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International Journal of Advanced Research and Publications

ISSN: 2456-9992

Non-Performing Loans: Perception Of Somali


Bankers
Hassan Haibe Osman, Vikneswaran
Asia Pacific University of Technology and Innovation, School of Business and Economics, South City Plaza, Persiaran Serdang Perdana,
Seksyen 1, 43300 Seri Kembangan, Selangor, Malaysia, PH-00252 063 411 2721
hassanhaibe@outlook.com

Author School of Computer Science and Engineering, University, Jalan Innovasi, Technology Park Malaysia, Bukit Jalil, Kuala Lampur,
59000 Malaysia, PH-006 657 567 5676
vikneswaran.manual@apu.edu.my

Abstract: Among various indicators of financial stability, banks‟ non-performing loan assumes critical importance since it reflects on the
asset quality, credit risk and efficiency in the allocation of resources to productive sectors. Non-performing loans has become a concerning
issue for banking sector in recent times. Thusly, this study examines the perception of Somali bankers regarding the determinants of NPLs
of Somali banks using primary information collected from 180 bankers working in twelve Somali banks. The researcher applied multiple
regression and correlation matrix analysis aiming to find out the factors that may have an effect on the non-performing loans of Somali
banks. The bankers perceive that the selected variables of this study have an effect on the NPLs of Somali banks. The empirical results of
the regression and correlation analysis established strong positive and significant relationship between NPLs of Somali banks and the three
variables of unemployment rate, interest rate and inflation rate. The findings also reveal that GDP has a weak but positive and significant
relationship with the NPLs, whilst credit monitoring, political interference and banker‟s incompetence established a weak positive and
insignificant relationship with the NPLs of Somali banks. The study suggests that the bank management should increase their expenditure
for training and development programmes, which would enhance the loan quality monitoring, and debt collection management of the
bankers. It is also suggested to the government and regulatory bodies that the country‟s unemployment rate should be kept low, extra care
should be given to inflation rate and interest rate fluctuations, political interference should be limited or reduced to zero and the country‟s
banking sector need to be revitalised by increasing the commercial banking services capacity of the Central Bank.

Keywords: Non-performing loans, Interest rate, Inflation rate, GDP, Credit monitoring, Political Interference, Banker‟s incompetence

1. INTRODUCTION the primary function of the commercial banks. As noted by


Commercial bank is described as a financial institution Kwambai and Wandera (2013), these banks play an
whose current operations consist of accepting deposits important role in emerging economies where most
from the public and issuing loans. The receiving of borrowers have no access to capital markets. Thus, they
deposits and provision of loans distinguishes „banks‟ from are considered as an intermediary between the depositors
other financial institutions. The existence of both banks and the borrowers. Hence, banks play a major role with in
and non-bank financial institutions in a formal and the financial system and their soundness and stability are a
organized way is collectively known as the financial main concern for the financial stability of the economic
system; it consists of an auxiliary network of institutions system of a country (Nkurrunah, 2014). However, some of
that provide financial services within a given country the loans given out by the lending institutions
(Dhungana and Updhyaya, 2012). To name a few of these unfortunately become non-performing and eventually
institutions and the functions they perform are: (1) national result in bad debts with adverse consequences for the
banks that issue currency and sets the monetary policy, (2) overall financial performance of the institutions. Loans
investments banks which specialise in capital market become non-performing when it cannot be recovered
issues and trading, and (3) commercial banks that takes within several months after the stipulated time expires
deposits and gives loans to customers. According to governed by the respective contractual terms and
Karim, Chan & Hassan (2010), the banking sector still obligations (Bholat et al., 2016). However, if such assets
remains the primary form of financial intermediation in do not generate any income, the banks‟ ability to repay the
many countries and as such is the biggest channel for the deposit amount (to the depositors) on the due date would
mobilization of domestic savings and local funds, the main be in question. Therefore, the banks with such asset would
source of external capital to firms and the key player in a become weak and such weak banks lose the faith and
payment system. Thus, it is undeniable that the banking confidence of the customers. Ultimately, unrecoverable
sector plays a vital role in the growth and improvement of amounts of loans are written off as Nonperforming loans
the economies (Viswanadham and Nahid, 2015). They (Mallick, 2010). On the other hand, if the collaterals are
provide loans to individuals; businesses organisations and inadequate to cover the costs and at the same time, the
governments to support them finance investments and borrowers are insolvent, the banks have to provide a sum
development undertakings as a means of assisting their of money as the loan loss provisions from its own capital
growth in particular and or contributing towards the that may lead to potential unprofitability (Balgova, Nies
economic development of a country in general. and Plekhanov, 2016). In extreme cases, very high level of
Accordingly, channelling of funds from the surplus-fund NPLs may lead to an individual bank‟s insolvency and
units (SFUs) to deficit-fund units (DFUs) in the form of further to systematic bank failures (Bholat et al., 2016).
loans and advances to numerous sectors of the economy is Non-performing loans became the source of fear among

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ISSN: 2456-9992

banks and financial sector since the global financial crisis However, not a single database (including World Bank
(GFC) while many developed countries found themselves database1) was found to have displayed information on the
having high level of NPLs at respective state banks (Ozili, level of NPLs in Somali banks. Though the reasons
2017). Saba, Kouser, & Azeem (2012) are of the opinion (factors) that causes rise in NPLs were historically
that the issues pertaining to non-performing loans are recognized as the macroeconomic factors, with the
necessary to be studied as they are responsible for occurrence of the GFC, the idea has broadened to bank-
numerous financial and economic difficulties of the specific factors as well (Balgova, Nies & Plekhanov,
developed and developing nations, these issues 2016). As the level of NPLs and factors affecting the
incorporate less per capita income, diminishing profits and NPLs in Somali banking sector are not clear yet, it is vital
financial crisis of the banking sector. Financial System: to identify the various factors, which may have significant
The context of Somalia In the context of Somalia, the effect on the loan repayment performance in Somali
banking sector is, in reality, in its early stage. Since 1991, banks. Hence, a more particular background check on the
Somalia has been moving practically without banks. The following sub-topics (the selected variables in this study)
Central Bank of Somalia (CBoS) has had very limited would help us to understand the actual scenario and its
commercial banking services, correspondent relationships possible effect on the loan repayment capacity of the
with foreign banks and inadequate supervisory capacity to banks‟ customers in Somalia.
oversee the financial sector of the country. Moreover,
foreign banks are also basically absent (Paul et al., 2015).
Hence, customary money exchange frameworks (the
money exchange operators) sprung up to fill the crevices
made by the nonappearance of formal banks. The scenario
is similar to a nation that has worked without an
entrenched central regulatory system or central bank and
without a financial regulation by the authorities; financial
institutions have essentially been working in a vacuum
(Powell, Ford and Nowrasteh, 2008). Therefore, as the
country strives to rebuild its shattered economy, the need
of a viable commercial banking sector is indispensable.
Nevertheless, the banking division in Somalia has realised
some gigantic development in the recent five years. New
banks have been set up and the existing banks have
broadened their administrations to accommodate the
increasing demand of financial services. Some portion of
the force in development have been activated by the
expanded engagement between the government, the
international donors and the financial institutions,
including the 2013 resumption of associations with the
International Monetary Fund (International Monetary
Fund, 2017a). Lately, the country has begun to see some
investment and new business inaugurations from both
local and global businessmen, in spite of the savagery still
overflowing in the nation (Economic Index of Freedom,
2017).

1.1 The extent of non-performing loans in Somalia


In the aftermath of the GFC, non-performing loans became
a major concern for some developing as well as
underdeveloped countries (Akinlo and Emmanuel, 2014).
Especially, in the recent years, the rise of high level of
NPLs and capital provisions by banks to cover the NPLs
in the African region has become major thought for
bankers of the region (see Figure 1.). As it was reported,
close to one third of the loans are non-performing in the
banks of Eastern and Central African countries, which
Somalia is part of geographically (International Monetary
Fund, 2017c). Another report presents that African
Development Bank (AfDB), which has its presence in
Somalia, has very high level of NPLs, as one-fifth of their
loans are dedicated to private sectors (Humphrey, 2014).
Contrarily, some Eastern African countries were reported
to have low level of NPLs earlier in this decade, such as,
Uganda (2.2 percent), Kenya (6.2 percent), Tanzania (6.7
percent) and Rwanda (11.3 percent) (Haniifah, 2015).
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ISSN: 2456-9992

Figure 1: Percentage of NPLs and capital provisions in the African region

1.1.1 Unemployment rate in Somalia country of whom are dependent on the remittance (Paul et
Somalia is the world‟s 83rd most populous country with al.,2015).
10.6 million people (Jaffer & Hotez, 2016). It is to note
that a large number of the country‟s population are 1.1.2 Interest rate in Somali banks
deprived of the basic needs. Over 730 thousand people in In Somalia, interest rate is religiously prohibited, as it is a
the country are dependent on survival aid and only 30 per 100 percent Muslim society. Instead, the country uses
cent of population has access to clean drinking water. bank profit as a proxy for the interest rate in the market
Additionally, there are more than 1.1 million internally system to influence the determination of money supply and
displaced population and 1 million refugees in the country demand (Mohamud, 2015). Though no databases was
(Paul et al., 2015). Along with these, increasing found to have revealed the trend and level of profit rate in
unemployment has added further problems for the people. Somalia, the banks in the Eastern African region (Kenya
According to UN report, the region is experiencing an and Uganda) were reported to have lower banking profits
unemployment rate of over 66 per cent (Yusuf, 2015). due to historically declining interest rates (EY, 2014). The
Furthermore, in the recent years, Somali MTOs are facing World Bank development indicators show a historical data
difficulties in accessing banking services in the developed (1990-1996) of declining effective interest rate in Somalia
countries resulted in resisting them transferring foreign (see Figure 2); no subsequent reliable information is
remittances inside the country. Having faced this high risk, available. Hence, it is perceived in the study that Somalia
both banks and MTOs are exiting the sectors, leading to also may have similarly low profit rate in the current
shortage of funds to the Somali customers living in the times.

Figure 1: Effective interest rate in Somalia (1990-1996)

1.1.3 Inflation rate in Somalia lowest -15 per cent recorded in 2010. In 2015, the rate was
Somalia historically has been facing high inflation and in recoded at -3.5 per cent (see Figure 3). The high range of
the recent years with a high level of fluctuation (Guleid, fluctuation and skyrocketing inflation in the country
Maina & Tirimba, 2015). Since 1961 till 2015, the country resulted from lack of financial regulatory mechanisms and
had an average inflation rate of 22.22 per cent, with a massive printing of fake Somali shillings over the past
highest 216 per cent of inflation rate recorded in 1990 and several years. Inflation has further resulted to several
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implications including reduction in the citizens‟ standard growth of the economy (Center for Research and
of living and supply of basic needs and overall declining Dialogue,2004).

Figure 2: Inflation rate in Somalia (2006-2015

1.1.4 Gross Domestic Product (GDP) According to the World Bank (2016) in 2015, 32 per cent
Somalia‟s GDP is one of the lowest in the world with a of the donor commitments were realized as a result of
large number of the population being dependent on foreign many factors, including lower oil prices and other
aids and remittances. However, in the recent years, bureaucratic hurdles. Domestic revenue is still insufficient
economic growth of the country remained steady (see to allow the government to deliver services to citizens.
figure 4). GDP was calculated as $5.9 billion in 2015 and The administrative and security sectors account for more
projected to reach $6.2 billion in 2016. The country than 85 per cent of total spending while economic and
remains one of the poorest in the world with a GDP per social services sectors account for about 10 per cent of
capita of $450 in 2015 and a poverty headcount of 51.6 total expenditure. Poor collection capacity, narrow tax
per cent. Among the major contributors of GDP, trade base, absence of the necessary legal and regulatory
including imports and exports is counted for almost 76 per frameworks, and lack of territorial control hinder full
cent of the GDP followed by consumption and investment revenue mobilization in the country.
being 8 per cent of the GDP (World Bank, 2016).

Figure 3: Nominal GDP of Somalia (1995-2016)

1.1.5 Credit monitoring in Somali banks portion of the loans in the past being dedicated to political
No reliable information on the past or present condition of connections and the supervisory capacity of the CBoS
credit monitoring in Somalia is available. As information being very weak, the credit monitoring capacity of the loan
on the level of NPLs in Somalia is also not available, it managers in other Somali banks have always been
was not possible to estimate the trend or pattern of credit minimal. Furthermore, they were not required to enhance
monitoring among Somali banks. However, the their monitoring ability and skills. Considering this
International Bank of Somalia (IBS) was found claiming scenario, IMF came ahead to facilitate a staff-monitored
to have a risk management committee that is in charge of programme for the Somali banks starting from May 2016
credit monitoring and assessment (Union of Arab Banks, to April 2017. The programme is aimed at re-establishing
2017). However, considering the fact that the country the country‟s macroeconomic stability, building capacity
being recovering from its 25 years of civil wars and a large to strengthen macroeconomic management, improving

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governance and monitoring capacity as well as providing superpower, has gone under the worst crisis of its history
technical assistance (International Monetary Fund, 2016). (Nkurrunah, 2014)As such, many banks have failed and
governments were incurring considerable costs to revive
1.1.6 Political interference in Somali banking sector the banking sector. However, given the relative stability of
Somalia's banking system has been vigorously affected by the banking system made lately, another form of rivalry
the political tumult for the last few decades that has between the banks giving credit to family units and private
concealed the nation's current history. There are currently ventures has been created. By developing share of bank
small numbers of banks operating actively in the country. advances in these areas, banks are exposed to the dangers
This, however, is not in stark contrast to pre‐1991 of stuns on macroeconomic factors resulting bad debts and
Somalia; the nation had a long history of banking system non-performing loans (Ejigu, 2015). Consequently, in the
instability. According to KPMG (2014) in the late 1970s context of Somalia academic researchers have always
and early 1980s the banking system was to a great extent neglected researches on the non-performing loans of
of financing instrument for public agencies. The Somali banks historically. Neither the non-performing
Commercial and Investment Funds Bank was announced loans itself nor the factors affecting NPLs have come to
bankrupt, and the Development Bank was not able to forefront in the research arena. Rather other countries
provide new loans in 1989. The budgetary framework fell were the preferred locations of many researchers.
into profound emergency and, with the complicity of Moreover, the existing researches of the recent past
degenerate and corrupt authorities, the vast majority of investigated the factors affecting NPLs in scattered
every day operations of the financial system tumbled to the manner. In fact, none of the literatures took account of all
bootleg and black market (Timothy, 2016). As noted by the variables (factors) selected in the current study. The
Samatar (2008) prior to the 1991 government collapse, closest selection of variables were made by Bhattarai
Somalia had three major banks in addition to the Central (2014), who did not examine unemployment rate and
Bank of Somalia, namely, The Somali Commercial Bank, banker‟s incompetence. Hassan, Ilyas and Rehman (2015)
the Commercial and Savings Bank of Somalia, and the ignored inflation rate, unemployment rate and GDP and
Somali Development Bank, however, much of the national Mondal (2016) and Farhan et al. (2012) left credit
banking system collapsed as a result of the civil war. monitoring, banker‟s incompetence and political
Generally, credit markets have been to a great extent interference for others to study. Hence, the effect of the
pre‐dominated by casual trust‐based group loaning; seven selected variables on the NPLs of not only Somali
assurance of credit‐worthiness and relief of counterparty banks, but also banks of other countries in a single
risks were both tended to be made through familial and research paper can be regarded as „extinct‟. Further, in
faction relationships. Pre‐independence provincial powers case of six of the seven selected variables except political
had a constrained banking attendance prior to the interference, the existing literatures revealed differential
administrative crumple, and the central bank additionally findings in relation to the effect of the variables on NPLs
offered a restricted menu of commercial banking services (notably, all the researchers unanimously found only
(Powell, Ford and Nowrasteh, 2008). positive and significant relationship between political
interference and NPLs). As such, in case of the
1.1.7 Banker’s incompetence at Somali banks relationship between GDP and NPLs, whereas Mondal
The actual scenario on bankers‟ knowledge, skills (2016), Makri, Tsagkanos and Bellas (2013) and Saba,
(competencies) and capacities are not clear to the Kouser and Azeem (2012) found positive significance,
researcher as no reliable information was found on this Messai and Jouini (2013), Farhan et al. (2012) and Nkusu
matter. However, a study on the personnel working at the (2011) found negative significance and even Vatansever
United Nations Support Office for the African Mission in and Hepsen (2013) revealed no significance. Similar
Somalia revealed that training and development phenomena can be noticed in the relationship of inflation
programmes have a positive impact on employee rate and interest rate with NPLs. These varying results do
engagement as well as their capacity and competency not form standard findings like the effect of political
improvement (Angela, 2014). Therefore, the need for interference mentioned above. Hence, for the effect of the
T&D programmes to improve bankers‟ competence at the other variables on NPLs, the concept is still ambiguous
Somali banks is also essential. and varies across organisations, industry or country.
Lastly, though there are researchers that adopted the OLS
2. STATEMENT OF THE PROBLEM (Ordinary Least Square) and GMM (Generalized Method
Issues of non-performing loans have gained more attention of Moments) method, none of them were found to have
in the past few decades due to their major role in financial adopted these models for investigating the relationships of
crisis in many parts around the world including Latin banker‟s incompetence, political interference and credit or
America, East Asia and Sub-Saharan Africa. Saba, loan monitoring. For instance, having adopted the OLS
Kouser, & Azeem (2012) are of the opinion that Non- model, Bonilla (2012) investigated the effect of inflation,
Performing Loans are necessary to be studied as they are unemployment and GDP on NPLs, whereas Saba, Kouser
responsible for numerous financial and economic and Azeem (2012) only investigated only the effect of
difficulties of the developed and developing nations, these interest rate on NPLs. On the other hand, using GMM
issues incorporate less per capita income, diminishing model, Makri, Tsagkanos and Bellas (2013) examined the
profits and financial crisis of the banking sector. effect of GDP and unemployment and San et al. (2015)
Additionally, due to the increment in non-performing explored the impact of interest rate, inflation rate and
loans the US economy, which is perceived as a unemployment rate on NPLs. Furthermore, researchers in
investigating the factors affecting NPLs except the
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ISSN: 2456-9992

aforementioned two studies rarely used the GMM model. because they are often the victim of natural calamities like
As such, considering all above knowledge gaps, the droughts or heavy rain fall, cyclones and landslides for
purpose of this research is to examine the effect of the which they cannot collect the repayment amount at their
seven selected factors (unemployment rate, interest rate, expected time. Traders also face loan default due to their
inflation rate, gross domestic product, credit monitoring, exposure to foreign exchange rate risk and (any) loss in
political interference and banker‟s incompetence) on the the businesses. Chimkono, Muturi and Njeru (2016)
non-performing loans of Somali banks by using reinstated that non-performing loans are major factors of
quantitative analysis and through distributing banks‟ income source and if the NPLs increases, it
questionnaires among the sample bankers of the banks. adversely affect the performance of banks.

3. LITERATURE REVIEW 3.2 Defining the Concept of Unemployment Rate


Kantar and Aktas (2016) provided the simplest definition
3.1 Defining the Concept of Non-performing Loans of unemployment; they defined it as the situation of being
As defined by Balgova, Nies and Plekhanov (2016), a loan without job for a certain short period of time. Musai and
is regarded non-performing when it is overdue or in Mehrara (2014) stated that unemployment is when some of
default for several months. Likewise, According to Asfaw, the population of a country are unable to find a suitable
Bogale and Teame (2016), a non-performing loan is a loan job. According to Sileika and Bekeryte (2013),
that is in default or close to being default. A loan is said to unemployment is defined as the economic condition
be in default when it fails to make the repayments of whereby working-age individuals are unemployed for at
principal or interest specified in its loan contract and has least the last four weeks at a certain point of time and still
no intention of repaying in the future. When it happens, in need of a job. Hence, unemployment rate is the measure
from debtor‟s (borrowers) side they face inability to apply of the unemployed people for at least four weeks in a
for new loans and from lender‟s (banks) side, they face country. Additionally, unemployment rate is also the
funding costs. Thus in order to meet the funding costs; measure of economic health, as lower unemployment rate
banks usually foreclose the collaterals provided by banks. indicates better economic situation in a country. There are
However, if the collaterals are inadequate to cover the also particular definitions of unemployment provided by
costs and at the same time, the borrowers are insolvent, the different organisations and groups. For instance,
banks have to provide loan loss provisions (a sum of International Monetary Fund (IMF) defines unemployment
money) from its own capital, leading to potential as an annual percentage measurement of labour force that
unprofitability (Balgova, Nies & Plekhanov, 2016). Bholat cannot find a job. International Labour Organisation (ILO)
et al. (2016) also defined that an NPL is a loan, repayment defines that unemployment is the situation in which
of which has not been made by a borrower according to people, aged 16 and above, who are without job or
contractual terms and obligations. They argued that an continuously searching for job for the last four weeks and
increase in the number or level of NPL is a bad news for available to join work in the next two weeks (Aqil et al.,
banking and other financial institutions, as their funding 2014). Furthermore, according to the U.S. Bureau of
costs rise with the increase in NPLs. In extreme cases, Labour Statistics (BLS), unemployed people are those
very high level of NPLs may lead to an individual bank‟s who are completely unemployed, discouraged to work,
insolvency and further to systematic bank failures. In fact, marginally attached to the labour force, working part-time
the concept of NPLs were the most relevant topic in but want to work full-time and actively looking for jobs
financial sector during the global financial crisis while (Thies, 2017). Unemployment impacts on society and
many countries found themselves with high NPLs at the economy in different ways. It decreases the knowledge and
respective state banks (Ozili, 2017). Cucinelli (2015) skills of the labour force while increases the costs of
perceived that non-performing loans are crucial to credit producing labour force. According to the economic theory
risk of any types of banks, as their lending behaviour is of crime, unemployment causes increased level of crimes
affected by credit risk negatively. As such, if loans default, such as drug abuse, robbery and smuggling (Musai &
it turns to non-performing loans and credit risk increases, Mehrara, 2014).
banks then tend to provide fewer loans to investors.
Therefore, maintaining credit risk to very low level is 3.3 Relationship between Unemployment rate and
essential. Though the reasons (factors) that causes rise in Non-performing Loans
NPLs were historically recognized as the macroeconomic In terms of relationship between unemployment rate and
factors, with the occurrence of the global final crisis the NPLs, some studies found significant relationship between
idea has changed and gone beyond the economic factors to unemployment rate and non-performing loans, while few
bank specific factors such as poor managerial others supported the contrary view. Makri, Tsagkanos and
competencies in evaluating potential debtors and making Bellas (2013) examined the non-performing loans of the
decisions on wise loan provision (Balgova, Nies & banks in Eurozone and concluded that the non-performing
Plekhanov, 2016). Awan, Nadeem and Malghani (2015) loans have strong correlation with various macroeconomic
found that that the major reasons behind non-performing factors such as gross domestic product and unemployment
loans are ineffective monitoring followed by poor credit rate. Balgova, Nies and Plekhanov (2016) reported that
condition, lack of business management competency and their findings in terms of relationship between economic
unwillingness. They further asserted that those who made condition (such as, unemployment rate) and non-
up the most portions of non-performing loans were performing loan supported the theoretical view of the
farmers and traders. Farmers face loan default, probably earlier literatures, which indicates a positive relationship
between the two. Bonilla (2012) applied the Ordinary
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Least Square (OLS) model in examining the factors the amount of money or fee paid by someone to someone
affecting NPLs in two European countries, namely, Spain else for using the latter‟s money. It is paid by debtor
and Italy. The study considered credit growth, wage, (investors) when money is borrowed and received by
inflation, unemployment and GDP as the independent creditor (banks) when money is lent. It is the additional
variables among these, only unemployment, wage and amount of money charged by banks on the principal
GDP were found to have significant effect on NPLs. amount of a debt security or loan contract to the loan-
Furthermore, by applying the „6-months lag‟ model for receiving investors. It is expressed in the unit of
Spanish banking sector and ‟12-months lag‟ model for percentage on annual basis. Thus, an interest rate can be
Italian banking sector, the study found that unemployment easily recognized and understood from its standard figure
rate affects more significantly on Spanish banks than used worldwide. Based on Keynes‟ theory of interest rate,
Italian banks. Mileris (2014) studied the non-performing any changes in interest rate tremendously affect
loans in the commercial banks of the EU countries and investment activities. As such, rising interest rates increase
proved the view that banking non-performing loans are the investment cost, since bond prices rise when interest
heavily dependent on economic changes such as, rise in rates rise; and when bond prices are high, investors are
unemployment. As such, they have a positive relationship reluctant to borrow from banks with high price and high
between each other. The study implied that the rise of interest rate. Thus, the demand for investment is reduced
NPLs in 2010 is considered to be caused by the increasing when interest rate rises. However, when interest rate falls,
level of unemployment in 2009 in the EU countries. the scenario is completely opposite. Bond prices also fall
However, the study by Mondal (2016) on the non- accordingly and investors become more interested to
performing loans of 22 commercial banks in Bangladesh borrow with low price and low rate of interest. This
found that macroeconomic factors such as, unemployment situation stimulates investment (Khurshid, Wuhan &
rate is positively but insignificantly correlated with the Suyuan, 2015). The above situation can be explained in
non-performing loans in Bangladeshi banks. He concluded terms of interest rate spreads. Interest rate spreads is the
that though he found statistically insignificant relationship difference between the interest rate charged to borrowers
between unemployment rate and non-performing loans, he and the rate paid to depositors (Were & Wambua, 2014).
also found that non-performing loan would still increase When interest rate falls, the interest rate spreads increases
by 1.18 per cent, if the unemployment rate increases by 1 in turn and investors feel reluctant to save and rather spend
per cent, as both of them were positively correlated. more on investment. However, when interest rate rises, the
Likewise, Kurti (2016) also found insignificant but interest rate spreads decreases and it makes the investment
positive relationship between unemployment rate and non- decision difficult Khan and Sattar (2014). Interest rates
performing loans in Albanian banking sector. can be either short-term or long-term. Example of a short-
Additionally, contrary to all above, Klein (2013) revealed term interest rate that matures within a year is federal
insignificant relationships between unemployment rate and funds and example of a long-term interest rate that matures
NPLs in the Central, Easter and South Eastern European in more than one or more years is yields on private bonds
banks. The study used panel data model for the period of or Treasury securities. Short-term interest rate usually has
1998 to 2011 and examined the potential impact of GDP more impact on aggregate demand than its counterpart,
growth, unemployment and inflation on NPLs. However, since investors‟ perceptions are normally based on short-
only the unemployment turned out to be insignificant. term forecast and demand (Kiley, 2014). Interest rates can
Bhattarai (2014) examined the possible effect of energy also be either fixed or variable types. Fixed interest rates
crisis, lack of timely budgetary expenditure, government are unchangeable regardless of the situation and interest
and instable political environment, monitoring and rate movement and therefore, interest rate risk remains
evaluation of loans, banker‟s perception, interest rate, with the lenders. However, variable interest rates are
unemployment rate and exchange rate on the non- adjusted concurrently to hedge against the uncertain future
performing loans of Nepalese commercial banks and also interest expense faced by borrowers (usually medium to
concluded that unemployment rate is not much important large firms) and therefore, the interest rate risk is
variable to influence NPLs in Nepal. transferred to the borrowers (Athavale & Edmister, 2011).

3.4 Defining the Concept of Interest Rate 3.5 Relationship between Interest Rate and Non-
Khon Maynard Keynes postulated one of the most performing Loans
remarkable concepts of interest rate in his theory of In case of the association of interest rates with non-
interest rate; more specifically in his work, “The General performing loans, researchers were of different views.
Theory of Employment, Interest and Money” (1936). Whereas some of them found to have a positive
According to Keynes, interest rate determines the level of relationship, some others found negative relationship. Few
employment, affects money supply and investment others also concluded an insignificant relationship
activities in the economy. Keynes provided three distinct between the two variables. Warue (2013) examined the
definition of interest rate. Firstly, it is the compensation or impact of several macroeconomic factors (such as, lending
reward to the lenders for not-hoarding the money with interest rates, real GDP, GDP per capita, government
them. Secondly, it is the price that balances up the desire expenditure and exports and imports) on non-performing
to hold cash within lenders and the supply of cash to loans of different bank size (large, medium and small
borrowers. Thirdly, it is a measure of reluctance to give banks) from 1995 to 2009, employing both pooled and
out money in liquid form to the borrowers (Appelt, 2016). fixed type of panel econometrics approach. The study
Khan and Sattar (2014) provided the simplest definition of found that lending interest rate has a positive and
interest rate in their paper. As they stated, interest rate is significant relationship with non-performing loans in
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larger and medium banks; however, no significant should affect almost all the commodities and should not be
relationship with small banks‟ non-performing loans. temporal. As such, if the rise in the price level only affects
Jameel (2014) conducted a 10 years long study from 2000 a single commodity or even occurs for a single day, it is
to 2010 also using time-series econometric model aiming not regarded as inflation (Kanwar, 2014). Inflation is
to examine the relationships of GDP, weighted average measured by inflation rate, generally in the unit of annual
lending rate, loan‟s maturity time period, capital adequacy percentage change in the general price index (usually
ratio and credit deposit ratio with the non-performing CPI). Inflation rate is defined as the rate at which the
loans in Pakistani banking sector. The study concluded general level of prices for goods and services rise annually
that whereas, determinants such as, GDP growth rate and (Kanwar, 2014). Inflation has both positive and negative
capital adequacy ratio negatively affect non-performing impacts on the economy. From the aspect of positive
loans, weighted average lending (interest) rate positively impacts, central bank can adjust nominal interest rate to
affects the non-performing loans in Pakistan. On the mitigate future recessions and increase investment in non-
contrary, Chege (2014) studied on the non-performing monetary capital projects. However, the negative impacts
loans of 39 commercial banks in Kenya and revealed that are more extensive, with the rise of inflation, the real value
interest rate has a strong but negative linear relationship of money decreases, investment and savings may even
with NPL. As such, higher interest rate will result into become discouraged among investors and they may begin
higher non-performing loans in Kenyan banks. In relation hoarding money perceiving that the prices would increase
to the duration of interest rate‟s impact on non-performing in the future (Uwubanmwen & Eghosa, 2015). Inflation is
loan, Sheefani (2015) asserted that macroeconomic factors measured using three approaches, namely, the Gross
such as, interest rate and inflation rate determines NPLs in National Product (GNP) implicit deflator, the Consumer
the long run in the Namibian banking sector. However, Price Index (CPI) and the Wholesome or Producer Price
since the macroeconomic environment in the country is Index (WPI or PPI) (Semuel & Nurina, 2015). There are
very critical, he suggested for continuous monitoring on also several causes of inflation, revealed by academic
the performance of non-performing loan and interest rate literatures. Based on the drivers, inflation is denoted by
fluctuation. However, Islamoglu (2015) opposed the view particular names. Excessive growth in money supply is the
and commented that the relationship between commercial main driver of inflation, as most of the economists agree.
loan interest rate and non-performing loan is rather short- Additionally, excessive aggregate demand causes
term in terms of causality relationship. The study was inflation, which is known as demand-pull inflation. When
conducted based on time-series data from 2002 to 2013 inflation arises from upward pressure of production costs,
using the VARM (Vector Autro-Regression Model) and it is regarded as cost-push inflation. However, while
VECM (Vector Error Correction Model). The VARM was inflation arises from inefficient production, distribution or
used to test multivariate regression among the variables marketing system in the economy, it is denoted as
and the VECM was used to identify more than one structural inflation (Kanwar, 2014; Bayo, 2011).
integration relationship between time-series. Furthermore,
the Granger Causality Test was also used to test the long- 3.7 Relationship between Inflation Rate and Non-
term effect of the selected independent factors.However, performing Loans
Bhattarai (2014) revealed that interest rate was one of the Similar to the relationship of interest rate with NPLs,
variables that was found to have insignificant relationship researchers also found both positive and negative
with NPLs in Nepalese banking sector. The other variables relationship with non-performing loans. Farhan et al.
used in this study were inflation rate, unemployment rate, (2012) conducted a perception study of the bankers in 10
exchange rate, political interference and ownership, loan Pakistani banks on the effect of macroeconomic factor on
monitoring and evaluation, energy crisis, budgetary non-performing loans. They examined the possible
expenditure, growth rate of GDP and borrower‟s honesty. association of inflation, unemployment, GDP growth,
The study used macroeconomic theory as the conceptual exchange rate, interest rate an energy crisis with NPLs.
theory, which states that expansionary situation and The study revealed that along with all other variables
declining situation create optimistic environment and (except GDP growth), inflation had a positive and
pessimistic environment respectively in the business. significant relationship with non-performing loans in
Hassan, Ilyas and Rehman (2015) examined the effect of Pakistan. They stated that economic determinants of NPLs
various bank-specific factors such as, interest rate, credit could be derived using life-cycle consumption model. The
monitoring, credit assessment and rapid credit growth and model argues that low-income borrowers have more
social factors such as, banker‟s incompetence and political probability to be default on loans as they have more
interference on NPLs and revealed that only interest rate chances to be unemployed and are unable to repay loans
had a weak significance on NPLs of Pakistani banking with high interest rates. Mehmood, Younas and Ahmed
sector in comparison to the other variables. (2013) studied on the macroeconomic effect on non-
performing loans in Pakistani commercial banks and
3.6 Defining the Concept of Inflation Rate concluded that inflation rate is positively significant in
Inflation is defined as the persistent rise in the general relationship with non-performing loans. As such, if 1 unit
level of prices (Semuel & Nurina, 2015). However, not decreases inflation rate, the NPL will as well decreased by
every rise in the price level is regarded as inflation. Only if 2.59 units (2.6 times). However, Abebrese, Pickson and
the rise in the price level is constant, sustained and Opare (2016) found a negative but significant relationship
enduring, it is regarded as inflation (Bayo, 2011). between inflation and loan performance. As such, if
Furthermore, there are more conditions to denote a rise in inflation increases, it reduces loan performance. In another
the price level as inflation such as, the price level rise word, the level of non-performing loans increases with the
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rise of inflation (positive relationship). However, Anjom increases while an economy faces inflation or rising
and Karim (2016) reported a negative but significant effect prices. The relationship between the two types is Real
of inflation on non-performing loans in Bangladeshi GDP = (Nominal GDP / price index) X 100. GDP is also
banking sector. As such, an increase in inflation rate expressed in terms of GDP per capita, which is the total
would decrease the level of NPLs. Though both these output of the country per person (Mallett & Keen, 2012).
studies found contrary findings, Khemraj and Pasha There are three methods to measure GDP, namely
(2009) uniformed these views. According to them, high Expenditure method, Value-Added or Production method
inflation in the current period would reduce the level of and Income method. The foremost method takes into
non-performing loans; however, the high inflation from the account of consumption (C), investment (I), government
previous period would cause increment in the level of non- expenditure (G) and gross exports (X) and imports (M).
performing loans. As such, he found both negative and As such, the equation to find GDP according to the
positive relationship between inflation and non-performing expenditure method stands as GDP = C + I + G + (X – M).
loans in Guyanese banking sector, but in two different Under the income method, GDP is calculated as GDP =
time perspectives. Some researchers also found Compensation of employees + Rent + Interest +
insignificant relationship between inflation rate and NPLs. Proprietor‟s Income + Corporate Profits + Indirect
Gezu (2014) found that inflation rate (INFR) has negative business taxes + Depreciation + Net foreign factor income.
and insignificant relationship with non-performing loans in Net foreign factor income is the difference between
Ethiopian commercial banking sector. It indicates that income earned by the rest of the world and income earned
though rising inflation may reduce the amount of NPLs, from the rest of the world. Moreover, under the value-
the relationship is not very clear or established. Bhattarai added method (also known as output method or net
(2014) revealed that inflation rate has insignificant product method), GDP is calculated as GDP = value of
relationship with NPLs along with the other variables, sales of goods – value of purchase of intermediate goods
which are interest rate, unemployment rate and exchange to produce the goods sold (Konchitchki & Patatoukas,
rate in the Nepalese banking sector. Likewise, the study by 2014).
Ali and Iva (2013) who examined the bank-specific factors
on NPLs in the Albanian banking sector revealed that 3.9 Relationship between Gross Domestic Product and
inflation rate had an insignificant effect on NPLs. They Non-performing Loans
further found that real exchange rates and loan growth rate Similar to the characteristics of the association of both
have a positive relationship with NPLs, whereas GDP inflation rate and interest rate with NPLs, researchers also
growth and interest rate have negative association with revealed both positive and negative relationship of gross
NPLs. domestic product (with GDP) with NPLs. It is hereby
important to note that GDP in this study can be
3.8 Defining the Concept of Gross Domestic Product interchangeably referred to the GDP growth rate in on
Gross Domestic Product (GDP) is the basic measure of the other academic literatures. In case of positive and
economic status, performance and development of a significant relationship between GDP and NPLs indicate
country (Semuel & Nurina, 2015). GDP is defined as the that the level of non-performing loans rise with the rise of
total market values of all officially recognised final goods GDP growth rate and vice versa. Mondal (2016) examined
and services in a country in a given period of time (year) the effect of four macroeconomic variables (GDP,
(Rahman, 2013). As Desmond et al. (2015) stated, GDP unemployment, inflation and interest rate spread) on the
includes the products and services produced and delivered NPLs of 22 commercial banks in Bangladesh applying the
respectively in a country both by nationals and non- time-series data from 2005 to 2014. The study revealed
nationals residing in the country. However, in that whereas both GDP and unemployment is positively
accumulating the market values, GDP does not simply add significant to NPLs, interest rate and inflation rate behaves
up quantities of the goods and services directly. Moreover, otherwise. Additionally, Makri, Tsagkanos and Bellas
the values of goods and services produced by nationals at (2013) examined the factors affecting non-performing
foreign country do not fall in the scope of GDP. The loans of the banks in 14 out of 17 Eurozone countries and
values of non-market goods, illegal goods and leisure concluded that the non-performing loans have strong
activities also are not included in the scope of GDP. In positive correlation with various macroeconomic factors
addition, no intermediate goods are considered in (annual percentage GDP growth rate, unemployment and
calculating GDP, rather only final goods. GDP benefits us public debt) and bank-specific factors (capital adequacy
in several ways. Firstly, it is used to measure the ratio, return on equity and rate of previous year‟s NPLs).
healthiness of a country. Secondly, it is used to determine Their study employed the Generalised Method of the
the standard of living of individuals in the country. Moments (GMM difference) estimation method, as it
Thirdly, it is used to determine the growth prospects of the provides unbiased and consistent results. Saba, Kouser and
economy of a country. Fourthly, it is used to compare the Azeem (2012) investigated the effect of Real GDP per
size of economies from all over the world. Furthermore, it capita, interest rate and total loans on the NPLs of US
is also used to compare the growth rate of world banking sector using a panel data from 1985 to 1997 using
economies (Desmond et al., 2015). GDP is generally OLS regression model. The study revealed that Real GDP
categorised into two types, namely, Real GDP and per capita has the strongest and significant relationship (68
Nominal GDP. Real GDP does not take account of the percent) with NPLs followed by interest rate (40.7
rising prices and hence, it ignores any possibility of percent) and total loans (28.1 percent). However, majority
inflation. On the other hand, Nominal GDP assumes that of the researchers revealed that GDP affects NPLs
prices of goods and services may increase. Hence, it significantly but negatively. It indicates that declining
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growth rate of GDP would increase the amount of NPLs. purposes, the quality of the loan is being maintained or the
As such, Messai and Jouini (2013) investigated on the repayment sources of the borrowers are protected so that
association of both macroeconomic variables (GDP no unexpected default occurs (Idris & Nayan, 2016).
growth rate, interest rate and inflation rate) and bank- There are several tools used by banks in monitoring their
specific factors (loan loss reserves to total loans ratio, loans such as, relationship management, transaction
return on assets and profitability of bank assets) with the account monitoring, loan stress testing, internal credit
NPLs of 85 banks in three European countries, namely, scoring and ratings. Among all of these, credit bureau
Italy, Greece and Spain from 2004 to 2008. The study ratings have been suggested as one of the timely method as
found that while GDP growth rate and profitability of bank it has more capacity of forecasting the likelihood of loan
assets shows significant negative relationship with NPLs, default (Nakamura & Roszbach, 2013).
the remaining variables show contrary or positive
relationships. Moreover, Farhan et al. (2012) also found 3.11 Relationship between Credit Monitoring and
significant negative relationship of GDP growth with Non-performing Loans
NPLs of Pakistani banks, whereas the other variables Most researchers indicated poor credit monitoring to be
(interest rate, inflation, exchange rate and energy crisis) the cause of increased non-performing loans. In another
were found to have positive relationships. Additionally, word, they found strong negative relationship between
Tsumake (2016) studied on the Botswana banking sector credit monitoring and NPLs. As such, the weaker the
using 10 years of data and revealed that whereas GDP credit monitoring becomes, the higher the non-performing
growth and inflation have a negative and significant loans rise up. Asfaw, Bogale and Teame (2016)
relationship with the NPLs, the other two variables, real investigated on the major factors affecting the NPLs of
interest rate and unemployment rate affect significantly Development Bank of Ethiopia (DBE) using the samples
and positively on the NPLs of Botswana banks. Nkusu from 77 NPLs. The independent variable they selected
(2011) conducted a study to investigate the linkage was bank-specific factors (credit assessment, credit
between non-performing loans and macroeconomic monitoring, high interest rate, credit size and lax credit
performance of 26 advanced economies from 1998 to terms) and customer-specific factors (loan diversion,
2009 and concluded that poor macroeconomic wilful defaulting and poor credit culture of customers). As
performances such as slower GDP and higher the result of their study revealed, along with all the above
unemployment rate could be associated with increasing factors, credit monitoring was identified as a major cause
non-performing loans in advanced economies. The study of NPLs. Abdeta (2015) also studied on the Development
adopted a panel vector autoregressive (PVAR) approach Bank of Ethiopia (DBE) and asserted a similar view that
(as it helps to identify how the variable respond to the credit monitoring and follow ups directly affect NPLs of
shock affecting each variable) and relied upon the impulse the bank. The study revealed that poor monitoring and
response functions (IRFs) to identify the significance of follows up increases NPLs by 31.8 percent compared to
the response of each variable over a four-year forecast strict monitoring and follow up. As such, the probability of
period. There are also very few studies, which found NPLs is high when the banks undertake poor monitoring
insignificant relationships between GDP and NPLs. and follow up. However, the study also pointed out that
Vatansever and Hepsen (2013) investigated the Turkish even if a loan is poorly assessed, it may avoid loan default
banking sector and revealed that the variables such as, by adequate monitoring. Similarly, Geletta (2012) also
Turkey‟s GDP growth, the Euro Zone‟s GDP growth, debt revealed that failed loan monitoring, poor credit
ratio, loan to asset ratio, consumer price index, real sector assessment, aggressive lending, underdeveloped credit
confidence index, USD/Turkish Lira rate and the volatility culture, borrower‟s lack of knowledge, willful default and
of the Standard & Poor‟s 500 stock market index have fund diversion, lenient credit terms and excessive
insignificant effect on NPLs. financing by banks are the main causes of loan default of
both the state-owned and private banks in Ethiopia.
3.10 Defining the Concept of Credit Monitoring Hassan, Ilyas and Abdul Rehman (2015) examined the
Credit Monitoring generally refers to information effect of bank-specific factors (credit monitoring, credit
gathering for not only new loans but also evaluating the growth, interest rate and credit assessment) and social
information gathering process for existing loans factors (political interference and banker‟s acceptance) on
(Instefjord & Hiroyuki, 2015). Regular monitoring of the NPLs of Pakistani banks. The findings of their study
loans involves daily, weekly or fortnightly reviewing the showed that except interest rate, all other factors have
borrowers‟ position in terms of transactions, fund significant effect on NPLs. As such, lack of credit
utilisation and fund diversion (Alam, Haq & Kader, 2015). monitoring is also a major factor to cause high NPLs in
The main rationale of credit monitoring is to detect signs Pakistan. There are also some other literatures that
of difficulty in repaying loans by the borrowers and explained the above findings in the light of hypotheses of
minimize potential losses (Ugoani, 2016). Loan „bad luck‟ and „skimping‟ postulated by Berger and
monitoring is an integral part of banks or bank-specific DeYoung in 1997. For instance, as Rajha (2016) Abdeta
(internal) factor which aims to ensure credit facilities (2015) and Klein (2013) reinstated, the „bad luck‟
remain within the performing loan circle or simply, credits hypothesis argues that bad management that is
are collected in not more than 90 days of the loan maturity characterised by poor credit scoring, loan underwriting,
or specific credit collection period according to the monitoring and controlling skills often pose the probability
particular credit terms. Hence, credit monitoring takes to have increased NPLs. Accordingly, the „skimping‟
place to ensure full compliance of loan agreement from the hypothesis argues that high cost efficiency affects the
borrowers as to whether the loan is being used for eligible NPLs. Banks often try to achieve short-term profits by
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reducing the costs on monitoring. Though it may help the almost all the aspects of the bank are interfered by the
banks in short-term, they pose themselves in risks in the chairman.
long-term. Thus, the NPLs grow high in the long run when
the banks dedicate less effort in ensuring loan quality. 3.12 Relationship between Political Interference and
However, there are researchers who found contrary Non-performing Loans
findings. Joseph et al. (2012) examined the factors As reviewed below, all the recent studies unanimously
affecting NPLs of CBZ Bank Limited in Zimbabwe and revealed the existence of a significant effect of political
revealed that internal factors such as poor credit interference on non-performing loans of banks around the
monitoring, insider loans, inadequate risk management, world. As such, Hassan, Ilyas and Abdul Rehman (2015)
weak credit analysis and poor credit policy have very revealed significant relationship between political
limited influence on the NPLs, rather external factors such interference and NPLs from the Pakistani banking
as government policy, natural disaster and borrower‟s perspective. They added that when terms of the loan
integrity significantly affects the NPLs in Zimbabwe. advancements are compromised and when loans are being
Defining the Concept of Political Interference Shen and disbursed under political pressures to politicians it leads to
Lin (2012) defined political interference as the situation in even higher non-perming loans. Similarly, having
which executives of government banks are substituted investigated on the Nigerian state-owned banks, Adeyemi
within 12 months of the political elections in a country. (2011) discovered that political interference has an impact
They are of the view that financial performance declines on non-performing loans. As the study revealed, most
when a bank is politically involved. As such, a politically public-owned financial institutions in Nigeria were
influenced bank displays the worst performance compared politically influenced to grant loans and overdrafts to
the non-political and private banks. They also argued that politicians, which eventually became bad debts and
developing countries are largely affected by political remained unpaid. Agarwal et al. (2016) examined the
interference than developed countries. Moreover, political interference on the Mexican commercial banks
withdrawing any political interference would lead a bank and revealed that though the loan terms are better for
to revive its profitability and performance. According to political loans rather than non-political loans, they often
Kumar (2014), political interference causes significant result to higher default rates. In fact, the default
costs to economy. A political interference may be imposed probability rises by 12 percent upon provision of a loan to
in the form of regulating banks‟ lending decisions to a politically involved client. Likewise, Bhattarai (2014) in
certain sectors. Hence, if government banks are regulated her study on the Nepalese commercial banks indicated that
to stop lending to certain sectors like manufacturing firms, instable political environment increases the level of NPLs.
those firms may face significant costs and the banks at the Collins and Wanjau (2011) also revealed that political
same time are to make adequate decision to mitigate the interference was the major contributor to the bad loans in
situation and increase the amount of loans to other the Kenyan banking sector that took place in the form of
permitted sectors. Ozaki (2014) asserted that government- insider lending (provision of loan given to insiders of the
influenced state banks‟ operations in Nepal are politically banks who are politically engaged). For example, most of
interfered in many ways. For example, lending decisions, the large local bank failures such as, Continental Bank and
planning, budgeting as well as appointment, transfer and Pan African Bank befallen due to extensive insider lending
promotion of a chief executive officer and other to politicians.
executives may be under strict political intervention from
time to time. The study revealed that even in the case of a 3.13 Defining the Concept of Banker’s Incompetence
politically-influenced bank which was being managed by Incompetence, in general, refers to the underlying
external management after restructuring takes place, the knowledge, skills and attributes that enable people to
Nepalese government still continued to control its lending deliver effective and improved job performance (Brits &
decisions by offering loan waivers and lending to Veldsman, 2014). Besides these, competence may refer to
politically priority sectors. Agarwal et al. (2016) defined a expertise and emotional intelligence all of which are key
politically-influenced bank as only if it has 45 percent or elements in improving a banker‟s competence (Tejada,
more loans provided to politically connected people or 2015). In fact, competence is regarded as one of the
businesses. They also found that politically connected crucial component of professionalism in banking industry.
loans increase the loan volume of commercial banks by According to Bashah et al. (2012), competencies can be of
0.7 percent and decrease the interest rate spreads by 5 to 6 two types: essential competencies and differentiating
percent, lowering down the banks‟ profitability. They competencies. Examples of the prior one is knowledge,
perceived that political interference may take two forms: skills and abilities that are easy to develop. However, the
one is by controlling lending decisions and the other one is latter one is difficult to develop, such as, self-images,
by appointing a politically involved person as the motives and social roles. They further asserted that the
chairman of the bank‟s board management. For example, a differentiating competency enables a banker to provide
politically engaged bank would offer favourable loan superior performance being differentiated from the
terms to its politically connected clients with longer average performance. Julius (2015) reinstated seven
maturities, larger loan quantities and lower collateral characteristics of managerial competencies in banks, such
requirements. Furthermore, if a politically engaged person as, technical (job-related) skills, interpersonal skills,
becomes the chairman of the bank‟s management board, conceptual skills (to understand the goals of the banks),
the recruitment of unskilled, unexperienced and politically diagnostic skills (to be able to assess each individual
favoured employees increases in the bank and decisions on borrower), communication skills, decision-making skills
(to be able to accurately decide on who to provide loans)
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and time management skills (to facilitate the debt investigated the selected variables previously, some of the
collection process effectively). As banker‟s competence researchers have made their researches inconclusive by
has been widely discussed with its importance since the recommending future research on the topic or particular
global financial crisis, the researcher was also of the view variables or when there are evident contradiction among
that banker‟s competence helps to prevent loan defaults, the previous literatures in terms of the causality-effect
financial losses and bank failures to many extent. relationship. In the following paragraphs, the above
rationales are discussed in separate points. Firstly, though
3.14 Relationship between Banker’s Incompetence and quite a number of researchers (Asfaw, Bogale and Teame
Non-performing Loans (2016), Tsumake (2016), Abdeta (2015), Chege (2014),
While referring to banker‟s incompetence, some Gezu (2014) and Joseph et al. (2012)) have come ahead to
researchers denoted it as poor management, bad investigate the factors affecting NPLs in some countries in
management or unskilled management. Though there are the African continent, not a single existing research of the
few researchers who found both significant and recent or far past focused on the non-performing loans in
insignificant relationships between the banker‟s the Somali banking context. Hence, this research may
competencies and the level of non-performing loans, this focus on the Somali banks‟ NPLs and possible associated
relationship theory has been disregarded by majority of the the factors to fill the gap precisely. Secondly, none of the
researchers historically or even in the recent times. reviewed literatures investigated effect of all the variables
Hassan, Ilyas and Rehman (2015) in their study on the (selected in this study) in a single research paper. Though
Pakistani banks found significant relationship between Mondal (2016), Ilyas and Abdul Rehman (2015),
banker‟s incompetence and NPLs. They found that about Bhattarai (2014) and Farhan et al. (2012) took account of
83 percent of the bankers commented that adequate and up four to five of these variables in their studies, other
to date training plays key role in making effecting loan researchers were not even closer to this consideration
decisions. In fact, this is the only study that used the term (selection). Therefore, considering the seven independent
„banker‟s competence‟ in the recent times aiming to find variables (possible factors) in this study, it will be adding
its effect on NPLs. According to them, bankers with high new information to the research database. Thirdly, some of
qualification are in a place to judge the credibility of a the researchers made their studies inconclusive by
borrower more effectively, contributing to lower loan recommending few variables to be studied in the future
default cases. They placed banker‟s incompetence under researches. It is found that not many researchers examined
the category, social factor rather than the bank-specific the effect of credit monitoring, political interference and
factors as they argued that competent bankers can banker‟s incompetence on NPLs, rather they suggested
understand and communicate their customers to convert these to be studied in future. For instance, Sheefani (2015)
their NPLs into performing loans. Likewise, Islam and suggested that the effect of credit monitoring needs to be
Nishiyama (2016) examined the banks in four South Asian studied in the future. Fourthly, in case of political
countries, namely, Bangladesh, India, Pakistan and Nepal interference, no contrary literature stating insignificant
and revealed that besides, inflation, GDP growth, bank relationship was found. Hence, if the current study finds
size and cost inefficiency, bad management also explains insignificant effect of political interference on NPLs, it
the level of NPLs in the banking sector. Similar findings will be a unique information in the field of non-performing
were revealed by Iuga and Lazea (2012) who asserted that loans and banking. Last but not least, all the variables
incompetence of the banking personnel is the main cause except political interference were found to have significant
of increasing NPLs. They further pointed out few or insignificant relationship with non-performing loans.
characteristics of the incompetency, such as, inappropriate For instance, whereas Balgova, Nies and Plekhanov
interview, inadequate financial analysis and monitoring of (2016), Mileris (2014), Makri, Tsagkanos and Bellas
the clients as well as inaccurate documentation and (2013) and Bonilla (2012) found significant relationship
acceptance of poorly guaranteed loans. However, Quadt between unemployment rate and NPLs, Mondal (2016),
and Nguyen (2016) revealed that bad management does Kurti (2016), Bhattarai (2014) and Klein (2013) found
not have any significant relationship with NPLs, rather contrary or insignificant relationship. Likewise, Asfaw,
only external factors explains the level of NPLs. They Bogale and Teame (2016), Abdeta (2015), Geletta (2012)
examined the relationship between efficiency and NPLs at revealed significant relationship, whereas Joseph et al.
40 Nordic (Denmark, Finland, Norway, Sweden and (2012) concluded insignificant relationship between credit
Iceland) banks by applying the Granger-causality monitoring and NPLs. Hence, the identified gap is whether
technique. As the study concluded, the level of NPLs is significance or insignificance is the real phenomenon in
increased with the increase in external or macroeconomic terms of the causality of each variable with NPLs in the
factors (inflation, interest rate and GDP) rather than any context of Somali banks. This study is directed to be the
internal factor of banks. first-hand and reliable source of the above information

3.15 Research Gaps 4. DATA ANALYSIS AND FINDINGS


Gap identification is vital to a research project, which
involves the existence of a practical problem to be 4.1 Pearson Correlation
investigated, clear contradiction with and among the According to Pallant (2013) Pearson correlation
existing literatures (Dissanayake, 2013). As such, for a coefficient is a measure of the strength of a linear
research gap or knowledge gap to be justified, the reasons association between two variables and is denoted by (r).
might be that the chosen research site has always been out Basically, a Pearson correlation attempts to draw a line of
of others‟ research focus, not many researchers
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best fit through the data of two variables. It takes the range variable, and a value of -1 indicates a negative association;
values from +1 to -1, the sign out the front indicates that is, as the value of one variable increases, the value of
whether there is a positive correlation or negative the other variable decreases. Therefore, though different
correlation. Therefore, a value of 0 indicates that there is authors suggest different interpretations, for this research
no association between the two variables while a value of the strength of the relationship is based on Cohen (1988)‟s
1 indicates a positive association; that is, as the value of guidelines in determining the strength of the correlation
one variable increases, so does the value of the other between the variables as shown in table one below.

Table1: Cohen's 1988 Guidelines

1 Small r = .10 to .29


2 Medium r = .30 to .49
3 Large r = .50 to 1.0

The following tables illustrate the correlation coefficient monitoring r=(.264**), GDP r=(.252**), banker‟s
between the dependent variable (Non-performing loans) incompetence (.194**). Correlation between Non-
and the independent variables of this study (unemployment performing loans and Unemployment Rate As table 2
rate, interest rate, inflation rate, GDP, credit monitoring, exhibits, the relationship between unemployment rate and
political interference, banker‟s incompetence). The non-performing loans was investigated using Pearson
Pearson correlation test indicates a significant and a correlation test (r), with the value of alpha set at 0.05, this
positive correlation between the dependent variable and all shows strong positive correlation between the two
the seven independent variables of this research, the variables (r=0.543, p-value = 0.000 0.05). This supports
strongest relationship exists between the first independent the alternative hypothesis that there is a relationship
variable (unemployment rate) and the dependent variable between unemployment rate and non-performing loans of
(non-performing loans) where the r= (.543**). This is Somali banks.
followed by interest rate, r= (524**) and inflation rate
r=(.511**), then political interference (.291**), credit

Table 1 Correlations between DV and IV1

Correlations
DV IV1
Pearson Correlation 1 .543**
Non-performing Loans Sig. (2-tailed) .000
N 180 180
Pearson Correlation .543** 1
Unemployment Rate Sig. (2-tailed) .000
N 180 180
**. Correlation is significant at the 0.01 level (2-tailed).
Source: The researcher computed from SPSS software version 22.0

Correlation between Non-performing loans and relationship between the variables (r= 0.524, p-value =
Interest Rate 0.000 0.05) as can be seen in table 3. We reject the null
Pearson correlation test (r) was used to investigate the hypothesis and support the alternative hypothesis that
relationship between interest rate and non-performing there is a relationship between interest rate and the non-
loans of Somali banks. With Alpha value set at 0.005, the performing loans of Somali banks.
correlation analysis established a strong positive

Table 3: Correlations between DV and IV2

Correlations
DV IV2
Pearson Correlation 1 .524**
Non-performing Loans Sig. (2-tailed) s .000
N 180 180
Pearson Correlation .524** 1
Interest Rate Sig. (2-tailed) .000
N 180 180
**. Correlation is significant at the 0.01 level (2-tailed).
Source: The researcher computed from SPSS software version 22.0

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4.1.1 Correlation between Non-performing loans and less than 5% and their correlation coefficient r=0. 511.
Inflation Rate This supports the alternative hypothesis that there is a
Based on the Pearson correlation analysis test in table 4, relationship between inflation rate and non-performing
inflation rate and non-performing loans of Somali banks loans of Somali banks.
are found to have a strong positive relationship at 0.000
significance level as the p-value of these two variables is

Table 4: Correlations between DV and IV3

Correlations
DV IV3
Pearson Correlation 1 .511**
Non-performing Loans Sig. (2-tailed) .000
N 180 180
Pearson Correlation .511** 1
Inflation Rate Sig. (2-tailed) .000
N 180 180
**. Correlation is significant at the 0.01 level (2-tailed).
Source: The researcher computed from SPSS software version 22.0

4.1.2 Correlation between Non-performing loans and between the variables (r= 0.252, p-value = 0.001 0.05) as
GDP shown in table 5. This supports the alternative hypothesis
By using Pearson correlation test (r) to examine the and we reject the null hypothesis that there is a
relationship between GDP and non-performing loans of relationship between GDP and the non-performing loans
Somali banks. With Alpha value set at 0.005, the of Somali banks.
correlation analysis established a positive relationship

Table 5: Correlations between DV and IV4

Correlations
DV IV4
Pearson Correlation 1 .252**
Non-performing Loans Sig. (2-tailed) .001
N 180 180
Pearson Correlation .252** 1
GDP Sig. (2-tailed) .001
N 180 180
**. Correlation is significant at the 0.01 level (2-tailed).
Source: The researcher computed from SPSS software version 22.0

4.1.3 Correlation between Non-performing loans and correlation between the two variables (r=0.264, p-value =
Credit Monitoring rate 0.000 0.05). This supports the alternative hypothesis that
As table 6 exhibits, the relationship between credit there is a relationship between credit monitoring and non-
monitoring and non-performing loans was investigated performing loans of Somali banks.
using Pearson correlation test (r), with the value of alpha
set at 0.05, the evidence shows that there is strong positive

Table 6: Correlations between DV and IV5

Correlations
DV IV5
Pearson Correlation 1 .264**
Non-performing Loans Sig. (2-tailed) .000
N 180 180
Pearson Correlation .264** 1
Credit Monitoring Sig. (2-tailed) .000
N 180 180
**. Correlation is significant at the 0.01 level (2-tailed).
Source: The researcher computed from SPSS software version 22.0

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4.1.4 Correlation between Non-performing loans less than 5% and their correlation coefficient r=0. 291.
and Political Interference This supports the alternative hypothesis that there is a
Based on the Pearson correlation analysis test in table 7, relationship between political interference and non-
political interference and non-performing loans of Somali performing loans of Somali banks.
banks are found to have a positive relationship at 0.000
significance level as the p-value of these two variables is

Table 7: Correlations between DV and IV6

Correlations
DV IV6
Pearson Correlation 1 .291**
Non-performing Loans Sig. (2-tailed) .000
N 180 180
Pearson Correlation .291** 1
Political Interference Sig. (2-tailed) .000
N 180 180
**. Correlation is significant at the 0.01 level (2-tailed).
Source: The researcher computed from SPSS software version 22.0

4.1.5 Correlation between Non-performing loans and Banker’s Incompetence

Table 8: Correlations between DV and IV7

Correlations
DV IV7
Pearson Correlation 1 .194**
Non-performing Loans Sig. (2-tailed) .009
N 180 180
Pearson Correlation .194** 1
Political Interference Sig. (2-tailed) .009
N 180 180
**. Correlation is significant at the 0.01 level (2-tailed).
Source: The researcher computed from SPSS software version 22.0

As table 8 exhibits, the relationship between banker‟s table (Model Summary) provides information about the
incompetence and non-performing loans was investigated regression line‟s ability to account for the total variation in
using Pearson correlation test (r), with the value of alpha the dependent variable. Table 9 demonstrates model
set at 0.05, the findings and results shows a very weak summary of the dependent variable of this research that is
positive correlation between the two variables (r=0.194, p- non-performing loans. In accordance to table, the R
value = 0.009 0.05). This supports the alternative Square value is 0.420 and the Adjusted Square value is
hypothesis that there is a relationship between banker‟s 0.396. R Square is known as the coefficient of
incompetence and non-performing loans of Somali banks. determination with its value ranging between (0) and (+1)
and measures the proportion of variation in a dependent
4.2 Regression Model variable that can be explained statistically by the
independent variables. Moreover, it also shows the degree
4.2.1 Model Summary of goodness of fit for the multiple regression equation
The regression results comprise three tables the Model estimated by the researcher.
Summary, the Annova and the Coefficients table. The first

Table 9: Model Summary

Model R R Square Adjusted R Square Std. Error of the Estimate


1 .648a .420 .396 2.33854
a. Predictors: (Constant), IV7, IV3, IV4, IV6, IV1, IV5, IV2

This indicates if the independent variable of this study can variables, in other words, 42% of the values fit the model.
be explained by the dependent variables, the coefficient of Additionally, the R Square and the Adjusted R Square
determination R Square would have been equal to (1). respectively values at 0.420 and 0.396 and could indicate
However, in this research, 42% of the variation of the there is a moderate degree of goodness of fit in the
dependent variable could be explained by the independent regression model of the researcher.
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4.2.2 Anova and Coefficients of the Study due to fitting the regression model is much greater than the
The analysis of variance tests (ANOVA) tests whether the inaccuracy within the model then the value of F will be
model is significantly better at predicting the outcome. greater than 1 and SPSS calculates the exact probability of
Precisely, the F-ratio represents the ratio of the obtaining the value of F by chance (Piaw, 2013). For the
improvement in prediction that results from fitting the data of this research the F=17.8, which is very unlikely to
model (labelled „Regression‟ in table 31), relative to the have happen by chance (p < .001). This can be interpreted
inaccuracy that still exists in the model (labelled that the final model significantly improves the ability to
„Residual‟ in table 10) (Pallant, 2013). If the improvement predict the outcome variable

Table 10: ANOVAa

Model Sum of Squares df Mean Square F Sig.


Regression 680.171 7 97.167 17.768 .000b
1 Residual 940.629 172 5.469
Total 1620.800 179
a. Dependent Variable: Non-performing Loans
b. Predictors: (Constant), IV7, IV3, IV4, IV6, IV1, IV5, IV2

In another words, table 31 shows that F = 17.768 with 2008). The results of the T-test for the individual
significance (Sig.) of 0.000, which means that the regression coefficients for the IVs of this research
probability of these results occurring by chance is less than (unemployment rate, interest rate, inflation rate, GDP,
5%. The F-Test determines the probability of the credit monitoring, political interference and banker‟s
relationship between dependent variable and the incompetence) are respectively 4.392; 2.378; 2.809;
independent variables occurring by chance (Greener, 0.776; 1.236; 0.103 and 0.050. The probability of
2008). Additionally, table 32 below shows the coefficients occurrence of the first four variables is less than 5%; On
of this research. The T-test is generally used to determine the other hand, the probability of occurrence of the last
the probability of the impact of the independent variables three variables is greater than 5%.
on the dependent variable occurring by chance (Greener,

Table 11: Coefficientsa

Standardized
Unstandardized Coefficients
Model Coefficients Sig.
B Std. Error Beta t
(Constant) 2.496 2.284 1.093 .276
Unemployment Rate .356 .081 .321 4.392 .000
Interest Rate .181 .076 .191 2.378 .002
Inflation Rate .245 .087 .219 2.809 .000
GDP .051 .066 .050 .776 .001
1 Credit Monitoring .092 .075 .090 1.236 .218
Political Interference .009 .082 .008 .103 .918
Banker‟s Incompetence .004 .086 .003 .050 .961
a. Dependent Variable: Non-performing Loans

However, the beta values tell us about the relationship “sig.” value of the last three IVs shows to be greater than
between the DV and the IVs. The positive sign of the beta 0.05 meaning that these predictors do not contribution to
indicates that there is a positive relationship between the the model.
predictor and the outcome. Thusly, for this data all the
predictors have positive values and the beta for the seven 4.3 Comparisons of Findings with the Literature
independent variables are 0.356 for unemployment rate,
0.181 for interest rate, 0.245 for inflation rate, 0.051 for 4.3.1 Unemployment Rate
GDP, 0.092 for credit monitoring, 0.009 for political The first objective of the study was to examine the effect
interference and 0.004 for banker‟s individual. of unemployment rate on the non-performing loans of
Furthermore, each of these beta values has an associated Somali banks. Thusly, the empirical correlation results of
standard error indicating to what extent these values would this study suggest that there is a strong positive (r=0.543)
vary across different samples, and these standard errors relationship between unemployment rate and NPLs of
are used to determine whether or not the b value differs Somali banks. Moreover, the regression coefficient results
significantly from zero. Therefore, if the t-test associated indicate significant relationship (Sig.=0.000) between the
with b values is significant (sig. is less than 0.05) then the two variables. Together the findings of correlation and
predictor is making a significant contribution to the model. regression this study establishes a strong positive and
Accordingly, as table 11 implies the “sig.” value of the significant relationship between the two variables. These
first four IVs is less than 0.05 indicating that these findings are in line with the previous literatures of Makri,
predictors are making contribution to the model, while the Tsagkanos and Bellas (2013) who examined the non-

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performing loans of banks in Eurozone and found a strong established a negative and insignificant relationship
positive correlation and others such as Balgova, Nies and between NPLs and inflation rate in Ethiopian commercial
Plekhanov (2016), Bonilla (2012), Mileris (2014) who all banks, Nepalese banking sector and Albanian banking
found a positive correlation between unemployment rate sector respectively. Therefore, based on the literatures
and non-performing loans. However, the results of this reviewed the relationship between inflation rate and non-
study also contradict the literatures of Mondal (2016), performing loans seems ambiguous. According to Nkusu
Kurti (2016) and Klein (2013) who all found insignificant (2011) higher inflation rate can affect the level of NPLs
relationship between unemployment rate and NPLs. As positively or negatively. Theoretically high inflation
noted by to Musai and Mehrara (2014) unemployment should reduce the real value of debt and hence make debt
impacts on society and economy in different ways. It servicing easier. However, high inflation may pass through
decreases the knowledge and skills of the labour force to nominal interest rate and weaken some borrower‟s
while increases the costs of producing labour force. ability to service debt by reducing real income when
According to the economic theory of crime, wages are adhesive (Louzis, Vouldis and Metaxas 2010).
unemployment causes increased level of crimes such as
drug abuse, robbery and smuggling. However, in Somalia 4.3.4 Gross Domestic Product (GDP)
the unemployment rate is very high, 66% as of 2015 The fourth objective of this study was to examine the
according to the World Bank and this high unemployment effect of GDP on the NPLs of Somali banks. The
could be one of the main reasons of the high non- empirical correlation results of this variable established a
performing loans in Somali banks. very weak positive relationship (r=0.252, Sig.=0.001)
between GDP and NPLs of Somali banks. Additionally,
4.3.2 Interest Rate the regression coefficients‟ results indicate significant
The second objective of the study was to examine the relationship (Sig.=0.001) between the variables. Though,
effect of interest rates on the NPLs of Somali banks. Both the results of the correlation and the regression were
the regression and correlation results indicate that there is similar by direction, the correlation results indicate
a strong positive and significant (r=0.524, Sig.0.002) weakness of the relationship. This infers that increase in
relationship between the interest rate and NPLs. The GDP growth rate results in a decrease of the level of NPLs
finding of this variable is consistent with the findings of loan giving banks and vise versa. These findings are
revealed by Jameel (2014) and Warue (2013) who both being consistent with the findings of Mondal (2016),
found positive and significant relationship of interest rate Tsumake (2016), Makri, Tsagkanos and Bellas (2013),
on NPLs. On the other hand, the finding of this variable is Messai and Jouini (2013), Saba, Kouser and Azeem
inconsistent with the studies of chege (2014) who studied (2012) and Farhan et al. (2012) who all found positive
commercial banks of Kenya and found positive but relationship between GDP and NPLs and Nkusu (2011)
negative linear relationship, Bhattari who revealed that and Vatansever and Hepsen (2013) who also revealed
interest rate have insignificant relationship with NPLs in insignificant relationship between the NPLs and GDP
Nepalese banks and Hassan, Ilyas and Rehman (2015) growth rate. Nevertheless, Beck, Jukubik and Piloiu
who examined the effect of various bank-specific factors (2013), insinuate that in theory an improvement in the real
including interest rate and revealed that only interest rate economy should see an instantaneous reduction in the
had a weak significance on NPLs of Pakistani banking NPLs of a country. This is because the growing economy
sector in comparison to the other variables. However, as increases the borrowers‟ income and ability to repay debts
argued by Nkusu (2011) an upsurge in interest deteriorates and generally increases the overall financial soundness and
the credit disbursement ability of the debtors, therefore stability. Thusly, when all subjects in the economy are
banks should constantly review the interest rates on loans supposedly getting higher incomes, they will be more
since loan failures are higher for banks which increase capable of settling their debts and this will lead to lesser
their real interest rates. bad debts, defaults and non-repayments.

4.3.3 Inflation Rate 4.3.5 Credit Monitoring


The third objective of this study was to examine the effect The fifth objective of this study was to examine the effect
of inflation rate on the NPLs of Somali banks. Similar to of credit monitoring on the NPLs of Somali banks. The
the unemployment and interest rates the empirical empirical results of the correlation indicate a very weak
correlation results of the third IV (Inflation rate) reveals positive correlation (r=0.264) between credit monitoring
strong positive relationship (r=0.511) between NPLs of and the NPLs of Somali banks. Moreover, the regression
Somali banks and the fluctuation of inflation in the coefficients results show insignificant relationship between
country, while the correlation results also show significant the variables (Sig.=0.218). Thusly, both the regression and
relationship between the variables (Sig.=0.000) which is correlation results establish weak positive insignificant
consistent with the findings of Mehmood, Younas and relationship. The findings of this study are in line with the
Ahmed (2013) and Farhan et al. (2012) who found findings of Asfaw, Bogale and Teame (2016), Hassan,
positive and significant relationship of NPLs and inflation Ilyas and Abdul Rehman (2015), Abdeta (2015) and
rate of Pakistani banks; and Abebrese, Pickson and Opare Geletta (2012), who all found a positive relationship
(2016), Anjom and Karim (2016), who discovered between NPLs and credit monitoring. There are other
negative but significant relationship of NPLs and inflation literatures that explained the above findings in the light of
rate of Bangladeshi banks. However, the findings of this hypotheses of „bad luck‟ and „skimping‟ postulated by
variable are inconsistent with the literature of Gezu Berger and DeYoung (1997). For instance, as Rajha
(2014), Bhattari (2014) and Ali and Iva (2013) who (2016) Abdeta (2015) and Klein (2013) reinstated, the
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„bad luck‟ hypothesis argues that bad management that is 5. SUMMARY AND DISCUSSION OF THE FINDINGS
characterised by poor credit scoring, loan underwriting, As Somali banking sector has long been facing high non-
monitoring and controlling skills often pose the probability performing loans, the situation played as a motive behind
to have increased NPLs. Accordingly, the „skimping‟ conducting this study. Furthermore, since no earlier
hypothesis argues that high cost efficiency affects the research was found that examined the NPLs of Somali
NPLs. Banks often try to achieve short-term profits by banks, this knowledge gap also motivated the study. This
reducing the costs on monitoring. Though it may help the study considered non-performing loans as the dependent
banks in short-term, they pose themselves in risks in the variable and unemployment rate, interest rate, inflation
long-term. Thus, the NPLs grow high in the long run when rate, gross domestic product, credit monitoring, political
the banks dedicate less effort in ensuring loan quality and interference and banker‟s incompetence as the
this might be the reason of this finding causing the weak independent variables. Interestingly, this is the first ever
positive insignificant relationship between the NPLs of study that took into account all the above variables in a
Somali banks and credit monitoring. single study. The research objectives of the study were to
investigate the effect of all the aforementioned variables
4.3.6 Political Interference on the NPLs of Somali banks. Accordingly, the research
The sixth objective of this study was to examine the effect considered both public and private Somali banks as the
of political interference on the NPLs of Somali banks. The research site and the respondents were selected using a
empirical results of the correlation established a very weak non-probability sampling method. It also implemented a
positive correlation (r=0.291) between NPLs and political quantitative analysis by distributing and collecting survey
interference of the Somali banks. Moreover, the regression questionnaire to the respondent bankers. The collected
coefficients results show insignificant relationship between primary data were analysed using SPSS tool. The results
the variables (Sig.=0.918). Thusly, both the regression and from the demographics of the respondents show that
correlation results establish weak positive insignificant majority of the respondents were male (72.2 %), young,
relationship and the findings of this variable are consistent below 30 years old (56.7%), completed degree level
with the results of Hassan, Agarwal et al. (2016), Ilyas and (55%) and have experience of more than 3 years (54.4%).
Abdul Rehman (2015), Bhattarai (2014), Wanjau (2011) The null hypotheses of the study recognise that each of the
and Adeyemi (2011), who all unanimously revealed the independent variables has an impact on the NPLs of
existence of a significant effect of political interference on Somali banks. However, the findings of the study show
the NPLs of banks around the world, though the results of that all the null hypotheses are rejected. Firstly, the study
this study establish insignificant. The reason behind this found that unemployment rate has an effect on the NPLs
insignificant positive effect of political interference on the of Somali banks. This finding is consistent with the
NPLs of Somali banks could be the initiatives that the findings of Balgova, Nies and Plekhanov (2016), Mileris
Somali central government is undertaking for the last (2014), Makri, Tsagkanos and Bellas (2013) and Bonilla
couple of years to mitigate and reduce the political (2012). Secondly, this study revealed that interest rate has
corruption involving state banks. an impact on the NPLs of Somali banks. The finding is
consistent with the findings revealed by Jameel (2014) and
4.3.7 Banker’s Incompetence Warue (2013). Thirdly, the study also found that inflation
The seventh and last objective of this study was to rate has an effect on the NPLs of Somali banks which is
examine the effect of banker‟s incompetence on the NPLs consistent with the findings of Abebrese, Pickson and
of Somali banks. The correlation findings of this variable Opare (2016), Anjom and Karim (2016), Mehmood,
established the weakest positive correlation (r=0.194) of Younas and Ahmed (2013), Farhan et al. (2012) and
this study, which is between NPLs of Somali banks and Khemraj and Pasha (2009). Fourthly, gross domestic
banker‟s incompetence. Moreover, the regression product was found to have an impact on the NPLs of
coefficients results show insignificant relationship between Somali banks, being consistent with the results of Mondal
the variables (Sig.=0.961). Thusly, together the regression (2016), Tsumake (2016), Makri, Tsagkanos and Bellas
and correlation results establish weak positive and (2013), Messai and Jouini (2013), Saba, Kouser and
insignificant relationship between NPLs and banker‟s Azeem (2012) and Farhan et al. (2012). Fifthly, credit
incompetence. The findings of this variable are consistent monitoring was also found to have an impact on the NPLs
with the results of Islam and Nishiyama (2016), Hassan, of Somali banks, which is consistent with the findings of
Ilyas and Rehman (2015) and Iuga and Lazea (2012). Asfaw, Bogale and Teame (2016), Hassan, Ilyas and
Adequate and up to date training of the bank officers Abdul Rehman (2015), Abdeta (2015) and Geletta (2012).
involving the loan giving process plays a key role in Sixthly, the study revealed that political interference also
making effective loan decisions. In fact, Hassan, Ilyas and has an impression on the NPLs of Somali banks. The
Rehman (2015) done the only study that used the term result is consistent with the results of Hassan, Agarwal et
„banker‟s competence‟ in the recent times aiming to find al. (2016), Ilyas and Abdul Rehman (2015), Bhattarai
its effect on NPLs of Pakistani banks. According to them, (2014), Wanjau (2011) and Adeyemi (2011). Last but not
bankers with high qualification are in a place to judge the least, banker‟s incompetence was also found to have an
credibility of a borrower more effectively, contributing to impact on the NPLs of Somali banks, which is consistent
lower loan default cases. They placed banker‟s with the findings of Islam and Nishiyama (2016), Hassan,
incompetence under the category, social factor rather than Ilyas and Rehman (2015) and Iuga and Lazea (2012).
the bank-specific factors as they argued that competent
bankers could understand and communicate their
customers to convert their NPLs into performing loans.
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5.1 Contributions of the Study customers‟ financial background, identify the required
collaterals, measure the loan quality and take necessary
5.1.1 Theoretical contributions steps to facilitate a better debt collection process while
Firstly, not a single existing research focused on the non- facing the possibility of loan defaults. The findings of the
performing loans in the Somali context, as far as our study would also encourage the Somali banking authority
knowledge concerns. Hence, this study fulfils the lacking to organise internal and spend for external trainings and
of literatures on the NPLs of Somali banking sector. development programmes that would increase the level of
Secondly, none of the earlier literatures took account of all bankers‟ competency, especially in case of loan quality
the variables (factors) selected in the current study. monitoring and assessment. It may consequently reduce
However, this study has covered the gap by examining all the level of non-performing loans. The study further
the seven variables in a single research. Thirdly, some of benefits the government and national regulatory
the reviewed literatures recommended for future organisations, as they will be able to understand and
researches, especially in case of the impact of several identify the root causes of high NPLs in the country‟s
variables on non-performing loans that those studies did banking sector. Accordingly, it would encourage them to
not investigate. For example, Sheefani (2015) suggest that keep unemployment rate, interest rate and inflation rate
the impact of credit monitoring need to be studied by and political interference low for a healthy financial
future literatures. Thus, this study fulfils the suggestions system.
made by the researchers at large extent. Fourthly, the three
variables, namely, credit monitoring, political interference 5.2 Limitations of the Study
and banker‟s incompetence were not studied in a single Limitations are normally those factors that limit a study
research by many researchers. Only Hassan, Ilyas and from obtaining expected outcomes. This study has also
Abdul Rehman (2015) was found to have studied the several limitations addressed below. Firstly, time
impact of these three variables on NPLs. Hence, this study constraint is a major limitation to this study as the primary
also added important information in the case of impact of data were collection over a period of only one month.
the three factors on non-performing loans. Fifthly, the Hence, the study does not reflect the banker‟s perception
study is found to have empirical evidence that the findings regarding the impact of the selected variables on NPLs in
of this study were inconsistent with the conclusion made the long run. Secondly, financial constraint is also another
by several researchers such as, Bhattarai (2014) and Klein limitation to this study that restricted the researcher from
(2013) in case of the impact of unemployment rate on obtaining data from a large number of banks. As such, not
NPLs; Hassan, Ilyas and Rehman (2015) and Bhattarai all the Somali banks were approached mentioned in the
(2014) in case of the impact of interest rate on NPLs; chapter 1. Thirdly, lack of cooperation from the
Gezu (2014), Bhattarai (2014) and Ali and Iva (2013) in respondents was also another limitation of this study.
case of the impact of inflation rate on NPLs; Vatansever While approached, a number of bankers were reluctant to
and Hepsen (2013) in case of the impact of GDP on NPLs; respond to the questionnaire and consequently, the
Joseph et al. (2012) in case of the impact of credit response rate was primarily not high. However, the
monitoring on NPLs and Quadt and Nguyen (2016) in researcher managed to obtain expected primarily data
case of the impact of banker‟s incompetence on NPLs. from the pre-calculated number of samples eventually.
Last but not least, though this study aimed to examine the
5.1.2 Practical contributions possible effect of the variables on the NPLs, it did not
The measure of non-performing credit is one of the investigate the direction of the impact such as, positive or
markers of a financial system‟s strength or weakness, the negative relationship. Hence, this is also a limitation of the
less the non-performing loans the better the financial research.
soundness of the economy. In the event that the non-
performing credit is more, there will be poor financial 5.3 Recommendations for Future Research
related wellbeing and emergency may bring about the This study did not investigate the direction (positivity or
economy. Therefore, studying and identifying factors that negativity) of the impact of the selected variables on the
contribute to the borrowers‟ inability to repay the non-performing loans of Somali banks. Hence, it is
advances is necessary. As the bankers‟ perception towards suggested that the future researchers may investigate the
the major factors triggering non-performing loans were direction of the selected variables in a single research.
considered, the study recognised the selected independent Furthermore, this research did not take account of the
variables and their impact on the NPLs. It is expected that bank-specific factors such as, credit assessment, credit
the study will benefit the researchers of the field and size, credit terms, credit growth, capital adequacy ratio,
similar interests. As the research has added new return on equity, return on assets, and loan loss reserves to
information in the context of Somali banking sector and in total loans ratio, and profitability of bank assets and
case of the impact of the selected seven variables on macroeconomic factors such as, public debt, exchange
NPLs, the future researchers will be able to obtain rate, government expenditure and exports and imports.
necessary information from the study‟s findings Hence, the future researchers may investigate the possible
investigating NPLs in Somali banks. The study will also impact of the aforementioned variables on the NPLs of
benefit bankers (loan managers) of the Somali banks. The Somali banks. Recommendation to the Management of the
loan managers will be able to identify the major causes or Somali Banks In order to ensure a better relationship
factors of NPLs in their banks more effectively as all the management with the customers, an effective loan quality
seven factors in this study were found to have impact on assessment and an efficient debt collection process, there
the NPLs. Additionally, they will be able to analyse is no other means than improving the competencies (the
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ISSN: 2456-9992

knowledge and skills according to recent trends) of the borrowings and improved public services and investment.
bankers, especially loan managers. Furthermore, Banks One major concern in Somalia is the issue of corruption,
need to deliberately and regularly organise training and which needs laws to be implemented to ensure fair, and
development (T&D) programmes focusing on credit transparent dealings across the spectrum of financial
enhancement process, credit approval conditions, loan markets and companies to have proper disclosures.
quality monitoring and debt collection process for Recently Anti-Corruption Act is brought to Somali
respective employees of loan and risk management parliament waiting to be passed. Furthermore, the
departments. Furthermore, monitoring programmes such government needs to ensure that the banks especially the
as, the SMP organised by IMF (mentioned in chapter 1) state banks have limited political involvement and fewer
can be collaborated with international agencies that will amounts of loans provided to politically engaged debtors
make the bankers and loan managers understand the bigger (Sufi, 2017). However, if the government can ensure very
picture of credit monitoring and its effect on reducing loan limited or no political loans, that will result into lower
defaults in various countries. level of NPLs indeed. Somalia is one of the world‟s most
remittance-dependent country being the recipient of
5.3.1 Recommendation to the Government and US$1.3 billion every year that accounts for 25-45 per cent
Financial Regulatory Authorities of the country‟s economy and about 80 per cent of start-up
One of the reasons of high NPLs in the Somali banks is the capital of small businesses in the region (International
high unemployment rate in the Somali region. Hence, it is Monetary Fund, 2017b). However, the problem facing the
clear that due to high unemployment, many debtors are regional banking section is that till now, there is
unable to repay loans within the loan maturity. In order to inadequate commercial banking services and supervisory
avoid the situation, the government should ensure a job or capacity of the Central Bank (Paul et al., 2015).
income source for all the citizens. This will increase the Furthermore, the Central Bank has very limited
demand for more expenditure among the public and in turn corresponding relationship with the foreign banks and
will increase the growth of GDP, resulting to lower the money transfer operators. Hence, it is suggested that the
NPLs. Therefore, managing unemployment is critical for government should build more sustainable financial
political dependability. The unemployed youth populace industry by increasing the commercial banking services
(67 per cent) contributes essentially to unpredictable capacity of the Central Bank and maintaining good
movement and cooperation in fanatic exercises, including relationships with foreign governments in order to ensure
Al-Shabaab the activist jihadist group, which is seen as quick arrival of the remittances and lower NPLs.
another type of employment in the country. With high
youth unemployment and low overall labour force 6. CONCLUSION
participation, the Somali experts set up the National Non-performing loans are not only a threat to the
Development Plan that spotlights on the accompanying economic and financial stability of a country but also
key points: how to accomplish higher financial globally as we have seen financial crisis by the theses
development, make employments, and assimilate the loans in East Asian Countries, America and Sub-Saharan
Somali outcasts and refugees coming back from Kenya; Africa. Moreover, a colossal volume of non-performing
remittances streams; and organizing social wellbeing nets loans fills in as preface to financial fragility. Thusly, there
and squeezing philanthropic conditions (International is a need of identifying the factors responsible for these
Monetary Fund, 20017a). As several earlier study found loan defaults, as many authors and researchers believe that
both positive and negative of interest rate on non- once these factors are identifying then policies and
performing loans, it is ambiguous that whether government regulations can be put in place to minimise and or prevent
needs to increase interest rate reduce it. The local the causes. The existing literature in the area of non-
government should be extra careful in navigating the performing loans concentrated on analysing secondary
monetary policy of the region so that they can avoid any data in finding out the major factors contributing to the
inverse action to increasing NPLs and may fluctuate the loan defaults, however, this study focused on the views
level of interest rate depending on the financial situation of and perceptions of the Somali bankers who deal with and
the banks. The government of Somalia also needs to be handle the daily activities of the loan portfolios. It is the
careful in endorsing policy on maintaining the inflation researchers‟ believe that the bankers who are actually
rate in the country. For the past few years, the country has dealing with these issues on a daily basis could better
been facing both ups and downs in the inflation rate. In describe the factors or elements causing or contributing
2015, the country faced deflation after an inflation in the the loan defaults. Therefore, this study incorporates the
previous year (see Figure 3 in chapter 1). However, it is first ever investigation of the effect of unemployment rate,
suggested that the government should maintain upwards interest rate, inflation rate, GDP, credit monitoring,
within 2 to 3 percent inflation rate in the upcoming years political interference and banker‟s incompetency on NPLs
so that the industry remains competitive, the wages (salary in the context of Somali banking sector. The findings of
scales) of productive workers are adjusted and, in some the study revealed that all the factors were found to have
cases, may boost economic growth. GDP was also found an effect on the NPLs of Somali banks. It is expected that
to have ambiguous relationship with NPLs in the reviewed the study has added valuable information in the field of
studies. As currently, the GDP growth in the country is NPLs and its factors. The research is expected to be
steady, the government should ensure that it does not equally beneficial for prospective researchers,
decline and remains steady or go upwards in order to meet management of the banks and the government. Finally, it
the goals of higher average incomes, better standards of is suggested that the bank management should increase
living, lower unemployment, lower government
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ISSN: 2456-9992

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