ASSESSMENT OF LENDING POLICY AND PRACTICE OF

COOPERATIVE BANK OF OROMIA/CASE STUDY IN

SHASHEMENE BRANCH

A RESEARCH PAPER SUBMITTED TO DEPARTEMENT OF BANKING

AND FINANCE IN PARTIAL FULFILLMENT OF THE REQUIREMENT
FOR BA DEGREE IN BANKING AND FINANCE

BY ABRAHAM TESFAYE

ADVISOR GADISE GEZU (MSc)

JIMMA UNIVERSITY
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF BANKING AND FINANCE

JIMMA

ETHIOPIA
Acknowledgement
First of all I would like to thank almighty God for helping me in the successful achieving of this
paper. I would like to forward my gratitude to my advisor GadiseGezu for her willful guidance
scientific following up, cooperation. As well as devoting her time for the accomplishment of this
study. I also would like to make a large thanks to my family and relatives for their contribution
to my success

II
Table of Contents
Acknowledgement.......................................................................................................................................II
Abstract......................................................................................................................................................IV
CHAPTER ONE..........................................................................................................................................1
INTRODUCTION.......................................................................................................................................1
1.1. Background of the Study..................................................................................................................1
1.2. Background of the Organization.......................................................................................................2
1.3. Statement of the Problem................................................................................................................4
1.4. Objective of the Study......................................................................................................................6
1.4.1. General Objective of the Study..................................................................................................6
1.4.2. Specific Objective of the Study.................................................................................................6
1.5. Significance of the study...................................................................................................................6
1.6. Scope of the Study............................................................................................................................7
1.7. Limitation of the Study.....................................................................................................................7
CHAPTER TWO.........................................................................................................................................8
LiteratureReview.....................................................................................................................................8
2.1. Introduction......................................................................................................................................8
2.2 Concept of Lending Policy..................................................................................................................8
2.2.1Commercial Banks’ Performance................................................................................................9
2.2.2. Loan policy..............................................................................................................................10
2.2.3 The Loan Application Letter.....................................................................................................11
2.2.4 Credit Analysis.........................................................................................................................11
2.2.5 Loan Pricing.............................................................................................................................12
2.2.5.1Factors That Should Be Considered In Loan Pricing..............................................................12
2.2.6 Collateral..................................................................................................................................13
2.2.6.1 Adequacy of Margin..............................................................................................................13
2.2.6.2Marketability of securities:.....................................................................................................13
2.2.6.3 Documentation.......................................................................................................................14
2.2.7. Classification of loans..............................................................................................................14
2.2.8Factors Affecting the Lending Decisions...................................................................................15
2.3Empirical Literature..........................................................................................................................16
2.3.1 Bank Performance and Lending Policies..................................................................................17

III
CHAPTER THREE...................................................................................................................................19
METHODOLOGY OF THE STUDY.............................................................................................................19
3.1. Research Design..............................................................................................................................19
3.2. Source of data.................................................................................................................................19
3.3. Method of Data Collection..............................................................................................................19
3.4. Method of sampling.......................................................................................................................19
3.5 Method of data analysis..................................................................................................................20
CHAPTER FOUR.....................................................................................................................................21
4.1 DATA ANALYSIS AND INTERPRETATION...........................................................................................21
4.2 Interview Finding.............................................................................................................................27
CHAPTER FIVE.......................................................................................................................................28
CONCLUSION AND RECOMMENDATION...............................................................................................28
5.1conclusion.........................................................................................................................................28
5.2 Recommendation...........................................................................................................................29
Reference...................................................................................................................................................30
Appendix I.................................................................................................................................................31
Jimma University....................................................................................................................................31
Appendix II...............................................................................................................................................34

IV
Abstract
Bank Lending policy is a statement of its philosophy; this study was designed to assess lending
policy and the practice of cooperative bank of Oromia at Shashamane abosto branch. The main
objective of the study was to assess whether the bank follow genuine lending policy or not
complied with it by considering the current operation of the bank in order to do this research
data has been collected through questionnaires and interview method of data collections. Sample
has been taken from total population available for the study by using random sampling
technique; from 189 loan customers of the bank 50 loan customers have been selected using
simple random sampling technique to collect data. The data has been organized by using both
qualitative and quantitative techniques through tabulation and percentage to generate possible
results. After the required data have been collected from primary sources, an appropriate
analysis has been made by using descriptive analyzing methods for appropriate conclusion.
Finally, feasible recommendation has been made on identified weakness regarding lending
policy and the practice.

V
 CHAPTER ONE
INTRODUCTION

1.1. Background of the Study

In order to have general understanding regarding bank and development of private bank
currently, I would like to throw some insight about the concept of bank. Accordingly, some
author stated that, the word bank is derived from the word “Bancus” or “Banquet” which means
a bench. Some other sector says, is a “banck” as German word which indicate joint stock Bank is
financial institutions that serve as a financial intermediate.(Colind Campbell, 1987).

Financial institution promotes economic efficiency too by gathering the surplus fund of millions
f individual groups and some other organizational depositors and making them available to
inventors who are engaged in different economic activities In addition to this the bank also serve
as a means of capital accumulation in the form of saving with or without interest as the need of
the customer. Furthermore, bank is place where secret document and highly valuable jewelry
could keep. in the other hand the bank loan policy and procedure provide guidelines for
determining suitable lending requirement, format and preparation of loan proposal, among other
things credit offer are required to follow some basic guideline in formulating lending decision
(Shelagh Heffernan, 1996).

Financial sector of the county in general and cooperative bank of oromia in particular were coup
up with the general principle of the country’s financial policy. The lending policy of the bank
plays a key role in the allocation of credit among various possible uses. Credit is provided if
business firm lack the ability to pay back with interest the amount they borrow, because they
failed to spend the fund productivity. Banker performs the lending functions well if they
correctly evaluate the proposed uses of loans. Private ownership of bank provides an incentive
for bankers to lend money successfully, because bank owners receive maximum return on their
bank stock only if bank officers successfully lend funds at the highest possible rate of return that
are consistent with reasonable prospect of repayment (colinD.cambell.1987)

1
When we come to the history of banking in Ethiopia, modern banking services were started in
1906 with the entry of foreign owned bank of Abyssinia. As to the legal basis of current private
banking system, monetary and banking proclamation no. 83/94 and licensing and supervision of
banking business no. 89/94 laid down founding basis for investing on banking sector (Lidia,
2006).

However this study was assess lending policy and practical efficiency of cooperative bank of
Oromia Abosto branch in Shashemene town.

1.2. Background of the Organization

Establishment of the organization

Cooperative bank of oromia (SC) was established to fulfill the demand supply gap observed in
the financial services among cooperatives and other operators in oromia region. The bank was
registered commercially, on October 29, 2004, in accordance with the commercial code of
Ethiopia and licensed by the national bank of Ethiopia as per licensing and supervision of
banking business No. 84/1994 starts its operation on 8th of September, 2005.

Service of the Bank

As a service the bank is provide many services to his customer from those services provided by
the bank is

Deposit account

It is a service that given by the bank account that pays interest but that imposes the requirement
of notice (or a penalty in terms of interest) before withdrawal can be effected; a deposit receiptis
an acknowledgement by the bank that sums have been deposited and are being held for the
account of the depositor. And it isPlacement of funds in an account with the bank

Saving Deposit

Initial deposit of birr 50 is required to open this account, interest paid on monthly basis.

2
Fixed Time Deposit

Interest bearing account with agreed maturity dates and attractive interest rate on large deposited
fund of longer maturity periods.

Demand Deposit

Non-interest bearing checking account can be opened with an initial deposit of birr 500.

Children’s Trust Account

It is special types of deposit opened by parents or guardians for their children’s future benefits
such as covering their higher education force. To open suck account, parents or guardians should
present a document that indicates the age of the child.

Loans and Advances/Credit Products/

Term loan (medium and short), agriculture, domestic trade service, manufacturing, export,
building and construction, merchandise loan, overdraft (OD) facility import/export letter of
credits advances against import bills, advance against export bills, letter of guarantee and
consumption loan.

Local Money Transfer

Delivers fast and efficient local money transfer service at all its branches.

Foreign Banking

Import and export letter of credit facilities, incoming foreign remittance through the transfer
agents, dahabshill, x-press money, western ion and swift

Foreign exchange service at international department, sheger, Adama, shashemene,DireDawa,

Qarsa, Gulele, Burayu and Merkato branches.

3
Branch Network

Cooperative bank of oromia (SC) commenced operation with 6 branches. Currently the bank
renders efficient and quality banking service to its customers though its 52, branches throughout
Oromia.

Cooperative bank of Oromia, shashemene branch was opened in 8th September, 2005 and it was
one of among the 52, branch with which cooperative bank of Oromia (sc) delivering its service.

(Cooperative bank of oromia annual report 2008/09)

1.3. Statement of the Problem

In deeded, every financial institution should have to issue effective policy specify type, size and
terms of loan. The designation of such genuine policy never made the institution competent
enough, effective and efficient unless the institution complied with them. Procedure and system
listed in the loan policy has to be followed consistency at all to ensure sound, improved and
qualified lending service.

According to Amidu (2006), bank credit channel has focused on two issues. The first issue
centered whether there are categories of borrowers who depend on bank lending in that any
change in banks’ willingness to lend immediately affects their investment and spending
decisions. The other issue is whether monetary policy changes directly constrain bank lending to
borrowers. Both conditions are necessary for bank lending to play a special role in the monetary
transmission mechanism. Some recent research provides support for the view that certain
borrowers, especially small businesses, are very dependent on banks for financing (Abor, 2004).

To fill the practical gap that exist between the demand of customer and the service of the bank,
the banks are expected to comply with those rules and should look the consequence; they would
enable the bank to be sensitive for demand of its customers. In order to be profitable the bank
shall be near to the customer and observe what practical inconsistence is there in relation to its
policy (Mishikin, 1992).

4
The researcher believes that this study fulfil the gap found between the previous study that
researched by different and many researchers with in different times. The gaps that make this
research different from previously done research are;-

 The range of time, that the previous researcher depends on complex figure in order to
represent and analysis the data. Due to this, now day there are many changes in bank such
as technological change and structural change which affects the whole activities of the
bank.

 The research tried to study the bank lending policy and practice in relation to the demand
of customer and the supply of the banks in providing lending services.
 The previous researchers depend on large numbers of branches and broad structure. But
the researcher depend on small number of branch and narrow structure .because in large
number of branches it’s difficult to assess the banks’ lending policy and practices .but the
researcher select the specific branch in Shashamane town as it is easy to assess the bank
lending policy and practice

 Generally, the researcher believes that, the above mentioned gap filled by findings of new
information and by modifying the researched one in order to provide a better
understanding of lending policy and practice of the bank.
However, this study was aim to assess the lending policy and its practical effect of the
cooperative bank of Oromia at Shashamane district.

The researcher studied to answer the following research question.

 How much the loan applicant’s has knowledge about the lending policy and procedure of
bank?
 Does the bank charge a fair interest on loan?
 What are those criteria of acceptable security according to the bank lending policy?

5
1.4. Objective of the Study

1.4.1. General Objective of the Study

The general objective of the study was to assess the lending policy and its practical aspect of the
cooperative bank of oromia at shashemene district.

1.4.2. Specific Objective of the Study

It was the continuation of the general objective and attempt have been made to convey the deep
rooted intent of the background of the research,

Specific objectives of the study are:-

 To assess how much loan customer of the bank knows the lending policy and practices of
the bank.
 To evaluate that does the bank charge fair interest on loan to the customer
 To identify a criteria of acceptable collateral according to the bank policy.

1.5. Significance of the study

Moreover, the study is expected to serve as a basis for subsequent studies on the topic; to provide
basic data about the policy, and get an important solution for the variables, to provide useful
information about lending policy and practice of cooperative bank of Oromia and great
importance for the bank because it collects feedback from loan outcomes also the bank could use
it to improve and clarify its policy and service.

The study has much significance, among these some of them are:-

 A researcher acquires knowledge and experience and add some stock of knowledge what
he had
 The study also has a great importance for the bank because it collects feedback from loan
outcomes about its service, policy and procedure with their practical significance. The
bank could use to improve and clarify its policy and service.
 Furthermore, the study services as a bench mark to conduct further study on the area.

6
1.6. Scope of the Study
Due to different difficulties to conduct the study in all branch of the bank, the study was
concentrate only on cooperative bank of Oromia Shashamane abosto branch in Shashamane city
and particular on the lending policy and practical aspect of the bank.

1.7. Limitation of the Study

While conducting these research paper, there are a lot of constrained encountered the researcher.

 Unavailable of reference material and lack of supportive tools.

 The total questionnaire duplicated and distributed were not collected fully because of
carelessness of few respondent

7
 CHAPTER TWO
LiteratureReview

2.1. Introduction
This chapter reviews the existing literature on the subject under research. The matter contained
in this chapter relates to past studies on bank lending policy and practice on banks. It also
narrates research work carried and gives a critical review of these existing literatures.

2.2 Concept of Lending Policy

Lending policies are the commercial banks set rules and regulations put in place to ensure bank
offers credit to retail and corporate parties. Credit policies revolve around a number of credit
parameters. Customer affordability is one of such parameters, which is also termed as debt
service ratio. The ratio aims to measure the customer’s income against the customer’s existing
and prospective liabilities to evaluate his ability to service any new debt he or she acquires. This
ratio is determined by the central bank of a given country and it tends to be the same across
banks (Morsman 1993).
Credit scoring is another policy parameter is especially applied in a high volume retail lending
environment. It is based on the concept that applicants will perform in a similar way to existing
customers with a similar demographic profile. A higher score means that a loan will be approved
but those applicants that have a lower score will have their loans declined. Each commercial
bank develops its own scorecard and this determines whether the lending policy is stringent or
not(Morsman 1993)
Verification is another important guide to banks credit policies. The process may, depending on
the local regulations market practices, channel of acquisition and discretions of the country‘s
credit policy, involve verification of the applicants business and or residential address. Credit
reference bureau is an information bureau that helps the financiers to know more about the
customer’s borrowing history and consequently will form a basis of a decision on whether lend
or not. In Kenya for example central bank requires that all banks list all customers who have
defaulted previously and that no lender should approve a facility unless a confirmation has been
done by the credit reference bureau. Banks need to monitor carefully the risk-return profile of

8
their lending portfolio to meet capital adequacy guidelines and to ensure long-term survival. The
objective of the bank is to maximize profits thus maximize the shareholders wealth. If the
primary objective of all bank lending policy is to make trouble-free advances, the financial
capacity and previous borrowing experience of a loan applicant and their determination to repay
their debts is all-important(Morsman 1993)

Weinstein and Yafeh, (1998) indicated that applying stringent lending criteria to customer
borrowers may, in effect; lead to their exclusion from the financial system is not socially
acceptable or legitimate. At the same time, failure to provide for credit risk increases the
likelihood of loan default, which in the short term increases financial institution costs and in the
long term is passed on to other borrowers in the form of more expensive and or less accessible
retail credit. The consumer bankruptcy research emphasizes the need for managers to balance the
accessible image and social responsibilities of banks with vigilant assessment and monitoring of
The credit risk of individual borrowers (Yafeh, 1998)

2.2.1Commercial Banks’ Performance

Successful bank operations require managers to weigh complex trade-offs between growths,
return, and risk. By forcing line managers to include the opportunity cost of equity when making
investment and operating decisions, banks expect to elicit better decision-making by managers.
Implementing performance measurement and incentive systems driven by economic profit
allocated equity capital, senior managers also hope to align managerial behavior more closely
with the interests of shareholders. To measure banks’ creditworthiness and risk exposures is a
complicated issue and it is not easy to interpret banks’ accounting data, Diamond (1984). argued
that “Indicators of business failures and nonperforming loans are also usually available only at
low frequencies, if at all; the latter are also made less informative by banks desire to hide their
problems for as long as possible. This means that it is needed to use as fully as possible, all
available financial information from the official financial statements of banks in making
financial analysis of banks’ performance (Brown Bridge, 1998).

The focus of financial analysis for the management of any bank (or the banking sector as a
whole) should be on the efficiency of performance of the bank measured from the viewpoint of

9
investors and shareholders’ income maximization. More widely, all stakeholders have to be
interested in the performance results of the banks. The concept of a stakeholder monitor is useful
to take into account in designing performance analysis of any bank. In carrying out bank
performance analysis, it is important to emphasize that banks differ in their corporate governance
from firms in other, less regulated industries. These differences, in turn, present their own
challenges for bank managers, regulators, depositors, investors, and other stakeholders. Various
measures of rates of return are used mainly for that purpose. We fully agree with the opinion that
“Relaying too heavily on just a few indicators of bank profitability can be misleading. While
interest margin and noninterest expenses to gross income remain the key measures, they should
ideally be supplemented by the analysis of other operating ratios (BrownBridge,1998)

The efficiency of the banking system has been one of the major issues in the new monetary and
financial environment. The efficiency and competitiveness of financial institutions cannot easily
be measured, since their products and services are of an intangible nature. Many researchers have
attempted to measure the productivity and efficiency of the banking industry using outputs,
costs, efficiency and performance. The scale and scope economies of banking have been one of
the issues related to the competitiveness and efficiency of banks which have been studied
extensively. Morsman (1993) recognized the multi-product nature of financial intermediaries and
used a cost function to evaluate the scale and scope economies of credit unions in Canada. They
found that large multi-product credit unions are more cost-efficient than small single-product
credit unions. Chijoriga (1997) uses interest margin as a performance measure for U.S.
commercial banks. He defines interest margin as the difference between interest income and
expense divided by total assets. BrownBridge (1998)
The major purpose of a bank was to generate profit for its shareholders. Banks may have many
duties and obligation to the public and to the community at large. But it must not be forgotten
that they were private profit –making enterprise. Despite the growing range of bank service,
lending remain the sources of profit to banks (Julian Hoyle, 1987).

2.2.2. Loan policy

Credit policy is a policy concerning the lending activities of the bank. Which is formal and
written, it is also known as “loan policy”. It is desirable to have explicit lend policies for the
following reason.

10
  to establish the direction and of the fund
 to control the composition and size of loan portfolios
 To determine the general circumstance under which it is appropriate to make a loan
Item Includes In a Loan Policy

The following are the major items included in a loan policy:

 types of loan to be made

 acceptable security and credit worthiness
 maturity
 excess line
 loan commitment

2.2.3 The Loan Application Letter

The loan application should clearly indicate the following:

 applicants name
 full address of the applicant
 amount of loan requested in birr
 the collateral offered
 made of repayment, monthly, quarterly, semi-annual and annual
Sources of repayment

The application letter should be signed by the loan applicant as well as the mortgage personal
guarantee if there is any.

When loan application is received by the banks it is necessary to examine and identify as to who
the applicant is, to insure that the loan requested is initiated by legitimate body on top of this, if
the property to be mortgaged is owned by a third party. The consent of the mortgages should be
obtained together with application letter (Hoyle and Geoffrey, 1987).

2.2.4 Credit Analysis

Credit analysis is the method by which one calculates the credit worthiness of a business
organization. The purpose of credit analysis and appraisal is to assess the likelihood that the

11
customer will repay the loan in accordance with stipulated terms. In the analysis of customers
loan request the lending officer must strictly evaluate the request in line with its ability and
desire to repay the loan. Amount applied for should also be evaluated carefully considering the
capacity to repay and attainability of borrower’s business plan.

Analysis of Financial Statement

The financial statement like the balance sheet, income statement and cash flow statement should
be carefully analyzed to determine the financial soundness of the application and assess the
repayment capacity. Credit analysis involves a wide variety of financial analysis technique.
including ratio and trade analysis involves a wide variety of financial analysis techniques,
including ratio and trend analysis as well as the creation of projections and a detailed analysis to
measures the liquidity and profitability of the business in the decision making o the amount and
types of loan to be granted (Shelagh Heffernan, 1996)

2.2.5 Loan Pricing

The pricing of bank loan involves the fixation of interest and in some cases, the imposition of
loan fees. Interest rate may be either fixed or variable. A fixed ration is one remains the same
during the loan contract. a variable rate is one that may change during the term of loan.

2.2.5.1Factors That Should Be Considered In Loan Pricing

Loan should be priced at a level of sufficient to cover all cost, funded needed provision to
allowance accounts and facilitate the accretion of capital. Specific consideration should be given
to the:-

 cost of fund
 the cost of service loan
 cost of operation
 credit risk
 interest rate risk (IRR)
 the competitive environment

12
A shift in anyone of these components could warrant a pricing adjustment. Failure to do so could
result in insufficient carding to meet capital needs. Therefore, loan pricing programs require
constant review and management.(Shelagh Heffernan, 1996)

2.2.6 Collateral
Bank often think that security is the most vital element for the bank in any loan arrangement, but
in fact it is really secondary to the viability of the loan arrangement itself and only provides a
further safe guard for the bank. the chief consideration with customers who already known to the
bank is whether the customer income or earning from his/her business is sufficient to enable the
payment to be made.

If the decision is that the loan shall be granted we can then reinforce the decision with any
security that is available, but if the loan proposal is basically unsound the bank will not proceed
even in security with known customers should be regarded as insurance cover should the worst
happen?

The most common types of security taken are:-

 mortgage over landed property

 mortgage over stock and shares
 assignment of a life policy
 guarantee
General principles of secured advances

2.2.6.1 Adequacy of Margin

The word “margin” has special meaning and significance the banking business. In banking
terminology, margin means the difference between the market value of the security and amount
of the advance granted against it.

2.2.6.2Marketability of securities:
Advance are usually granted for short periods by the commercial bank because their deposit
resources/except term deposition/ are either repayable on demand or at short notice. if the
customer defaults I making payment, he banker has to liquidate the security. It is therefore

13
essential that the security offered by a borrower may be disposed of without loss of time and
money. A banker should be very cautious in accepting assists, which are not easily marketable.

2.2.6.3 Documentation
Documentation means that necessary documentation; e.g. agreement of pledge or mortgage etc.
are prepared and signed by borrower at the time of securing a loan from the bank.

Realization of the advances:- if the borrower defaults in making payment on the specified data,
the banker may realize this debt from the sale proceeds of the securities pledge to him (Julia
Hyle and Geoffrey White Head, 1987).

2.2.7. Classification of loans

Bank loans can be classified in variety of ways. They can be classified as follow.

On the basis of purpose:.

Normally bank loans can be classified accordingly to the purpose for which it is borrowed. For
example, loans given for trading activities are known as commercial loan. Loan given for
industrial activities are known as industrial loans and loan given for purchase of customer
durables goods/refrigerator televisions etc are called customer loan.

On the basis of security:

A Bank loan can be securities loan or unsecured loan. Secured loan are those loans are secured
by a security offered by the borrower unsecured loans are based more exclusively on borrower’s
integrity and financial condition, expected future income and past recurred of repayment. The
largest commercial borrowers are able to borrow on an unsecured basis.

On the basis of maturity

Bank loan can be classified according to the maturity of the loan into short term, medium term
and long term loans. Short term loan are usually defined as those loans with maturities one year
or less. Medium term loans mature in more than one year and up to 5 or 7 years. Long term loans
may be for more than 7 year, or on demand basis.

14
On the basic of method repayment

Bank loans may be repaid in one lump sum or installment basis. Lump sum loan are usually
referred as straight loan. Installment loans required periodic payment of principle usually of
equal amount (Harold Barger, 1962).

2.2.8Factors Affecting the Lending Decisions

The loan allocation and the loan portfolio of any individual financial institution e.g. commercial
banks will be dictated by lending decisions. The nature, size, and the structure of loan portfolio is
a reflection of financial institutions lending decisions. The lending decisions are influenced by
the following:

The size of the lending institution: - This is very vital in determining the size of the loan to lend.
Further, it also restricts the potential market for borrowers such that if a financial institution is
small and therefore its geographical coverage is small, its lending decision will differ from
Multinational financial decisions. Its loaning decisions will also depend on the business potential
on the areas of its coverage. The small financial institutions should therefore consider their local
community and immediate environment when drawing up the lending decisions. Multinationals
will consider a wider environment (George & Simonson, 2000).

Economic conditions: - It refers to the economic activities around financial institutions operating
environment. Many banks are usually located in areas where economic activities are either
dominated by manufacturers or service industry, etc. Lending policies 23 should therefore be
tailored according to the pre-dominant business activity in the bank’s environment. Of great
importance here is to focus on the flow of business within this environment and design policies
that are able to tap the benefits to the business. In periods of corporate bankruptcy, it is also
important to notice that certain loan policies are important to help re-organize bankrupt
institutions and transform them into highly profitable organizations (Dyer, 1997).

Credit Analysis:-The purpose of credit analysis is to assess the likelihood that a borrower will
default on a given loan. Credit analysis consists of evaluating a borrower’s needs and financial
conditions which includes: Character or the person’s traits such as honesty, ethical
considerations, integrity, etc. This is usually based on the borrower’s past behaviour in both
banking & repayments of loans borrowed earlier. Capacity of the borrower which focuses on

15
whether the borrower has the ability to generate sufficient funds to liquidate the loan and still
stay financially healthy. This will include assessing the manager’s ability, policy documents of
the firm, investment policies, strategic plans, credit statements, etc. as well as judge the market
potential of the institution. The judgment should be both on liquidity as well as solvency of the
Institution

According to the provisions of Central Bank, all loans offered by banks must be secured to
protect the borrower’s funds. The value of the security should be ascertained and title documents
charged to the loan which should not exceed 2/3 of the value of the securities. Capital or the
money personally invested into the business by the loan and is an indication of how much the
borrower has at risk should the business fail. Interested 24 lenders and investors will expect the
loan to have contributed from their own assets and to have undertaken personal financial risk to
establish the business before advancing any credit (George &Simonson2000)

2.3Empirical Literature
A lot has been reviewed in terms of lending activities of various commercial banks. Some
opinions deliberated on the factor responsible for banks willingness to extend much credit to
some sector of the economy, while some discussed effect of such extension of credits on
productivity and output. Most of these earlier studies agreed on the fact that it is logical for banks
to have some basic lending principles or consideration to act as a check 16 in their lending
activities. Since there are many studies in respect of bank‘s lending behavior, it is therefore
imperative to highlight and consider some effect of lending policies that economist and
professionals alike have proposed as virtually significant in explaining the loan portfolio
performance. According to Amidu (2006), bank credit channel has focused on two issues. The
first issue centred whether there are categories of borrowers who depend on bank lending in that
any change in banks’ willingness to lend immediately affects their investment and spending
decisions. The other issue is whether monetary policy changes directly constrain bank lending to
borrowers. Both conditions are necessary for bank lending to play a special role in the monetary
transmission mechanism. Some recent research provides support for the view that certain
borrowers, especially small businesses, are very dependent on banks for financing (Abor, 2004).

16
2.3.1 Bank Performance and Lending Policies
Prior research suggests that banks strongly influence economic development and the efficient
allocation of funds resulting in a lower cost of capital to firms, a boost in capita formations, and
an increase in productivity (Fama, 1985). The formulation of effective lending procedure and
policies heightened the importance of internal regulatory mechanisms of banks such as corporate
governance leading to better improve bank profitability. In particular, lending policies in
commercial banks are expected to improve banks’ valuation, cost of capital, performance, and
risk-taking behavior. Notwithstanding, the economic relevance of banks and lending framework
within banks which has increase market credibility and subsequently enables bank to collect
funds at lower cost and lower risks (Basel ,2004). Stafford(2001) studied bank’s performance
from 27 developing countries. They find evidence that there is higher valuation of firms in
countries with better lending practices.

Given the importance of lending in commercial banks, the efficiency of a bank's lending policies
is expected to significantly influence its financial performance (Esty& Megginson,2003).

An extensive body of literature argues that effective lending policies influence better financial
performance of banks. Lending policy framework is important function of financial institutions
in creating value for shareholders and customers. Bank engages in lending policies formulation if
it enhances shareholder value, create customer satisfaction, reduce loan loss defaults and increase
ban profitability. Thus, effective lending policies in banking firms are expected to enhance the
value of the firm and shareholder wealth.

Perro and Ruoff (1997), indicated that Korean commercial banks and merchant banking
corporations had been significantly been affected by poor lending policies, and that the
subsequent profitability of financial institutions decline. There is therefore more emphasize on he
importance of improving existing lending policies as a precondition for successful financial
liberalization.

Lending framework dictates that as long as the demand for liquidity from depositors and
borrowers is not too highly correlated, the intermediary should pool these two classes of
customers together to conserve on its need to hold costly liquid assets the buffer against
unexpected deposit withdrawals and loan take downs. Funding growth through core saving has

17
become largely a thing of the past. The advent of nonbank competition and the rise of third-party
funding, implies that community banks now operate in a dynamic funding market, which
requires the use of more sophisticated lending policies. Industry experts point to many different
underlying causes for the bank improvement in investment products; new delivery systems such
as the internet withstand the competition from other financial institutions (Boucher,1996).

Ewert et al. (2000) study the determinants of bank lending performance in Germany using credit
file information of 260 medium-sized firm borrowers for the period 1992- 1998. The study aims
at testing the several theories relating collateral to interest rate premiums and therefore lending
performance, using a random effects model on panel data analysis to eliminate the borrower and
time-specific effects. Two models were estimated with interest rate premiums and probability of
distress as the two predicted variables. Interest rate premium was set to be predicted in a random
effects model by among other variables: collateral; bank relationships; bank firm rating; firm
characteristic and firm size. The highlight of this study’s finding was that interest rate premium
increased with rise in the collateral pledged. This was contrary to the signaling and firm
characteristics theories above, where we would expect higher interest rate premium for firms
pledging little or no collateral. However, estimation of distress probabilities of the 19 same firms
revealed that more collateral and covenant in credit contracts lead to lower distress probabilities.
Combining the above results, the study gives controversial finding that riskier credit contracts are
assigned lower interest rate premiums by banks.

18
 CHAPTER THREE

METHODOLOGY OF THE STUDY

3.1. Research Design

The researcher has used descriptive method to conduct this research. The researcher used
descriptive method which describing, summarizing, presenting the qualitative data because of it
describes anything as it is.

3.2. Source of data

For the purpose of this study the researcher has employed primary source of data concerning to
this study. The primary source of data has been obtained from loan customers and loan officers
of the bank.

3.3. Method of Data Collection

There are various data collection methods such as questionnaires, interviews and observation.
Among these methods a researcher has used self-administrate questionnaire for loan customer
and personal interviews for loan officers.

3.4. Method of sampling

The study has been conducted through distribution of questionnaires to loan customers and by
making interview to loan officers. However, to distribute questionnaire for all loan customers
and to make interview with all loan officers it is very costly and time consuming, as a result
sample have taken.

Therefore to ensure accuracy, the researcher has used random sampling technique and with the
total study population size of 700, with this 24 samples of loan customer from all total
population and all employees have been taken. So the sample size from total target population
can be determined by Yamane formula:-

19
n=N/1+N (e)2

=700/1+700(0.04)

n=24.14≈24

Where: N= total number of population

n= required sample size

e2= margin of error term 20%

3.5 Method of data analysis

The researcher has used descriptive method of data analysis. The method of analysis is that
collected data categorized then tabulation of data has been followed and analyzed using both
qualitative and quantitative means of analysis. The quantitative analysis has been organized,
described and systematically interpreted. The collected data through quantitative analysis have
been systematically analyzed into tabular forms in terms of frequency and percentages 24 loan
customer from all total population and all employees (loan officer) have been taken

20
 CHAPTER FOUR
4.1 DATA ANALYSIS AND INTERPRETATION
In this section, the study deals with the analysis and interpretation of the collected data. The data
were collected from primary source as mentioned here in the previous chapter of the study. The
survey analysis result and discussion were divided in to two including the survey result from
questionnaire and interview.

From the total study population size of 700, 24 sample sizes had been designed. Following direct
distribution and collection of questionnaire and the collected data amount to 83.3%, which mean
out of 24 questionnaire distributed, 4 questionnaires has been remain uncollected and not
returned back. The analysis conducted based on the information obtained from questionnaire
which was distributed to the loan customers.

Table4.1: show personal background of the respondents

In number In percent

Sex Male 14 70%

Female 6 30%
Total 20 100%
Age 18-25 5 25%
26-35 7 35%
>35 8 40%
Total 20 100%
Job/Occupation Civil servant 4 20%
Business 12 60%
man/merchant
Employees 4 20%
Total 20 100%
What kind of trade Wholesaler 5 41.67%
you are doing? Retailer 7 58.33%

Total 12 100%

21
Source: primary data from questionnaire, 2018

As it can be seen from the above 14 (70%) of the borrower were male, whereas the remaining
6(30%) were females. The figures shows that male have still taken more loan from the bank.

Based on the above data 5(25%) of borrowers were found between the age of 18-25 years,
whereas as 7(35%) were in the age between 26-35 and 8(40 %), the largest group of the borrower
were at the age greater than 36 years old. These indicate that the majority of the borrow was
found in maturity and may be regarded as out of productive age

Regarding to their job/occupation from the borrowers, 12(60%) were business man and 4(20%)
and 4(20%) were civil servant and employers respectively. As to the data, more of the borrowers
were merchant or business man, and out of them 5(41.67%) were wholesalers and 7(58.33%)
were retailers. From this we understand that business man occupation position take higher place
in the bank

Table 4.2: shows how long the borrowers exists as a loan customers

For how many years you exists as a In number In percent

loan customers
<1 year 2 10%
1 year 3 15%
< 2 years 6 30%
2 years 4 20%
>2 years 5 25%
Total 2 20 100%
Source: primary data from questionnaire 2018

According to the above 5(25%) of borrowers were existed as a loan customer for greater than 2
years. Whereas 3(15%) and 2(10%) existed as a loan customer for one year and less than a year.
On the other hand, 4(20%) and 6(30%) customer were remain as a loan customer for about 2
years and less than 1 years respectively so from this we understand that the customers are more
similarity to their duration

22
Table4.3: shows why borrower prepared cooperative bank of oromia

What makes you to prepare cooperative bank of In number In percent

Oromia from other bank
Quality of survive 8 40%
Nature of loan requirement 6 30%
Nature of interest rate 2 10%
Location 4 20%
Total 20 100%
Source: primary data from the questionnaire 2018

As presented in the above table 8(40%) prefers cooperative bank of Oromia due to its quality
service and 6(30%) prefer because of nature of loan requirement 2(10%) and 4(20%) of
borrowers prefer because of nature of interest rate and location of bank respectively. Therefore,
from these, the one might conclude that, majority of borrower prefer cooperative bank of Oromia
in its quality of service

Table4.4: shows types ad purpose of loan

What types of loan you take from the bank In number In percent
Construction loan 4 20%
Commercial loan 15 75%
Industrial loan 1 55%
Total 20 100%
For what purpose you take loan
To establish new business 5 25%
To purchase equipment 6 30%
For expansion of existing business 8 40%
For construction 1 5%
Total 20 100%
Source: primary data from questionnaire, 2018

23
The above table shows information about the types of loan and purpose of loan. Accordingly
4(20%) and 15(75%) of loan directed towards constructing and commercial loan, whereas 1(5%)
were taken as industrial loan. With regard to the purpose of loan, largest share were taken the
purpose of expansion of existing business. From these one can understand that more than half of
the loan is given for commercial purpose.

Table4.5: shows length of loan approval

How many working days it takes from the date In number In percent
of application to approval
1-10 days 15 75%
11-20 days 5 25%
21-30 days
More than 30days
Total 20 100%
Is a lending policy is flexible
Yes 12 60%
No 4 20%
No response 4 20%
Total 20 100%
Source: primary data from questionnaire2018

As to the table here is above, around 15(75%) respondents verified that, the process of loan from
the date of commencement of application to the day of authorization could take 1-10 day only so
long as they complied with the requirement. Whereas the rest 5(25%) replied that, their loan
application would take longer than from 11-20 days. The reason to such managerial decision as
to some specific loan application and also examination of collateral including field observation
in relation to loan application would take considerable amount of time.

Again respondent were asked that whether the lending rule is flexible or not, for thus 4(20%) of
respondent verified that was not flexible and the rest 12(60%) affirmed that, the rule was
flexible, whereas remaining 4(20%) of respondents were remain silent. Additionally, those from
this we understand that lending policy is flexible

24
Table4.6: shows does bank give loan as expected

Do you get the loan amount as expected or asked In number In percent

Yes 15 75%
No 5 25%
No response
Total 20 100%
Source: primary data from questionnaire2018

As presented in the above table 15(75%) said that they get the loan amount as they want whereas
5(25%) didn’t get a loan amount. They stated the reason that rigidity as lending policy and bank
failure to regard their economic efficiency and capacity.

Table4.7: shows do a bank as collateral

Does a bank askcollateral for a loan In number In percent

Yes 20 100%
No
No response
Total 20 100%
Source: primary data from questionnaire2018

As presented in the above table, all the borrower said that, the bank ask them collateral to grant a
loan. From this we can conclude the borrowers provide building and machinery as collateral and
also the bank accepts surely (personal guarantee).

25
Table4.8 shows interest rate in loan

Do you think that the interest rate a bank charge In number In percent
on loan is fair
Yes 17 85%
No 3 15%
No response
Total 20 100%
Source: primary data from questionnaire 2018

The information there is the above table, 17(85%) of borrowers said that the interest rate charged
on loan is fair and 3(15%) of borrower said, the interest rate charged on loan is not fair from their
perspective according to the respondent of majority the interest rate charged on loan if bank is
fair.

Loan Customer Satisfaction from customer

According to the response of the borrowers that majority of the borrower were satisfied with the
overall lending system and serving of the bank. Some of them said that they are slightly
dissatisfied with the lending system. They were asked why they are not satisfied and forwarded
the fact that makes them dissatisfied. Among the factor which set by those of an satisfied
borrowers are; delay of decision, lengthy procedure of lending procedure and rigid are major
one.

The other respondent said that the bank encourage the loan customers to continue as a loan
customer through providing miscellaneous service, such as advice on how do they run their
business and the money usage which borrower from the bank.

26
4.2 Interview Finding
Based on the interview from loan officer a cooperative bank of oromia Shashamane branch,
currently the bank has around to loan customer. He said that number of loan customers increase
from time to time, he also add that, the bank provides some training and evaluate them how they
know lending policy and owns of the bank. As to time, greater than half of loan customer would
have to be known/knew loan policy where as some of the remain were new borrowers and needs
to give training and after all that they will know well.

The officer said that, guidance, counseling and training if necessary was part and paces of the
bank service to its customer. The banks accept building and machinery as collateral according to
the lending policy of the bank the property which is given as collateral should meet the following
criteria;

- The marketing value of this security should not be less than the loan amount granted.
- The property given as collateral should be marketable
- Perishable property is not taken as collateral
- The property should not be owned by government
- Borrowers should have to bring ownership title/title deed, evidence
- The customer repays the loan in one lump sum and installment basis. The installment
periods are monthly, quarterly, semi-annually and annually.

27
 CHAPTER FIVE
CONCLUSION AND RECOMMENDATION

5.1 conclusion
The main aim of this research is to assess the lending policy and practice of cooperative bank of
Oromia specifically at Shashamane abosto branch for this purpose the researcher employed or
used questioner and interview as data collection method, simple random sampling to select
sample from target population and descriptive method of data analysis from this study the
researcher come up with the following findings; - .
 The number of male borrowers is greater than the number of female borrowers.
 The majority of the borrowers were found in the age of greater than 35, and somehow
they were in the age of maturity.
 Borrowers do not get the loan amount as expected.
 The rate of interest charged on loan is fair.
 The loan customers get appropriate of guidance and counseling on lending policy from
the bank.
 Almost all customers have enough knowledge on lending policy of the bank.
 Not all of the bank loan customers are satisfied with over all lending system of the bank
 The bank has good side, in its providing miscellaneous services such as advice on how
they run the business and how they use the borrower fund wisely.
 The bank accepts building, machinery and personal guarantee as collateral.

28
5.2 Recommendation
Based on finding of the study the researcher forward the following recommendation

 Due to rigid loan policy most borrowers not able to get the amount of loan as they
expected. It is advisable to the banker to make flexible loan policy. It is advisable, if the
banker lend the right amount of fund that the borrowers request because the borrower
amount may not be enough to finance the business.
 it is advisable if a Banker is make its service better, quality, modern, speedy and the rate
of interest is must be determined on the basis of preparing bank work. These will help the
bank to be competent and able to increase its market share as well as profit.
 It is better, if the banker continue providing currently existing service to their loan
customers like guidance and counseling on lending policy, giving training and
information about the loan policy.
 For the reason that the bank accepts building, machinery and personal guarantee as
collateral requirement shall be designed in the manner that regards the economic
efficiency and capacity of the loan custody because, this helps the bankers to attract may
effective business person.

29
 Reference
 Broll, U., T. Pausch and P. Welzel (2002) Credit Risk and Credit
Derivatives in Banking.
 Cooperative bank of oromia annual report 2009/10
 Colind Campbell, 1987, 1st ed. Money, banking and monetary policy
Discussion Paper No. 228. Germany. University of Augsburg.
 Frederic Mishikin, 1992, 2nded. The economics of money, banking and
finance market.
 Harold Darger, 1992, 2nd ed. money, banking and public policy.
 Julian Hoyle and Geoffrey White Head, July 1987, 3rd ed. element of
banking.
 LidiyaGirma, 2006, thesis assessment of people attitude toward bank
service
 Morsman, E. (1993). Commercial Loan Portfolio Management,
Robert Morris Associates,
 Philadelphia, 1993.
 Shelagh Heffernan, 1996, 1st ed. Modern banking in theory and
practice.

30
 Appendix I
Jimma University
College Of Business and Economics
Department of Banking and Finance
Questionnaire filled by loan customers

The purpose of this questionnaire is to collect data for the research paper. Your genuine response
for the following question is extremely important for the successful completion of this paper. I
would like to thank you in advance for your cooperation.

Notice that:

 No need to write your name on this questionnaire

 Thick (√) mark only on your choice.
 Write your opinion on the space provided.
1. Sex: Male Female
2. Age: 18-25 26-35 >35
3. Job/occupation: civil servant business man (merchant) employee
other specify_______________________________
3.1 If you are a merchant what kind of trade are you doing?
Wholesaler retailer other (specifies)______________
4. For how many years you exist as a loan customer?
Less than a year 1 year less than 2 years
2 year more than 2 year
5. What makes you to prefer cooperative bank of oromia from other bank?
Location quality of service nature of interest rate
Other specify_____________________________
6. What type of loan you take from bank
Consumer’s loan commercial loan industrial loan

31
 Other (specify)__________________________

7. For what purpose you take loan?

To establish new business purchase of equipment
For expansion of existing business other (specify)________________
8. Do you have enough knowledge about lending policy and procedures of cooperative bank
of oromia?
Yes No No response
8.1 If your answer for question number 9 is yes how much you know?
High very high good little
8.2 If your answer for question number 9 is no why?
……………………………………………………………………………….
9. Does the bank as you suggestion about its lending policy and procedures?
Yes No No response
10. Do you get the loan amount as expected?
Yes No No response
10.1 If your answer for question number 11 is “no” why?
______________________________________________________________________
11. How many working days it takes from loan application to loan approve?
1-10 days 11-20 days 21-30 days more than 30 days
12. Is the lending procedures of the banking is long?
Yes No No response
13. Does the bank ask you collateral to take a loan?
Yes No No response
14. What type of property you grant as collateral to take a loan?
Building machinery license car
other(specify)_____________________
15. Do you think that the interest rate bank charge on loan is fair?
Yes No No response

16. Are satisfied with the overall lending system of the bank?

32
 Yes No No response
17. If no why? __________________________________________________
18. Is the bank encouraging you to extend as a loan customer?
Yes No No response
19. Suggest some idea, which the bank has to do in order to formulate an attractive lending
policy and procedure?
________________________________________________________________________
_______________________________________________________
Thank you for your cooperation

33
Appendix II
Interview question forwarded for loan officers

1. How many loan customer are there in you branch?

2. The number of customers from time to time increases, decrease or stable?
3. How do you evaluate your loan customers whether they know your lending policy and
procedures?
4. Do you think that you borrows know well the bank lending policy and procedure?
5. Do you give and counseling to your loan customer on how they follow the lending
procedure?
6. Does the bank as collateral while lending?
7. What type of property your banks accept as collateral?
8. What is a criteria of acceptable security according to your bank lending policy?
9. How the customer repays the loan they take?
10. Do you encourage your customer to continue as a loan customers?
11. If you have suggestion!

34
35