Chapter one

Introduction

1.1Background of the study

MFIs are organizations that provide financial services, including loans, savings, and insurance, to individuals who are often excluded from traditional banking systems (Alade  et al., 2020).The origin of credit unions roots back to 1844, when the idea was first materialized in Rochdale, England, by weavers seeking a means to provide financial security for the poor (Nebaet al., 2019). Since then, the concept spread to various parts of the world, with all unions serving as essential channels for financial access, especially in rural and low-income areas (Alade et al., 2020).

The modern concept of microfinance can be traced back to the 1970s when Dr. Muhammad Yunus founded the Grameen Bank in Bangladesh. The primary goal was to provide small loans to the impoverished without requiring collateral, thus enabling them to start small businesses and improve their living conditions (Yunus, 2010). This model proved successful and inspired the establishment of numerous microfinance institutions (MFIs) worldwide. These institutions, such as credit unions, downscaled commercial banks, and financial cooperatives, primarily focused on improving the financial inclusion of the poor and fostering economic empowerment (Christen  et al., 2003).

Globally, with the success of the model, financial inclusion through MFIs gained significant traction, especially in regions where access to financial services was limited. The primary objective of MFIs is to operate profitably to maintain their stability, sustainability, and performance, often facilitated by sound credit policies (Aliuet al., 2014).In the 1990s and 2000s, the microfinance sector experienced significant growth, with increased involvement from commercial banks and international investors. This period also saw the development of new financial products tailored to the needs of the poor, such as micro-insurance and mobile banking services (Ledgerwood, 1996). The focus shifted from merely providing credit to promoting financial inclusion and empowering the underserved populations (Isern, 2012).

The shift towards broader financial inclusion didn’t come without challenges. As MFIs considered more and more low income borrowers, They (MFIs) gradually began seeing growing levels of loan defaults. Some borrowers soon began missing repayment schedules, resulting in loan delinquency. Loan delinquency is defined as the failure to repay loans on time and it has been a critical challenge for MFIs. Loan delinquency in MFIs arises from various factors, including borrowers’ inability to generate sufficient income, poor loan appraisal processes, and external economic shocks (Hwandi, 2015). High delinquency rates can threaten the financial stability of MFIs, as they rely on timely repayments to fund new loans and cover operational costs. Having identified delinquency as a problem in MFIs, several studies have identified key factors contributing to loan delinquency in MFIs. These include high interest rates, inadequate loan sizes, lack of proper monitoring, and improper client selection (Addae-Korankye, 2014) Additionally, external factors such as economic downturns and natural disasters can exacerbate delinquency rates (Warue, 2012)

To ameliorate the risk of loan delinquency in MFIs, the need for effective delinquency management became crucial in order to ascertain their sustainability. (Dhakal, 2015) stated that, the main strategies to manage delinquency included thorough credit appraisal processes, regular monitoring of borrowers, and the continuous provision of financial education to clients. MFIs also started employing various techniques to mitigate the risk of delinquency, such as group lending, with borrowers collectively responsible for each other’s loans, and the use of collateral or guarantees (Giné&Karlan, 2014). Also, MFIs equally began to implement measures to reschedule or refinance loans for borrowers facing temporary financial difficulties. This approach helps maintain the relationship with the borrower while reducing the risk of default (Cull et al., 2011). Training programs for both staff and clients on effective loan management and financial literacy, essential components of delinquency management (Field et al., 2013).Broadly. Loan delinquency management can be defined as; the process of identifying, monitoring, and resolving loans that are overdue or at risk of default.

In Europe and the United States, the early roots of microfinance were shaped by credit unions and cooperatives. The first credit union, established in 1844 in Rochdale, England, became a model for other countries across Europe and North America (Nebaet al., 2019). These institutions primarily aimed to provide financial security to working-class communities who lacked access to formal financial services. In the United States, credit unions have continued to grow, often focusing on small-scale savings and loans for their members. In Europe, however, microfinance initiatives began expanding more aggressively in the late 20th century, especially in Eastern Europe, where transitions from centrally planned to market economies created a void in financial services for small entrepreneurs (Merslandet al., 2010). Delinquency management problems equally have followed this growth and is being actively combated through excepts from the traditional banking sector. To improve delinquency management, microfinance institutions in Europe try to implement various innovative financial strategies, including; credit scoring systems to assess the creditworthiness of borrowers before approving loans. Despite these efforts, there is still evidence to suggest that by and large, delinquency management remains a significant challenge for microfinance institutions in Europe.(EMN, 2019)

In Asia, microfinance saw significant growth, particularly in Bangladesh, where Grameen Bank, founded by Nobel laureate Muhammad Yunus in the 1970s, pioneered the model of providing microloans to the rural poor without requiring collateral (Yunus, 1999). The success of Grameen Bank helped propel the idea of microfinance as a tool for poverty alleviation worldwide. Asia, especially countries like India, the Philippines, and Indonesia, embraced microfinance as a means to foster small entrepreneurship and support marginalized communities. In these countries, MFIs not only provide loans but also assist in financial literacy and other capacity-building activities for small businesses (Rhyne, 2012). The rapid success of microfinance in Asia has often been attributed to high population density, a large informal sector, and the resilience of community-based lending models (Cull  et al., 2011).

One of the core elements for the success of MFIs is corporate governance, which involves the systems and processes by which these institutions are directed and controlled. Effective governance helps ensure that MFIs are transparent, accountable, and aligned with their long-term goals, such as improving financial inclusion and mitigating risks such as delinquency (Norlia et al., 2011). A key challenge faced by MFIs is delinquency, which can be exacerbated by weak governance. Collateralization, a practice dating back to the Roman Empire, is an essential tool in mitigating lending risks by securing loans through assets. However, microfinance institutions often lack sufficient collateral, relying instead on social collateral, such as trust and reputation, to manage risk (Liberti et al., 2010). As a result, effective corporate governance is crucial in ensuring that MFIs adopt sound credit policies and risk management practices, which help prevent delinquency.

As the global landscape of MFIs continues to evolve, the African continent remains a focal point for their impact. While many African countries are still dominated by traditional banking systems, MFIs have become vital in extending credit to underserved populations. This is especially evident in countries such as Nigeria, where over 850 MFIs operate despite high bank penetration (CBN, 2018). In South Africa, despite the presence of some of Africa’s largest banks, micro-credit institutions continue to play a central role in providing financial services to the low-income and small business sectors (Kristensen et al., 2014). The importance of these institutions in rural communities cannot be overstated, as they provide vital access to credit for individuals who otherwise would not be served by conventional financial institutions (Hussain, 2014).

Turning to Cameroon, the history of MFIs in the country dates back to 1963 with the establishment of the first cooperative savings and loans institution in Njinikom, in the North West region (Long, 2009). This was followed by significant regulatory developments in the 1990s, including the passage of the Law No. 90/053 of 1990, which allowed for the formation of cooperatives and common initiative groups, further fostering the growth of MFIs in the country. As of today, Cameroon is home to over 850 MFIs (Long, 2009In Bamenda, the microfinance banking sub sector has faced with risk management challenges which necessitates the adoption of the Risk Based Supervision approach of overseeing microfinance banks in 2010.

Despite their importance, MFIs in Cameroon arechallenged with high delinquency rates and limited access to capital. These challenges have led to regulatory reforms aimed at improving governance and ensuring the financial stability of these institutions. For example, the crisis of the 1990s, where MFIs incurred significant losses due to poor risk management and over-competition, prompted the government to tighten regulations, including monitoring and control systems (Elle, 2012). These efforts are essential for improving the governance of MFIs and ensuring that they fulfill their role in financial inclusion and poverty alleviation.

Corporate governance, particularly in terms of risk management and accountability, is crucial in managing the delinquency challenges faced by MFIs in Cameroon. Studies have shown that effective governance, including proper oversight, resource allocation, and strategic decision-making, can mitigate risks such as defaults and enhance the performance of MFIs (Claessens et al., 2013; Hermes et al., 2011). Effective board structure and auditing are critical elements of good governance that contribute significantly to delinquency management in MFIs. A well-structured board can ensure that there is transparency in decision-making, while auditing practices help detect financial irregularities early, thus preventing potential delinquency issues (Merslandet al., 2010). Proper credit policies, including clear loan terms and interest rates, are also vital for ensuring the sustainability of MFIs and minimizing the risk of loan defaults. Attempts at implementing Network wide digitized loan monitoring and follow-up systems to ensure that borrowers history is available for all in the network and that borrowers are meet their loan repayment obligations have shown modest effectiveness, indicating that improvements on different components of governance will inevitably yield adequate results in loan delinquency management

Governments and policy makers have modified current laws and, in certain situations, developed new protocols especially suited to the requirements of microfinance institutions (MFIs) in order to guarantee their long-term viability. The procedures by which these institutions are run and governed, as well as the interactions between management, the board, shareholders, and other stakeholders, have been reorganized as a result of these regulatory reforms. In essence, MFIs’ corporate governance frameworks are constructed in compliance with national and international standards and agreements (Gupta &Mirchandani, 2019; Rhyne, 2012).

However, poor governance has led to deterioration in the financial health of some institutions, particularly when institutions under price the risks associated with uncollateralized lending (Mersland et al., 2010). As delinquency rates remain a persistent challenge for MFIs, it is essential that Category 1 MFIs in regions like North West implement more robust corporate governance practices, including strategic risk management approaches and well-defined credit policies, to mitigate these issues. Strengthening the audit processes and enhancing board structures in these institutions can also play a significant role in improving financial performance and reducing delinquency (Norlia et al., 2011; Claessens et al., 2013).

1.2. Statement of the Problem

Loan delinquency refers to the failure of a borrower to make timely payments on a loan. It is a common problem that affects both lenders and borrowers in various ways. Lenders may lose revenue, incur additional costs, and face regulatory penalties for having a high delinquency rate. Borrowers meanwhile ,may suffer from damaged credit scores, increased interest rates, and legal actions from lenders. Delinquency management is a critical curbing tool implemented in the operations of microfinance institutions, to control loan delinquencies from affecting their financial performance and sustainability. In the context of microfinance institutions, loan delinquency management is particularly important, as these institutions provide financial services to low-income individuals and small businesses, who may have limited financial resources and a high risk of credit default.

Despite the various strategies aimed at delinquency management, microfinance institutions in Bamenda  have been facing challenges in managing and preventing loan delinquency. According to a study by Muriuki (2015), the average loan delinquency rate in microfinance institutions in Cameroon is around 10%, markedly higher than the 5% international benchmark. This suggests that microfinance institutions in Bamenda are facing significant challenges in managing delinquency.

One possible explanation to the high delinquency rates is the lack of effective corporate governance practices in microfinance institutions. In the context of microfinance institutions, corporate governance is critical in ensuring that the institution is managed in a responsible and sustainable manner. However, research has shown that many microfinance institutions in Africa, including those in Cameroon, have weak corporate governance practices, which can contribute to poor financial performance and high delinquency rates (Muriuki, 2015).

In particular, three components of corporate governance practices are critical in managing delinquency in microfinance institutions: credit policy, board structure, and auditing. A weak credit policy can lead to lax lending standards, which can increase the risk of delinquency. In the same light, a weak board structure leads to poor oversight and management of the institution, which contributes to high delinquency rates. Weak auditing processes equally will lead to inaccurate financial reporting, resulting in heightened delinquency problems and consequently, difficulties in effective delinquency management. Furthermore, the reported rates of delinquency in microfinance institutions in Bamenda, indicate that there exist several inadequacies in the implementation of these key components of corporate governance.

This study aims therefore, to quantitatively and qualitatively investigate the effect of these key corporate governance practices (credit policy, board structure, and auditing) on the outcomes of delinquency management in category 1 microfinance institutions in Bamenda, The study will examine the relationship between these components of corporate governance practices and delinquency management, to identify the problems and challenges hindering their successful deployment in the context of microfinance institutions in Bamenda and equally recommend amendments.

1.2.1  Research Questions

1.2.1.1 Main research question

What is the effect of corporate governance practices on loan delinquency management of category 1 MFIs in Bamenda ?

1.2.1.2 Specific research question

1. What is the effect of board structure on loan delinquency management of category 1  MFIs in Bamenda ?
2. What is the effect of credit policies on loan delinquency management of category 1 MFIs in Bamenda?

• What is the effect of Auditing on loan delinquency management of category 1 MFIs in Bamenda?

1.3     Research objectives

1.3.1 Main research Objectives

To examine the effect of corporate governance practices on loan delinquency management  in category 1 MFIs in Bamenda

1.3.2 Specific research Objectives include;

1. To assess the effect of board structure on loan delinquency management of category 1 MFIs in Bamenda
2. To analyze how credit policies affects loan delinquency management of category 1 MFIs in Bamenda

• To investigate the effect of Auditing on the management of loan delinquency of category 1 MFIs in Bamenda