Research Report. Karamagi Oscar

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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


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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

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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

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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


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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

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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


Correlation results indicated a significant and positive relationship between relationship lending and

credit repayment performance (r = .396**, p


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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). Self-

administered 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

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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.

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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.

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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.

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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.

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Figure 1.1: Conceptual Framework

Source: Developed form Brown and Zehnder, (2006); Orebiyi, (2002); Ongena and Smith, (2000); Kon

and Storey, (2003); Degryse and Cayseele, (2000).

Borrower Behaviour

Values

Attitudes Experiences

Beliefs

Relationship Lending

Trust

Commitment

Credit Repayment Performance

Recovery rate

Arrears rate

Portfolio at risk

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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.

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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

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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

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(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 (Bergeret. 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 long-

lasting 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 ofBrown & 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 free-

rider problem of monitoring since the bank internalizes the benefits of such investments.

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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

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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).

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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

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was used to select the business borrowers whereas, purposive sampling was used to select the

staff.

Table 3.1: Sample size

Staff Category Population Sample

Credit Officers 187 118

Borrowers 950 274

Total 1,137 392Source: 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.

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3.7 Measurement of the Variables

Borrower behaviourwas 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 lendingwas 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.

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Table 3.2 Validity and Reliability

Variable Anchor Cronbach Alpha Value

Borrower Behaviour 5-Point .6832

Relationship Lending 5-Point .9134Credit Repayment Performance 5-Point .8724

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.

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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:

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Table 4.1: Gender and Category of the respondents

Category

TotalCredit officers Borrowers

Gender

Male

Count 75 119 194

Row % 38.66 61.34 100Column % 65.22 44.74% 50.92

Female

Count 40 147 187

Row % 21.39 78.61 100

Column % 34.78 55.26 49.08

Total

Count 115 266 381

Row % 30.18 69.82 100

Column % 100 100 100


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


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Table 4.2: Age Group and Category of the respondents

Respondent Category


Age Group

18-24 yrs

Count 7 7

Row % 100 100Column % 2.63 1.84

25-29 yrs

Count 15 27 42

Row % 35.71 64.29 100

Column % 13.04 10.15 11.02

30-34 yrs

Count 23 39 62

Row % 37.10 62.90 100

Column % 20 14.66 16.27

34-39 yrs

Count 51 106 157

Row % 32.48 67.52 100

Column % 44.35 39.85 41.21

Over 40 yrs

Count 26 87 113

Row % 23.01 76.99 100

Column % 22.61 32.71 29.66

Total

Count 115 266 381

Row % 30.18 69.82 100

Column % 100 100 100


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 34-

39 years age group.

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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


Level of

Education

Certificate

Count 34 34

Row % 100 100

Column % 12.78 8.92

Diploma

Count 3 71 74

Row % 4.05 95.95 100

Column % 2.61 26.69 19.42

Degree

Count 80 91 171

Row % 46.78 53.22 100

Column % 69.57 34.21 44.88

Masters

Count 32 70 102

Row % 31.37 68.63 100

Column % 27.83 26.32 26.77

Total

Count 115 266 381

Row % 30.18 69.82 100

Column % 100 100 100


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.

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4.2.4 Tenure and Category of the respondents

Frequency tabulation was used by the researcher to present tenure and category of the


Table 4.4: Tenure and Category of the respondents

Tenure Frequency %ge Cumulative %

0-3yrs 37 32.17 32.17

3-6 yrs 47 40.87 73.04

6-9 yrs 25 21.74 94.78

Over 9 yrs 6 5.22 100

Total 115 100


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.

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:

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Table 4.5: Relationships between the variables

1 2 3

Borrower Behaviour (1) 1.000

Relationship Lending (2) .280** 1.000

Credit Repayment Performance (3) .427** .396** 1.000

** Correlation is significant at the 0.01 level (2-tailed).


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


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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


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Table 4.6: Regression Analysis

Model

Unstandardized

Coefficients

Standardized

Coefficients t Sig.

B Std. Error Beta

(Constant) 1.525 .307 4.963 .000

Borrower Behaviour .279 .090 .294 3.091 .003

Relationship Lending 7.433E-02 .078 .108 .955 .342

Dependent Variable: Credit Repayment Performance

R Square = .276

Adjusted R Square = .255


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.

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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

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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

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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

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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

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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

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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.

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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:

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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

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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.

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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

Documents

Research Report. Karamagi Oscar