CHAPTER ONE

INTRODUCTION

This chapter presents the background to the study, statement of the problem, objectives and research questions of the study, scope of the study, and significance of the study.

1.1 Background to the study.

Loan is one of the many factors that can be used by a firm to influence demand for its products. According to Horne and Wachowicz (1998), firms can only benefit from loan if the profitability generated from increased sales exceeds the added costs of receivables. Myers and Brealey (2003) define loan as a process whereby possession of goods or services is allowed without spot payment upon a contractual agreement for later payment.

Loan management is one of the most important activities in any company and cannot be overlooked by any economic enterprise engaged in loan irrespective of its business nature. It is the process to ensure that customers will pay for the products delivered or the services rendered.

Loan management is concerned primarily with managing debtors and financing debts. The objectives of loan management can be stated as safe guarding the companies’ investments in debtors and optimizing operational cash flows. Policies and procedures must be applied for granting loan to customers, collecting payment and limiting the risk of non-payments.

Honker Faze Rashid(2009), Loan management is a term used to identify accounting functions usually conducted under the umbrella of Accounts Receivables.. He explains that the process of loan management begins with accurately assessing the loan-worthiness of the customer base. This is particularly important if the company chooses to extend some type of loan line or revolving loan to certain customers. Proper loan management calls for setting specific criteria that a customer must meet before receiving this type of loan arrangement. As part of the evaluation process, loan management also calls for determining the total loan line that will be extended to a given customer.

According to Nwankwo (2000), loan management constitutes the largest single income-earning asset in the portfolio of most banks. This explains why banks spend enormous resources to estimate, monitor and manage loan quality. This is understandably, a practice that impact greatly on the lending behaviour of banks as large resources are involved.

Myers and Brealey (2003) describe loan management as methods and strategies adopted by firms to ensure that they maintain an optimal level of loan and its effective management. It is an aspect of financial management involving loan analysis, loan rating, loan classification and loan reporting.

Nelson (2002) views loan management as simply the means by which an entity manages its loan sales. It is a prerequisite for any entity dealing with loan transactions since it is impossible to have a zero loan or default risk. The higher the amount of accounts receivables and their age, the higher the finance costs incurred to maintain them. If these receivables are not collectible on time and urgent cash needs arise, a firm may resort to borrowing and the opportunity cost is the interest expense paid.

Nzotta (2004) pointed out that loan management greatly influences the success or failure of commercial banks and other financial institutions. This is because the failure of deposit banks is influenced to a large extent by the quality of loan decisions and thus the quality of the risky assets. He further notes that, loan management provides a leading indicator of the quality of deposit bank’s loan portfolio. A key requirement for effective loan management is the ability to intelligently and efficiently manage customer loan lines. In order to minimize exposure to bad debt, over-reserving and bankruptcies, companies must have greater insight into customer financial strength, loan score history and changing payment patterns.

According to the business dictionary financial performance involves measuring the results of a firm’s policies and operations in monetary terms. These results are reflected in the firms return on investment, return on assets and value added.

 Stoner (2003) as cited in Turyahebwa (2013), defines financial performance as the ability to operate efficiently, profitably, survive, grow and react to the environmental opportunities and threats. In agreement with this, Sollenberg and Anderson (1995) assert that, financial

Performance is measured by how efficient the enterprise is in use of resources in achieving its objectives.

Hitt, et al (1996) believe that many firms’ low performance is the result of poorly performing assets. MFIs earn financial revenue from loans and other financial services in the form of interest fees, penalties, and commissions. Financial revenue also includes income from other financial assets, such as investment income. MFI‟s financial activities also generate various expenses, from general operating expenses and the cost of borrowing to provisioning for the potential loss from defaulted loans. Profitable institutions earn a positive net income (i.e., operating income exceeds total expenses).

Today, Microfinance institutions are seeking financial sustainability. Many MFIs were restructured in order to achieve financial sustainability and finance their growth. Sustainability is defined as the capacity of a program to stay financially viable even if subsidies and financial aids are cut off (Woolcock, 1999). It embraces “generating sufficient profit to cover expenses while eliminating all subsidies, even those less-obvious subsidies, such as loans made in hard currency with repayment in local currency” (Tucker and Miles, 2004). Tucker and Miles (2004) studied three data series for the period between March 1999 and March 2001 and found that self-sufficient MFIs are profitable and perform better, on return on equity (ROE) and return on assets (ROA), than developing-world commercial banks and MFIs that have not attained self-sufficiency. In order to optimize their performance, MFIs are seeking to become more commercially oriented and stress more on improving their profitability; therefore self-sustainability.

1.2  Problem statement.

Proper loan management is a prerequisite for a financial institution’s stability and continued profitability, while a deteriorating quality of loan management is the most frequent cause of poor financial performance among MFIs.

 According to Gitman (1997), the probability of bad debts increases as loan standards are relaxed. Firms must therefore ensure that the management of receivables is efficient and effective.

Bart Baesens and Tony Van Gestel, (2009), argue that poor management of loans in form of delays in collecting cash from debtors as they fall due has serious financial problems, increased bad debts and affects customer relations.

Effective loan management practices and loan accounting practices should be performed in a systematic way and in accordance with established policies and procedures. To be able to prudently value loans and to determine appropriate loan provisions, it is particularly important that banks have a system in place to reliably classify loans on the basis of loan risk to facilitate repayment of loans by customers (Kagwa, 2003) and goes ahead to stress that if loan management is not properly handled, then the overall financial performance of an institution is affected.

It is against this background that the researcher wishes to examine the impact of loan management on the financial performance of Micro Finance Institutions in Buea.

1.3 General objective

To examine the impact of loan management on the financial performance of MFIs in Cameroon taking a case study of P & T credit union, Buea.

1.4 Specific objectives of the study

1. To establish the loan management policies employed by Micro Finance Institutions.
2. To find out how loan management affects the performance of Micro Finance institutions.
3. To establish strategies to improve financial performance of Micro Finance Institutions.

1.5 Research questions

1. What loan management policies are employed by MFIs?
2. How does loan management affect financial performance?
3. Which strategies can be adopted to improve financial performance of MFIs?