CHAPTER ONE

INTRODUCTION

1.1 Introduction

This study looked at the effects of operational risks on the financial performance of microfinance institutions in buea. In order to reach our objectives, we divided the study into five chapters comprising of chapter one being the introduction, chapter two being the literature review, chapter three made of the methodology, chapter four the presentation of findings and chapter five discussion, conclusion and recommendation.

 This chapter one thus introduces the study by presenting the background information to the subject, statement of the problem, research questions, objectives and hypotheses, significance of study, scope of study and definition of key terms.  For any research to be meaningful it has to serve a purpose and for that reason, this part of the study introduces basic information about this research as it seeks to show the purpose or essence of the study. Chapter two comprises of the review of concepts, theories, empirical literature that are related to the study. Chapter three discusses the methodology starting with research design, area of study, population, sampling method and size, data collection and analysis. Chapter four presents discussion of findings from the data collected and lastly chapter five is on discussion of results, conclusion and recommendation.

1.2 Background of the Study

Banks face a number of risks in order to conduct their business, and how well these risks are managed and understood is a key driver behind Performance (Aduloju et al., 2022).  

The concept of risk has evolved over the years as such. Risk was considered as an uncertainty which could have an adverse or negative effect on the achievements of objectives. But with recent research and development of the theory, it is clear that risk could present itself as well positive aspects. This could be seen from the definition of risk by ISO 31000 that risk are the positive opportunities or negative threats of uncertainties on the achievement of defined objectives

Commercial banks like other corporations are established so as to maximize their shareholder wealth. Wealth is the function of risk and return. Commercial banks are in the risk business. In the process of providing financial services, they assume various kinds of risks. The risks differ in their natures and occurrences pertaining to different business activities. Some of the main risks faced by banks include credit risk, market risk and operational risk. Credit risk is the risk of loss of principal or loss of a financial reward stemming from the borrower’s failure to repay a loan or meet contractual obligations. Market risk is the risk of losses arising from changes in value of the market risk factors Kimei (2007).

The Basel commission on Banking supervision (BSBC), has defined operational risk as the risk of losses resulting from inadequate or failed internal processes, people and system or from external events. Operational risk can be divided into those losses that are expected and those that are unexpected. Operational risks in banks manifest itself through people, process systems etc. With regards to people it occurs during employee errors, fraud and the death or departure of key personnel. Operational risk in line with systems occurs when there is system failure or short down and it encompasses inter-branch connectivity, power backup systems, information technology systems and other technical systems. In line with process, it occurs as a result of failure in banking procedures and processes. And lastly in line with legal risk, it manifests through failure with compliance to financial and monetary authorities.  

Operational risk is not a new risk, but hard evidence suggests that this risk is significant and maybe growing, virtually every catastrophic financial institution loss that has taken place during the past 20 years (Bloom & Galloway 199). An example of operation risk occurred in the past years; a bond trader of Daiwa Bank in New York had caused and hidden losses of USD 1.1 billion through non-compliant transactions and scam deals. Daiwa did not have any appreciable management controls or even the simplest internal control that could have immediately expose the fraudulent transactions. The bank became insolvent; eleven senior executives were ordered to pay damages as they failed to supervise staff. (Jorion, 2001).

In September 1998, the Banking Committee on Banking Supervision (BCBS) published a document Operational risk management (ORM) in which operational risk is treated as a self-contained regulatory issue “The New Basel Capital Accord” formulated in a proposal in 1999, released in 2001 and became effective in 2007. In it, it was acknowledged that large losses in banking industry are due to operational risk and can be avoided when they are identified, analyzed, monitored and controlled properly so as to reduce operational risk exposure and mitigate losses resulting from operational failures tangibly manifesting itself in the likes of business disruption, control failures, errors, misdeeds, or external events (Meshack et al, 2016).

The seven designated categories of loss events given in Basel II, also by adopted in Solvency II and the EU regulations are as follows: Internal fraud committed internally in an organization; External fraud committed by third parties includes; Employment practices and workplace safety risks; Clients, products and business practice; Damages to physical assets; Business Disruption and System Failures; Execution, Delivery, and Process Management (ED and PM)

In the recent years, several significant operational risk events have also occurred, including fraudulent actions such as those of Lloyds Banking Group and Barclays in 2006 that created €5.9billion and €4billion losses, respectively;  Société Générale in 2008 resulting in a loss of almost €6.3 billion; those of Bank of America and Citigroup in 2012 causing losses of $175.5 million and $22 million, respectively; and those of Rabo bank and Fondiaria-SAI in 2013 generating losses of $1 billion and €252 million, respectively, indicate that even financial institutions operating presumably complicated risk management systems are vulnerable to severe operational loss events (Pakhchanyan, 2016). In order to curb operational risk, there is the need to implement a vigorous and sound operational risk management (control) solutions (Barakat, 2014).

Operational Risk control then is the set of methods by which firms evaluate potential losses and take action to reduce or eliminate such threats. It is a technique that utilizes findings from risk assessments. The goal is to identify and reduce potential risk factors in a company’s operations, such as technical and non-technical aspects of the business, financial policies and other issues that may affect the well-being of the firm (Kenton, 2023). Operational risk control seeks to control the risk impact, which is the potential or actual loss or damage that the bank may incur due to operational risk events. Banks implement effective and proportionate risk mitigation and control strategies, such as risk avoidance, risk reduction, risk transfer, and risk retention to reduce the likelihood or impact of operational risk events, or to enhance the resilience and recovery capabilities of the bank. Banks also develop and test contingency plans, business continuity plans, crisis management plans, and incident response plans to ensure the continuity and recovery of critical operations in case of disruptions or emergencies. Some of these practical techniques used by banks include: Implement strong access controls both physical and systems to sensitive areas like the safes or other important valuables; Regular control, spot checks, audits and reconciliation s; Secure storage and encryption of data; Employee training roles and task expected, on data privacy practices and cyber security etc; Diversify suppliers, service providers and sources; Regular security updates and patches in the system, setting up system backups; Segregation of duties, that is ensuring maker and checker rules are followed for every operations, setting up cash amounts and approval authorization limits; Installations of security guards, security cameras; Setting up clear policies and procedures for banking operations; Establishing insurance policies for staff protections, fire or other hazards etc

Risk control aims to minimize and manage risks, but it cannot remove them entirely. Some risks are inherent in the business environment or the nature of the industry, while others may arise from unforeseen circumstances. The goal of risk control is to reduce the likelihood and potential impact of risks on the organization, helping to build resilience and maintain stability in the face of uncertainty (Kenton, 2023).

According to (Nair, 2007), in developed nations operational risk control systems have continued to grow and this has fostered them in attaining their overall performance. Other emerging market segments like in the middle and Central America have had to invest in sophisticated operational risk control systems. This trend is attributed to a need to comply with the Basel II accord, which requires banks to invest in internal risk mitigation processes, data infrastructure and analytical competences for enhanced growth and profitability.

Banks play an essential role in the development of any economy by facilitating businesses, trade, and ensuring judicious allocation of idle funds. Banks are also pivotal in the implementation of government monetary policies (Nguyen, Vu & Le, 2017). The Banking industry is one of the largest industries occupying the highest position in the ranks of industries in Cameroon. In achieving its objectives which is centered around its operations the industry must absolutely be achiebing operational efficiency (Bernanthos, 2018). In Cameroon, most bank employees due to a lot of engagement in operational setbacks and malpractices find it difficult to contribute to the overall performance of the organization.

This therefore justifies the creation of national laws, such as the Central Africa Banking Commission (COBAC) in 1990 and the Pan African Organization for the Harmonization of Business Law in Africa (OHADA) in 1992 for all banking establishments in the Central African Economic and Monetary community (CEMAC) to regulate the activities of commercial banks in Cameroon. However, despite the above moves commercial banks still find it difficult to be effective. It is thus necessary to Assess the effectiveness of some operational risk control techniques that will help curb this situation and further improve on the overall performance of banks.

1.3 Statement of the Problem 

There are several commercial banks in Cameroon that started as Cameroonian-owned banks, but today have foreigners as majority shareholders, or even as complete owners of the banks. The said banks were plunged into crises or liquidity problems because some dubious Cameroonian businessmen including contractors, borrowed huge sums of money from the banks and would not repay (Pefok, 2022). All these could be linked to Fraud, errors, inefficiency, ineffectiveness, and mismanagement committed linked to operational lapses

Specifically, several banks have been slammed with sanctioned fines over the years by the national regulatory bodies like BEAC, COBAC, and MINFI for non-compliance with regulations and norms governing the banking sector. In the year 2019, The Central African Banking Commission (COBAC) issued sanctions on Cameroonian bank managers that followed its September 22, 2018, meeting, the conclusions of which were published by Abbas Mahamat Tolli, the commission’s Chairman and Governor of BEAC. The concerned managers reportedly violated exchange regulations and did not comply with prudential standards (businessincameroon, 2019). In 2022, the General managers of NFC Banks SA, CCA, and Bank Atlantique were slammed with warning notices which came together with a fine for not complying with the regulations on Anti-money laundry regulations. The operations that led to these sanctions were caused by employee errors and improper monitoring of processes and procedures which are directly linked to operational risk. Operational risks in banks manifest itself through people, process systems, and legal risk. With regards to people, it occurs during employee errors, fraud and the death or departure of key personnel. Operational risk in line with systems occurs when there is a system failure or system shut down and it encompasses inter-branch connectivity, power backup systems, information technology systems, and other technical systems. In line with process, it occurs as a result of failure in banking procedures and processes. And lastly, in line with legal risk, it manifests through failure with compliance to financial and monetary authorities. 

It was therefore necessary to identify and assess the effectiveness of operational risk control techniques used by commercial banks in Cameroon. Such findings were to help us propose feasible solutions that will aid in the development of well-adapted long-term operational risk control techniques to mitigate their business risks.

1.4 Research Questions

1.4.1 Main Research Question

To what extent are the operational risk control techniques of commercial banks in Cameroon effective?

1.4.2 Specific Research Questions

And in relation to the main research question, the following questions were posed:

1. To what extent is the risk retention technique of micro-finance institutions in Cameroon effective?
2. To what extent is the risk transfer technique of micro-finance institutions in Cameroon effective?

• To what extent is the risk reduction technique of micro-finance institutions in Cameroon effective?

1. To what extent is the risk avoidance technique of micro-finance institutions in Cameroon effective?

1.5 Research Objectives

1.5.1 Main Objective

The study sought to assess the effectiveness of operational risk control techniques of micro-finance institutions  in Cameroon.

1.5.2 Specific Objectives

 The study sought to attain the following specific objectives:

1. To examine the extent to which the risk retention technique of micro-finance institutions in Cameroon is effective
2. To determine the extent to which the risk transfer technique of micro-finance institutions in Cameroon is effective

• To analyze the extent to which the risk reduction technique of micro-finance institutions in Cameroon is effective

1. To investigate the extent to which the risk avoidance technique of micro-finance institutions in Cameroon is effective

1.6 Research hypotheses                                                                                                                  

H₀₁: The Risk retention tehnique is not effective in micro-finance institutions  in Cameroon.

H₀₁: The Risk transfer is not effective in micro-finance institutions  in Cameroon.

H₀₁: The Risk reduction is not effective in micro-finance institutions  in Cameroon.

H₀₁: The Risk avoidance is not effective in micro-finance institutions  in Cameroon.