Risk Management in Import and Export Financing by Commercial

RISK MANAGEMENT IN IMPORT AND EXPORT FINANCING BY COMMERCIAL

BANK: A CASE OF DEVELOPMENT FINANCE COMPANY UGANDA (DFCU) BANK

ANDREW KIMBUGWE

BSc (Hons) MAK

2012/HD06/448U

A RESEARCH PROJECT SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE AWARD OF THE DEGREE OF MASTERS IN BUSINESS ADMINISTRATION OF MAKERERE UNIVERSITY

NOVEMBER 2018

DEDICATION

This work is dedicated to my father Prince Charles Jjemba Kimbugwe who gave up much of his resources to ensure I got a good education at the different early stages of my life.

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ACKNOWLEDGEMENT

My sincere thanks go to my supervisor Mr. Alfred Okwee for his valuable guidance throughout the entire process of producing this report.

Many thanks to colleagues, staff and customers of DFCU bank

Above all, to the Almighty God who is great and makes everything beautiful in His own timing.

TABLE OF CONTENTS

STATEMENT OF DECLARATION ...... i

LIST OF TABLES ...... ix

LIST OF FIGURE...... ix

LIST OF ACRONYMS ...... x

ABSTRACT ...... xi

CHAPTER ONE ...... 1

GENERAL INTRODUCTION ...... 1

1.0 Background ...... 1

1.1 Statement of the Problem ...... 3

1.2 Objectives of the Study ...... 5

1.2.1 General Objective ...... 5

1.2.2 Objectives of the study...... 5

1.3 Research Questions ...... 6

1.4 Scope of the Study ...... 6

1.5 Significance of the study ...... 7

1.6 Definition of key terms ...... 7

1.7 Limitations of the Study...... 8

CHAPTER TWO ...... 9

LITERATURE REVIEW ...... 9

2.0 Introduction ...... 9

2.1 Risks involved in the financing of export and import of goods ...... 13

2.2 Risk management practices put in place by the commercial banks specifically dfcu when financing import and exports...... 16

2.3 Challenges faced and benefits of having in place proper risk management tools in banking sector ...... 17

2.4 Relationships among the risks, challenges and benefits of risk management practices...... 21

2.4.1 The relationship between risks involved in financing of exports, imports and risk management practices put in place by commercial banks ...... 21

2.4.2 The relationship between having risk management practices in place by commercial banks and challenges they face of operating them...... 22

2.4.3 The relationship between having risk management practices in place by commercial banks and benefits of operating them...... 22

CHAPTER THREE ...... 24

METHODOLOGY ...... 24

3.0 Introduction ...... 24

3.1 Research Design...... 24

3.2 Study population ...... 24

3.3 Sampling design and sample size ...... 25

3.4 Data sources ...... 25

3.5 Data collection methods and analysis techniques ...... 26

3.6 Validity and Reliability ...... 27

3.6.1 Validity ...... 27

3.6.2 Reliability ...... 28

3.7 Ethical Consideration ...... 28

CHAPTER FOUR ...... 29

DATA PRESENTATION, ANALYSIS AND INTERPRETATION ...... 29

4.0 Introduction ...... 29

4.1 Response rate ...... 29

4.2 Characteristics of the respondents ...... 30

4.2.1 DFCU customers ...... 30

4.2.2 DFCU staff ...... 33

4.3 Identification of the risks involved in the financing of export and import of goods ...... 35

4.3.1 Responses from the DFCU customers ...... 35

4.3.2 Responses from DFCU staff ...... 36

4.4 Exploration of the risk management practices put in place by the commercial banks when financing imports and exports ...... 37

4.5 The challenges faced and benefits of having in place proper risk management tools in DFCU bank...... 38

4.6 The Relationships among the Variables under study among the risks, challenges and benefits of risk management practices...... 39

4.6.1 The relationship between risks involved in financing of exports , imports and risk management practices put in place by commercial banks ...... 40

4.6.2 The relationship between having risk management practices in place by commercial banks and challenges they face of operating them...... 41

4.6.3 The relationship between having risk management practices in place by commercial banks and benefits of operating them...... 42

CHAPTER FIVE ...... 43

DISSCUSION, CONCLUSION AND RECOMMENDATIONS ...... 43

5.0 Introduction ...... 43

5.1 Discussion of the Findings ...... 43

5.1.1 Risks involved in the financing of export and import of goods ...... 43

5.1.2 Risk management practices put in place by the commercial banks when financing imports and exports ...... 43

5.1.3 Challenges faced and benefits of having in place proper risk management tools in DFCU bank...... 44

5.1.4 The Relationships among the risks, challenges and benefits of risk management practices...... 45

5.2 Conclusions ...... 46

5.3 Recommendations ...... 48

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5.4 Areas of further research ...... 51

REFERENCES ...... 52

Appendices ...... 58

APPENDIX I: NUMBER OF LETTERS OF CREDIT...... 58

APPENDIX II: QUESTIONNAIRE FOR THE STAFF OF DFCU BANK ...... 59

APPENDIX III: QUESTIONNAIRE FOR THE CUSTOMERS OF DFCU BANK ...... 62

APPENDIX IV: RISKS, CHALLENGES AND BENEFITS INVOLVED IN FINANCING OF EXPORT AND IMPORT OF GOODS ...... 64

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LIST OF TABLES

Table 4.1: Category of customers Table 4.2: Years of banking with DFCU Table 4.3: Importation frequency of customers Table 4.4: Export frequency of customers Table 4.1: Annual value of export and import by customers Table 4.2: Years of experience with DFCU Table 4.3: Department of the staff Table 4.4: Stage of financing transaction Table 4.9: Customers responses Table 4.11: Risk management practices Table 4.5: Challenges encountered when putting in place proper risk management tools… Table 4.6: Benefits of having in place risk management practices. Table 4.7: Showing correlation between risks involved in financing of exports and imports and risk management practices put in place by commercial banks Table 4.8: Showing correlation between having risk management practices in place by commercial banks and challenges they face of operating them Table 4.9: Showing correlation between having risk management practices in place by commercial banks and benefits of operating them Table 5.1: Showing the DFCU customers recommendations

LIST OF FIGURE

Figure 4.1: Rate of respondents

LIST OF ACRONYMS

BOP Balance of Payment CIBN Chartered Institute of Banking of Nigeria COSO Committee of Sponsoring Organisation CRM Credit Risk Management DFCU Development Finance Company Uganda EAC Export Assistance Centers ECAs Export Credit Agencies EPZ Export Processing Zone GATS General Agreement in Trade Services GATT General Agreement on Tariff and Trade ICC International Chamber of Commerce IDA International Development Association IMF International Monetary Fund LC Letter of Credit OECD Organisation for Economic Cooperation and Development RM Risk Management S&P Standard and Poors SMEs Small Medium Enterprises

SPSS Statistical Package for Social Scientists

TRIPs Trade Related Intellectual Property Rights UAE United Arab Emirates UNCTAD United Nations Conference on Trade and Development US United States of America USD United States Dollar WTO World Trade Organisation

ABSTRACT The purpose of this study was to examine risk management in import and export financing by commercial banks. The study looked at the risks involved in the financing of export and import of goods by DFCU bank, its risk management practices and challenges faced and benefits of having in place proper risk management tools. This was a non-experimental research using primary and secondary data with a target population that included all bank clients utilising import, export loans and trade finance instruments used during the period running from 2013 to

2016. Also included were DFCU staff members in the departments responsible for origination and processing of the related transactions. Out of the sixty eight questionnaires administered, sixty one were completed and returned posing an acceptable response rate of ninety percent. The collected data was presented using frequency tables which were analyzed by Pearson correlation coefficient using SPSS.

The study established that fraud was a risk banks had to mitigate when financing exports and imports through the appointment of a collateral manager to supervise the movement of the cargo that secured the loan. It also showed a positive relationship between the bank ensuring that the financed goods were insured and that this kind of risk management protected and enhanced the bank’s reputation. It was further established generally that about 50% of the DFCU staff believed that information technology systems contributed to the foundation of having in place proper risk management practices. The study recommended that some of the risk management practices which are in place should be reviewed and reconfigured to support the loan approval process rather than appear to delay and cause reduction of business development for the bank. Such practices included the review of the client’s past performance and request for collateral to cover the loan which increased the turnaround time and thus reduction in volume of business.

CHAPTER ONE GENERAL INTRODUCTION 1.0 Background Countries engage in international trade for two basic reasons; both of them contribute to their gains from trade. First one, countries trade due to the difference between each other, because countries can benefit from differences by doing things in which they do relatively well. The second reason is that countries trade in order to achieve economies of scale in production, in other words’ a country would benefit if it only produced only a limited range of goods, so it can produce those goods at a larger scale and hence be more efficient (Krugman P. , 2012).

A dramatic loss has taken place in the banking industry during the last decade. Banks that had been doing well suddenly shocked by large losses because of imbalanced credit exposures, unadjusted interest rate or derivative exposures that were not assumed to hedge by adjusting balance sheet risk. As a result, commercial banks have considered upgrading total risk management systems (Krugman P., 2012).

As a main component of banking business, trade finance is very sensitive to any changes in the global economic environment. With difficult market conditions and arrival of Basel III, export finance has to struggle and adapt to a new change (Ivan, 2014). Export finance became one of key players in the growth strategy of many banks and agencies as they identified advantages and opportunities for both of them by working together (Euromoney, 2013). As for export credit agencies (ECAs), researchers claimed that they are trying to provide a sustainable growth of their home market by providing a more diverse and forehanded support than in the past(Ivan,

2014).Based on the current economic environment ECAs are also playing a major role in trade finance all over the world. Risk management is said to be a cornerstone of prudent banking

1 practice (Ivan, 2014). Undoubtedly true that all banks in the present-day volatile environment are faced with large number of risks such as credit risk, liquidity risk, foreign exchange risk, market risk and interest rate risk, among others – risks which may threaten a bank’s survival and success. Risk management in trade finance has the banks focus on the following areas among others

Firstly, product related risks where the seller automatically has to accept as an integral part of their commitment, for example, specified performance warranties, agreed maintenance or service obligations. The buyer must consider how external factors such as how negligence during production or extreme weather during shipping could affect their product.

Secondly, manufacturing risks are particularly common for products which are tailor-made or have unique specifications. Often the seller would be required to cover costs of any readjustments of the product until the buyer sees fit, because the product can’t be resold to other buyers.

Transport risks, if the buyer fails to insure the cargo shipment in a proper way, the insurance could be invalid if, for example, the port or transport route changes and the items arrive in a substandard condition.

Furthermore, currency risks, due to the increased volatility seen in the money market and the need to operate in various currencies, policies needed to be flexible and cater accordingly.

Exchange rate volatility can affect all sizes of business, this is important when there are changes to the value of assets, liabilities and cash flows; this is certainly the case when denominated in a foreign currency.

In other words, financing international trade is a business of risk. For this reason, efficient risk management is a must. Carey (2001) indicated in this regard that risk management is more important in the financial sector than in other parts of the economy. The purpose of financial institutions is to maximize income and offer the most value to shareholders by offering a variety of financial services, and especially by managing risks properly.

In Uganda, commercial banks have been working side by side with the foreign commercial banks and local private banks to serve the financial market. Most of these commercial banks are found to offer import credit through the letter of credit mechanism. These banks have established relationship with the foreign banks to handle import financial transactions smoothly and efficiently. The entire import financing operations are guided and controlled by commercial bank’s foreign exchange control operations and import policy.

According to International Monetary Fund (Annual Report, 2010), funds are provided to developing countries to help them purchase United States goods and services. McJones (2010) observed that IDA services are no longer highly operational in Uganda, but there are Export

Assistance Centers, EAC, that offer technical assistance to exporters of which the Ugandan

Version is Export Processing Zone (EPZ). This research work looked at the risk management in import and export financing by commercial banks in Uganda.

1.1 Statement of the Problem Despite the fact that banks tend to have positive attitude towards providing import and export credit to the clients because of comparatively less perceived risks in such credit, all import and export firms cannot obtain the financing programs of banks smoothly as per commercial bank needs.

According to dfcu bank annual reports running from 2013 to 2015, there was a decline in the number of acceptance and letters of credit issued from amount totaling Uganda shillings 1,048 millions to less than 500 millions. During the same period, the portfolio concentration of loans in the trade and commerce dropped from 22% to 18% between 2013 and 2014. Refer to appendix I for the table showing the number of letters of credit and loans booked.

The paucity of foreign exchange at the disposal of banks often created bottlenecks in providing

Letter of Credit (LC) based import and export financing. In case of margins to be paid to the banks by clients for opening letter of credit, commercial banks are found to show discriminatory behavior. LC margins were found to vary from 10 to 100 percent depending upon the bank-client relationship and perceived risk in each export transaction. Clearly, that was contrary to the interest of small importers and natural justice. The import of goods in planned quantity at the right time is inhibited due to strict foreign exchange and customs rules.

It is true that banks possessing executives with adequate knowledge and strong skill-base in foreign exchange handling are capable of rendering efficient import and export financing services. The number of bank branches equipped with such core competencies is extremely limited resulting in import and export financing problem for the clients. Newspaper reports revealed that the import and export firms are dissatisfied with high interest rate on different types of financing along with various miscellaneous charges, which definitely lead to the escalation of import costs and resulting eventually in price hike of the imported goods in the domestic market.

The inflation sharp increase witnessed during the past years is due to increase in the price of imported goods. Under such situation, consumer sufferings can be easily understood.

Uganda is an import-dependent country. It has to import goods for catering to the national scarcity in the supply of essential goods, import of raw materials, accessories and machineries to foster the industrialization process. Its import expenditure has been increasing rapidly. In the backdrop of the situation, the country is in need of efficient, diversified, effective and time befitting import financing programs. But at present, it seems to be lacking greatly in the country.

It can be said that our banking system is lagging far behind the expectations of firms in respect of import and export financing. Large import and export firms also allege that their import and export financing needs cannot usually be met without syndicate import and export financing. The above problem clearly hints that an exhaustive study on risk management of import and export financing in Uganda may be undertaken to enrich the existing literature. This induced the researcher to embark upon this study with specific emphasis on DFCU bank.

1.2 Objectives of the Study 1.2.1 General Objective

The study sought to examine risk management in import and export financing by DFCU

bank.

1.2.2 Objectives of the study

1. To identify the risks involved in the financing of export and import of goods.

2. To explore the risk management practices put in place by the commercial banks when

financing imports and exports.

3. To examine the challenges faced and benefits of having in place proper risk management

tools in DFCU bank.

4. To examine the relationships among the risks, challenges and benefits of risk

management practices.

1.3 Research Questions 1. What are the risks involved in the financing of export and import of goods?

2. What are the risk management practices put in place by the commercial banks when

financing imports and exports?

3. What are the challenges faced and benefits of having in place proper risk management

tools in banking sector?

4. The following are the research questions about the relationships among the risks,

challenges and benefits of risk management practices.

a) What is the relationship between risks involved in financing of exports and imports and

risk management practices put in place by commercial banks?

b) What is the relationship between having risk management practices in place by

commercial banks and challenges they face of operating them?

c) What is the relationship between having risk management practices in place by

commercial banks and benefits of operating them?

1.4 Scope of the Study

The study focused on risk management in import and export financing by DFCU bank. DFCU was established in 1964 as a development institution and has its headquarters at plot 26

Kyadondo Road in Kampala, Uganda. The study looked at the risks involved in the financing of export and import of goods, risk management practices put in place when financing imports and exports and challenges faced and benefits of having in place proper risk management tools. The

6 study covered a period of 4 years from 2013 to 2016.This period of study was selected because it was considered long enough to enable the researcher come up with comprehensive and comparative information since risk management related practices are subject to policy changes as they emerge from time to time.

1.5 Significance of the study In view of acute shortage of literature on import and export financing in Uganda, students pursuing higher studies in Finance and Marketing cannot acquire up-to-date practical knowledge on the subject. Hopefully, this study may help to reduce this shortage of literature in the field and is expected to enlighten the students. In fact, import and export financing programs and practices need to be well-designed to meet the needs of firms in Uganda.

The findings of this study may assist commercial banks specifically DFCU in achieving need- based qualitative improvement in the import and export financing programs and procedures so that they may gain the easy access to the credit facilities and thereby complete the transaction properly for the benefit of the bank.

It is often complained that a lot of manipulations occur in the process of import and export financing. In a bid to overcome this problem, this study may provide invaluable inputs for making right decision at the right time.

1.6 Definition of key terms Risk Management: Risk management refers to the practice of identifying potential risks in advance, analyzing them and taking precautionary steps to reduce/curb the risk.

Import: An import is a good brought into a jurisdiction, especially across a national border, from an external source. The party bringing in the good is called an importer. An import in the receiving country is an export from the sending country.

Export: An export is a function of international trade whereby goods produced in one country are shipped to another country for future sale or trade. The sale of such goods adds to the producing nation's gross output.

Financing: Is the act of providing money for a project or transaction.

Commercial Banks: This is a financial institution providing services for businesses, organisations and individuals. Services include offering current, deposit and saving accounts as well as giving out loans to businesses. A commercial bank is defined as a bank whose main business is deposit-taking and making loans.

1.7 Limitations of the Study The respondents took a lot of time answering to the questions which caused the the researcher much pressure while following up. However, the researcher devoted time to the project and in some cases had to call up the respondent who completed the questionnaire while on call before one could hang up.

Financial constraint since research required money for printing, transport and airtime to make calls. However, the researcher minimized the costs as lowest as possible by typing the work himself and printed from affordable places.

CHAPTER TWO LITERATURE REVIEW 2.0 Introduction International economic relations and, in particular, international trade is constantly and rapidly growing industry that requires a solid theoretical framework for the establishment and improvement of practical financial products and instruments (Fomichev, 2005).

Export financing is a synthetic discipline that combines foreign trade, credit and insurance of financial risks. The theoretical basis of export credit with government support originates in the

"General Theory of Employment, Interest and Money", later called "Keynesian" where Keyns raises the question of government guarantees, as well as the probability of financial risks in international trade (Feenstra, 2004).

At the same time, with the development of international trade, its laws also underwent a comprehensive analysis that led to the emergence in the 19th century, and the development in the first half of the 20th century, theories of international trade in the works of Ricardo, and after that in works of the Heckscher-Ohlin, Rybczynski and Leontiev. In the second half of the 20th century there were further development of trade theories in the writings of the "new Keynesian"

J. Stiglitz, L. Sammers and P. Krugman and they actually spawned a new trade theory and new economic geography (Feenstra, 2004).

When companies indulge in business, it is obvious that they will be exposed to one type of risk or another which in most cases is an uncertainty although at times it can be certain that it will occur. Banks are one of such businesses whose risk is very sure because they don’t function in isolation given the dynamic environment in which they operate, the volatility of the financial markets in which they participate, diversification and the competitive environment in which they

9 find themselves(Williams et al., 2006). Even though it is certain that risk will occur, it is not always possible in most cases to eliminate, reduce or ameliorate it (Keith, 1992). So, the best possibility for companies is to try to manage the risk so as to reduce the possibility of occurrence or to reduce the consequences. These possibilities can range from “do nothing at all” to attempting to nullify the effect of every identified risk (William et al., 2006). But, because of the nature of the banking activity, a bank can’t find itself in a position to do nothing at all or to nullify the risk. So, all she does is to live with it but look for means to manage it. Given the riskiness of her activities, a bank does not wait to introduce risk management at a certain stage of its activities but does so right from the start. This is so because her activities are so correlated in such a way that if not well handled, the effect / consequences can be connected and can even lead to bankruptcy. For this goal to be attained, decision makers need to first of all identify the risk involved, measure its intensity, assess it, monitor it and then look for measures on how to control it. This act of managing the risk is called RM. RM is “a course of action planned to reduce the risk of an event occurring and/or to minimize or contain the consequential effects should that event occur” (Keith, 1992).

Although the effects of all risks types can cause negative consequences to the bank, credit risk has been pinpointed or identified as the key risk associated with negative consequences in terms of its influences on bank performance (Sinkey, 1992). This means if credit risk is not well managed, it can lead to failure. Thus, for any bank to succeed, its Credit Risk Management must be handled with a lot of seriousness. This is because should a loss occur, the bank will have to

“extend its hands” to get funds from other means to meet up or cover the losses. A clear reason why a correct management of credit risk is very important is because banks have a limited

10 capacity to absorb loan losses and these loses can be covered only by using income generated by other profitable loans or by bank capital (Boffey & Robson, 1995).

Banks like any other firm or corporation have formal laid down policies and principles that have been put in places by the board of directors on how to manage credits and this have to be carefully implemented by management. This restricts supervisors or managers on how to take action. They must do so by looking at the policies laid down to know if they are doing the right thing at the right time. Maness & Zietlow, 2005 specified that a credit policy has four major components which include; credit standards, credit terms, credit limits and collection procedures.

Despite the rules, it does not mean that the credit policies are stereotyped. “A good lending policy is not overly restrictive, but allows for the presentation of loans to the board that officers believe are worthy of consideration but which do not fall within the parameters of written guidelines” (Greuning & Bratanovic, 2003). Since the future is uncertain, flexibility must be allowed for easy adaption to changing condition (maybe internal or environmental). For a sound

CRM to be attained, after the risk in the lending activity has been identified, the bank’s credit risk management policies and the philosophies have to be used in order to control the credit risk

(Greuning & Bratanovic, 2003, p. 151).

According to (Greuning & Bratanovic, 2003), specific risk management measures include three kinds of policies;

- Policies aimed to limit or reduce credit risk (concentration and large exposures, adequate

diversification, lending to connected parties, or over exposures)

- Policies of asset classification (mandate periodic evaluation of collectability of the

portfolio of loans and other credit instruments, including any accrued and unpaid interest,

which exposes a bank to credit risk).

- Policies of loss positioning (making of allowances at a level adequate to absorb

anticipated loss).

The truism that import and export financing holds the ace in economic development and growth of any nation may have accentuated the importance of this business portfolio, especially in the financing sector. Indeed, a much available financing of export and import by the appropriate institutions will have great impact on the economy of that country.

In Nigeria like any other countries, Kravis (2007) observed that international trade could also make it possible for a country to specialize by the Chartered Institute of Banking of Nigeria

(CIBN), Lagos branch; the participants discussed exchange control regulations in Nigeria in the context of rules and regulations of International Trade. One of them, Nwagu (2009) argued that the aspect of import and export transactions ranging from the means of financing of these transactions, to the role of multilateral agencies as well as aspects of regulations and banks compliance. In his paper titled: “Balance of Payments (BOP) and Foreign Exchange

Management. The Nigerian Experience,” Moran (2003) observed that the external sector of every economy is quite vital in the contemporary world where nations and individuals are interdependent. Moran said that nations specialized to maximize their competencies and natural endowments, which informed international trade. As well, he says, certain nations are more successful than others in the course of economic activities, and thus end up stronger in international trade.

Udo (2009) noted that it is the need to foster economic growth and global prosperity that gave rise to the establishment of international organizations concerned with promoting free trade and development. These organizations include World Trade Organization (WTO), United Nations

Conference on Trade and Development (UNCTAD), Organization for Economic Co-operation and Development (OECD) and International Chamber of Commerce (ICC). Udo mentions the rules and regulations for international trade, which impacts on the financial market, in particular the opening of letter of credit and bills for payment. According to him, the Code of Conduct for trade policy is provided in the World Trade Organization (WTO), which contains a set of specific legal obligation regulating trade policies of member states. These embodied in the

General Agreement on Tariff and Trade (GATT), the General Agreement in Trade Services

(GATS) and the agreement on Trade Related Intellectual Property Right (TRIPs) “concludes

Udo. According to Moha (2007), the rules and principles of the WTO constrain the freedom of governments to use specific trade policy instruments while they influence the balance between interest groups seeking protection and those favouring open markets in the domestic political market place. Another rule with WTO trade policy is the dispute settlement and enforcement of rules. This is vital for the smooth functioning of the trading system, concludes Moha.

2.1 Risks involved in the financing of export and import of goods Banks make a wide variety of loans to a wide variety of customers for many different purposes.

However, some businesses often encounter difficulties when applying to providers of finance for credit to support fixed capital investment and to provide working capital for their operations

(Tucker and Lean, 2003). Business’ access to bank loans was mainly affected by both demand and supply constraints. The demand constraints refer to factors that made it difficult for businesses themselves to seek external finance from financial institutions such as poor quality of

13 potential projects that qualify for funding , the inability of businesses to draft convincing business plans and lack of adequate collateral to secure the loan. The supply constraints refer to those factors that make it difficult for financial institutions like banks to lend (supply loans) to businesses including, higher levels of informational asymmetries related to SME lending, higher transactional costs, inherently riskier nature of businesses and institutional weakness in developing countries that make it more difficult for financial institutions to lend to businesses.

SMEs are viewed to be risky because many of them do not survive due to a myriad of reasons.

SME closure rates exceeded 20% per year (Liedholm, 2001) and most of them fail in their first year (Biekpe, 2004). The level of risk is inversely related to the size of the firm. In terms of transaction costs, banks experience higher transaction costs in their dealings with SMEs. The cost of lending may in some circumstances be viewed as fixed. These costs include administrative, legal and acquisition of information from a specialized agent. The cost structure for two loans is likely to be quite similar regardless of the size of the loan. For example, it may cost a bank a similar dollar amount to process an SME loan request of $10,000 as against a loan of $100,000 from a larger corporation. Therefore, due to scale economies, the cost of lending to larger firms is likely to be lower. Also, transactional costs in terms of loan monitoring after disbursement are disproportionately higher for businesses.

Bilkey (1978) who attempted to summarize the literature on export behavior of firms observed that the most frequent serious obstacles to exporting reported by U.S. firms in the empirical studies are: insufficient finances, foreign government restrictions, insufficient knowledge about foreign selling opportunities, inadequate product distribution abroad, and a lack of foreign market connections. Prior research also noted that though banks are a major source of external capital for small firms it is more difficult for them to obtain bank loans than do large firms

(Schiffer and Weder, 2001). Small firms obtained only 30% of their financing from external sources, whereas large firms met up to 48% of their financing needs through external financing

(World Bank, 2004).

According to the African Economic Conference of 2015, many of the firms in Uganda lack an empowering formal legal status, which ultimately denies them the necessary capacity, tools and prerequisites for them to access and have effective demand for credit. They lack the prerequisites for credit access and demand such as collateral to acquire mortgages, pledges etc. These also require formal instruments to place them within the formal law where they operate.

Binks et al. (1992) cautioned that restricted access to bank debt by small businesses may not be directly attributable to their size but rather to problems associated with the availability of information from which projects are evaluated (information asymmetry). They argue that such information problems are not peculiar to the small business sector alone, but are predominant there because of the anticipated (proportionately) higher costs of information-gathering associated with that sector. The provision of finance by a bank to a firm could be considered as a simple contract between the two parties in which the bank is the principal and the firm is the agent. This relationship potentially led to the problem of information asymmetry (Binks et al.,

1992). The problem of information asymmetry is exacerbated in developing countries because information about the credit quality of borrowers is limited. Credit rating agencies are virtually non-existent whilst credit reference bureaus remain largely undeveloped. The coverage of reputable credit agencies such as S&P does not encompass a vast majority of African firms and in any case coverage will be for only the well established firms. In Ghana for example, local credit rating agencies have not emerged to fill this informational gap. Though a credit reference

15 bureau has been established in Ghana, it is in its infant stage and the issue of coverage for SMEs remains a concern.

2.2 Risk management practices put in place by the commercial banks specifically dfcu when financing import and exports.

Significant studies have examined risk management practices worldwide. However, the empirical studies in the context of Uganda are scarce. Moreover, the number of publications showing comparison between the commercial banking seemed to be scanty. The following was an endeavour to capture the core findings from major literature. Linbo (2004) worked with risk management in major banks of United States. The author provided two important information on the bank efficiency. His finding suggested that profitability was sensitive to credit risk.

Niinima¨ki (2004) asserted that the degree of risk taking depended on the structure and side of the market in which competition takes place. If the banks work in a monopoly market or banks are competing only in the loan market, deposit insurance had no effect on risk taking. Banks in this situation tended to take more risk than that of a competitive market operator, although intense risk taking was avoided. In contrast, introducing deposit insurance increased risk taking if banks competed for deposits. As a result, the deposit rates become extremely high, thus forcing banks to take excessive risks.

Wetmore (2004) examined the correlation between loan-to-deposit and liquidity risk. From his findings, it is found that loan-to-deposit ratio had increased which in turn influenced the change in asset to liability ratio. A positive relation between these two variables had revealed in his study. In a study of top 20 Japanese banks, Khambata and Bagdi (2003) revealed that the financial derivatives (for example, off-balance-sheet) had been extremely used by the major banks. These banks used this as profit diversification. Comparing their results of Asian banks

16 with major banks in USA and Europe, Asian banks lagged behind in practicing profit diversification. Al-Tamimi (2002) investigated commercial banks in UAE. He revealed that the credit risk was a major concern. Credit risk was examined by Salas and Saurina (2002) among the Spanish banks. The study covered 1985-1997 and compared the determinants of problem loans. Various risk management practices in financial organizations became the need of the time just after the financial distress faced by the whole world in last decade. In particular, United

States required long time to restore their economy with serious regulatory changes. Many post crisis analysts found dissimilarities in terms of risk identification and management in different banks and financial organization before and during the crisis which was a self-destructive thought that brought such loss to the world economy. Risk management defines the need of identification of core risks, method to develop consistent and accurate risk measurement, give the importance of risk reduction, avoidance and transfer through proper risk return calculation and best monitoring procedures of risk position for the organization. For banks, meeting the regulation not necessarily could avoid bankruptcy or financial harassment. Bank personnel required reliable risk identification, measurement and management culture to follow and monitor best risk-reward ratio.

2.3 Challenges faced and benefits of having in place proper risk management tools in banking sector

As routine as import and export finance may be, as for other forms of credit, there is an element of risk to be borne. Commercial risk stems essentially from the inability of one of the parties involved to fulfill its part of the contract: for example an exporter not being able to secure payment for his merchandise in case of rejection by the importer or in case of bankruptcy or insolvency of the importer.

Alternatively, the importer bears the risk of a delayed delivery of goods. Traders further have to deal with exchange rate fluctuation risk, transportation risk and political risk. A rapid unexpected change in the exchange rate between countries of the traders could destroy the profitability of the trade, while the imposition of a currency conversion or transfer retraction could be even more damaging.

The global financial crisis which started in mid-2007 placed obstacles to access to export finance for micro and small enterprises in Africa. According to an International Monetary Fund (IMF) report on the situation, policymakers in Africa had generally made an effort to heed the IMF’s recommendations for tighter supervision of financial institutions to avoid the chain reaction effect of the crisis (International Monetary Fund, 2010). Consequently, most banks’ reaction to the increased oversight has been to focus on their traditional target market clients and not assume incremental risks with small enterprises operating in non traditional markets.

In the current crisis, it was clear that access to affordable trade finance had been constrained. A number of banks, global buyers, and firms surveyed by the World Bank are reported to be constrained by lack of trade finance and other forms of finance, such as working capital and Pre- export financing. In addition, the costs of trade finance are substantially higher than they were pre-crisis, raising the problem of affordability for exporters. Small enterprise exporters in developing countries appeared to be facing the greatest difficulties in accessing affordable credit.

In a World Bank survey of 60 global buyers and suppliers in early 2009, 40 percent of companies indicated that foreign sales had been delayed or cancelled due to drops in new orders, and 30 percent due to difficulties in obtaining trade finance (Arvis and Shakya, 2009). Findings from two other World Bank surveys of 400 firms and some 80 banks in 14 developing countries across

18 five regions indicated that although a drop in demand played a central role in explaining the decrease in trade finance flows, 30 percent of firms, especially micro and small enterprises, stated that lack of finance explain the decline in exports (Malouche, 2009).

The benefits of having an effective risk management are pointed out in the COSO framework and it is stated that enterprise risk management “helps an entity to get to where it wanted to go and avoid pitfalls and surprises along the way” (COSO 2004). It helps management to achieve the entity’s goals and prevents loss of resources and helps to ensure effective reporting and compliance with laws and regulation, thus avoiding damage to the entity’s reputation and other associated consequences. According to COSO (2004) an effective enterprise risk management enabled the entity to:

- Align risk appetite and strategy - enhance risk response decisions - reduce operational

surprises and losses

- Identify and manage multiple and cross-enterprise risks

- Seize opportunities

- Improve deployment of capital.

The components of risk management described below, are related to the benefits of an active risk management, but will also affect the monetary and non-monetary values in an entity:

Aligning risk appetite and strategy

Management first evaluates different strategic alternatives, and then sets objectives aligned with the selected strategy, establishing a basis for operations, reporting and compliance objectives and develop mechanisms to manage the related risks. All of this has to be aligned with the entity’s risk appetite.

Enhancing risk response decisions Risk management provided support to identify and select among alternative risk responses. The risk responses mentioned in the COSO framework are divided into four familiar groupings (Hillson 2002):

Avoid: Eliminate uncertainty by making a threat impossible to occur or find another way

to achieve objectives that can reduce the impact of the risk to zero.

Reduce/mitigate: Actions are taken to reduce the likelihood or impact, or both, of a risk

to an acceptable level for the entity.

Share/transfer: Reduce likelihood or impact of a risk by transferring or sharing risk to

another stakeholder better able to manage the risk.

Accept: Recognizing that the risk should be taken, and no action is taken to affect risk

likelihood or impact

Hillson (2002) also suggested four groupings when responding to identified opportunities, as the risk responses already mentioned above seem to be most appropriate when dealing with threats:

Exploit: Paralleling avoid. Seek and take measures to make the opportunity definitely

happen.

Enhance: Paralleling mitigate. Seek to increase the likelihood and/or the impact of the

opportunity in order to maximize the benefit to the entity.

Share: Paralleling transfer. Find a partner able of managing the opportunity, who can

maximize the likelihood of it happening and/or increase the potential benefits.

Ignore: Paralleling accept. No action is taken.

Reducing operational surprises and losses Through risk management entities gain enhanced capability to identify potential events, assess risk and establish responses, thus reducing unwelcome surprises and associated costs and losses.

Identifying and managing multiple and cross-enterprise risks Facing numerous risks that affect different parts of the organization, the management needs to not only manage individual risks, but also understand interrelated impacts. Risk management enables effective response to the interrelated impacts, and integrated responses to multiple risks.

Seizing opportunities By considering a full range of potential events, rather than just threats, the management is able to identify and proactively exploit opportunities.

Improving deployment of capital Robust information can be obtained through the risk management process, which allows the management to effectively assess overall capital needs and enhance capital allocation.

2.4 Relationships among the risks, challenges and benefits of risk management practices. 2.4.1 The relationship between risks involved in financing of exports, imports and risk management practices put in place by commercial banks According to Williams et al. (2006) when companies indulge in business, it is obvious that they will be exposed to one type of risk or another which in most cases is an uncertainty although at times it can be certain that it will occur. Banks are one of such businesses whose risk is very sure because they don’t function in isolation given the dynamic environment in which they operate, the volatility of the financial markets in which they participate, diversification and the competitive environment in which they find themselves. Even though it is certain that risk will occur, it is not always possible in most cases to eliminate, reduce or ameliorate it (Keith, 1992).

Risk management can be most effective when it is applied consistently across the banking organization with policies and procedures developed by risk experts who have the training and experience for their specific country, area, and client mix. It is incumbent upon front-line officers to use the tools and processes to guide their daily interactions with customers (AT. Kearney,

2009).

2.4.2 The relationship between having risk management practices in place by commercial banks and challenges they face of operating them. Meyer (2000) stated that the fundamental elements of sound risk management are easy to describe in the abstract but are far more difficult to apply case-by-case. Each situation is unique, built around the roles and capabilities of individuals and the structure, activities and objectives of the institution. What works for one firm may, of course, be unsatisfactory for another. According to Malouche (2009) findings from two World Bank surveys of 400 firms and some 80 banks in

14 developing countries across five regions indicated that although a drop in demand played a central role in explaining the decrease in trade finance flows, 30 percent of firms, especially micro and small enterprises, stated that lack of finance explain the decline in exports.

2.4.3 The relationship between having risk management practices in place by commercial banks and benefits of operating them. According to Rider (2014) in spite of the challenges around integration of risk management systems and processes it presented a number of benefits. Centralization and integration created clear ownership and increased standardization of processes.

Conclusion Although there is rich literature about risk management in import and export financing by commercial bank, this literature does not relate directly to import and export financing by DFCU alone. There are several risk management practices DFCU engage dependent on the

22 effectiveness and efficiency of commercial bank processes; however it cannot be assumed that all commercial banks are the same or that all employees are the same. The assumptions made by one discipline about the relationship between import and export financing and risk management in commercial bank, needed to be examined by other disciplines with expertise in understanding the dynamics of risk management within commercial banks like DFCU. The implication for management is that more research is necessary to dispel the myths that these factors are generic and applicable to all commercial banks. Best practices are improved by continual research and it is for this reason the researcher has sought ground to carry out more research about the selected area of study, risk management and import and export financing and how they affect operations at DFCU.

CHAPTER THREE METHODOLOGY 3.0 Introduction This chapter presents the methodology that was used in the study, and was presented by research design, area of study, study population, data collection methods, procedures of data collection, sample size, data collection instruments, data management and processing, data analysis and measurement of variables.

3.1 Research Design This study was non-experimental research using primary and secondary data. Kerlinger (2006) defined non experimental research as a systematic, empirical enquiry in which the scientist does not have direct control of the independent variable because their manifestation had already occurred or because they inherently cannot be manipulated. It is noted that the variable under study does not lend itself to manipulation and the aim of the research was to describe the phenomenon, which is, financing difficulties experienced by small nontraditional importers and exporters. This research approach answers the questions: what, who, where, when and how

(Mugenda and Mugenda, 2003). Descriptive researches are often used when an amount of knowledge about the subject already exists; this knowledge can then be used to categorize into models and frameworks (Lind et al, 2005).

3.2 Study population The target population included all clients with import and export loans and trade finance instruments used during the period under study from 2013 to 2016 and the DFCU staff members in the departments responsible for origination and processing of the related transactions. The data included client business names and the type of transaction. There were 45 clients who utilized import, export and trade finance instruments during the period under study and 30 members of

24 staff in the credit, development and institutional banking departments responsible for processing the transactions from start to end.

3.3 Sampling design and sample size Interviews were carried out so as to take care of those instances where the respondent selected did not understand the survey as a result of linguistic barrier.

Purposive sampling and Convenience sampling were used. Purposive sampling was aimed at sampling people with known roles and a range of participants within the Institute. The researcher selected a sample based on their understanding that the respondents had the key information they require (Amin, 2005). Purposive sampling was useful in selecting cases rich with information to enable in depth study (Oso & Onen, 2009). Convenience sampling technique was used through the staff connected to DFCU specifically in administration and technicians. Convenience sampling allowed the researcher to select units that were close at hand and easy to rich (Amin,

2005).

A total sample size 28 out of 30 employees at DFCU was used and sample of 40 out of 45 clients. The selection of the sample was selected according to the Sample Technique by Krejcie and Morgan (1970). The technique showed the relationship between sample size and total population.

3.4 Data sources Secondary data was collected through previous DFCU records. The study also relied on publications in journals, books and online publications to ensure that a comprehensive overview of the issues was considered. The primary data comprised evidence obtained through structured questionnaires which are quantitative and qualitative in nature so as to gain an insight and

25 understanding into the operations of the importers and exporters and the bank surveyed. The questionnaire is designed based on open and closed ended questions

3.5 Data collection methods and analysis techniques Questionnaire A data collection namely questionnaire was employed in collecting primary data to accomplish the study (Bhattacharyya 2003). The structured questionnaire consisting of closed questions with a five point Likert scale was designed and administered to selected technical staff in finance, operations, sales and credit departments of DFCU. It was also administered to the customers.

Interview Survey The Interview was an oral questionnaire where the researcher gathered data through direct verbal interactions with participants (Amin, 2005). Interview is a qualitative research technique that involved conducting individual interviews with a small number of respondents to explore their perspectives on a particular idea, program and situation to explore issues in depth (Boyce, 2006).

The interview method enabled the researcher to collect information on how the participants felt and thought (Burns, 2000). One of the major advantages of the interview is that it is a face-to- face interaction that allows the researcher to ask difficult questions as they observe the participant’s body language, and to probe until clarity is obtained. The interviewer obtained information that the subject would probably not reveal under other circumstances (Babbie,

1990).

Document Review This method involved delivering information by carefully studying written documents (Amin,

2005). The researcher read relevant documents in DFCU like policy documents, annual reports,

26 and many others in order to establish and set the research pace. This method helped the researcher to consider data that was relevant to the study.

Secondary sources included Uganda Bureau of Standards report, Import and Export Standards,

Textbooks, annual reports from DFCU.

Qualitative data was analyzed in accordance to the research objectives. Patterns and connections within and between categories were identified. It was presented in form of notes, word-for-word transcripts, single words, brief phrases and full paragraphs (Powell & Renner, 2003). Data was interpreted by composing explanations and substantiating them by the respondents open responses. In analyzing qualitative data, conclusions were made on how different themes and variables are related.

In order to manage data, the researcher ascertained that the questionnaires were accurately recorded and completed to satisfaction with consistence. To ensure completeness and uniformity in the qualitative data, careful editing was done.

In the processing of data, manual checks were done during data collection to ensure legibility of handwriting for correctness of data.

3.6 Validity and Reliability 3.6.1 Validity To ensure validity, the questionnaire was tested in order to check its content, construct and face validity. Content validity refers to how well an instrument includes a representative sample of questions that relate to the content domain being measured (Patten, 2004; Wallen & Fraenkel,

2001), while Construct validity determined the nature of psychological construct or characteristics being measured by the instrument. Content and construct validity were ensured by

27 the supervisor and peers from the banking sector who helped in the review to ensure the instrument accurately measured the variables it intended to measure in the study. Face validity dealt with format of the instrument and included aspects like clarity of printing, font size and type and appropriateness of language among others.

3.6.2 Reliability Reliability indicated the degree to which a survey instrument was consistent with what it measured (Litwin, 1995). To ensure reliability, the instrument was pre-tested with a sample of respondents, who were not necessarily included in the sample size. Pre- test results showed that the questions were easily understood and answered in the same way by the sampled respondents and hence the instrument was reliable.

3.7 Ethical Consideration The researcher began the study by properly identifying himself to the respondents, he informed the respondents about the topic and the objectives of the study, the type of questions to be asked and the possible consequences that the research had on the respondents, especially the importance of its findings to the risk management and its related activities. He left the questionnaires with respondents to be answered within three weeks after which were collected back for analysis.

CHAPTER FOUR DATA PRESENTATION, ANALYSIS AND INTERPRETATION 4.0 Introduction This Chapter of the study dealt with data presentation, analysis and the interpretation of the results in reference to research objectives outlined below:

1. To identify the risks involved in the financing of export and import of goods.

2. To explore the risk management practices put in place by the commercial banks when

financing imports and exports.

3. To examine the challenges faced and benefits of having in place proper risk management

tools in DFCU bank.

4. To examine the relationships among the above variables under study.

The findings were based on the primary data collected, summarized and presented in tables and figures showing frequencies and percentages. It was also based on the results of analysis of

Pearson’s correlation coefficient.

4.1 Response rate According to the sample technique by Krejcie and Morgan (1970) the researcher approached sixty eight (68) respondents. He collected data from sixty one (61) who completed and returned questionnaires giving a response rate of ninety percent (90%) as showed in the figure below.

According to Rubin and Earl (2009), a response rate of seventy percent (70%) is very good for analysis and reporting.

Figure 4.1: Rate of respondents

Source: Primary data

4.2 Characteristics of the respondents The demographic features of the respondents’ characteristics for the DFCU staff included; years of experience in the bank, department in the bank and level of involvement in the transaction assessment. For the customers of DFCU bank; how long they banked with DFCU, annual frequency of export or importation and average cost of the annual consignment.

4.2.1 DFCU customers a) Category of customers The table below presented the categorisation of DFCU customers who responded. Majority of the respondents were importers representing 67.5% and 32.5% are exporters.

Table 4. 10: Category of customers Category

Category Frequency Percent Valid Percent Cumulative Percent

Valid Importer 27 67.5 67.5 67.5

Exporter 13 32.5 32.5 100.0

Total 40 100.0 100.0

Source: Primary data

30 b) Years of banking with DFCU

The results showed that majority of the respondents were between 0 -10 years of banking with

DFCU (67.5%), 11 - 15 years (12.5%) and the distribution of the banking relationship above 16 years was 10% as shown in the table below. 10% of the respondents did not return information and are reported as missing.

Table 4. 11: Years of banking with DFCU Frequency Percent Valid Percent Cumulative Percent

Valid Below 5 years 17 42.5 47.2 47.2

5-10 years 10 25.0 27.8 75.0

11-15 years 5 12.5 13.9 88.9

Above 16 years 4 10.0 11.1 100.0

Total 36 90.0 100.0

Missing 99 4 10.0

Total 40 100.0

Source: Primary data c) Frequency of annual importation by the importers who are DFCU customers

The table below illustrated the customers and their frequency of using DFCU services to make importations. 10% used the banking services once, 22.5% twice, 10% thrice and 20% more than thrice. 10 % did not respond to the study and the 27.5% are exporters who did not use DFCU for any importation financing.

Table 4. 12: Importation frequency of customers Importation_freq Frequency Percent Valid Percent Cumulative Percent Valid 0 11 27.5 30.6 30.6 Once 4 10.0 11.1 41.7 Twice 9 22.5 25.0 66.7 Thrice 4 10.0 11.1 77.8 Above 8 20.0 22.2 100.0 thrice Total 36 90.0 100.0 Missing 99 4 10.0

Total 40 100.0

Source: Primary data

d) Frequency of annual exports by the exporters who are DFCU customers

The table below illustrated the customers and their frequency of using DFCU services to do exports. 5% used the banking services twice, 2.5% thrice, 22.5% more than thrice. 10 % did not respond to the study and 60% are importers who did not use DFCU for any export financing.

Table 4. 13: Export frequency of customers Frequency Percent Valid Percent Cumulative Percent

Valid 0 24 60.0 66.7 66.7

Twice 2 5.0 5.6 72.2

Thrice 1 2.5 2.8 75.0

Above Thrice 9 22.5 25.0 100.0

Total 36 90.0 100.0

Missing 99 4 10.0

Total 40 100.0

Source: Primary data

32 e) Annual value of exports and imports done by DFCU customers

The table below showed the amount of financing customers obtained from DFCU for their transactions as follows: 32.5% between USD (0 – 100,000), 37.5% USD (100,000 – 500,000),

20% USD (500,000 – 1,000,000). 10% did not respond to the study.

Table 4. 14: Annual value of export and import by customers Valid

Frequency Percent Percent Cumulative Percent

Valid 0-100,000 13 32.5 36.1 36.1

100,000-500,000 15 37.5 41.7 77.8

500,000-1,000,000 8 20.0 22.2 100.0

Total 36 90.0 100.0

Missing 99 4 10.0

Total 40 100.0

Source: Primary data

4.2.2 DFCU staff a) Years of experience in the bank.

The results showed that majority of the respondents had been in the bank between 4 to 9 years

(46%) and those below 4 years were 28.6% while the distribution of respondents above 10 years was 14.3% as shown in the table below.

Table 4.15: Years of experience with DFCU Frequency Percent Valid Percent Cumulative Percent

Valid Below 4 years 8 28.6 32.0 32.0

4 to 9 years 13 46.4 52.0 84.0

Above 10 years 4 14.3 16.0 100.0

Total 25 89.3 100.0

Missing 99 3 10.7

Total 28 100.0

Source: Primary data b) Department of the staff

The table below represented the bank department to which the respondents belonged. Majority of the staff came from sales department (35.7%) followed by credit (25%), operations (17.9%) and finance (10.7%).

Table 4.16: Department of the staff Frequency Percent Valid Percent Cumulative Percent

Valid credit 7 25.0 28.0 28.0

finance 3 10.7 12.0 40.0

operations 5 17.9 20.0 60.0

sales 10 35.7 40.0 100.0

Total 25 89.3 100.0

Missing 99 3 10.7

Total 28 100.0

Source: Primary data

34 c) Stage of financing transaction

The table below illustrated the level of the transaction and how many staff from different departments responded to the study. Most staff (35.7% ) were at the origination level , followed by those at the reviewing stage (21.4%), then checking (17.9%) and lastly approval which returned 14.3%.

Table 4. 17: Stage of financing transaction Frequency Percent Valid Percent Cumulative Percent

Valid origination 10 35.7 40.0 40.0

checking 5 17.9 20.0 60.0

reviewing 6 21.4 24.0 84.0

approval 4 14.3 16.0 100.0

Total 25 89.3 100.0

Missing 99 3 10.7

Total 28 100.0

Source: Primary data

4.3 Identification of the risks involved in the financing of export and import of goods

4.3.1 Responses from the DFCU customers

Table 4.18: Customers responses Strongly Strongly Risks Involved. Disagree Disagree Neutral Agree Agree % % % % % Limited access to affordable pre-export financing due to strict bank loan conditions 0 0 0 47.5 42.5 Price fluctuation due to changing economic conditions. 0 0 5 35 50 Holding stock under collateral manager adds an extra cost burden that eats into the profits. 0 0 40 15 35 Lack of adequate understanding of how a letter of credit works 10 22.5 27.5 25 5

The table above showed 50 % of the respondents agreed that price fluctuation due to changing economic conditions was one of the risks they faced during the financing of imports and exports.

This was because of the operational costs born by the suppliers during the sourcing of raw materials within the countries of production and interest rates of obtaining funds. The customers were requested to share any more risks they thought are involved in the process and the responses can be seen in appendix 3.

4.3.2 Responses from DFCU staff Table 4. 19: DFCU staff responses

Strongly Strongly Risks involved Disagree Disagree Neutral Agree Agree % % % % % Financing of export and import of goods is influenced by price due to exchange rates fluctuation 0 0 3.5 32.1 53.6 Financing of export and import of goods is influenced by Fraud 10.7 21.4 32.1 17.9 7.1 Financing of export and import of goods is influenced by country / political Risk 0 0 21.4 42.9 25 Financing of export and import of goods influenced by supplier actions? 0 0 0 39.3 50

Key to note was that 53.6% of the staff strongly agreed that financing of export and import of goods face the risk of price changes due to exchange rate fluctuation. Since the banks set the interest rates the respondents were able to see the immediate impact on the customers operations especially on pricing of the goods. Also 50% of the staff strongly agreed that supplier actions were part of the risks that had to be mitigated. The actions of the supplier which may be deliberate or through negligence were managed by advising clients to open letters of credit that protected the dfcu clients. The staff were requested to share any more risks they thought are involved in the process and the responses can be seen in appendix 3

4.4 Exploration of the risk management practices put in place by the commercial banks when financing imports and exports

Table 4.20: Risk management practices Strongly Strongly Risk management practices Disagree Disagree Neutral Agree Agree % % % % % Assessment of the client’s s past financial performance 0 0 0 25 64.3 Request for collateral (security) from client for the funds offered 0 0 7.1 28.6 53.6 Insurance of goods----- 0 0 0 35.7 53.6 Appointment of collateral manager 0 0 10.7 35.7 42.6

The respondents strongly agreed that the following risk management practices had to be in place in order to complete safe lending process that financed imports and exports : assessment of the client’s past financial performance (64.3%) , requesting the client to present collateral (53.6%) , ensuring the goods are insured by a reputable insurance company (53.6%). The client’s past performance helped provide some comfort to the bank that they can handle the obligations of the nature they were about to sign off. Then the collateral was a fall back position incase the client couldn’t meet there contractual obligation of servicing the loan in the stipulated period and lastly the insurance of goods protected all the parties involved in case of any damage or unforeseen complications on the goods. The staffs were requested to share any more risk management practices they thought are involved in the process and the responses can be seen in appendix 3

4.5 The challenges faced and benefits of having in place proper risk management tools in DFCU bank.

a) Challenges

Table 4. 21: Challenges encountered when putting in place proper risk management tools

Strongly Strongly Challenges Disagree Disagree Neutral Agree Agree % % % % % Rising Costs of administration for the parties involved 0 0 17.9 28.6 42.9 The turnaround time for a transaction increases. 0 0 7.1 28.6 53.6 Banks more often deal with documents and never see the goods which exposes them to fraud. 0 0 7.1 7.1 75 Volume of business may decrease due to client’s concern for delays and levels of compliance with processes 0 3.6 21.4 28.6 35.7

From the table above it was established that 53.6% and 75% of the respondents strongly agreed that the key challenges of implementing the risk management practices were the increase in turnaround time on a transaction and exposure to fraud as the bank dealt with documents and not the goods financed respectively. The respondents were requested to share any more challenges they thought are involved in the process and the responses can be seen in appendix 3

b) Benefits

Table 4.22: Benefits of having in place risk management practices.

Strongly Strongly Benefits Disagree Disagree Neutral Agree Agree % % % % % Bank can easily identify and assess key operational risk exposures 0 0 0 32.1 57.1 Bank’s reputation is well protected and enhanced among its clientele 0 3.6 17.9 35.7 32.1 Default on loans is minimized and repayment potential increased. 0 3.6 32.1 32.1 21.4 Prepares the bank to play in the global trade arena safely and profitably. 0 3.6 39.3 39.3 7.1

The key benefits that respondents strongly agreed upon was that the placement of risk management practices were enabling the bank’s ability to easily identify and assess key operational risk exposures (57.1%) and enhancing the bank’s reputation (32.1%). The respondents were requested to share any more benefits they thought are involved in the process and the responses can be seen in appendix 3.

4.6 The Relationships among the Variables under study among the risks, challenges and

benefits of risk management practices.

Using the Pearson (r) correlation coefficient, the nature and the direction of the relationships between the study variables was established. The results of the correlation analysis are shown in the tables below:

4.6.1 The relationship between risks involved in financing of exports , imports and risk management practices put in place by commercial banks Table 4.23: Showing correlation between risks involved in financing of exports and imports and risk management practices put in place by commercial banks

1 2 3 4 5 6 7 8

Exchange_rates_fluctuation (1) 1 -.400* .140 .164 -.012 -.468* -.343 -.514** Influenced_by_fraud (2) -.400* 1 .458* -.096 .013 .427* .354 .636**

Influenced_by_political_risk (3) .140 .458* 1 .273 .158 .128 .045 -.029

Influenced_by_supplier_actions (4) .164 -.096 .273 1 -.014 -.035 -.230 -.240

Client_financial_performance (5) -.012 .013 .158 -.014 1 -.189 .400* .327

Request_for_collateral (6) -.468* .427* .128 -.035 -.189 1 .408* .303

Insurance_of_Goods (7) -.343 .354 .045 -.230 .400* .408* 1 .548** Use_of_collateral_manager (8) -.514** .636** -.029 -.240 .327 .303 .548** 1

** Correlation is very significant at the 0.01 level (2-tailed). * Correlation is significant at the 0.05 level (2-tailed).

The results of Pearson correlation coefficient as indicated in the table above, established that there was a significant positive correlation between financing of goods being influenced by fraud and appointment of a collateral manager ( r = 0.636, p<.01). This meant that fraud was a risk banks had to mitigate when financing export and imports through the appointment of a collateral manager to supervise the movement of the cargo that secured the loan. Therefore in cases where fraud was investigated, it turned out that goods had been released with presentation of fraudulent documents without payment and thus necessitating the appointment of collateral manager.

4.6.2 The relationship between having risk management practices in place by commercial banks and challenges they face of operating them.

Table 4. 24: Showing correlation between having risk management practices in place by commercial banks and challenges they face of operating them

1 2 3 4 5 6 7 8

Client_financial_performance (1) 1 -.189 .400* .327 -.119 -.050 .201 -.144

Request_for_collateral (2) -.189 1 .408* .303 -.374 -.367 -.094 -.564**

Insurance_of_Goods (3) .400* .408* 1 .548** -.337 -.485* -.195 -.568** Use_of_collateral_manager (4) .327 .303 .548** 1 -.415* -.518** -.183 -.702**

Rising_admin_costs (5) -.119 -.374 -.337 -.415* 1 .190 -.381 .546**

Transaction_turn_around_time (6) -.050 -.367 -.485* -.518** .190 1 .440* .558** Banks_deal_with_documents (7) .201 -.094 -.195 -.183 -.381 .440* 1 .114

Vol_of_business_decrease (8) -.144 -.564** -.568** -.702** .546** .558** .114 1

** Correlation is very significant at the 0.01 level (2-tailed). * Correlation is significant at the 0.05 level (2-tailed).

The results of Pearson correlation coefficient as indicated in the table above, established that there was a significant positive correlation between rising costs of administration for the bank and decrease in volume of business (r=0.546,p<.01). Also the increased turn around time for transactions and decrease in volume of business (r=0.558, p<.01). These results implied that the bank’s volume of business reduced due to the customers’ concerns for delays and request for levels of compliance with risk management practices that was reflected in the rising costs of administration for the bank and the increased turnaround time for transactions.

4.6.3 The relationship between having risk management practices in place by commercial banks and benefits of operating them.

Table 4. 25: Showing correlation between having risk management practices in place by commercial banks and benefits of operating them

1 2 3 4 5 6 7 8

Client_financial_performance (1) 1 -.189 .400* .327 .089 .165 .063 -.138

Request_for_collateral (2) -.189 1 .408* .303 .349 .515** -.029 -.294

Insurance_of_Goods (3) .400* .408* 1 .548** .408* .561** -.096 -.515**

Use_of_collateral_manager (4) .327 .303 .548** 1 .515** .503* -.014 -.505*

Key_operational_risks_identified (5) .089 .349 .408* .515** 1 .367 -.079 -.593**

Bank_reputation_enhanced (6) .165 .515** .561** .503* .367 1 .022 -.416*

Loan_default_minimized (7) .063 -.029 -.096 -.014 -.079 .022 1 .324

Bank_global_trade (8) -.138 -.294 -.515** -.505* -.593** -.416* .324 1

** Correlation is very significant at the 0.01 level (2-tailed). * Correlation is significant at the 0.05 level (2-tailed).

A positive and significant relationship was observed to exist between the bank ensuring that the financed goods are insured and the protection and enhancement of its reputation (r =.561** , p<.01). This implied that insurance of goods was a worthwhile risk management practice and it enhanced the reputation of the bank among the clientele.

CHAPTER FIVE DISSCUSION, CONCLUSION AND RECOMMENDATIONS 5.0 Introduction This chapter presented a discussion and conclusions drawn from the study findings, literature and recommendations. The chapter ends by suggesting areas for further research.

5.1 Discussion of the Findings 5.1.1 Risks involved in the financing of export and import of goods As earlier mentioned in the literature review business’ access to bank loans is mainly affected by both demand and supply constraints. The demand constraints referred to factors that made it difficult for businesses themselves to seek external finance from financial institutions such as poor quality of potential projects that qualify for funding , the inability of businesses to draft convincing business plans and lack of adequate collateral to secure the loan. From this research on DFCU it was established that 42% of the clients strongly agreed that access to funding was limited due to the banks strict lending conditions.

According to the African Economic Conference of 2015, many of the firms in Uganda lack an empowering formal legal status, which ultimately denies them the necessary capacity, tools and prerequisites for them to access and have effective demand for credit. They lack the prerequisites for credit access and demands such as collateral to acquire mortgages. This assessment was well reflected in the risks sighted by the respondents in chapter four of this research.

5.1.2 Risk management practices put in place by the commercial banks when financing imports and exports

The data captured from the responses of the staff indicated that risk management practices where in place but generally came at a high price of implementing them at DFCU. According to the literature review, significant studies have examined risk management practices worldwide

43 however, the empirical studies in the context of Uganda are scarce. Moreover, the number of publications showing comparison between the commercial banking seemed to be scanty.

The respondents strongly agreed that the following risk management practices had to be in place in order to complete safe lending process that finances imports and exports : assessment of the client’s past financial performance (64.3%) , requesting the client to present collateral (53.6%) , ensuring the goods are insured by a reputable insurance company (53.6%). The client’s past performance helped provide some comfort to the bank that they can handle the obligations of the nature they were about to sign off. Then the collateral was to serve as a fall back position incase the client couldn’t meet there contractual obligation of servicing the loan in the stipulated period and lastly the insurance of goods protected all the parties involved in case of any damage or unforeseen complications on the goods.

5.1.3 Challenges faced and benefits of having in place proper risk management tools in DFCU bank.

From the literature review after the global financial crisis, it was clear that access to affordable trade finance had been constrained. A number of banks, global buyers, and firms surveyed by the

World Bank were reported to be constrained by lack of trade finance and other forms of finance, such as working capital and Pre-export financing. In addition, the costs of trade finance are substantially higher than they were pre-crisis, raising the problem of affordability for exporters.

Small enterprise exporters in developing countries appear to be facing the greatest difficulties in accessing affordable credit. That view aligned with results of this research as respondents sighted challenges with risk management tools as making hard to approve lending to clients.

From this research on DFCU it was established that 53.6% and 75% of the respondents strongly agreed that the key challenges of implementing the risk management practices were the increase in turnaround time on a transaction and exposure to fraud as the bank dealt with documents and not the goods financed respectively

According to the literature review , the benefits of having an effective risk management are pointed out in the COSO framework and it is stated that enterprise risk management “helped an entity to get to where it wanted to go and avoided pitfalls and surprises along the way” (COSO

2004). It helped management to achieve the entity’s goals and prevented loss of resources and helped to ensure effective reporting and compliance with laws and regulation, thus avoiding damage to the entity’s reputation and other associated consequences. In agreement with the

COSO frame work the study on DFCU a positive and significant relationship was observed to exist between the bank ensuring that the financed goods are insured and the protection and enhancement of its reputation (r =.561** , p<.01). This implied that insurance of goods was a worthwhile risk management practice and it enhanced the reputation of the bank among the clientele

5.1.4 The Relationships among the risks, challenges and benefits of risk management practices. From the study it was established that there was a significant and positive relationship between fraud and lack of collateral. This meant that fraud was a risk banks had to mitigate when financing export and imports through the appointment of a collateral manager to supervise the movement of the cargo that secured the loan. Therefore in cases where fraud was investigated, it turned out that goods had been released with presentation of fraudulent documents without payment and thus necessitating the appointment of collateral manager.

Furthermore, from this study on DFCU it was established that there was a significant positive correlation between rising costs of administration for the bank and decrease in volume of business (r=0.546,p<.01). Also the increased turn around time for transactions and decrease in volume of business (r=0.558, p<.01). These results implied that the bank’s volume of business reduced due to the customers’ concerns for delays and request for levels of compliance with risk management practices that was reflected in the rising costs of administration for the bank and the increased turnaround time for transactions.

In the previous chapter the table showing risk management practices that the staff indicated as put in place to help mitigate risks, they noted that these practices came at a cost of reducing the volume of business if not well implemented.

5.2 Conclusions The study showed that the respondents both clients and the DFCU staff agreed about the existence of key risks that are involved in the financing of goods. The risks seemed to intersect at some points such as the clients sighted the big volumes of documentation requested by banks that they couldn’t gather and also the bank noting that customers wouldn’t provide the necessary documentation for processing their loans. The study also established significance around fraud as a risk banks had to mitigate when financing export and imports through the appointment of a collateral manager to supervise the movement of the cargo that secured the loan. Therefore in cases where fraud was investigated, it turned out that goods had been released with presentation of fraudulent documents without payment and thus necessitating the appointment of a collateral

46 manager. These findings provide an explanation why the bank insisted on full and authentic documentation.

It was established generally that about 50% of the DFCU staff believed that information technology systems contributed to the foundation of having in place proper risk management practices. From the study it was also noted that there was a significant relationship between rising costs of administration for the bank when implementing the risk management practices and decrease in volume of business. And indeed the increased turn around time for transactions as attempts were made to comply with the risk management practices and decrease in volume of business. These results implied that the bank’s volume of business reduced due to the customers’ concerns for delays and request for levels of compliance with risk management practices that was reflected in the rising costs of administration for the bank and the increased turnaround time for transactions. According to the literature, there weren’t empirical studies to show risk management practices in commercial banks of Uganda but this study suggests that it’s quite expensive for the banks to have and later implement these practices.

Drawing from the responses of the study which showed that both challenges and benefits existed when DFCU put in place risk management practices, study established the following on the two variables. First, the challenges appeared to make implementation of risk management tools a huddle to be cleared to approve lending to clients and thus making it expensive on the side of the bank. Secondly, the study showed significant relationship between the bank ensuring that the financed goods are insured and the protection and enhancement of its reputation. This implied that insurance of goods was a worthwhile risk management practice and it enhanced the reputation of the bank among the clientele.

5.3 Recommendations a) DFCU should prepare a less laborious list of required documents for their

customers and ensure potential and existing clients are sensitized. This list must

not compromise the key risk assessments that the bank depends on to lend safely.

b) Some of the risk management practices which are in place should be reviewed

and configured to support the loan approval process rather than appear to delay

and cause reduction of business development for the bank. Such practices

included the review of the client’s past performance and request for collateral to

cover the loan which increased the turnaround time and thus reduction in volume

of business.

c) DFCU customers were asked by the researcher how they thought the bank can

help them in order to manage risk:

Table 5.1: Below is the table showing the DFCU customer recommendations dfcu can help DFCU must not make payment for goods before the client confirms condition of the goods. Put in place a quick financing product specific for businesses like fishing with perishable goods to avoid unnecessary losses. To engage us and appreciate the seasons involved in our importation and make early plans to help us meet the financing requirements. Provide loans with less security requirements especially to clients with proven record. DFCU to help to provide financing alternatives that intervene in situations that come up outside the normal processes especially for clients with a good reputation with the bank. It helps to make stop gap measures to avoid delays and losses. DFCU should link their financial assessment process to the actual on- ground operation to match the market reality. Because of the uncertainties involved, banks always insist that their clients must provide some information such as detailed business plans that is met to fit their system and not the client’s market reality The bank needs to provide extra funding without asking for additional collateral if it’s already holding some security for an outstanding loan. This reduces the burden on the business to raise collateral needed for an emergency loan. Dfcu bank and other financial institutions should set affordable interest rates that won’t leave our business in a loss making position as we struggle to pay back the loan. Update our records with the credit reference bureau on time to avoid time wastage while obtaining funding from other banks. The bank can provide more products such as tax loan to help clear taxes in addition to the outstanding loan. It sometime occurs that goods arrive when the business has no money for taxes. Dfcu must support clients without experience in putting together bank documentation by providing hands on help rather than reject the application. Organise financing workshops where businesses can share best practices and also acquire more knowledge on alternatives in import and export financing. The fees involved on loan administration are sometimes too much. Dfcu can think about one off arrangement fee that caters for all the activities associated with offering a loan. The bank should be able to provide feedback on the possibility of acquiring a loan within 3 days or less. Rather than taking one through lengthy process with no idea of the outcome. DFCU must not make payment for goods before the client confirms condition of the goods.

Put in place a quick financing product specific for businesses like fishing with perishable goods to avoid unnecessary losses. To engage us and appreciate the seasons involved in our importation and make early plans to help us meet the financing requirements. Provide loans with less security requirements especially to clients with proven record. DFCU to help to provide financing alternatives that intervene in situations that come up outside the normal processes especially for clients with a good reputation with the bank. It helps to make stop gap measures to avoid delays and losses. The requirement for a detailed business plan can be waived or revised for short term transactions. dfcu to find a way to reduce the burden on the business to raise additional collateral needed for an quick loans for repeat borrowers. The bank must set a fixed affordable interest rate that does not change for the period of the loan. We request for better records management. Officers can request for same documents which have already been submitted. Our goods arrive with the taxes having been hiked and this requires quick financing. Dfcu can provide ways to clear the taxes and collect from the borrower. Give feedback on the possibility of obtaining a loan with in a week. We welcome workshops to help our businesses improve and learn more about risk mitigation in financing. Multiple fees for loan arrangement can be combined into one pay off. dfcu needs to improve on feedback time pertaining the decision of a yes or no. DFCU must not make payment for goods before we see them. Access to funds for trading should have a different approval process that is quicker. Dfcu officer should talk to us to find out what financing options can good for our businesses. Provide loans with less security requirements especially to clients with proven record. dfcu before making payments must call back always to avoid fraudlent transactions. The process of loan assessment should be more realistic and reflect the market conditions. Extra collateral needed to meet additional lending conditions is not necessary when dfcu is holding my security. Without affordable interest rates my business struggles to service the loan. Look into the rates.

5.4 Areas of further research Due to the scope and the limitations highlighted in chapter three, further research can be conducted in the following areas:

a) The scope of the study explored the risks involved in financing of imports and exports

and a selected number of clients and staff provided their opinions. Further research can

be done on how businesses have reorganized their operations to mitigate the risks in order

to minimize disruptions and delays,

b) The research concentrated on risk management practices put in place by DFCU to help

manage the risks involved in providing loans to its customers. Further research is

recommended into how the practices have impacted the business flow and magnitude.

This will help give some quantitive view on the opinions offered by the respondents

about the risk management practices have affected volume of business.

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Appendices

APPENDIX I: NUMBER OF LETTERS OF CREDIT.

Number LCs Import & Export Number of Import Year booked Number of LC clients loans booked & Export clients 2013 7 7 8 8 2014 4 4 5 5 2015 5 5 5 5 2016 4 4 7 7 Total 20 20 25 25 Source: dfcu trade finance database

APPENDIX II: QUESTIONNAIRE FOR THE STAFF OF DFCU BANK

Dear respondent,

I am a student at Makerere University pursuing a Masters degree in Business Administration. I am examining the risk management in import and export financing by DFCU bank. You have been selected to participate in this study by providing us with relevant information based on your experiences with DFCU.

Please answer diligently and the information sought is required only for academic purposes and will be treated with maximum confidentiality.

SECTION A: Background Information (Please Tick Appropriate) 1. Your years of experience in the bank Less than 4 years 4 – 9 years 10 years and above

2. Your department in the bank Finance Credit Sales and Marketing Operations

3. Level of involvement in the trade finance related transaction assessment Origination Checking Reviewing Approval

Section B: Risks involved in the financing of export and import of goods

What is your level of agreement with the following statements on risks involved in financing of exports and imports? Use a scale of 1-5 where; 1. Strongly Disagree (SD) 2. Disagree (D) 3. Neutral (N) 4. Agree (A) 5. Strongly Agree (SA) SN Risks involved in the financing of export and import of goods. 1 2 3 4 5

1. Financing of export and import of goods is influenced by price due to exchange rates fluctuation 2. Financing of export and import of goods is influenced by Fraud

3. Financing of export and import of goods is influenced by country / political Risk 4. Financing of export and import of goods influenced by supplier actions?

5. What are the other risks involved in the financing of export and import of goods? ……………………………………………………………………………………………………… ……………………………………………………………………………………………………… Section C: Risk management practices put in place by the commercial banks when financing imports and exports What is your level of agreement with the following statements on Risk management practices put in place by the commercial banks when financing imports and exports? Use a scale of 1-5 where; 1. Strongly Disagree (SD) 2. Disagree (D) 3. Neutral (N) 4. Agree (A) 5. Strongly Agree (SA) SN Risk management practices 1 2 3 4 5

The bank put in place the following in place to mitigate risks

1. Assessment of the client’s s past financial performance

2. Request for collateral (security) from client for the funds offered

4. Insurance of goods-----

5. Appointment of collateral manager

6. What are other risk management practices put in place by the commercial banks when financing imports and exports?

……………………………………………………………………………………………………… ………………………………………………………………………………………………………

Section D: Challenges faced and benefits of having in place proper risk management tools in banking sector

What is your level of agreement with the following statements on challenges faced and benefits of having in place proper risk management tools in banking sector? Use a scale of 1-5 where; 1. Strongly Disagree (SD) 2. Disagree (D) 3. Neutral (N) 4. Agree (A) 5. Strongly Agree (SA) SN Challenges faced 1 2 3 4 5

1. Rising Costs of administration for the parties involved

2. The turnaround time for a transaction increases.

3. Banks more often deal with documents and never see the goods which exposes them to fraud. 4. Volume of business may decrease due to client’s concern for delays and levels of compliance with processes Benefits

1 Bank can easily identify and assess key operational risk exposures

2 Bank’s reputation is well protected and enhanced among its clientele

3 Default on loans is minimized and repayment potential increased.

4 Prepares the bank to play in the global trade arena safely and profitably.

5. What are other benefits enjoyed and challenges faced of having in place proper risk management tools in banking sector?

APPENDIX III: QUESTIONNAIRE FOR THE CUSTOMERS OF DFCU BANK

Dear respondent,

I am a student at Makerere University pursuing a Masters of Business Administration. I am examining the risk management in import and export financing by DFCU bank. You have been selected to participate in this study by providing us with relevant information based on your experiences with DFCU.

Please answer diligently and the information sought is required only for academic purposes and will be treated with maximum confidentiality.

SECTION A: Background Information (Please Tick Appropriate)

1. For how long have you banked with DFCU bank Below 5 Years 5-10 Years 11-15Years Above 16 Years

2. What’s the annual frequency of your importation Once Twice Thrice Above 3 times

3. What’s the annual frequency of your export?

Once Twice Thrice Above 3 times

4. What’s the average cost of your annual consignment Below USD 100,000 Between USD100,000 – 500,000 Above USD 500,000

SECTION B: Risks involved in the financing of export and import of goods

What is your level of agreement with the following statements on risks involved in financing of exports and imports? Use a scale of 1-5 where; 1. Strongly Disagree (SD) 2. Disagree (D) 3. Neutral (N) 4. Agree (A) 5. Strongly Agree (SA) SN Challenges involved in the financing of export and import of goods. 1 2 3 4 5

1. Limited access to affordable pre-export financing due to strict bank loan conditions 2. Price fluctuation due to changing economic conditions.

3. Holding stock under collateral manager adds an extra cost burden that eats into the profits. 4. Lack of adequate understanding of how a letter of credit works

SECTION C: What are the risks involved in the financing of export and import of goods? ……………………………………………………………………………………………………… ……………………………………………………………………………………………………… ……………………………………………………………………………………………………… What are the challenges faced and benefits in getting trade finance from dfcu bank?

……………………………………………………………………………………………………… ……………………………………………………………………………………………………… How can dfcu bank help you to mitigate risks involved in financing imports and exports?

APPENDIX IV: RISKS, CHALLENGES AND BENEFITS INVOLVED IN FINANCING OF EXPORT AND IMPORT OF GOODS

a) Risks involved in the financing of export and import of goods. Customer reponses: category risks involved

Locating trusted suppliers who can provide up to standard goods. This process will require scouting Importer visits that can be costly. Fish is highly perishable and therefore the need for quick liquidity to process consignments but its Exporter always delayed which can lead to cancellation of order due to lack of funds. The wheat imported for bread baking has to be done in seasons. One needs money during those Importer seasons but we find ourselves with no funds and thus donot tap into good prices. Supplied goods being substandard due to client's inability to access enough funds for good quality Importer goods. Spending money on the processing activities and the bank delays to offer the loan which affects the Importer planned activities involved in delivery. One of the risks with financing imports is uncertainty about the condition of goods from suppliers who demand advance payment which can hamper business growth if we buy less not to take much Importer risk. At times the banks are unwilling to increase the loan without a corresponding increment in collateral. For a business dealing with fluctuating prices it risks all activities connected to the Importer shipment to suffer extra as they look for collateral which exposes us to losses We agree to short term financing which the bank sets at a high interest rate that causes the paid Exporter interest to plough into the revenues and we risk making no profits. As a foreign entity we find it quite time consuming spending time on issues concerning setting up business due to many government requirements to obtain an export license which in turn affects our Exporter investment returns. An inability to access the right information about financing alternatives on the market when it’s Exporter needed causes problematic delays Exporter Locating trusted suppliers who can provide up to standard goods. Fish is highly perishable and therefore the need for quick liquidity to process consignments but its Importer always delayed which can lead to cancellation of order due to lack of funds. The wheat imported for bread baking has to be done in seasons. One needs money during those Importer seasons but we find ourselves with no funds and thus donot tap into good prices. Supplied goods being substandard due to client's inability to access enough funds for good quality Exporter goods.

Spending money on the processing activities and the bank delays to offer the loan which affects the Importer planned activities involved in delivery. One of the risk with financing imports is uncertainty about the condition of goods from suppliers who demand advance payment which can hamper business growth if we buy less not to take much Exporter risk. At times the banks are unwilling to increase the loan without a corresponding increment in collateral. For a business dealing with fluctuating prices it risks all activities connected to the Exporter shipment to suffer extra costs which exposes us to losses We agree to short term financing which the bank sets at a high interest rate that causes the paid Importer interest to plough into the revenues and we risk making no profits. Risk of fraudulent goods from the potential suppliers that is usually borne by us after the bank has Importer made the payment and goods cannot be returned. An inability to access the right information about financing alternatives on the market when it’s Importer needed causes problematic delays The wheat imported for bread baking has to be done in seasons. One needs money during those Importer seasons but we find ourselves with no funds and thus do not tap into good prices. Supplied goods being substandard due to client's inability to access enough funds for good quality Exporter goods. Spending money on the processing activities and the bank delays to offer the loan which affects the Importer planned activities involved in delivery. One of the risks with financing imports is uncertainty about the condition of goods from suppliers who demand advance payment which can hamper business growth if we buy less not to take much Exporter risk. At times the banks are unwilling to increase the loan without a corresponding increment in collateral. For a business dealing with fluctuating prices it risks all activities connected to the Importer shipment to suffer extra as they look for collateral which exposes us to losses We agree to short term financing which the bank sets at a high interest rate that causes the paid Importer interest to plough into the revenues and we risk making no profits. Fluctuating prices of oil needs financing that is flexible in terms of amounts. Lack of access to such Exporter financing jeopardizes our capacity. Importer Our suppliers need cash in advance to release any fuel. Under funding limits our business growth. Potential losses due to fluctuations in prices of pharmaceuticals. By the time we order exchange Importer rates are with in the margin of profit and due to delays we are bound to suffer losses. Locating trusted suppliers who can provide up to standard goods. This process will recure scouting Importer visits that can be costly. Importer At electro gas the risk is obtaining working capital at low rates that will give us profitability. Importer Fluctuating prices of oil needs financing that is flexible in terms of amounts. Lack of access to such

financing jeopardies our capacity. Importer Our suppliers need cash in advance to release any fuel. Under funding limits our business growth. Importer MHD faces the risk of breaching contracts due to delays at the bank as they process the loans. Capital intensive investments like mining struggle to obtain funding due to the large amounts of Exporter money needed to inject into the operations. Few banks are willing to take a chance. Suppliers of grannules used for plastics on the international market are limited. We face the risk of Importer sourcing fake raw materials.

other risks Lack of documented bank credit polices for some trade finance products. Too many exceptions and waivers to the policy which may suggest that current underwriting guidelines may not be in line with the Bank’s priorities or financial goals. Poorly executed loan documentation undermines the bank’s ability to enforceable claim for repayment, including liquidation of collateral or the right to demand payment When collection problems persist and risk ratings deteriorate, many banks find it beneficial to transfer problem loans to an independent work-out team. Usually these loans are not recovered. Without sufficient risk tools banks can’t identify portfolio concentrations or re-grade portfolios often enough to effectively manage risk. Risk of deliberate fraud that is usually borne by the banks when we issue tokens which are credit products that are met to be secure to help clients transact. Trade finance products have a different credit policy which is not well documented.. For good risk management the tools must be aligned with the bank's strategic goals. Risk is without proper support the process can be futile. Lack of proper guidelines of liquidating collateral in the event the client fails to pay risks the bank suffering losses. When poorly performing loans increase, the risk appetite for the bank reduces which risks the growth of business. Risk driven lending can harm the growth of business. Fraudesters targeting the bank and causing disruptions. Lack of clear risk tools to fit the credit analysis. Failure to anticipate in time the clients who may default. Banks inadequate preparation to deal with problem loans before they are total losses. Working with text book matrix on credit analysis that doesnot fit the market environment factors. Working with customer documents that are not authenticated such as financial statements. These can easily provide a unrealistic picture of the clients financial performance. Goods lacking a market to generate revenue for the client to service the loan Forged documents that are meant to give a favourable financial position to the client. In the pursuit of hitting sales targets the risk of submitting substandard applications.

Some trade finance products are so technical that well trained personal are hard to find. Failure of client to perform as per contract obligations. Client’s ability to perform as per contract can risk regular loan servicing. Delayed payments from borrower's contractor that may cause default on payment Offering clients a bank product that doesn’t fit their operations which often exposes them to default.

b) Risk management practices put in place by the commercial banks when financing imports and exports. Other staff opinions: Other risk mgt practices Credit scoring systems that can help assess factors like expected sales turnover, business type, collateral assets and others determine the credit risk associated with a borrower. Systems in place such as SWIFT that can help mitigate risk associated with interbank transactions, foreign transactions and other types of transactions happening outside the bank. If the transaction at one end is successful but unsuccessful at the other end, loss occurs. We have in place strong IT systems with banking platforms that can halt security breaches in which data may be compromised. These IT systems receive constant technology upgrades to mitigate the exposure to cyber attacks. Segregation of staff duties helps to reduce internal theft and risks related to fraud. This prevents one individual from taking advantage of the numerous aspects of transactions and business processes or practices. Reducing complexity of a tool in different business processes mitigates operational risks. Dfcu achieves that by curtailing manual activities and the number of people and exceptions that rise during the implementation of business processes Key Performance Indicators (KPIs) are critical for timely detection and mitigation of risks, provided they are continuously monitored and reviewed. This helps to identify discrepancies proactively and manage them accordingly. Periodic assessments of all facets of operational risks bring more relief to organizational management. It is imperative to be risk-ready by gauging regulatory obligations, IT assets, skills, competencies, processes and business decisions. A well-documented and descriptive credit policy is the cornerstone of sound lending. Credit policies address the inherent and residual risks in lending. A documented loan approval authorities which are approved by the Board of Directors. This assists to maintain a balance between credit quality and profitable loan portfolio growth, appropriate lending authority controls must exist. Reporting and monitoring Loan Performance. It is important to identify trends within the loan portfolio and isolate potential problem areas. Ensuring all applications are subjected to the scoring systems to assess factors that are associated to the business of the borrower. Agreed set of interpretation guide lines for documents that are related to lending without ambiguity. Ensuring IT systems have regular updates on the firewalls to stop cyber attacks

IT systems that have levels of approval with checks and balances. Maintain a database of risks associated with loans that have performed and otherwise. The borrower must present a track record of performance in the operations to confirm competence. Confirming that audited accounts from the borrower are prepared by certified accountants. A form that helps indicate a score from the credit analysis. The score will then help management make lending decision. Periodic review of controls in place to mitigate the risks. Obtaining a market survey to assess the potential performance of goods under the existing economic conditions A properly designed credit policy is a key risk management practice. Proper checks on the documentation about the competence of the borrower in the area of operations must be obtained. Appropriate checks and balances in the approval process of the loan are one of the risk mitigants. Monitoring , reporting and evaluation of the funded transaction is key to ensure goods actually came through. Proper and thorough interpretation of the financial statements presented by the borrower.

c) Challenges faced and benefits of having in place proper risk management tools in banking sector. Other staff opnions:

Challenges Deciding on how to mitigate risk you cannot be entirely scientific, so the bank must also use human judgments that may not be integrated into some electronic systems Cost and Control associated with operating a some of the risk management tools is quite high and may not be welcome to be taken on. With the existence of tools, it’s hard to decide which to one to use, more often than not, the bank will take a one tool fits all approach to risk management, which can result in wrong decisions. Losses from risk of deliberate fraud that is usually borne by the banks when we issue tokens which are credit products that are met to be secure to help clients transact Operational risk which is due to failed internal processes, people and systems or from external events. Its occurs in situations where staff members are negligent with clients information and other aspects of the transaction. Failure of personnel to quickly learn the IT systems within the risk management tools that can lead to potential losses due to programming errors.

Deliberate security breaches targeting the applications that are installed to prevent data being compromised Having the right people in the right jobs that can operate and execute the technology. This can help appropriate workforce utilization, adherence to timelines, enhanced quality, and fewer errors and process breakdowns.

Skipping periodic assessments of operational risks due to focus on other demanding activities of the operations. Writing a fair and all descriptive credit policy that incorporates the interests of all stake holders can be a challenge. Yet this is the cornerstone of lending.

Heavily depending automated isk tools can lock out the human judgment which can bring balance to the system.

Cost involved in risk management tools is high.

Some of the tools used are text book and may not be relevant to the enviroment.

All risk associated to financing may not be indentified to provide a better management tool.

Credit teams use risk management tools to decline good business.

Credit teams may use these tools to deny good deals approval The challenge though is that the management team if entirely relays on the outcome of the risk management process they are bound to miss out on what is on the market that fits the client needs.

Human errors that render the tool inefficient due to lack of knowledge.

Management's failure to respect the tools in place and curmvent the processes. The risk management tools can easily hold back new innovations that will drive the business growth due to risk averse approaches.

Lack of assessments of the tools. the bank may become too risk averse

Credit policy that is meant to be a risk management tool can end up cutting growth.

Benefits Proper risk management tools allow for predicting and forecasting and also measuring the potential risk factor in any transaction. The bank’s management can also make use of certain risk management tools which can act as a valuable measurement that can be used to determine the level of lending. Secure IT systems reduce the risk of security breaches in which data can compromised. They reduce the impact of systemic risk which is meant not affect a single bank but the whole industry. Industry failures can be held at bay. The bank’s reputation has been enhanced significantly. The strong risk mitigation strategies have increased our customer’s confidence in the bank Segregation of tasks for the staff has ensured that the right people end up in the appropriate roles. Having the right people in the right jobs can reduce issues pertaining to business process execution and skill and technology usage. This also results in appropriate workforce utilization, adherence to timelines, enhanced quality, and

69 fewer errors and process breakdowns. Periodic review of risk incidents and various remedial activities employed in the past makes way for some of the most effective strategies to counter future risks Monitoring the loan Performance helps to identify trends within the loan portfolio and isolate potential problem areas. Reports to senior management provide sufficient information for an independent evaluation of risk and trends. Analysts can’t change risk management model parameters easily, which reduces the possibility of manipulation and collusion to favour the clients All risks involved can be properly measured and a decision made with safe boundaries. The magnitude of lending portfolio can be determined from the risk management process. Frandsters can be intercepted, With a database of historic risk , the bank can put in place controls that are more effective. Approval time is improved. Security breaches can be cubbed on time. The management team can benefit from the proper risk managed process and make safe and comfortable decisions All risks involved can be properly measured and a decision made with safe boundaries. The magnitude of lending portfolio can be determined from the risk management process. Frandsters can be kept at bay. With a database of historic risk , the bank can put in place controls that are more effective. Approval time is improved. Security breaches can be cubbed on time. The market will have confidence in the bank's security. The bank can focus on business growth without worrying about linkages that can eat into the profits.