CHAPTER ONE 

INTRODUCTION

1.1  Background of the Study

Commercial banks are the oldest and most diversified of all financial intermediaries. Banks have in the past 10 years made tremendous growth profits and asset growth in Cameroon. Banks like other business enterprises aim to earn profits and grow their balance sheet. They earn profits principally by obtaining funds at relatively low interest rates and then lending the funds or investing in securities at higher interest rates. The balance sheet of any bank means that it’s assets indicates what the bank owns or claims that the bank has on external entities (individuals, firms, governments and other banks). A bank’s liabilities indicate what the bank owes, or claims that external entities have on the bank (Saunders, 2008).

A sound, progressive and dynamic banking system is a fundamental requirement for economic development. As an important segment of the tertiary sector of an economy, commercial banks act as the backbone of economic growth and prosperity by acting as a catalyst in the process of development. They inculcate the habit of saving and mobilize funds from numerous small households and business firms spread over a wide geographical area. The funds so mobilized are used for productive purposes in agriculture, industry and trade (Vossen, 2010).

This study focused on the financial performance of commercial banks in Kenya. Aburime(2008) observed that the importance of bank financial performance can be appraised at the micro and macro levels of the economy. At the micro level, profit is the essential Prerequisite of a competitive banking institution and the cheapest source of funds. It is not merely a result, but also a necessity for successful banking in a period of growing Competition on financial markets. Hence the basic aim of every bank management is to maximize profit, as an essential requirement for conducting business.

At the macro level, a sound and profitable banking sector is better able to withstand negative shocks and contributes to the stability of the financial system. Bank profits provide an important source of equity especially if re-invested into the business. This should lead to safe banks, and as such high profits could promote financial stability (Flamini et al, 2009). However, too high profitability is not necessarily good. Uzhegova (2010) observed that too high profitability could be indicative of market power, especially by large banks. This may hamper financial intermediation because banks exercising strong market power may offer lower returns on deposit but charge high interest rates on loans. Too low profitability, in turn, might discourage private agents (depositors and shareholders) from conducting banking activities thus resulting in banks failing to attract enough capital to operate. Furthermore, this could imply that only poorly capitalized banks intermediate savings with the corresponding costs for sustainable economic growth.

1.1.1  Asset Management

According to Crockford, (1986) asset and liability management (often abbreviated AM) is the practice of managing risks that arise due to mismatches between the assets and liabilities. The process is at the crossroads between risk management and strategic planning. It is not just about offering solutions to mitigate or hedge the risks arising from the interaction of assets and liabilities but is focused on a long-term perspective: success in the process of maximizing assets to meet complex liabilities may increase profitability. The traditional AM programs focus on interest rate risk and liquidity risk because they represent the most prominent risks affecting the organization balance-sheet (as they require coordination between assets and liabilities).But AM also now seeks to broaden assignments such as foreign exchange risk and capital management. According to the Balance sheet management benchmark  survey  conducted  in  2009  by  the  audit  and  consulting company PricewaterhouseCoopers (PwC), 51% of the 43 leading financial institutions participants look at capital management in their AM unit.

1.1.2  Financial Performance

Financial performance and financial profitability are frequently used as interchangeable terms, (Burkhardt& Wheeler, 2013). With the increasing number of analysis and research papers referencing financial performances, there is a need to

have basic understanding of definition of financial performance and its various measures, (Burckhardt, 2013). Therefore, choosing a particular measure of financial performance depends on how well it meets the intended purpose. Financial performance of a bank is defined as its capacity to generate sustainable profitability, (European Central Bank (ECB), 2010). Therefore we can say that financial performance of a bank is its ability to employ the available resources to increase shareholders’ wealth and generate sustainable profits to strengthen its capital base through retained earnings to ensure future profitability.

Measurement of financial performance of any firm is crucial in deciding the strategies to be formulated to ensure that the firm is in the right path. This is particularly important in order to establish if a firm is making losses which if they become consistent may lead a firm to depleting its capital base, (ECB, 2010). Key drivers of measuring bank performances are earnings, efficiency, risk taking and leverage, (ECB, 2010). Firstly, a bank must be able to generate earnings to remain in operation, secondly, it should be efficient meaning it should be able to generate revenue from the given assets and make profits, thirdly, it should be able to adjust its earnings to overcome the various risks involved such as credit risk and finally it should be able to improve its results through the way it functions.

There are various ways through which bank performance can be measured. European Central Bank (2010) report has categorized them in to three major categories which are traditional, economic and market based measures. The traditional measures are similar to those used by other firms which include Return on Assets (ROA) which is the net income for the year divided by the total assets. The other measure is Return of Equity (ROE) which is the internal performance measure of shareholder’s value and this is the most famous measure of financial performance. The Economic measures of performance aim at assessing the economic results generated by the bank from its economic assets. The market based measures depend on the way the capital market value the performance of firm as compared to its economic and accounting value.

1.1.3  Effects of Asset Management on Financial Performance

According to Schoeb (2006), the primary goal of asset management is to produce a high quality, stable, large, and growing flow of net interest income. This goal is accomplished by achieving the maximum combination and level of assets, liabilities and financial risk. Asset Management calls for the understanding of the interaction between the various types of risks to ensure that they are not evaluated in isolation. According to Schoeb (2006), the primary goal of asset-liability management is to produce a high quality, stable, large, and growing flow of net interest income. This goal is accomplished by achieving the maximum combination and level of assets, liabilities and financial risk. Asset Management calls for the understanding of the interaction between the various types of risks to ensure that they are not evaluated in isolation. According to Schoeb (2006), the primary goal of asset-liability management is to produce a high quality, stable, large, and growing flow of net interest income. This goal is accomplished by achieving the maximum combination and level of assets, and financial risk. Asset Management calls for the understanding of the interaction between the various types of risks to ensure that they are not evaluated in isolation.

1.2  Research Problem

The issue of jointly managing assets and liabilities arises in a number of industries, such as banking, insurance, and pension funds, as well as at the level of individual households. The definitions of assets, liabilities, and risks are specific to each institution, but, very generally, assets may be viewed as expected cash inflows, and liabilities as expected cash outflows. Although short-term risks arising from the possibility that an institution’s assets will not cover its short-term obligations are important to assess and quantify, AM is usually conducted from a long-term perspective. It therefore suffices to say that, AM is considered a strategic discipline that influences the financial performance as opposed to a tactical one to take market position (Choudhry, 2007).

In so far as the importance of the above discourse is concerned, AM is an integral as it is a significant component/determinant of financial performance of any financial institution especially the commercial banks. According to Romanyuk (2010), AM has its pros and cons that cannot go unmentioned if a balanced and scholarly approach is to be achieved in this research. He says that some of the challenges of AM include but are not limited to; Firstly, each client has their particular objectives, risk tolerances, and constraints, and it would be difficult to devise an optimization algorithm that would realistically account for these specific characteristics when evaluating portfolio allocation decisions. Secondly, long term strategic decisions depend on factors whose forecasts may not be readily available to the bank. Thirdly, risk preferences and their changes over time must be translated into mathematical language, which is far from trivial.

Finally, a reasonable AM model must put all of its different components (assets, liabilities, goals, institutional and policy constraints, etc.) together in a meaningful manner, which is difficult. Conversely, AM has benefits whose real value far outweighs any of the aforementioned challenges. Firstly an understanding of the company’s overall position in terms of its obligations; comprehensive strategic management and investment in view of liabilities; the ability to quantify risks and risk preferences in the AM process; better preparation for future uncertainties; and, ideally, gains in efficiency and performance from the integration of asset and liability management. If an AM framework is well done and implemented, banks would make great and sustainable profitability and growth trends going by the value of the aforementioned benefits. It suffices to authoritatively say that proper formulation and implementation of AM concept would spur financial performance.

However, if the data and statistics from the Citi research (2012) on Cameroon banks is something to go by, it is evident that poor AM management has crippled if not weakened the growth of commercial banks in Cameroon. This has led to the fall of some banks and to others, it has led to inevitable/forced mergers so as to remain afloat. This therefore warrants further study for AM is essential to a strong banking sector hence its poor management can lead to catastrophic destruction to the financial sector of Cameroon’s budding economy.

This study addressed the following research question: What is the effect of asset management practices on the performance of commercial banks in Cameroon?

1.3  Objective of the Study

This research study sought to find out the effect of asset management on financial Performance of commercial banks in Cameroon