CHAPTER ONE

INTRODUCTION

1.1   Background of the Study

Financial innovation is important in determining economic growth in any economy. Various sectors of the economy depend on the financial sector for growth and without the input of the financial sector economic growth seems unrealistic since no economy performs without finances. The financial sector is therefore a key component of economic development in any country. It provides intermediation services by bringing together savers and investors by channeling funds to investments that guarantee positive return. A stable and efficient financial system pools, transfers and minimizes risks while at the same time increasing liquidity and information sharing through the use of more sophisticated financial products and technology (Puatwoe and Piabuo, 2017).

The Cameroonian market has recently witnessed a host of changes in the financial sector as a result of changes in the legal, regulatory, institutional framework and fast changing technology and its influence on the provision of financial services. The increasing development of the financial services sector has allowed many people to have access to financial services, especially those without prior access to these services. The main driver of this change has been mainly new technologies such as mobile phones and ATM machines, which have facilitated access to these services Laeven (2012). These technological innovations have transformed the Cameroonian financial sector landscape in the past few years, by helping to extend financial services to millions of poor people at relatively low cost.  

Mobile telephone money transfer services have also emerged strongly, allowing mobile phone users to make financial transactions or transfers across the country conveniently and at low cost.

The adoption of mobile phones has occurred at perhaps the fastest rate and to the deepest level of any consumer technology in history. (Buku and Meredith, 2013) The fixed line telephone, the predecessor to mobile phones took 100 years to reach only 80 percent of the population in developed countries while mobile phones have been adopted more than five times as fast. The benefit and impact of widely available mobile phone technology has been more apparent than in Africa, where networks of both fixed line communication and physical transportation infrastructure are often inadequate, unreliable, and dilapidated.

Currently, there are more Cameroonians who own a mobile phone rather than having access to a bank account. This lack of access to financial services, combined with the increasingly widespread use of mobile phones, has given rise to an informal practice of using mobile phones as an alternative to traditional banking systems Luc et al., (2012). Mobile phone users can transfer funds to other users through pre-paid mobile phone credits sent via short message service communication. Upon receipt, these credits are exchanged for cash or traded for goods and services in a type of informal, mobile phone based economy that provides basic financial services to otherwise un-served or unbanked populations (Duncombe and Boateng, 2009).

Financial innovation is used to refer broadly to any change in the financial system that improves the screening of technological entrepreneurs. Thus, financial innovation is neither limited to the invention of new financial instruments, nor is it limited to innovation by financial institutions. Financial innovation also includes more modern financial improvements, such as the new financial reporting procedures that facilitated the screening and monitoring of railroads in the 19th century, improvements in data processing and credit scoring that enhanced the ability of banks to evaluate borrowers since the 1970s, and the adoption and upgrading of private credit bureaus around the world during the last few decades (Laeven et al., 2012).

In some instances, new financial products are engineered from existing products. This demonstrates that the new instruments need not add new price risk to the system, but by adding liquidity and new intermediaries they may contribute additional credit or liquidity risks. An analysis of the demand for financial market services in an assumed perfect capital market setting supports an argument that financial market innovations are attempts to overcome real-world market imperfections while making a distinction is between imperfections that are man-made  such as taxes, regulatory barriers, and information disclosure versus those that segment domestic markets and are naturally present such as transaction costs, heterogeneous expectations, and consumption/investment/risk preferences. Innovations that overcome the former may directly frustrate national economic policies, including useful prudential policies.

Ho, (2006) describes financial innovation as the emergence of new financial products or services, new organizational forms or new processes for a more developed and completed financial markets that reduce costs and risks, or provide an improved service that meets particular needs of financial system participants. Ho further argues that the centrality of finance in a modern economy and its importance in economic growth naturally raise the requirement for financial innovation. Since finance is an input to virtually all production activities and most consumption activities, improvement in the financial sector will have positive, direct ramifications throughout the economy.   

According to Luc et al.,  (2012) financial innovation refers broadly to any change in the financial system that improves the screening of technological entrepreneurs. Thus, financial innovation is neither limited to the invention of new financial instruments, nor is it limited to innovation by financial institutions. Similar to the arguments by Laeven, Levine and Michalopoulos (2012) they further argue that financial innovation also includes more modern financial improvements, such as the new financial reporting procedures that facilitate the screening and monitoring improvements in data processing and credit scoring that enhances the ability of banks to evaluate borrowers and the adoption and upgrading of private credit bureaus around the world during the last few decades. 

Financial innovation influences the structure of financial markets, the financial behavior of economic agents and the types of financial products traded. It therefore influences the entire monetary transmission mechanism, and adds uncertainty to the financial environment in which central bank conducts monetary operations (Ho, 2006) Boot & Marino (2011) however suggest a cautious approach to innovations and their adoption in the banking sector. They assert that considering the herding behavior and more impulsive decisions that financial markets may facilitate include possibly the boom-bust nature of financial markets, they argue that the increased linkages between banks and the financial markets have augmented instability in banking and bank-based systems may have felt this most. One could say that the institutional structure including regulation has not kept up with the enhanced marketability and changeability of the industry.

Other major players within the financial system, such as commercial banks until recently looked at microfinance as a market niche. Attitudes continue to evolve as developing countries strife at incorporating microfinance into the mainstream financial system. Thanks to ongoing expansionary and aggressive market penetration measures adopted by major players, CAMCCUL, CCA and MC2, growing customers and members confidence in the 1st Trust and CCA brand and swift response made by  major stakeholders following the collapse of COFINEST to regain customers and members confidence. Major players such as MC2 launched more than eight new units that fully went operational, while CAMCCUL registered more than ten new units.

The exponential growth that greeted the microfinance market of Cameroon in 2010 slows down in 2011 following the collapse of a major player CONFINEST that affected customers and member’s confidence negatively. In early 2011, the government announced the official closure of COFINEST with major shareholders arrested for mal-practices and mismanagement in the market. This sparked fear within depositors and non-depositors who rushed in other microfinance institutions to withdraw their deposits. However, with quick action taken by major stakeholders such as the government to ensure creditors start receiving their funds, and assurance from other players such as CAMCCUL, MC2, and CCA customers gradually regain confidence

Following the collapsed of CONFINEST a major player in the microfinance sector in 2011 regulatory authorities became actively involved in the control and supervision of MFIs activities. For example, control mission from the regulatory and supervisory authority COBAC became increasingly present in major MFIs to scrutinize their activities with respect to basic prudential norms. Again, attempt by the government to win the interest of different stakeholders particularly in the phase of the crises in North Africa and the Presidential election billed for October 2011 led to a corporate citizenship image. COBAC recently started a nationwide evangelism to sensitize promoters of microfinance institutions in Cameroon on the need of professionalism so the sector does not become an all-comers affair.

The Cameroon microfinance landscape is out rightly dominated by class one institution that controls close to 86% of the market in terms of number of institutions and outlets with CAMCCUL the market leader controlling an outright 55% of the overall market. In 2010, and 2011 category one MFI constituted about 510 of the 589 institutions existing in Cameroon at the time. The growing number of category one institution is their easy formation, lower capital requirements and the fact that they can easily opt to belong to a network and benefit the many advantages from the umbrella institution. The case of CAMCCUL, MC2 and CVECA are good examples. However, in value terms and overall market growth, category two institutions experienced the fastest growth, registering more than 35% of value and volume growth in 2010/2011.  Thanks to their strong position in most urban areas and target of the mid to richer portion of the deprived segment of the population.

Through growing partnership between commercial banks and MFIs in Cameroon, the distribution of electronic cards became increasingly noticeable between MFIs customers in 2011. Major Commercial banks such as Afriland First Bank distributed electronic cards to MFIs clients through MC2 their rural banking channel, while EB-ACCION the microfinance brand introduced by Ecobank in partnership with Accion International, distributed electronic cards to its customers with possibilities of their customers to withdraw cash using the card directly from the ATMs installed in the MFI. This trend is expected to continue particularly as major category two institutions warm up for license as a full flesh bank.

Over the forecast period the microfinance market is expected to continue to register an annual growth of 15%, in deposits, credits, and number of outlets. Growth is expected to be driven by growing members and customers` acceptance of mobile money and micro-insurance, activities of new players such as EB-ACCION, expansionary strategies adopted by CCA and 1st Trust and favorable measures put in place by the government to protect depositors.  Again, new players of late have laid emphasis on daily cash collections, with concepts such as bankers on wheel, backup and money pause increasingly gaining customers` acceptance. The present of successful and sustainable microfinance models such as the MC2, of the First bank Group and the credit Union that have been able to overcome the challenges traditionally faced by the financial services sector in servicing the low income population are prominent factors expected to drive growth. 

In its traditional microfinance form, the route of formal microfinance activities can be traced back in 1963 following the creation of the first cooperative savings and loans institution (Credit Union), at Njinikom in the North West region of Cameroon by a Roman Catholic clergy. Development of microfinance institutions and their activities remain blurred until the early 1990s when President Paul Biya in order to incorporate the elites and various interest groups into his New Deal Policy passed the remarkable law N⁰90/053 of 19 December 1990 relating to freedom of associations, and Law N⁰92/006 of 14th August 1992 relating to cooperatives, companies and common initiative groups. 

Another major contributing factor to the growth and development of microfinance activities in Cameroon can be linked to the banking crisis in the late 1980s that resulted to the closure of branches of commercial and developmental banks in rural areas and some cities. Many top executives lost their jobs, some were dismissed. Some of these executives and employees formed cooperative credit unions that function like mini banks. As microfinance activities gained heavy weight in the financial system of the country, the roles of different stakeholders became clearly defined as the supervisory authorities configured MFIs within the national territory

With growing interest in the sector in the absence of effective governance mechanism, the monetary authority in other words the Ministry of Finance took over control of the microfinance sector initially placed under the ministry of Agriculture. This led to a series of texts relating to sub regional integration, supervision and control of microfinance activities. These texts were adopted unanimously by a council of Finance Ministers from the Economic and Monetary Community of Central Africa (CEMAC) by 2005.

Since after the classification, commercial banks involvement in microfinance in Cameroon has increasingly become visible. Starting with, Afriland First Bank- created MC2, the microfinance brand in 1992, BICEC another giant in the banking sector created ACEP and CVECA, while from the opposite direction CAMCCUL network created UBC a commercial bank that out rightly failed to take advantage of the pool of competitive advantage offered by CAMCCUL. New players in the sector include SGBC that introduced the Ad-vans microcredit brand and Eco-bank that brought in EB-ACCION the latest player in the market in 2009.

Cameroon microfinance industry gain credence from the fact that it is serving mostly people who have been made un-bankable by the traditional banking system. This is expected to further facilitate the development of microfinance in Cameroon.

Microfinance institutions (MFIs) have improved access to credit and banking services for poor Cameroonians. Reports are frequent in newspapers of dubious MFIs disappearing with the meager savings of poor earners. Such impostors have pushed the general public to be wary of any newcomer into the sector.

The growing success of CAMCCUL, MC2, and CCA over the last five years has engineered commercial banks like SGBC, and Eco bank to introduce their own rural banking channels. SGBC introduced Ad vans Cameroun, while Eco bank in partnership with ACCION International introduced EB-ACCION. MFIs are increasing their focus toward client, geographical diversification and product innovation. At this level, while prominent MFIs are striving for commercial banking license, commercial banks view MFIs as potential and efficient channels for the delivery of products and services to rural areas with the scale of the MFI industry projected to increase.

The microfinance sector is developing rapidly in Cameroon. What remains missing is the urgent need for commercial banks and other major stakeholders including donors and government institutions to contribute in finding a solution in some of the major problems identified in the industry.

The effects of financial innovation on the growth of Micro Finance Institutions (MFIs) can be understood by measuring and analyzing the following quantitative performance parameters over a period of time. These are changes in the number of products / services the firm offers to its clients, the features and the classes of financial products over a period of time. Likewise, any change in the number of clients or in the number of branches of Micro Finance Institutions (MFIs) has over the period of time signifies growth. This signifies increase in the market share or increase in targeted market segments (Otego, 2006).

The change in geographical coverage or change in number of branches or representation in different regions brought about by innovation can also signify growth. Lastly change in the collective financial performance can also shed light on any financial growth, increase or decrease in the total assets, earnings, loan portfolio and the profitability indexes resulting from revenue from the new products (Otego, 2006). 

1.2 Statements of the Problem

Financial innovation is important because it helps MFIs flourish around the world. Currently, innovation is a continual process aimed at delivering a larger range of financial goods and financial intermediation, which is a critical aspect in the financial services industry. Influencing financial institution competitiveness and progress (Mohanty and Panda, 2004). As a result, microfinance innovation offers new options from the unsatisfied or unbanked market segment in an economy with Cameroon no being an exception. According to the findings, the percentage of new products and services is a major indication of corporate performance in terms of revenue growth and overall shareholder returns. Furthermore, most financial organizations only make a marginal profit on new goods and services (Chege, 2008).

In some instances, new financial products are engineered from existing products. This demonstrates that the new instruments need not add new price risk to the system, but by adding liquidity and new intermediaries they may contribute additional credit or liquidity risks. An analysis of the demand for financial market services in an assumed perfect capital market setting supports an argument that financial market innovations are attempts to overcome real-world market imperfections while making a distinction is between imperfections that are man-made  such as taxes, regulatory barriers, and information disclosure versus those that segment domestic markets and are naturally present such as transaction costs, heterogeneous expectations, and consumption/investment/risk preferences. Innovations that overcome the former may directly frustrate national economic policies.

Financial innovation is a key feature of the world economy and has important implication for management of risk, and for securities and political system yet it remains little studied outside the economics and business studies Carletti, (2005).

Recent economic theories suggest that financial innovation is in conjunction with investors who neglect small risks (Gennaioli, et al. 2012), investors with biased expectations or institutionalized constraints (Shleifer and Vishny, 2010), or excessively competitive banking markets (Thakor, 2012) can lead to financial and economic instability.

Allen and Carletti (2006) prescisely warned that financial innovations, such as securitization, that transfer credit risk can hinder the effective screening of borrowers, boosting financial fragility. Consistent with these views, (Dell Ariccia, et al. 2012), Keys, Mukherjee, Seru, and Vig (2010), and Mian and Sufi (2009) find that securitization reduced lending standards and increased loan delinquency rates, while simultaneously boosting the supply of loans and financier profits effectively enhancing financial deepening (Loutskina and Strahan, 2009), and Henderson and Pearson (2010) show that financial institutions engineered financial products that exploited investors misunderstanding of the pay to these products.

The huge finance sector has extended and deepened in recent years as more financial institutions and better products have emerged. Because the banking industry has been widely covered, the future Micro Finance Sector has not received significant attention, the research considers the MFIs sector to be a fertile setting in which to conduct this research. as more research on financial inclusion continues to be done, few studies have been done focusing on financial innovation in Cameroon and especially how it has been impacted by the various innovations in the financial sector.

1.3 Research Question

Main Question

What is the effect of financial innovations on growth of microfinance institutions in Bamenda?

Specific Questions

• What is the effect of technological development on the growth of microfinance institutions in Bamenda?
• What is the effect of product innovations on the growth of microfinance institutions in Bamenda?
• What is the effect of service development or innovations on the growth of microfinance institutions Bamenda?

1.4   Research Objectives

Main Objective

 To assess the effects of financial innovations on the growth of microfinance institutions in Bamenda.

Specific Objectives

• To identify technological development on the growth of microfinance institutions in Bamenda.
• To assess the determinants of product innovations on the growth of microfinance institutions in Bamenda.
• To examine the effect of service innovations on the growth of microfinance institutions in Bamenda.