ABSTRACT

Microfinance institutions (MFIs) play a vital role in providing financial services to micro and small businesses in developing countries. However, the financial performance of MFIs in Bamenda 2, Cameroon, has been declining in recent years. This study investigates the effects of loan appraisal on the financial performance of MFIs in Bamenda 2. With its specific research questions which intent to examine the effect of loan policy and procedure, loan assessment, and loan monitoring on the financial performance in MFIs. This study were done through the descriptive data and quantitative research design was employed, using data collected from a sample of 10 MFIs using 5 employees per MFIs in Bamenda 2. Data were collected through a structured questionnaire administered to loan officer’s managers, accountants, internal control and .

Multiple regression analysis was used to examine the relationship between loan appraisal and financial performance. This result was overall significant at 5% level. The study found that loan appraisal has a significant positive effect on the financial performance of MFIs in Bamenda 2. Specifically, MFIs that use more robust loan appraisal techniques, such as credit scoring and financial ratio analysis, have higher levels of financial performance. Additionally, MFIs with stronger risk management practices, such as loan policy and procedure, loan assessment and loan monitoring have a higher level of financial performance. The study concludes that effective loan appraisal is essential for improving the financial performance of MFIs in Bamenda 2. MFIs should invest in training their staff in loan appraisal and risk management practices, and they should develop standardized loan appraisal policy and procedure to ensure consistency and objectivity in lending decisions.

By doing so, MFIs can reduce the risk of non-performing loans and improve their overall financial performance. The findings of this study have important implications for MFIs, policy makers, and researchers. MFIs should prioritize loan policy and procedure, loan assessment and loan monitoring practices to improve their financial performance and sustainability. Policy makers should create an enabling environment for MFIs to operate and provide incentives for them to adopt best practices in loan appraisal and risk management. Researchers should continue to investigate the factors that influence the financial performance of MFIs in different contexts.    

CHAPTER ONE

INTRODUCTION

Background of Study

The field of Microfinance has received a lot of attention since Muhammed Yunus received a Nobel Prize in 2006 after founding the Grameen Bank in 1976. Grameen Bank dispersed and recovered loans in Bangladesh. By 1990‟s lenders had learned how to increase loan repayment rates to make microfinance sustainable. Women were targeted as borrowers and they gave them money to invest in businesses that would create wealth for themselves J. Lindsay (2010) and thus improving their living standards. Microfinance refers to that part of the financial sector that responds to the financial demand of low- income households. Author in Bategeka (2001) suggests that Microfinance refers to financial services provided to low-income earners usually people who cannot get access to formal commercial banks.  Microfinance institutions provide small and short-term loans predominantly for trading, services and micro- enterprise activities  B. Klein, et al, (1999). Cameroon, many Microfinance Institutions provide financial services at a community level and have changed the lives of many small scale entrepreneurs. They provide their members with financial and social intermediation services to help improve their businesses. It has expanded to scores of other developing countries since its beginning in Bangladesh and even to some developed countries. However, the role of Microfinance Institutions (MFI) is a critical issue especially in financing the small and medium enterprises who find it too costly to access credit from Commercial Banks. 

For many years in Cameroon, the micro-finance sector has evolved and has been transformed into a system of provision of short term loans, savings, credits, money transfers, etc. thanks to various financial sector policies and programs undertaken by the government since independence. MFIs now are the primary sources of funds to small and medium size enterprises in Cameroon and other countries in the process of economic growth. Although finance literature explains the emergence of the micro-finance industry as an answer to an unfulfilled demand (Littlefield & Rosenberg, 2004), MFIs are not evenly spread around the globe and Cameroon in particular. Hardy et al. (2002), by comparing Cameroon and Gabon concludes that even though the countries have similarities common currency, comparable per capita income, the microfinance industry is more expanded in Cameroon than in Gabon. The environment in which MFI’s operate plays a vital role in the cross-country differences. While a lot has been written on factors influencing the development of the financial sector as a whole, almost nothing has been written on the factors determining microfinance performance and its macro environment. Most works on the microfinance industry focus on the institutional side of the organizations (Hudon, 2006). 

The impact of MFIs on poverty reduction, economic growth and women empowerment has increasingly received greater attention in many developing countries like Cameroon. Conversely, much has not been done linking the development of the microfinance industry with macroeconomic activities. Considering Cameroon, it is not very clear as to which macro-environments are more conducive for developing successful MFIs. In the current stage of development, where expanding access to financial services in rural areas is becoming increasingly important, the question is how are these institutions performing financially? Vanroose (2007) has identified possible factors that play a role in the uneven development of MFIs in Latin America. What similarly are the factors influencing micro-finance performance in Cameroon? The study therefore examines the factors that determine the performance of micro-finance institutions in Cameroon using the case of CamCCUL. 

The Cameroon microfinance sector has made remarkable progress during the last ten years, due to the dynamism of the main actors who are the State, the MFI and development partners (Fotabong, 2008). The above progress is evident by the volume of microfinance activities, proximity of the targeted vulnerable customers and the flexibility of the access conditions to the services which help to fight against poverty. But currently, the sector faces serious problems since 1990 because of the economic crisis that made Cameroon to devaluate its currency in 1994.Also regarding specific prudential standards, many microfinance establishments failed to comply with the required standard for the solidarity fund. The difficulties can be outlined as problems involved in the control and supervision of the sector, in the regulation framework, and in the establishment of microfinance enterprises. The micro-finance sector in Cameroun remains exposed to illegal practices. All the establishments approved for the first category equally carry out unapproved operations patterning to the second category. The insufficiency in the control of the microfinance sector due primarily to the insufficiency of financial, human and material means at the disposal of the regulatory and control agencies remain a big problem. The legislative framework and law enforcement of the MFI are characterized by insufficiencies such as Gilbel (2015) the monitoring is not exhaustive. The organization of the COBAC stipulates that monitoring should be permanent and should be done using functioning computer tools in an identical way as those of banks to guarantee transparency and accountability. However, the accounting chart of MFE was adopted in 2009 and became applicable only from January 2010.

Benjih, (2004) MFI’s have difficulties in mobilizing long term resources and to sign contracts of long term with their personnel to guarantee stability. It is because some personnel do not hesitate to quit once they have better opportunities, the prudential ratios are always standardized for the mutuality institutions of saving and credit co-operatives, which do not allow a good evaluation and comparison of the institutions at the national as well as at the sub-regional levels. Such a situation creates a lot of functioning weaknesses including inadequate human and financial resources, a strong volatility of the financial resources which is expressed by the fact that a large majority of financial resources are consisted of savings and deposits at short notices, absence of average techniques and logistics permitting a regular, effective, and constant follow-up of activities at the time of the receptions of credits in general and products do not correspond to the needs of clients. Therefore, despite the difficulties, the Cameroonian micro-finance institutions occupy currently, an appreciable range in the field of the micro-finance at the international scale. It is therefore interesting to evaluate the determinants of financial performance in CamCCUL, a giant financial structure in the micro finance institutional sector in Cameroon. The study therefore stipulates that the financial performance of CamCCUL is not significantly related to portfolio quality, market concentration, operating expenses, and the size of the organization.

The concept of credit can be traced back in history but it was not appreciated until after the

Second World War when it was largely appreciated in Europe and later to Africa Kitui J. K(2015). Banks in USA gave credit to customers with high interest rates which sometimes discouraged borrowers hence the concept of credit didnot become popular until the economic boom in USA in 1885 when the banks had excess liquidity and wanted to lend the excess cash Ditcher, Prentice Hall (2003). 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.

 A loan or Credit may be regarded as credit granted where the money is disbursed and its recovery is made on a later date a debt for the borrower  Warue. N(2012). Credit is given for a definite purpose and for a predetermined period.  Interest is charged on the loan at agreed rate and intervals of payment. Coupled with the above, a loan process is an entire sequence of steps, from the time a loan application is received or a loan offer is accepted to the time when the loan is closed, the loan proceeds are disbursed, and the aggregate amount (principal plus interest) is placed on the lender’s books as an asset  Arora. S (2005). 

 The particular credit standards applied in making loans have been accompanied by the use of special methods of credit appraisal. In extending medium-term credit, bankers look beyond seasonal or temporary business transactions of the borrower, and expand their credit investigations beyond the limits that are usually set in making short-term loans. The influence of business cycles and of long-term economic forces upon the financial position of the borrower is carefully weighed. Moreover, term credit analysis, although strongly resembling that used by investment bankers, differs from the techniques applied to public issues of corporate bonds or notes. As term loans and debt securities privately purchased from issuing concerns are not marketable assets, lenders cannot look to factors directly affecting market prices, except where the borrowing concern has a similar issue of securities outstanding in the hands of the public. Since a lending institution often cannot look to a public market for a continuing appraisal of the borrower’s credit or the liquidation of a loan, it must increase its requirements with respect to quality and augment the care with which it scrutinizes such credits, Neil. H and Raymond. J(1942).  

As with any financial institution, the biggest risk in microfinance is lending money and not getting it back.  Furthermore, MFIs provide unsecured loans, that is loans without any collateral. In case a client defaults, the MFI does not have any asset to meet its loss, which makes the credit even riskier. Credit risk is directly related to the portfolio of the Organization and is one of the most significant risks from an MFI perspective. Whenever an MFI lends to a client there is an inherent risk of money not coming back, that is the client turning into a defaulter. Credit is simply the possibility of the adverse condition in which the client does not pay back the loan amount. The risk is of greater significance for MFIs as it has to deal with large number of clients with limited literacy. The  people  covered  are  those  who  cannot  avail  credit  from  Banks  and  such other  financial  institutions  due  to  the  lack  of  the  ability  to  provide  guarantee  or  security against the money borrowed. Many banks do not extend credit to these kinds of people due to the high default risk for repayment of interest and in some cases the principle amount itself. Therefore, these  institutions  are required  to  design  sound  credit  management  that  entails  the identification of existing and potential risks inherent in lending activities Abhay N (2016). Generally, Micro finance refers to the provision of financial services to those excluded from the formal financial system United Nations Capital Development Fund (UNCDF) (2002). It therefore targets the informal sector that comprise of small and micro enterprises, which are located in urban and semi urban areas. Small and micro enterprises are loosely structured and therefore keep on changing from time to time depending on market trends and other factors that affect their businesses since most of them are privately owned. However, despite the fact that Microfinance Institutions have tried their level best to offer credit facilities to the public and then reduce their Portfolio at Risk (PAR) through reducing the default rate by various techniques, it still matters a lot to evaluate the relevancy of the appraisal process on the overall performance of the loan repayment. Indeed, the appraisal stage is thought to largely determine whether a loan will be properly repaid or defaulted.

It is against this background that the researcher found it necessary to carry out a study on the effect of the loan appraisal process management on credit performance of MFIs in Uganda. The success of MFIs seems to largely depend on the effectiveness of their credit management systems including the Loan appraisal process because these institutions generate most of their income from interest earned on loans extended to small and medium entrepreneurs. There is a high incidence of credit risk reflected in the rising levels of non-performing loans by the MFIs, a situation that has adversely impacted on their profitability Migiri D .O(2002). 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.

1.2 Statement of the Research Problem

The financial performance of microfinance institutions (MFIs) in Bamenda 2 has been declining in recent years. This decline can be attributed to several factors, including ineffective loan appraisal practices. Loan appraisal is a critical process that helps MFIs assess the creditworthiness of potential borrowers and make informed lending decisions. However, many MFIs in Bamenda 2 lack the expertise and resources to conduct thorough loan appraisals, leading to an increase in non-performing loans and a decrease in financial performance

Inadequate Loan Appraisal Techniques: Many MFIs in Bamenda 2 rely on traditional loan appraisal techniques that are not tailored to the unique needs of micro and small businesses. This can lead to inaccurate assessments of borrowers’ creditworthiness and an increased risk of loan defaults. Lack of Risk Management Practices: Weak risk management practices can compound the problems caused by inadequate loan appraisal. MFIs may fail to properly classify and provision for non-performing loans, leading to an underestimation of financial risk and a decline in financial performance. Limited Capacity Building: MFIs in Bamenda 2 often lack the resources and expertise to train their staff in effective loan appraisal and risk management practices. This can lead to a perpetuation of poor lending practices and a further decline in financial performance. Absence of Standardized Loan Appraisal Guidelines: The lack of standardized loan appraisal guidelines in Bamenda 2 can lead to inconsistent and subjective lending decisions. This can result in an uneven distribution of risk across the loan portfolio and a negative impact on financial performance.

To address the problems identified above, the following solutions can be implemented. To solve the problem of inadequate Loan Appraisal, MFIs in Bamenda 2 should adopt more robust loan appraisal techniques that are specifically designed for micro and small businesses. This may involve using credit scoring models, financial ratio analysis, and cash flow projections to assess borrowers’ creditworthiness. To solve the problem of Risk Management, MFIs should implement comprehensive risk management practices that include loan classification, provisioning, and stress testing. This will help them to identify and manage financial risks more effectively and improve their financial performance. The problem of limited capacity building can be solved by MFI by identifying the areas where their capacity is limited. This could include aspects such as staff skills, operational processes, information management and financial or governance. MFI can also seek support from various stakeholders such as donor agencies, technical assistant providers or industrial association. To solve the problem of standardized loan guide line, the MFI should ensure flexible credit assessment, customized loan products, decentralized decision making and continuous refinement.

Provide Capacity Building: MFIs should invest in training and development programs for their staff to enhance their skills in loan appraisal and risk management. This will improve the quality of lending decisions and contribute to improved financial performance. Develop Standardized Loan Appraisal Guidelines: The development of standardized loan appraisal guidelines for MFIs in Bamenda 2 would ensure consistency and objectivity in lending decisions. This would reduce the risk of non-performing loans and improve financial performance. Efficient of loan appraisal 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). Therefore, the study shall focus on establishing the relationship between loan appraisal and financial performance of micro finance institutions in Bamenda

Research Question 

1.3.1 Main Research Question

What is the effect of loan appraisal practices on the financial performance of MFI’s in Bamenda?

1.3.1 Specific Research Questions

• How has loan policy and procedures effected the financial performance in MFI’s in Bamenda?
• In what way has loan assessment effected the financial performance in MFI’s in Bamenda?
• What effect those loan monitoring has in the financial performance in MFI’s in Bamenda?

Research Objectives

1.4.1 The Main Objective

To assess the effect of loan appraisal practices on the financial performance of MFI’s in Bamenda.

1.4.1 The Specific Objectives

• Evaluate the effect loan policy and procedures on the financial performance of MFI’s in Bamenda.
• Investigate how loan assessment has effect the financial performance of MFI’s in Bamenda.
• Analyze how loan monitoring has effected the financial performance of MFI’s in Bamenda

1.5 Research Hypothesis

H1: there is a significant relationship between loan policy and procedures on the financial performance in MFI’s in Bamenda.

H1: there is a significant relationship between loan policy and the financial performance in MFI’s Bamenda.

H1: there is a relationship of loan monitoring and the financial performance in MFI’s in Bamenda.