DETERMINANTS OF PROJECT LOAN DEFAULT:

EVIDENCE FROM DEVELOPMENT BANK OF ETHIOPIA

BY

ADVISOR

A THESIS SUBMITTED TO ST. MARY’S UNIVERSITY SCHOOL OF GRADUATE

STUDIES IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DERGREE
OF MASTERS OF BUSINESS ADMINISTRATION IN ACCOUNTING AND FINANCE

St. Mary’s University

Addis Ababa, Ethiopia

June, 2020

This is to certify that the thesis prepared by, entitled “Determinants of project loan default:
evidence from development bank of Ethiopia” and submitted for partial fulfilment of the
requirements for the award of Master’s degree in Business Administration in Accounting and
Finance compiles with the regulations of the University and meets the accepted standards with
respect to originality and quality.

Signed by the Examining Committee:

External Examiner _______________________ Signature ________________

Date_____________

Internal Examiner ______________________ Signature __________________

Date_____________

Advisor_____ Signature ________ Date________________

________________________________________

Chair of Department or Graduate Program Coordinator

 DECLARATION

I, the undersigned, declare that this thesis is my original work; prepared under the guidance of
Abreham G/giorgis(ASS.Prof). All resources of materials used for the thesis have been duly
acknowledged. I further confirm that the thesis has not been submitted either in part or in full
to any other higher learning institution for the purpose of learning any degree.

Name Signature

I
 ENDORSEMENT

This thesis has been submitted to, School of Graduate Studies for examination with my
approval as a university advisor.

Advisor Signature

June 2020

II
 ACKNOWLEDGEMENTS

I would like to express my thanks and appreciation to my, for his patience, guidance,
professional assistance and dedication of his precious time in reading and correcting the paper.
It has helped me to improve the quality of my thesis.

Next, my sincere and heartfelt gratitude goes to ##############who greatly helped me with
the paper and the completion of this study would have not been realized without his help. My
warmest gratitude and appreciation also goes to my family and friends for their wonderful
contribution and moral support.

Finally, I would like to thank the development bank of Ethiopia employees who gave their most
valuable responses questionnaire. Without their kind cooperation, this study would not be
complete.

III
 Table of Contents

DECLARATION..................................................................................................................................II
ENDORSEMENT.................................................................................................................................II
ACKNOWLEDGEMENTS..................................................................................................................II
ABSTRACT..........................................................................................................................................II
CHAPTER ONE....................................................................................................................................2
INTRODUCTION.................................................................................................................................2
1.1. Background of study...............................................................................................................2
1.2. Statement of the problem........................................................................................................2
1.3. Research questions..................................................................................................................2
1.4. Objectives of the study............................................................................................................2
1.4.1. General objective.............................................................................................................2
1.4.2. Specific objectives of the study.......................................................................................2
1.5. Hypothesis of the study...........................................................................................................2
1.6. Scope of the study...................................................................................................................2
1.7. Significance of the study.........................................................................................................2
1.8. Organization of the Study.......................................................................................................2
2. LITERATURE REVIEW............................................................Error! Bookmark not defined.
2.1. Introduction...........................................................................Error! Bookmark not defined.
2.1.1. Definition of Non-performing loans..............................Error! Bookmark not defined.
2.1.2. Criteria for Differentiating NPLs...................................Error! Bookmark not defined.
2.1.3. Non-performing Loans Provisioning.............................Error! Bookmark not defined.
2.1.4. Effects of NPLs..............................................................Error! Bookmark not defined.
2.1.5. Theories underpinning non-performing loans...............Error! Bookmark not defined.
2.1.6. Determinants of Non-performing loans.........................Error! Bookmark not defined.
2.2. Empirical review...................................................................Error! Bookmark not defined.
2.2.1. Empirical Evidence from other countries......................Error! Bookmark not defined.
2.3. Empirical Studies in Ethiopia................................................Error! Bookmark not defined.
2.4. Summary and Knowledge Gap.............................................Error! Bookmark not defined.
2.5. Conceptual Frame Work.......................................................Error! Bookmark not defined.

IV
CHAPTER THREE.............................................................................Error! Bookmark not defined.
METHODOLOGY..............................................................................Error! Bookmark not defined.
3.1. Research Design....................................................................Error! Bookmark not defined.
3.2. Target Population..................................................................Error! Bookmark not defined.
3.3. Determination of Sample Size...............................................Error! Bookmark not defined.
3.4. Sampling Method..................................................................Error! Bookmark not defined.
3.5. Sources and tools of data collection......................................Error! Bookmark not defined.
3.6. Validity and reliability of the instrument..................................Error! Bookmark not defined.
3.6. Data Analysis........................................................................Error! Bookmark not defined.
3.7. Study Variables.....................................................................Error! Bookmark not defined.
3.7.1. Dependent variable............................................................Error! Bookmark not defined.
3.7.2. Independent Variables.......................................................Error! Bookmark not defined.
CHAPTER FOUR..............................................................................Error! Bookmark not defined.
4. RESULTS AND DISCUSSIONS..............................................Error! Bookmark not defined.
4.1. Introduction.........................................................................Error! Bookmark not defined.
4.2. Demographic Presentation of Respondents......................Error! Bookmark not defined.
4.2.1. Educational qualification of respondents..................Error! Bookmark not defined.
4.2.2. Working experience.....................................................Error! Bookmark not defined.
4.2.3. Descriptive Analysis of the bank................................Error! Bookmark not defined.
4.2.4. Descriptive analysis of data collection........................Error! Bookmark not defined.
4.2.5. Question related to relation between credit assessment and occurrence of the
nonperforming loans..................................................................Error! Bookmark not defined.
4.2.6. Question related to Employees Proficiency...............Error! Bookmark not defined.
4.2.7. Questions concerning to Customer specific factors. .Error! Bookmark not defined.
4.2.8. Questions concerning to Relation between collateralizing loans. Error! Bookmark
not defined.
4.2.9. Questions concerning to Monitoring Ensures Loan Performance Statements
Error! Bookmark not defined.
4.2.10. Diagnosis Tests..........................................................Error! Bookmark not defined.
4.2.11. Normality Test..........................................................Error! Bookmark not defined.
4.2.12. Auto correlation Tests..............................................Error! Bookmark not defined.
4.2.13. Heteroscedasticity Test............................................Error! Bookmark not defined.

V
 4.2.14. Multicollinearity Test...............................................Error! Bookmark not defined.
4.2.15. Results of Regression Analysis................................Error! Bookmark not defined.
4.2.16. Interpretations of Variables....................................Error! Bookmark not defined.
CHAPTER FIVE.................................................................................Error! Bookmark not defined.
SUMMARY, CONCLUSION AND RECOMMENDATIONS..........Error! Bookmark not defined.
5.1. Introduction...........................................................................Error! Bookmark not defined.
5.2. Summary of findings.............................................................Error! Bookmark not defined.
5.3. Conclusion.............................................................................Error! Bookmark not defined.
5.4. Recommendation...................................................................Error! Bookmark not defined.
REFERENCES....................................................................................Error! Bookmark not defined.
ANEXX 1.............................................................................................Error! Bookmark not defined.

VI
 ABSTRACT

This study assesses the determinants of project loan default: evidence from development bank of
Ethiopia. The study revealed the important findings that were derived from quantitative and
qualitative analysis: in line with the objective of this research the trend of determinants of project
loan default: evidence from development bank of Ethiopia, In this study, employed descriptive
research method and explanatory research design and tries to determinate of project loan default by
adopted questionnaires to gather first hand and service period. Then, reliability and
validity test was conducted in order to check the inconsistency of the data. The reliability
was tested through statistical package for social sciences (SPSS) and Cronbach alpha
correlation coefficient was used to satisfy the reliability tests. Purposively selects 6 credit units
there have 300 employs directly engaged credit managing as target population by considering the
loan number and loan diversification. The study had 155 questionnaires distributed and from those
questionnaires 138 were collected and returned for analysis. In addition, as regression results show,
the significance effects of the bank Credit assessment impact on increasing of project loan default
with coefficient of 0.24, Customer factors 0.317, Credit monitors 0.18, collateralizing loans 0.12
and 0.054 Employees Proficiency 0.179.They are all positively related with all project loan default.
Generally the study affirmed direct impact of Credit assessment, Customer factors, Collateralizing
loans Employees Proficiency, and Credit monitors on project loan default. The policy implications
of the study suggest that Development Bank of Ethiopia may need to exercise and develop both
qualitative and quantitative method in its day to day making an effort to control and cunning action
for all project loan default by the bank and revised its loan policy and procedure accordingly.

Key Words: Collateralizing loans, Credit assessment, Collateralizing loans Credit monitors, and
Customer factors, DBE, Employees Proficiency and project loan default.

VII
 CHAPTER ONE
INTRODUCTION

This chapter gives a brief background of the study and introduces the thrust for the research and
beneficiaries of the study. The chapter also states statement of the problems, objectives of the
study and proposed hypothesis for the study. This chapter also provides the significance of the
study, scope of the study as well as limitations of the study. In short, it is the foundation upon
that the rest of the thesis is going and guides the researcher in carrying out the thesis.

Background of study

No one can refuse the importance of financial institutions in any developed or developing
economy; financial institutions are not only easing the credit flow in the economy,but also
improve the productivity by stimulating the investment in the long run (Richard, 2011).
Economic growth is possible with a sound financial sector (Rajaraman and Visishtha, 2002). It is
classified as good or poor performance in any country or region. Good performance of this
financial institution is the symbol of prosperity, whereas, poor performance of this institution
hinders the economic growth and structure of the particular region and also affects the whole
world (Khan and Senhadji, 2001).

The level of nonperforming loan (NPL), hereafter in a Bank’s loan portfolio should be well
managed in order to keep the quality of Bank asset, to maintain or improve the efficiency and
effectiveness of the bank. In general, to undertake sustainable and sound credit operation good
(NPL) management is among the crucial issues. An optimal NPL management mainly requires
standardized and sustainable credit risk management and prudent pre and post credit
administration practices which includes the following: undertaking due diligent assessment or
know your customers (KYC) principles, standardized project appraisal, loan approval and
continuous credit monitoring and evaluation, loan workout, taking timely and appropriate action
before and after loan default (sources).

NPL has attracted more attention in recent decades. Several studies examined bank failures and
find that asset quality is an indicator of insolvency (Shelagh Heffernan, 2005). Therefore; the
large amount of bad loans in the banking system generally results in a bank failure. The NPL are

8
among the main causes of the problems of economic stagnation (Monicah, 2011). Each impaired
loan in the financial sector increases the possibility to lead company to difficulty and
unprofitability. The minimization of NPL is a necessary condition for improving economic
growth. When NPL retained permanently, these will have an impact on the resources that are
enclosed in unprofitable areas. Thus, NPL are likely to hamper economic growth and reduce the
economic efficiency (Hou, 2007). The problem to NPL can arise from factors specific to the
bank (internal factors) or macroeconomic imbalances (external factors).

Development Bank of Ethiopia is one of the public banks in Ethiopia that provide mainly long
term (5-20 years) investment credit to borrowers in different sectors. Financing long term credit
has high credit risk which in turn expose for high NPLs. According to loan portfolio report of the
Bank as at June 30, 2018, the Bank’s NPLs was Birr 15.44 billion; this accounted for 39.43% of
the total loan portfolio. Currently this large and growing NPLs amount makes the issue of NPLs
questionable and crucial in DBE (audited DBE financial report).

This study should be attempts to explore some of the Bank specific, external factors and
borrowers’ related factors for occurrence of NPL in the case of Development Bank of Ethiopia
(DBE) which are causing bad loans by considering the opinion/perception of credit operators in
DBE.

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1.1. Statement of the problem

Successful project management is an instrumental to bring out broad-based and sustainable

development. Ethiopia aspires to become a middle-income country by 2025; towards this end,
the country has devised several projects. For these projects to contribute meaningfully
development endeavor of the country there needs to be efficient and effective project financing;
is a vital tool that supports the realization of developmental projects thereby bring out economic
development. As government owned bank, DBE is uniquely positioned in the banking industry
as it is empowered to extend project finance along with working capital loans as a package.
Accordingly, DBE extends sustainable credit facility for those engaged in manufacturing, agro-
processing industries, mining or extractive industries and commercial agricultural projects.
However, provision of credit alone does not support the economic development of the country
unless it is supplemented with efficient utilization of the fund and repayment of loans as per the
loan agreement (DBE, 2018).

The bank extends loans fund, are obtained from two sources. These are domestic and foreign
sources of fund. If the Bank is to be sustainable alongside providing loan to the needy,
ascertaining sustainability through appropriate loan recovery should be given priority. One of the
mechanisms of sustaining the Bank’s financial ability is making their payment performance of
the bank’s clients effective. This will help to realize better asset quality among others. In fact,
non-performing loan (NPL) ratio is used as measurement of a bank’s asset quality. This is the
standard criterion and one of the prudential standards, guidelines and rating systems for African
Development Banks and Finance Institutions (ADBFI) in which DBE is a member. As a member
DBE has agreed to perform towards this standard, which clearly states that NPL should not
exceed 15% of the gross loan portfolio or total outstanding loan (guidelines and rating system for
African development banks finance institutions). However, NPL of DBE reaches to high
percentage as 39.34% (it accounts about Birr 15.44 billion) for the budget year ended June 30,
2018(audited DBE financial report). This shows that the performance of the Bank is way below
the standard. This evidently shows that there is a problem of loan collection, whose factors worth
studying.

In fact, there are a lot of empirical studies on factors that affect banks nonperforming loan by
Combine both bank specific and macroeconomic factors jointly. Among these studies,
10
Wondimagegnehu (2012), on the determinants of NPLs of banking industry in Ethiopia;
Seyoum, et.al, (2016) on the factors that affect NPL of DBE central Region are worth
mentioning. The study conducted by Wondimagegnehu (2012) focused on bank specific
determinants of NPL in the banking industry in general, while the second study focused on bank
and borrower-related factors affecting NPL of DBE.

The major loophole of the studies is the fact that they focus on bank-specific variables. This
study was contributes to fill this gap as its major departure from the above-mentioned studies,
the current study uses econometrics model to identify determinants of project loan default and
focuses on factors related not only to the Bank and borrowers. Based on the above listed
motivations and the growing trend of project loan default in DBE in general and head office in
particular, this study was a very strong justification to be undertaken.

1.2. Research Questions

Having the above revealed statements of the problem, the subsequent research questions to be in
this study are indicated as follow:

i. What is the impact of credit assessment methods of the bank on NPL ratio level of the
bank?
ii. What is the impact of employee skill capacity on NPL ratio level of the bank?
iii. What is the impact of customer specific factors on NPL ratio level of the bank?
iv. Is there a relationship between Collateralized lending and non-performing loans?
v. Does Credit monitoring determine loan default?

1.3. Objectives of the study

1.3.1. General objective
The main objective of this study is to examine the project loan default determinants of
Development Bank of Ethiopia.

1.3.2. Specific Objectives of the Study

More specifically, the researcher assessed the following objectives:

i. To examine there is a relationship between credit assessment and occurrence of project

loan default.
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 ii. To examine there is a relationship between employee skill capacities on the project
loan default.
iii. To examine there is a relationship between customer specific factors on the level
project loan default ratio
iv. To examine there is a relationship between collateralized lending and project loan
default.
v. To examine there is a relationship between credits monitoring and loan default in
DBE.

1.4. Hypothesis of the Study

The researcher proposes to test the following hypothesis:

H1 There is a significant positive/ negative relationship between credit assessment of a bank

and bank’s project loan default.
H2 There is a significant positive/ negative relationship between Employee skill capacity gap
of the bank and bank’s project loan default.
H3 There is a significant positive/ negative relationship between customer specific factors of
a bank and bank’s project loan default.
H4 There is a significant positive/ negative relationship between Collateralized lending of a
bank and bank’s project loan default.
H5 There is a significant positive/ negative relationship between Credits monitoring of a
bank and bank’s project loan default.

1.5. Scope of the Study

This study contributes to understanding and analysis of determinant factors affecting project loan
default and to set effective and efficient credit management tools in DBE.

This research paper, which was essentially, identified determinant factors affecting project loan
default in DBE researcher purposively, selects 6 credit units from 13 operating units in the bank
by considering the loan number and loan diversification. The study covers from June 30
2018NPL of development banks. Because the researcher in order to get recent and current data.

Limitation of the Study

12
The researcher faces the following challenges during the time of research:

• Unwillingness of some respondents to give necessary information and answer for the due
the sensitivity of the issue in donor-grantee relationship.

• Resource limitation to include the top management perspective.

1.6.Significance of the Study

The outcome of the study will provide useful input for both credit policy reviewers of the
Bank to articulate prudent NPLs management policy, procedures and practices in the Bank’s
credit policy, for giving emphasis on major determinants of NPLs and undertaking proactive
actions on causes of NPLs based on the recommendations of the study. In general, the study
findings are important for sustainable and optimal NPLs management of the Bank as it identify
the major causes and determinants of NPLs in the Bank. By doing so the bank will improve its
asset quality, resource mobilization, efficiency in areas of loan administration operations, project
loan default and the study is also significant for the bank as it helps the bank in achieving its
vision. Moreover, it may also help other researchers as a source of reference and as a stepping
stone for those who want to make further study on the issue of NPLs in the DBE context
afterwards. Finally, it may provide a possible opportunity to all stake holders to gain deep
knowledge about the leading cause of NPLs in DBE and its solution in near future to be done by
DBE in order to decrease NPLs.

1.7. Organization of the Study

This study is organized into five chapters. The first chapter deals with introductory parts,
which have back ground of the study, statement of the problem, research questions, objectives of
the study, significance of the study, and scope of the study and limitations of the study are
addressed. The second Chapter discusses review of relevant theoretical and empirical literature.
The third Chapter describes the research methodology. It explains the research design and
approach, target population, sample size, sources and data collection instrument and data
analysis techniques. The fourth Chapter briefly discusses the result and major findings of the
study. The fifth chapter contains the conclusion and recommendation of the study.

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 CHAPTER THREE
METHODOLOGY

Methodology involves a blue print for the collection, measurement and analysis of data.
Moreover, the chapter reveals an overall scheme, plan or structure conceived to aid the
researcher in testing the research hypothesis. In this stage, most decisions about how research
was executed and how respondents were approached, as well as when, where and how the
research was completed is discussed. Therefore, in this part of the study describes the research
design and methodology that were used to guide the study under the following sub-headings: the
research design, target population, sample and sample design, sample frame, reason for the
sampling, data collection instruments, data collection procedures and data analysis procedures.

3.1. Research Design

The choice of research design depends on the objectives that the researchers want to achieve
(John, 2007). The plan represents the overall strategy used in collecting and analysing data in
order to test research questions. In this study, employed descriptive research method since,
descriptive research examines a situation as it is and enables us to understand the way things to
assess the project loan default in the Development Bank of Ethiopia. According to Kerlinger
(1973) survey is a method that studies large population (universe) by selecting and studying the
samples from the population to discover the relative incidence, distribution and interrelations of
sociological and psychological variables.

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Apart from the descriptive research design, the study also used explanatory research design and
tries to determinate of project loan default. In exploratory research, the focus is on gaining
insight into the subject and to become familiar with the subject area for more rigorous
investigation later (Cooper & Schindler, 2003).

3.2. Target Population

Target population is the specific population about which information is desired. According to
Ngechu (2004), a population is a well-defined or set of people, services, elements, events and
group of things or households that are being investigated. Mugenda and Mugenda (2003),
explain that the target population should have some observable characteristics, to which the
researcher intends to generalize the results of the study. There are 300 staffs directly engaged
credit managing and administrating 5,204 loans in DBE at this time. Commonly the bank
categorized its working units in head quarter, and district based on loan sanction limit. District
can able to manage up to 45 million loan amount and any loan greater than 45 million loan
amounts administered at head office (zena limat bank). For this study both units are included
during the survey. The researcher purposively selects 6 credit units as target population from 13
operating units in the bank by considering the loan number and loan diversification. The selected
working units have 300 staffs to pursue loans administration. See Table 1 below.

Table 11:Targetpopulation
S Selected units of the Staff engaged in Credit related
.No. bank Activities
1 Head office 70
2 Addis Ababa District 55
3 Adama District 38
4 Bahirdar District 54
5 Jimma District 36
6 Mekelle District 47
Total 300
Source: DBE Human Resource Management Directorate

3.3. Determination of Sample Size

From the population frame the required number of subjects, respondents, was selected in order
to make a sample. For this study Simple Random Sampling technique was used to select the

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sample. According to Cochran (1977). The sample size formula used for the study depicted in
Equation 1 as follow.
Equation 1: Sample Size formula
NZ +α 2 P(1−P)
n=
Nα + Z 2 P(1−P)
Where:
N: Target Population size = 300
n: Sample size
Z: Confidence level = 2.58
P : Largest Possible Proportion = 0.50
α: Sampling errer = 1%
( 0.01¿¿ 2)(0.50)(1−0.50)
n=(300)(2.58)+ ¿
774 = 155
(300)(0.01)+(2.58¿¿ 2)(0.50)(1−0.50)= ¿
5
An appropriate sample size for this number of population (i.e. 300 individuals) is 155
employees working in credit areas of the bank from selected or stratified districts.

3.4. Sampling Method

The study limit participants because of time, financial related problems of the researcher. In
order to simplify the study, purposive sampling was employed. Purposive sampling technique
was employed deliberately in order to get general stand of bank project loan default fromsix
credit units.Respondents were select by random sampling technique of lottery method from
each unit. Further all positions and respective tasks were list involving credit processing, loan
provisioning, monitoring and follow-ups. Furthermore, professionals may classified based on
positions held in the structure of credit department. Such professionals include, loan officers,
credit analysts, credit directors, relationship managers and recovery & monitoring officers etc…

3.5. Sources and tools of data collection

The study used primary data which consists of questionnaire with directly engaged credit process
staffs to identify the reason behind such high loan default. The questionnaire is composed of
structured questions and Likert scale questions. Moreover, secondary data such as DBE annual

16
report, brushers and ‘zena limat bank’ periodical used to overview the DBE performance during the
previous years.

3.6. Validity and reliability of the instrument

3.6.1. Validity of the Research Instrument

Oroho (2009) suggests validity as the accuracy and meaningfulness of inferences, which are
based on the research result. The questionnaires used in the study are standard questionnaires
whose validity and reliability were tested by it’s the researcher. However, they were discussed
with research advisor for suggestion and got advisor’s consent. Thus, questionnaires were
distributed without additional pre-test.
3.6.2. Reliability of the Research Instrument

The reliability of the research measurement and its consistency of the research is very important
task. Data reliability ensures the precision with which data is collected. Considering this the
study used a pre-testing by distributing small number of questionnaires to sample in order
to recognize either they understand or not the questions concepts. The study conducted pilot
study to test the reliability and validity of the research instrument. The study used 10 percent of
the population for pilot testing. Consequently, 10 percent of 155 translated into approximately
15 DBE’s employee. The study used random sampling to select 15 credit managing and
administrating employee and officers of who were not included in the main survey. With the
exception of demographic characteristics, other variables were measured as construct.
These variables had several items that measured the same concept or phenomenon. Thus
this study tested for reliability based on the Cronbach‘s alpha values for each measurement
construct and then for the overall items used in the 138 questionnaire. The reliability
results for eachmeasurement construct are presented in table. The result shows that the
Cronbach‘s alpha for project loan default constructs is 0.757with a total of 1 items. This
implies that the items included in project loan default are indicative of the same underlying
disposition. The Cronbach‘s alpha for Customer factors, Employees Proficiency ,Credit
Assessment, Credit monitors and collateralizing loans constructs Cronbach alpha results were
0.742, 0.878, 0.930, 0.762 and 0.942 respectively. Implying that the items in the construct are
indicative of the same underlying disposition. The value of the Cronbach ‘s alpha for all

17
measurement constructs is greater than or equal to the 0.7 value implying that the research
instrument is reliable.

Variable Number of Items Cronbach’s Alpha

Customer factors 5 0.742
Employees Proficiency 6 0.878
Credit Assessment 9 0.93
Credit monitors 14 0.762
collateralizing loans 4 0.942
Project loan default 1 0.757

3.6. Data Analysis

After the data collected from both primary and secondary sources through questionnaire the
researcher analyzed the results based on their nature and type accordingly.

The researcher analyzed the result of quantitative data with descriptive and qualitative analysis
employed to describe the median values of the scores of the responses of the respondents’ level of
agreement and disagreement with a given statement under each Likert type of questions.

Econometrics model were employed in order to analysis determinants of NPL in Development Bank
of Ethiopia. Regression models for linear outcomes allow a researcher to explore how each
explanatory variable affects the according to the collected. The challenge of interpretation is to a
summary of the way in which changes in the independent variables are associated with changes
in the outcome that best reflect the key substantive processes without overwhelming yourself or
your readers with distracting detail (Greene, 2003).

The Model specification will be as follow:

NPL= β1+ β2 Empskill + β3 CrdtMon + β4 CollLen + β5 Creasstc + β6Custfact μ

CrdtMon= credit monitoring, means follow up and control of disburse loan.

Empskill= employee skill capacity
CollLen = collateralized lending, this holding any assets for second way out of loan
Creasst = credit assessment

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Custfact= customer specific factor
μ = error term which captured other variables that are not included in the model.
β1= intercept of the model
β2, β3, β4, β5= slope of each independent variable.

3.7. Study Variables

Project loan default is dependent variables used in this study. It is measured in terms of
Nonperforming loans to gross loan. Besides, explanatory variables included in this study are loan
to deposit ratio, capital adequacy ratio, profit, lending rata and effective tax rate. As noted by
Brooks (2008) including more than one explanatory variable in the model never indicates the
absence of missed variables from the model. Thus, to minimize the effect of missed variables
from the model, the researcher was included disturbance term in this study.

3.7.1. Dependent variable

Project loan default

Project loan defaults are loans that are outstanding both in its principal and interest for a long
period of time contrary to the terms and conditions under the project loan contract. Any loan
facility that is not up to date in terms of payment of principal and interest contrary to the terms of
the loan agreement is NPLs. Thus, the amount of nonperforming loan represents the quality of
bank assets (Tseganesh, 2012).

According to the Ethiopian banking regulation, “Nonperforming loan and advances are a loan
whose credit quality has deteriorated and the full collection of principal and/or interest as per the
contractual repayment terms of the loan and advances are in question” (NBE, 2008). NPL is a
loan that delays for the payment of principal and interest for more than 90 days. Deterioration in
asset quality is much more serious problem of bank unless the mechanism exists to ensure the
timely recognition of the problem. It is a common cause of bank failure. Poor asset quality leads
nonperforming loan that can seriously damage a banks’ financial position having an adverse

19
effect on banks operation (Lafunte, 2012).It distresses the performance and survival of banks
(Mileris, 2012).It is measured or indicated by the amount of NPLs to gross loans.

3.7.2. Independent Variables

Independent variables are explanatory variables that explain the dependent variables. In case,
independent variable included in this study are indictors of credit monitoring, employee skill
capacity, collateralized lending, credit assessment, and customer specific factor. Majority of
these variables are modified and adopted from previously done studies based on the extent of
their effect on nonperforming loan whereas one of these variable, that is effective tax rate is
added from the researcher’s own perception.

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