Effect of loan defaults on the performance of commercial banks

Abstract

The major aim of the study was finding the effect of loan defaults on the performance of commercial banks. The objectives of the study included: To establish the effect of diversions of loan funds by a borrower on banks operating profits, to determine the effect of bank monitoring and supervision on the liquidity of banks, to assess how absence of information sharing by lending institutions affects the debt maturity structures of banks, the dimensions of loan defaults used included; Diversion of loan funds by the borrower, inadequate monitoring and supervision. Absence of Information sharing by other lending institutions while those for performance of commercial banks were Operating profits, Liquidity position of the Banks, Debt maturity structures . The study focused on examining the effect of loan defaults and performance of commercial banks. The study used a case study research design of a sample of 48 respondents out of a population of 58 people of which by Purposive sampling method especially for the employees of the bank while for the customers, the researcher used stratified random sampling. Primary source of data used to collect data was a structured questionnaire and the secondary source of data was from the financial statements of the case study. Using SPSS 16.0, correlations, frequency, graphs, analyzed the data collected and tables the researcher used to present the data. The findings of the study revealed that loan defaults affect the performance of commercial banks. Findings showed there is a relationship between likely defaulters of loans and purpose which represents whether loans are used for the intended purpose meaning that most of the customers that divert the money are likely to default and it is a negative relationship(r = -0.429, p = 0.059). The correlation is significant at 99% confidence level. The likely defaulters reduce as the percentage use of loans increases. Percentage use of the loan is also related to purpose and usage of the loan service represented by (r=-0.408, p=0.74), (r=-0.286 p=0.22) respectively. The findings indicated a negative relationship between loan defaults and performance of commercial banks meaning that though loan defaults reduce, other factors affect the performance of commercial banks. Therefore implies that diversion of loan funds affects the operating profits of the bank thus confirming that the bad loan crisis in the banking industry caused by diversion of funds by borrowers to unrelated businesses, through fraudulent means according to ENS economic bureau. The researcher recommends that for the case of centenary bank-Wakiso branch (case study) and banks as a whole. For banks to monitor the purpose of the loan, money issued out they should set up a separate team for credit services that is involved in all lending decisions of the bank, to reduce on the number of likely defaulters and increase effective use of the loan money issued out to its customers henceforth ,increasing the loan recovery rate Banks should also consider proper auditing of the financial statements and consider the recommendations as per the auditors so that the policies that are developed in relation with the credit policies are efficient, effective and attainable to make the monitoring, supervision, satisfaction of customer service a success. There is a relationship between diversion of loan funds by borrowers and the operating profits of the bank, which lies within a confidence level of 99%, there is also a relationship between absence of credit information sharing and debt maturity structure of banks, which lies within the confidence level of 95%. Lastly, there is a relationship between bank monitoring and supervision on the liquidity position of the bank, which lies within the confidence level of 95%. In conclusion, there is a relationship between loan default and performance of commercial banks within the 95% confidence level thus confirming that loan defaults affect the performance of commercial banks.