Lender–borrower relationships on credit quality in Uganda: the case of Microfinance Institutions in Kampala

Abstract

This study is about the effect of Lender- Borrower relationship on credit quality in Microfinance Institutions in Uganda. The study focused on customer participation, relationship lending, lending terms and conditions and credit quality and the relationships between these variables. The study was cross sectional and data was collected from 126 respondents in six microfinance institutions. Both qualitative and quantitative methods of analysis were used in the study. It has been established that there is a strong positive relationship between customer participation and relationship lending. Evidence from the study suggests that higher levels of customer participation improve relationship lending. If an MFI involves customers in generating solutions to the problems arising during interaction of both parties, and allows customers to generate ideas, relationship lending can improve. Furthermore a significant positive relationship between relationship lending and lending terms and conditions has been established. A better lending relationship can influence better terms and conditions of borrowing. A customer with a favorable relationship with the MFI would secure a loan quickly, at a lower interest rate and with minimal collateral. A statistically significant positive relationship between relationship lending and credit quality has also been established. Better relationship lending improves the quality of the credit in MFIs since a borrower may obtain individualized service, and gain empathy as well as reliable services. Lending terms and conditions, customer participation and relationship lending are all significant predictors of credit quality, accounting for up to 73% of the variation in credit quality. Such a strong predictive power is confirmed by a small standard error of estimate, which means that these results are generalizable to the population from which the study sample was drawn. However, lending terms and conditions as well as relationship lending are individually better predictors of credit quality than customer participation. In situations of resource scarcity, any MFI that is interested in improving credit quality should start by offering favorable lending terms and conditions, build relationship with customers and then introduce customer participation in problem solving and idea generation. MFIs should charge a fairly reasonable interest rate, introduce favorable collateral requirements, and should engage customers in solving problems. They should also provide advisory services, undertake through customer assessment and constant loan monitoring and need to demonstrate to their clients that both parties are complementary and are in business to help each other.