Criteria for Assessing Small and Medium Enterprises' Borrowers in Ghana (original) (raw)

This study focused on developing an insight into the decision making process which lenders employ in granting loans to SME borrowers. Questionnaires were administered on selected bank branch managers of conventional banks, rural banks and savings and loans companies. Findings from this study has brought to the fore some interesting revelations. The results indicated that when loan managers are deciding on whether to accept or reject an SME loan application, intended purpose of loan, repayment of previous loan, repayment schedule, type of business activity, size of loan relative to size of business and availability of collateral, ranked highest on their criteria list. On the contrary, CVs of clients, government guarantee of loans, charges on assets and gearing ranked lowest on the criteria list in terms of importance. The relevant factors identified in this study showed that lenders took particular interest in risk when dealing with SMEs. This is not out of place, as every business seeks to make profit and thus they need to be sure of recouping their monies when they lend them out to small businesses. It is thus very necessary for SME borrowers to develop an understanding of the decision criteria used by financial institutions in order to increase the probability of getting their loan request approved by fulfilling the required criteria adequately. During the past decade, the financial sector in Ghana has undergone major changes mainly through the financial sector structural adjustment programme as part of the economic recovery programme. Moreover, globalisation, mergers and acquisitions, and the emergence of new technologies have contributed dramatically to stiffer competition and pressures on profitability. In such a competitive marketplace, attracting profitable customers is a priority of all the financial institutions' (FI) managers especially banks. Banks are profit-seeking institutions that must provide acceptable returns to shareholders or go out of business. However, they operate under the objectives of profit maximisation through appropriate risk management strategy (Sinkey, 1998). This means that they must be prudent in the application of sound lending practices to assess the credit risk of the borrowers. It is reported that earnings from the lending activities account for more than 80 percent or more of the bank's profits (Wong, 1997). To estimate the borrowers' probability of default, FIs focus on the borrower's creditworthiness through gathering, processing and analysing timely and accurate information and small firms are no exception. The small business sector is now an increasingly important source of profitability for the banks. When lending to small businesses, the major task of lenders in reducing or avoiding credit risk is to overcome the problem of asymmetric information. This problem occurs when one party to a contract knows relevant information which has a material effect on the contract, but which is not known to the other party. The small business borrowers when approaching the banks for loans always have an information advantage over the bankers that sometimes lead the former to overstate the soundness of their business projects in relation to the funding sought (Storey, 1994). Banks usually end up making unprofitable loans. Furthermore, the action of these borrowers who successfully obtain bank loans is not directly observable by the bank. These borrowers might use the funds for other purposes than stipulated in the loan contract. Therefore, banks must not only investigate the creditworthiness of the small business borrowers but also monitor their activities once they have obtained the loans.