CHAPTER ONE

INTRODUCTION

1.1Background to the Study

Microfinance institutions currently operate in over 100 countries, serving more than 92 million clients with an overall portfolio of 65 billion US dollars in loans and 27 billion dollar in savings

(Outlook, 2011). Viability of MFI’s depends much on the ability of microfinance in managing. One of the problems faced by microfinance institutions lending to the customers in Cameroon is loan . Several efforts have been made by lenders and policy makers to deal with the situation. (Schreiner, 1997) in his study on a framework for analysis of the performance and sustainability of subsidized Microfinance argue that, group lending model is one of the best practices in Africa. The MFIs lends to self-help groups (SHGs) which on lends to the group members. This suggests that group governance including self- internal regulations and screening process for members for loan qualifications, may affect loan  levels of the lending MFI. MFIs and SHGs operate under the influence of external factors such as macroeconomic factors which are beyond their control. This implies that in absence of quality governance and strategic plans aimed at mitigating adverse effect of external factor on credit risk, may contribute to high levels of delinquent loans.

Several financial institutions to measure their financial stability and performance utilize profitability ratios. These ratios are key indicators of credit analysis in most banks as well as MFIs, as they are linked to the results that are attributable to the performance of management (Gibson, 2012). Regularly used ratios are Return of equity as well as return on assets. The superiority level of return on equity should be at least 15% and 30%, for Return on Assets; it should be at least 1%. ROE is a significant indicator in measuring profitability, consequentially, financial performance. Further, ROE evaluates the efficiency of MFIs illustrating the level at which MFIs reinvest their earnings to generate their projected future revenue. As defined by

(Öttker-Robe &Podpiera, 2010), ROE is measured by dividing a corporation’s net annual income after tax by shareholder equity. It establishes the revenue derived from equity. An increase in ROE might indicate that an institution’s revenue is on the rise without necessarily adding more capital. Thus, a rise on return on equity as well as return on assets indicates that the institution is financially stable.

Microfinance in Tanzania began with Non-Government Organizations and SACCOs (Savings and Credit Cooperative Organizations) in 1995 and has continued to grow with the increased success of microfinance internationally. At the beginning of 1995, MFI‟s was mainly linked to women and poverty alleviation. The government tried to convince commercial banks to support small and medium businesses. Once the National Microfinance Policy was implemented in 2001, microfinance was officially recognized as a tool for poverty eradication and with its increased use and exposure to the country; banks took an advantage of interest rate in offering microfinance. 

Loan is the situation that occurs when loan payments are past due. A delinquent loan (or loan in arrears) is a loan on which payments are past due. In other words, the failure to repay an obligation when due or as agreed is termed as. Example, in consumer instalment loans, missing two successive payments will normally make the account delinquent. In Capita one credit card company, a delay of payments for 15 to 30 days is generally allowed before declaring.  Default occurs when a borrower cannot or will not pay his or her loan. The MFI no longer expects to receive repayment. MFI may continue with the collection efforts such as collecting collateral. Before MFIs accelerate a defaulting borrowers loan account, it is required by law to give the client an opportunity to request loan servicing, this is a process by which clients facing default or financial distress who meet certain eligibility requirement may have their debt modified or even reduced to allow continuation of its normal operations. Such modifications may be by Loan re-amortization and re-scheduling, Loan Consolidation, Interest rate reduction, loan reorganization and adjustment, Loan Cancellation/Charge off (Lawrence et al., 1995).

Loan management is a skill; it can be learnt like any other skill. Learning how to manage begins with understanding what is ? Its origins and consequences to the organization. Monitoring is part of this skill also. Microfinance staff must be trained on management from the very beginning, once they enter a MFI. Policies and procedures in any MFI must be designed in accordance with proper management practices. Preventing and acting on delinquent clients depend on this design. 

Loan servicers should handle trigger-event defaulters differently from no-equity defaulters; accordingly, they advise lenders and servicers to offer a consensual resolution to only to trigger-event defaulters who have a demonstrated desire to avoid foreclosure. Some researchers suggest that trigger-event defaults should be expected among subprime loans1 independent of risk associated with particular loan terms. Apart from above factors, it is possible for other factors, such as specific loan product features, to play a major role in mortgage default. Even before the recent rise in subprime mortgage originations and delinquencies, one could find some empirical support for an association between loan features such as adjustable interest rates and higher default risk (Ambrose and Capone, 1997).

Efforts to ensure sustainable financial services have been weighed down with the problem of loan, (Osuntogun, 1980) (Akinwuni, 1988). Strategic default on loan is quite widespread among clients (Jacklen& Ryne, 1991).In particular, high co-variant risk of investment portfolios and low level of commercialization in small business add to the propensity of defaulting among clients of these credit sources (Besley&Coate, 1995). On the part of financial lending institutions, there is the problem of asymmetry information which makes formal lenders unable to properly screen, monitoring use of loans to ensure satisfactory levels of loan repayment, among clients (Besley&Coate, 1995).

Loan recovery is one of the critical determinants of profitability and viability and crucial to the health of a microfinance institution (Diagneet al., 2000). Poor recovery hampers the institutions’ capability to recycle funds and adversely affect the effective management of its resources and ultimately its profitability. The incidence of over dues in the loan repayments among clients has been increasing over the years and has turned out to be the single most important factor responsible for steady erosion of the financial soundness and fitness of the financial institution. The persistence of over dues has chocked the credit line of most financial institutions and restricted the recycling of funds. Unless the over dues are substantially brought down, the impact of various measures to improve viability of MFIs would not be visible. This makes loan management central to the viability of formal lending schemes and programs.

Proper loan management begins with a good default Prevention Plans that provide clients with a unique, long-term solution to the problem of loan default. A properly developed and executed default Prevention Plan will identify the unique root causes of default by clients and lay out, in accountable, objective and measurable ways, the steps which MFIs and clients will take to address the identified problems. Lending institutions have a great deal of data about clients. There is no gainsaying, that resources such as financial statements and the business office will maintain data which may be important in case client fails to make payments on a direct loan from microfinance institution or fails to comply with other terms of the loan agreement, the MFI may accelerate the loan account after fulfilling certain procedural requirements. MFI may take step to repossess and sell the collateral used to secure the loan, (Lawrence et al., 1995).

Existing literature confirm that proper loan management can make a delinquent clients to recuperate and seize from being a credit risk. For instance, systematic, persistent and coordinated use of collection policy and tool are critical in loan management but having an effective loan servicing and collection system depend to a large extent on the capability to generate and disseminate timely and accurate report on loan portfolio status, and past due payments (Mill, 1993). More so, rates are important in rights both as a measure of the incidence of client’s distress and as a warning of the danger of more serious type of distress such as repossession, foreclosure or bankruptcy. Beyond this, rate is of interest for their broader implications for such fundamental elements of general economic activity as farmers spending decisions and credit policy of lending institutions. In view of these, financial institutions that lend to the clients of the economy have over time utilized for a number of management strategies. The question is how effective are these strategies? (OlomolaA. , 1992).

(Emmanuel, 2003) in their study on the effectiveness of loan management strategies of formal lenders among farmers in AkwaIbon state Nigeria confirm that the loan reducing strategies were not judiciously implemented by the lenders. Also, the behaviour of selected variables under the going  management regime suggest that primary occupation, loan size, loan use, duration of loans and visits of bank officials are some of the variables that need to be manipulated to achieve the desired level of loan repayment. Invariably, proper implementation of the existing loan management strategies and proper manipulation of factors that support loan repayment would be invaluable in enhancing the effectiveness of the existing loan management strategies in reducing loan repayment problems in AkwaIbom State, Nigeria. In Tanzania, the history of microfinance starts way back in 1985 when the Government promoted and established the Presidential Trust Fund in mid-1990. Other MFIs emerged such as PRIDE, SEDA, FINCA, and YOSEFO. In the late 1990s the Bank of Tanzania started specialized banks which are commonly known as community banks and cooperative banks. These include Kilimanjaro Cooperative Bank, Mufindi Community Bank and Kagera Cooperative Bank. Akiba Commercial Bank became the first Commercial Bank to venture into microfinance (Bank of Tanzania, 2011).

The National Microfinance Bank, AKIBA Commercial bank and CRDB Bank are some of the supporters of microfinance in Tanzania. Other organizations involved in microfinance in

Tanzania, including FINCA, BRAC, PRIDE and SEDA as well as the Tanzania Postal Bank. Community banks and small banks have taken an interest in this, as well as many NGOs and non-profit organizations (Millinga, 2010).

A recent 2013, survey done by the Bank of Tanzania (the overseer of microfinance under the Ministry of Finance) updated the directory of microfinance practitioners and includes basic information on microfinance institutions including commercial banks, financial institutions, Non-Governmental Organizations (NGO), Savings and Credit Cooperatives Societies (SACCOs) and Savings and Credit Associations (SACAs). The directory includes a total of 8 banks, 45 CBOs, 2companies, 95 Government programs, 1,620SACCOs, 48 SACAs and 62 NGOs (BOT, 2013).

 Management is a major issue in microfinance. The success of micro finance institution (MFI) start with proper management. All staff in one MFI must be trained on management. From the field to the top management and trustees, everyone must be able to understand the mechanisms of and manage it.  Management is a skill; it can be learnt like any other skill. Learning how to manage begins with understanding what is? Its origins and consequences on the organization, monitoring is part of this skill also. Micro finance staff must be trained on management from the very beginning, once they enter a MFI. Policies and procedures in any MFI must be designed in accordance with proper management practices. Preventing and acting on delinquent clients depends on this design (Ojo, 2012).

As illustrated by (Aduda & Kalunda, 2012), Kenya is known as one of the African countries at the forefront in the discovery of the significance of MFIs as a poverty eradication tool thus more efforts have been directed in the development and promotion of the MFI sector. Microfinance industry in Kenya has evolved and is carried out in diverse institutional forms, which include the semi-formal, formal and non-formal providers (Muriuki, Maru, & Namusonge, 2015). The formal institutions include commercial banks; Credit only MFIs, Deposit taking microfinance banks, semi-formal include co-operative societies, NGOs. Further, in-formal financial institutions include Rating Savings and Credit Association (ROSCAs), and

Accumulating Saving and Credit Associations (ASCAs). (Ayele, 2015) 

Microfinance has evolved as an economic development approach that assist SMEs, the poor, and households that cannot access the more institutionalized monetary system, in mustering savings, and acquiring access to financial services (Kindie, 2012). Various MFIs have come up to bridge the gap for the unsatisfied demand for financial services by small enterprises and low-income earners in Kenya. These MFIs includes microfinance banks, Credit only MFIs, Commercial Banks focusing on microfinance, Developmental Institutions, Insurance Companies (micro-insurance), SACCOs and Wholesale MFI lenders. The establishment and registration of Association of Microfinance Institutions (AMFI) in 1999 under the Societies Act was to operate as an oversight association for the MFIs doing business in Kenya. AMFI’s major objective is to promote expansion and progress of Microfinance institutions by encouraging well-organized as well as efficient presentation of services.

AMFI report (2013) indicated a gross portfolio increase in 2012 because of the raise of interest rates on loans in the perspective of elevated inflation. The report also indicates that profitability and sustainability levels of the sector dropped dramatically because of high operating costs that resulted from expensive lending rates and high-risk exposure. In addition, Operations self-sufficiency (OSS) decreased in the year 2012 and the decrease was because of decreased performance of the Deposit taking microfinance as their Operations self-sufficiency dropped from 114% to 104% as of December 2011. Further, higher operating costs led to decreased levels of efficiency and profitability. The funding costs increased to 8.6% while operating costs shot up to 26.7%. In terms of operational costs associated with staffing ration increased to 53.3 percent as more MFI operation called for more field staff. This shows that on overall, the operational self-sufficiency and sustainability of microfinance institutions in Kenya have been decreasing over the years (AMFI, 2013).

The Microfinance institutions in the republic of Cameroon including the private microfinance institutions, rural and community Banks and some commercial Banks are face with loan, which may have long-term consequences if not addressed. One of the best defences against business failure, as well as an important driver of business growth is the point of an effective loan management, which manages risk and enable the creation and presentation of values.  Successful organizations know how to take advantage of opportunities and counter threats, in many instances through effective application of controls and therefore improve their growth.  Although, the emphasis laid on the detection of loan default and many other regularities have changed and the role of loan management has become more sophisticated as the concept of loan default is an integral part of a MFIs governance system and the ability to manage risk which is understood, effectuated and actively monitored by the governing body, management and other personnel to take advantage of the opportunities and to counter the threats of achieving the MFIs objectives.

In the nutshell, as MFIs strive to achieve their missions and goals, they need to continually, access and evaluate their loan management structure to assure that it is well designed and operating effectively, appropriately updated to meet changing conditions, and provides reasonable assurance that the objectives of the departments are being achieved. Specifically managers need to examine loan to determine how well it is performing, how it may be improved, and the degree to which it helps identify major risks for default customers, waste, abuse and mismanagement. In recent years, Bamenda has experienced an exposure in the number of MFIs and credit unions.  The separation of ownership and control that characterizes the modern corporation creates potential conflicts of interest between managers and shareholders.  The primary functions of the board of directors are to monitor managerial actions, assist management by providing advice, and put an end to any management decisions that will be harmful to shareholders. As such, one of the main cry of most top managers has been the implementation of loan  management  procedures to effectively monitor, evaluate and reduce default in micro financial institutions like for example  MFIs.  When properly designed and consistently enforced, it will help MFIs to safeguard its resources, produce reliable loans reports and comply with laws and regulations.

1.2 Statement of the Problem

Loan management play a vital role in the performance of every microfinance institution with regards to this study there are problems that seek answers. Some of the problems faced in loan management are poor screening method in knowing unsuitable or bad business ideas, poor method of accessing the borrower’s ability to manage project and failure to document available collateral sources.

What some MFIs do concerning loan management which is not working is that they fail to evaluate fully if the creditor is capable of paying back the loan. For example, they may check if the creditor has collateral for his loan and fail to check the past financial record of the creditor.

Also another thing they fail to do or work on is to identify the loan term that is short term loan or long term loan which is more favourable to them. They do not know which loan term yield more interest to them so as to concentrate on it and this may lead to mismanagement.

Another thing MFIs is doing concerning loan management that is not working is that they wait till when the loan is due before they start calling the creditor to come and complete the payment of the loan. This will cause the institution not to recovery its loan on time since it took them a long time to tell and make their creditor know that he has to complete the payment of the loan on time and this may cause the institution to face the problem of loan  which can also lead to bankruptcy to institution.

1.3 Research Questions

1.3.1. The main research question

What are effects of loan  management on the financial performance of MFIs in Bamenda?

1.3.2. Specific Questions

The specific research questions.

• Is there any effect of loan appraisal on the financial performance of MFIs in Bamenda? What is the effect of reasonable interest rate on the financial performance of MFIs in Bamenda?
• What is the effect of monitoring clients on the financial performance of MFIs in Bamenda MFIs?
• How does training before and after disbursement of loans affects the financial performance of MFIs of Bamenda?

1.4 Research Objectives

1.4.1. The main objective

To examine the effects of loan management on the financial performance of MFIs in Bamenda.

1.4.2. The specific objectives are:

• To determine the effect of loan appraisal on the financial performance of MFIs in Bamenda.
• To recommend the effect of reasonable interest rate on the financial performance of MFIs in Bamenda.
• To assess the effect of monitoring clients on the financial performance of MFIs in Bamenda.
• To investigate the effect of training before and after disbursement of loans on the financial performance of MFIs in Bamenda.