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8/3/2019 Credit Score 2
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AN INVESTIGATION ON THE EFFECT OF CREDIT SCORING ON SMALL
BUSINESS LENDING: CASE OF EQUITY BANK LIMITED
SUBMITTED BY:
LILIAN NJERI
REG NOXXXXXXXXXX
Research Proposal submitted in partial fulfillment of requirements of award of a
bachelors degree in xxxxxxxxxxxxxx of Kenya Methodist University.
NOVEMBER 2
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ABSTRACT
Commercial bank lending to small businesses has received a great attention in the
country in the recent past. The main concern is the availability of credit, given that small firms
have over a long time faced significant problems in getting funding for their desired projects due
to a lack of credible information. Small businesses are more opaque in getting information than
large corporate since small firms normally lack certified financial auditing statements to reflect
satisfactory financial information. Further, since small firms lack publicly traded equities, there
are no public scores that might estimate their quality. This makes it hard for the small enterprises
to obtain financial aid for its expansion. Small business credit scoring offers a great help in
eliminating information opacity and help improve the relations between small ventures and the
financial institutions (Berger and Udell 2006).
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DECLARATION
I declare that this paper is my own original work researched in the field and has not been
submitted to any other institution for examination.
STUDENT: SIGN:
..
SUPERVISOR SIGN:
.. .
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DEDICATION
I dedicate this piece of work to my dear family, for their continued support throughout ourendeavors and preparation this paper.
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ACKNOWLEDGEMENT
I wish to thank anyone who contributed in one way or the other to make this work successful.
Special thanks to my supervisor for the continued guidance throughout the project development.
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Table of Contents
ABSTRACT ................................................................................................................................................. i
DECLARATION .......................................................................................................................................... ii
DEDICATION ........................................................................................................................................... iii
ACKNOWLEDGEMENT ...................................................................................... ....................................... iv
CHAPTER ONE .......................................................................................................................................... 1
INTRODUCTION ....................................................................................................................................... 1
1.1 Background of the Study ................................................................................................................ 1
1.1.1 Equity Bank Limited Profile .......................................................................................................... 2
1.1.2 Kenya Commercial Bank profile ................................................................................................... 3
1.2 Research Objectives ....................................................................................................................... 3
1.2.1General Objective.................................................................................................................... 3
1.2.2 Specific Objectives.................................................................................................................. 3
1.2.3 Research Question................................................................................................................... 4
1.3 Statement of the problem .............................................................................................................. 4
1.4 Importance of the study ................................................................................................................. 5
1.5 Scope of the Study ......................................................................................................................... 6
1.6 Anticipated Limitations of the Study ............................................................................................... 6
CHAPTER TWO ......................................................................................................................................... 7
2.1 LITERATURE REVIEW ................................................................................ .......................................... 7
CHAPTER THREE .................................................................................................................................... 12
3.1 METHODOLOGY ...................................................................................... ..................................... 12
3.2 Study area .................................................................................................................................... 12
3.3 Study population ................................................................................. ......................................... 12
3.4 Data collection ............................... .............................................................................................. 12
3.5 Sampling Design .................................................................................. ......................................... 12
3.6 FINDINGS ..................................................................................................................................... 13
3.6.1Case 1: Equity Bank .................................................................................................................... 13
3.6.2 Case 2: Kenya Commercial Bank ................................................................................................ 13
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3.7 CONCLUSION ................................................................................................................................... 13
CHAPTER FOUR ...................................................................................................................................... 14
SUMMARY CONCLUSION AND RECOMMENDATION ............................................................................... 14
4.1 SUMMARY OF FINDING .................................................................................................................... 14
4.1.1 Similarities ................................................................................................................................ 14
4.2 SUMMARY ................................................................................................................................... 15
4.3 CONCLUSION ................................................................................................................................... 15
4.4 RECOMMENDATION ........................................................................................................................ 16
References............................................................................................................................................. 17
Appendix 1 ............................................................................................................................................ 19
Appendix 2 ............................................................................................................................................ 21
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CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Fewer than 20 percent of small to medium sized enterprises (SMEs) in Kenya have ever
received credit from formal financial institutions. Access is limited due to challenges in assessing
SME risk in a cost effective manner. Lenders in Kenya address this risk-assessment problem
either by not lending to SMEs at all or by requiring collateral and charging high interest rates.
High-income countries, such as the United States, have addressed this challenge in part by using
credit scoring. Credit scoring has the potential to offer a number of benefits which can improve
access to credit for SMEs. There are also a number of prerequisites that must be in place,
however, in order to fully realize the potential benefits of an effective risk management strategy
that incorporates credit scoring.
Credit history or credit report is, in many countries, a record of an individual's or company's past
borrowing and repaying, including information about late payments and bankruptcy. The term
"credit reputation" can either be used synonymous to credit history or to credit score. This
information is used by lenders such as credit card companies to determine an individual's credit
worthiness; that is, determining an individual's willingness to repay a debt. The willingness to
repay a debt is indicated by how timely past payments have been made to other lenders. Lenders
like to see consumer debt obligations paid on a monthly basis.
The other factor in determining whether a lender will provide a consumer credit or a loan is
dependent on income. The higher the income, all other things being equal, and the more credit
the consumer can access. However, lenders make credit granting decisions based on both ability
to repay a debt (income) and willingness (the credit report) as indicated in the past payment
history.
These factors help lenders determine whether to extend credit, and on what terms. With the
adoption of risk-based pricing on almost all lending in the financial services industry, this report
has become even more important since it is usually the sole element used to choose the annual
percentage rate (APR).
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1.1.1 Equity Bank Limited Profile
Equity Bank Limited (formerly Equity Building SocietyEBS) commenced business on
registration in 1984. It has evolved from a Building Society, a Microfinance Institution, to now
the all-inclusive Nairobi Stock Exchange and Uganda Securities Exchange public listed
Commercial Bank. With over 6.7 million accounts, accounting for over 57% of all bank accounts
in Kenya, Equity Bank is the largest bank in the region in terms of customer base and operates in
Uganda and Southern Sudan. The institution also ranks in the most profitable companies in the
Kenya after recording a pre-tax profit of Kes. 9 Billion for the year 2010.
The original founders of EBS were inspired by the desire to create a financial service provider
which would reach the majority of the Kenyan population. This desire was out of the realization
that the low and medium income earners had no access to formal banking and neither could they
afford banking services (the unbanked population). By December 1993, the Central Bank of
Kenya (CBK) declared that Equity was technically insolvent. Out of its findings, the CBK noted
that there was poor supervision by the board, nonperforming loans stood at 54% of the Kes. 12
Million portfolio, accumulated losses were Kes. 33 Million, capital base of Kes. 3 Million and
customer deposits were being used to meet operating expenses. The CBK was limited in its
powers to request closure as Equity had been registered at the Registrar of Building Societies. As
an MFI, Equity had access to short term savings and could grant short term facilities.
As a turnaround strategy, to attract deposits there was need to zero rate the minimum account
opening balance. Account holders could also deposit and withdraw anytime. Ledger fees and
account maintenance fees were scraped. This was a time when other banks had minimum
deposits requirements to open an account and withdrawals were allowed once a week. In 2000,
the Board realized the need to have the right processes in place to sustain its growth and
therefore engaged international consultants to put in place formalized operations and processes.
The sore, Equity customers were low income workers, small business traders, farmers andgovernment employees. The banks vision, mission, values and critical success factors were
heavily entrenched in human touch of business with emphasis on community and livelihood
enhancement.
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1.1.2 Kenya Commercial Bank profile
Kenya commercial bank (KCB) is a major player in the banking sector in Kenya an east Africa.
It is a large bank in customer reaching, profit margins and more so regional branch penetration. It
has branches almost in all regions in Kenya and to a large extent in Ugandan, Tanzanian and
South Sudans capitals.
Kenya Commercial Bank has different accounts to suit different clientele. Largely the bank
though has been seen s among the big banks, which cater for middle and high income earners.
This image has however been portrayed due to the mushrooming microfinance institutions. Due
to the delays in the large banks to scale their account opening fees and minimum account
balances over the years, it has drawn may small scale businesspersons and farmers to the smaller
banks like Family Bank andEquity Bank among others.
Recent adjustments and thorough campaignshave seen the bank win the hearts of low and middle
level income earners as well as small-scale farmers and businesspersons. Offering unsecured
loans to small-scale farmers and youth and women groups has been another boost to the KB
operations. This is true since if Kenya is to realize economic growths as projected, then we need
to economically empower our citizens, a factor which man banks have realized and are now
reaching for the low income and small scale businesses for funding.
e period and other contractual obligations of the credit card or loan.
1.2 Research Objectives
1.2.1 General Objective
The study will aim at investigating the effect of Credit Scoring on Small Business Lending on at
Equity Bank Limited.
1.2.2 Specific Objectives
1. To establish the current usage of credit scoring.2. To establish the relationship between credit rating usage and quality of loans3. To establish the relationship between credit rating scores and rate of interest
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1.2.3 Research Question
This research seeks to empirically examine the effect of the use of credit scoring by large
banking organizations on small business lending in low- and moderate-income (LMI) areas. The
fundamental question here is whether credit scoring has aided lenders like Equity Bank or
Kenya Commercial Bank determine the extend of credit offer to a client, and on what terms.
Have the regulations helped the banks harness their strategic resources to grow a quality loan
portfolio and whether borrowers with low risk rating enjoyed preferential rates on loans. The
purpose of this study will be to try and answer these questions and to explore the use of credit
rating to small scale borrowers.
1. Is the credit scoring/rating being implemented by lenders?2. How is the system meeting the intended goals? Is it suited for the target market?3. Is the banking industry lending rates based on riskiness of the borrower?4. What cost to the customer are our products?5. Is the credit scoring cost-benefit rational to the banks?6. Is the banking industry responsive and cooperative in the implementation of the credit
scoring?
7. What is the overall communication of the ratings to the borrowers8. What are the perceptions of managers, employees and customers about the credit
scoring?
1.3 Statement of the problem
The Credit Information Sharing mechanism was launched in Kenya following the getting of the
Banking (Credit Bureau) Regulations, 2008 on 11th July 2007. The Regulations were issued
pursuant to an amendment to the Banking Act passed in 2006 that made it mandatory for the
Deposit Protection Fund and institutions licensed under the Banking Act to share information on
Non-Performing Loans through credit reference bureaus licensed by the Central Bank of Kenya.
In addition, the amendment to the law also provides for sharing of information on Performing
Loans.
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Many borrowers make a lot of effort to repay their loans, but do not get rewarded for it because
this good repayment history is not available to the bank that they approach for new loans. On the
other hand, whenever borrowers fail to repay their loans banks are forced to pass on the cost of
defaults to other customers through increased interest rates and other fees. Put simply - good
borrowers are paying for bad. This is unfair. Credit reporting allows banks to better distinguish
between good and bad borrowers. Someone who has failed to pay their loan at one bank will not
simply be able to walk to another bank to get another loan without the banks knowing about it.
Over time better information on potential borrowers should mean that it will be both cheaper and
easier to obtain loans.
Three years on after the launch, there is little data available to assess whether the objectives of
the credit bureau regulations were met. This research seeks to empirically examine the effect of
the use of credit scoring by large banking organizations on small business lending in low- and
moderate-income (LMI) areas. The fundamental question here is whether credit scoring has
aided lenders like Equity Bank Limited to determine whether to extend credit, and on what
terms. Have the regulations helped Equity Bank harness its strategic resources to grow a quality
loan portfolio and have the borrowers with low risk rating enjoyed preferential rates on loans.
The purpose of this study will be to try and answer these questions and to explore the use of
credit rating to small scale borrowers.
1.4 Importance of the study
Based on the above stated problem statement, this research study will be significant to Equity
Bank, Kenya Commercial bank and the other banking fraternity in that they will try to advocate
the importance of credit scoring. The study will further highlight the benefits to the organization
after investing in credit scoring systems and borrowing customers database. Its envisaged that
the outcome of the research will shed some light and weight in the importance of a well-
developed credit history and credit scoring.
The study will also provide a benchmark to which other researchers can base their study in
regard to the impact of credit scoring on the banking sector locally. The potential for saving
money is tremendous, as it will benefit from reduced default; there will be enhanced
coordination and collaboration with other banks in providing data and information on borrowers
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risk and so are the opportunities to better meet the customers demands. Because of the dynamic
nature of lending, Equity bank will be in a position to compete effectively with its competitors
and to provide better services to its clientele at large.
1.5 Scope of the Study
This research is mainly intended to determine the effect of information and communication
technology advancements performance of banks. The study is, therefore, conducted on the
banking sector and narrowed down to small business lending, a case study on Equity and Kenya
Commercial banks. The customers to be interview are those who have borrowed from the bank
before and after the implementation of the credit scoring guidelines. The study+ will be carried
out for a period of three months i.e. January to March 2011.
1.6 Anticipated Limitations of the Study
Given that, this study involves extensive interaction and collection of data from different
personalities and on personal finance issues, difficulties are bound to arise. These have been
anticipated and explained under various titles as follows,
a) Financial constraints - This study is narrowed down to a small area (main branch) because oflack of adequate funds. This limits the researcher get deeper to the study area, and may be
visit several branches of the bank.
b) Data Scantiness- access to some sensitive data may be difficult. For instance, customernumbers drop, actual investments costs of the new systems and budget figures and real
performance data.
c) Lack of enough time for fieldwork might impede the conduct of the research.
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CHAPTER TWO
2.1 LITERATURE REVIEW
Theories concerning small business credit markets emphasize the existence of significant
information asymmetries between borrowers and lenders (Nakamura, 1993). It is also believed
that such market imperfections can result in credit rationing by lenders, particularly when loans
are unsecured (Stiglitz and Weiss, 1981). To mitigate such problems, borrowers and lenders have
historically used long-term relationships, or close and continuous interactions that generate
useful information about the borrowers financial states (Frame, 1994). Moreover, small
businesses are thought to be dependent on local banks for such relationship-based borrowing.
Empirical evidence confirms both the value of lending relationships (Petersen and Rajan, 1994;
Berger and Udell, 1995; and Cole, 1998) as well as the use of local commercial banks for small
business credits (Elliehausen and Wolken, 1990).
Credit scoring uses quantitative measures of the performance and characteristics of past
loans to predict the future performance of loans with similar characteristics. For lenders in rich
countries in the past decade, scoring has been one of the most important sources of increased
efficiency. Lenders in rich countries, however, score potential borrowers based on
comprehensive credit histories from credit bureaux and on the experience and salary of the
borrower in formal wage employment. Most microfinance lenders, however, do not have access
to credit bureaux, and most of their borrowers are poor and self-employed. The two chief
innovations of microfinanceloans to groups whose members use their social capital to screen
out bad risks and loans to individuals whose loan officers get to know them well enough to
screen out bad risksrely fundamentally on qualitative information kept in the heads of people.
Scoring, in contrast, relies fundamentally on quantitative information kept in the computers of a
lender. Can microfinance lenders use scoring to cut the costs of arrears and of loan evaluations
so as to improve efficiency and thus both outreach and profitability?
Indeed, Berger and Udell (1996) synthesize two theories positing that the provision of banking
services to small businesses decreases with bank size and organizational complexity. The first is
that the small business lending is fundamentally different from large firm lending in that the
former credits are more information intensive and relationship-driven. The second, based on the
work of Williamson (1967), emphasizes managerial diseconomies of scale with the provision of
multiple activities in large, complex organizations.1 Berger and Udells empirical tests indicate
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that large banks tend to charge relatively lower loan rates to and less often require collateral of
small business borrowers. However, they find that large banks reduce their volume of relatively
costly relationship loans via price or quantity rationing. Related work by Cole, Goldberg, and
White (1998) indicates that large banks typically employ standard financial statement criteria in
the loan decision process, while small banks focus more on their impression of borrower
character.
The aforementioned research suggests that small business loan underwriting is conducted
differently in large and small banks. Today, in fact, most large banks use automated underwriting
systems for small business lending based upon credit scores. Credit scoring is the process of
assigning a single quantitative measure, or score, to a potential borrower representing an estimate
of the borrowers future loan performance (Feldman, 1997). While credit scores have been used
for some time in the underwriting of consumer loans, this technology has only recently been
routinely applied to commercial credits. This is because commercial loans were thought to be too
heterogeneous and that documentation was not standardized either within or across institutions
(Rutherford 1994/1995). However, credit analysts ultimately determined that the personal credit
history of small business owners is highly predictive of the loan repayment prospects of the
business. Thus, personal information is obtained from a credit bureau and then augmented with
basic business-specific data to predict repayment. Eisenbeis (1996) presents an excellent
overview of the history and application of credit scoring techniques to small business loan
portfolios.
This development is in stark contrast to the perceived importance of a local bank-
borrower relationship. In fact, because of scoring systems, borrowers can obtain unsecured credit
from distant lenders through direct marketing channels. Second, the price of small business loans
should decline -- especially for high credit quality borrowers that will no longer will have to bear
the cost of extensive underwriting. Also, increased competition -- resulting from small
businesses having access to more lenders -- should further lower borrowing costs. Third, credit
scoring should increase credit availability for small businesses. Better information about therepayment prospects of a small business applicant makes it more likely that a lender will price
the loan based on expected risk, rather than denying the loan out of fear of charging too little.
Moreover, the widespread use of credit scoring should increase future prospects for asset
securitization by encouraging consistent underwriting standards.
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Empirical evidence concerning Feldmans predictions is limited to the effect of credit
scoring on small business credit availability. Indeed, Frame, Srinivasan, and Woosley (2001)
estimate that the use of credit scoring increases the portfolio share of small business loans by 8.4
percent for their sample of large commercial banking organizations. Of course, in light of the
findings of Berger and Udell (1996) and Cole, et al. (1998), this increase in lending likely
represents a combination of new business offset somewhat by a decline in relationship-based
loans by large banks. Experiments in Bolivia and Colombia (Schreiner 2000, 1999a, 1999b)
suggest that scoring for microfinance can indeed improve the judgement of risk and thus cut
costs.
Scoring is probably the next important technological innovation in microfinance, but
scoring will not replace loan groups or loan officers, and it will never be as effective as it is in
rich countries because much of the risk of microloans is unrelated to characteristics that can be
quantified inexpensively. Still, scoring can still be useful in microfinance because some risk is
related to characteristics that are inexpensive to quantify, and current microfinance technologies
do not seem to take advantage of this as much as they could.
While the principles outlined above apply uniformly to small business credit markets, those
geographic areas characterized by a large concentration of LMI households may be affected in
additional ways. First, due to asymmetric information problems, banks may have historically
elected to more readily ration small business credit in LMI areas due to their questionable
economic health. That is, lenders may have redlined, or used the physical location of the
business as a crude proxy for the riskiness of the loan. Credit scoring, by reducing these
informational asymmetries, should serve to reduce redlining and further increase the flow of
small business loans in LMI areas. Second, credit scores are designed to be objective risk
measures that may significantly reduce the willingness and ability of a loan officer to
discriminate based upon the borrower based on subjective judgments. This is particularly
important in LMI areas in which minority groups are generally over-represented. Thus, we
expect increased objectivity to increase credit availability in LMI areas. Third, credit scoringmodels may not accurately measure the probability of loan repayment for LMI borrowers if the
population of loans used to build the model was not sufficiently diverse. This could either help or
hinder small business credit availability in LMI areas depending upon whether the model
parameters are valid for the LMI sub-population.
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Study after study has shown that credit scoring is a vital part of a well-functioning,
modern financial system.25 The unimpeded flow of objective, neutral information between
legitimate parties enables credit lenders to make fast, accurate, and competitive decisions to
approve more applicants and expand access to credit, especially into underserved groups that
would otherwise have no access to these financial resources. In addition, credit scoring facilitates
the fair pricing of financial products. Without objective credit scores, it is much more difficult
for lenders to price products according to individual risk levels. Instead lenders set prices
according to average risk levels or using subjective, less precise, and potentially arbitrary
methods to make decisions. This results in products that are excessively expensive for low-risk
consumers and unfairly inexpensive for high-risk consumers, thus restricting access to financial
resources. The use of credit scores has played a critical role in extending credit to market
segments that have been historically underserved. And nearly one third of households had an
automobile lease or loan. Credit scoring plays a vital role in economic growth by helping expand
access to credit markets, lowering the price of credit and reducing delinquencies and defaults. In
the United States, credit scoring helps drive the American economy and makes credit affordable.
For consumers, scoring is the key to homeownership and consumer credit. It increases
competition among lenders, which drives down prices. Decisions can be made faster and cheaper
and more consumers can be approved. It helps spread risk more fairly so vital resources, such as
insurance and mortgages, are priced more fairly. For businesses, especially small and medium-
sized enterprises, credit scoring increases access to financial resources, reduce costs and helps
manage risk. For the national economy, credit scoring helps smooth consumption during cyclical
periods of unemployment and reduces the swings of the business cycle. By enabling loans and
credit products to be bundled according to risk and sold as securitized derivatives, credit scoring
connects consumers to secondary capital markets and increases the amount of capital that is
available to be extended or invested in economic growth.
Three years on after the launch, there is little data available to assess whether the
objectives of the credit bureau regulations were met. This research seeks to empirically examinethe effect of the use of credit scoring by large banking organizations on small business lending in
low- and moderate-income (LMI) areas. The fundamental question here is whether credit scoring
has aided lenders like Equity Bank Limited to determine whether to extend credit, and on what
terms. Have the regulations helped Equity Bank harness its strategic resources to grow a quality
loan portifolio and have the borrowers with low risk rating enjoyed preferential rates on loans.
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The purpose of this study will be to try and answer these questions and to explore the use of
credit rating to small scale borrowers.
This research concerns an investigation on the effect of Credit Scoring on Small Business
Lending on at Equity Bank Limited and as such, the dependent variables will be lower interest
credit and quality loan portfolio while the independent variable will be the use of credit score
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CHAPTER THREE
3.1 METHODOLOGY
The study aims to establish the use of credit scores in small-scale lending in Kenya as opposed to
the traditional underwriting. This is necessitated by the fact that, in many developed countries,
the use of credit scoring practices by banks is widely documented but in Kenya, information on
the extent of use of credit scoring practices is not available.
3.2 Study area
This research mainly intendeds to see the level of utility of information and communication
technology, to achieve history and credit sharing information. The study is geared towards
banking sector but narrowed down to small business lending, a case study on Equity and Kenya
Commercial Banks. The study however, will only involve the main branches, located in Nairobi.
3.3 Study population
The study targets customers who have borrowed from the banks before and after the
implementation of the credit scoring guidelines.
3.4 Data collection
Data used in the research comprised of primary data, sourced from the target population through
the use of questionnaires.
3.5 Sampling Design
Due to the sensitivity of the study to personal financial matters, random sampling of willing
person was employed. A number of one thousand despondences were picked.
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3.6 FINDINGS
3.6.1Case 1: Equity Bank
70% of equitys customers with prompt payment (and 100% success rate) with previous loans
indicates they found it easier to access subsequent loans. The customers indicate incentives on
negotiable rates and low loan insurance fees. The customers also indicate having an upper hand
when sourcing for a bigger loan.
100% of the customers who indicated they had irregular repayment of previous loans indicated
difficulties in accessing subsequent loans. They show a limited chance to negotiate for higher
loans or interest rate and indicate high feeon insurance charges. The customers feel that their
assets (security) and their monthly income were being ignored when calculating the rates and
repayment periods.
3.6.2 Case 2: Kenya Commercial Bank
20% of the customers with prompt payment (100% success repayment) of their previous loans
indicated a relief in their subsequent loans. They indicated low rates and ease of loan
negotiations. The remaining 80% indicates they found no difference, and the interest rates were
only based on their repayment period and market trends. They cited their assets (collateral) and
monthly incomes as their negotiating tools.
100% of the customers with delayed repayment in the previous loans indicated difficulty in
accessing subsequent loans. They cited delays in the processing of the loan, high rates and high
insurance fees.
3.7 CONCLUSION
The level of utility of credit scoring for the small scale business lending is minimal. Equity bank
seems to be on the forefront in adapting to system. The level of customer awareness on the use of
the system is also very low. It is however clear that the banks have a customers credit history as
it is evident that the banks blacklists its defaulting customers.
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CHAPTER FOUR
SUMMARY CONCLUSION AND RECOMMENDATION
4.1 SUMMARY OF FINDING
Equity bank seemed to factor in customer credit history since many its customers with prompt
payment (and 100% success rate) in their previous loans indicates they found it easier to access
subsequent loans. The customers indicate incentives on negotiable rates and low loan insurance
fees. The customers also indicate having an upper hand when sourcing for a bigger loan.
Defaulting customers indicated difficulties in accessing subsequent loans. They have a limited
negotiating power for higher loans or interest rate and indicate high fee on insurance charges.
Customers asset does not play a key role in determining the highest loan the customer canafford.
In KCB, only a small number of customers 20 with prompt payment (100% success repayment)
of their previous loans indicated a relief in their subsequent loans. Many customers indicates
they found no difference, and the interest rates were only based on their repayment period and
market trends. They cited their assets (collateral) and monthly incomes as their negotiating tools.
Defaulters however, found difficulty in accessing subsequent loans. They cited delays in the
processing of the loan, high rates and high insurance fees.
4.1.1 Similarities
The two banks seem to be keen on loan defaulters. This shows the two banks has adopted the
system to black list defaulters and limit their credit access in the future. This serves as a
disincentive to any borrower and so the borrowers will strive to meet their loan obligations.
4.1.2 Differences
Equity Bank has showed a positive note in the use of credit scores in handling of their customers.
This is paired with incentives of low rates and low fees on loan insurance. Good customers are
relieved the tedious scrutiny of their assets and monthly incomes. The customers have upper
hand in negotiating higher loans in the subsequent attempts.
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Kenya Commercial Bank on the other hand is seen as insensitive to the previous good record of
their customers. The extent of incorporating credit scores to give the loanees incentives, the bank
has stuck to traditional underwriting. The customers undergo the same thorough scrutiny before
accessing loans. No prevalence is given to them despite their successful repayment of previous
loans.
4.2 SUMMARY
The idea of using credit scoring as the sore determinant of the lending criteria has not been
fully realized in Kenya. Many businesspersons have no idea of how the scores are done and
neither do they know any advantages of the system. Its also clear that our bank have poor
credit history achieving methods. The utilization of information and communication
technology in achieving the credit history of the clients is very low. The information on
personal credit scores is not available as the central credit score bureau is yet to be realized in
Kenya.
4.3 CONCLUSION
Credit score is largely determined by:
i. Payment Historyhow borrowers paid their bills in the past can give lenders anindication of how they will pay in the future.
ii. Credit Historyhow long borrowers have had and successfully managed credit.iii. Outstanding Debthow much credit borrowers have and how much they have used.iv. Types of Creditis the loan personal or for business?
Credit scoring has proved to have the following advantages:
a) Borrower-Lender Interaction:with credit scoring, it saves the borrower the time tonegotiate for a loan. This is due to the appraisingrecord of accomplishment and therefore
the lender has some confidence in the borrower and will put less restriction on the
borrower if he has a good credit score.
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b) Loan Pricing: The price of small-business loans will decline for higher-credit qualityborrowers under credit scoring because these borrowers no longer have to bear the cost
of a full human underwriting.
c) Availability of Credit for Small Business: Better information about the repaymentprospects of a small-business applicant makes it more likely that a lender will price the
loan according to its expected risk. This prospect should increase the availability of
credit to small businesses.
Despite the advantages posed by the use of credit scores in the small-scale business cases,
it is clear that our banks have not fully employed the idea. The Kenyan public is oblivious
of the use of the credit scoring method. Many small businesses are seemed to rely on
limited information of business lending cases and are afraid of taking bigger loans.
4.4 RECOMMENDATION
The use of credit scoring, as well as loan standardization, offers substantial cost advantages in
the evaluation of the risks that goes in hand with lending. It is clear with credit score, a customer
finds it easy to access future loans based on the success of the previous loans. This is a positive
move where good customers are rewarded by low interests rate and are have higher chances to
access future loans. This is a big step as opposed to the traditional system where the good
customers suffered the wrath of defaulters as the banks aims at recovering their lost cash in
terms of increased rates for subsequent loans.
Despite the gains of the credit scoring method as opposed to the traditional underwriting, the
commercial banks in Kenya have not fully adopted the system. The banks need to be sensitized
on the use of the credit scores to improve the lender-borrower relations.
The Kenyan public is oblivious of the credit scoring rationale. The public should be sensitized on
the advantages of the system and how it works
A central bureau should be made available and shared with all banks. Individuals should also be
in a position to access their credit scores and translated into scorecards, which should aid them in
other sectors like in mortgages.
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References
Charles B. Wender and Matthew Harvey, SME Credit Scoring: Key Initiatives, Opportunities,
and Issues, Access Finance Newsletter, The World BankGroup, March 2006, Issue No.
10.
Hsia D.C. (1978) Credit scoring and the equal credit opportunity act.Hastings Law Journal,
30 (2), pp. 371-448.
Joseph W. Duncan, Congress Faces Critical Decision About Consumer Credit Legislation (The
Fair Credit Reporting Act of1970 and 1996), 62 Bus. Econ. July 2003.
Pagano, M & Jappelli, P, Information Sharing in Credit Markets, Journal of Finance, Vol LVIII,
No. 5, December1993.
Petersen, Mitchell and Raghuram Rajan. The Benefits of Lending Relationships: Evidence
From Small Business Data. Journal of Finance. Volume 49(1) March, 1994. Pages 3-37.
Rutherford, Reid. Securitizing Small Business Loans: A Bankers Action Plan. Commercial
Lending Review. Volume 10(1), Winter1994-95. Pages 62-74.
Stiglitz Joseph and Andrew Weiss. Credit Rationing in Markets with Imperfect Information.
American Economic Review. Volume 71(3), June, 1981. Pages 393-410.
Thomas L.C. (2000), A survey of credit and behavioral scoring: forecasting financial risk of
lending to customers,International Journal of Forecasting, 16 (2), pp. 149-172.
Thomas L.C., Ho J. and W.T. Scherer (2001), Time will tell: behavioural scoring and the
dynamics of consumer credit assessment,IMA Journal of Management Mathematics,
12,pp. 89-103.
Varghese, Robin, Ph.D., & Turner, Michael, Ph.D., The Benefits of Wider Participation in Full
File Credit Reporting in Latin America and the Costs of the Status Quo, Information
PolicyInstitute, March 27, 2006, Page 2
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Williamson, Oliver. The Economics of Defense Contracting: Incentives and Performance in R.
McKean, ed., Issues in Defense Economics. Columbia University Press: New York,
1967.
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Appendix 1
Borrowers Survey (Questionnaire)
Instructions
a. Tick appropriate boxes where applicable and fill the blank spaces accordinglyb. All information given will only be used for research.c. Do not write your name or business name anywhere in this questionnaire
1. Are you in business, self-employed or both?Explain.............................................................................................................
2. Have you ever borrowed money in Equity Bank?Yes ( ) No ( )
3. If yes what was the purpose of the loan?a.
Business working capital
b. Mortgageec. Personal loand. Emergency loane. Other (specify)
4. Was it your first time to borrow?Yes ( ) No ( )
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5. If No in 4. Above, what was the interest rate on your previous loan?...............................................................................................
6. How was your repayment?a. Good (prompt payment)b. Delayed paymentsc. Unable to payd. Written off by bank
7. If the repayment was good, were you given any incentive in the second facility based on thegood repayment record? ........................................
If Yes, Explain.................................................................................................
8. If the repayment was bad, were you penalised by the bank on the subsequent facility?...........................................................................
If yes, explain.......................................................................................................
9. Does the rate of interest of the loan advanced by the bank for subsequent loan(s) linked tohow you repaid your previous loan?
THANKS
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Appendix 2
Borrowers Survey (Questionnaire)
Instructions
d. Tick appropriate boxes where applicable and fill the blank spaces accordinglye. All information given will only be used for research.f. Do not write your name or business name anywhere in this questionnaire
10.Are you in business, self-employed or both?Explain.............................................................................................................
11.Have you ever borrowed money in Kenya Commercial Bank?Yes ( ) No ( )
12.If yes what was the purpose of the loan?f. Business working capitalg. Mortgageeh. Personal loani. Emergency loanj. Other (specify)
13.Was it your first time to borrow?Yes ( ) No ( )
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14.If No in 4. Above, what was the interest rate on your previous loan?...............................................................................................
15.How was your repayment?e. Good (prompt payment)f. Delayed paymentsg. Unable to payh. Written off by bank
16.If the repayment was good, were you given any incentive in the second facility based on thegood repayment record? ........................................
If Yes, Explain.................................................................................................
17.If the repayment was bad, were you penalised by the bank on the subsequent facility?...........................................................................
If yes, explain.......................................................................................................
18.Does the rate of interest of the loan advanced by the bank for subsequent loan(s) linked tohow you repaid your previous loan?
THANKS