CHAPTER ONE

INTRODUCTION

1.1 Background of the study

1.1.1 Conceptual background.

In Cameroon, all commercial banks activities are being control by an agency called COBAC. In the CEMAC zone, the regulation of COBAC was important because most of the MFIs operating in the sub-regions were believed to have reached financial sustainability and were now trying to operate as commercial banks or financial institutions (Turker and Miles, 2004). This lead to a rise in competition between these MFIs thus affecting lenders, decrease accountability and distorted governance practices within the sector (Mclntosh et al, 2005). He argue that, as the result of the rise in the number of MFIs operations in the sub-region, most of these MFIs competing directly for poor client; therefore they are unable to price the risk associated with the uncollateralized loans they provided to these poor clients. Some of these poor clients took advantage of the situation to take out multiple loans from different lenders and when it was time to repay, they were unable to do so. This resulted to high level of bad debts incurred by MFIs and high delinquency rate witnessed in the late 1990s (Dixon et al, 2007). In order to recovery this loans, MFIs were force to employ various unorthodox method (Dixon et al, 2007).This in one way or the other reduced the performance of MFIs. Financial performance of microfinance particularly across African economies where less understood partly due to inadequate data Honohan, (2004). However, while is it importance for microfinance institutions to be profitable? Profitability is an appropriate mechanism for achieving long terms viability of microfinance industry. Profit may be and importance source of equity in a microfinance institutions. Profitability of microfinance is the measure of the overall performance, effectiveness of the firm. It is uses to measure the performance of management, identifying whether a company may be worthwhile investment and determine the institutions capacity relative to its competitors. On the other hand, the indication of profit in the banking sector include profit earn by the bank, growth and expansion prospects of the bank. An institution should earn profit in order to survive and grow over a long period. Profit is essential nuts, wrong to assume that every action initiated by management of the company is maximizing profit. It is a fact that, sufficient profit must be earned to sustain the operations of the business to be able to obtain fund from investors for expansion and growth. Profit in general is the difference between expenses and revenue over a period of time Van Horne, (2002). In economic sense, Profit will mean, net in wealth, net cash flow and change in the values of the firm asset. It is assume that item of revenue and expenses are on cash basis still they will be difference between accounting profit and cash profit. Profit is the result of operations of an organization. Profit maximization is considered by the traditional economics as the objective of the firm.

1.1.2 Historical background.

In the past years money lending can be traced to about 3000 BC in ancient Mesopotamia. Location in today’s Meddle East, ancient Mesopotamia was home to many different groups, including Sumerians, Assyrians, and Persians. Before fiat currency was widely used, these ancient people used food as a way to pay their debts. With the promise of harvest in the spring, farmers would borrow seeds and then shares their crops to pay their debts. During this lending period, the people where using their wife and children as collateral if in case they did not meet payment of their debt. The wife and children will work for 3 years with the lender before the debt is cancel. Due to this, the ancient people started asking the government to provide some forms of loan relief in time of difficulties. In Indian, the first bill of exchange was to determine the date of payment. However, in the modern days, a central bank or financial authority will regulate moneylenders. There is a limit of how much money can be lend, which make the risk of huge debt occurring less likely. They number of loans available today included; secured loans, unsecured, pawn broking, demand and concession. Microfinance can be trace back as long as to the middle of the 1800s when the theories Lysander Spooner was written over the benefit from small credits to entrepreneur and farmers as a way of getting the people out of poverty.

According to consultative Group to Assist the Poor (CGAP, 2001) report, nearly three billion (n) Poor people lack access to the basic financial services essential for them to manage their businesses and it is estimated that about 35% of people in developing countries live below the poverty line subrata. In Ghana, it has been estimated that the poverty level for women across all the regions of Ghana is 51% and that of men is 49% (GRS, 2003). These people cannot grow their businesses owing to lack of access to credit. Microfinance therefore comes in to bridge this gap by evolving as an economic development approach intended to assist economically active poor through the provision of micro financial services. Today used of micro financing has its roots in the 1970s when organizationssuch as Grameen Bank of Bangladesh with the microfinance Pioneer Mohammad Yunus, was starting and shaping the modern industry of micro financing. Microfinance in 1970s was a program thatpeople could relied on to repay their loans and that it was possible to provide financial base to poor people through market base enterprises without subsidy. Shore bankwas the first microfinance and community develop bank founded in 1974.

1.1.3 Theoretical background

The theoretical foundations of this study are minimizing ex-ante moral hazard theory and loan pricing theory.

1.1.3.1 Minimizing ex-ante moral hazard theory

This theory was proposed by Kenneth Arrow. In his 1971paper, “the theory of moral hazard”, Arrow argued that risk-averse individuals will tend to take on more risk when they know that their losses will be covered by insurance or some other form of protection. This creates a moral hazard, where individuals take on more risk than they otherwise would. To minimize this moral hazard, Arrow proposed that individuals should be required to bear some of the risk they take on. The main limitation of the moral hazard is that it does not have complete information about the risks they are taking on. This can lead to individuals taking on more risk than they would if they had perfect information.

1.1.3.2   Loan pricing theory

This theory was propose by H.V Prochanowin 1944 based on the loan practice of extending loan to the public. He argued that, loans assigned to the clients should be examined based on the capacity of this client and the interest rate set on these loans should be low in order to encourage the poor. Loan pricing theory often assumes that lenders have perfect information about the credit risk of borrowers and can accurately assess the profitability of default. In practice, lenders may face challenges in accurately assessing loan risk, especially for borrowers with limited credit history or in volatile economic conditions. This can lead to mispriced loans and potential losses for lenders.

1.2 Problem of the statement

Microfinance institutions play an important role in every economy. NGO (2016) pointed that finance is the lifeblood of any business. Microfinance Institutions (MFIs) over a couple of decades has moved from the giving of subsidized credit that depends on the benevolence of donors to a self-sustainable financial company that gives credit to its clients. They offer funds to all the sectors of the economy with some terms and conditions of repayment. The success of microfinance depends on a number of factors including loan recovery strategies.

However, it becomes unfortunate that all loan granted by MFIs end up not being fully recovered. This may be as a result of late repayment or customer delinquency (inability to pay).Repayment of loans by clients ensures sustainability of microfinance institutions and therefore default by clients to repay loans (credit) tends to affect MFIs in diverse ways. Low financial performance, unsustainability and bankruptcy may be some of the consequences faced by MFIs as a result of delinquent loans.

The purpose of this study is to examine the effect of loan delinquency on the financial performance of Ntarinkon Cooperative Credit Union. It seeks to assess the effect of internal and external factors of loan delinquency on the financial performance of MFIs.

1.3 Research questions

The research questions are divided into two parts, the main research questions and the specific research objectives.

1.3.1 Main research questions

What are the effects of loan delinquency on the financial performance of microfinance institutions case of NTACCUL?

1.3.2 Specific research questions

• What is the effect of the internal factors of loan delinquency on the financial performance of microfinance institution case of NTACCUL?
• What is the effect of the external factors of loan delinquency on the financial performance of microfinance institution case of NTACCUL?

1.4 Research objectives

The research objectives are divided into two parts, the main research objectives and the specific research objectives.

1.4.1 Main research objectives

The main objective of this study is to examine the effects of loan delinquency on the financial performance of microfinance institutions case of NTACCUL.

1.4.2 Specific research objectives

• To assess the effect of the internal factors of loan delinquency on the financial performance of microfinance institution case of NTACCUL.
• To assess the effect of the external factors of loan delinquency on the financial performance of microfinance institution case of NTACCUL.