CHAPTER ONE

INTRODUCTION

1.1 Introduction

This study seeks to evaluate the effect of accounting information on lending decisions in Microfinance Institutions in Buea. As lending decisions have long-term effects on MFIs, the analysis of accounting information is crucial. This work is organized into five chapters. Chapter one covers the introduction along with the background information pertaining to the study.

It also addresses the study objectives, hypotheses, the significance of the study, and its scope. Chapter two reviews the work of other researchers which covers the conceptual, theoretical and review of empirical literature. It also brings out the gaps and contributions of the study. Chapter three outlines specific approaches and procedures adopted among alternatives that include research design, area of study, population of the study, sampling procedures and size, data collection instrument, and data analysis procedure. It also addresses ethical issues. Chapter four covers the presentation of findings and chapter five discusses on the findings, draws conclusions and recommendations.

1.2 Background of the study

At the time of inception, accounting was developed specifically in order to record and classify monetary transactions as well as provide the financial results of the operations of business entities. However, over the years, the concept of accounting has evolved and nowadays the techniques, rules and procedures of accounting are being used on a much wider and comprehensive context (Mintz, 2013). Seetharaman and Raj (2011) defined accounting information as data organized for the special purpose of decision-making. Accounting information as a scientific process is about provision of financial information needed to take decision especially when it comes to acquisition and use of scarce corporate resources as well as the elimination of wastes in the wealth creation chain to maximize profit (Uche & Nwankwoeke, 2021).

Accounting information plays a vital role in business because it helps you track income and expenditures, ensure statutory compliance and provide investors, management and government with quantitative financial information which can be used in decision-making. Analyzing organizations’ accounting information has been an important tool for decision makers such as creditors, investors, business analysts and financial managers (Aifuwa, Saidu, Osaruese & Osazevbar, 2019).

They utilize the data when assessing the performance of businesses. Ultimately, a lender really wants to know just how much risk is involved when lending a business money, which can be determined by reviewing the organization’s financial accounting information. Once this level of risk is determined, the lender will also be able to outline exactly how much to lend and at what interest rates.

Microfinance institutions (MFIs) are categories of financial institutions targeting individuals and small businesses who lack access to conventional banking and related services. Microfinance institutions in Cameroon are committed to improve the lives of the poor or low- income people through the provision of credits, savings and other financial services (Robinson, 2001). Accounting information of the borrowers is important to facilitate the roles of MFIs in entirely economical and financial undertakings in the contemporary world (Saleh, 2018).

According to Minnis and Sutherland (2016), MFIs lending involves long-term, medium or short-term loans that are provided to individuals and business organizations. In this regard, MFIs are extremely vital in savings, mobilizations and financial resource allocation to individuals, group of persons and institutions, which makes them an important phenomenon in economic growth and development (Cassar, Zeballos & Wydick, 2015).

The monetary atmosphere is a dynamic one, so MFIs must plan for them to survive. Loans granted are based on certain factors which must be considered in lending which in turn influence the lending determination and support the MFIs in monitoring growth after such loans have been granted (Idewele, 2020).

It must be noted that lending is probably the most important service provided by MFIs and loans are the most important assets held by MFIs and MFIs generate a greater proportion of their incomes from lending activities. In order to maximize available lending opportunities, MFIs require adequate accounting information to evaluate the probability of loan repayment, estimate the potential loss if the borrower does not pay and decide on the terms of financing if a loan is to be granted (Uche & Nwankwoeke, 2021).

According to them, information often required are those that deal with solvency, liquidity and profitability of the firm seeking credit. In utilizing the data presented to them by customers for purpose of lending, the MFIs are interested in financial accounting information which enables them to reach an initial loan decision and also helps them to monitor progress after the loan has been granted.

The MFIs as users of accounting information would want to satisfy themselves that the customer will be able to meet the interest payment accruing during the period of the loan and repayment of capital sum at the end of the loan period. The managers of the borrowing firm may likely be tempted to manipulate this information to change the perception of the financial situation of the enterprise that the other stakeholders have. (Takoudjou, Djoutsa & Simo, 2013).

Accounting information fully plays its role only if it meets the quality criteria of relevance and reliability as defined by the Financial Accounting Standard Board (FASB).

Accounting Information is reliable if that information could be checked, reviewed and verified by concerning persons with objective evidence. It is relevant when that information is timely, comparable and understandable. It is only when these criteria are met that accounting information can be credible and gain the confidence of the users of the financial statements. The relevance of a firm`s accounting information is important in making business decisions which involve borrowing decisions and corporate governance (Scorţe & Farcas, 2013).

Likewise, in the MFIs sector, lending decision largely relies on the borrowing firm`s accounting information that adhered to the Financial Accounting Standards (FASB) Thus, the relevant balance sheet, the statement of cash flows and its income statement are based on the level of compliance with accounting bodies of standards such as the Financial Accounting Standard Board (FASB).

Ong’era and Onditi (2016) indicated that one of the factors responsible for MFIs failures in Africa is the poor management of lending. This results from MFIs employees’ failure to consider and analyze the borrowers’ accounting information such as borrower’s expenses, liabilities and asset. They also fail to understand the structure of cash flow statement and income (profitability) prior approving and releasing loans. These problems lead to inadequate and poor repayment, monitoring and follow-ups resulting from the poor return on assets.

The other studies by [Minnis and Sutherland (2016); Donelson et al. (2014)] also identified the presence of significant effects of accounting information use on MFIs capability of screening and monitoring. The study found it is more indeterminate and uncertain yielding indistinct relations among borrowers accounting information and MFIs’ lending decisions. This was found to be contrary to most studies that approved debt agreements with MFIs that are a function of borrowers accounting information.

Despite the fact that lending business is a high return business and major income generating activity in the MFIs industry, its undertaking encompasses enormous risks to both the lenders and the borrowers. Hence, MFIs in avoiding to be subjected to an extensive array of financial risks, they usually make a critical analysis of borrowers accounting information (Greuning & Bratanovic, 2009).

According to Emeni (2014), the overall goal of the information provided by financial accounting is centered on three core financial statements: balance sheet, income statement and cash flows statement. The balance sheet provides the reports of the company resources (the assets), the company’s obligations (the liabilities), and the owners’ equity. This is very important in MFIs lending decisions as it reports the difference in what is owned (assets) and what is owed (liabilities).

Emeni (2014) argued by supporting the idea that the income statement provides information on the amount of net income earned by a company during a period. This can be used to project the future earning, important in repaying the loan. The last one includes the statement of cash flows which indicates the amount of cash collected and paid out by a borrower in the three forms of activities: operating, investing, and financing.

The underutilization of this information means increasing lending risk and increased non-performing loans. Similarly, Emeni (2014) asserted that a credit high risk is largely caused by an ineffective evaluation of borrower balance sheet, income statement, and cash flows statement in making loans decisions. In addition, Mvula (2011) opined that lending (credit) risk is the most serious and expensive risk allied with financial institutions and its impact on performances is relatively significant to any other risks threatening the microfinance sector`s solvency. Generally, accounting information is considered by the microfinance institutions to be a tool to overcome the high credit risk of lending business in determining the ability to repay the loan taken (Trimisiu, 2012).

Despite the fact that many pieces of literature signify the vital role of accounting information, in recent decades the MFIs lending practices have witnessed little compliance with the three principles guiding their operations of profitability, liquidity and solvency (Donelson, Jennnings & Mclnnis 2014). The increased business competitions in most of the lending process have not effectively considered the accounting information but they base on personal relationships and security-based lending. On the other hand, according to non-performing loans (NPLs).

Sharon (2007) underpins the important contribution made by loans in the development of an economy. However, she also notes that its non-payment can also lead to huge losses by MFIs in particular and country in general. People establish businesses with the principal objective of making profits (Rawlin et al. 2012). The principle of wealth maximization is still the key motivation for any business to exist. For this reason, assets acquired in the course of business should generate income for the business. Since loans constitute the main assets for all the lending institutions, there is need for MFIs to put in place efficient mechanisms to manage loan portfolios so as to generate revenues among lending institutions (Daniel & Wandera, 2013).

Although it is largely accepted that financial statements prepared largely to help external, primarily investors and creditors in their business decisions, (FASB, 1978), there has not been adequate empirical work that has been carried out to examine how this information is useful in processing lending decision and how or whether this has effect on the levels of non-performing loans. Thus, this study seeks to investigate the use of accounting information (balance sheet, income statement and cash flow statement) in making lending decisions on the level of Non-performing loan (NPL).

1.3 Statement of Problem

For years, there has been a significant increase in MFIs solvency problems in Cameroon largely caused by non-performing loans (NPL). A study was conducted by Toh et al., (2016) in Cameroon, in a descriptive study using questionnaires, these authors analyzed the reason for today`s collapse of MFIs. Variables such as high level of competition, limited capital, regulation issues and non-performing loans were interrogated. They concluded using regression analysis that non-performing loans were amongst the leading cause of insolvency rate in Cameroon. This stems from the inadequate scrutiny of borrowers accounting information (Richard, 2011). It becomes risky to continue lending activities with uncertainties which in turn can affect MFI`s performance.

The importance of managing bad loans by lending institutions cannot be over emphasized. The problem of bad loans is a common phenomenon in most countries which makes MFIs’ ability to make loans and grow greatly compromised (Petersson & Wadman, 2004). These gradual increasing proportions of non-performing loans raise the question on the efficiency in MFIs` screening and monitoring of the borrowers accounting information. Adequate scrutiny of borrowers` accounting information will lead to a healthy loan portfolio, which will result to increased profitability and enhances investors and depositors in the MFI sector. On a similar note, inadequate use of accounting information resulting to non-performing loans has been cited as the major threat to MFIs` survival (MacDonald, 2006). Kroszner (2002), opines that there is a close relationship between non-performing loans and MFI insolvency.

Existing literature recognizes the use of financial statement variables in making lending decisions (Cole et al. 2004), (Barret 1990). However, though many researchers have been able to prove that use of financial statements is important in making lending decisions, the studies done have not validated financial statement importance by measuring whether use or non-use of financial statements has impact on NPLs. Majority of the studies done have been on the global determinants of NPLs which have been studied by different countries and different scholars such as Mileris (2012), Tomak (2013), Ahmed & Bashir (2013) and Shingjerji (2013). This gap serves as motivation for this study.

1.4 Research Questions

1.4.1 Main Research Question

What is the effect of accounting information on lending decisions in MFIs in Buea

1.4.2 Specific Research Questions

1. How does using borrowers` assets and liabilities affect lending decisions in MFIs in Buea?
2. What impact does using borrowers` cash flow statements have on lending decisions in MFIs in Buea?
3. What effect do borrowers` profit levels have on lending decisions in MFIs in Buea?

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