Abstract

This study was about the impact of ratio analysis on granting loan by commercial banks. The objectives were to find out the various types of ratios and their relationships in determining the loan portfolio in granting of loans in commercial banks and to examine the Relationship of ratio analysis in granting of loans in commercial banks.

The methods of data collection were primary, primary data which are information gotten directly from the field through the administration of questionnaire. Data was obtained using questionnaires of sample size 30. The methods of analysis were descriptive analysis and regression analysis.

Our findings shows a strong significant positive relationship between the ratio analysis and lending decision (r=0.689**, p>0.01) which presupposes that if commercial banks effectively makes use of financial ratios it will lead to correct lending decisions by 68.9%. Therefore 31.1% is the gap that needs to be closed by commercial banks and this is majorly due to short falls of the ratio analysis.

This study is important because it enables commercial banks know the influence ratio analysis have on the granting of loans in microfinance’s which is important for decision making by the microfinance’s themselves and the government. It was recommended that microfinance institutions should regulate their lending effort as they look on the influence ratio analysis have on granting of loans. This will have the effect of ensuring a stable banking sector which plays a big role in the economy.

CHAPTER ONE

INTRODUCTION

1.1 Background of the study

Commercial banks are special institutions in modern economy  and key pillars of financial systems because of their ability to efficiently transform financial claims of savers into claims (advances) issued to businesses, individuals and governments (Mishkin and Eakins, (2007).

A commercial banks  ability to evaluate information, control and monitor borrowers implies that the commercial bank accepts a credit risk on this loans in exchange for a fair return sufficient to cover the cost of funding.Credit risk arises from the possibility that the borrower will not be a potential defaulter to the bank (Mishkin and Eakins, 2007.

According to UBAKA (1996), ratio is defined as a useful tool  which analysis’s a set of financial statements.  It is a tool available to accountants to analyze a set of financial statements.

The three basic financial statements which form the bedrock from which the financial ratios are usually computed for analysis are:

(a) Balance sheet

(b) Profit and loss statement

(c) Statement of charges in financial position

Analysis of the above financial statements requires ratio analysis which is mostly done by higher level management to which responsibility is maximizing profits and planning for the future.

Financial ratios are measurements of a business financial performance .ratio helps an owner or other interested parties develop and understand the overall financial health of the company(sujarweni,vw(2017) .financial ratios are used by busineses and analyst to determine how a company is financed.The various ratios are :

(1.)Liquidity RatioThis ratio measure’s the firm’s ability to fulfill short-term commitments and obligations out  of its liquid assets.  These ratios particularly interest the firm’s short-term creditors liquid assets include accounts receivable and other debts owed to the firm which will generate cash when those debts are paid in the near future.

1.2 Problem Statement

Banks are scared of extending loans to customers due to the risk involved.  Bank lending even, while considered important is regarded as a risk because of the problems it is associated with.  The problem of unrepaid loan is a criticism of bank’s judgment thus; every bank has to employ an analysis financial statement of the borrower at a given period.  Most banks are characterized by poor lending which may arise in poor appraising of borrower’s financial statement.

The banks in most cases, share the common belief of customer that, the fact that he is making profit is an open scheme to the heart of the treasury and thus the bank fails to see that there is no simple way of assessing the borrower’s financial position before lending.  In lending activities, it is necessary to see that money for repayment will be available at the appropriate time.  The basic problem therefore is the inability of banks to recover their potential borrowers.

Many researches on the cause of bank failures find that asset quality is a statistically significant predictor of insolvency (Dermirgue-Kunt, (1997), and that failing banking institutions always have high level of non-performing loans prior to failure. It is argued that the non-performing loans are one of the major causes of the economic stagnation in many world economies.

Each nonperforming loan in the financial sector is viewed as an image of an ailing unprofitable enterprise. If the non-performing loans are kept existing and continuously rolled over, the resources are locked up in unprofitable sectors, thus, hindering the economic growth and impairing the economic efficiency.

According to the study carried out by (Waweru and Kalani 2009) in Kenya, customer failure to disclose vital information during the loan application process is considered to be the main customer specific factor. The persistence of nonperforming loans would require a review of the capacity of the credit evaluation managers together with the quality of the decision models that they use.

If it is true that customer information as a factor contribute to nonperforming loans, then it is important identifying and evaluating the information that credit managers employ in evaluating potential borrowers. Banks do financial analysis and the information that the analysis is based on is derived from financial statements and manipulated in ratio form.

Relating to a banks potential client, financial analysis may concern two domains of decisions, one related to business strategy, the other performance evaluation. Insolvency of a firm may incorporate liquidation, receivership and administration of a company by bankers or others with financial stake. Consequently any method capable of assisting in identifying the danger of insolvency gives potential to ensure efficient use of resources. Ratios can help separate financially distressed firms from the non-failed firms in the year before the declaration of bankruptcy at an accuracy level better than 90%.

There is however one recurring question with the use of financial ratios, which ratios among the hundreds which can be computed easily from the available financial data should be analyzed to obtain the information for the task at hand without confusing the users? The research hopes to help resolve this problem of ratio selection by examining ratios found useful by the commercial banks in making their lending decisions. Discrimination is required in order to identify a limited set of financial ratios which are used by the banks in deciding on the credit worthiness of their clients.the researcher in this study tries to answer the following questions.

1.2.1 .Main research question

What is the impact of Ratio analysis on the granting of loans to commercial banks?

1.2.2. Specific research questions.

1. What is the effect of the solvency ratio on the granting of loans to commercial banks?.
2. What is the effect of liquidity ratio on the granting of loans to commercial banks?
3. What is the effect of the profitability ratio on the granting of loans to commercial banks?

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