CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

The concept of credit can be traced back in history. it was not appreciated until and after the Second World War when it was largely appreciated in Europe and later to Africa (Kiiru, 2004).Banks in USA gave credit to customers with high interest rates which sometimes discouraged borrowers hence the concept of credit didn’t become popular until the economic boom in USA in 1885 when the banks had excess liquidity and wanted to lend the excess cash (Ditcher, 2003).

When a company grants credit to its customers it incurs the risk of non-payment. Credit management, or more precisely credit control management, refers to the systems, procedures and controls, which a company has in place to ensure the efficient collection of customer payments thereby minimizing the risk of non-payment (Mokogi, 2003).

Credit is one of the many factors that can be used by a firm to influence demand for its products. According to Horne and Wachowicz (1998), firms can only benefit from credit if the profitability generated from increased sales exceeds the added costs of receivables. Myers and Brealey (2003) define credit as a process whereby possession of goods or services is allowed without spot payment upon a contractual agreement for later payment.

In Africa the concept of credit was largely appreciated in the 50’s when most banks started opening the credit sections and departments to give loans to white settlers. In Kenya credit was initially given to the rich people and big companies and was not popular to the poor. In 1990s loans given to customers did not perform which called for an intervention. Most suggestions were for the evaluation of customer’s ability to repay the loan, but this didn’t work as loan defaults continued (Modurch, 1999). The concept of credit management or control became widely appreciated by Microfinance Institutions (MFI’s) in the late 90s, but again this did not stop loan defaults to this date (Modurch, 1999).

The economic crisis that occurred in 2007 and 2008 along with the credit crunch placed credit risk management into the regulatory focus. Subsequently, supervisory bodies instigated more transparency. This called for financial institutions in the lending business to have comprehensive knowledge of their borrowers (customers) and their associated credit risk (Lybeck, 2011).

World Bank defines Micro Finance Institutions (MFIs) as institutions that engage in relatively small financial transactions using various methodologies to serve low income households, micro enterprises, small scale farmers, and others who lack access to traditional banking services CBS (1999). Financial intermediation is of great importance in any economy (Dondo and Ongila 2006). According to Kenya’s Poverty Reduction Strategy Paper (PRSP) and vision 2030, the financial sector is expected to play a catalytic role in facilitating economic growth through SMEs. Access to formal credit by small-scale business persons has been quite poor particularly among the low-income category. This is largely as a result of the credit policies associated with loans provided by the formal sector (Ringeera, 2003).

A key requirement for effective credit management is the ability to intelligently and efficiently manage customer credit lines. In order to minimize exposure to bad debt, over-reserving and bankruptcies, companies must have greater insight into customer financial strength, credit score history and changing payment patterns. The ability to penetrate new markets and customers hinges on the ability to quickly and easily make well-informed credit decisions and set appropriate lines of credit. Credit management starts with the sale and does not stop until the full and final payment has been received. It is as important as part of the deal as closing the sale. In fact, a sale is technically not a sale until the money has been collected (Haron, Justu, Nebat,& Mary, 2012). It may be difficult to establish an optimal credit policy as the best combination of the variables of credit policy is quite difficult to obtain. A firm will change one or two variables at a time and observe the effect. It should be noted that the firm’s credit policy is greatly influenced by economic conditions (Pandey, 2008). As economic conditions change, the credit policy of the firm may also change.

Microfinance Institutions and other finance institutions must develop a credit policy to govern their credit management operations (Pandey, 2008) and since microfinance institutions generate their revenue from credit extended to low income individuals in the form of interest charged on the funds granted (Central Bank Annual Report, 2010) the loan repayments may be uncertain. The success of lending out credit depends on the methodology applied to evaluate and to award the credit (Ditcher, 2003) and therefore the credit decision should be based on a thorough evaluation of the risk conditions of the lending and the characteristics of the borrower.

Numerous approaches have been developed in client appraisal process by financial institutions. They range from relatively simple methods, such as the use of subjective or informal approaches, to fairly complex ones, such as the use of computerized simulation models (Horne, 2007). Many lending decisions by Microfinance institutions are frequently based on their subjective feelings about the risk in relation to expected repayment by the borrower. Microfinance institutions commonly use this approach because it is both simple and inexpensive. While each company would have its own method of determining risk and quality of its clients, depending on the target group, the following client evaluation concepts are useful for most occasions. These concepts are referred to as the 5C’s of credit appraisal as explained by Alison (2016). These elements are Character, Capacity, Collateral, Capital and Condition.

The financial sustainability of MFIs is a necessary condition for institutional sustainability (Hollis & Sweetman, 1998). It has been argued that unsustainable MFIs will not help the poor in the future because the MFIs will be gone (Schreiner, 2000).According to Nyamsogoro (2010), it is better not to have MFIs than having unsustainable ones indicating how important the sustainability of MFIs is. Research in the field of sustainability has flourished since when more attention has been given to the long term aspect of microfinance which can widespread around developing countries only if lending to the poor is proven to be sustainable (Iezza, 2010). Nawaz (2010) identified the determinants of MFIs profitability and sustainability using a panel data set of 179 MFIs worldwide. The evidence does not support the trade-off between outreach and sustainability, however, the trade-off between costs and sustainability of MFIs is well supported.

Nowadays, microfinance institutions are seeking financial sustenance. Many MFIs were restructured to achieve financial sustainability and finance their growth. For Sustainability can be define as the capacity of a program to stay financially attainable even if subsidies are cut off (Woolcock, 1999). it support “generating sufficient profit to cover expenses while exterminating or eliminating all subsidies, even those subsidies that are not obvious , such as loans made in hard currency with repayment in local currency “ (Tucker and Miles, 2004). They studied three data series for the period between March1999 and March 2001 and established that self-sufficient microfinance institutions are profitable and perform better, on return on equity (ROE) and return on assets (ROA), than developing world commercial banks and MFIs that have not attained self-sufficiency. To maximize their performance, microfinance institutions are seeking to become more commercially oriented and stress more on elevating their profitability, therefore, self- sustainability

• Statement of the Problem

The success of MFIs or Banks  largely depend on the effectiveness of their credit management systems because these institutions generate most of their income from interest earned on loans extended to small and medium entrepreneurs(Nebat,2012). Granting credit to customers is an important investment option for financial institution which comes with high risk and thus the need for credit risk management (Control) to ensure reduced loan default rate while at the same time advancing credit in a fair and undiscriminating manner. According to McMenamin (1999), weak credit risk management is a primary cause of many business failures including financial institutions. Hempelet.al (1994) in his study focusing on national banks that failed in the mid-1980s in the U.S.A found that the consistent element in the failures was the inadequacy of the bank’s management system for controlling loan quality. Microfinance customers constitutes sub-prime markets and can be described as constituting the greater part of the population pyramid and are characterized by little or no financial means, poor credit history, low incomes, unreliable borrowers, subsistence activities and high possibility of going bankrupt( Molem&Mbinker,2015).

The Cameroon banking sector, inclusive of MFIs, witnessed some growth which could be measured through increase in profit, outreach, and customers. This growth was not sustained as they started to experience some crisis characterized by instability. The result could be seen with so many banks and MFIs going bankrupt and Ministry of finance closing down about 82 MFIs between 2014 and 2015, The number of MFIs dropped from 645 in 2011 to 418 in 2015.The failure or poor performance of these financial institutions could be traced to the poor handling of financial services and high vulnerability to shocks like credit risk and capital inadequacy. The Central Bank Annual Supervision Report, 2010 indicated high incidence of credit risk reflected in the rising levels of non- performing loans by the MFI’s in the last 10 years, a situation that has adversely impacted on their profitability. This trend not only threatens the viability and sustainability of the MFI’s but also hinders the achievement of the goals for which they were intended which are to provide credit to the rural unbanked population and bridge the financing gap in the mainstream financial sector.A number of studies have been done in both developed and developing countries on credit management or control mainly focusing on large financial institutions such as banks. Most studies in MFIs have focused on their financial performance and the performance of their customers mainly the SMEs (Rukwaro (2000), Kitaka (2006) and Mokogi (2003). These studies among other finding have indicated a high default rates among the MFIs.

Nzotta (2004) opined that credit management greatly influences the success or failure of commercial banks and other financial institutions. This is because the failure of deposit banks is influenced to a large extent by the quality of credit decisions and thus the quality of the risky assets. He further notes that, credit management provides a leading indicator of the quality of deposit banks credit portfolio. A key requirement for effective credit management is the ability to intelligently and efficiently manage customer credit lines. In order to minimize exposure to bad debt, over-reserving and bankruptcies, companies must have greater insight into customer financial strength, credit score history and changing payment patterns. Credit risk exposure continues to be a significant basis of problems for the lending institutions. This issue is even more imperative with reference to microfinance institutions in Cameroon. As defined by Kairu (2009) microfinance is the process of providing monetary services to the unbanked or low-income earners. It also refers to the sustainable practice of offering those services. These institutions lend to low income earners, a group that is believed to be very risky in terms of exposure to credit risk. Therefore, credit risk can be defined as the likelihood of loss owing to a borrower’s failure to meet his obligation (loan, line of credit) (HKIB, 2012).

MFIs earn financial revenue from loans and other financial services in the form of interest fees, penalties, and commissions. Financial revenue also includes income from other financial assets, such as investment income. An MFI‟s financial activities also generate various expenses, from general operating expenses and the cost of borrowing to provisioning for the potential loss from defaulted loans.

Sound credit management is a prerequisite for a financial institution’s stability and continuing profitability, while deteriorating credit quality is the most frequent cause of poor financial performance and condition. According to Gitman (1997), the probability of bad debts increases as credit standards are relaxed. Firms must therefore ensure that the management of receivables is efficient and effective .Such delays on collecting cash from debtors as they fall due has serious financial problems, increased bad debts and affects customer relations. If payment is made late, then profitability is eroded and if payment is not made at all, then a total loss is incurred. On that basis, it is simply good business to put credit management at the front end by managing it strategically.

Mbah and Wasum (2019) carried out a study on credit management on the sustainability and profitability of microfinance institutions in Cameroon and noted that efficiency and effectiveness were the main challenges facing Cameroon service delivery. With any financial institution, the biggest risk is lending money and not getting it back. Credit risk is a very critical situation for financial institutions because most micro lending is not secured that is, traditional collateral is not often used to secure microloans (Craig Churchill and Dan Coster, 2001). The persons covered are those who cannot benefit credit from banks and other financial institutions due to lack of the ability to provide assurance or security against the money. Many banks do not give credit to these types of people due to high default risk for repayment of interest and in some cases the principal amount itself. Thus, these institutions are required to design sound credit management that signifies the identification of existing and potential risks intrinsic in lending activities. So therefore, the researcher aims at determining the effect of credit control on the sustainability of community Credit Company.

• Research Questions

The research questions to be answered for the study will be divided into main and specific research questions

• Main Research Question

The main research question for the study goes is:

What is the effect of credit control on the sustainability of community Credit Company?

The specific research questions for the study are as follows

1.3.2 Specific Research Questions

• What is the role of credit monitoring on the sustainability of Community Credit Company
• How does credit risk identification influence the sustainability of Community Credit Company?
• Can the adoption of daily cash collection influence or help in enhancing the sustainability of Community Credit Company?
  • Research Objectives
    • Main Objectives

The main objective of the study is to determine the effect of credit control on the sustainability of community Credit Company in Cameroon.

• Specific Objective

• To evaluate the role of credit monitoring on the sustainability of Community Credit Company in Cameroon.
• To investigate the extent to which credit risk identification influence the sustainability of Community Credit Company in Cameroon.

To determine if the adoption of daily cash collection can influence or help in enhancing the sustainability of Community Credit Company