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.