Analysis of credit risk exposure on performance of financial institutions in Uganda: case of MDIS in Uganda (Pride, UGAFODE, FINCA AND EFC Microfinance Ltd 2014-2019)

Abstract

The main purpose of the research is to analyze the impact credit risk exposure on performance of financial institutions in Uganda for a period 2014-2020 using panel data for a sample of 4 MDIs. The study examines the bearing of three credit risk exposure mechanism credit rating (CR), capital adequacy ratio (CAR) and loan to deposit ratio (LDR) on the financial performance (ROE and ROA) of MDIs. The study is motivated perceived relevance of credit risk exposure on performance of credits. The target population of the study was 4 licensed MDIs which were in operation in Uganda by 01 July 2020. Synthesizing the financial distress theory, this study tested the credit risk exposure and its relationship on financial performance. The study adopted descriptive quantitative design. Secondary data from the financial statements and annual reports were sourced from the individual bank websites and analyzed with SPSS to generate descriptive statistics, correlation and regression analysis to predict on how credit risk exposures relate with ROE and ROA in MDIs. The findings revealed that credit risk exposure has a significant positive relationship with financial performance of MDIs. The credit risk exposure include CR has positive relationship with ROE (0.767**) and ROA (0.878**); LDR has positive relationship with ROE (0.656**) and ROA (.675**) and CAR has positive relationship with ROE (.625**) and ROA (.645**). Other findings from regression analysis that is R value of 0.604a indicated a strong degree of correlation between credit risk exposure (CR, CAR & LDR) and profitability (ROE & ROA). The regression diagnostic test predicted that LDR (0.721, p<0.05) and CR (0.657, p<0.05) have significant effect on the financial performance of MDIs. MDIs have to emphasize the principals of lending credit to worthy clients to eliminate likely risk resulting from non-performing credits. The study recommends that MDIs should automate the management of credit risk exposures through credit rating practices, monitoring and control of loan to deposit ratio, following capital adequacy ratio to improve performance of credits in relation with increase in returns of equity and returns on assets. Further, MDIs need to invest more in research to discover new and innovative credit risk early warning assessment techniques and customer-friendly techniques of collecting funds from clients to increase the loan deposits for credit creation.