BORROWER BEHAVIOUR, RELATIONSHIP LENDING AND CREDIT REPAYMENT PERFORMANCE IN CENTENARY BANK

BY

OSCAR KARAMAGI 2003/HD10/404U

A RESEARCH REPORT SUBMITTED TO THE SCHOOL OF HIGHER DEGREES IN PARTIAL FULFILLMENT FOR THE AWARD OF THE DEGREE OF MASTER OF SCIENCE IN ACCOUNTING & FINANCE OF MAKERERE UNIVERSITY

NOVEMBER, 2011

DECLARATION

I, Oscar Karamagi declare that this dissertation is my own original work, and it has never been presented to any University or institution for the award of any academic qualification.

Signature Date: Oscar Karamagi 2003/HD10/404U

APPROVAL

This is to certify that this dissertation has been submitted with our approval as University supervisors.

Sign: ------------------------------------------- date: -----------------------------------------------Dr. Nkote Nabeta Supervisor

Sign: ------------------------------------------- date: -----------------------------------------------Mr. Fred Luganda Supervisor

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DEDICATION

This piece of work is dedicated to my family particularly to my wife and son Cedric for their encouragement and the Almighty God for His ever presence and guidance in times of need.

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ACKNOWLEDGEMENT

I am specifically delighted to acknowledge the immeasurable assistance of my dear parents Mr. and Mrs. Felix Ndoleriire and the understanding and selfless assistance of my wife Violet.

To the participating respondents who always warmly welcomed me and made my research very fruitful, I thank them. My special thanks go to my supervisors, Dr. Nkote Nabeta and Mr. Fred Luganda for their professional academic guidance during my research. I would also like to thank all the members of my family, my classmates and all my lecturers at the University, and all my teachers and fellow students who have been a source of continuous encouragement and growth. I am also indebted to all the people whose support made this study a success. I would like to thank them here as I will not be able to mention all of them by name.

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TABLE OF CONTENTS DECLARATION....................................................................................................................................i APPROVAL..........................................................................................................................................ii DEDICATION.....................................................................................................................................iii ACKNOWLEDGEMENT....................................................................................................................iv TABLE OF CONTENTS......................................................................................................................v LIST OF TABLES...............................................................................................................................ix ABSTRACT.......................................................................................................................................xiv CHAPTER ONE....................................................................................................................................1 INTRODUCTION.................................................................................................................................1 1.1 Background to the Study ................................................................................................................1 1.2 Statement of the Problem.................................................................................................................3 1.3 Purpose of the Study........................................................................................................................3 1.4 Objectives of the Study....................................................................................................................3 1.5 Research Questions..........................................................................................................................4 1.6 Scope of the Study...........................................................................................................................4 Study Scope...........................................................................................................................................4 Geographical Scope...............................................................................................................................4 1.7 Significance of the Study.................................................................................................................4 1.8 Conceptual Framework....................................................................................................................5 Figure 1.1: Conceptual Framework......................................................................................................6 CHAPTER TWO...................................................................................................................................7 LITERATURE REVIEW......................................................................................................................7

2.1 Introduction......................................................................................................................................7 2.2 Borrower Behaviour and Credit Repayment Performance .............................................................7 2.3 Relationship Lending and Credit Repayment Performance .........................................................11 2.4 Borrower Behaviour and Relationship Lending ...........................................................................15 2.5 Borrower Behaviour, Relationship Lending and Credit Repayment Performance ......................16 CHAPTER THREE.............................................................................................................................18 RESEARCH METHODOLOGY........................................................................................................18 3.1 Introduction....................................................................................................................................18 3.2 Research Design ...........................................................................................................................18 3.3 Study Population ...........................................................................................................................18 3.4 Sample of the Study.......................................................................................................................18 Table 3.1: Sample size.........................................................................................................................19 3.5 Data Sources..................................................................................................................................19 Primary data was obtained through the use of self-administered questionnaire to respondents following systematic and established academic procedures, as suggested by Nunnally and Bernstein (1994). The questionnaires were used for the collection of data from borrowers and staff. ..............19 Secondary data was obtained through the already existing banks literature and any other literature from Centenary Bank annual reports, credit performance reports, BoU Reports and journal articles. The reason for this was to make comparison of secondary data with primary data. ..........................19 3.6 Data Collection Instruments..........................................................................................................19 3.7 Measurement of the Variables.......................................................................................................20 3.8 Reliability and Validity of the Research Instruments....................................................................20 Table 3.2 Validity and Reliability.......................................................................................................21

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3.9 Data Analysis ................................................................................................................................21 3.10 Limitations of the Study..............................................................................................................21 CHAPTER FOUR ..............................................................................................................................23 RESULTS AND FINDINGS OF THE SURVEY...............................................................................23 4.1 Introduction....................................................................................................................................23 4.2 Sample Characteristics...................................................................................................................23 4.2.1 Gender and Category of the respondents ..................................................................................23 Table 4.1: Gender and Category of the respondents ..........................................................................24 4.2.2 Age group and Category of the respondents .............................................................................24 Table 4.2: Age Group and Category of the respondents ...................................................................25 4.2.3 Level of Education and Category of the respondents ...............................................................26 Table 4.3: Level of Education and Category of the respondents .......................................................26 4.2.4 Tenure and Category of the respondents ..................................................................................27 Table 4.4: Tenure and Category of the respondents ..........................................................................27 Source: Primary data...........................................................................................................................27 According to the results in table 4.4 above 32.17% of the staff had worked with the bank for 0-3 years, 40.87% had worked for 3-6 years, 21.74% had worked for 6-9 years and 5.22% had worked for over 9 years. From the results the majority of the respondents had worked for 3-6 years with the bank. 27 4.3 Correlation Analysis.....................................................................................................................27 Table 4.5: Relationships between the variables...................................................................................28 4.3.1 Borrower Behaviour and Credit Repayment Performance......................................................28

4.3.2 Relationship Lending and Credit Repayment Performance ......................................................28

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Correlation results indicated a significant and positive relationship between relationship lending and credit repayment performance (r = .396**, p<.01). The results reveal that trust and commitment on the part of the borrowers and staff contributed much on the performance of credit repayment and therefore enhanced the credit repayment rate, caused a reduction in arrear rate and portfolio at risk at the bank. This is confirmation that if the management of the bank put a lot of emphasis on improving lending relationships, this would enhance credit repayment performance..........................................28 4.3.3 Borrower Behaviour and Relationship Lending ........................................................................29 4.3.4 Borrower Behaviour, Relationship Lending and Credit Repayment Performance ...................29 4.5 Regression Analysis ......................................................................................................................29 Table 4.6: Regression Analysis..........................................................................................................30 CHAPTER FIVE.................................................................................................................................31 DISCUSSION, CONCLUSION AND RECOMMENDATIONS.......................................................31 5.1 Introduction....................................................................................................................................31 5.2 Discussion .....................................................................................................................................31 5.2.1 Borrower Behaviour and Credit Repayment Performance......................................................31

5.2.2 Relationship Lending and Credit Repayment Performance ......................................................32 5.2.3 Borrower Behaviour and Relationship Lending ........................................................................33 5.2.4 Borrower Behaviour, Relationship Lending and Credit Repayment Performance ...................34 5.3 Conclusions....................................................................................................................................37 5.4 Recommendations..........................................................................................................................38 5.5 Areas for further study ..................................................................................................................40 BIBLIOGRAPHY................................................................................................................................41 APPENDIX I.......................................................................................................................................43

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APPENDIX II......................................................................................................................................45

LIST OF TABLES DECLARATION....................................................................................................................................i APPROVAL..........................................................................................................................................ii DEDICATION.....................................................................................................................................iii ACKNOWLEDGEMENT....................................................................................................................iv TABLE OF CONTENTS......................................................................................................................v LIST OF TABLES...............................................................................................................................ix ABSTRACT.......................................................................................................................................xiv CHAPTER ONE....................................................................................................................................1 INTRODUCTION.................................................................................................................................1 1.1 Background to the Study ................................................................................................................1 1.2 Statement of the Problem.................................................................................................................3 1.3 Purpose of the Study........................................................................................................................3 1.4 Objectives of the Study....................................................................................................................3 1.5 Research Questions..........................................................................................................................4 1.6 Scope of the Study...........................................................................................................................4 Study Scope...........................................................................................................................................4

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Geographical Scope...............................................................................................................................4 1.7 Significance of the Study.................................................................................................................4 1.8 Conceptual Framework....................................................................................................................5 Figure 1.1: Conceptual Framework......................................................................................................6 CHAPTER TWO...................................................................................................................................7 LITERATURE REVIEW......................................................................................................................7 2.1 Introduction......................................................................................................................................7 2.2 Borrower Behaviour and Credit Repayment Performance .............................................................7 2.3 Relationship Lending and Credit Repayment Performance .........................................................11 2.4 Borrower Behaviour and Relationship Lending ...........................................................................15 2.5 Borrower Behaviour, Relationship Lending and Credit Repayment Performance ......................16 CHAPTER THREE.............................................................................................................................18 RESEARCH METHODOLOGY........................................................................................................18 3.1 Introduction....................................................................................................................................18 3.2 Research Design ...........................................................................................................................18 3.3 Study Population ...........................................................................................................................18 3.4 Sample of the Study.......................................................................................................................18 Table 3.1: Sample size.........................................................................................................................19 3.5 Data Sources..................................................................................................................................19 Primary data was obtained through the use of self-administered questionnaire to respondents following systematic and established academic procedures, as suggested by Nunnally and Bernstein (1994). The questionnaires were used for the collection of data from borrowers and staff. ..............19

Secondary data was obtained through the already existing banks literature and any other literature from Centenary Bank annual reports, credit performance reports, BoU Reports and journal articles. The reason for this was to make comparison of secondary data with primary data. ..........................19 3.6 Data Collection Instruments..........................................................................................................19 3.7 Measurement of the Variables.......................................................................................................20 3.8 Reliability and Validity of the Research Instruments....................................................................20 Table 3.2 Validity and Reliability.......................................................................................................21 3.9 Data Analysis ................................................................................................................................21 3.10 Limitations of the Study..............................................................................................................21 CHAPTER FOUR ..............................................................................................................................23 RESULTS AND FINDINGS OF THE SURVEY...............................................................................23 4.1 Introduction....................................................................................................................................23 4.2 Sample Characteristics...................................................................................................................23 4.2.1 Gender and Category of the respondents ..................................................................................23 Table 4.1: Gender and Category of the respondents ..........................................................................24 4.2.2 Age group and Category of the respondents .............................................................................24 Table 4.2: Age Group and Category of the respondents ...................................................................25 4.2.3 Level of Education and Category of the respondents ...............................................................26 Table 4.3: Level of Education and Category of the respondents .......................................................26 4.2.4 Tenure and Category of the respondents ..................................................................................27 Table 4.4: Tenure and Category of the respondents ..........................................................................27 Source: Primary data...........................................................................................................................27

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According to the results in table 4.4 above 32.17% of the staff had worked with the bank for 0-3 years, 40.87% had worked for 3-6 years, 21.74% had worked for 6-9 years and 5.22% had worked for over 9 years. From the results the majority of the respondents had worked for 3-6 years with the bank. 27 4.3 Correlation Analysis.....................................................................................................................27 Table 4.5: Relationships between the variables...................................................................................28 4.3.1 Borrower Behaviour and Credit Repayment Performance......................................................28

4.3.2 Relationship Lending and Credit Repayment Performance ......................................................28 Correlation results indicated a significant and positive relationship between relationship lending and credit repayment performance (r = .396**, p<.01). The results reveal that trust and commitment on the part of the borrowers and staff contributed much on the performance of credit repayment and therefore enhanced the credit repayment rate, caused a reduction in arrear rate and portfolio at risk at the bank. This is confirmation that if the management of the bank put a lot of emphasis on improving lending relationships, this would enhance credit repayment performance..........................................28 4.3.3 Borrower Behaviour and Relationship Lending ........................................................................29 4.3.4 Borrower Behaviour, Relationship Lending and Credit Repayment Performance ...................29 4.5 Regression Analysis ......................................................................................................................29 Table 4.6: Regression Analysis..........................................................................................................30 CHAPTER FIVE.................................................................................................................................31 DISCUSSION, CONCLUSION AND RECOMMENDATIONS.......................................................31 5.1 Introduction....................................................................................................................................31 5.2 Discussion .....................................................................................................................................31 5.2.1 Borrower Behaviour and Credit Repayment Performance......................................................31

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5.2.2 Relationship Lending and Credit Repayment Performance ......................................................32 5.2.3 Borrower Behaviour and Relationship Lending ........................................................................33 5.2.4 Borrower Behaviour, Relationship Lending and Credit Repayment Performance ...................34 5.3 Conclusions....................................................................................................................................37 5.4 Recommendations..........................................................................................................................38 5.5 Areas for further study ..................................................................................................................40 BIBLIOGRAPHY................................................................................................................................41 APPENDIX I.......................................................................................................................................43 APPENDIX II......................................................................................................................................45

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ABSTRACT

The study sought to examine the relationship between borrower behaviour, relationship lending and credit repayment performance in Centenary Bank. The methodology used was cross-sectional survey design with a sample population of 392 respondents that were selected using purposive sampling technique and simple random sampling. A self-administered questionnaire was used to collect the data, processed and analyzed using the Statistical Package for Social Sciences (SPSS V16). Selfadministered questionnaires and personal interviews were used to collect responses.

The findings revealed that there were significant positive correlations between borrower behaviour, relationship lending and credit repayment performance which implied that the way borrowers behaved during credit accessibility or after acquiring credit from the bank, had a lot of effect on determining the relationship that is formed during the lending process which would in turn affect effectiveness and efficiency of credit repayment. From the regression results, it was apparent that borrower behaviour was a strong predictor of credit repayment performance, therefore, the management of the bank should put a lot emphasis on development of well nurtured relationships with borrowers so as to smoothen the lending process. Likewise, management should carry out a lot of awareness to the borrowers through training, workshops and dialogue so as to sensitize them on how best to invest the money and be able to pay back their debt without straining hard.

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CHAPTER ONE INTRODUCTION

1.1 Background to the Study Lending is a risky enterprise because repayment of loans can seldom be fully guaranteed. According to Brown, Falk, & Fehr, (2004), implicit contracts between lenders and borrowers, thus, banking relationships can motivate high effort and timely repayments. Fehr & Zehnder, (2005) also confirm that long-term relationships are a powerful disciplinary device. They posit that in credit markets dominated by short-term interactions, borrowers may only be motivated to repay if they know that, due to credit reporting, their current behaviour is observable by other lenders. The work of Fehr & Zehnder, (2005) indicates that the impact of credit reporting on repayment behaviour and credit market performance is highly dependent on the potential for relationship banking. Therefore, when bilateral relationships are not feasible, the credit market essentially collapses in the absence of acceptable borrower behaviour. As repayments are not third-party enforceable, many borrowers default and lenders cannot profitably offer credit contracts (Brown, Falk, & Fehr, 2004). The availability of information on past repayment behaviour allows lenders to condition their offers on the borrowers' reputation. As borrowers with a good track record receive better credit offers, all borrowers have a strong incentive to sustain their reputation by repaying their debt (Orebiyi, 2002). Therefore, by repeatedly interacting with the same borrower, lenders establish long-term relationships that enable them to condition their credit terms on the past repayments of their borrower. As only a good

reputation leads to attractive credit offers from the incumbent lender, borrowers have strong incentives to repay. The Ugandan banking problems have been complicated by poor borrower behaviour and credit repayment in the banking system, making it difficult to gauge the severity of the situation or propose timely solutions. Centenary Bank is a commercial micro bank operating with over 28 branches country wide. Jacobson, (1999) and Carlton et. al., (2001) assert that the bank is one of the leading providers of microfinance services in rural Uganda. With respect to Centenary Bank, the major problem facing the bank has been identified as failure to manage loan default (Centenary Bank Annual Reports, 2005, 2006, 2007). The management of the bank depends on incentives to repay on time; instant arrears information and delinquency tracking; immediate action to enforce repayment; and rigorous recovery in case of defaulting to achieve loan repayment (Annual Report, 2005).

Out of the 28 operational branches of Centenary Bank micro lending performance indicates that the total portfolio for the headquarter branch is approximately UGX. 14.1 billion of which UGX. 3.7 billion is in individual micro loans with a total arrears rate of 3.7% for the year 2007. For the years 2006 and 2005, the bank closed with arrear rates of 3.6% and 5.46% respectively. In addition, the banks micro lending performance for the last three years reveals that it has continued to record average arrear rates of 4.24% and Non-Performing Assets (NPA) rates of individual micro loans of 1.4% where the acceptable rate by Bank of Uganda is 1%. The above weaknesses may be responsible for the high default rate. It is upon this background that the study seeks to establish the relationship between borrower behaviour, relationship lending and credit repayment performance at Centenary Bank.

1.2 Statement of the Problem The performance of credit repayment in Centenary Bank has declined as evidenced by the annual report of Centenary Bank (2009) which revealed that the recovery rate and arrears rate were low, profitability margins had gone down and there was poor capacity utilization. Further evidence indicates continuous increase in the default rate. This could be due to poor borrower behaviour and lack of relationship lending as evidenced by unfavourable lending methodologies.

1.3 Purpose of the Study The study sought to examine the relationship between borrower behaviour, relationship lending and credit repayment performance in Centenary Bank. 1.4 Objectives of the Study i) To examine the relationship between borrower behaviour and credit repayment performance in Centenary Bank. ii) To establish the relationship between relationship lending and credit repayment performance in Centenary Bank. iii) To establish the relationships between borrower behaviour and relationship lending in Centenary Bank. iv) To examine the relationship between borrower behaviour, relationship lending and credit repayment performance in Centenary Bank.

1.5 Research Questions i) What is the relationship between borrower behaviour and credit repayment performance in Centenary Bank? ii) What is the relationship between relationship lending and credit repayment performance in Centenary Bank? iii) What is the relationship between borrower behaviour and relationship lending in Centenary Bank? iv) What is the relationship between borrower behaviour, relationship lending and credit repayment performance in Centenary Bank?

1.6 Scope of the Study Study Scope The study focused on the relationship between borrower behaviour, relationship lending and credit repayment performance in Centenary Bank. Geographical Scope The study was carried out in all the branches of Centenary Bank in Central division, Kampala district. 1.7 Significance of the Study i) The study will add to the already existing literature on determinants of credit repayment performance. ii) The study is expected to enable commercial banks identify the credit management policies that are critical in the lending business.

iii)

The financial institution used as a case study in the research will be able to improve on its lending policy formulation and assessment of its credit risk management abilities.

iv)

The study is expected to provide guidance to the Central Bank and other regulators in the credit risk management policy formulation.

v)

The study is expected to stimulate further research into the area of lending policy formulation and performance of loans.

1.8 Conceptual Framework The model shows the relationship between borrower behaviour, relationship lending and credit repayment performance. The independent variables are borrower behaviour and relationship lending with credit repayment performance as the dependent variable. The model shows that borrower behaviour and relationship lending enhance credit repayment performance.

According to the conceptual framework, borrower behaviour affected the relationship during the lending process between the borrowers and bank loan officers which in turn affected the credit repayment performance of the bank (recovery rate, portfolio growth and portfolio quality). From the model borrower behaviour was measured according to borrower values, attitudes, experiences and beliefs; relationship lending was measured according to trust and commitment and credit repayment performance was measured according to recovery rate, arrears rate and portfolio at risk.

Figure 1.1:

Conceptual Framework
Credit Repayment Performance Recovery rate Arrears rate Portfolio at risk

Borrower Behaviour Values Attitudes Experiences Beliefs

Relationship Lending Trust Commitment

Source: Developed form Brown and Zehnder, (2006); Orebiyi, (2002); Ongena and Smith, (2000); Kon and Storey, (2003); Degryse and Cayseele, (2000).

CHAPTER TWO LITERATURE REVIEW

2.1 Introduction This chapter covered the review of the literature on the relationships between borrower behaviour, relationship lending and credit repayment performance.

2.2 Borrower Behaviour and Credit Repayment Performance Consumer behaviour is rarely the result of a single motive. Several factors combine to make one buy or consume a product or service; or a borrower to promptly repay or default repayment of a facility. Behaviour primacy theory holds that, common behaviour results mainly from an individuals interactions with the environment (Nguyen, 2007). As the environment changes, individuals tend to cope by changing their behaviour. Thus bank borrowers' behaviour is determined by economic, cultural, social, psychological, personal and political factors: Economics was the first discipline to construct a specific theory of buying behaviour. The Marshallian Economic theory postulates that consumers strive to maximize their utilities and do this by consciously calculating the consequences of any (purchase) decision. The key economic factors that influence borrower behaviour are income, expenditure patterns, cost of investment project, and marketing success of the project (Kon and Storey, 2003). Expenditure pattern refers to the relative extravagance of the borrower in spending. The higher the extravagance, the higher the chances of borrowing and defaulting. The need for borrowing and the amount of loan needed depend on the cost of the project for which the credit is sought.

A person's culture arguably, exerts the broadest influence on his or her behaviour. Lazer and Cull defined culture as the learned patterns of symbolism and behaviour that are passed from one generation to the next; it represents the totality of values that characterize a society. (Kon and Storey (2003) asserted that people live in a cultural milieu that embraces their history, values, morals, customs, art, and language. Kotler' also identified four types of sub-cultural influences on consumers as nationality groups, religious groups, racial groups, and geographical areas (Orebiyi, 2002). Social psychologists view the social environment as the chief determinant of cognitive structure as well as of perceptual bias. Cognition is the process by which we make sense of the things we perceive. Man, as a social being, is often influenced by other persons and by a group he belongs or aspires to belong to (Nguyen, 2007). These may include family members, friends, neighbours, office colleagues, reference groups, social roles, statuses, etc. The fear of being ostracized by church or club members or reference groups could motivate a borrower to repay a facility. Conversely, bad friends and neighbours could influence one to default repayment of facility extended to him or her.

Such psychological factors in a certain way as motivation, perception, learning, beliefs and attitude have profound impact on consumer behaviour (Kon and Storey, 2003). A motive is a need that is sufficiently pressing to drive the person to act. Thus, needs give rise to drives which energize motives which then stimulate behaviour. Many psychologists have developed theories of human motivation. Abraham Maslow propounded the hierarchy of needs theory which sought to arrange human needs into physiological, safety, social, esteem and self actualization and which shows that people are motivated at different times by these different needs. Sigmond Ereud in his psycho-analytic theory assumes that the real psychological forces

shaping people's behaviour are largely complex and unconscious even to the individual himself. Frederick Herzberg's two factor theory reduced Maslow's motivator into satisfiers and dis-satisfiers.

Kotler is of the opinion that a motivated person is ready to act. How he eventually acts is influenced by his or her perception of the situation. He contends that different people in same environment can perceive a phenomenon in different ways due to the perceptual process of selective attention, selective distortion and selective retention. Gestalt psychology argues that our perception depends on patterns formed by various stimuli and on the order of our expressions (Orebiyi, 2002). We thus see an object in relation to its background or environment. Furthermore, when people act they learn. Learning refers to changes in people's behaviour arising from experience. Finally, beliefs and attitudes are acquired through acting and learning and influence consumer behaviour. A belief is a descriptive thought that a person holds about something (Kon and Storey, 2003). Attitude is a disposition to act. It comprises cognitive, evaluative and action tendencies. From the above analysis, the propensity to repay a facility depends inter-alia on the borrowers belief and attitude which are learnt and which depend also on perception and motivation (Nguyen, 2007). Consumer behaviour is also influenced by the consumer's personal characteristics, notably his age, life-cycle stage, occupation, economic circumstances, life style, personality and self-concept. There is no gain saying the fact that older people are less prone to taking risks than youngsters. This means they are more likely to repay debts than the later people. Same argument goes for people at the mid and later stages of their life-cycle. Additionally, professionals with sound occupation, personality, self-concept and life-style will be higher in debt repayment rate than the others

(Nguyen, 2007). Human beings are politica1animals. Their involvement in politics project them into limelight and thus make them less prone to loan defaults. Additionally, political environment may make or mar a project financed by debt and consequently enhance or hinder the prompt repayment of such debt.

Relationship lending is regarded as a potentially vital instrument linking interests of borrowers with those of lenders through a screening mechanism that identifies reliable economic agents and selects the good from bad borrowers (Brown and Zehnder, 2006). Economic contracts involving relational issues have economic viability to the extent that all parties to a financial contract gain from the lending relationship (Berger et. al., 2001). Lenders have an incentive to utilize greater relationships in the lending process to take advantage of the information generated in the process and the resultant reduction in monitoring. On the other hand, loyal borrowers are given the opportunity to establish the necessary reputation required for loan availability and accessibility (Orebiyi, 2002). Further, because it is not necessary to undertake explicit contracting in relationship lending, bureaucratic procedures associated with verification of documents and collateral requirements are reduced.

Current financial literature points out that organizations that emphasize stronger and longlasting relationships with consumers often perceive this to be a core element of the services they offer (Ongena and Smith, 2000). Recent studies indicate that relational strategies seek to address closer and more cooperative relationships with customers ( Nguyen, 2007). Lending relationships are viewed as a form of lender-borrower interactions including partnerships, collaborative linkages and alliances. Further, establishment of these relationships is viewed as

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an indicator that markets are evolving from emphasis on mere transaction oriented marketing where firms carried out transactions without prior consideration of consumer desires, to emphasis on relation-oriented marketing involving aggressive, integrated, goal-oriented, and systematic pursuit of customers (Hendriske and Veerman, 2001). The significant aspect of these relationships is that firms have a greater bargaining power, and so generate potential for greater competition by capturing a greater share of the market. 2.3 Relationship Lending and Credit Repayment Performance One of the primary objectives of financial institutions is to provide financial services (credit and saving) to people in order to release financial constraints and help alleviate poverty. Each financial institution tries to maximize its repayment performance, whether or not it is profit oriented (Han, 2008). High repayment rates are indeed largely associated with benefits both for the financial institution and the borrower. They enable the financial institution to cut the interest rate it charges to the borrowers, thus reducing the financial cost of credit and allowing more borrowers to have access to it (Kon and Storey, 2003). Improving repayment rates might also help reduce the dependence on subsidies of the financial institution which would improve sustainability. It is also argued that high repayment rates reflect the adequacy of financial institutions services to clients needs. They limit the incidence of cross subvention across the borrowers. Related also, repayment performance is a key variable for donors and international funding agencies on which many financial institutions still depend for their access to funds. The first-best level of repayment performance is a perfect (100%) on-time repayment rate (Ongena and David, 2001). If the maximum repayment rate the financial institution can reach given its lending methodology is lower than the targeted 100%, the financial institution will use second-level strategies to increase its repayment performance. Such strategies include the

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allocation of larger loans to borrowers with lower default probability and attempts to reduce the delay in repayment. The financial institution will develop incentive mechanisms so as to meet these objectives. The main factors influencing repayment are either related to information asymmetries, to adverse shocks affecting the borrower, or to the low performance of institutions (Elsas and Krahnen, 2000). Information asymmetries arise when gaining information on the characteristics or on the behaviour of the borrower is costly for the financial institution. Information asymmetries generate problems of adverse selection, allocation of loans to borrowers with undesirable characteristics such as a high level of risk or inability to take advantage of the loan as well as moral hazard the borrower may behave in an undesirable way (make little or insufficient effort to take advantage of his loan or used it for unproductive purposes) ( Lown and Morgan, 2003). Adverse selection and moral hazard increase the proportion of borrowers who cannot repay their loans on time. Borrowers that have enough money to reimburse their loan might also default strategically. The cost of strategic default might indeed be low if the lending institution has low collateral requirements and if the legal system gives little power to the financial institution to enforce contracts. Financial institutions try to restrict the occurrence of those three types of situations in designing appropriate credit schemes.

The theoretical foundations of relationship banking are found in the modern literature of financial intermediation that acknowledges the special role of banks in alleviating the informational asymmetries in the credit markets. Early works of Brown & Zehnder (2006) stress the information production function of banks. Screening and monitoring procedures give an information advantage to banks that allow them to overcome information and incentive

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problems between the bank and the borrower. Therefore, the main benefit attributed to bank financing with respect to other sources of finance is that banks help overcome problems of asymmetric information by producing and analyzing information and by designing loan contracts that improve borrowers' incentives. Bank financing may also entail some costs.
Degryse & Cayseele (2000) develop a model of loan pricing in which firms bear search costs to

find a new bank. They show that loan rates offered by the relationship bank are higher than those offered at competing banks, because the latter are willing to offer an interest lower than their funding cost in order to capture the firm. The critical assumption in that model is the existence of exogenous search costs. In the early nineties, two influential papers warned about the potential costs of bank lending even when there are no exogenous costs of starting a relationship. Elsas & Krahnen (2000) present a model in which relationships arise endogenously. A bank that lends to a firm learns more about that borrower's characteristics than do other banks.

This generates an asymmetry of information among banks. Therefore, a distinction is made between relationship (informed) banks and transaction (uninformed) banks. Informed lenders can capture some rents generated by their older costumers, while the uninformed competitors face a winner's curse problem. In a competitive world, the implication for loan pricing is increasing interest rates with the duration of the relationship. In the model of Kano, Uchida,
Udell & Watanabe (2006) a firm balances the costs and benefits associated to two borrowing

sources, namely informed debt and arm's length debt. Bank debt is provided by an informed bank that monitors the firm and exerts some control on the owner's decision to continue a project only if it has positive net present value. However, informed bank debt generates

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distortions on the owner's incentives to exert effort. In contrast, arm's length debt guarantees that the owner exerts the optimal level of effort but lenders do not have control over the owner's continuation decision. Rajan shows that borrowing from multiple sources is a way to restrict the bank's ability to extract surplus. In a later contribution, Kon & Storey (2003) derived the optimal loan contract that avoids the lock-in costs with a single lender: a long-term debt contract consisting in a line of credit that the lending bank may terminate at any point in time, but if it chooses to continue financing it should do so at ex ante specified terms. This arrangement can optimally limit the informed lender's bargaining power without the need for multiple bank relationships.

Nguyen (2007) consider a model of repeated moral hazard, without learning and risk neutrality.

In the optimal loan contract, the loan interest rate and collateral requirements decrease with the duration of the bank-borrower relationship, after the firm has demonstrated some project success. In a recent contribution, Freixas (2005) presents a model where relationships arise because there is an initial fixed cost of monitoring, that is, repeated lending from the same bank avoids duplication of monitoring costs. The consequence is that the loan interest rate in the second period is larger than in the initial one because incumbent banks are able to extract rents on the loan renewal. Summarizing, the optimal contract in the models of Ongena & Smith
(2001) predict that interest rate increases with the duration of the relationship. In contrast, the

models of Orebiyi (2002) show that interest rates should decline as relationships matures. Finally, some authors argue that loan rate smoothing arises as part of an optimal contract between borrowers and banks, that is, loan interest rates should be at over the duration of the bank firm relationship.

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2.4 Borrower Behaviour and Relationship Lending Long-term ties between main banks and their clients generate value and increase economic efficiency. Little is known, though, on how this value is divided among the stakeholders involved in such relationships. In the course of building the relationship, the lender accumulates borrower specific information which gives him significant benefits ( Dell.Ariccia
and Marquez, 2006). To the extent that the lender passes these benefits to the borrower,

relationships will also be valuable from the borrower's point of view. The modern literature on financial intermediation has long emphasized the value creation function of lending relationships. In a context of asymmetric information in credit markets, lending relationships facilitate the information exchange between the borrower and the lender through repeated interaction over the duration of the relationship and through the provision of multiple financial services. Lenders invest in generating information from their client and borrowers are more inclined to disclose information (Boot 2000). Consequently, the information asymmetries between the bank and the client are lessened as time goes by. This process enhances economic efficiency through many channels. First, having a long-term horizon facilitates the design of implicit credit contracts over the duration of the relationships that may increase value. This is achieved, for instance, through reduction in welfare dissipating collateral requirements (Kano, Uchida, Udell and Watanabe, 2006 ), through the deployment of welfare-enhancing inter-temporal tax-subsidy schemes in loan pricing, as well as through more flexible contracting terms (Boot, 2000). Second, the re-usability of the information generated by the lender over repeated transactions and over time is also beneficial in terms of savings on the fixed cost of screening and monitoring (Degryse and Cayseele, 2000). Third, it avoids the freerider problem of monitoring since the bank internalizes the benefits of such investments.

15

Higher monitoring levels increase value since, for instance, they help solve principal-agent problems of managerial behaviour. Additionally, relationship banks develop sector-specific expertise that enhances the value of financed projects ( Cole, Goldberg and White, 2004). Furthermore, relationship lending contributes greatly to economic growth by promoting the efficient allocation of capital as long as better informed banks provide credit to the most productive projects first. At the same time, close bank-form relationships entail some costs.

2.5 Borrower Behaviour, Relationship Lending and Credit Repayment Performance The impact of credit reporting on repayment behaviour should depend on the presence of alternative disciplining mechanisms. One alternative disciplining mechanism is relationship banking. Theoretical models suggest that implicit contracts between lenders and borrowers, i.e., banking relationships, can motivate high effort and timely repayments ( Cole, Goldberg and
White, 2004). Empirical studies confirm that some credit market segments (in particular, small

business lending) are pervaded by relationship banking and that these relationships improve the access of potential borrowers to credit (Berger and Udell, 2006). Experimental studies also confirm that long-term relationships are a powerful disciplinary device. In credit markets dominated by repeated interactions (e.g., working capital loans), information sharing may therefore not be required to discipline borrowers. In contrast, in credit markets dominated by short-term interactions (Brown, Falk, and Fehr 2004, Fehr and Zehnder 2005), borrowers may only be motivated to repay if they know that, due to credit reporting, their current behaviour is observable by other lenders. Our results indicate that the impact of credit reporting on repayment behaviour and credit market performance is highly dependent on the potential for relationship banking. When

16

bilateral relationships are not feasible, the credit market essentially collapses in the absence of credit reporting. As repayments are not third-party enforceable, many borrowers default and lenders cannot profitably offer credit contracts (Berger and Udell, 2002). The introduction of a credit registry in this environment greatly enhances the performance of the credit market. The availability of information on past repayment behaviour allows lenders to condition their offers on the borrowers' reputation. As borrowers with a good track record receive better credit offers, all borrowers have a strong incentive to sustain their reputation by repaying their debt. As a consequence a well functioning credit market is established in which a large percentage of the available gains from trade is realized. When relationship banking is feasible, credit reporting has no such effect on market performance. In this environment, the market participants solve the moral hazard problem related to repayment even in the absence of a credit registry. By repeatedly interacting with the same borrower, lenders establish long-term relationships that enable them to condition their credit terms on the past repayments of their borrower. As only a good reputation leads to attractive credit offers from the incumbent lender, borrowers have strong incentives to repay (Berger, Miller, Petersen, Rajan and Stein, 2005) . The disciplining effect of these banking relationships is sufficiently strong so that the introduction of a credit registry only slightly improves credit market performance. Nevertheless, even when relationship banking is feasible, a credit registry does affect market outcome. First, the credit market is less dominated by specific borrower--lender relations, as these are no longer necessary to enforce repayment. Second, by improving the information available to "outside" lenders, a credit registry reduces the ability of incumbent lenders to extract rents from relationships (Brown, and Zehnder, 2006).

17

CHAPTER THREE RESEARCH METHODOLOGY

3.1 Introduction This chapter shows how the research was conducted. It describes the research design, study population, sampling procedure and sample size, data sources and collection instruments, measurement of variables and data analysis. 3.2 Research Design A cross-sectional survey design was used to study the relationship between borrower behaviour, relationship lending and credit repayment performance. The survey was analytical and descriptive in nature studying the state of affairs of the bank at a point in time. 3.3 Study Population The target population included 1,137 comprising of 187 credit officers and 950 business borrowers in all the branches of Centenary bank in central division. According to the Centenary bank Monthly credit report for central division, the bank disburses an average of 950 loans to business borrowers. Therefore, the responses from borrowers were represented by the number of the average monthly business borrowers from all the branches in central division. 3.4 Sample of the Study The sample size was 392 respondents (118 credit officers and 274 borrowers) selected basing on a table for determining sample size by (Krejcie & Morgan, 1970). Simple random sampling

18

was used to select the business borrowers whereas, purposive sampling was used to select the staff. Table 3.1: Sample size Population 187 950 1,137 Sample 118 274 392

Staff Category Credit Officers Borrowers Total

Source: Centenary Bank Annual Report, (2009)

3.5 Data Sources Primary Data Primary data was obtained through the use of self-administered questionnaire to respondents following systematic and established academic procedures, as suggested by Nunnally and Bernstein (1994). The questionnaires were used for the collection of data from borrowers and staff. Secondary Data Secondary data was obtained through the already existing banks literature and any other literature from Centenary Bank annual reports, credit performance reports, BoU Reports and journal articles. The reason for this was to make comparison of secondary data with primary data. 3.6 Data Collection Instruments A self administered questionnaire was used to collect data from respondents given that they were many in numbers that it would take much time to interview them face to face. More precise information was collected from the different categories of the respondents.

19

3.7 Measurement of the Variables Borrower behaviour was measured basing on the item scale adapted from Nguyen, (2007). The items in the domain were scored on the 5 point Likert scale ranging from strongly disagree (1) to strongly agree (5). Relationship lending was measured basing on the item scale adapted from Berger and Udell,
(2002). The items in the domain were scored on the 5 point Likert scale ranging from

strongly disagree (1) to strongly agree (5). Credit repayment performance was measured basing on the item scale adapted from
Orebiyi, (2002). The items in the domain were scored on the 5 point Likert scale ranging

from strongly disagree (1) to strongly agree (5). 3.8 Reliability and Validity of the Research Instruments Closed questionnaire were developed in harmony with the guidelines specified by Sekaran (2000). First, an item analysis was done to see whether the items in the instrument belong there and a pre test was carried out to check validity and reliability so as to minimize on vagueness of the results to be generated. The validity of the instrument was further measured using the Content Validity Index (CVI). Reliability (internal consistency and stability) of the instruments was tested using Cronbachs Alpha Coefficient. The researcher first tested inter item consistency reliability to ensure that there was the consistency of respondents answers to all items in the measure.

20

Table 3.2
Variable

Validity and Reliability

Anchor 5-Point 5-Point 5-Point Cronbach Alpha Value .6832 .9134 .8724

Borrower Behaviour Relationship Lending Credit Repayment Performance

Source: Primary data

3.9 Data Analysis Data collected from the primary source was compiled, sorted, edited for accuracy and clarity, classified, coded into a coding sheet and analyzed using a Statistical Package for Social Science (SPSS 16.0). During data analysis, cross tabulations, and frequency tabulations, Pearsons correlation analysis and regression analysis were used to present the results of the study. The cross tabulations and frequency tabulations were used to present the results for the sample characteristics, the Pearsons correlation analysis was used to present the relationships between the study variables and a regression analysis was used to study the variance in credit repayment performance caused by a combined effect of borrower behaviour and relationship lending. 3.10 Limitations of the Study i) Respondents withholding information due to fear of being victimized. However, the researcher assured them that the information would be kept confidential. ii) Unwillingness of respondents to fill questionnaires. The researcher ensured consistency in contacting the respondents and made sure reminders are sent to them to fill the questionnaires.

21

iii)

Respondents having a view of not obtaining any direct benefit from the research results. However the researcher assured them that they would benefit in the long run when the pertinent issues are raised to management and acted upon.

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CHAPTER FOUR RESULTS AND FINDINGS OF THE SURVEY

4.1 Introduction This chapter comprises of a presentation of results and their interpretation. The presentation in this chapter shows the results as tested according to the objectives of the study. The chapter begins with the demographic characteristics of the respondents such as age, educational level, tenure and gender which were all presented using cross tabulations. The descriptives for the items in the instrument were also presented using means for each item to define the relative opinion of the respondents for that particular item. The results from the Zero Order correlations and the regression analysis results were presented.

4.2 Sample Characteristics To present sample characteristics, cross tabulations and frequency distributions were used to indicate variations of respondents based on age, educational level, tenure and gender. The sample characteristics were presented basing on the responses from staff and borrowers.

4.2.1

Gender and Category of the respondents Cross tabulation was used by the researcher to present the Gender and Category of the respondents. Table 4.1 below presented the results:

23

Table 4.1:

Gender and Category of the respondents

Category Credit officers Borrowers 75 119 38.66 61.34 65.22 44.74% 40 147 21.39 78.61 34.78 115 30.18 100 55.26 266 69.82 100

Male Gender Female

Count Row % Column % Count Row % Column % Count Row % Column %

Total 194 100 50.92 187 100 49.08 381 100 100

Total Source: Primary data

From the results in table 4.1 above, out of the 194 male respondents, 38.66% were credit officers and 61.34% were borrowers, whereas, for the female respondents, 21.39% were credit officers and 78.61% were borrowers. From the results, male were more responsive compared to their female counterparts. 4.2.2 Age group and Category of the respondents Cross tabulation was used by the researcher to present the age group and category of the respondents. Table 4.2 below presented the results:

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Table 4.2:

Age Group and Category of the respondents

Respondent Category Credit officers Borrowers 7 100 2.63 15 27 35.71 64.29 13.04 10.15 23 39 37.10 62.90 20 14.66 51 106 32.48 67.52 44.35 39.85 26 87 23.01 76.99 22.61 115 30.18 100 32.71 266 69.82 100

Total 7 100 1.84 42 100 11.02 62 100 16.27 157 100 41.21 113 100 29.66 381 100 100

18-24 yrs

25-29 yrs

Age Group

30-34 yrs

34-39 yrs

Over 40 yrs

Count Row % Column % Count Row % Column % Count Row % Column % Count Row % Column % Count Row % Column % Count Row % Column %

Total Source: Primary data

According to the results in table 4.2 above, 1.84% of the respondents belonged to the 18-24 years age group, 11.02% belonged to the 25-29 years age group, 16.27% belonged to the 30-34 years age group, 41.21% belonged to the 34-39 years age group and 29.66% belonged to the 40 years and above age group. Additionally, 30.18% of the respondents were credit officers and 69.82% were borrowers. From the findings, the majority of the respondents belonged to the 3439 years age group.

25

4.2.3 Level of Education and Category of the respondents Cross tabulation was used by the researcher to present the level of education and category of the respondents. Table 4.3 below presented the results: Table 4.3: Level of Education and Category of the respondents
Respondent Category Credit officers Borrowers 34 100 12.78 3 71 4.05 95.95 2.61 26.69 80 91 46.78 53.22 69.57 34.21 32 70 31.37 68.63 27.83 26.32 115 266 30.18 69.82 100 100

Level of Education

Certificate

Diploma

Degree

Masters

Total Source: Primary data

Count Row % Column % Count Row % Column % Count Row % Column % Count Row % Column % Count Row % Column %

Total 34 100 8.92 74 100 19.42 171 100 44.88 102 100 26.77 381 100 100

From table 4.3, all the respondents who possessed certificate level of education were borrowers (100%), for the diploma holders, 4.05% were credit officers and 95.95% were borrowers. For the degree holders, 46.78% were credit officers and 53.22% were borrowers. Lastly, for the masters holders, 31.37% were credit officers and 68.63% were borrowers.

26

4.2.4 Tenure and Category of the respondents Frequency tabulation was used by the researcher to present tenure and category of the respondents. Table 4.4 below presented the results: Table 4.4: Tenure 0-3yrs 3-6 yrs 6-9 yrs Over 9 yrs Total Tenure and Category of the respondents Frequency %ge Cumulative % 37 32.17 32.17 47 40.87 73.04 25 21.74 94.78 6 5.22 100 115 100

Source: Primary data

According to the results in table 4.4 above 32.17% of the staff had worked with the bank for 03 years, 40.87% had worked for 3-6 years, 21.74% had worked for 6-9 years and 5.22% had worked for over 9 years. From the results the majority of the respondents had worked for 3-6 years with the bank.

4.3 Correlation Analysis In this section, the results that address the research questions are presented and Pearsons correlation test was used to answer the research questions of the study. To investigate the relationships among the constructs a Zero-order correlation table was generated. Pearson correlations were run to establish the relationships between the study variables so as to answer the objectives of the study. The results are presented in the table below:

27

Table 4.5:

Relationships between the variables

1 2 3

Borrower Behaviour (1) Relationship Lending (2) Credit Repayment Performance (3)

1.000 .280** 1.000 1.000 .427** .396**

** Correlation is significant at the 0.01 level (2-tailed). Source: Primary data

4.3.1

Borrower Behaviour and Credit Repayment Performance Correlation results indicated a significant positive relationship between borrower behaviour and credit repayment performance (r = .427**, p<.01). This is confirmation that borrower values, attitudes, experience and beliefs had a positive effect on the improvement of loan repayment rate, reduction on the arrears rate and portfolio at risk of the bank. The results imply that if borrower behaviour was in favour of the banks credit terms, this would positively affect credit repayment performance.

4.3.2 Relationship Lending and Credit Repayment Performance Correlation results indicated a significant and positive relationship between relationship lending and credit repayment performance (r = .396**, p<.01). The results reveal that trust and commitment on the part of the borrowers and staff contributed much on the performance of credit repayment and therefore enhanced the credit repayment rate, caused a reduction in arrear rate and portfolio at risk at the bank. This is confirmation that if the management of the bank put a lot of emphasis on improving lending relationships, this would enhance credit repayment performance.

28

4.3.3 Borrower Behaviour and Relationship Lending Correlation results indicated a significant and positive relationship between borrower behaviour and relationship lending (r = .280**, p<.01). The results provide basis that borrower values, attitudes, experience and beliefs positively determined borrower commitment and trust which implied that a unit change in borrower behaviour would enhance the quality of lending relationships at the bank. When the borrowers positively behave towards the credit terms of the bank, this would improve the quality of the lending relationships between the borrowers and the bank. 4.3.4 Borrower Behaviour, Relationship Lending and Credit Repayment Performance Correlation results indicated a significant and positive relationship between borrower behaviour and relationship lending (r = .280**, p<.01), and relationship lending and credit repayment performance (r = .396**, p<.01). This implies that the way borrowers behaved during credit accessibility or after acquiring credit from the bank, had a lot of effect on determining the relationship that is formed during the lending process which would in turn affect effectiveness and efficiency of credit repayment. Therefore, having favorable borrower values, attitudes, experience and beliefs in an environment which promotes trust and commitment on either parties, this would greatly enhance credit repayment performance at the bank. 4.5 Regression Analysis Regression analysis was used to determine the extent to which borrower behaviour, relationship lending predict credit repayment performance in Centenary Bank. The results obtained are shown by table 4.6 below:

29

Table 4.6:

Regression Analysis
Unstandardized Coefficients B 1.525 .279 7.433E-02 Std. Error .307 .090 .078 .108 Standardized Coefficients Beta 4.963 .000 .294 3.091 .003 .955 .342

Model (Constant) Borrower Behaviour Relationship Lending R Square = .276 Adjusted R Square = .255 Source: Primary data

Sig.

Dependent Variable: Credit Repayment Performance

Table 4.6 shows that the adjusted R square results indicate that the combination of borrower behaviour and relationship lending predict 25.5% of the variance in Credit Repayment Performance of Centenary Bank. The most significant predictor of credit repayment performance was borrower behaviour (Beta= .294, t= 3.091, Sig. = 0.003) whereas relationship lending (Beta= .108, t=.955, Sig 0.342) was not found to be a significant predictor of credit repayment performance. The low value of the adjusted R square is revelation that other than borrower behaviour and relationship lending, there were other variables that influenced credit repayment performance at the bank.

30

CHAPTER FIVE DISCUSSION, CONCLUSION AND RECOMMENDATIONS

5.1 Introduction This chapter presents the discussion, conclusions, and recommendations arising out of the research findings in chapter four and suggests areas for further study. The study has generated several findings of which are in line with existing literature and previous research findings. 5.2 Discussion 5.2.1 Borrower Behaviour and Credit Repayment Performance The findings revealed a significant positive relationship between borrower behaviour and credit repayment performance which implied that if the borrower behaviour was in favour of the banks credit terms such that the borrowers complied with them then this would affect credit repayment performance. This is in agreement with Berger, Miller, Petersen, Rajan & Stein
(2005) assertions that the behaviour of the borrower will be sensitive to ethics, consequences of

alternative actions including inaction, and the response of parties concerned to the borrower. Lending in low-income countries is notoriously difficult. Clients typically lack adequate collateral and lenders often have limited information about the profitability of their customers. Information asymmetries coupled with costly enforcement of repayment severely limits the profitability of lenders. The problem is particularly acute in agriculture because the nature of production precludes the use of many of the mechanisms used in microfinance ( Berger & Udell,
2002). In addition, all farmers need cash at the same time, so allowing some farmers to borrow

only after others have repaid their loans is problematic because some farmers would end up

31

receiving credit when they do not need it ( Berger & Udell, 2006). Even if all clients were allowed to borrow at the same time, joint liability may be ineffective if most production shocks are covariate. 5.2.2 Relationship Lending and Credit Repayment Performance The findings showed a significant and positive relationship between relationship lending and credit repayment performance which implied that if the bank put a lot of emphasis on nurturing borrower relationships, this would enhance credit repayment performance by 35.6%. The findings are supported by Elsas (2005) and Ongena and Smith (2000) who posit that the theoretical foundations of relationship banking are found in the modern literature of financial intermediation that acknowledges the special role of banks in alleviating the informational asymmetries in the credit markets. Early works of Degryse & Cayseele (2000) stress the information production function of banks. Screening and monitoring procedures give an information advantage to banks that allow them to overcome information and incentive problems between the bank and the borrower. Therefore, the main benefit attributed to bank financing with respect to other sources of finance is that banks help overcome problems of asymmetric information by producing and analyzing information and by designing loan contracts that improve borrowers' incentives.

Elsas (2005) explored the determinants of self assessments of German universal banks with respect to their house bank status, and found that duration of the bank-borrower relationship is not related to house bank status. Another issue is that many studies find that the duration of the bank-borrower relationship is highly correlated with form age (e.g. Berger and Udell 1995, Cole 1998). The length of the relationship reflects private information obtained by the lender

32

whereas age reflects public information on the reputation and survival of the form. Consequently, the studies that do not control for age and examine the effect of length are susceptible to biased results. Finally, the length of the relationship is right censored, meaning that it measures the past history between the bank and the form. Lending relationship has to do with the future expectation to deal with the same customer, and therefore, duration may be undervaluing the strength of relatively new relationships.

5.2.3 Borrower Behaviour and Relationship Lending According to the findings, a significant and positive relationship between borrower behaviour and relationship lending was observed which implied that a unit positive change in borrower behaviour would enhance the quality of lending relationships by 28%. This is in line with the assertions made by Elsas & Krahnen (2000) that when the borrowers positively behave towards the credit terms of the bank, this would improve the quality of the lending relationships between the borrowers and the bank. This is in agreement with existing literature which postulates that long-term ties between main banks and their clients generate value and increase economic efficiency. Little is known, though, on how this value is divided among the stakeholders involved in such relationships. In the course of building the relationship, the lender accumulates borrower specific information which gives him significant benefits (Boot, 2000). To the extent that the lender passes these benefits to the borrower, relationships will also be valuable from the borrower's point of view. The modern literature on financial intermediation has long emphasized the value creation function of lending relationships. In a context of asymmetric information in credit markets, lending relationships facilitate the

33

information exchange between the borrower and the lender through repeated interaction over the duration of the relationship and through the provision of multiple financial services. The literature on relationship lending has identified many benefits and some costs of such relationships. Elsas & Krahnen (2000) provides a very detailed explanation of each of them with their implications. In the following two subsections we summarize the main insights in Han (2008) and complement them with some recent contributions. Relationship lending adds value through various channels. Relationship lending facilitates the information exchange between the borrower and the lender. Lenders invest in generating information from their client firms and borrowers are more inclined to disclose information because of the preservation of certain confidentiality (Kon & Storey, 2003). The lower informational asymmetries make it possible to overcome problems of moral hazard and adverse selection otherwise inherent in credit markets. For instance, they ameliorate the project-choice moral hazard (Diamond 1991) and solve agency problems of managerial behavior (Lown & Morgan, 2003).

5.2.4 Borrower Behaviour, Relationship Lending and Credit Repayment Performance The findings revealed a significant and positive relationship between borrower behaviour and relationship lending and credit repayment performance which implied that the way borrowers behaved during credit accessibility or after acquiring credit from the bank, had a lot of effect on determining the relationship that is formed during the lending process which would in turn affect effectiveness and efficiency of credit repayment. In credit markets, borrowers typically have more information about their investment opportunities, their own character and their prior indebtedness than lenders. Dell.Ariccia & Marquez, (2006) posits that this asymmetry of information gives rise to selection problems for lenders and potential moral hazard of

34

borrowers, which may lead to a rationing of credit. In many countries problems of asymmetric information are aggravated by the fact that loan contracts are costly to enforce (Elsas &. Krahnen, 2000). One response to asymmetric information and costly enforcement in the credit market is information sharing between lenders about the characteristics and behavior of their borrowers. Theoretical models suggest that information sharing can reduce adverse selection in markets where borrowers approach different lenders sequentially (Han, 2008). Moreover, information sharing can also have a strong disciplining effect on borrowers. The model of Diamond (1989) suggests that a public credit registry can motivate borrowers to choose agreed projects. Further models show that information sharing can discipline borrowers into exerting high effort in projects (Vercammen 1995; Padilla and Pagano 2000) and repaying loans (Klein 1992).
Kano, Uchida, Udell & Watanabe, (2006) show that aggregate bank credit to the private sector is

higher in countries where information sharing is more developed. Analyses of firm-level survey data (Kon & Storey, 2003) further show that access to bank credit is easier in countries where credit bureaus or registries exist. These studies cannot clearly identify the direction of causality between information sharing and credit volume. After all, theory suggests that information sharing will emerge where lenders benefit more from them ( Ongena & Smith, 2001) and this is certainly the case where the credit volume is higher. Thus a positive correlation between credit reporting and credit market performance may arise simply because credit bureaus are more likely to emerge in countries where current lending is vibrant or an expansion of credit activity is expected. By applying experimental methods, our study allows us to circumvent this endogeneity issue and identify how the exogenous introduction of a credit registry affects credit market performance.

35

The impact of credit reporting on repayment behavior should depend on the presence of alternative disciplining mechanisms. One alternative disciplining mechanism is relationship banking. Theoretical models suggest that implicit contracts between lenders and borrowers, i.e., banking relationships, can motivate high effort and timely repayments (Boot and Thakor 1994). Empirical studies confirm that some credit market segments (in particular small business lending) are pervaded by relationship banking and that these relationships improve the access of potential borrowers to credit (Orebiyi, 2002). Experimental studies also confirm that long-term relationships are a powerful disciplinary device. In credit markets dominated by repeated interactions (e.g. working capital loans), information sharing may therefore not be required to discipline borrowers. In contrast, in credit markets dominated by short-term interactions (e.g. consumer credit markets when borrower mobility is high), borrowers may only be motivated to repay if they know that, due to credit reporting, their current behavior is observable by other lenders. In this paper we examine how the impact of credit reporting on repayment is related to the presence of relationship banking. As repayments are not third-party enforceable, many borrowers default and lenders cannot profitably offer credit contracts. The introduction of a credit registry in this environment greatly enhances the performance of the credit market. The availability of information on past repayment behavior allows lenders to condition their offers on the borrowers reputation. As borrowers with a good track record receive better credit offers, all borrowers have a strong incentive to sustain their reputation by repaying their debt. As a consequence a well functioning credit market is established in which a large percentage of the available gains from trade is realized. When relationship banking is feasible, credit reporting has no such effect on

36

market performance. In this environment, the market participants solve the moral hazard problem related to repayment even in the absence of a credit registry. By repeatedly interacting with the same borrower, lenders establish long-term relationships which enable them to condition their credit terms on the past repayments of their borrower. As only a good reputation leads to attractive credit offers from the incumbent lender, borrowers have strong incentives to repay. The disciplining effect of these banking relationships is sufficiently strong so that the introduction of a credit registry only slightly improves credit market performance (Berger, Miller, Petersen, Rajan & Stein, 2005) . Nevertheless, even when relationship banking is feasible, a credit registry does affect market outcome. First, the credit market is less dominated by specific borrower-lender relations, as these are no longer necessary to enforce repayment. Second, by improving the information available to outside lenders, a credit registry reduces the ability of lenders to extract rents from relationships. 5.3 Conclusions The study sought to investigate the relationship between borrower behaviour, relationship lending and credit repayment performance. In general, the study looked at the effect of borrower behaviour and relationship lending on credit repayment performance in Centenary Bank. In particular, the study examined relationships between the study variables borrower behaviour, relationship lending and credit repayment performance. All the relationships were significantly positive. It also examined the effect of the study variables on the dependent variable and all study variables were found to be significant predictors of credit repayment performance.

37

The results revealed that there was a significant positive correlation between borrower behaviour, relationship lending and credit repayment performance which implied that the way borrowers behaved during credit accessibility or after acquiring credit from the bank, had a lot of effect on determining the relationship that is formed during the lending process which would in turn affect effectiveness and efficiency of credit repayment. Therefore, the management of the Bank should put in place credit evaluation procedures that aim at ascertaining the behaviour of the borrower and along with the credit repayment period, monitor closely the behaviour of the borrower while ensuring that the required lending relationship is not compromised in the process. This will greatly enhance the credit repayment performance of the bank. From the regression results, it was clear that borrower behaviour and relationship lending were strong predictors of credit repayment performance, therefore, the management of the bank should put a lot of emphasis on development of well nurtured relationships with borrowers so as to smoothen the lending process. Likewise, management should carry out a lot of awareness to the borrowers through training, workshops and dialogue so as to sensitize them on how best to invest the money and be able to pay back their debt without straining hard. Sensitization of borrower will help the bank identify the challenges the borrowers meet during the acquisition of credit and after acquisition of the credit and consequently find solutions. 5.4 Recommendations In light of the research findings, the following recommendations are made:

38

a)

The model could only explain 25.5% in variance of credit repayment performance of centenary bank, it is recommended that a study be carried out consisting of other factors which were not part of the model so as to predict credit repayment performance.

b)

According to the findings, borrower behavior was found to be a strong predictor of credit repayment performance. Therefore, the management of the bank should draw a lot of emphasis on borrower values, attitudes, experiences and beliefs as this will influence the banks overall credit repayment performance at the bank.

c)

The findings revealed that there was a significant relationship between relationship lending and borrower behaviour. The management of the bank should invest in the enhancement of relationship lending between the bank and its customers so as to create trust in the banks brand, products and services. Here the bank should ensure constant contact with its customers through the provision of the required information about the banks products and services. Also, the management should ensure that bank policies, terms of reference and regulations are clear to both staff and the customers.

d)

From the findings it was revealed that there was a significant relationship between relationship lending and credit repayment performance. Credit officers and management must know their customers very well since such knowledge would easily help in loan administration. Relationship management should be encouraged. A banker should be able to assess the customers needs, potentials, constraints, strengths and weaknesses and design products that will satisfy him. Through it also the customers willingness to pay can be assessed.

e)

The significant relationship between borrower behaviour and relationship lending from the findings calls for loan agreements that are incentive compatible. At the time a loan is

39

made, the lender must be sure that after disbursement it will be in the borrowers interest to repay the loan. The lender must be satisfied that loans given will improve the position of the borrower and this should be brought to the knowledge of the borrower.

5.5 Areas for further study a) Future research should attempt to collect data from other industries such as academic institutions, government ministries to see whether other services are the same and could therefore benefit from this study. b) The study concentrated on borrower behaviour, relationship lending and credit repayment performance in regard to Centenary Bank However, a similar research can be carried out in other banks.

40

BIBLIOGRAPHY Berger, A.N. , Miller, N.H., Petersen, M.A., Rajan, R.G. and Stein, J.C. (2005). Does function follow

organizational form? Evidence from the lending practices of large and small banks, Journal of Financial Economics 76, 237-269, 2005. Berger, A.N. and Udell, G.F., (2002). Small business credit availability and relationship lending: The importance of bank organizational structure, Economic Journal 112, pp. F32F53, 2002. Berger, A.N. and Udell, G.F., (2006). A more complete conceptual framework for SME finance. Journal of Banking and Finance, forthcoming 2006. Boot, A. W. A., (2000). .Relationship Banking: What Do We Know?.Journal of Financial Inter-mediation 9(1), 7-25. Brown, M. and Zehnder, C. (2006) Credit Reporting, Relationship Banking, and Loan Repayment. Swiss National Bank Working Paper No. 2006-3. Cole, R.A., Goldberg, L.G. and White, L.J. (2004). Cookie-cutter versus Character: The Micro Structure of Small Business Lending by Large and Small Banks, Journal of Financial and Quantitative Analysis 39, 227-251, 2004. Degryse, H. and Cayseele, P.V., (2000). Relationship lending within a bank-based system: Evidence from European small business data, Journal of Financial Intermediation 9, 90-109, 2000. Dell.Ariccia, G. and R. Marquez, (2006). "Lending booms and lending standards." Journal of Finance 61, 25112546. Elsas, R. and J. P. Krahnen (2000), Collateral, Default Risk, and Relationship Lending: An Empirical Study on Financial Contracting, CEPR Discussion Paper n. 2540. Han, L., (2008). Bricks vs. Clicks: SME Online Banking Behaviour and Relationship Banking. International Journal of Entrepreneurial Behaviour and Research (forthcoming).

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Kano, M., Uchida, H., Udell, G.F. and Watanabe, W., (2006). Information Verifiability, Bank Organization, Bank Competition and Bank-Borrower Relationships, RIETI discussion paper 06-E-003, the Research Institute of Economy, Trade, and Industry, 2006. Kon, Y. and Storey, D.J., (2003). A Theory of Discouraged Borrowers. Small Business Economics 21, 37-49. Lown, C. and Morgan, D. (2003). "The credit cycle and the business cycle: New .ndings using the loan o cer opinion survey", Journal of Money, Credit, and Banking, 38(6): 1575-1597. Nguyen, C.H. (2007). Access to credit and borrowing behaviour of rural households in a transition, paper presented at International Conference on Rural Finance Research Moving Results into Policies and Practices, 19-21 March, Rome. Ongena, S. and David C. Smith, (2001). The duration of bank relationships, Journal of Financial Economics, 61, pp. 449-475. Orebiyi, J.S. (2002). Agricultural loan repayment and its determinants in the rural credit markets of Imo state Nigeria, International Journal of Agriculture and Rural Development, Vol. 3, pp. 37-45.

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APPENDIX I
QUESTIONNAIRE Dear Respondent, This questionnaire seeks to establish the relationship between BORROWER BEHAVIOUR, RELATIONSHIP LENDING AND CREDIT REPAYMENT PERFORMANCE IN COMMERCIAL BANKS IN UGANDA: A CASE OF CENTENARY BANK , you have been selected to participate in this study. Thank you for your time and cooperation SECTION I: GENERAL INFORMATION Please tick the appropriate box for the questionnaire that follow below: Demographic Characteristics 1. 2. Gender: Male Female

For how long have you worked with Centenary Bank? Years old Tick 0-3yrs (1) 3-6 yrs (2) 6-9 yrs (3) Over 9 yrs (4)

Level of Education Qualification Tick Certificate (1) Diploma (2) Degree (3) Masters (4) Other (5)

Age group Years old Tick 18-24 25-29 30-34 34-39 40+

Please indicate by ticking in the appropriate box to what extent you agree/disagree to the following statements below. SECTION II: BORROWER BEHAVIOUR

(SD- Strongly Disagree, D- Disagree, N- Not Sure, A- Agree and SA- Strongly Agree)
SD In order to induce desired behavior of a borrower, Centenary Bank (CB) always uses the threat of cutting off credit 1 D 2 N 3 A 4 SA 5

43

Borrowers usually avoid defaulting on loans because this tarnishes their reputation The reputation of the borrower usually plays a big role in the enforcement of credit contracts at CB CB is at a disadvantage of establishing the credibility of a borrower CB always offers more flexibility in granting credit to borrowers Lending money after following the required procedures enhances recoverability of loans Our borrowers are usually more responsible when subjected to credit contracts Borrowers usually have long terms in mind when they make future plans Borrowers are usually more determined to use loan money effectively for income generating activities Borrowers always pay their loans promptly Usually borrowers take a lot of time to make a decision about the loan Lenders willingness to provide the needed loan amount usually affects the borrowers decision to take the loan Creativity of lender to provide the borrower with specific terms and solutions usually affects the borrowers decision to take the loan In CB relationship lending is a potentially vital instrument linking interests of borrowers with those of the bank At CB, loyal borrowers are usually given the opportunity to establish the necessary reputation required for loan availability and accessibility Lack of business skills usually hinders proper loan investment by borrowers Multiple borrowing usually leads to client non payment of loans SECTION III: Relationship Lending (SD- Strongly Disagree, D- Disagree, N- Not Sure, A- Agree and SA- Strongly Agree) SD D I have confidence in Centenary Bank 1 2 The bank gives me a feeling of confidence 1 2 I have the feeling that the bank is trustworthy 1 2 I trust the bank 1 2 I trust the loan appraisal process used by the bank 1 2 I am willing to go the extra mile to buy/access the products and services of the bank 1 2 I have clear commitment towards my job 1 2 I am committed to doing my job 1 2 I am committed to the timely processing of customer loan appraisals 1 2 I would recommend the bank to a family member, friend or acquaintance 1 2 I certainly like the bank 1 2 I am very satisfied with the bank 1 2 The management of the bank is committed to satisfying my expectations 1 2 The management of the bank meets my expectations 1 2 I have a favorable opinion about the bank. 1 2 Through long-term ties between our clients and the bank, we have been able to generate value 1 2 There is increased economic efficiency as a result of long-term ties between our clients 1 2 SECTION IV: CREDIT REPAYMENT PERFORMANCE (SD- Strongly Disagree, D- Disagree, N- Not Sure, A- Agree and SA- Strongly Agree) SD Usually 30 credit lines/accounts are opened in a week Always 10% of the loan customers accounts are over due for payment every month Provision of bad loan debtors has been increasing by 5% over the last three years Profitability on credit borrowed has been increasing by 10% and above Financial performance goals usually set are attained by management Management is usually not forced to attain good financial performance on its loan portfolio The staff are usually rewarded for attaining good financial performance measures Our customers usually pay their loans on due dates As a result of high repayment rates, our bank always offers adequate financial services to clients needs As a result of high repayment rates, our loan portfolio has grown by 10% to 15% over time 1 1 1 1 1 1 1 1 1 1

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 N 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 D 2 2 2 2 2 2 2 2 2 2

2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 A 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 N 3 3 3 3 3 3 3 3 3 3

3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 SA 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 A 4 4 4 4 4 4 4 4 4 4

4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4

5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5

SA 5 5 5 5 5 5 5 5 5 5

44

The Bank of Uganda usually rates our bank highly as a result of high loan recovery rates There are usually delays in credit repayments by our customers Information asymmetry usually hinders proper credit repayment by our clients Adverse shocks affecting the borrower are usually a major cause of poor credit repayment Through banking relationships, we have always been able to attain high effort and timely repayments The Bank of Uganda usually rates our bank highly as a result of low portfolio at risk Our portfolio at risk is usually used as a basis to determine bad debts Portfolio at risk is usually used to determine subjective provisioning

1 1 1 1 1 1 1 1

2 2 2 2 2 2 2 2

3 3 3 3 3 3 3 3

4 4 4 4 4 4 4 4

5 5 5 5 5 5 5 5

APPENDIX II
QUESTIONNAIRE (Borrowers) Dear Respondent, This questionnaire seeks to establish the relationship between BORROWER BEHAVIOUR, RELATIONSHIP LENDING AND CREDIT REPAYMENT PERFORMANCE IN COMMERCIAL BANKS IN UGANDA: A CASE OF CENTENARY BANK , you have been selected to participate in this study. Thank you for your time and cooperation SECTION I: GENERAL INFORMATION Please tick the appropriate box for the questionnaire that follow below: Demographic Characteristics 1. 2. Gender: Male Female

For how long have you been a customer of Centenary Bank? Years old Tick 0-3yrs (1) 3-6 yrs (2) 6-9 yrs (3) Over 9 yrs (4)

Level of Education Qualification Tick Certificate (1) Diploma (2) Degree (3) Masters (4) Other (5)

Age group Years old Tick 18-24 25-29 30-34 34-39 40+

45

Please indicate by ticking in the appropriate box to what extent you agree/disagree to the following statements below. SECTION II: BORROWER BEHAVIOUR

(SD- Strongly Disagree, D- Disagree, N- Not Sure, A- Agree and SA- Strongly Agree)
SD In order to induce desired behavior of a borrower, Centenary Bank (CB) always uses the threat of cutting off credit Borrowers usually avoid defaulting on loans because this tarnishes their reputation The reputation of the borrower usually plays a big role in the enforcement of credit contracts at CB CB is at a disadvantage of establishing the credibility of a borrower CB always offers more flexibility in granting credit to borrowers who have had a good track record Lending money to borrowers with good track record usually enhances recoverability of loans Borrowers usually have long terms in mind when they make future plans Borrowers are usually more determined to use loan money effectively for income generating activities Borrowers always pay their loans promptly Usually borrowers take a lot of time to make a decision about the loan Lenders willingness to provide the needed loan amount usually affects the borrowers decision to take the loan Creativity of lender to provide the borrower with specific terms and solutions usually affects the borrowers decision to take the loan In CB relationship lending is a potentially vital instrument linking interests of borrowers with those of the bank At CB, royal borrowers are usually given the opportunity to establish the necessary reputation required for loan availability and accessibility Lack of business skills usually hinders proper loan investment by borrowers Multiple borrowing usually leads to client non payment of loans SECTION III: Relationship Lending (SD- Strongly Disagree, D- Disagree, N- Not Sure, A- Agree and SA- Strongly Agree) I have confidence in Centenary bank. I feel a strong sense of belonging towards Centenary bank I have the intention of using Centenary bank always. I feel Centenary bank staff have a commitment towards customers I am committed towards this bank. I maintain a high level of commitment to my bank. I always consider other alternative banks that cares for its customers. I trust the bank and its staff. The bank staff are open with customers The bank staff are honest with customers Centenary Bank always delivers what they promise. Centenary Bank is reliable. I am convinced that the bank does not hold their important information to customers I am convinced that the bank performs their tasks professionally. I have confidence in Centenary Bank The bank gives me a feeling of confidence I have the feeling that the bank is trustworthy I trust the bank I trust the loan appraisal process used by the bank SD 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 D 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 N 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 A 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 SA 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 D 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 N 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 A 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 SA 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5

46

I am willing to go the extra mile to buy/access the products and services of the bank I have clear commitment towards my job I am committed to doing my job I am committed to the timely processing of customer loan appraisals I would recommend the bank to a family member, friend or acquaintance I certainly like the bank I am very satisfied with the bank The management of the bank is committed to satisfying my expectations The management of the bank meets my expectations I have a favorable opinion about the bank. SECTION IV: CREDIT REPAYMENT PERFORMANCE (SD- Strongly Disagree, D- Disagree, N- Not Sure, A- Agree and SA- Strongly Agree)

1 1 1 1 1 1 1 1 1 1

2 2 2 2 2 2 2 2 2 2

3 3 3 3 3 3 3 3 3 3

4 4 4 4 4 4 4 4 4 4

5 5 5 5 5 5 5 5 5 5

SD The high interest rates hinder quick debt servicing I usually default on my credit repayments I pay my loans on due dates As a result of high repayment rates, my bank always offers adequate financial services to clients needs As a result of high repayment rates, I am unable to pay on time There are usually delays in credit repayments by customers Information asymmetry usually hinders proper credit repayment by clients Adverse shocks affecting the borrower are usually a major cause of poor credit repayment Through banking relationships, I have always been able to attain high effort and timely repayments 1 1 1 1 1 1 1 1 1

D 2 2 2 2 2 2 2 2 2

N 3 3 3 3 3 3 3 3 3

A 4 4 4 4 4 4 4 4 4

SA 5 5 5 5 5 5 5 5 5

47