Abstract

Lending is one of the principal business activities for banks. A loan portfolio, therefore, forms a substantial amount of a bank’s assets because it is the predominant source of interest income.

However, when loans go bad, they tend to have some serious effects on the financial health of banks through provisions for bad debts, in line with banking regulations.

In view of the critical role, banks play in the economy of a country, it is worth finding out the effects of bad loans (loan delinquency) on the financial performance of banks.

The study was carried out to establish the effects of loan delinquency management on the financial performance of commercial banks, focusing on ECOBANK CAMEROON. It specifically focused on the effects of bad loans on profitability.

The method of data analysis used was the multi list square regression method. The study also looked at the trend analysis of bad loans (non-performing loans) during the twelve-year period under review and the factors that account for bad loans.

Secondary data were used in the study. The findings showed that the bank’s non-performing loan has been increasing during the period under consideration in which 2012 recorded the highest increase.

It was established that these provisions negatively affected the financial performance of the bank through a reduction in profits.

The study identified ineffective loan monitoring and poor credit vetting as the major factors accounting for bad loans.

To improve the quality of the bank’s loan portfolio, some measures have been recommended to the management of the bank. These are credit training programs, effective loan monitoring, and adequate collateral.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

It is believed that the English word’ bank’ is derived from the Italian word Banco [long bench], because Jewish bankers sat on them while providing currency exchange and Loan services, normally in popular areas like markets or preaching halls.

Banks could equally trace its origin to the German word bench meaning a pile, the word Germans used to represent a kind of public debt. Regardless of their origin banks are important financial institutions linking the world’s economies.

Banks have been around since the first currencies were minted. Perhaps even before then in some other form. During this period, coins of various shapes and sizes were used in place of fragile impermanent bills. However, these coins needed to be kept in a safe place.

Ancient houses didn’t have safe steel and as such most wealthy people preferred to keep their money in the temples. The priest usually occupied the temple giving it some form of security.

The fact that most temples were the center of financial activities made the temples to be always ramshackle during wars.

Coins could be hoarded more easily than other commodities such as 300pounds pigs. So a class of wealthy people took it upon themselves to lend these coins to people who needed them with interest.

As such temples generally handled large loans as well as loans to various sovereigns. With time roman great builders took it upon themselves to take banking out of the temples to a distinct building.

During this period money lenders had as much money as loan sharks do today. With time there was a monumental shift of power in the relationship between the creditor and the debtor as landed noblemen were untouchable through most of history, passing debts on to descendants until either the creditor or the debtors lineage died out.

Banks are germane to economic development through the financial services they provide. Their intermediation role can be said to be a catalyst for economic growth.

The efficient and effective performance of the banking industry over time is an index for financial stability in any economy.

The extent to which a bank extends credit to the public for productive activities accelerates the Pace of a nation’s economic growth and its long-term sustainability.

Lending is one of the main activities in Cameroon and other parts of the world .This is evidenced by the volume of loans that constitute banks’ assets and the annual substantial increase in the amount of credit granted to private and public sectors of the economy.

According to Comptroller (1998) lending is the principal business for most commercial banks. A loan portfolio is therefore typically the largest asset and the largest source of revenue for banks. In view of the significant contribution of loans to the financial health of banks through interest income earnings, these assets are considered the most valuable assets of banks.

According to International Monetary Fund (IMF) country report No 10/259 of July 2010 on the soundness of the banking system in Cameron and CEMAC, the total number of loans given to customers accounted for about 50% of banks’ liquidity both in Cameroon and the CEMAC region.

As per the   IMF report, total loans to customers’ in2007 amounted to 69.7% in Cameroon and 51.9% in the CEMAC region and increased to 60.8% in2009. The reason why banks give much attention to the lending activity, especially in periods of a stable economic environment, is that a substantial amount of banks’ income is earned on loans which contribute significantly to the financial performance of banks.

The above literature gives sample evidence that healthy loan portfolios are vital assets for banks in view of their positive impact on the performance of banks.

Unfortunately, some of these loans usually do not perform and eventually result in bad debts which affect banks liquidity and earnings on such loans.

These bad loans become cost to banks in terms of their implications on the quality of their assets portfolio and profitability.

This is because in accordance with banking regulations, banks make provisions for non-performing loans and charge for bad loans which reduce their loan portfolio and income.

Banks equally make provisions for bad debts, bad debts are an amount shown in a financial statement representing amounts formerly classified as receivable that will probably be written off. Banks, therefore, charge for bad loans which reduce their loan portfolio.

1.2 Statement of the problem

In spite of the large income generated from banks portfolios, available literature shows that huge portions of banks loan usually go bad and therefore affect the financial performance of banking institutions (controller, 1998).

liquidity determines the number of loans given to customers.  According to IMF country report No 10/259 of July 2010, the NPLs ratio increased from 11.5 to 12.9 percent in 2009, reflecting both the weaker economy in 2009 and the more aggressive bank lending behaviour in 2008, in which bank credit to the non-government sector had risen by about 15 percent in real terms. Cameroon’s NPL ratio remains higher than the CEMAC average.

Indeed bad loans can lead to the collapse of banks which have huge balances of these non-performing loans if measures are not taken to minimize the problem. The banking industry plays a vital role in the development of the economy of Cameroon.

Huge bad loans could therefore affect banks in the performance of this important role. In view of the above it is necessary to examine the effect of loan delinquency on the of performance commercial banks. Thus, what is the effect of loan delinquency on the performance of commercial banks?

Specifically:

1. What are the causes of loans delinquency?
2. What is the relationship between loan delinquency and the profitability of commercial banks?

1.3 Objectives of the study

The main objective of the study is to determine the effect of loan delinquency on the performance of commercial banks.

The specific objectives are:

1. To determine the causes of loan delinquencies
2. To examine the effects of loan delinquency on the profitability of commercial banks
3. To make necessary recommendations

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