ABSTRACT

The study is based on finding out the impact of the influence of financial management practices on the performance of cooperative in Buea municipality with specific objectives of evaluating loan assessment techniques used by banks and finding out various risk management tools used to manage credit risk. In order to verify it, secondary data were used to carry out ratio analyses and trend analyses which were then correlated to the percentages changes in profits. The findings of the study indicated that the Non-Performing loans (NPL) to total loans ratio which is one of the risk management indicators is a major predicator and is significantly related to bank financial performance, followed by the loan to total deposit ratio and loans to total assets ratios that have an inverse impact on financial performance of banks.

CHAPTER ONE

INTRODUCTION

1.1 ORGANISATION OF THE STUDY

 This write up is organized in five chapters as follows: Chapter one provides the background information, the statement of the problem, the research questions, the objectives, the hypothesis, significance and delimitations.  Chapter two gives the literature review which includes the empirical literature review, theoretical and the conceptual literature review. Then Chapter three describes the methodology of the study and Chapter four gives the analysis and discussions and finally Chapter five is the conclusion.

1.2 BACKGROUND OF THE STUDY

Commercial banks face various risks that can be categorized in to three groups; financial (with credit risk being a component), operational and strategic (Cornett & Saunders, 2012). These risks have different impact on the performance of commercial banks. The magnitude and the level of loss caused by credit risk compared to others are severe to cause bank failures (Morris, 2013). Over the years, there have been an increased number of significant bank problems in both matured and emerging economies. Various researchers have studied reasons behind bank problems and identified several factors (Basel, 2006). Credit problems, especially weakness in credit risk management (CRM), have been identified to be a part of the major reasons behind banking difficulties.

Loans constitute a large proportion of credit risk as they normally account for 10-15 times the equity of a bank (Kitua, 2011). Thus, banking business is likely to face difficulties when there is a slight deterioration in the quality of loans. Poor loan quality has its roots in the information processing mechanism. Brown and Bridge (2011) observed that these problems are at their acute stage in developing countries. The problem often begins right at the loan application stage (Knight, 2013) and increases further at the loan approval, monitoring and controlling stages, especially when credit risk management guidelines in terms of policy and strategies/procedures for credit processing do not exist or weak or incomplete. The nonperforming loans (NPLs) represent credits which the banks perceive as possible loss of funds due to loan defaults. They are further classified into substandard, doubtful or lost. Bank credit in lost category hinders bank from achieving their set target (Shaw et al., 2012). Credit risk management models include the systems, procedures and control which a company has in place to ensure the efficient collection of customer payments and minimize the risk of nonpayment.

Globally, banks have adopted credit risk management practices. The Macaulay (2008) investigated the adoption of credit risk management Khan Practices in the United States and reported that over 90% of the banks in that country have adopted the Khan practices. Effective credit risk management has gained an increased focus in recent years, largely due to the fact that inadequate credit risk policies are still the main source of serious problems within the banking industry. Moreover, banks need to manage credit risk in the entire portfolio as well as the risk in individual credits transactions. The bank of Jamaica conducted an empirical study on the implementation of credit risk management policies by commercial banks in that country. The study which involved all the 73 banks in that country found out that only 46% had implemented them in full. This was partly attributed to the poor way in which the regulations had been communicated. Credit policies establish the framework for lending and reflect an institution’s credit culture and ethical standards. To be effective, policies must be communicated in a timely fashion, be implemented through all levels of the organization by appropriate procedures and revised periodically in light of changing circumstances. Measuring the risks attached to each credit activity permits the determination of aggregate exposures to counterparties for control and reporting purposes, concentration limits and risks/reward returns.

One bank failure may have a contagion effect on the other banks leading to a systematic failure of the whole banking industry in a country or even a whole region as witnessed during the Asian Bank crisis (2013-2009). Privately owned banks are more likely to implement credit risk management polices than state owned banks. Geithner (2013) investigated credit risk management policies for state banks in china using a survey research design. The study found out that with the increasing opening of the financial market, the state owned commercial banks in china are faced with the unprecedented challenges. As the core of national finance and vital of national economy, the state owned commercial banks could not rival with foreign banks unless they make profound changes. And the reform of credit risk management is a major step that determines whether the state owned commercial banks in china would survive the challenges or not.

Also, banks are exposed to different types of risks, which affect the performance and activity of these banks, since the primary goal of the banking management is to maximize the shareholders’ wealth, so in achieving this goal banks’ manager should assess the cash flows and the assumed risks as a result of directing its financial resources in different areas of utilization. Credit risk is one of the most significant risks that banks face, considering that granting credit is one of the main sources of income in commercial banks. Therefore, the management of the risk related to that credit affects the profitability of the banks (Li and Zou, 2014). The importance of credit risk management in banks is due to its ability in affecting the banks’ financial performance, existence and growth.

 Banks today are the largest financial institutions around the world, with branches and subsidiaries. There are plenty of differentiations between types of banks. And much of this differentiation rests in the products and services that banks offer (Howells & Bain, 2008,). For instance, commercial banks hold deposits, bundling them together as loans.

Credit risk management is very important to banks as it is an integral part of the loan process. It minimizes bank risk, adjusted risk rate of return by maintaining credit risk exposure with view to shielding the bank from the adverse effects of credit risk. Banks are investing a lot of funds in credit risk management modeling. Banks need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credits or transactions. Banks should also consider the relationships between credit risk and other risks. The effective management of credit risk is a critical component of a comprehensive approach to risk management and essential to the long-term success of any banking organization.  Credit risk can be accessed through analyzing the financial performance of commercial banks in an attempt to mitigate impacts arising from credit defaults. The future of these banks depends on the possession of good credit risk management dynamics. Since exposure to credit risk continues to be the leading source of problems in banks world-wide, banks and their supervisors should be able to draw useful lessons from past experiences. Banks should now have a keen awareness of the need to identify, measure, monitor and control credit risk as well as to determine that they hold adequate capital against these risks and that they are adequately compensated for risks incurred. The existing procedures for credit risk management are not adequate to compete with the existing financial and economic challenges thus the need for continued study and analysis on the matter of credit risk and managing it. Credit risk management is very essential to optimizing the performance of financial institution. Recognizing this importance, this paper focuses on understanding the credit risk management system of commercial banks operating in Kenya and its effects on the loans repayment performance.

With the major functions of accepting deposits from customers and granting funds out in the form of loans, thus performing a middle man role between surplus spending and deficit spending units (known as financial intermediation), Commercial Banks have expanded significantly over the past decades all over the globe. Loan portfolio is not only considered as a largest asset as well as pre-dominate source to generate revenue but one of the biggest risk source for the financial institution’s soundness and safety as well (Richard et al., 2008). Hence credit risk management is considered to be one of the road maps for soundness and safety of the sector through prudent actions as well as monitoring and performance. Despite of the efforts made by the financial institutions number of problems increased significantly in both, emerging as well as matured economies of the world (Basel, 2004). Most important of all the risks associated to financial institutions is weak credit risk management, being a threat for the banking sector (Chijoriga, 1997). There should be systematic distribution of loans according to well established credit policies and procedures provided by (Schreiner, 2003). Well formulated loan policy is beneficial for institutional performance. Hence it helps organizations to follow the same for risk management as well as fulfilling regulatory requirements (Joana, 2000). Loan review is a part of policy and is crucial, helping management in problem identification on regular basis to check either loan officers are following the policy in true letter and spirit or not. The review policy is better implemented by commercial bank hence they were easily able to top up loans in no time through use of modern technology unlike institutions (Craig, 2006).

Furthermore, in Africa, on one hand, Cameroon banking system is made up of 11 commercial banks operating in the country (of which the six largest are foreign owned, with three holding more than 50 percent of the sector’s asset and counting for more than 55 percent of deposit) and two government owned specialized financial institution (CAMPOST and CFC). Globally, Cameroon has 15 operational commercial banks, with aggregate assets of 1,700 billion CFA francs (about $ 3 billion). BEAC sets benchmark interest rates for the banking and institutions state treasuries. Throughout the 2008-2009 financial crises, Cameroons banking system remained solid. The regulatory board has restructured a few ailing banks. The corporate community still complains about stringent prudential regulations, low lending volume, and poor quality of service. The banking sector is regulated, but financial institutions tend to suffer from under-performance on local debt and unpaid loans from both commercial and individual debtors. The presence of an American Bank-Citibank-has made financial transactions easier for U.S. companies. 

On the other hand, commercial banks have also been active in the Nigerian economy for many centuries now. According to the IMF Country Report N°13/146 of May 2013 Nigeria has a financial sector made up of thousands of financial institutions among which there exist 21 commercial banks with a total banking sector assets of N1821 Trillion as at end December 2011, which represented 53.6% of the country’s GDP. The 3 biggest banks in Nigeria include First Bank of Nigeria with total assets worth $186 Billion approximately, followed by Zenith Bank PLC with $14147 Billion and United Bank for Africa that has total assets of $11.901 Billion.

More so, according to Fabrice Tchakounte K. (Jan 2018), banks have also evolved in Cameroon over the years and have played a key role in the financial system. The Cameroonian banking system is constituted of 13 commercial banks among which the first three banks are Société Générale de Banques du Cameroun (SGBC) Banque Internationale du Cameroun pour l’Epargne et e Crédit (BICEC) and Afriland First Bank with respective capital of 12,5Billion XAF, 12Billion XAF and 15,8Billion XAF. And in terms of total assets, SGBC registered 668661Billion XAF followed by BICEC with658468Billion XAF and Afriland First Bank with 654902 Billion XAF, Cameroon experienced a severe economic crisis in the early 1990’s which resulted to a drop of 50% in the value of its currency, the CFA Franc which used to be pegged to the former French Franc.

 Then, the banking system watched the failure of two major banks namely: the liquidation of Banque Merden BIAO Cameroun (BMBC) in 1996 and Credit Agricole du Cameroun (CAC) in 1997. Although COBAC put in place better policies and prudential norms to ensure the stability of the system, it still experienced the failure of Amity Bank PLC in 2008 whose assets were bought over by Banque Atlantique in May 2009 and later in 2011 Union Bank of Cameroon PLC was recapitalized by Oceanic Bank Nigeria and which was bought over just recently by ECOBANK.

These various bank crises may lead to a reflection that the risks involved in the banking activity is one to take in consideration to the greatest extend be it the liquidity risk, the credit risk, the foreign exchange risk, the market risk, or the operational risk. Risk management tools should be as efficient and effective as to be able to mitigate those latter risks inherent to the banking business.

 1.3 STATEMENT OF THE PROBLEM

COBAC normalized the prudential regulations. As planned, in July 2022, COBAC ended the temporary COVID-related forbearance prudential requirements (applied since mid-2020) and increased the capital conservation buffer by 50 basis points to 2.5 percent. The termination of these measures, coupled with resumed regular onsite inspections, are expected to contribute to a more accurate assessment of banks’ health. Capital adequacy modestly improved on average in 2022 to 14.7 percent, in part owing to the suspension of dividend distribution. After improving in 2021, the reported NPL ratio increased to 19.4 percent of total gross loans in 2022Q1, even with forbearance. The reported NPL ratio is likely to increase further following the normalization of temporary measures and COBAC onsite inspections that may shed light on pandemic related credit losses. Although liquidity is segmented, overall liquidity ratios are at 171 percent of short-term liabilities in 2022Q1. The banks’ loan portfolio grew 7.7 percent in 2022Q1 from end-2021.

Several studies have been done globally on the relationship between credit risk management practices and nonperforming loans. For instance, Greuning and Bratanovic (2012) studied the basis of a sound credit risk management system including guidelines that clearly outlines the scope and allocation of bank credit facilities and the manner in which the credit portfolio is managed. This study reviewed how loans are originated, appraised, supervised and collected. Mutangili (2011) did a study on nonperforming Loans and macro financial vulnerabilities in advanced economies and established that a sharp increase in NPL triggers long-lived tailwinds that cripple macroeconomic performance from several fronts.

Banks have adopted various risk management practices (Korir, 2012). Itis however not clear which one is the most effective in reducing NPLs. Carrying out the research helped to empirically understand if the credit risk management in practice really matter to commercial banks then; it should significantly contribute to reduce the NPLs. This study aimed to establish the effects of credit risk management on loan repayment performance in commercial banks.

Although COBAC put in place better policies and prudential norms to ensure the stability of the system, it still experienced the failure of Amity Bank PLC in 2008 whose assets were bought over by Banque Atlantique in May 2009 and later in 2011, Union Bank of Cameroon PLC was recapitalized by Oceanic Bank Nigeria and which was bought over just recently by ECOBANK. Also, the Commercial Bank of Cameroon (CBC) which is typically owned totally by Cameroonians faced financial difficulties for many years and is currently under restructuring. Also, some Microfinance Institutions collapsed recently such as FIFFA, and COFINEST just to mention those two.

According to Obiero (2013) found out that, out of the 39 banks which failed during the period of 1984 and 2013, 37.8 % collapsed mainly due to poor quality lending. The ratio of non-performing loans to gross loans increased from 5.2% in December 2013to 5.6%in December 2014(CBK bank supervision annual report, 2014). The increase in nonperforming loans signaled an increase in credit risk.

Also, according to Fabrice Tchakounte K. (Jan 2018), despite all efforts put in place by commercial banks in Cameroon, their credit risk in the form of nonperforming loans still exists on their bank’s loan portfolio. In addition, the credit experts of these banks sometimes have overlapping functions, which result to them being mixed up with the type of risk to focus on since other types of risks such as interest rate risk, market risk, liquidity risk, currency risk and operational risk also exist. Also with the information asymmetry that exists between borrowers and lenders, it had led to credit experts to be more likely to select projects that are dubious than those that will succeed to grant financing. Based on the above problems, the following questions were asked:

1.4 RESEARCH QUESTIONS

1.4.1 MAIN RESEARCH QUESTION

To what extend does credit risk management affects loan recovery in BICEC bank buea?

1.4.2   SPECIFIC RESEARCH QUESTIONS

1. What is the effect of capital adequacy ratio on loan recovery in BICEC?
2. How does asset quality affect loan recovery in BICEC?
3. What is the effect of management efficiency on loan recovery in BICEC?

1.5   OBJECTIVE OF THE STUDY

1.5.1 MAIN OBJECTIVE

 _To study and examine the impact of credit risk management on loan recovery in BICEC bank buea.

1.5.2    SPECIFIC OBJECTIVE

1. To analyze the effect of capital adequacy ratio on loan recovery in BICEC.
2. To investigate how does asset quality affect loan recovery in BICEC.
3. To evaluate the effect of management efficiency on loan recovery in BICEC.

1.6   HYPOTHESIS

To accomplish the aim of this research project, the following hypotheses have been posed:

𝐻_𝑜1: Capital adequacy does not affect loan recovery of BICEC.

𝐻_𝑜2: Assets quality does not affect loan recovery of BICEC. 

𝐻_𝑜3: Management efficiency does not affect loan recovery of BICEC.