Abstract

The purpose of this study was to analyze the effect of credit risk management on the performance of MFIs in Cameroon, case of AWICCUL. Credit risk management is of paramount importance to business men and the business world as whole. The study made use of AWICCUL as case study. Data for the period 2009-2015 was used. We have employed the regression model to do the analysis.

In this model, we have defined profit (ROA) as a performance indicator while loans to deposits ratio, capital adequacy ratio and non-performing loans as credit risk management indicators. The findings and analysis show that credit risk management has a significant effect on the performance of microfinance institutions in Cameroon.

The study recommends that MFIs in Cameroon should establish a credit risk management team that should be responsible for taking actions that will help in minimising credit risk, this credit risk management team should mitigate Credit risk problems such as high level of nonperforming loans by critically screening of loan applications before granting them. Participation in portfolio planning and management should be encouraged within the MFIs in Cameroon.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Stability and profitability of a financial institution depends solely on the credit management practices in that institution while poor performance is attributed to weakening credit quality. The management of credit risk can play down operational risk while locking in realistic income.

The first step to managing credit risk is ensuring that the lending staff complies with the laid down industry lending standards and policies. Secondly, the financial institutions should ensure that their credit policies manage other areas of credit risk such as syndicated loans, evergreen loans just to name a few and there is minimal individual lending. An institution’s board and management should ensure that there are set targets in terms of loan portfolio mix included in the yearly planning.

Credit risk management is a structured approach to managing uncertainties through risk assessment, developing strategies to manage it and mitigation of risk using managerial resources (Kargi, 2011). The strategies include transferring to another party, avoiding the risk, reducing the negative effects of the risk, and accepting some or all of the consequences of a particular risk (Kargi, 2011).

Effective credit risk management is the process of managing an institution’s activities which create credit risk exposures, in a manner that significantly reduces the likelihood that such activities will impact negatively on a bank’s earnings and capital (NBE guideline issued in 2003). Credit risk is not confined to a bank’s loan portfolio, but can also exist in its other assets and activities. Likewise, such risk can exist in both a bank’s on-balance sheet and its off-balance sheet accounts (NBE guideline issued in 2003).

Credit or default risk is the risk that the promised cash flows from loans and securities held by financial institutions may not be paid in full. Should a borrower default, both the principal loaned and the interest payments expected are at risk (Saunders and Cornett, 2003). The potential loss a financial institution can experience suggests that financial institutions need to collect information about borrowers whose assets are in their portfolios and to monitor those borrowers overtime (Saunders and Cornett, 2003).

Credit risk is the uncertainty associated with borrower’s loan repayments. In general when borrowers’ asset values exceed their indebtedness they repay loans but when borrowers’ assets values are less than loan values, they do not repay and they could therefore exercise their option to default (Sinkey, 2002).

As defined by Gregory (2010) credit risk occurs when counterparty is not in a position or is unwilling to meet his or her obligation. It may be distinguished in terms of an actual default or declining of counterparty’s credit quality. Owing to the fact that credit risk exposure goes on as the foremost basis of tribulations in financial institutions globally, these institutions draw constructive lessons from these past occurrences.

Financial institutions as an overview should have a keen responsiveness of the need to recognize, determine, observe and manage credit risk. Furthermore, these institutions should ensure that their capital is sufficient to counter these risks as well as ensure superior compensation for the risks incurred.

As defined by Gibson (2012), performance may be referred to as the extent to which financial goals and objectives of a financial institution have been accomplished or are being attained. It is a process of matching up the revenue generated to the institution’s set policies. It is a key measure for assessing the financial/profitability health of a particular organization within the set time.

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.

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 and 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.

A superior return on equity or return on assets indicate enhanced revenue projection for a MFI expansion and pliability to shocks, and thus leads to lower credit risk (Öttker-Robe & Podpiera, 2010). Likelihood of counterparty defaulting on his or her obligations is referred to as default risk. This brings about deterioration of the credit quality deteriorates or else there is an increase in default risk. As stated by Gregory (2010), it is difficult to evaluate the extent of credit risk since information on non-payment and resurgence rates are not wide-ranging.

As illustrated by Otieno and Nyagol (2016), the microfinance industry is on the rise and gaining significance in the global financial sector. In their study, there were over a thousand microfinance institutions at the end of year 2010 with a projected borrower base of around two hundred million and an outstanding portfolio in excess of forty four billion dollars. The growth of borrowers stood at 12% from 2003 to 2008 and a portfolio outstanding 34%. The greatest growth rate in terms of borrowers was seen in Asia.

Likelihood of counterparty defaulting on his or her obligations is referred to as default risk. This brings about deterioration of the credit quality deteriorates or else there is an increase in default risk. As stated by Gregory (2010), it is difficult to evaluate the extent of credit risk since information on non-payment and resurgence rates are not wide-ranging.

As illustrated by Otieno and Nyagol (2016), the microfinance industry is on the rise and gaining significance in the global financial sector. In their study, there were over a thousand microfinance institutions at the end of year 2010 with a projected borrower base of around two hundred million and an outstanding portfolio in excess of forty four billion dollars.

The growth of borrowers stood at 12% from 2003 to 2008 and a portfolio outstanding 34%. Just like many other African countries, the microfinance sector’s springboard in Cameroon was the banking system restructuring engaged by the Ministry of Finance (MINFI) and the Banking Commission for Central Africa (COBAC). The expansion of MFIs in Cameroon during the 1980s can highly be explained by the gap left by the restructuring of the banking sector in most developing countries, which was characterized by the restraining or rationing of credit opportunities. Cameroon was not an exception.

In Cameroon, the history of microfinance dates back to more than one century in its traditional form popularly known as “NjangiorTontine”. The introduction of “modern” microfinance in Cameroon started in 1963 by a Catholic priest Father Alfred Jansen, in Njinikom in the North-West Region of Cameroon (Creusot, 2006). This idea of Credit Unionism spread all over the North-West and South-West regions of Cameroon and by 1968, 34 credit unions that were already in existence joined together to form the Cameroon Cooperative Credit Union League (CamCCUL) Limited.

CamCCUL is therefore the umbrella organization of cooperative credit unions and the largest MFI in Cameroon and the Communauté Économique des États de l’Afrique Centrale(CEMAC) sub-region (www.camccul.org).

There are more than 460 registered MFIs in Cameroon with a sum amounting to over FCFA 258 billion which has been accumulated by way of deposits from close to one million customers (Gwasi and Ngambi, 2014). On a global note, the microfinance industry has realized important growth rate and as the number of microfinance institutions and customers continue to grow, regulation of the industry becomes a question of interest since the sustainability of these institutions is highly debated. A more efficient micro financial sector may eventually translate into higher rates of economic growth and thus the ability of governments to alleviate poverty.

Despite the increasing regulation of the microfinance sector in Cameroon and the constant efforts being made by the government authorities2 to enhance the performance of these MFIs, the sector still faces a lot of challenges. Regular news about the microfinance sector in Cameroon is the constant close down of several microfinance establishments or the sudden and spectacular bankruptcy of some MFIs which reduce customers’ confidence. We still have in mind the COFINEST and FIFFA cases.

The sector is also criticized for providing services only to bankable customers and on almost same conditions as banks forgetting their social responsibility of providing financial services to those who are excluded from the traditional banking system. This can be explained by the fact that these MFIs are mostly emanations of banks and therefore operate with their mother bank conditions. According to the COBAC report on the microfinance sector (2008), the level of not performing loans and default rate are still very high in the sub-region.

Moreover, interest rates still remain globally very high than those of the banks although less than interest rates charged by informal moneylenders in spite of competition (COBAC 2008). The volume of loans and savings mobilized by the sector is still very low as compared to that of the banking sector (about 5.5% of the banks’ deposits and 4.8% of the banks’ loans in 2008 against 7% and 6% respectively in September 2007).

More so, there is uneven geographical distribution of MFIs across the national territory (Fotabong, 2012; Kobou et al., 2009), with less than 48% of these MFIs located in rural areas meanwhile close to 60% of the population of Cameroon leaves in rural areas.

Despite the remarkable expansion of savings, the transformation coefficient into credit still remains very low and more seriously, is the violation of basic prudential norms stipulated by the Banking Commission as well as poor internal control.

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