Credit Default Risk and its Determinants of Microfinance Industry in Ethiopia

Abstract

Despite the current enthusiasms in applying the concept of microfinance as a poverty alleviation tool in many countries, the risk management aspects of micro-financing should not be overlooked. This paper highlights several incidences of default risks in microfinance institutions. The problem identified was that microfinance programs perform scantily because of delay in repayment and high default rates. Hence, it was important to establish if these limitations prevailed in the selected 6 MFIs in Ethiopia schemed by determining the default rate and the grounds of the observed trends. Therefore, in order to address those issues, the researcher used primary data collected through structured questionnaire and referred to secondary sources of data. As a result, the collected data and information were compiled and analyzed for possible indications of problem areas. So, the outcomes revealed that the MFIs default rate increased over the review period and averaged 27.1 per cent as well. The core factor of default was found to be poor business performance. Besides, credit diversion to unprofitable uses, domestic problems, numerous dependents, and tenancy problems were other factors that caused credit default. Further, the inference results of the descriptive statistics and the probit model show that education, income, loan supervision, suitability of repayment period and availability of other credit sources are important and significant factors that enhance the credit repayment performance, while credit diversion and credit/loan size are found to significantly increase credit default. There were serious problems observed in the screening mechanism the institutions employed, i.e. borrowers who are good payers like literate were rationed more, while those who contribute to the default problem like male and who apply for larger loan amounts were rationed less. So, the lending institutions are particularly recommended to improve these problems observed in its rationing mechanism. Moreover, the processes should be worked out to identify borrower capacity and any obligations that may interfere with repayment. Finally, the selected MFIs should intensify recovery of outstanding balances from defaulters through increased borrower follow-up. 

Keywords: MFIs, credit default, credit diversion, loan rationing, impact, creditworthy