i

CREDIT MANAGEMENT POLICY AND PROFITABILITY OF A COMMERCIAL

BANK A CASE STUDY OF HOUSING FINANCE BANK (HFB)

SUBMITTED BY:

BARASA WAFULA MICHAEL

06/K/4111/EXT

SUPERVISOR:

WASSWA GABRIEL

A RESEARCH REPORT SUBMITTED IN PARTIAL FULFILMENT OF THE

REQUIREMENT FOR THE A WARD OF THE DEGREE OF BACHELORS OF

COMMERCE FROM MAKERERE UNIVERSITY

JULY 2011

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DECLARATION

I, Barasa Wafula Michael declare that this research report is my original work and has not

been published or submitted to any University before and where other people’s literature has

been used, acknowledgment has been duly accorded.

RESEARCHER:

Signature……………………………………………………..Date……………………………

……………………

BARASA WAFULA MICHAEL

ii

APPROVAL

This is to certify that this piece of research was submitted to the University with my approval

as the candidate’s supervisor.

Signature……………………………………………………………….Date…………………

……………………………

MR.WASSWA GABRIEL

Supervisor.

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DEDICATION

I dedicate this piece of work to my dear parents MR. and MRS. WAFULA and the family for

their financial and moral support in my studies. It is the achievement they have indeed

worked for. Thank you and be rewarded abundantly.

iv

ACKNOWLEDGEMENT

I wish to extend my gratitude to all persons for the immeasurable support and useful

contribution towards my studies.

I would like to extend my sincere thanks to my supervisor Mr. Wasswa Gabriel for the

assistance, advice, patience and time he accorded me towards the success of this work.

I equally thank all my lecturers, who beyond their core duty of teaching, overwhelmingly

imparted wisdom that have remained a guiding stick in my life and my studies at the

University.

To my dear friends and colleagues: Ms M. Felister; Ms N. Aida; Mr. I. Joel; Mr. Kitongo K;

Mr. Kibet K; Mr. M. Sebastian and Ms. W. Juliet, I thank you very much for whatever

assistance you accorded me. May the Almighty God reward you abundantly.

Most importantly, I praise and thank God for the love, grace, strength and providence. I pray

that He leads me yet again into the green pastures.

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TABLE OF CONTENTS

APPROVAL ......................................................................................................................... ii

DEDICATION ..................................................................................................................... iii

ACKNOWLEDGEMENT .................................................................................................... iv

LIST OF TABLES ............................................................................................................... ix

ABSTRACT ......................................................................................................................... x

LIST OF ABBREVIATIONS: ............................................................................................. xi

1.0 INTRODUCTION ......................................................................................................... 1

1.1 Background of the Study ................................................................................................. 1

1.2 Statement of the Problem ................................................................................................ 2

1.3 Purpose of the Study........................................................................................................ 2

1.4 Objectives of the Study ................................................................................................... 2

1.5 Research Questions ......................................................................................................... 3

1.6 Scope of the Study........................................................................................................... 3

1.7 Significance of the Study ................................................................................................. 3

2.0 LITERATURE REVIEW ........................................................................................ 5

2.1 Introduction ..................................................................................................................... 5

2.2 Credit Management Policy .............................................................................................. 5

2.2.1 Credit Procedures ......................................................................................................... 5

2.2.2 Credit Standards ........................................................................................................... 7

2.2.3 Credit Terms ................................................................................................................ 9

2.4 Profitability .................................................................................................................. 12

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2.5 Relationship between Credit Management Policy and Profitability levels ...................... 13

3.0 METHODOLOY .................................................................................................... 14

3.1 Introduction ................................................................................................................... 14

3.2 Research Design ............................................................................................................ 14

3.3 Study Area .................................................................................................................... 14

3.4 Sampling population and size ........................................................................................ 14

3.5 Sampling procedures ..................................................................................................... 15

3.6 Source of Data ............................................................................................................... 15

3.6.1 Primary Data .............................................................................................................. 15

3.6.2 Secondary Data .......................................................................................................... 15

3.7 Data collection Instruments ........................................................................................... 15

3.7.1Questionnaire .............................................................................................................. 16

3.7.2 Interviews ................................................................................................................... 16

3.8 Data processing, Analysis and presentation ................................................................... 16

3.8.1 Data processing .......................................................................................................... 16

3.8.2 Data Analysis ............................................................................................................. 16

3.8.3 Data Presentation ........................................................................................................ 16

3.9 Limitations and Constraints and their possible solutions ................................................ 16

4.0 PRESENTATION, ANALYSIS AND INTERPRETATION OF FINDINGS ........... 18

4.1 Introduction ................................................................................................................... 18

4.2 General Findings ........................................................................................................... 18

4.2.1 Findings on gender distribution .................................................................................. 19

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4.2.3 Findings on how long the employees have worked with HFB. .................................... 20

4.3 Findings on the Credit Management Policy ................................................................... 21

4.3.1 Findings on the credit standards .................................................................................. 21

4.3.1.2 Findings on HFB’ requisition of collateral to extend credit to customers. ................. 22

4.3.1.3 Finding on whether HFB considers the prevailing conditions before extending credit

to borrower........... .............................................................................................................. .22

4.3.1.4 Findings on whether HFB takes in account its financial position prior to allocating

loan its customers. ............................................................................................................... 23

4.3.1.5 Findings on whether the borrower’s ability to pay is considered in extending loans to

borrowers.......... ................................................................................................................. .24

4.3.2 Findings on the Credit Terms...................................................................................... 25

4.3.2.3 Findings on whether HFB offers cash discount to its loan customers . ....... 26

4.5 Findings on HFB Profitability level ............................................................................... 29

4.4.1 Findings on whether HFB has been making sufficient profits to cover up all the

operation costs. ................................................................................................................... 29

4.6 Relationship between Credit Management Policy and the Profitability levels ................ 30

CHAPTER FIVE............................................................................................................... 31

5.0 SUMMARY, CONCLUSION AND RECOMMENTATIONS .................................. 31

5.1 Introduction ................................................................................................................... 31

5.2 Summary of the Findings .............................................................................................. 31

5.3 Conclusions ................................................................................................................... 32

5.4 Recommendations ......................................................................................................... 32

5.5 Suggested Areas for Further Research: .......................................................................... 32

viii

REFERENCES .................................................................................................................. 33

APPENDICES .......................................................................................................................

I.Budget ..................................................................................................................................

I.Questionnaires ......................................................................................................................

III.The Introdutory Letter ........................................................................................................

ix

LIST OF TABLES

Table 3.1: Showing the sample population and size. ............................................................ 15

Table 4.1: showing the findings on response to study. ......................................................... 18

Table 4.2: Employee gender distribution ............................................................................. 19

Table 4.3: Employee educational background...................................................................... 19

Table 4.4: showing the age distribution of HFB’ employees ................................................ 20

Table 4.5: Showing the lengths the employees have worked with HFB................................ 20

Table 4.6: showing customers willingness to pay ................................................................ 21

Table 4.7: showing the HFB requisitioning for collateral for debt extension to customers.... 22

Table 4.8: showing the findings on whether the prevailing conditions affect the HFB in

extending credit to customers. ............................................................................................. 22

Table 4.9: whether HFB considers its financial state before allocating credit to customers... 23

Table 4.10: on the findings if HFB considers the customer’s ability to pay the before

allocating the loan. .............................................................................................................. 24

Table 4.11: Showing the findings on the credit policy followed by HFB ............................. 25

Table 4.12: showing the findings on the credit period that HFB follows: ............................. 25

Table 4.13: showing the cash discount rates that HFB allow to its loan borrowers ............... 26

Table 4.14: whether the collection efforts applied by HFB are effective in collecting debt:.. 27

Table 4.15: showing other determinants of bank profitability levels .................................... 28

Table 4.16: showing whether HFB has been making the anticipated profits. ........................ 29

Table A: showing the expenditures schedule ........................................................................ 1

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ABSTRACT

The topic of study was; “Credit Management Policy and Profitability of Mortgage Firm in

Housing Finance Bank Ltd”. The objectives of the study were: To establish the bank’s credit

management policy, To assess and analyze HFB’s profitability and To establish the between

credit management and HFB’s profitability.

The study was a cross-sectional survey covering a period of six months from January to June

2011. Qualitative and quantitative data were collected from the employees of the bank in

various departments. The sample size comprised of 35 respondents who were purposely and

simple randomly selected to minimize biases in the results. Self administered questionnaires

were the main data collection instrument and the findings were analyzed using frequencies,

percentages and SPSS was used to analyze the relationship between credit management

policy and profitability in HFB.

The findings on the bank’s credit management policy show that there is an efficient credit

policy in place, the employees literally know it and so help the bank in implementing it even

though the bank at times lack funds to update the policy to meeting the dynamic customer

needs. The findings showed that other factors; bank-specific and the macroeconomic

variables, also affect the profit levels of the bank. The findings on the bank’s profitability

have been slightly above average even though making losses at times. The findings on the

relationship between the credit management policy and the profitability showed a positive

relationship of 0.486.

Recommendations on the bank’s credit management policy were that; the employees were to

be trained better in the implementation skills of the policy and that more funds should be

allocated to credit department to enable the periodic update of the policy to meet the

changing customer needs. Recommendations on the bank’s profitability were that it should

emphasize on the collateral, and the use of the reminders, insurance policy and litigation to

minimize losses resulting from investing in vulnerable clients.

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LIST OF ABBREVIATIONS:

HFB…………. Housing Finance Bank

Co……………. Company

Ltd……………. Limited

AgDm…………Ag Decision Maker

SPSS…………..Statistical Packages for Social Sciences

ACCA …………..Associated Chattered Certified C Accountant

%age…………….Percentage

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CHAPTER ONE

1.0 INTRODUCTION

1.1 Background of the Study

Credit management policy is a comprehensive process that deals with identifying the

target markets, credit extension; credit monitoring and identifying the proceeds. Credit

management policy entails the mechanisms, standards and the parameters that guide the

bank officers in granting loans and manage the loan portfolio under the banking

discipline. Credit policy is defined as a set of guidelines designed to minimize costs

associated with credit while maximizing benefits from it McNaughton (1996).

Profitability, it is always associated with performance and productivity. Therefore, pure

profit is the increase in wealth that an investor gets out of making an investment taking

into account all costs associated with it including the opportunity cost of capital Graham

(1996). Therefore, for the business to exist, it has to be profitable.

The Housing Finance Bank where the research is based is headquartered at Investment

House, Plot 4, Wampewo Avenue, Lower Kololo. Housing Finance Bank Co. Ltd was

established on 7/12/1967 basically as a mortgage finance company. Mortgage finance is

the main business of the bank and as of 31/12/2007 was commanding a market share of

70%. Mortgage is described as a broad array of loans secured by real property like

commercial or residential estate, industrial property or land. The HFB offers the

following mortgage products: home mortgage loan; residential multi-units; commercial

construction purchase mortgage; equity release; Agency mortgage among others. Other

activities include: deposit acceptance; honoring checks, bills and related instruments;

secured and non-secured lending; foreign exchange services and participation in clearing

systems.

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The research study

was carried out to establish whether there is a positive relationship between the credit

management policy and profitability levels with the case study of HFB. The findings of

which may usefully be applicable to all financial institutions to manage properly their

financial resources invested in credit. The findings may also be significant to other policy

makers in planning for economic development of a country in addition to helping the

business owners to see that their funds are properly managed.

1.2 Statement of the Problem

Housing Finance Bank has remained a leading mortgage firm in Uganda given the fact

that it has remained a monopoly ever since its inception in 1967. However, being a

commercial bank it has remained an underperformer as it is being rated number ten in the

country (New Vision Nov. 11th 2010). It is on this ground that the researcher bases his

study to establish whether the bank has been managing its credit policy effectively other

factors that affect the profitability levels in Housing Finance Bank Co Ltd.

1.3 Purpose of the Study

The study intends to establish the relationship between credit management and

profitability levels in the HFB.

1.4 Objectives of the Study

The study objectives include:

i. To establish whether the Housing Finance Bank (HFB) has an effective and

efficient credit management policy in place.

ii. To establish other factors which affect profitability levels of HFB

iii. To assess and analyze the profitability levels of the HFB.

iv. To establish the relationship between credit management policy and profitability.

3

1.5 Research Questions

To achieve the above question objectives, the researcher will be guided by the

questions below:

i. What is the Housing Finance Bank’s credit management policy?

ii. What other factors affect the profitability levels of HFB?

iii. What is the Housing Finance Bank’s profitability level?

iv. What is the relationship between credit management policy and profitability in

HFB?

1.6 Scope of the Study

1.6.1 Subject scope

The study will focus on examining the relationship between credit policy management

and profitability in HFB-Uganda Ltd and also establishing other factors that affect its

profitability levels.

1.0 Geographical scope

The study will be carried out at HFB Investment House.

1.6.3 Time scope

The study covers the period between January and July 2011 to conclusively justify the

research findings.

1.7 Significance of the Study

The study will be significant in the following ways:

To examine the relationship between credit policy and profitability, the findings will be

helpful in order to manage credit so as to improve the bank’s profitability.

4

The study findings will help scholars to seek more knowledge about the credit

management policy in many other financial institutions in order to shot light on credit

policy for profitability.

The findings will also be helpful in building on the already existing literature about credit

policy.

The policy makers and government will find the study findings vital especially in

building and widening on the existing information on the credit policy management and

profitability.

The researcher will find the study significant in the fulfillment of the requirement for the

award of the degree of Bachelor of Commerce at Makerere University.

Financial institutions will find the research findings useful in providing an insight in to

the sound credit management practices.

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CHAPTER TWO

2.0 LITERATURE REVIEW

2.1 Introduction

The researcher in this chapter will define the variables under study both theoretically and

empirically in the existing literature about credit management policy and profitability.

2.2 Credit Management Policy

Credit management policy is defined as the rules and guidelines established by top

management that governs the company’s credit department audits performance in the

extension of credit privileges Jim Franklin (2010). It is simply a set of guidelines designed to

minimize costs associated with credit while maximizing benefits from it McNaughton (1996).

Credit management policies entail the credit procedures, credit standards and credit terms.

2.2.1 Credit Procedures

To achieve the good goals of credit management policy Franklin (2010) advised the adoption

use of credit procedures. To Franklin, credit procedures are specific ways in which top

management requires the credit department to achieve the credit management policies. The

credit procedures include instructions on what data to be used for credit investigation and

analysis process, provide information for data approval process, account supervision and

instances requiring management’s notification. Such credit collection efforts include the use

of reminders, insurance policy, the use of litigation and final write off as highlighted below:

2.2.1.1 Reminders

This basically involves sending a demand note to inform the debtor of the amount due, and if

no response is gotten, progressive steps using tighter measures are taken Pandey (1998).

6

These other measures include sending a polite letter to the customer and if no response, the

customer is contacted through the telephone or actually visiting him or her and as the last

resort tending towards legal measures Kasozi (1998).

2.2.1.2 Insurance policy

This involves a business firm undertaking to insure all the debts that are rated bad. The firm

should insure all the debts that are above the money level BPP (2002). Insurance companies

undertake to compensate the creditor firm in the event that the debtor defaults and as such the

insurer must accept such an arrangement only when the client company has an effective

credit policy Kakuru (2001).

2.2.1.3 Factoring debtors

This involves the sale of debts to the financial institutions. The debtor factoring is a

cushionary measure to safeguard the company money since credit firm obtains in advance the

credit cash from the insurer and that it incurs lower costs involved with credit Flouck (2001).

In this way creditor gets relieved off the collection and administrative costs of debts and other

risks involved in managing such loans.

2.2.1.4 The use of litigation

This involves taking legal action against the customer who fails to meet his obligations. This

arises when credit is a bad debt where there is a major break down in the repayment

agreement resulting in undue delays in collection in which it appears that legal maybe

required to effect collection (Kasozi 1998). This is resorted to as the last measure and more

so where the firm’s relationship with the customer has soared.

7

2.2.1.5 Final write off

This is where in the books of the company the debt is declared uncollectible and therefore, it

is written off as bad debt. If debts are deemed to bad and that they have been lost, it is then

better to scrap them from the books of accounts to give them a true and fair view of the

company’s financial position BPP (2000).

2.2.2 Credit Standards

These are the criteria that the client should meet to qualify for credit and according Kakuru

(2000). These require intensive analysis to ensure effectiveness. To Bogeson (1994) credit

standards are the criteria that the firm follows when selecting customers for credit allocation.

It is vital for the credit standards to be set basing on individual credit applicant by considering

credit information, credit limits and default rate Kakuru (2001). Pandey (1993) recognizes the

5Cs as measurement parameters in setting credit standards and these include;

2.2.2.1 Character

This evaluates the applicants’ traits to analyze the willingness to meet the credit obligations.

Kakuru (2000) highlighted the following variables to consider when analyzing applicant’s

character This is done considering the applicant’s banking behavior from the bank records,

the level of education, mental status, occupation stability, contact, attachment to government

agencies and the previous dealings with bank. This is done to ascertain the applicant’s honest

AgDm (2011 updates).

2.2.2.2 Capacity

This evaluates the applicant’s ability to pay the debt when advanced in the required time

period. This is ascertained by evaluating the value of customer’s capital and asset offered as

collateral against the loan.

8

2.2.2.3 Capital

This refers to the general conditions of the firm. This is ascertained by the analysis of the

financial statements with special emphasis on the risks and the debt-equity ratios and also

evaluating the customer firm working capital positions Floucks (2001). The financial

manager can also assess the balance sheet to ascertain how much the owner has invested into

the business as his own personal stake BPP (2000).

2.2.2.4 Collateral

This refers to items like land, houses, commercial and residential estates or any other

property of value offered as security of the value of the loan extended to the borrower Kakuru

(2001). The collateral should be safe, easily marketed and that its value should be able to

cover up the debt when sold in case the borrower defaults to pay Van Horne (1995).

2.2.2.5 Conditions

These refer to the prevailing economic and financial environment which may affect or be a

detriment to the borrower’s ability to pay the debt and which may prove unprofitable to the

creditor. For instance, under inflationary tendencies it is unsuitable to grand credit as the

creditor is bound to loose on the loaned amount if not earning low returns. The financial

manager should form a reasonable judgment regarding the chances of default and estimate

the probability of loss under such conditions Pandey (1996).

It is important that the credit standards are set basing on individual credit applicant bearing in

mind the credit information, credit analysis and credit limits AgGm (2011 update).

2.2.2.6 Credit information

This involves the application of reliable and timely information that is critical in managing

the credit process. Credit information is critical in the sense that it helps minimize losses

9

resulting from investing in unreliable credit clients Kakuru (2001). Such information include;

the customers’ years in present business, the length of time at present location, financial data,

credit rating with other vendors and credit rating agencies and the information about the

principals of the company and other related information.

2.2.2.7 Credit analysis

This involves establishing customers’ willingness and ability to meet the loan obligations as

they fall due. The firm’s credit analysis should ensure that the loans meet the company’s set

credit standards McNaughton (1996), and that it should follow a typical domestic process

flow beginning with data collecting and moving to action observing AgDm (2011 updates).

The credit analysis in an important aspect in n designing a credit policy since it culminates

into the seasons regarding the amount of loan to be extended to the applicant, Maurice and

Monitiz (1970).

2.2.2.8 Credit limit

This is the maximum amount of credit which the firm can extend to customers at any point in

time. In setting up the credit limit, considerations must be taken to maximize the returns in

terms of the sales and also the financial strengths of the customer to ascertain whether he will

be able to pay the credit obligation. More so, the credit limit should be flexible and revisable

so often to suit the dynamisms and advantage of the opportunities in the market.

2.2.3 Credit Terms

Credit terms refer to the stipulations under which the firm or the bank institution offers credit

to borrowers Pandey (1993). Pandey recommends the following as the credit terms:

10

2.2.3.2 Credit period

This is the schedule of the interest payment and the final settlement of the principal amount.

It is the time length between credit extension time to the expected time the customer is

expected to pay back the credit Llewellyn and Ginza (1972).

2.2.3.2 Cash discount

This is a percentage reduction on the debt amount to be paid by the borrower. This acts as an

incentive to induce the customer to repay the credit obligation within or less than the credit

period. Cash discount acts as a tool to accelerate credit collections from the customers and

this helps the firm reduce on the level of receivables and their associated costs Reigner and

Hill (1997).

Once a credit decision has been made, the bank has to decide on the credit period, amount

and period of the cash discount if any, and the credit instrument to be used Tumuhimbise

(1996).

2.3 Other factors Affecting Bank Profitability

A study by Allen and Bali (2004) during the period between 1973 and 2003, to examine the

catastrophic risk of financial institutions evidences the pro-cyclicality of both the operational

and catastrophic risk measurements, implying that macroeconomic, systematic and

environmental factors play a considerable role in determining the returns of financial

institutions. Bank profitability is also shaped by bank-specific factors and the macroeconomic

control variables in which the bank operate are not under the direct control of the bank’s

management Athanasoglou, et al (2006b).

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2.3.1 Bank-Specific Factors

2.3.1.1 Bank Activity Mix

This is an important proxy for the overall level of risk undertaken by banks to the extent that

different sources of incomes are characterized by different credit risk and volatility. Interest

bearing is generally regarded as a riskier than fee based activities which would need to be

rewarded by higher returns and that banks with relatively high non-interest earning assets are

generally less profitable Demirguc-Kunt and Huizinga (1998).

2.3.1.2 Capital

Capital is an important variable in determining the bank profitability, although in the

presence of capital requirement it may proxy risk and regulatory costs Al-Haschimi (2007).

In imperfect capital markets, well-capitalized banks need to borrow less in order to support a

given level of assets and tend to face lower costs of funding due to lower prospective

bankruptcy costs Allen and Bali (2004). Also, in the presence of asymmetric information a

well-capitalized bank could provide a signal to the market that a better than average

performance should be expected Berger (1995). This shows a negative association between

capital and profits.

2.3.1.3 Market Power

This according to Flamini, McDonald and Schumacher (2009), is a major determinant of

profits because banks in more concentrated markets should be capable of adjusting spreads in

response to unfavorable changes in the macroeconomic environment to leave the returns

unaffected. The market power is measured by the market concentration, the impact of

managerial inefficiencies Al-Haschimi (2007) and the coefficient of squared size variable

Brock and Rojas Suarez (2000).

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2.3.2 Macroeconomic Control Variable

The macroeconomic control variables include inflation, price of fuel, price of commodities,

economic development of each country and the institutional environment in which the banks

operate in Angbazo (1997). In the study to analyze the determinants of interest rate margins

in six countries of European Union it was observed that macroeconomic volatility and

regulations have a significant impact on the bank profit levels, Saunders and Schumacher

(2000).

2.4 Profitability

Profitability is measured by the incomes and the expenses. Income is the money generated

from the activities of the business for example, the interest incomes on the loan obligations.

Expenses are the costs of the resources used up or consumed by the business. These costs

include the opportunity cost for tying up the funds in debts, the cost of running the credit

operations, cost of time to chase for debts, cost of bad debts and cost of debt recovery Leong

(2009).

Profitability be defined as either accounting or economic profits. Accounting profits is the

excesses of the incomes over the expenses. This involves all the taxable incomes less all the

deductible expenses. For a business unit to run, it must be making profits Drucker(1968).

However, a single non-profit financial year may not really harm the business of the firm, but

when the firm incurs losses in consecutive years this may jeorpadize the viability of that

business Don (2009).

The accounting profits are measured to ascertain the success of the business; to see the

business’ chances of survival; and to ascertain its ability to reward the owners for their

investment into the business, and this according to Don is the main goal of the management.

The measurement of accounting profit is done by several instruments some of them include

13

the income statement which accounts for the ending finsncial year. Another such instrument

is the proforma income statement that measures projected profitability of the business for the

coming accounting year.

Economic profit is computed by deducting the opportunity cost from the net income Graham

(1996). The opportunity cost include the money, the labor and the management ability

directed towards credit allocation AgDm (2011 updates). Economic profits are computed to

provide the business with a long-term perspective to oversee its continued operation.

The firms profitability is influenced by the structure of the revenue generating assets like

credit in banks which generate revenue in terms of the interest incomes. Also profitability is

dependant on the firm’s ability to eliminate risks in the asset operation to ensure

correspondence between the assets and the liabilities Bobakova (2003).

2.5 Relationship between Credit Management Policy and Profitability levels

Advancing credit to applicants imply that a firm’s money is tied up somewhere whose

payment is in the future. Given the fact that the future is characterized by great uncertainty,

the availability of credit is negatively related profitability because it is never known whether

these debts would be collected, and that the firms use the funds for survival than for

investment and restructuring Sharpele (2000).

Conversely, if the firm more so a commercial bank constrains credit it lowers on its profit

levels Don (2009). This is because such financial institutions earn returns in terms of the

interest incomes charged on these loans. These lower profit levels may also be due to a

number of sources including lower investment levels and misallocation of variable inputs

Brigham (1997). Thus, there is need to have an efficient credit management policy to

minimize the costs involved in loan allocation whereas on the other hand maximizing the

returns from such undertakings.

14

CHAPTER THREE

3.0 METHODOLOY

3.1 Introduction

The chapter covers the following sections namely: the research design, the study area, sample

size and sampling procedure, source of data, data collection procedures, analysis and

presentation and the problems encountered during the study.

3.2 Research Design

A cross sectional study design was used where both the quantitative and qualitative data were

collected from January to July 2011 to ascertain the relationship between credit management

policy and profitability.

3.3 Study Area

The study was carried out at Housing Finance Bank Company Limited, Head Office, at

investment House, plot 4, Wampewo Avenue Lower Kololo.

3.4 Sampling population and size

The study was done on 35 respondents who are staff from credit control department, staff

from finance department, accounting section and some senior management. Special

considerations were given to the knowledge and skills of the respondents in relation to the

variables under study and the for gender observance.

15

Table 3.1: Showing the sample population and size.

POPULATION SIZE

Employees from the finance department 14

Employees from accounts section 12

Credit risk evaluators 6

Senior managers 3

Total 35

Source: Primary data.

3.5 Sampling procedures

Persons were selected into a sample population by simple random from the population of

employees to avoid biasness. The sample population was stratified into specific groups

where each was researched for relevant information.

3.6 Source of Data

3.6.1 Primary Data

These were new facts about the variables under study collected directly from respondents.

3.6.2 Secondary Data

These entailed the review of already existing literature from recognized journals, reports,

publications, newspapers and articles that carried information on credit management

policy and profitability.

3.7 Data collection Instruments

These are the tools that were used to collect the data and they include.

16

3.7.1 Questionnaire

These are simple structured questions that were served to the population under their views

and facts about the facts. The data collected was then edited, sorted and coded for

completeness.

3.7.2 Interviews

The researcher here sat with the bank’s junior staff posing questions and recorded their

responses.

3.8 Data processing, Analysis and presentation

3.8.1 Data processing

The collected data was edited, sorted and coded in readiness for analysis.

3.8.2 Data Analysis

The collected and organized data were classified and analyzed using the frequency tables

with the help of the Statistical Package for Social Sciences (SPSS) to establish the

relationship between credit management policy and profitability.

3.8.3 Data Presentation

The analyzed data were presented in tables with frequencies and percentages in order to

come up with systematic and well organized information for decision makers.

3.9 Limitations and Constraints and their possible solutions

Financial costs to cover the purchase of stationary, movements to meet respondents and

facilitations like airtime. The researcher tried to minimize some expenditure which may

not have added value to the study.

Poor response, this is in the case of unanswered and semi-answered questionnaires and

unwillingness of the respondents to answer the question during interviews.

17

The researcher found it difficult to access the bank’s confidential information. The

researcher had to have an introductory letter and confirm that the study was purely

academic.

The problem of time constraint, the researcher had to pursue his academics alongside

undertaking the research during that short period. This limited the desire to do intensive

study in the variables under study. The researcher had to come with a Gantt chart to guide

him in the study.

18

CHAPTER FOUR

4.0 PRESENTATION, ANALYSIS AND INTERPRETATION OF FINDINGS

4.1 Introduction

The chapter involves the presentation of the findings in reference to the research question

raised in chapter one of this study. The findings were obtained from both primary and

secondary data sources.

The data were presented and analyzed using SPSS, frequencies tables and percentages

that were used to establish the relationship between the variable under.

4.2 General Findings

Table 4.1: showing the findings on response to study.

SCALE RESPONSE

Freq. %age

Yes 35 87.5

No - -

Non-response 5 12.5

Total 40 100

Source: Primary data

The findings from the table shows that 87.5% of employees approached for response

accepted. It is from this that researcher formed the sample size. Thus the study was based on

sample size of 35 respondents who are employees of the HFB. Findings on their personal

background information are as follows:

19

4.2.1 Findings on gender distribution

The findings on the employees’ gender distribution were analyzed in the table below.

Table 4.2: Employee gender distribution

SEX Total

Response Male Female

Frequency 16 19 35

Percentage 45.7 54.3 100

Source: Primary data

The findings show that most female respondents than the males. It is probable then that HFB

has more female employees than their male counterparts.

The findings from the table shows that most of the HFB’ employees are above the age of 30

years. This may probably be giving HFB an experience in implementing its credit policy

since such people react positively to enthusiastic changes.

Findings on employee educational background.

The on the HFB’s workers’ educational level were analyzed as in the table below.

Table 4.3: Employee educational background

Response Educational level Total

University Tertiary colleges Basic Education

Frequency 17 11 7 35

Percentage 48.6 31.4 20 100

Source: Primary data.

20

From the above it is clear that HFB has a learned employee base with 48.6% of them having

gone through university and 31.4% through the tertiary colleges. It is probable that these

learned employees have helped HFB to implement credit management policy. The other 20%

had attained only secondary education.

Table 4.4: showing the age distribution of HFB’ employees

RANGE RESPONSE

Freq. %age

20-30 Years 4 11.4

31-35 Years 20 57.2

36-40 Years 7 20

41 Years and above 4 11.4

Total 35 100

Source: Primary data

4.2.3 Findings on how long the employees have worked with HFB.

There was need to establish how long the employees had worked with HFB and findings

below show what the researcher found.

Table 4.5: Showing the lengths the employees have worked with HFB.

EMPLOYEES WORKING

DURATION IN YEARS

RESPONSE

Freq %age

Less than 1 year 2 5.7

Between 1 and 3 years 6 17.2

Between 3 and 5 years 9 25.8

5 years and above 18 54.3

TOTAL 35 100

Source: Primary data

21

The findings in the table above show that 54.3% of the employees have worked with HFB

more than five years. the other 25.8% between three and five years, 17.2% for up to three

years and a small percent of 5.7% for up to a year. This may likely be a reason to believe that

HFB have built an effective credit management policy through the long serving workers.

4.3 Findings on the Credit Management Policy

To ascertain whether the HFB has an efficient credit management policy in place that enabled

it to remain profitable for long, the following findings were discovered.

4.3.1 Findings on the credit standards

4.3.1.1 Findings on whether HFB assess the deb tors’ willingness before

extending loan credit .

The findings on the willingness of the HFB’ customers to pay back their loan obligation was

analyzed as below.

Table 4.6: showing customers willingness to pay

ATTRIBUTE RESPONSES TOTAL

YES NO NON-

RESPONSE

Freq. %age Freq. %age Freq. %age Freq. %age

Customers

banking behavior

26 74.4 4 11.4 6 17.2 35 100

Customers’ job

and business

29 82.9 _ _ 6 17.1 35 100

Customers loyal

to HFB

24 68.6 6 17.2 5 14.3 35 100

Customers’

educational level

21 60 14 40 _ _ 35 100

Source: Primary data

22

The findings in the table above shows that HFB assesses the customers’ willingness to pay

the debt by strictly laying emphasis on the attributes mentioned in the table. That is 74.4%

said yes to customers’ banking behavior, 82.9% to customers’ source of income, 68.6 % to

customers loyal to HFB and 60% to applicants’ educational level.

4.3.1.2 Findings on HFB’ requisition of collateral to extend credit to customers.

The researcher wanted to establish whether the bank requisitions for collateral to extend loans

to borrowers and analyzed the findings in the table below.

Table 4.7: showing the HFB requisitioning for collateral for debt extension to

customers.

RESPONSE Freq. %age

Yes 30 85.7

No 1 2.9

Non-response 4 11.4

Total 35 100

Source: Primary data

The findings show that 85.7% of the respondents say HFB requisitions for collateral for the

extension of credit to the borrowers.

4.3.1.3 Finding on whether HFB considers the prevailing conditions before extending

credit to borrowers.

Table 4.8: showing the findings on whether the prevailing conditions affect the HFB in

extending credit to customers.

SCALE RESPONSE

Freq. %age

Yes 17 48.6

No 15 42.9

Non-response 3 8.5

Total 35 100

Source: Primary data

23

From the table it is clear that the bank does not put much emphasis on the prevailing

conditions as a prerequisite to extending credit to the customers with only 48.6% supporting

it while 42.95 rejecting it.

4.3.1.4 Findings on whether HFB takes in account its financial position prior to

allocating loan its customers.

Table 4.9: showing whether HFB considers its financial state before allocating credit to

customers.

SCALE RESPONSE

Freq. %age

Strongly agree 30 85.7

Agree 3 8.6

Not sure 2 5.7

Disagree - -

Strongly disagree - -

Total 35 100

Source: Primary data

The findings from the table above show that 85.7% of the respondents strongly agree that

HFB considers its financial conditions before giving loans to the applicants.

24

4.3.1.5 Findings on whether the borrower’s ability to pay is considered in extending

loans to borrowers.

Table 4.10: on the findings if HFB considers the customer’s ability to pay the before

allocating the loan.

SCALE RESPONSE

Freq. %age

Strongly agree 34 97.1

Agree 1 2.9

Not sure - -

Disagree - -

Strongly agree - -

Total 35 100

Source: Primary data

The findings reveal 100% of the respondents agree that HFB considers the borrowers’ ability

to repay the loan before such customer is given the credit he is seeking of which 97.1 strongly

supports this.

25

4.3.2 Findings on the Credit Terms

The researcher took consideration on credit period, cash discount and the credit term

policy followed by HFB and the findings were analyzed as below:

4.3.2.1 Findings on which type of credit policy is followed by HFB

Table 4.11: Showing the findings on the credit policy followed by HFB

CREDIT POLICY RESPONSE

Freq. %age

Stringent 14 40

Optimum 18 51.4

Lenient 3 8.6

Not sure - -

Total 35 100

Source: Primary data

From the findings a large percent of 40% of the respondents believe HFB follows a stringent

credit policy while 51.4% believes that HFB opts for an optimum credit policy and a lean

8.6% hold on the lenient. It is then probable that much as HFB follows an optimum policy

and at other times it opts for a stringent policy and may probably be the reason why HFB

claims a larger market share in mortgage business.

4.3.2.2 Findings on the credit period followed by HFB

Table 4.12: showing the findings on the credit period that HFB follows:

CREDIT PERIOD RANGE RESPONSE

Freq. %age

Below 1 month 12 34.3

1-6 months 9 25.7

7-12 months 6 17.1

1-5 years 5 14.3

Over 5 years 3 8.6

Total 35 100

Source: Primary data

26

The finding shows that the respondents have a wide variation on the credit period HFB

adopts. It is likely that HFB applies different credit period to different customers and

probably HFB has no standard credit period to all customers.

4.3.2.3 Findings on whether HFB offers cash discount to its loan customers .

Table 4.13: showing the cash discount rates that HFB allow to its loan borrowers

CASH DISCOUNT RATES RESPONSE

Freq. %age

Up to 1.5% 10 28.6

1.6-2.5% 10 28.6

2.6-3.5% 8 22.8

Over 3.6% 7 20

Total 35 100

Source: Primary data

From the findings 28 respondents show that HFB allows up to 3.5% cash discount to induce

the debtors to pay promptly a representation of 80% of the responses. However, it is probable

that HFB allows different cash discount rate to different customers.

27

4.3.3 Findings on whether the collection procedures that HFB use are

effective.

Table 4.14: showing whether the collection efforts applied by HFB are effective in

collecting most debt:

RESPONSES Reminders Insurance Factoring Litigation Write off

Strongly

Agree

Freq. 15 20 18 10 25

%age 42.8 57.1 51.4 28.6 71.4

Agree Freq. 10 12 12 2 7

%age 28.6 34.3 34.3 5.7 20

Not Sure Freq. 3 - 4 8 3

%age 8.6 - 11.4 22.8 8.6

Disagree Freq. 4 3 1 15 -

%age 11.4 8.6 2.9 42.9 -

Strongly

Disagree

Freq. 3 - - - -

%age 8.6 - - - -

Total Freq. 35 35 35 35 35

%age 100 100 100 100 100

Source: Primary data

The findings show that 71.4% of the respondents agree that HFB employ use of reminders as

collection efforts, 81.4% strongly agree and agree that HFB insures its debts, 85.7% say the

28

bank sells off its debts and 91.4% believe that bad debts are written off. Whereas 34.6%

accept that the bank resorts to legal action to reclaim the debts 71.7% deny this. It may then

be concluded that the bank follows optimum procedure.

4.4 Findings on other determinants of bank profit levels

Table 4.15: showing other determinants of bank profitability levels

FACTOR RESPONSE

YES NO TOTAL

Freq. %age Freq. %age Freq. %age

Activity mix 25 71.4 10 28.6 35 100

Capital 29 82.9 6 7.1 35 100

Market power 19 54.3 16 45.7 35 100

Macroeconomic

variable

32 91.4 3 8.6 35 100

Source: primary data.

The findings show that other factors too affect the profit levels of the bank. 71.4%, 82.8%,

54.3% and 91.4% of the respondents believe the bank activity mix; capital; bank market

power; and macroeconomic variables respectively affect the profit level.

29

4.5 Findings on HFB Profitability level

4.4.1 Findings on whether HFB has been making sufficient profits to cover up all the

operation costs.

Table 4.16: showing the findings on whether HFB has been making the anticipated

profits.

SCALE RESPONSE

Freq. %age

Yes 21 57.1

No 9 25.7

Not sure 5 14.2

Total 35 100

Source: Primary data

The findings show that 57.1% of the respondents believe that HFB has been profitable

enough to cover all its operation costs. This may probably why HFB has maintained the

leading market share since its inception. The other 25.7% of the respondents hold that HFB

has not been profitable whereas 14.2 are not sure likely because they may not be

knowledgeable about HFB’s performance history.

30

4.6 Relationship between Credit Management Policy and the Profitability

levels

5.6 Table 4.17: Showing the relationship between the Credit Management Policy

and Profitability.

Source: Primary data

From the analysis in the table above one can draw a conclusion that there is a 0.486 positive

relationship credit management policy and profitability though weak. This weak relationship

may be as a result of influence of other factors affecting bank profitability.

Credit management

policy

profitability

Credit management policy Pearson correlation

Sig.(2-tailed)

N

1.00

35

0.486*

.003

35

Profitability Pearson correlation

Sig-(2-2tailed)

N

0.486*

0.003

35

1.00

35

31

CHAPTER FIVE

5.0 SUMMARY, CONCLUSION AND RECOMMENTATIONS

5.1 Introduction

The chapter focuses on summary of the findings of the study, the conclusions, the

recommendations and suggested areas of further research to build the study variable under

consideration.

5.2 Summary of the Findings

The summary of the findings is presented in respect to the research objectives as can be seen

below:

The findings revealed that bank has a credit management policy and that many of these

employees are knowledge in the implementation skills of the policy. There was also a

problem of lack of funds to adjust the policy periodically so as to meet the dynamic customer

needs.

The findings also show that the level of bank profitability is also determined by other factors

which include the bank-specific variables and the macroeconomic control variables.

The findings on the profitability levels of HFB showed that the bank earns lower profit levels,

going up and down time and again due to political upheavals. However, the bank registered

positive and upwards profits from 2002.

The analysis of the findings showed that there is a positive relationship of 0.486 between

credit management policy and profitability level.

32

5.3 Conclusions

Basing on the objectives of the research study it was concluded that HFB has a credit

management policy in place that includes; following a stringent credit policy, strict credit

standards and tight credit collection procedures. The HFB has been making profits as per the

findings of the study though such profits have been up and down. However in the formative

years the HFB made negative profits due to unfavorable financial conditions caused by

political instabilities. There is a positive relationship of 0.483 between credit management

adopted by HFB and its profitability. Bank profitability is also determined by bank-specific

variables like the bank activity mix, capital and the market power, and also by the

macroeconomic control variables.

5.4 Recommendations

The employees were to be trained better in the implementation skills of the policy adopted by

the bank and more funds should be directed to the credit department to enable the periodic

update of the policy to meet the changing customer needs, these will enable the bank to have

an effective credit policy. The bank should also emphasize on collateral and the use of the

reminders, insurance policy and the litigation to minimize costs resulting from investing in

vulnerable clients and maximize returns.

5.5 Suggested Areas for Further Research

1. Research on other factors that affect profit making of financial institutions.

2. Effects of credit policy on economic growth.

3. Credit policy and information technology in cost minimization in commercial banks.

4. Reconciliation of the politics and credit policy to ensure maximum returns

33

REFERENCES

Al-Haschimi A. (2007); Determinants of Bank Spreads in Sub- Saharan Africa, draft

Allen, L. and T.G. Bali (2004); Cyclicality in Catastrophic and Operational Risk

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Angbazo, L. (1997); Commercial Banks, Net Interest Margins, Default risk, Interest Rate,

Risk and Off Balance Sheet Banking, Journal of Banking and Finance 21, 56-87.

Athanasoglou, P., Delis M. and C. Staikouras(2006); Determinants of Bank Profitability in

the South Eastern European Region, Bank of Greece Working Paper 06/47.

At Floucks (2001); Financial Management and Control; London.

BPP (2000); Financial Management and Control paper for ACCA, London.

Brigham (1997); Financial Management 8th

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Brock, P. and L. Rojas Suarez (2000); Understanding the Behaviors of Bank Spreads in Latin

America, Journal of Development Economics 63, 113-134.

Don Hofstrand (2009); Understanding Profitability

Drucker P. F. (1968); The Practice of Management, Pan.

Eric Bogeson (1994); Sources of Finance for African Business, Miami USA.

Graham Can (1990); Financial Management, ACCA London College Publications.

I.M. Pandey (1995); Financial Management and Policy, Prentice Hall.

34

Ing. Vikto’ria Bobakova, Csc. (4/2003); Raising The Profitability of Commercial Banks,

BIATEC, Volume XI.

James C. and Van Horne (1994); Financial Mgt & Policy, entice Hall Private Ltd India.

J.P. Morgan (2011); Entrepreneur of 2011.

Kakuru Julius (2001); Finance & Business Division, Crown Publishers Nakawa, MUBS.

Maurice and Monitiz (1970); The Credit Management Dilemmas in the Evaluation of the

Credit Policy.

McNaughton (1996); Building strong Management and responding to changes.

M. E. Sharpele (2000); Emerging Markets and Trade

Reigner K. D. and Hill N. C. (1997); Determining the cash discount in the firm’s credit

policy.

Nduhukire, Rosebell (2002); The Effects of Credit Policy on Performance.

The New Vision; (Nov. 2010).

Tumuhimbise Manasseh (1997); Makerere University Business School, Journal.

Valentine Flamini, Calvin McDonald and Liliana Schumacher (2009); Determinants of

Commercial Bank Profitability in Sub-Saharan Africa, IMF Working Paper.

Van Horne (1985), J.C.; Financial Management Policy, Prentice-Hall of India.

Vera Hughes and Weller D. (1989); Financial Management.

1

APPENDICES

I. Budget

Research involved expenditures and these were as presented in the table below.

Table A: showing the expenditures schedule

ITEMS Cost in UGX

1. Travelling expenses

30000

2. Contacting Respondents

25000

3. Typing and printing costs

45000

4. Photocopying expenses

5000

Total

85000

2

I. Questionnaires

I Barasa Wafula Michael a student at Makerere University, wishing to undertake a purely

academic research study in your institution and kindly requests you to provide responses in

these few questions. The information provided on this questionnaire will be treated with

utmost confidentiality and only for academic purposes. Your contribution to the success of

this study will be highly appreciated.

Do not write your names on this questionnaire.

BASIC INFORMATION

1. Tick in boxes to indicate whether a male or a female.

YES

NO

2. How old are you? Indicate your age in the range shown.

20-30 Years

31-35 Years

36-40 Years

Above 40 Years

3. Tick to indicate educational level.

University

Tertiary college

Basic education

4. How long have you worked with HFB?

Less than 1 Year

1-3 Years

3-5 Years

Above 5 Years

3

CREDIT MANAGEMENT POLICY

5. Do you often ask for bank references before granting credit to customers?

YES

NO

6. (a) Dou you always want to know the nature of your creditors businesses and/or jobs?

YES

NO

(b) If YES to 2(a), which do you assign most?

I. Permanent jobs/ business

II. Temporal jobs/business

III. (i)and (ii)

7. (a) Is the credit period by the applicants a major consideration in the granting credit?

YES

NO

(b) If YES in 7(a) above, which credit period do you consider most appropriate?

Short

Optimum

Long

8. (a) Is the applicant’s ability to repay the credit a main factor to consider?

YES

NO

(b) If YES in 4(a), specify;

I. Applicant’s salary.

II. Applicant’s business incomes

III. Balance sheet

IV. All of the above

4

9. Is collateral needed before extending credit?

YES

NO

10. (a) Do you have loyal customers?

YES

NO

(b) Do you consider the time an applicant has been dealing with you before granting

credit?

YES

NO

11. Which credit term policy does the bank follow?

I. Stringent policy

II. Lenient policy

III. Optimum policy

12. (a) Which credit period do you follow?

I. Below 1 month

II. 1 to 6 months

III. 7 to 12 months

IV. 1 to 5 years

V. Over 5 years

(b) Do you have a standard credit period for all customers?

YES

NO

13. (a) Do you offer cash discounts to customers who pay in the time period?

YES

NO

5

(b) If YES in 9(a) above, at what percentage of cash discount do you allow?

1.5%

2%

Variable

14. On the scale of 1-5, how do you respond to the collection procedures of the bank?

Variable Weight

Strongly agree 5

Agree 4

Not sure 3

Disagree 2

Strongly disagree 1

(a) Reminders

5 4 3 2 1

(b) Insurance policy

5 4 3 2 1

(c) Factoring debtors

5 4 3 2 1

(d) Litigation

5 4 3 2 1

(e) Final write off

5 4 3 2 1

15. (a) In your opinion, is credit management policy the sole determinant of bank

profitability?

YES

NO

6

(b) If NO in 15 (a) above, by what extent?

SMALL

LARGE

INFORMATION ON HFB’S PROFITABILITY

16(a) Has HFB been making sufficient profits to cover up all its operational costs?

YES

NO

NOT SURE

(b) If YES in 15(a) above, were the shareholders satisfied with the dividend payout in

the previous financial year?

YES

NO

NOT SURE

RELATIONSHIP BETWEEN CREDIT MANAGEMENT POLICY AND

PROFITABILITY OF HFB

17(a) In your opinion, how do you rate the firm’s credit management policy?

Very Effective

Effective

Ineffective

Very Ineffective

(b) Will implementing an effective credit management policy affect HFB’s

profitability levels?

YES

NO