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    AN INVESTIGATION ON THE EFFECT OF CREDIT SCORING ON SMALL

    BUSINESS LENDING: CASE OF EQUITY BANK LIMITED

    SUBMITTED BY:

    LILIAN NJERI

    REG NOXXXXXXXXXX

    Research Proposal submitted in partial fulfillment of requirements of award of a

    bachelors degree in xxxxxxxxxxxxxx of Kenya Methodist University.

    NOVEMBER 2

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    i

    ABSTRACT

    Commercial bank lending to small businesses has received a great attention in the

    country in the recent past. The main concern is the availability of credit, given that small firms

    have over a long time faced significant problems in getting funding for their desired projects due

    to a lack of credible information. Small businesses are more opaque in getting information than

    large corporate since small firms normally lack certified financial auditing statements to reflect

    satisfactory financial information. Further, since small firms lack publicly traded equities, there

    are no public scores that might estimate their quality. This makes it hard for the small enterprises

    to obtain financial aid for its expansion. Small business credit scoring offers a great help in

    eliminating information opacity and help improve the relations between small ventures and the

    financial institutions (Berger and Udell 2006).

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    DECLARATION

    I declare that this paper is my own original work researched in the field and has not been

    submitted to any other institution for examination.

    STUDENT: SIGN:

    ..

    SUPERVISOR SIGN:

    .. .

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    DEDICATION

    I dedicate this piece of work to my dear family, for their continued support throughout ourendeavors and preparation this paper.

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    ACKNOWLEDGEMENT

    I wish to thank anyone who contributed in one way or the other to make this work successful.

    Special thanks to my supervisor for the continued guidance throughout the project development.

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    Table of Contents

    ABSTRACT ................................................................................................................................................. i

    DECLARATION .......................................................................................................................................... ii

    DEDICATION ........................................................................................................................................... iii

    ACKNOWLEDGEMENT ...................................................................................... ....................................... iv

    CHAPTER ONE .......................................................................................................................................... 1

    INTRODUCTION ....................................................................................................................................... 1

    1.1 Background of the Study ................................................................................................................ 1

    1.1.1 Equity Bank Limited Profile .......................................................................................................... 2

    1.1.2 Kenya Commercial Bank profile ................................................................................................... 3

    1.2 Research Objectives ....................................................................................................................... 3

    1.2.1General Objective.................................................................................................................... 3

    1.2.2 Specific Objectives.................................................................................................................. 3

    1.2.3 Research Question................................................................................................................... 4

    1.3 Statement of the problem .............................................................................................................. 4

    1.4 Importance of the study ................................................................................................................. 5

    1.5 Scope of the Study ......................................................................................................................... 6

    1.6 Anticipated Limitations of the Study ............................................................................................... 6

    CHAPTER TWO ......................................................................................................................................... 7

    2.1 LITERATURE REVIEW ................................................................................ .......................................... 7

    CHAPTER THREE .................................................................................................................................... 12

    3.1 METHODOLOGY ...................................................................................... ..................................... 12

    3.2 Study area .................................................................................................................................... 12

    3.3 Study population ................................................................................. ......................................... 12

    3.4 Data collection ............................... .............................................................................................. 12

    3.5 Sampling Design .................................................................................. ......................................... 12

    3.6 FINDINGS ..................................................................................................................................... 13

    3.6.1Case 1: Equity Bank .................................................................................................................... 13

    3.6.2 Case 2: Kenya Commercial Bank ................................................................................................ 13

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    3.7 CONCLUSION ................................................................................................................................... 13

    CHAPTER FOUR ...................................................................................................................................... 14

    SUMMARY CONCLUSION AND RECOMMENDATION ............................................................................... 14

    4.1 SUMMARY OF FINDING .................................................................................................................... 14

    4.1.1 Similarities ................................................................................................................................ 14

    4.2 SUMMARY ................................................................................................................................... 15

    4.3 CONCLUSION ................................................................................................................................... 15

    4.4 RECOMMENDATION ........................................................................................................................ 16

    References............................................................................................................................................. 17

    Appendix 1 ............................................................................................................................................ 19

    Appendix 2 ............................................................................................................................................ 21

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    CHAPTER ONE

    INTRODUCTION

    1.1 Background of the Study

    Fewer than 20 percent of small to medium sized enterprises (SMEs) in Kenya have ever

    received credit from formal financial institutions. Access is limited due to challenges in assessing

    SME risk in a cost effective manner. Lenders in Kenya address this risk-assessment problem

    either by not lending to SMEs at all or by requiring collateral and charging high interest rates.

    High-income countries, such as the United States, have addressed this challenge in part by using

    credit scoring. Credit scoring has the potential to offer a number of benefits which can improve

    access to credit for SMEs. There are also a number of prerequisites that must be in place,

    however, in order to fully realize the potential benefits of an effective risk management strategy

    that incorporates credit scoring.

    Credit history or credit report is, in many countries, a record of an individual's or company's past

    borrowing and repaying, including information about late payments and bankruptcy. The term

    "credit reputation" can either be used synonymous to credit history or to credit score. This

    information is used by lenders such as credit card companies to determine an individual's credit

    worthiness; that is, determining an individual's willingness to repay a debt. The willingness to

    repay a debt is indicated by how timely past payments have been made to other lenders. Lenders

    like to see consumer debt obligations paid on a monthly basis.

    The other factor in determining whether a lender will provide a consumer credit or a loan is

    dependent on income. The higher the income, all other things being equal, and the more credit

    the consumer can access. However, lenders make credit granting decisions based on both ability

    to repay a debt (income) and willingness (the credit report) as indicated in the past payment

    history.

    These factors help lenders determine whether to extend credit, and on what terms. With the

    adoption of risk-based pricing on almost all lending in the financial services industry, this report

    has become even more important since it is usually the sole element used to choose the annual

    percentage rate (APR).

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    1.1.1 Equity Bank Limited Profile

    Equity Bank Limited (formerly Equity Building SocietyEBS) commenced business on

    registration in 1984. It has evolved from a Building Society, a Microfinance Institution, to now

    the all-inclusive Nairobi Stock Exchange and Uganda Securities Exchange public listed

    Commercial Bank. With over 6.7 million accounts, accounting for over 57% of all bank accounts

    in Kenya, Equity Bank is the largest bank in the region in terms of customer base and operates in

    Uganda and Southern Sudan. The institution also ranks in the most profitable companies in the

    Kenya after recording a pre-tax profit of Kes. 9 Billion for the year 2010.

    The original founders of EBS were inspired by the desire to create a financial service provider

    which would reach the majority of the Kenyan population. This desire was out of the realization

    that the low and medium income earners had no access to formal banking and neither could they

    afford banking services (the unbanked population). By December 1993, the Central Bank of

    Kenya (CBK) declared that Equity was technically insolvent. Out of its findings, the CBK noted

    that there was poor supervision by the board, nonperforming loans stood at 54% of the Kes. 12

    Million portfolio, accumulated losses were Kes. 33 Million, capital base of Kes. 3 Million and

    customer deposits were being used to meet operating expenses. The CBK was limited in its

    powers to request closure as Equity had been registered at the Registrar of Building Societies. As

    an MFI, Equity had access to short term savings and could grant short term facilities.

    As a turnaround strategy, to attract deposits there was need to zero rate the minimum account

    opening balance. Account holders could also deposit and withdraw anytime. Ledger fees and

    account maintenance fees were scraped. This was a time when other banks had minimum

    deposits requirements to open an account and withdrawals were allowed once a week. In 2000,

    the Board realized the need to have the right processes in place to sustain its growth and

    therefore engaged international consultants to put in place formalized operations and processes.

    The sore, Equity customers were low income workers, small business traders, farmers andgovernment employees. The banks vision, mission, values and critical success factors were

    heavily entrenched in human touch of business with emphasis on community and livelihood

    enhancement.

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    1.1.2 Kenya Commercial Bank profile

    Kenya commercial bank (KCB) is a major player in the banking sector in Kenya an east Africa.

    It is a large bank in customer reaching, profit margins and more so regional branch penetration. It

    has branches almost in all regions in Kenya and to a large extent in Ugandan, Tanzanian and

    South Sudans capitals.

    Kenya Commercial Bank has different accounts to suit different clientele. Largely the bank

    though has been seen s among the big banks, which cater for middle and high income earners.

    This image has however been portrayed due to the mushrooming microfinance institutions. Due

    to the delays in the large banks to scale their account opening fees and minimum account

    balances over the years, it has drawn may small scale businesspersons and farmers to the smaller

    banks like Family Bank andEquity Bank among others.

    Recent adjustments and thorough campaignshave seen the bank win the hearts of low and middle

    level income earners as well as small-scale farmers and businesspersons. Offering unsecured

    loans to small-scale farmers and youth and women groups has been another boost to the KB

    operations. This is true since if Kenya is to realize economic growths as projected, then we need

    to economically empower our citizens, a factor which man banks have realized and are now

    reaching for the low income and small scale businesses for funding.

    e period and other contractual obligations of the credit card or loan.

    1.2 Research Objectives

    1.2.1 General Objective

    The study will aim at investigating the effect of Credit Scoring on Small Business Lending on at

    Equity Bank Limited.

    1.2.2 Specific Objectives

    1. To establish the current usage of credit scoring.2. To establish the relationship between credit rating usage and quality of loans3. To establish the relationship between credit rating scores and rate of interest

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    1.2.3 Research Question

    This research seeks to empirically examine the effect of the use of credit scoring by large

    banking organizations on small business lending in low- and moderate-income (LMI) areas. The

    fundamental question here is whether credit scoring has aided lenders like Equity Bank or

    Kenya Commercial Bank determine the extend of credit offer to a client, and on what terms.

    Have the regulations helped the banks harness their strategic resources to grow a quality loan

    portfolio and whether borrowers with low risk rating enjoyed preferential rates on loans. The

    purpose of this study will be to try and answer these questions and to explore the use of credit

    rating to small scale borrowers.

    1. Is the credit scoring/rating being implemented by lenders?2. How is the system meeting the intended goals? Is it suited for the target market?3. Is the banking industry lending rates based on riskiness of the borrower?4. What cost to the customer are our products?5. Is the credit scoring cost-benefit rational to the banks?6. Is the banking industry responsive and cooperative in the implementation of the credit

    scoring?

    7. What is the overall communication of the ratings to the borrowers8. What are the perceptions of managers, employees and customers about the credit

    scoring?

    1.3 Statement of the problem

    The Credit Information Sharing mechanism was launched in Kenya following the getting of the

    Banking (Credit Bureau) Regulations, 2008 on 11th July 2007. The Regulations were issued

    pursuant to an amendment to the Banking Act passed in 2006 that made it mandatory for the

    Deposit Protection Fund and institutions licensed under the Banking Act to share information on

    Non-Performing Loans through credit reference bureaus licensed by the Central Bank of Kenya.

    In addition, the amendment to the law also provides for sharing of information on Performing

    Loans.

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    Many borrowers make a lot of effort to repay their loans, but do not get rewarded for it because

    this good repayment history is not available to the bank that they approach for new loans. On the

    other hand, whenever borrowers fail to repay their loans banks are forced to pass on the cost of

    defaults to other customers through increased interest rates and other fees. Put simply - good

    borrowers are paying for bad. This is unfair. Credit reporting allows banks to better distinguish

    between good and bad borrowers. Someone who has failed to pay their loan at one bank will not

    simply be able to walk to another bank to get another loan without the banks knowing about it.

    Over time better information on potential borrowers should mean that it will be both cheaper and

    easier to obtain loans.

    Three years on after the launch, there is little data available to assess whether the objectives of

    the credit bureau regulations were met. This research seeks to empirically examine the effect of

    the use of credit scoring by large banking organizations on small business lending in low- and

    moderate-income (LMI) areas. The fundamental question here is whether credit scoring has

    aided lenders like Equity Bank Limited to determine whether to extend credit, and on what

    terms. Have the regulations helped Equity Bank harness its strategic resources to grow a quality

    loan portfolio and have the borrowers with low risk rating enjoyed preferential rates on loans.

    The purpose of this study will be to try and answer these questions and to explore the use of

    credit rating to small scale borrowers.

    1.4 Importance of the study

    Based on the above stated problem statement, this research study will be significant to Equity

    Bank, Kenya Commercial bank and the other banking fraternity in that they will try to advocate

    the importance of credit scoring. The study will further highlight the benefits to the organization

    after investing in credit scoring systems and borrowing customers database. Its envisaged that

    the outcome of the research will shed some light and weight in the importance of a well-

    developed credit history and credit scoring.

    The study will also provide a benchmark to which other researchers can base their study in

    regard to the impact of credit scoring on the banking sector locally. The potential for saving

    money is tremendous, as it will benefit from reduced default; there will be enhanced

    coordination and collaboration with other banks in providing data and information on borrowers

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    risk and so are the opportunities to better meet the customers demands. Because of the dynamic

    nature of lending, Equity bank will be in a position to compete effectively with its competitors

    and to provide better services to its clientele at large.

    1.5 Scope of the Study

    This research is mainly intended to determine the effect of information and communication

    technology advancements performance of banks. The study is, therefore, conducted on the

    banking sector and narrowed down to small business lending, a case study on Equity and Kenya

    Commercial banks. The customers to be interview are those who have borrowed from the bank

    before and after the implementation of the credit scoring guidelines. The study+ will be carried

    out for a period of three months i.e. January to March 2011.

    1.6 Anticipated Limitations of the Study

    Given that, this study involves extensive interaction and collection of data from different

    personalities and on personal finance issues, difficulties are bound to arise. These have been

    anticipated and explained under various titles as follows,

    a) Financial constraints - This study is narrowed down to a small area (main branch) because oflack of adequate funds. This limits the researcher get deeper to the study area, and may be

    visit several branches of the bank.

    b) Data Scantiness- access to some sensitive data may be difficult. For instance, customernumbers drop, actual investments costs of the new systems and budget figures and real

    performance data.

    c) Lack of enough time for fieldwork might impede the conduct of the research.

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    CHAPTER TWO

    2.1 LITERATURE REVIEW

    Theories concerning small business credit markets emphasize the existence of significant

    information asymmetries between borrowers and lenders (Nakamura, 1993). It is also believed

    that such market imperfections can result in credit rationing by lenders, particularly when loans

    are unsecured (Stiglitz and Weiss, 1981). To mitigate such problems, borrowers and lenders have

    historically used long-term relationships, or close and continuous interactions that generate

    useful information about the borrowers financial states (Frame, 1994). Moreover, small

    businesses are thought to be dependent on local banks for such relationship-based borrowing.

    Empirical evidence confirms both the value of lending relationships (Petersen and Rajan, 1994;

    Berger and Udell, 1995; and Cole, 1998) as well as the use of local commercial banks for small

    business credits (Elliehausen and Wolken, 1990).

    Credit scoring uses quantitative measures of the performance and characteristics of past

    loans to predict the future performance of loans with similar characteristics. For lenders in rich

    countries in the past decade, scoring has been one of the most important sources of increased

    efficiency. Lenders in rich countries, however, score potential borrowers based on

    comprehensive credit histories from credit bureaux and on the experience and salary of the

    borrower in formal wage employment. Most microfinance lenders, however, do not have access

    to credit bureaux, and most of their borrowers are poor and self-employed. The two chief

    innovations of microfinanceloans to groups whose members use their social capital to screen

    out bad risks and loans to individuals whose loan officers get to know them well enough to

    screen out bad risksrely fundamentally on qualitative information kept in the heads of people.

    Scoring, in contrast, relies fundamentally on quantitative information kept in the computers of a

    lender. Can microfinance lenders use scoring to cut the costs of arrears and of loan evaluations

    so as to improve efficiency and thus both outreach and profitability?

    Indeed, Berger and Udell (1996) synthesize two theories positing that the provision of banking

    services to small businesses decreases with bank size and organizational complexity. The first is

    that the small business lending is fundamentally different from large firm lending in that the

    former credits are more information intensive and relationship-driven. The second, based on the

    work of Williamson (1967), emphasizes managerial diseconomies of scale with the provision of

    multiple activities in large, complex organizations.1 Berger and Udells empirical tests indicate

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    that large banks tend to charge relatively lower loan rates to and less often require collateral of

    small business borrowers. However, they find that large banks reduce their volume of relatively

    costly relationship loans via price or quantity rationing. Related work by Cole, Goldberg, and

    White (1998) indicates that large banks typically employ standard financial statement criteria in

    the loan decision process, while small banks focus more on their impression of borrower

    character.

    The aforementioned research suggests that small business loan underwriting is conducted

    differently in large and small banks. Today, in fact, most large banks use automated underwriting

    systems for small business lending based upon credit scores. Credit scoring is the process of

    assigning a single quantitative measure, or score, to a potential borrower representing an estimate

    of the borrowers future loan performance (Feldman, 1997). While credit scores have been used

    for some time in the underwriting of consumer loans, this technology has only recently been

    routinely applied to commercial credits. This is because commercial loans were thought to be too

    heterogeneous and that documentation was not standardized either within or across institutions

    (Rutherford 1994/1995). However, credit analysts ultimately determined that the personal credit

    history of small business owners is highly predictive of the loan repayment prospects of the

    business. Thus, personal information is obtained from a credit bureau and then augmented with

    basic business-specific data to predict repayment. Eisenbeis (1996) presents an excellent

    overview of the history and application of credit scoring techniques to small business loan

    portfolios.

    This development is in stark contrast to the perceived importance of a local bank-

    borrower relationship. In fact, because of scoring systems, borrowers can obtain unsecured credit

    from distant lenders through direct marketing channels. Second, the price of small business loans

    should decline -- especially for high credit quality borrowers that will no longer will have to bear

    the cost of extensive underwriting. Also, increased competition -- resulting from small

    businesses having access to more lenders -- should further lower borrowing costs. Third, credit

    scoring should increase credit availability for small businesses. Better information about therepayment prospects of a small business applicant makes it more likely that a lender will price

    the loan based on expected risk, rather than denying the loan out of fear of charging too little.

    Moreover, the widespread use of credit scoring should increase future prospects for asset

    securitization by encouraging consistent underwriting standards.

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    Empirical evidence concerning Feldmans predictions is limited to the effect of credit

    scoring on small business credit availability. Indeed, Frame, Srinivasan, and Woosley (2001)

    estimate that the use of credit scoring increases the portfolio share of small business loans by 8.4

    percent for their sample of large commercial banking organizations. Of course, in light of the

    findings of Berger and Udell (1996) and Cole, et al. (1998), this increase in lending likely

    represents a combination of new business offset somewhat by a decline in relationship-based

    loans by large banks. Experiments in Bolivia and Colombia (Schreiner 2000, 1999a, 1999b)

    suggest that scoring for microfinance can indeed improve the judgement of risk and thus cut

    costs.

    Scoring is probably the next important technological innovation in microfinance, but

    scoring will not replace loan groups or loan officers, and it will never be as effective as it is in

    rich countries because much of the risk of microloans is unrelated to characteristics that can be

    quantified inexpensively. Still, scoring can still be useful in microfinance because some risk is

    related to characteristics that are inexpensive to quantify, and current microfinance technologies

    do not seem to take advantage of this as much as they could.

    While the principles outlined above apply uniformly to small business credit markets, those

    geographic areas characterized by a large concentration of LMI households may be affected in

    additional ways. First, due to asymmetric information problems, banks may have historically

    elected to more readily ration small business credit in LMI areas due to their questionable

    economic health. That is, lenders may have redlined, or used the physical location of the

    business as a crude proxy for the riskiness of the loan. Credit scoring, by reducing these

    informational asymmetries, should serve to reduce redlining and further increase the flow of

    small business loans in LMI areas. Second, credit scores are designed to be objective risk

    measures that may significantly reduce the willingness and ability of a loan officer to

    discriminate based upon the borrower based on subjective judgments. This is particularly

    important in LMI areas in which minority groups are generally over-represented. Thus, we

    expect increased objectivity to increase credit availability in LMI areas. Third, credit scoringmodels may not accurately measure the probability of loan repayment for LMI borrowers if the

    population of loans used to build the model was not sufficiently diverse. This could either help or

    hinder small business credit availability in LMI areas depending upon whether the model

    parameters are valid for the LMI sub-population.

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    Study after study has shown that credit scoring is a vital part of a well-functioning,

    modern financial system.25 The unimpeded flow of objective, neutral information between

    legitimate parties enables credit lenders to make fast, accurate, and competitive decisions to

    approve more applicants and expand access to credit, especially into underserved groups that

    would otherwise have no access to these financial resources. In addition, credit scoring facilitates

    the fair pricing of financial products. Without objective credit scores, it is much more difficult

    for lenders to price products according to individual risk levels. Instead lenders set prices

    according to average risk levels or using subjective, less precise, and potentially arbitrary

    methods to make decisions. This results in products that are excessively expensive for low-risk

    consumers and unfairly inexpensive for high-risk consumers, thus restricting access to financial

    resources. The use of credit scores has played a critical role in extending credit to market

    segments that have been historically underserved. And nearly one third of households had an

    automobile lease or loan. Credit scoring plays a vital role in economic growth by helping expand

    access to credit markets, lowering the price of credit and reducing delinquencies and defaults. In

    the United States, credit scoring helps drive the American economy and makes credit affordable.

    For consumers, scoring is the key to homeownership and consumer credit. It increases

    competition among lenders, which drives down prices. Decisions can be made faster and cheaper

    and more consumers can be approved. It helps spread risk more fairly so vital resources, such as

    insurance and mortgages, are priced more fairly. For businesses, especially small and medium-

    sized enterprises, credit scoring increases access to financial resources, reduce costs and helps

    manage risk. For the national economy, credit scoring helps smooth consumption during cyclical

    periods of unemployment and reduces the swings of the business cycle. By enabling loans and

    credit products to be bundled according to risk and sold as securitized derivatives, credit scoring

    connects consumers to secondary capital markets and increases the amount of capital that is

    available to be extended or invested in economic growth.

    Three years on after the launch, there is little data available to assess whether the

    objectives of the credit bureau regulations were met. This research seeks to empirically examinethe effect of the use of credit scoring by large banking organizations on small business lending in

    low- and moderate-income (LMI) areas. The fundamental question here is whether credit scoring

    has aided lenders like Equity Bank Limited to determine whether to extend credit, and on what

    terms. Have the regulations helped Equity Bank harness its strategic resources to grow a quality

    loan portifolio and have the borrowers with low risk rating enjoyed preferential rates on loans.

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    The purpose of this study will be to try and answer these questions and to explore the use of

    credit rating to small scale borrowers.

    This research concerns an investigation on the effect of Credit Scoring on Small Business

    Lending on at Equity Bank Limited and as such, the dependent variables will be lower interest

    credit and quality loan portfolio while the independent variable will be the use of credit score

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    CHAPTER THREE

    3.1 METHODOLOGY

    The study aims to establish the use of credit scores in small-scale lending in Kenya as opposed to

    the traditional underwriting. This is necessitated by the fact that, in many developed countries,

    the use of credit scoring practices by banks is widely documented but in Kenya, information on

    the extent of use of credit scoring practices is not available.

    3.2 Study area

    This research mainly intendeds to see the level of utility of information and communication

    technology, to achieve history and credit sharing information. The study is geared towards

    banking sector but narrowed down to small business lending, a case study on Equity and Kenya

    Commercial Banks. The study however, will only involve the main branches, located in Nairobi.

    3.3 Study population

    The study targets customers who have borrowed from the banks before and after the

    implementation of the credit scoring guidelines.

    3.4 Data collection

    Data used in the research comprised of primary data, sourced from the target population through

    the use of questionnaires.

    3.5 Sampling Design

    Due to the sensitivity of the study to personal financial matters, random sampling of willing

    person was employed. A number of one thousand despondences were picked.

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    3.6 FINDINGS

    3.6.1Case 1: Equity Bank

    70% of equitys customers with prompt payment (and 100% success rate) with previous loans

    indicates they found it easier to access subsequent loans. The customers indicate incentives on

    negotiable rates and low loan insurance fees. The customers also indicate having an upper hand

    when sourcing for a bigger loan.

    100% of the customers who indicated they had irregular repayment of previous loans indicated

    difficulties in accessing subsequent loans. They show a limited chance to negotiate for higher

    loans or interest rate and indicate high feeon insurance charges. The customers feel that their

    assets (security) and their monthly income were being ignored when calculating the rates and

    repayment periods.

    3.6.2 Case 2: Kenya Commercial Bank

    20% of the customers with prompt payment (100% success repayment) of their previous loans

    indicated a relief in their subsequent loans. They indicated low rates and ease of loan

    negotiations. The remaining 80% indicates they found no difference, and the interest rates were

    only based on their repayment period and market trends. They cited their assets (collateral) and

    monthly incomes as their negotiating tools.

    100% of the customers with delayed repayment in the previous loans indicated difficulty in

    accessing subsequent loans. They cited delays in the processing of the loan, high rates and high

    insurance fees.

    3.7 CONCLUSION

    The level of utility of credit scoring for the small scale business lending is minimal. Equity bank

    seems to be on the forefront in adapting to system. The level of customer awareness on the use of

    the system is also very low. It is however clear that the banks have a customers credit history as

    it is evident that the banks blacklists its defaulting customers.

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    CHAPTER FOUR

    SUMMARY CONCLUSION AND RECOMMENDATION

    4.1 SUMMARY OF FINDING

    Equity bank seemed to factor in customer credit history since many its customers with prompt

    payment (and 100% success rate) in their previous loans indicates they found it easier to access

    subsequent loans. The customers indicate incentives on negotiable rates and low loan insurance

    fees. The customers also indicate having an upper hand when sourcing for a bigger loan.

    Defaulting customers indicated difficulties in accessing subsequent loans. They have a limited

    negotiating power for higher loans or interest rate and indicate high fee on insurance charges.

    Customers asset does not play a key role in determining the highest loan the customer canafford.

    In KCB, only a small number of customers 20 with prompt payment (100% success repayment)

    of their previous loans indicated a relief in their subsequent loans. Many customers indicates

    they found no difference, and the interest rates were only based on their repayment period and

    market trends. They cited their assets (collateral) and monthly incomes as their negotiating tools.

    Defaulters however, found difficulty in accessing subsequent loans. They cited delays in the

    processing of the loan, high rates and high insurance fees.

    4.1.1 Similarities

    The two banks seem to be keen on loan defaulters. This shows the two banks has adopted the

    system to black list defaulters and limit their credit access in the future. This serves as a

    disincentive to any borrower and so the borrowers will strive to meet their loan obligations.

    4.1.2 Differences

    Equity Bank has showed a positive note in the use of credit scores in handling of their customers.

    This is paired with incentives of low rates and low fees on loan insurance. Good customers are

    relieved the tedious scrutiny of their assets and monthly incomes. The customers have upper

    hand in negotiating higher loans in the subsequent attempts.

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    Kenya Commercial Bank on the other hand is seen as insensitive to the previous good record of

    their customers. The extent of incorporating credit scores to give the loanees incentives, the bank

    has stuck to traditional underwriting. The customers undergo the same thorough scrutiny before

    accessing loans. No prevalence is given to them despite their successful repayment of previous

    loans.

    4.2 SUMMARY

    The idea of using credit scoring as the sore determinant of the lending criteria has not been

    fully realized in Kenya. Many businesspersons have no idea of how the scores are done and

    neither do they know any advantages of the system. Its also clear that our bank have poor

    credit history achieving methods. The utilization of information and communication

    technology in achieving the credit history of the clients is very low. The information on

    personal credit scores is not available as the central credit score bureau is yet to be realized in

    Kenya.

    4.3 CONCLUSION

    Credit score is largely determined by:

    i. Payment Historyhow borrowers paid their bills in the past can give lenders anindication of how they will pay in the future.

    ii. Credit Historyhow long borrowers have had and successfully managed credit.iii. Outstanding Debthow much credit borrowers have and how much they have used.iv. Types of Creditis the loan personal or for business?

    Credit scoring has proved to have the following advantages:

    a) Borrower-Lender Interaction:with credit scoring, it saves the borrower the time tonegotiate for a loan. This is due to the appraisingrecord of accomplishment and therefore

    the lender has some confidence in the borrower and will put less restriction on the

    borrower if he has a good credit score.

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    b) Loan Pricing: The price of small-business loans will decline for higher-credit qualityborrowers under credit scoring because these borrowers no longer have to bear the cost

    of a full human underwriting.

    c) Availability of Credit for Small Business: Better information about the repaymentprospects of a small-business applicant makes it more likely that a lender will price the

    loan according to its expected risk. This prospect should increase the availability of

    credit to small businesses.

    Despite the advantages posed by the use of credit scores in the small-scale business cases,

    it is clear that our banks have not fully employed the idea. The Kenyan public is oblivious

    of the use of the credit scoring method. Many small businesses are seemed to rely on

    limited information of business lending cases and are afraid of taking bigger loans.

    4.4 RECOMMENDATION

    The use of credit scoring, as well as loan standardization, offers substantial cost advantages in

    the evaluation of the risks that goes in hand with lending. It is clear with credit score, a customer

    finds it easy to access future loans based on the success of the previous loans. This is a positive

    move where good customers are rewarded by low interests rate and are have higher chances to

    access future loans. This is a big step as opposed to the traditional system where the good

    customers suffered the wrath of defaulters as the banks aims at recovering their lost cash in

    terms of increased rates for subsequent loans.

    Despite the gains of the credit scoring method as opposed to the traditional underwriting, the

    commercial banks in Kenya have not fully adopted the system. The banks need to be sensitized

    on the use of the credit scores to improve the lender-borrower relations.

    The Kenyan public is oblivious of the credit scoring rationale. The public should be sensitized on

    the advantages of the system and how it works

    A central bureau should be made available and shared with all banks. Individuals should also be

    in a position to access their credit scores and translated into scorecards, which should aid them in

    other sectors like in mortgages.

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    References

    Charles B. Wender and Matthew Harvey, SME Credit Scoring: Key Initiatives, Opportunities,

    and Issues, Access Finance Newsletter, The World BankGroup, March 2006, Issue No.

    10.

    Hsia D.C. (1978) Credit scoring and the equal credit opportunity act.Hastings Law Journal,

    30 (2), pp. 371-448.

    Joseph W. Duncan, Congress Faces Critical Decision About Consumer Credit Legislation (The

    Fair Credit Reporting Act of1970 and 1996), 62 Bus. Econ. July 2003.

    Pagano, M & Jappelli, P, Information Sharing in Credit Markets, Journal of Finance, Vol LVIII,

    No. 5, December1993.

    Petersen, Mitchell and Raghuram Rajan. The Benefits of Lending Relationships: Evidence

    From Small Business Data. Journal of Finance. Volume 49(1) March, 1994. Pages 3-37.

    Rutherford, Reid. Securitizing Small Business Loans: A Bankers Action Plan. Commercial

    Lending Review. Volume 10(1), Winter1994-95. Pages 62-74.

    Stiglitz Joseph and Andrew Weiss. Credit Rationing in Markets with Imperfect Information.

    American Economic Review. Volume 71(3), June, 1981. Pages 393-410.

    Thomas L.C. (2000), A survey of credit and behavioral scoring: forecasting financial risk of

    lending to customers,International Journal of Forecasting, 16 (2), pp. 149-172.

    Thomas L.C., Ho J. and W.T. Scherer (2001), Time will tell: behavioural scoring and the

    dynamics of consumer credit assessment,IMA Journal of Management Mathematics,

    12,pp. 89-103.

    Varghese, Robin, Ph.D., & Turner, Michael, Ph.D., The Benefits of Wider Participation in Full

    File Credit Reporting in Latin America and the Costs of the Status Quo, Information

    PolicyInstitute, March 27, 2006, Page 2

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    Williamson, Oliver. The Economics of Defense Contracting: Incentives and Performance in R.

    McKean, ed., Issues in Defense Economics. Columbia University Press: New York,

    1967.

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    Appendix 1

    Borrowers Survey (Questionnaire)

    Instructions

    a. Tick appropriate boxes where applicable and fill the blank spaces accordinglyb. All information given will only be used for research.c. Do not write your name or business name anywhere in this questionnaire

    1. Are you in business, self-employed or both?Explain.............................................................................................................

    2. Have you ever borrowed money in Equity Bank?Yes ( ) No ( )

    3. If yes what was the purpose of the loan?a.

    Business working capital

    b. Mortgageec. Personal loand. Emergency loane. Other (specify)

    4. Was it your first time to borrow?Yes ( ) No ( )

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    5. If No in 4. Above, what was the interest rate on your previous loan?...............................................................................................

    6. How was your repayment?a. Good (prompt payment)b. Delayed paymentsc. Unable to payd. Written off by bank

    7. If the repayment was good, were you given any incentive in the second facility based on thegood repayment record? ........................................

    If Yes, Explain.................................................................................................

    8. If the repayment was bad, were you penalised by the bank on the subsequent facility?...........................................................................

    If yes, explain.......................................................................................................

    9. Does the rate of interest of the loan advanced by the bank for subsequent loan(s) linked tohow you repaid your previous loan?

    THANKS

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    Appendix 2

    Borrowers Survey (Questionnaire)

    Instructions

    d. Tick appropriate boxes where applicable and fill the blank spaces accordinglye. All information given will only be used for research.f. Do not write your name or business name anywhere in this questionnaire

    10.Are you in business, self-employed or both?Explain.............................................................................................................

    11.Have you ever borrowed money in Kenya Commercial Bank?Yes ( ) No ( )

    12.If yes what was the purpose of the loan?f. Business working capitalg. Mortgageeh. Personal loani. Emergency loanj. Other (specify)

    13.Was it your first time to borrow?Yes ( ) No ( )

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    14.If No in 4. Above, what was the interest rate on your previous loan?...............................................................................................

    15.How was your repayment?e. Good (prompt payment)f. Delayed paymentsg. Unable to payh. Written off by bank

    16.If the repayment was good, were you given any incentive in the second facility based on thegood repayment record? ........................................

    If Yes, Explain.................................................................................................

    17.If the repayment was bad, were you penalised by the bank on the subsequent facility?...........................................................................

    If yes, explain.......................................................................................................

    18.Does the rate of interest of the loan advanced by the bank for subsequent loan(s) linked tohow you repaid your previous loan?

    THANKS