CHAPTER ONE

INTRODUCTION

1.1. Background of the Study

The deterioration in the quality of the loan portfolio of banks was the main cause of problems in the banking system and in financial crises in developed economies. Indeed, the increase in loan defaults, banking mortgage in the United States, underlines the links between macroeconomic and financial shocks and the relationship between the friction in the loan market and the risk of financial instability (Ahlem , 2013). Loan managements generally refer to loans which for a relatively long period of time do not generate income, that is the interest and the principal for these loans have been left unpaid for at least 90 days (Hippolyte, 2005). A study on the impact of loan recovery strategies on the financial sustainability of microfinance institutions in India. The researchers analyzed the effectiveness of different collection methods and their implications for institutional performance. The study underscored the importance of adopting efficient loan recovery practices to minimize credit risk and ensure long-term viability in the microfinance sector Khan et al. (2019)

 Loan risk management comes to maximize a bank risk adjusted rate of return by maintaining loan risk exposure within acceptable limits in order to provide a frame work for understanding the impact of loan risk management on banks profitability (Bessis, 2010).  The most profound impact of high loan managements in banks portfolio is reduction in the bank profitability especially when it comes to disposals (Campbell, 2007). Loan events usually include events such as bankruptcy, failure to pay a due obligation, repudiation/moratorium or loan rating change and restructure. In either case, the present value of the asset declines, thereby undermining the solvency of a bank (Colquitt, 2007).

Loan risk is critical since the default of a small number of important customers can generate large losses, which can lead to insolvency (Brown, 1975). Financial ratios are a tool that enables management to analyze business situations and to monitor the performance of their organization. Financial ratios expedite the process of financial statement analysis by reducing the large number of items involved into a relatively small set of readily comprehended and economically meaningful indicators (Altman & Saunder, 2018) . The impact of loan risk on the profitability of banking system identifies the relationships between the loan managements and banks and microfinances profitability and evaluate the effect of loan and advance default on banks profitability on Rwandan banks (Creswell, 2003). Rahman and Nasrin (2020). In their study, Rahman and Nasrin examined the relationship between loan management practices, including credit risk assessment and monitoring, and the financial performance of microfinance institutions in Bangladesh. The findings highlighted the crucial role of effective loan management in improving portfolio quality and reducing default rates, ultimately leading to enhanced institutional performance. It may be difficult to establish an optimal loan policy or credit policy as the best combination of the variables of loan policy is quite difficult to obtain. A microfinance institution will change or modify one or more variables at a time and observe the effect. It should be noted that a MFI’s credit policy is greatly influenced by the economic conditions (Pandey, 2008). As economic conditions change, the credit policy of the firm may also be changed.

Microfinance institutions and other finance institutions must develop a credit policy to govern their credit management operations (Pandey, 2008) and since microfinance institutions generate most of their revenue from credit extended to low income individuals in the form of interest charged on the funds granted, the loan repayments may be uncertain. The success of lending out credit greatly 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.  Mendoza and Lopez (2018) synthesized existing literature on loan management practices in microfinance institutions across various countries. The review highlighted key factors influencing loan portfolio performance, such as risk management techniques, client assessment processes, and collection strategies. The findings underscored the significance of implementing sound loan management practices to achieve optimal financial outcomes in microfinance operations Mendoza and Lopez (2018).

Numerous approaches have been developed in client appraisal process by financial institutions, which 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 in 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.

Therefore, micro finance institutions play a vital role in developing the different economic sectors, through them the stream of money is managed and controlled, investment opportunities are utilized and channels of funds can target productive and profitable projects,

1.2. Problem Statement

The theme of loan managements has attracted more attention in recent decades. Several studies examined bank failures and find that asset quality is an indicator of insolvency (Campbell, 2007). Banks still have a high level of impaired loans before the bankruptcy. Therefore, the large amount of bad loans in the banking system generally results in a bank failure (Colquitt, 2007). The Non-performing Loans are among the main causes of the problems of economic stagnation. Each impaired loan in the financial sector increases the possibility to lead company to difficulty and un-profitability (Demirgüç-Kunt, 1989). Therefore the biggest loan risk facing banking and financial intermediaries is the risk of customers or counter party default (Carey & Hrycay, 2001). The major cause of serious banking problems continues to be directly related to low loan standards for borrowers and counterparties, poor portfolio management, and lack of attention to changes in economic or other circumstances that can lead to deterioration in the loan standing of banks (Creswell, 2003). And it is clear that banks use high leverage to generate an acceptable level of profit. The excessively high level of loan managements in the banks can also be attributed to poor corporate governance practices, lax loan administration processes and the absence or non-adherence to loan risk management practices (Dwight, 2004). According to Banque Populaire du Rwanda [BPR], (2012) the amount of loans written off includes suspended interest on loan managements was 13,536,296 in 2011 and 14,840,278 in 2012 respectively.

Smith et al. (2021) found that effective loan management, including proper risk assessment, monitoring, and collection strategies, significantly influenced the financial performance and sustainability of microfinance institutions. Institutions that implemented sound loan management practices experienced lower default rates, higher portfolio quality, and improved operational efficiency. Moreover, maintaining a balance between loan growth and portfolio quality was crucial for long-term success in the microfinance industry Overall,et al. (2021) concluded that prioritizing effective loan management strategies was essential for microfinance institutions to achieve their social and financial objectives. By implementing best practices in loan management, these institutions could enhance their operational efficiency, reduce credit risk, and ultimately improve their financial performance and sustainability. Despide the numerius studies on this topic, there are different results as seen above and also, the micro finance sector still keep struggling to survive loan delinquencies, it is for this reason that the researcher wants to find out the effect of loan management on the performance of microfinance institutions

1.3 Research Questions

1.3.1 Main Research Questions

What is the effect of loan management on the performance of micro finance institution in Bamenda?

1.3.2 Specific Research Questions

1. To what extent does collection policy affect the performance of micro finance institutions in Bamenda.
2. To what extent does client appraisal affect the performance of micro finance institutions in Bamenda
3. To what extent does credit risks affect the performance of micro finance institutions in Bamenda.

1.4 Research Objectives

1.4.1 Main Research Objectives

The main objective of the study is to access the effect of loan management on the performance of micro finance institutions in Bamenda.

1.4.2 Specific Objectives

1. To examine the effect of collection policy on the performance of Micro finance institutions in Bamenda.
2. To evaluate how client appraisal affects the performance of micro finance institutions in Bamenda
3. To examine effects of credit risks on the performance of micro finance institutions.