CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Lending is the primary business activity for most financial organizations. The loan portfolio is often the greatest asset for microfinance firms and is the most common source of revenue. According to Boateng (2011). The loan portfolio is often the greatest asset for microfinance firms and is the most common source of revenue.  In the United States, effective credit risk management  of  the  loan  portfolio  necessitates  that  the  board  of  directors  and  management understand and oversee the bank’s risk profile and credit culture. To do so, they must have a solid understanding of the portfolio’s makeup as well as its inherent risks (Matovu & Okumu, 2013). For decades, good loan portfolio managers have focused their efforts on properly authorizing loans and closely monitoring loan performance. Despite the fact that these operations remain the backbones of loan portfolio management, prior credit problems, such as those linked with oil  and  gas  lending,  agricultural  lending,  and  commercial  real  estate  lending  in  the  1980s, have shown that portfolio managers should do more (Laurence, 2013).

The  major  goal  of  microfinance  is  the  provision  of  microloans  to  the  low-income  and  the  poor households (Bystrom, 2007). The chance that a microfinance institution (MFI) may not receive its money  back  from  borrowers  (plus  interest)  is  the  most  common  and  often  the  most  serious vulnerability  in  a  microfinance  institution.  Since most microloans are unsecured, delinquency can quickly spread from a handful of loans to a significant portion of the portfolio. This contagious effect is  exacerbated  by  the  fact  that  microfinance portfolios often have  a  high  concentration  in  certain business sectors. Consequently, many clients may be exposed to the same external threats such as livestock disease outbreak and bad weather. These factors create volatility in microloan portfolio quality, heightening importance of controlling credit risk. In this regard,  MFIs needs a monitoring system  that  highlights  repayment  problems  clearly  and  quickly,  so  that  loan  officers  and  their supervisors can focus on delinquency (repayment rate) before it gets out of hand. In lending services, a default is the failure to pay back a loan. A loan is delinquent when a payment is late (CGAP, 1999).

Delinquent  loans  are  also  called  impaired  loans  or  non-performing  loans  (NPL).  A loan is delinquent if payments or installments of the loan are delayed or overdue by a certain number of days. The time limit is usually 90 days, as often used by banks and financial institutions. So NPLs are those loans for which the principal and/or interest payments are in arrears by at least 90 days. Subsequently,  if  one  or  more  installments  are  never  repaid,  the  loan  becomes  default.  But delinquent loans do not always go into default. For instance, Athreya, Sánchez, Tam and Young (2018), in their study on consumer debt delinquency, observe that 85% of borrowers, who are late on payments by 2-3 months, pay during the next quarter, and 40% reduce their debt. Sharma and Zeller (1997), in their analysis on group-based microcredit programs, also opine that most of the arrears are eventually paid, albeit late. Even if the loans do not necessarily turn into default, delinquency adversely affects the financial performance of banks and other lending institutions. 

A delinquent loan becomes a defaulted loan when the chance of recovery becomes minimal. In microfinance group lending model is one of the best practices in Africa (Schreiner, 2003). The  MFIs lends  to  self-help  groups  (SHGs)  which  on  lends  to  the   group  members.  This  suggests  that  group governance  including  self-internal  regulations  and  screening  process  for  members  for  loan qualifications, may affect loan delinquency levels of the lending MFI. MFIs and SHGs operate under the influence  of  external  factors  such  as  macroeconomic  factors  which  are  beyond  their  control.  This implies that in absence of quality governance and strategic plans aimed at mitigating adverse effect of external factor on credit risk, may contribute to high levels of delinquent loans.

In  Europe,  in  the  view  of  Nwankwo  (2000),  “credit  constitutes  the  largest  single  income earning asset in the portfolio of most financial institutions. This explains why banks spend enormous resources to estimate, monitor and manage credit quality”. This is understandably, a practice that impact greatly on the lending behavior of banks and other financial institutions as large resources are involved.  In UK, Chodechai (2004) while investigating factors that affect interest rates, degree of lending volume and collateral setting in the loan decision of banks, says:  Banks have to be careful with their pricing decisions as regards to lending as banks cannot charge loan rates that are too low because the revenue from the interest income will not be enough to cover the cost of deposits, general expenses and the loss of revenue from some borrowers that do not pay (Chodechai, 2004).

In  Africa,  in  most  of  the  developments  that  improve  the  loan  portfolio’s  liquidity  have implications for price risk. Traditionally, the lending activities of most banks in Ghana were not affected by price risk.  Because loans were customarily held to maturity, accounting doctrine required book value accounting treatment. However, as banks develop more active portfolio management practices and the market for loans expands and deepens, loan portfolio has become increasingly sensitive to price risk (Nnanna, 2005).The banking industry has suffered massive losses over the last decade. Firms that had been performing  well  suddenly  announced  large  losses  due  to  credit  exposures  that  turned  sour, The  Reserve Bank of Zimbabwe (RBZ) pointed out what it terms “imprudent loan  portfolio

management  practices”  as  being  one  of  the  major  causes  of  the  banking  crisis  of  2004. Commercial  banks  have  nearly  uniformly  upgraded  their  loan  portfolio  management  and control systems as a result of this (Gieseche, 2004). Portfolio theory provides a foundation for understanding the interaction of systemic risk remand in Ugandan financial institutions. It has influenced how institutional portfolios are managed and encouraged the adoption of passive investment strategies.  As  more  and  more  organizations  move toward a management by projects approach,  portfolio  management  is  being  used  in  a  variety  of  other  fields, particularly project management (Okorie al., 2007). Microfinance institutions are an important instrument for boosting financial inclusion and alleviating poverty in developing countries

The  financing  of  sustainable  development  of  MFIs  is  clearly  deficient  when  levels  of loan delinquency remain high. Despite the fact that MFIs use various techniques of screening borrowers, the level of delinquent loan keeps on increasing. For instance, the stock of delinquent loans in self-help  groups  expanded  from  7.17%  in  2008  to  28.22%  in  Kerugoya  district  in  Kenya  while  for individual borrowers default increased from 2.21% in 2009 to 4.44% end of 2010 (Pamoja, 2010). In Bolivia loan delinquency increased by an average of 4% (i.e. from less than 5% to almost 9%) over 1999-2001 while by 2002 delinquency rose to 17% (Dinos & Ashta, 2010).  Internationally MFI portfolio delinquency levels began to deteriorate rapidly, with loans past due over 30 days (portfolio at risk) jumping from a median of 2.2 percent to 4.7 percent in June 2009 (CGAP, 2010).  loan  delinquency  hinders  financial  access  facilitation  to  the microfinance  client and  may  negatively  affect  the  level  of  private  investment; constrain the  scope of  MFIs credit to borrowers  through  reduction  of  MFIs’ capital,  and accumulation of  losses  to  compensate  for  loan  losses.  Indeed, loan delinquencies impoverish the borrower through loan securities seizures, loss of social status and personal integrity, legal fees and penalty charges.

1.2 Problem Statement

MFIs’  survival  is  largely  dependent  on  the  performance  of  their  loan  portfolios.  This  is because  MFIs  make  the  majority  of  their  money  through  interest  on  loans  to  small  and medium-sized businesses. The loan performance of these institutions, however, is determined by the loan portfolio management strategies used by the institution, including BRAC Uganda Microfinance ltd (Mbabazi, 2012).

Despite the growth of microfinance institutions in Bamenda, there remains a persistent issue of loan delinquency. Studies by Njong and Tabi (2015) suggest a correlation between ineffective loan portfolio methods and rising delinquency rates, pointing to a critical gap in the understanding of factors contributing to this phenomenon. Achua (2015) and Mbah (2018) identified factors contributing to this issue, emphasizing the need for an in-depth investigation into the specific impact of loan portfolio methods on delinquency rates. Addressing this gap is essential for the sustainable development of microfinance in Bamenda thus the reason for the study Effect of Loan Portfolio Methods on Loan Delinquency in Microfinance Institution in Cameroon (Case Study Bamenda II).

1.3. Research Questions

1.3.1. Main Research Questions

What is the Effect of Loan Portfolio Methods on loan delinquency in Microfinance Institution in Bamenda II?

1.3.2. Specific Research Questions

To what extent does risk identification and assessment affect loan delinquency in Microfinance Institution in Bamenda II?

What is the effect of credit quality analysis Methods on loan delinquency in Microfinance Institution in Bamenda II?

What is the effect of performance monitoring and reporting on loan delinquency in Microfinance Institution in Bamenda II?

1.4 Research Objective

1.4.1 Main Research Objective

To investigate the Effect of Loan Portfolio Methods on loan delinquency in Microfinance Institution in Bamenda II

1.4.2 Specific Research Objective

To find out the effect of risk identification and assessment affect loan delinquency in Microfinance Institution in Bamenda II

To examine the effect of credit quality analysis Methods on loan delinquency in Microfinance Institution in Bamenda II

To analyze the effect of performance monitoring and reporting on loan delinquency in Microfinance Institution in Bamenda II