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Determinants of Loan Repayment:

The Case of Microfinance Institutions
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Universal Journal of Accounting and Finance

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Universal Journal of Accounting and Finance 6(3): 108-122, 2018 http://www.hrpub.org
DOI: 10.13189/ujaf.2018.060303

Determinants of Loan Repayment: The Case of

Microfinance Institutions in Gedeo Zone,
SNNPRS, Ethiopia
Girma Gudde Jote

Accounting and Finance Department, Dilla University, Dilla, Ethiopia

Copyright©2018 by authors, all rights reserved. Authors agree that this article remains permanently open access under
the terms of the Creative Commons Attribution License 4.0 International License

Abstract The objective of this study was to identify development challenges over the decades in most
and examine the determinants of loan repayment in MFIs developing economies. One of the identified key
in Gedeo zone, SNNPRS, Ethiopia. In fact, identifying constraints faced by the poor is lack of access to formal
and examining such determinant factors of loan credit. Microfinance institutions were established to fill
repayment is vital in the achievement of profitability and the gap of scarce finance resources by providing funds to
sustainability of MFIs. Out of total population of 6662 the poor and lower income group to alleviating poverty
(1610 defaulter and 5052 non-defaulter borrowers), 364 and enhance their business activities. Different approaches
representative sample from borrowers are selected by have been employed in alleviating poverty; the one is
using stratified random sampling from borrowers by provision of credit for targeted poor. Credit is considered
dividing the borrowers in to two strata, in terms of loan to be an essential input to increase productivity [38].The
payment status as defaulters and non-defaulters. In this central provision of microfinance is delivery of small
connection, the researcher collected data from primary loans [13].
and secondary sources and analyzed by using binary Microfinance can be a critical element of an effective
logistic model. A total of ten explanatory variables were poverty reduction strategy. Well organized access and
included in this model and out of these, six variables were efficient provision of saving, credit and insurance
found to be statistically significant to influence the facilities in particular can enable the poor to smooth their
probability of loan repayment. These significant variables consumption, manage their risks better, build their assets
are: educational level, method of lending, nearness of gradually, develop their microenterprise, and enhance
borrower’s residence to the institutions, family size, and their income earning capacity. Thus, microfinance helps
income from activities financed by loan and training. The to promote economic growth and development [8].To this
researcher suggests that the identified significant variables end, the current study has tried to identify and examine
to be a spring board for further interventions by determinants of loan repayment in MFIs in Gedeo zone,
Microfinance institutions, stakeholders and policy makers SNNPRS, Ethiopia.
so as to come with a breakthrough to significantly
decrease or even avoid defaulting problems. On the basis 1.1. Statement of the Problem
of the study findings, the researcher also provided some
recommendations that are vital to reduce loan repayment The primary objective of MFIs is to provide financial
problems and improve loan repayment performance of services (credit and saving) to the poor in order to relieve
borrowers in the study area. These includes: proper financial constraints and help alleviate poverty.
training, continuous supervision, enough loan officers or Microfinance institutions offer loans mostly to urban and
committee and technical support for borrowers on rural peoples who cannot afford collaterals to get loans
profitable business activities. from banks. Financial services in Ethiopia are
characterized by a high urban concentration.To fill these
Keywords Microfinance Institution, Loan Repayment, gap microfinance institutions, provide credit to the poor,
Defaulters and Non-defaulters
who lack access of formal credit from financial
institutions.
Although the performance of the MFIs in Ethiopia has
been impressive since their establishment, they are not
1. Introduction free of default problems [55].[28]argued that default
Poverty alleviation has been one of the key problems destroy lending capacity as the flow of

CITE THIS PAPER

[1] Girma Gudde Jote , "Determinants of Loan Repayment: The Case of Microfinance Institutions in Gedeo Zone, SNNPRS,
Ethiopia," Universal Journal of Accounting and Finance, Vol. 6, No. 3, pp. 108 - 122, 2018. DOI: 10.13189/ujaf.2018.060303.
 Universal Journal of Accounting and Finance 6(3): 108-122, 2018 109

repayment declines, transforming lenders into welfare position of the MFI is maintained. When there is a loss in
agencies, instead of a viable financial institution. Loan the MFI liquidity due to high levels of non-repayment, the
default may also deny new applicants access to credit as cyclical flow of funds between the MFI and the borrowers
the microfinance institutions management problems will be interrupted [38].
augment in direct proportion to the increasing default Studies on loan repayment are not a new research area.
problem. One indicator of effective MFIs is the loan In fact, various researches have conducted in loan
performance of the borrowers [49]. High repayment rates repayment performance in different time, but the results of
are associated with the benefits for both MFIs and findings are still debatable among different researchers.
borrowers [24]. If there is high repayment rate, the The findings show there is inconsistency of result
relationship between the MFIsand their clients will be regarding the determinant factor variables. Some variables
good [18]. In contrast, if there is low repayment rate, both such as sex, education level, method of lending and loan
the borrowers and MFIs will be adversely affected. So, if size have debatable results. For instance; Bhatta and Tang
the MFIs are not viable because of default problem, [17] and [51] found sex has significant impact on
borrowers will not have access to loan and suffer from repayment rate, whereas [24] opposes this result.
poverty, which affects the development of the country as Regarding loan size, [59] found as loan size have positive
whole. impact on loan repayment.
According to [54], the most common and often the Whether default is random and influenced by erratic
most serious vulnerability in microfinance institution is behaviors or whether it is influenced by certain factors in
the chance that a microfinance institution (MFI) may not specific situations, therefore, needs an empirical
receive its money back from borrowers (plus interest). investigation so that findings can be used by Microfinance
The sustainability of microfinance institutions depends Institutions to manipulate their credit programs for the
largely on their ability to collect their loans as efficiently better [31]. Hence, this study aims to fill the
and effectively as possible. In other words, to be above-mentioned gaps by identifying and examining
financially viable or sustainable, microfinance institutions determinants of loan repayment in MFIs in Gedeo zone,
must ensure high portfolio quality based on 100% SNNPRS, Ethiopia.
repayment, or at worst low delinquency/default, cost
recovery and efficient lending [4]. 1.2. Objectives of the Study
Nowadays, high percentage of loans that are in arrears
is one of the key issues facing the microfinance industry. The main objective of the study is to identify and
In order for micro finance institutions (MFIs) reach scale examine determinants of loan repayment in Microfinance
and move towards operational and financial sustainability, institutions in Gedeo zone.
arrears rate must be reduced. High delinquency rates in In line with above general objective, the specific
credit programs for the poor were often blamed on poor objectives of the study are:
market infrastructure, deficient business income and 1. To examine the major demographic factors such as
client’s misallocation of loan funds to consumptions educational level, family size, and residence of
activities (Rural Financial Intermediation Program [45]. borrower, that impact loan repayment by the
MFIs must reach at the position of high repayment rate, borrowers of MFIs.
as high loan repayment rate benefits both MFIs and the 2. To investigate the main loan factors like loan size
borrowers. Every microfinance institution tries to and interest rate, that influence loan repayment
maximize its repayment performance. Improving performance of borrowers of MFIs.
repayment rate helps reduce the dependence of the MFIs 3. To examine the key economic factor like income
on subsidies, which would improve sustainability [24]. from activities financed by the loan that affect loan
One indicator of effectiveness of MFIs is the loan repayment performance of borrowers of MFIs.
repayment performance of the borrowers [5].It is also 4. To assess the main institutional factors like
argued that high repayment rate reflects the adequacy of training and method of lending that influence loan
MFIs’ services to clients’ needs and restrict the cross repayment performance of borrowers of MFIs.
subvention of the borrowers [24]. For borrowers, high 5. To investigate whether the cultural factors such as
repayment rate helps to obtain the next higher amount of loan diversion rate, and celebration and
loan [18]. Contrary to this, if there is low repayment rate, participation on social festivals have impact on
both the borrowers and the MFIs will be affected. In this loan repayment performance of borrowers of MFIs.
case, the borrowers will not be able to obtain the next
higher loan and the lenders will also lose their customer. 1.3. Research Hypothesis
In order to maintain sustainability of those MFIs,
examining determinant factors influencing loan repayment H1: Education is significantly associated with loan
is important, because if borrowers do not repay, then there repayment of MFIs.
may not be sufficient funds to ensure that the liquidity H2: Method of lending is significantly associated with
110 Determinants of Loan Repayment: The Case of Microfinance Institutions in Gedeo Zone, SNNPRS, Ethiopia

loan repayment of MFIs’ borrowers. important and significant factors that enhance the loan
H3: Celebration and participation on social festivals is repayment performance. [41] Studied factors that
significantly associated with loan repayment of MFIs’ determine loan repayment decision among farmers in
borrowers. Southwestern Nigeria during 2005. Data from 180
H4: Nearness to borrower’s residence is significantly respondents were collected through multistage sampling
associated with loan repayment of MFIs’ borrowers. technique. Tobit regression result showed education as
H5: Family size is significantly associated with loan important factors in determining loan repayment and
repayment of MFIs’ borrowers. reducing loan default.
H6: There is significant association between income Nearness of borrower’s residence to institutions: [26]
from activities financed by loan and loan repayment of clearly showed that 69.16% of the defaulter respondents’
MFIs’ borrowers. residence and businesses were near Harari Microfinance
H7: There is significant association between training institutions, whereas 30.84% were not near to Harari MFI.
and loan repayment of MFIs’ borrowers. As a result, distance of borrowers from the offices doesn’t
H8: There is significant association between loan affect the loan repayment rate of borrowers. This implies
diversion rate and loan repayment of MFIs’ borrowers. being far and/or near to the Microfinance institutions was
H9: Loan size is significantly associated with loan not related to the loan repayment performance and thereby
repayment of MFIs’ borrowers. to loan default. [1] Also indicated that the distance of
H10: There is significant association between interest borrowers from institutions don’t have significant impact
rate and loan repayment of MFIs’ borrowers. on the loan repayment problem. However, [12] found that
distance of borrowers has significant effect on the loan
default.
2. Review of Related Literature Family size: [41] have analyzed the determinants of
repayment decision among small holder farmers in
2.1. Determinant Factors Affecting Loan Repayment Southwestern State of Nigeria. The result showed that
borrowers with lower number of household members
2.1.1. Demographic Factors would meet their repayment obligation better than those
Education level: [50] assessed the determinants of loan with high number of household members. [7]argued that
repayment performance. The educational level coefficient family size had negative influence on the level of loan
had a positive sign indicating that education has direct repayment. The result of the model showed that family
relationship to the repayment rate and this showed that as size was statistically significant factor influencing timely
level of education increases, borrowers enhances their loan repayment performance positively [2]. However, [15]
ability to access, evaluate, and understand new production argued that family size had insignificant effect on loan
techniques. This underpins the assertion that educated repayment performance of smallholder farmers. [53]found
farmers are more amenable to risk taking and change than that number of dependents supported by borrower was
the non-educated ones. The result of this study showed significant determinant of the probability of loan
that the higher the literacy level of the clients, the higher repayment.
will likely be non-default.
[30] Fount result that showed education was important 2.1.2. Economic Factor
and significant factor that enhances the loan repayment Income from activities financed by the loan: [48]
performance. As per [3], education affects loan repayment found out that income from activities financed by the loan
positively. In addition, [48] found out that education is is important and significant factor that enhances the credit
important and significant factor that enhances the credit repayment performance. [53] found that income from the
repayment performance. [53] also found that educational loan activities financed by institution is significant
status is significant determinants of the probability of loan determinant of the probability of loan
repayment.[34]conducted a study on the factors affecting repayment.[30]analyzed the microfinance repayment
loan repayment performance. They found that education is performance of Oromia Credit and Saving Institution
an important determinant of loan repayment. An educated (OCSI) in Kuyu, Ethiopia. According to his finding
client is able to use modern technologies, perform farming income from activities financed by loan is positively and
activities based on cropping calendar, and manage significantly related to loan repayment performance and
resources properly. All these factors boost production, thereby reduces loan default.
which improves loan repayment.
[1] studied factors that influence micro finance and loan 2.1.3. Cultural Factors
repayment performance with particular reference to the Celebration and participation on social festivals:
Oromia Credit and Savings Share Company (OCSSCO) in According to [15], expenditure for social festivals was
Kuyu, through the application of descriptive statistics and found to have insignificant effect on loan repayment
the probit model. His finding shows that education is performance of smallholder farmers. [14]found that
 Universal Journal of Accounting and Finance 6(3): 108-122, 2018 111

celebrating social festival can negatively influence loan was found to have insignificant effect on loan repayment
repayment performance. performance.
Loan diversion rate: [30] analyzed the microfinance Interest rate: [35] argued that high interest rate caused
repayment performance of Oromia Credit and Saving delay in repayments of agricultural credit.[32]studied the
Institution (OCSI) in Kuyu, Ethiopia. According to his factors influencing on repayment performance of farmers
finding, loan diversion is significant and negatively in Khorasan-Razavi province of Iran during 2008. The
related to loan repayment rate. The negative sign implies logit model was used to explain the probability of loan on
that the use of diverted funds for non-income generating time repayment as a result of any of the identified
purposes. [48] argued that credit diversion was found to independent variables. The signs of the coefficient of
be significantly increase credit default. independent variables and significance of the variables
were used determining largely the impact of each variable
2.1.4. Loan Factors on probability of dependent variable. His study’s result
Loan size: [42] carried a study on determinant of loan shows that loan interest rate implies a negative effect on
repayment performance in Southeast State of Nigeria. repayment performance of recipients. By another way, as
They hypothesized that loan size to have a negative the loan interest rate increases the probability of loan
relationship with repayment rate. In other words, the default increases and thereby, negatively affects loan
higher the loan size given by the institution, the lower was repayment performance of borrowers.
the repayment rate of the clients. Their regression results
strongly disagreed with this hypothesis. It stipulated that 2.1.5. Institutional Factors
the higher the size of the loan to clients, the higher the Method of lending: Many of the MFIs in Ethiopia
repayment rate. This situation appears to be most provide similar financial products and use predominantly
unlikely because the amount to be repaid was relatively the group lending methodology, while individual lending
larger and if the loan was from development oriented is employed to a limited extent [11]. Because group
institution with subsidized interest rate and little chance of lending methodology addresses the asymmetric
repeat loans, the pressure or inclination of such clients distribution of information by transferring the burden of
would be to delay repayment. default risk to the contracting borrowers, thus transfers the
[37] described micro finance credit lending terms and costly screening to be done by the borrowers themselves.
repayment performance and stated the loan sizes in most Screening borrower’s risk is critical since, it affects loan
cases affect the nature of business and type of investment repayment and lenders profit thereby. Group lending
for the borrowers. The small loan size is often advanced schemes induce borrowers to engage in assortative
by the micro finance institutions as a way of minimizing matching wherein local knowledge about each other’s
risks. However, when the clients are not given adequate assets, capabilities, character traits are used to sort and
funds to cater for their business needs, they tend to self-select [43].
resort to multiple borrowing. This in turn affects their [20] theoretically shows that without sequential
repayment and increases the risks of the loan. The financing, group lending may suffer from
respondents were divided as to whether Brac Uganda is under-monitoring with borrowers investing in risky
giving them enough credit to cater for their business needs projects. The most important factor inciting lending
with some indicating that it was enough while others groups to repay is the relative value they attach to access
indicated that it was not. to future credit [21].[33] find that MFI tends to choose
[32]found that received loan size has positive effect on group lending when its main market is rural, when it
repayment performance of recipients. The study result of prefers female borrowers, and when the average loan
[40] showed that amount of loan obtained by farmers was amount is small. The studies show that group-based
the major factors that positively and significantly lending approach cannot ensure high repayment rate in
influenced loan repayment. [7] obtained that the amount MFIs.
of loan granted to farmers have major significant positive In the view of [46], group lending will also minimize
influence loan repayment. Among the determinants of loan default. Many microfinance institutions borrow in
loan repayment of microfinance institutions, loan size had groups and choose to lend to groups of borrowers rather
positive impact on loan repayment [42]. than on an individual basis. As opposed to this, the
According to [30] loan size was found to be microfinance institutions provide the loans so that the
significantly increase loan default. [48] suggested that borrowers are not limited to the money that they
credit/loan size was found to negatively influence the themselves can contribute. The general organization of
borrowers’ loan repayment performance. [53] found that group lending consists of a group of borrowers who work
loan size was significant determinant of the probability of together, support, and mentor one another to maximize the
loan repayment. But, [15] studied the determinants of loan impact that the loan can have on each individual.
repayment performance of smallholder farmers in North Additionally, in many group lending situations, the
Gondar, Ethiopia. His finding revealed that loan amount members of the group are responsible for selecting new
112 Determinants of Loan Repayment: The Case of Microfinance Institutions in Gedeo Zone, SNNPRS, Ethiopia

members and for the timely repayment by other members, defaults, when at least some members would have repaid
known as joint liability. As a result, group lending tends had they not been saddled with the weight of liability for
to lead to superior performance by the borrowers in their partners’ loans [16]
operating their businesses and better rates of loan Training: the finding of [52] stated that one of the
repayment. important requirements for the success of microfinance
Several studies have been performed on the group institutions is to create awareness to potential clients by
lending aspect of microfinance, and most research shows giving appropriate training to borrowers about loan
it to be an effective method. [56]builds on the theory that utilization, loan terms and obligations. In addition, [6]
group lending leads to improved performance by the agreed on the loan utilization and technical training should
borrowers. He explains that in additional to the support be given to improve the skill of potential and actual clients.
and guidance from the group, there is also a strong Technical support is important to increase the productivity
incentive for each individual to operate effectively due to of borrowers.
one’s personal reputation within the group. Furthermore, Training is one the important requirements for the
since groups generally are formed of members from the success of Microfinance institutions [12]. If lender
same village or community, repaying loans on time and in provides various training, the clients will able to
full affects borrowers standing within the community at understand the rules and regulations easily. They also
large, not limited to the lending group. However, while develop the skill how to do business and money utilization.
this social effect can produce positive outcomes for the Training is needed not only for clients, but also for loan
microfinance institutions, some researchers believe that it officers. In both cases, it has positive contribution to the
can lead to an unhealthy social environment. repayment rate. [39] also agrees on the importance of
The general consensus in the literature on group lending training due to decreasing default rate. Among the
and group liability is that group lending benefits both the determinants of loan repayment of microfinance
borrowers and the institutions. The borrowers receive the institutions, training duration had positive impact on loan
additional support and assistance from a group of repayment [42].But, [55] study reveals that there is
individuals dealing with the same types of issues. statistically insignificant association between training and
Furthermore, the institutions are able to lower costs by loan repayment performance because the training may not
relying on the lending groups to provide these services be continuous, relevant, timely and not catering the
that otherwise would be required from the institution itself. borrowers’ requirement.
Group lending also works to move institutions into a more
client-led realm, which has proven to be more effective in 2.2 Conceptual Framework of Determinants of Loan
creating sustainable development programs. Repayment
In microfinance institutions credits are provided in
group. The main characteristic of group lending is joint According to [36] conceptual framework involves
liability. This means that all group members are treated as forming ideas about relationships between variables in the
being in default if any one member of the group does not study and showing these relationships diagrammatically.
repay the loan. In group liability, there are both positive This study adopted the conceptual framework as shown in
and negative effects. The positive effect is that the figure 1 which demonstrates the conceptual framework of
successful borrowers may repay the loan of partners who the relationship between the dependent variable (loan
obtain sufficiently poor returns to make repayment repayment) and the independent variables (the determinant
profitability. The negative effect arises if the entire group factors affecting loan repayment performance of
Microfinance institution’s loan beneficiaries).

Source: Researcher’s construct (2017)

Figure 1. Conceptual Framework of the study
 Universal Journal of Accounting and Finance 6(3): 108-122, 2018 113

3. Research Methodology 3.4. Sampling Techniques and Sample Size

Determination
3.1 Research Approach The researcher employed stratified sampling in selecting
the representative’s borrowers following the method of
Research design is about the specific research strategy proportional allocation under which the sizes of the
that the researcher adopts to solve the research problem samples from different strata are relatively kept
[19]. There are two types of research designs. These proportional to the sizes of the strata. The sample for this
include the qualitative and the quantitative designs [23]. In study consists of defaulter and non-defaulter loan
view of their numerous benefits in achieving the stated beneficiaries responding to the questionnaires.
research objectives and in testing research hypothesis As per loan list survey, out of total 6662 borrowers, 1610
properly, the researcher has used both qualitative and borrowers are defaulter and 5052are non-defaulter
quantitative research designs in this study. borrowers. To develop the sampling size, lists of borrowers
were acquired from the entire four microfinance borrowers
3.2. Data Source and Type profile list. Representative sample are selected from the
total borrowers by using stratified sampling technique
One of the outstanding features of research is the dividing the borrowers (population) in to two strata, in
decision around who to collect the research data, from and terms of loan payment status as defaulters and
in what ways the research data should be gathered. This non-defaulters.
study was conducted based on both primary and secondary [57] sample size determination formula was adopted to
data. The primary data were collected by structured decide sample size of borrowers for this study. The number
questionnaires and face to face interviews. of borrowers was 1610 defaulters and 5052 non-defaulters,
The researcher used a questionnaire as the main tool for totally the target study size comprised of 6662 loan
gathering data for analysis. The questionnaires of this study beneficiaries. To select representative sample from this
included both closed and open-ended questions. The population, first, the initial sample size was determined by
questionnaires were prepared in English language and using the following scientific formula:
translated into Amharic to facilitate proper responses from
respondents. The questionnaires were pre-tested by pilot
study before conducting survey for the whole sample. In
Where z = value for selected alpha level of 0.025 in each
addition, qualitative data have been collected through
tail (for 95% degree of confidence) =1.96, (p). (q) =
semi-structured interview. Direct communication with the
estimate of variance = 0.25, e = the desired level of
managers of MFIs in the study area form part of the
precision (i.e., the margin of error), p is the estimated
personal interviewing process; the interviewer poses
proportion of the population which has the attribute in
questions to the managers in a face-to-face interviewing
question, q=1-p.
process.
Secondary sources include published and unpublished
materials about microfinance institution’s activities.
Secondary data forms part of the scientific data that have = 385
been gathered in the past. In this study, through an
Since the initial sample size (385) is greater than 5% of
extensive literature study, the researcher was able to gather
the total population (5% * 6662=333), Cochran’s (1977)
secondary data sets to be analyzed. As a result, relevant
correction formula have been used to calculate the final
global and national literatures on the research topic were
sample size. This calculation was done as follows:
reviewed for two reasons, to enhance the quality of
questions to be included in the questionnaires and to gather
highly credible primary data for analysis.

3.3. Target Population of the Study = 364

The population for this study is borrowers of OmoMFI Where, ‘N’ is the total population (6662) and ‘n’ is
Dilla branch, Letta MFI Dilla branch, Vision Fund MFI sample size of the study. The researcher has selected 364
Dilla branch and Vision Fund MFI Yirgacefe branch. The from borrowers as per stratified sampling. This sample size
number of borrowers’ data was collected from borrower can be used as representative of the microfinance
profile of the institutions. During data collection period, institutions’ beneficiaries, because of borrowers under
borrowers have been classified as defaulter and similar strata have homogenous characteristics and have
non-defaulter. Currently, the institutions have 6662 common environment in which they exposed for similar
borrowers. Hence, the total population of the study is 6662 problems.
borrowers.
114 Determinants of Loan Repayment: The Case of Microfinance Institutions in Gedeo Zone, SNNPRS, Ethiopia

These samples from borrowers (364) were selected from each Stratum using relative proportionate allocation in
relation to the percentage of total population. Hence, from the above two strata (defaulters and non-defaulters’ borrowers),
proportionate sample size was taken. The reason for using proportionate sample is to give equal chance for all
respondents.
To determine sample size from each stratum, the following sample size determination formula has been used:

Where: nh= sample size from each stratum, Nh= Total population in each stratum, Ns=Total population of the sum of
strata for study and n= Total sample size from the study population [29]. Based on this formula, sample size from each
stratum is provided in the table below.

Table 1. Proportionate sample size from each stratum

No. of borrowers in terms Total no.

of loan repayment status Of Proportionate sample size
Name of MFI Defaulters Non- defaulters borrowers Defaulters Non-defaulter Total
Omo MFI Dilla branch 200 1345 1545 11 73 84
Letta MFI Dilla branch 155 1312 1467 9 72 81
Vision Fund MFI Dilla
branch 450 1200 1650 24 66 90
Vision Fund MFI
Yirgacefe branch 805 1195 2000 44 65 109
Total 1610 5052 6662 88 276 364
Source: Author’s computation, 2017

3.5. Econometric Model Specification simplicity of calculation and that its probability lies
Loan repayment is a dependent variable, while different between 0 and 1. Moreover, its probability approaches
demographic, institutional, loan, economic and cultural zero at a slower rate as the value of explanatory variable
factors are considered as independent variables. In this gets smaller and smaller, and the probability approaches 1
study, the dependent variable assumes values 0 and 1, at a slower and slower rate as the value of the explanatory
which is 0 if the borrower is a defaulter and 1 if the variable gets larger and larger [25].
borrower is non-defaulter. Therefore, loan repayment is [27] pointed out that the logistic distribution (logit) has
treated as dichotomous dependent variable and a got advantage over the others in the analysis of
non-continuous dependent variable that does not satisfy dichotomous outcome variable in that it is extremely
the key assumptions in the linear regression analysis. flexible and easily used model from mathematical point of
There are several methods to analyze the data involving view and results in a meaningful interpretation. In
binary outcomes. However, for this particular study, logit statistics, logistic regression, or logit regression, or logit
model was selected over discriminant and linear model is a regression model where the dependent variable
probability models. The linear probability model (LPM) is categorical/binary dependent variable (most commonly
which is expressed as a linear function of the explanatory called dummy variables) - that is, where it can take only
variables is computationally simple. However, despite its two values, "0" and "1", which represent outcomes
computational simplicity, as recommended by [9] and [25], defaulter and non-defaulter.
it has a serious defect in that the estimated probability Logistic regression was developed by statistician David
values can lie outside the normal 0-1 range. Hence logit Cox in 1958. The binary logistic model is used to estimate
model is advantageous over LPM in that the probabilities the probability of a binary response based on one or more
are bound between 0 and 1. predictor (or independent) variables (features). It allows
Moreover, logit best fits the non-linear relationship one to say that the presence of a risk factor increases the
between the dependent and the explanatory variables. In probability of a given outcome by a specific percentage.
the analysis of studies involving qualitative choices, Since the dependent variable of the study (loan payment)
usually a choice has to be made between logit and probit have binary/dichotomous outcomes (defaulter and
models. According to [9], the statistical similarities non-defaulter), the binomial logistic regression model was
between logit and probit models make the choice between selected for this study to find the determinant factors
them difficult. The justification for using logit is its affecting loan repayment.
 Universal Journal of Accounting and Finance 6(3): 108-122, 2018 115

The binomial logistic model is one of the sophisticated binary response model that overcomes the limitations of the
LPM. In a binary response model, interest lies primarily in the response probability:

. (1)

Where, p(y = 1 x) is the probability that y=1(non-defaulting) given x(independent variable), y represents loan
repayment and x denote the full set of explanatory variables such as education level, method of lending, nearness of
borrower’s residence to the institutions, family size, loan size, loan diversion rate, income from activities financed by
loan, interest rate, celebrating and participating on social festivals, and training that affect loan repayment.
To avoid the LPM limitations, let us consider a class of binary response models of the form:
… (2)

Where, G is a function taking on values strictly between zero and one: 0<G(z)<1, for all real numbers z. This ensures
that the estimated response probabilities are strictly between zero and one. We write xβ = β1 x1 + … + βk xk. Logistic
function is a nonlinear function that is used for the function G in order to make sure that the probabilities are between
zero and one. In the logit model, G is the logistic function which is between zero and one for all real numbers z. This is
the cumulative distribution function for a standard logistic random variable:

… (3)

Where, Z = Xβ =β1 x1 + … + βk xk
The goal logistic regression is to find the best fitting (yet biologically reasonable) model to describe the relationship
between the dichotomous characteristic of interest (dependent variable=response or outcome variable) and a set of
independent (predictor or explanatory) variables. Logistic regression generates the coefficients (and its standard errors
and significance levels) of a formula to predict a logit transformation of the probability of presence of the characteristic
of interest:

Logit(P) can be back transformed to p by the following formula:

 When one categorical variable and one independent variable is included:

 When one categorical variable and several independent variables is included in the study:

Where, P(Y) is probability of Y occurring, e is natural logarithm base (e ≈ 2.71828...), b0 is interception at y-axis, bn
is regression slope coefficient of Xn, and Xnis predictor or independent variable that predicts the probability of Y.

(4)

Since one categorical/dummy/binary dependent variable and eleven independent variables are included in this study,
the binomial logistic regression model of this study becomes:
P(Y) denotes the probability of loan repayment (being non-defaulter). Logit model limits probabilities for values of
dependent variable between 0 and 1. Xi denotes the independent variables that influence loan repayment performance of
borrowers. β0 and βi, known as the parameters of the model, are, respectively, the intercept and slope coefficients.

3.6. Description of variables and their scale of measurement

From the theoretical and empirical literature, traditional observable characteristics that may influence the probability of
being defaulter or non-defaulter (loan repayment performance) were summarized with their respective unit of
116 Determinants of Loan Repayment: The Case of Microfinance Institutions in Gedeo Zone, SNNPRS, Ethiopia

measurement in table 2 below.

Table 2. Variables and their description
Variables Symbol Unit of measurement Expected sign/Hypotheses
Dependent variable
Loan repayment LP Nominal
Explanatory variables
Education Level EDL Ordinal + (high education level, high loan repayment performance)
+ (More individual lending scheme, better loan payment
Method of Lending MOL Nominal
performance )
Nearness of Borrower’s + (less distance from the institutions, high the probability of
NBRI Nominal
Residence to Institution loan repayment performance)
-(high family size , high probability of loan repayment
Family Size FSZ Continuous
performance)
+ (High loan amount, high the probability of loan repayment
Loan Size LSZ continuous
performance)
+ (Loan is used for intended purpose, High loan repayment
Loan Diversion Rate LDR nominal
performance)
Income from activities financed + (high income from activities financed by loan, high loan
INCOM Continuous
by loan repayment performance)
(High interest rate, low probability of loan repayment
Interest rate INTRT Continuous
performance)
Celebrating and participating on -(high expenditure on social festivals, low probability of loan
SOCFEST Nominal
social festivals repayment performance)
Training PLT Nominal + (Loan training, high loan repayment performance)
Source: own construct [2017]

3.7. Methods of data Analysis  Not deceiving the subjects [participants have
informed clearly about the aim, purpose and
Data analysis has been done after all the relevant data procedures of the study and was not deceived in
have been gathered from the respondents. The collected any way].
data were edited, coded and entered into a computer and
processed by SPSS Version 21.0 statistical software. The
empirical analysis of the study has been conducted using 4. Results and Discussion
binary logistic regression model, which deals with loan
repayment performance in total of 11 explanatory A total of 364 questionnaires, three hundred fifty (350)
variables included in this study. have been appropriately filled and returned. This implies
that the response rate for this study was seventy nine point
forty three percent (96.15%), which implies that highest
3.8. Ethical Consideration proportion of respondents were participated in the process
The following ethical considerations have given of data collection. This study employed binary logistic
attention by the researcher and enumerators while regression for data analysis.
conducting the research or collecting the data:
 Privacy of participants [the privacy of the 4.1. Regression result of Binary Logistic regression
participants have been respected]. model
 Voluntary participation [no participants was Here, econometric analysis was undertaken in order to
forced to take part in the research and participants identify determinants of loan repayment performance of
were free to withdraw from the research at any Microfinance institutions in Gedeo zone. As previously
moment]. explained, binomial logistic regression was employed to
 No harm to participants [the researchers ensured estimate the effects of hypothesized explanatory variables
that there is no any physical or psychological harm on the loan repayment performance of beneficiaries in the
done to the participants as a result of the study]. MFIs in Gedeo zone.
 Anonymity and confidentiality [all information The model was used to satisfy the specific objectives of
gathered during the study has been handled the study i.e., to identify and examine demographic
confidentially and permission from the participants factors, cultural factors, loan factors, institutional factors
was obtained for all information to be shared and economic factors that determine the loan repayment
publicly]. performance of borrowers in the study area.
Table 3. Regression result: dependent variable
95% C.I. for EXP(B)
Independent Variables B S.E. Wald df Sig. Exp(B)
Lower Upper
 Universal Journal of Accounting and Finance 6(3): 108-122, 2018 117

EDL .208** .122 2.903 1 .088 1.231 .969 1.563

MOL -.675** .388 3.033 1 .082 .509 .238 1.088
NBRI .894* .376 5.646 1 .017 2.445 1.170 5.113
FSZ -.384** .211 3.313 1 .069 .681 .450 1.030
LSZ .452 .370 1.497 1 .221 1.572 .762 3.245
LDR .325 .423 .592 1 .442 1.384 .604 3.172
INCOM .637* .260 6.006 1 .014 1.892 1.136 3.150
INTRT -.191 .213 .805 1 .370 .826 .544 1.254
SOCFEST .306 .353 .752 1 .386 1.358 .680 2.710
PLT .909** .547 2.759 1 .097 2.482 .849 7.253
Constant -2.579 2.421 1.135 1 .287 .076
Number of observation: 350 B=regression coefficient Exp(B) = odds ratio
Sig. = significance S.E. = Standard error, -2 Loglikelihood = 222.028
Cox & Snell R Square = .187, Nagelkerke R Square = .253
* and ** indicate that the coefficients are statistically significant at 5% and 10% level respectively
Source: binomial logistic regression model output, 2017

 Wald statistic: Alternatively, when assessing the predictor. Given that the logit is not intuitive,
contribution of individual predictors or focus is given for a predictor's effect on the
independent variables in a binomial logistic exponential function of the regression coefficient
regression model, one may examine the – the odds ratio.
significance of the Wald statistic. The Wald  S.E.: This is the standard error around the
statistic, analogous/comparable to the t-test in coefficient for the constant.
linear regression, is used to assess the significance  Sig.: This is the chi-square test that determine
of coefficients i.e., tests the effect of individual whether the association between independent
predictor while controlling other predictors. If the variable and depend variable is statistically
Wald statistic is located outside the lower and significant by comparing the p-value (sometimes
upper limit of a given confidence interval (99 called the prob-value) of independent variable
percent or 95 percent or 90 percent), null with the chosen significance level. The association
hypothesis is rejected and the independent variable is statistically significant and null hypothesis is
is significant. The reverse is true when Wald rejected when the p-value (value listed in the
statistic is located within the interval. In this column called “Sig.”) is smaller than or equals to
model, Wald statistic test is used to assess the the specified significant level like .05 or .01 or 0.1.
significance of an individual predictor. Whereas, when p-value listed in the sig. column is
greater than the specified significance level, the
The Wald statistic is the ratio of the square of the association between the independent variable and
regression coefficient to the square of the standard error of dependent variable is statistically insignificant.
the coefficient and is asymptotically distributed as a  Exp(B): This is the exponentiation of the B
chi-square distribution. Although several statistical coefficient, which is an odds ratio. This odds ratio
packages (e.g., SPSS) report the Wald statistic to assess is easier to interpret than the coefficient. It is used
the contribution of individual predictors, the Wald statistic to interpret the relation between the independent
has limitations. When the regression coefficient is large, variables and the probability that the dependent
the standard error of the regression coefficient also tends variable will be 1. The odds in favor of an event
to be large increasing the probability of Type-II error. The occurring is defined as the probability the event
Wald statistic also tends to be biased when data are will occur divided by the probability the event will
sparse. not occur. The odds ratio measures the impact on
 B: This is the coefficient for the constant (also the odds of a one-unit increase in only one of the
called the “intercept”) and the independent independent variables as indicated by the
variables of the model. In binomial logistic following formula
regression, the regression coefficients represent
the change in the logit for each unit change in the

4.2. Elaboration on Significant Explanatory Variables

Table 4. Hypotheses and results of significant dependent variables
118 Determinants of Loan Repayment: The Case of Microfinance Institutions in Gedeo Zone, SNNPRS, Ethiopia

Dependent Variables Symbol Expected sign/Hypotheses Result from binomial logistic regression model
+ (high education level, high loan
β of .208; positive association between education
Education Level EDL repayment performance)
level and loan repayment of MFIs’ borrowers
+ (More individual lending scheme, β of -.675; negative association between
Method of Lending MOL better loan payment performance ) individual oriented method of lending and loan
repayment of borrowers in MFIs
+ (less distance from the institutions,
β of .894; positive association between nearness
Nearness of Borrower’s high the probability of loan repayment
NBRI of borrower’s residence to institution and loan
Residence to Institution performance)
repayment of MFIs’ borrowers
- (high family size , high probability
FSZ β of -.384; negative association between family
Family Size of loan repayment performance)
size and loan repayment of MFIs’ borrowers
+ (high income from activities β of .637; positive association between income
Income from activities INCOM
financed by loan, high loan repayment from activities financed by the loan and loan
financed by loan
performance) repayment of MFIs’ borrowers
+ (Loan training, high loan repayment Β of .909; positive association between training
Training PLT
performance) and loan repayment of MFIs’ borrowers
Source: own construct [2017]

4.2.1. Demographic Factors 2) Nearness of borrower’s residence to institution

1) Educational level (EDL): It was hypothesized that (DIS): It was hypothesized that there is significant
education is associated with loan repayment of MFIs. The association between nearness of borrower’s residence to
result from binomial logistic regression model in the institution and loan repayment of MFIs. The result from
above table 3 and table 4 indicate positive sign for binomial logistic regression model in the above table 3
education level variable (β of .208), which implies and table 4indicate positive sign for nearness of
positive association between education level and loan borrower’s residence to institution variable (β of .894),
repayment MFIs. This shows that as level of education which implies positive association between nearness of
increases, borrowers enhance their ability to access, borrower’s residence to institution and loan repayment
evaluate, and understand new production techniques and MFIs. This shows that as borrower’s nearness to
technologies. Since the Sig. statistic or p-value in some institution increases (become closer to the institution), the
other statistical application (.088) is smaller than the possibility of borrowers to repay their loan increases.
chosen significance level (0.10 or 10 percent), the positive Being closer with a lender’s office will give an extra
association between education level and loan repayment is advantage to the lender and borrowers. This is because it
statistically significant i.e., the level of education is easy for the lender to monitor borrower’s business and
contributes to the variance in probability of borrower’s for borrowers to repay their loan.
loan repayment performance. Since the Sig. statistic or p-value in some other
By another way, as Wald statistic of education level statistical application (.017) is smaller than the chosen
(2.903) is outside of 95 percent confidence interval (.969 significance level (0.05 or 5 percent), the positive
– 1.563), the developed research hypothesis that there is association between nearness of borrower’s residence to
significant association between education level and loan institution and loan repayment is statistically significant
repayment is accepted. Hence, there is significant i.e., the nearness of borrower’s residence to institution
association between education level and loan repayment contributes to the variance or loan repayment performance
of MFIs. The result from binomial logistic model can be of borrowers. By another way, as Wald statistic of
interpreted as, other variables being constant, increase in nearness of borrower’s residence to institution (5.646) is
education level could lead loan repayment rate to be outside of 95 percent confidence interval (1.170 – 5.113),
improved by 1.231. By other way, increase in one year the developed research hypothesis that there is significant
schooling increases the odds ratio in favor of association between nearness of borrower’s residence to
non-defaulting by a factor of 1.231, ceteris paribus. institution and loan repayment is accepted. Hence, there is
This implies that education plays great role in raising significant association between nearness of borrower’s
the level of awareness, exposure to technologies, access to residence to institution and loan repayment of borrowers’
business information and to manage resources properly in MFIs.
which boost production and then improves loan The result from binomial logistic model can be
repayment. Education level of the borrowers is one of the interpreted as, other variables remain constant, increase in
variables that were thought to affect loan repayment nearness of borrower’s residence to institution increases
performance of the borrowers by different authors. This the borrowers’ loan repayment probability by 2.445. By
result is consistent with the findings of [3], [30], [48], [53], other way, increase in nearness of borrower’s residence to
[34], but inconsistent with that of [44]. Microfinance institution increases the odds ratio in favor
 Universal Journal of Accounting and Finance 6(3): 108-122, 2018 119

of loan repayment (being non-defaulter) by a factor of (INCOM): The researcher hypothesized that income from
2.445, ceteris paribus. Nearness of the borrower’s activities financed by the loan is associated with loan
residence to Microfinance institution is one of the repayment of MFIs. The coefficient from binomial logistic
variables that thought to affect loan repayment regression model in the above table 3 and table 4 indicate
performance of the borrowers by different authors. This positive sign for this variable (β of .637), which implies
result is consistent with the findings of [12], who found positive association between income from activities
that distance of borrowers has significant effect on the financed by the loan and loan repayment MFIs. This
loan default. But, it is against the findings of [26], [1] and shows that as the income from activities financed by the
[22], who indicated that the distance of borrowers from loan increases, borrowers enhance their ability to repay
institutions doesn’t have significant impact on the loan their loan on time.
repayment problem. Since the Sig. statistic or p-value in some other
3) Family size (FSZ): It was hypothesized that there is statistical application (.014) is smaller than the chosen
significant association between family size and loan significance level (0.05 or 5 percent), the positive
repayment of MFIs. The result from binomial logistic association between income from activities financed by
regression model in the above table 3 and table 4 indicate the loan and loan repayment is statistically significant i.e.,
negative sign for family size variable (β of -.384), that the change in the level of income from activities financed
shows negative association between family size and loan by the loan contributes to the change in probability of
repayment of MFIs. This shows that as borrower’s family borrower’s loan repayment performance. On the other
size increases, the probability of borrowers to repay their hand, as Wald statistic regarding income from activities
loan decreases. Having higher number of household financed by the loan (6.006) is outside of 95 percent
members will increase consumption expenses and other confidence interval (1.136 -3.150), the developed research
living expenses which led loan repayment difficult. hypothesis that there is no significant association between
Since the Sig. statistic or p-value (.069) is smaller than income from activities financed by the loan and loan
the chosen significance level (0.10 or 10 percent), the repayment is accepted. Hence, income from activities
negative association between family size and loan financed by the loan and loan repayment of MFIs’
repayment is statistically significant i.e., having lower or borrowers has significant association.
higher number of household members or family size The result from binomial logistic model can be
contributes to the change (increase or decrease) in interpreted as, other factors being constant, increase in
probability of loan repayment performance of borrowers. income from activities financed by the loan could lead
By another way, as Wald statistic of family size (3.313) is loan repayment rate to be improved by 1.892. By other
outside of confidence interval (.450 – 1.030), the way, increase in income from activities financed by the
developed research hypothesis that there is significant loan increases the odds ratio in favor of non-defaulting by
association between family size and loan repayment is a factor of 1.892, ceteris paribus. This result agrees with
accepted. Hence, there is significant association between findings of [48], [53] and [30], who found out that income
family size and loan repayment of borrowers in MFIs. from activities financed by the loan is important and
The result from binomial logistic model can be significant factor that enhances the credit repayment
interpreted as, other factors being equal, increase in family performance.
size lower the probability of borrowers’ loan repayment
by .681. By other way, increase in family size increases 4.2.3. Institutional Factors
the odds ratio in favor of loan defaulting by a factor 1) Method of lending (MOL): It was hypothesized
of .681, ceteris paribus. This result is consistent with the that there is significant association between method of
findings of [41] who have analyzed the determinants of lending and loan repayment of MFIs. But, the result from
repayment decision among small holder farmers in binomial logistic regression model in the above table 3
Southwestern State of Nigeria and obtained the result and table 4 indicate negative sign of coefficient for this
those borrowers with lower number of household variable (β of -.675), that shows negative association
members would meet their repayment obligation better between method of lending and loan repayment of
than those with high number of household members. borrowers in MFIs. This shows that as borrowers obtain
In addition, the result of this study conforms to findings loan individually, the probability to repay their loan
of [7] and [53] who argued that family size had negative decreases. If borrower obtained loan as per individual
influence on the level of loan repayment. However, the lending scheme, he or she will not obtain the support and
result of the model is inconsistent with the finding of [15], guidance from the others and incentive to operate
who argued that family size had insignificant effect on effectively as loan was taken individually. This negatively
loan repayment performance of smallholder farmers. influences the probability borrower’s loan repayment
performance.
4.2.2. Economic Factor As the Sig. statistic or p-value (.082) is smaller than the
1) Income from activities financed by the loan chosen significance level (0.10 or 10 percent), the
120 Determinants of Loan Repayment: The Case of Microfinance Institutions in Gedeo Zone, SNNPRS, Ethiopia

negative association between method of lending and loan diversion rate, interest rate and celebrating and
repayment is statistically significant i.e., obtaining loan as participating on social festivals were not significant
per individual lending scheme or group lending scheme determinants of loan repayment performance of borrower’s
contributes to the change (increase or decrease) in Microfinance institutions. Hence, except H3, H8, H9 and
probability of loan repayment performance of borrowers. H10, all research hypotheses are accepted.
By another way, as Wald statistic of method of lending
(3.033) is outside of confidence interval (.238– 1.088), the
developed research hypothesis that there is significant 6. Scope for Further Research
association between method of lending and loan
repayment is accepted. Hence, there is significant This study encourages further and comprehensive
association between method of lending and loan research into the interconnection between various
repayment of borrowers in MFIs. demographic, economic, institutional factors, cultural, loan
The result from binomial logistic model done by SPSS and other relevant factors, and loan repayment
version 21 can be interpreted as, other variables remain performance of borrowers in general. Also, there may be a
fixed, and obtaining loan as per individual lending scheme need to test if there is some sort of association between loan
lowers the probability of borrowers’ loan repayment repayment and purpose of borrowing. Additionally, this
by .509. On the other hand, the odds ratio in favor of loan study has focused on certain variables related to
defaulting increases by factor of .509, for borrowers who determinants of loan repayment performance of borrowers.
obtained loan individually, ceteris paribus. This finding is However, loan repayment performance on behalf of
similar with most empirical findings such as [56], [46] Microfinance institution was not extensively investigated.
and [43]. Thus, further researches can be conduct on this issue to
2) Training (PLT): The researcher hypothesized that breach the gap in this area. To provide basic information on
there is significant association between training and loan the determinants of Microfinance institution beneficiaries’
repayment performance of borrowers in MFIs, and it is loan repayment problem, the social, political and
found to influence positively and significantly the environmental dimensions and specific characteristics that
borrower’s loan repayment performance at 10 percent make rural borrowers of Microfinance institutions
significance level. If other variables hold constant, the susceptible to loan default and their managing mechanisms
delivering of well-organized and sufficient training demand future researchers’ attention. The study exploits
properly for borrowers increases the probability of one time survey and no one be able to address the
borrower’s loan repayment by 2.48. By other way, other determinant factors of beneficiaries of MFI loan repayment
variables kept constant, the odds ratio favoring loan problem in the area. Additional survey becomes crucial to
repayment performance increases by a factor of 2.482 for make sure this finding is Consistent. Further study needs to
borrowers who were trained. incorporate beneficiaries from different MFIs found in
If lender provides various training, the clients will able different zones, regions and countries.
to understand the rules and regulations easily. They can
also develop skill on how to do business and money
utilization. Training is needed not only for client but also
for loan officers. In both cases, it has a positive Acknowledgements
contribution to the repayment rate. The model results First, my innumerable praise goes to the Almighty God
show that this variable has a positive (as the coefficient of for giving me the opportunity, capacity and guidance
training i.e., β of .909 have positive sign) impact on the throughout my life. I am very honorable to appreciate the
loan repayment. This result agrees with the findings of sponsor of this study, Dilla University, which is one the
[39], [12], [42],[52] and [6]. But, it disagrees with the first generation universities in Ethiopia that strive to
result of [55] study, who reveals that there is statistically
produce knowledgeable graduates, to serve the community
insignificant association between training and loan
and to support problem solving researches thoroughly. My
repayment performance.
heart full thanks also goes to officers and borrowers of
MFIs in Gedeo Zone for providing evidence and reliable
data that is valuable for success of this study. It is also a
5. Conclusions great chance to express my deepest gratitude and thanks to
According to the outputs of binomial logistic regression my beloved mother, ALMAZ GUDETA for her support
model done by the SPSS version 21 [see table 3 and table and help in fulfilling the necessary financial and all other
4], education level, nearness of borrower’s residence to needs in my life.
institution, income from activities financed by the loan
and training are positively related with loan repayment,
whereas method of lending and family size have negative
association with loan repayment. This study similarly
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