The Effect Of Interest Rate On Loan Repayment In Micro Finance Banks In Nigeria

Project and Seminar Topics with material for Banking and Finance

Project and Seminar Topics with material for Banking and Finance


Abstract


The study sought to appraise the effect of interest rate on loan repayment in microfinance institutions. Stanford Micro Finance Bank, a microfinance institution in uyo was used as a case study for the study. The research was conducted using questionnaires and interviews. In all 100 customers and 20 employees were sampled for the research. The SPSS software was used to analyse the data for the research.

A systematic random sampling was used for the data collection. The findings of the research revealed that though interest rate plays a major role in loan repayment, other factors such as loan term and the repayment frequency also influence to a large extent the loan repayment. Customers indicated that though lower interest rate would enhance loan repayment, the issue of accessibility and availability of funds was paramount. To enhance loan repayment, the researcher recommends lower interest rate to ease loan repayment burden and loans granted should be amounts that customers can service. Again, micro-insurance could be established to protect the Institution and customers against any default


Chapter One


General Introduction

1.0 Background to the Study

A Microfinance Institution‟s main objective is to provide poor (MF Iand low income households with an affordable source of financial services. Interest charged on loans is the main source of income for these institutions, and because they incur huge costs, the rates are correspondingly high. Four key factors determine these rates: the cost of funds, the MFI’s operating expenses, loan losses, and profits needed to expand their capital base and fund expected future growth (Ghatak, 1999).

Many policy makers question why microfinance interest rates remain high even when some MFIs receive concessional funds to finance lending. Although some microlenders receive loan funds at concessional rates, they must cost these funds at market rates when they make decisions about interest rates to ensure the sustainability of the institution’s operations. Donors provide concessional funds for a particular usage only for a limited period, as do some governments. However, concessional funds cannot be considered a permanent source of funds for MFIs, and provision must be made through interest rates to sustain the lenders’ operations (Ghatak, 1999).

Inflation adds to the cost of microfinance funds by eroding microlenders’ equity. Thus, higher inflation rates contribute to higher nominal microcredit interest rates through their effect on the real value of equity. Microlenders have two kinds of operating costs: personnel and administrative. Because microlending is still a labor-intensive operation, personnel costs are high. Administrative costs consist mainly of rent, utility charges, transport, office supplies, and depreciation of fixed assets. Making and recovering small loans is costly on a per unit basis. Often loan recovery is executed by staffs who visit clients, increasing costs in time taken and transportation used. Poor physical infrastructure-inadequate road networks, transportation, and telecommunication systems-in many countries in which microlenders operate also increases administrative costs and adds significantly to the cost of microfinance operations. Inadequate law and order also contribute to high administrative costs as microcredit operations often involve cash transactions and the physical movement of cash (Pitt, and Khandker, 1998).

In many countries, the majority of microcredit is provided by a few leading institutions, and competition among them is mostly on non-price terms. This might not be the case in Nigeria where Microfinance Institutions (MFIs) spring up every day. Today in Nigeria the MFIs compete with traditional Banks in the cities as well as have dominance in the rural areas. Large-scale commercial banks with access to low-cost funds, low operating costs, extensive branch networks, and vast human and other resources to provide financial services efficiently are presently not significantly involved in microcredit. The lack of participation of such conventional financial institutions in the microcredit market also limits potential competition. Although it is widely recognized that microfinance alone will not end poverty, it is a vital step in that direction. Microfinance institutions, also known as MFIs, offer financial services to underserved, impoverished communities.

Previously, entrepreneurs seeking loans in impoverished communities had to provide collateral to borrow from unlicensed lenders at inequitably high interest rates. A number of factors, including high administrative costs relative to small loans and small returns, had kept banks from setting up branches in impoverished communities when surer profits were to be had elsewhere.

The lack of an efficient financial services industry has held back many would-be entrepreneurs with viable business plans from realizing their own potential. Women, in particular, have been excluded as loan candidates in developing communities. The lending practices of many emerging microfinance institutions have given people living in extreme poverty the opportunity to realize their potential in the business community (Rahman, 1999)


1.1 Problem Statement

Charging prices high enough to cover costs is essential for any business to survive in the marketplace. This is true for institutions providing microfinance services as it is for any other enterprise. Thus, it is not surprising that many successful microfinance institutions charge high interest rates to cover their high costs. However, despite the success of those institutions in expanding the supply of credit during the last two decades to an increasing number of poor and low-income households, most borrowers default in paying back those MFI loans.

Studies into microfinance in Nigeria did not concentrate on the effect of interest rate on loan repayment on Microfinance Institutions even at the time when MFIs are finding it very difficult to collect loans which have been given to beneficiaries is receiving much attention. This creates a serious research gap into microfinance of which this study seeks to close.


1.2 The Objectives of the Study

The objective of this study is to appraise the effect of Interest on loan repayment in Microfinance Institutions in Nigeria which includes:

  1. To appraise the effect of MFI interest rate on repayment of loans.
  2. To determine the effect of other factors on MFI loan repayment
  3. To appraise the factors that determines interest rate by MFIs
  4. To appraise the measures adopted to enhance the repayment of loans of MFIs.

1.3 Research Questions

Related to the problem, the research seeks to address four main questions outline below:

  1. What is the effect of high interest rate of MFI on the repayment of their loans?
  2. What is the effect of other factors on MFI loans repayment?
  3. What are the factors that determine interest rate by MFIs?
  4. What measures adopted by MFI to enhance the repayment of loans?

1.4 Significance of the Study

The significance to be derived from the study includes:

Providing the management of TCP and other MFIs with an insight into the effect of interest rates on loan repayment and recommendations to make adjustments where necessary.

It will also assist TCP and other MFIs to identify the other factors that also impact on loan repayment to enable them achieve a competitive edge in their respective businesses.

This study can be used as reference for further research. By conducting a research on a related subject, this study would serve as a platform to enhance their work. It will serve as a rich source of literature to other researchers, and the limitation of this research may be built on by others studying on the same topic. It is also hoped that findings from this research would confirm or refute the existing knowledge about the effect of interest on loan repayment on MFIs especially Tanoah Capital Point Limited.

Though this research is to partially fulfill an academic requirement for the award of a masters degree, it is expected that recommendations would be provided to complement regulatory bodies and government‟s MFIs problems efforts of repayment of in loans which address serve as a negative in the development of small and medium enterprises.


1.5 Scope of the Study

The study was conducted within the framework of the effect of interest rate on loan repayment on Microfinance Institutions. The study was carried out at the Tanoah Capital Point (TCP) Limited branch in Ikot Abasi. It is a case study approach of one particular MFI (TCP) and would not cover other MFIs to reflect the entire industry response to the effect of interest rate on loan repayment on MFI. Hence the results would not be generalised but its findings would be placed in the relevant context of the individual MFI studied.


1.6 Limitation of the Study

A project of this nature requires an extensive study of all microfinance companies in the metropolis. This requirement is constrained due to the dispersed nature of these companies and the lack of time and funding. Furthermore, the trustworthiness of respondents especially clients of the company cannot be guaranteed, since personal opinion can influence responses. In view of these limitations, however, it can serve as a useful input into decision and policy making.


1.7 Organisation of the Study

The research work is divided into five (5) chapters.

  1. Chapter one, is dedicated to the introduction and research context. Further relevant sections have addresses the statement of the problem, research questions, and the objectives of the study, significance of the study, scope and limitation of the study.
  2. Chapter two, is devoted to literature review, various views from different authors were reviewed as regards the effect of interest on loan repayment on MFIs and definition of variables.
  3. Chapter three concentrates on the background of the study area and the methodology of the research.
  4. Chapter four focuses on the Findings, Analysis and Discussions of Results.
  5. Chapter five covers the summary, conclusion and recommendations.

Chapter Five


Summary of Findings, Conclusion and Recommendations

5.1 Introduction

The previous chapters concentrated on the introductory aspect of the study which dealt into the problem statement, the objectives of the study, significance of the study, the scope and the limitations of the study. It also reviewed the relevant literature to the study. Furthermore, the methodology and the profile of the study area were also discussed. Finally, the data gathered through the use of questionnaire and interviews were also analysed and discussed which threw more light on the possible solutions to the questions raised at the introductory chapter. The focus of this chapter is to summarise the findings analysed from the data gathered through the questionnaire and interviews in chapter four. It also discusses the researchers recommendations which were the possible solutions to the problems identified and the conclusion to the study.


5.1 Summary of Findings

5.1.1 Findings on Appraising the Effect of MFI Interest Rate on Repayment Of Loans

On the effect of MFI interest rate on repayment of loans:

The MFI staff indicatedTCPinterest ratethatincreasestheburdenInstitutioonloan repayment. However, they mentioned that interest rate did not scare borrowers as a result of repayment problems.

Customers confirmed that low interest rate would make repayment of loans easier for them to repay their loans. Majority of the customers said sometimes TCP was justified in charging high interest rate in relation to the services the Institution renders. However, respondents said sometimes TCP interest rate caused borrowers o default on loans

5.1.2 Findings on the Effect of Other Factors on TCP Loan Repayment

Majority of the staff confirmed that the loan amount did not affect loan repayment more than the interest rate. The research revealed that that short loan terms affect repayment more than the interest rate. Also, fees and charges of TCP also increase the burden on loan repayment. Moreover, staff respondents disagreed that non collateralized loan of TCP affects repayment of loans.

Loan customers disagreed that loan amount affects loan repayment more than the interest rate, but agreed that short term loan terms schedule affect repayment.

5.1.3 Findings on Measures Put in Place to Enhance Repayment of the MFI Loans

Findings revealed that:

There were a number of measure measures available to management of the MFI to enhance repayment of loans. Firstly, borrowers should be properly screened before loans are given. Again, TCP staff should increased monitoring of loans to avoid funds diversion and loans should be given to group borrowers, so that repayment could be properly monitored. Also, approved loans should be disbursed on time. Lastly, on the mode of loan repayment, the day, time and season should be considered.


5.2 Conclusion

The research revealed that interest rate plays a role in loan repayment and customer relationship with microfinance institutions. Moral hazard has been one of the factors which cause loan default where loans are not committed to the very purposes for which the loans were given.

The loan amount does not affect loan repayment more than the interest rate. The research further revealed that that too short loan terms affect repayment more than the interest rate, fees and charges of TCP also increase the burden on loan repayment. Moreover, staff respondents disagreed that non collateralized loan of TCP affects repayment of loans. The loan customers‟ respondents disagreed that the interest rate, but agreed that short term loan terms schedule affect repayment.

Majority of the members of staff confirmed that TCP interest rate increases the burden on loan repayment. A number of the staff respondents agreed that interest rate has effect on loan repayment. Again they disagreed that interest rate scares borrowers as a results of repayment problems. This is because unlike the traditional banks, customers are able to access funds with ease from MFIs.

Loan customers indicated that low interest rate would make repayment of loans easier for borrowers. The research also revealed that sometimes TCP is justified in charging high interest rate in relation to the services they render, according to customers. Again, the research revealed that sometimes TCP interest rate causes borrowers to default on loans. The research also brought to the fore how delays in the disbursement of approved loans affected loan repayment.

In conclusion therefore, it is worthy to note that, the MFI high interest rate is not the only variable that affects loan repayment, but there are other factors such as the loan term, credit appraisal and monitoring. These are very key and  if the company should place emphasis on them, it would go a long way to increase its profitability and help to achieve its vision and mission.


5.3 Recommendations

Having looked at the effect of interest on loan repayment in microfinance institution at Tanoah Capital Point (TCP), the following recommendations are made:

  1. Though availability and accessibility of loanable funds very important, the Institution could consider lowering interest rate to enhance loan repayment.
  2. The Institution could consider the establishment of micro insurance to protect customers and the Institution in times default.
  3. There should be increased monitoring of loan to ensure that funds are not diverted, loans are used for the intended purpose and repayment made on time. This activity will require a lot of logistical support from the Institution.
  4. An important feature of microfinance is the concept of group guarantee. As respondents agreed, there should be increased training and education to ensure that applicants are properly screened before they can access the facility. This will help know the capacity of the applicants and the loan amount they can manage.
  5. The Central Bank and Policy makers should put in place the necessary control mechanisms to protect microfinance institutions and customers on the cost of doing business in relation to the interest rate charged by the banks. The Central Bank could progressively reduce the policy rate thereby reducing the cost of funds.

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