International Journal of Science and Research (IJSR) ISSN (Online): 2319-7064 Index Copernicus Value (2015): 78.96 | Impact Factor (2015): 6.391 Volume 6 Issue 4, April 2017 www.ijsr.net Licensed Under Creative Commons Attribution CC BY The Effect of Loan Appraisal Process Management on Credit Performance in Microfinance Institutions (MFIs): A Case of MFIs in Uganda Ronald Aliija 1 , Bernard Wakabi Muhangi 2 1 Mountains of the Moon University, Administrative Department of Finance, Fort Portal, Uganda 2 Mountains of the Moon University, School of Business and Management Studies, Fort Portal, Uganda Abstract: The study was carried out with the purpose of understanding the effectiveness of loan appraisal process management on the credit performance of MFIs in Uganda taking MFIs in Fort portal municipality in Western Uganda as a case study. The study objectives included; (i) analyzing the loan appraisal process by Microfinance institutions, (ii) examining the challenges faced by Credit officers at the appraisal stage of the Loan process and (iii) assessing the relationship between the loan appraisal process management and credit performance in Microfinance institutions in Fort Portal, Uganda. The researcher employed both qualitative and quantitative research approaches which involved the use of questionnaires to collect data from 44 loan officers and Credit Managers. The study revealed that MFIs use client appraisal in Credit management to a great extent. Further, it established that client appraisal is a viable strategy for mitigating credit risk. The study also established that there was a strong relationship between credit performance of MFIs and client appraisal. The researcher recommended that there is need for MFIs to enhance their client appraisal techniques so as to improve their credit performance. Keywords: Loan appraisal, credit performance, microfinance institutions 1. Introduction The field of Microfinance has received a lot of attention since Muhammed Yunus received a Nobel Prize in 2006 after founding the Grameen Bank in 1976. Grameen Bank dispersed and recovered loans in Bangladesh. By 1990‟s lenders had learned how to increase loan repayment rates to make microfinance sustainable. Women were targeted as borrowers and they gave them money to invest in businesses that would create wealth for themselves [1] and thus improving their living standards. The concept of credit can be traced back in history but it was not appreciated until after the Second World War when it was largely appreciated in Europe and later to Africa [2]. Banks in USA gave credit to customers with high interest rates which sometimes discouraged borrowers hence the concept of credit didn‟t become popular until the economic boom in USA in 1885 when the banks had excess liquidity and wanted to lend the excess cash [3]. In Africa the concept of credit was largely appreciated in the 50‟s when most banks started opening the credit sections and departments to give loans to white settlers. Microfinance refers to that part of the financial sector that responds to the financial demand of low- income households. Author in [4] suggests that Microfinance refers to financial services provided to low-income earners usually people who cannot get access to formal commercial banks. Microfinance institutions provide small and short-term loans predominantly for trading, services and micro- enterprise activities [5]. In Uganda, many Microfinance Institutions provide financial services at a community level and have changed the lives of many small scale entrepreneurs. They provide their members with financial and social intermediation services to help improve their businesses. It has expanded to scores of other developing countries since its beginning in Bangladesh and even to some developed countries. However, the role of Microfinance Institutions (MFI) is a critical issue especially in financing the small and medium enterprises who find it too costly to access credit from Commercial Banks. A loan or Credit may be regarded as „credit‟ granted where the money is disbursed and its recovery is made on a later date - a debt for the borrower [6]. Credit is given for a definite purpose and for a predetermined period. Interest is charged on the loan at agreed rate and intervals of payment. Coupled with the above, a loan process is an entire sequence of steps, from the time a loan application is received or a loan offer is accepted to the time when the loan is closed, the loan proceeds are disbursed, and the aggregate amount (principal plus interest) is placed on the lender‟s books as an asset [7]. As with any financial institution, the biggest risk in microfinance is lending money and not getting it back. Furthermore, MFIs provide unsecured loans, i.e. loans without any collateral. In case a client defaults, the MFI does not have any asset to meet its loss, which makes the credit even riskier. Credit risk is directly related to the portfolio of the Organization and is one of the most significant risks from an MFI perspective. Whenever an MFI lends to a client there is an inherent risk of money not coming back, i.e. the client turning into a defaulter. Credit is simply the possibility of the adverse condition in which the client does not pay back the loan amount. The risk is of greater significance for MFIs as it has to deal with large number of clients with limited literacy. The people covered are those who cannot avail credit from Banks and such other financial institutions due to the lack of the ability to provide guarantee or security Paper ID: ART20172815 DOI: 10.21275/ART20172815 2283