analysis of the research problem. Creswell, Plano Clark, (2003) refer to
this design as concurrent triangulation design because it involves the concurrent but separate
collection and analysis of quantitative and qualitative data. Creswell and Clark (2011) refer to it
as the convergent design because it involves collecting and analysing two independent strands of
data in a single phase, merging the two results and the looking for convergence and divergence
relationships between the two.

22

3.3 Study Population


According to Mugenda (2003), population is an entire group of individuals, events or objects
having a common observable characteristic. The researcher will draw the population from the
KCB bank branches in Laikipia County. The target population will be staff at the bank. The
population of staff in KCB branches in Laikipia County is approximately 78; as shown in table
3.1.

Table 3.1: Bank Staff Population


Category of Staff

Population

Management

Supervisory

14

Others

59

Total

78

Source: Economic Survey (2014)

3.4 Sampling Size and Sampling Procedure


A sample is a small proportion of a population selected for observation and analysis while
sampling is a deliberate rather than a haphazard method of selecting subjects for observation to
enable scientists infers conclusions about a population (Kothari, 2007). The study will adopt
stratified random sampling whereby each category of the staff will be sampled independently as
shown in the table 3.2. The study will use census survey on managerial and supervisory staff
while simple random sampling (at 30%) will be used on other category of staff.

23

Table 3.2: Sample size


Description

Population

Sample size

Description

Managerial

Census

Supervisory

14

14

Census

Others

59

18

Simple

Total

78

37

sampling (30%)

random

Source: Researcher (2015)

3.5 Data Sources and Collection


The study will obtain secondary data through a data collection form that will indicate the
profitability and loan sales of the banks. However, a semi- structured questionnaire will be used
to collect primary data from the bank staff. The questionnaires are preferred in this study because
respondents of the study are assumed to be literate and quite able to answer questions asked
adequately. Kothari (2007) terms the questionnaire as the most appropriate instrument due to its
ability to collect a large amount of information in a reasonably quick span of time. It guarantees
confidentiality of the source of information through anonymity while ensuring standardization
(Kerlinger, 1973). It is for the above reasons that the questionnaire will be chosen as an
appropriate instrument for this study.

The questionnaire will contain a mix of questions, allowing for both open-ended and specific
responses to a broad range of questions. The questionnaire will be divided into two sections
where section one will deal with the demographic information while section two will deal with
the study variables. However, section two will be subdivided into three subsections in line with
the variables in the study objectives.
24

3.6 Data Collection Procedure


The researcher will obtain an introductory letter from the University to collect data from the
Bank, then personally deliver the questionnaires to the banks and have them filled in his
presence. The researcher will employ self-administration approach of data collection and monitor
the process to ensure that unintended people will not fill the questionnaire or are not interviewed;
by personally conducting the interviews. The questionnaires will be filled and assistance will be
sought where possible thus raising the reliability.

3.7 Validity of Data Collection Instruments


Validity is the degree to which a test measures what it is supposed to measure. For validity of any
measuring instrument to be qualified it must be subjected to a pre-test (Mugenda & Mugenda,
2003). The researcher will test the validity of the instruments through a pilot study. The pre-test
will also allow the researcher to check on whether the variables collected could be easily be
processed and analyzed. The pre-testing will be carried out on a sample consisting of ten (10%)
of the respondents; from Equity bank, Laikipia town branch. Views given by the respondents
during pre-testing will be analyzed and used to improve the questionnaires before actual
collection of data. The researcher will also make consultations with his supervisor to confirm
validity of the research instruments.

3.8 Reliability of the Research Instrument


Reliability is the ratio of the true score variance to the observed score variance. It also refers to
the degree to which a test consistently measures whatever it is designed to measure (Yang &
Manfred, 2005). Thus the reliability of a standardized test is usually expressed as co-efficient
25

where the reliability co-efficient reflects the extent to which a test is free of error variance. The
study will use split-halves and internal consistency method to measure reliability. Splithalves method will be used by comparing the two halves of the responses to each other and
similarities identified. The more similarities between the two halves and each question can be
found the greater the reliability. Internal consistency method will be tested using Cronbachs
Alpha. Cronbach's alpha is a measure of internal consistency, that is, how closely related a set of
items are as a group. A "high" value of alpha is often used as evidence that the items measure an
underlying (or latent) construct (Warmbrod, 2007). Reliability with a predetermined threshold of
0.7 is considered acceptable. That is, values above 0.7 indicate presence of reliability while
values below signify lack of reliability of the research instrument (Warmbrod, 2007).

3.9 Data Analysis and Presentation


The process of data analysis will involve several stages namely; data clean up and explanation.
Secondary data will be analyzed using content analysis. The primary data will then be coded and
checked for any errors and omissions (Kothari, 2007). Frequency tables, percentages and means
will be used to present the findings. Responses in the questionnaires will be tabulated, coded and
processed by use of a computer Statistical Package for Social Science (SPSS) program to analyze
the data. The responses from the open-ended questions will be listed to obtain proportions
appropriately; the response will then be reported by descriptive narrative. Both descriptive and
inferential statistics will be used to analyze the data. Mean and standard deviations will be used
as measures of central tendencies and dispersion respectively. The relationship between the
dependent variable and the independent variables will be tested using Pearsons correlation.

26

3.10 Ethical Considerations


This study will observe confidentiality and privacy of respondents. Consent will be sought from
all respondents before data collection. Humane treatment will be observed throughout the study.
Should the findings of this study be published, the researcher will ensure nothing can be traced
back to any of the respondents. Where possible, pseudonyms will be used unless a respondent
prefers use of their real names.

27

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APPENDICES
Appendix I: Letter of Transmittal
Philip Musili Musyoka,
Kenyatta University,
Dear Respondent,
RE: SURVEY DATA COLLECTION
My name is Philip Musili. I am a student from the Kenyatta University. I am conducting a
survey on credit management and performance. The information provided by you will be
treated confidentially and will not be disclosed to any third party. Information will only be
collected for the purposes of research in order to establish the relation of the two variables. I
therefore request you to feel free and provide honest answers without fearing any
intimidation or disclosure of the information.
Your assistance and cooperation will be appreciated.
Kind Regards.

Philip Musili,
Researcher,
Kenyatta University.

31

Appendix II: Questionnaire


Questionnaire to bank staff

32

Appendix III: Budget

Appendix IV: Work Plan

33

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