Abstract

The study is on the effect of non-performing loans on the financial performance of commercial banks in Cameroon. The key concepts in the study are non-performing loans and financial performance of commercial banks in Cameroon, measured by Return on Equity (ROE) and Return on Assets (ROA), and nonperforming Loans are measured by some factors of non-performing Loans. Other factors affecting financial performance were considered as control variables. The control variables considered are; Bank Regulation and Loan Supervision.

This study was conducted through the use of a descriptive design. The Population of the study comprised 30 respondents that were administered a questionnaire each. A multilinear regression model was used to analyze the data.

The findings established that non-performing loans, measured by Grace Period (X1) and Insider Lending (X2), both positively affect the financial performance of commercial banks measured by Return on Equity, thereby satisfying our first hypothesis that, Nonperforming Loans (NPL) has an effect on the Return on Equity (ROE) of Commercial Banks in Cameroon.

On the other hand, the findings established that non-performing loans, measured by Monitoring and Screening (X5) positively affects the financial performance of commercial banks measured by Return on Assets, thereby satisfying our second hypothesis that, Non-performing Loans (NPL) has an effect on the Return on Assets (ROA) of Commercial Banks in Cameroon.

It also indicates that non-performing loans measured by Grace Period (X1), Insider Lending (X2), Monitoring and Screening (X5),  are good measures of nonperforming loans as the findings indicate that they are appropriate and statistically significant in explaining variance with both returns on equity and return on assets.

The study also indicates that Grace Period (X1), Insider Lending (X2), Monitoring and Screening (X5), affects the financial performance of commercial banks in Cameroon, positively and negatively, respectively. In essence, the study informs that mere reporting of increases in financial performance and increases in nonperforming loans could be misleading and that financial factors have the importance of enhancing the understandability of financial performance.

In particular, the analyzed variables of non-performing loans and with both return on equity and return on assets analysis can inform better on the effects of non-performing loans on the financial performance of commercial banks than a mere comparison of quantum figures.

CHAPTER ONE

INTRODUCTION

1.1 Background Information

Over the last 10 years, the quality of the loan and its portfolios across many economies worldwide stayed comparatively stable until the emergence of the 2007-08 financial crises. Since then, the quality of the bank assets declined quickly because of the world economic nosedive.

The reality is that loan performance is closely associated with the economy of any country and the decline in the loan performance was not yet standardized across the world economies (Gerstel and Baesens, 2008). The crucial problem faced by financial institutions in Cameroon is credit risk because of defaulters not repaying credits.

The failure to manage bad debts leads to insolvency and losses among financial institutions (Abiola & Olausi, 2014). The growing trend of loan defaults is becoming a concerning issue not only for the banking sector but also for the national economy of Cameroon. It hinders the financing capacity of the banks and, therefore, harms the overall socio-economic development of the country.

Among the various services provided by the bank, lending has been the primary activity for a decade.  Default loans can be described in an actual sense as bad loans, which banks are not proficient to earn from, it is uncertain in determining whether the debtors would be able to make their installments in regards to the amount owed or borrowed. Customers of banks in Cameroon consist of businesspersons and women, civil servants, contractors, and even the state itself and all are accountable for the poor performance of loans in the banking system.

Kofi and Dadzie (2012) found that some reasons for default include poor sales, sickness, lack of planning by clients, spending on unnecessary things by clients, poor record-keeping, and inadequate monitoring by loan officers. Moreover, it was observed that the implication of loan default to banks includes the inability to disburse more loans in the future, reducing operating profits, loan-able funds, and undermining the liquidity.

Von-Pischke (1980) as in Mungure (2015), states that some of the impacts associated with non-performing loans include the inability to recycle funds to other borrowers; unwillingness of other financial intermediaries to serve the needs of small borrowers; and the creation of distrust.

As noted by Baku and Smith (1998), the costs of loan delinquencies would be felt by both the lenders and the borrowers. The lender has costs in delinquency situations, including lost interest, the opportunity cost of principal, legal fees, and related costs. For the borrower, the default decision is a trade-off between the penalties in lost reputation from default versus the opportunity cost of forgoing investments due to working out the current loan.

Cameroon is a Member State of the Bank of Central African States (B.E.A.C.) and also a member of the Central African Economic and Monetary Community (CEMAC). These two bodies, BEAC and CEMAC constitute part of the “Franc Zone”. Franc Zone simply means those African States whose monetary policy is being directed by France especially in the domain of exchange rate with respect to currencies of other countries, convertibility to other currencies, centralization of international exchange reserves, and harmonization of regulations.

The Banking Industry in Cameroon is governed by laws and regulations whose sources are listed seriatim: International Conventions, Customs Laws, Ordinances, Presidential Decrees, Ministerial Orders, Circulars, and Court Decisions. These regulatory instruments are flexible in character, meaning they can be a subject of modification based on some socio-cultural, political, and economic development within Cameroon. Banking regulations vary between jurisdictions. (Nico Halle & Co. Law Firm).

With the liquidation of Banque Meridien BIAO Cameroun (BMBC) in 1996, Crédit Agricole du Cameroun (C.A.C.) in 1997, and the incorporation of the Commercial Bank of Cameroon (C.B.C.) in 1998, there exists 10 functional Commercial Banks in Cameroon.

These include: Société Générale des Banques au Cameroun (SGBC); Standard Chartered Bank of Cameroon (SCBC); Crédit Lyonnais du Cameroun (SCB-CL); Amity Bank Cameroon PLC; ECOBANK; Afriland First Bank; CITIBANK; Commercial Bank of Cameroon (CBC); Union Bank of Cameroon (UBC); Banque International du Cameroun pour l’Epargne et le Crédit (BICEC). BICEC was created following the restructuring of “Banque Internationale pour le Commerce et de l’Industrie du Cameroun” (BICIC).

Apart from Amity Bank PLC, Afriland First Bank, Commercial Bank of Cameroon, Union Bank of Cameroon, ECOBANK, CITIBANK, and Standard Chartered Bank, which are privately owned, the other banks above have government shareholdings of between 35% to 83% and are heavily influenced by the latter. Banks in Cameroon are all commercial banks mainly handling traditional banking functions, lending short-term and specializing in short-term self-liquidated trade finance. Long-term loans are accorded by the Central Bank (BEAC).

Commercial banks are the most important financial institution in many countries which encourage and mobilize savings and also channel such savings into productive investment, this is because of their high network of offices; and as well because the banks are strong and thus attract savers. Commercial banks, also accept deposits from their customers and lend to borrowers for various purposes; this role is paramount and outweighs every other one.

They serve as intermediaries between borrowers and savers. In the process of lending, new money is created by banks through the deposit lending multiplier effect. Obviously, credit creation is the main income-generating activity of banks (Kargi, 2011).

However, it exposes the banks to credit risk. The Basel Committee on Banking Supervision (2001) defined credit risk as to the possibility of losing the outstanding loan amount partially or totally, due to credit default risk. Credit risk is an internal determinant of bank performance. The higher the exposure of a bank to credit risk, the higher the tendency of the bank to experience financial crisis and vice-versa.

According to Ahmad and Ariff (2013), most banks in Cameroon and other economies such as Nigeria, Thailand, Indonesia, Malaysia, Japan, and Mexico experienced high Non-Performing Loans (NPLs) and a significant increase in credit risk during financial and banking crises, which resulted in the closing down of several banks in Indonesia and Thailand. The negative effect of credit risk and non-performing loans on banks’ financial performance and the economy, in general, has made the issue of NPLs a global one and of great importance in the last decades.

According to Hou and Dickinson (2007), many types of research on the motives of bank failures discovered that asset quality is a statistically sizable predictor of insolvency and that failing bank institutions constantly have a high stage of Non-performing loans prior to failure. Therefore, in managing the lending portfolio to achieve the desired results, the bank ought to supply sufficient interest to the above factors.

The economic system of every country is highly dependent on a vibrant and firm financial system. No good financial system can do without well-structured and efficient financial institutions specifically the banking industry. Khan and Senhadji, (2001) opined that the poor financial performance of these institutions does not only affect the economic growth and structure of the particular country but also affects the entire world. In his opinion, the good financial performance of these financial institutions is represented by affluence and economic growth in any country or region.

One of the main functions of financial institutions is to link the surplus and the deficit units in an economy or financial intermediation. Bossone (2001) in his opinion says that the bank’s intermediation services are exceptional because of its unique ability to finance production by lending its own debt to agents willing to accept it as one of its sources of funds. De Santis and Surico (2013) states that banks are best placed to refinance the real economy, in particular the small- and medium-sized firms, which are the biggest providers of employment in the economy.

Also, commercial banks play a critical role in developing economies where most borrowers do not have access to capital markets (Greuning and Bratanovic, 2003).  The efficiency of a bank’s financial performance is a function of how it is able to satisfy its customers at a minimum risk level and maximum profitability level.

One of the risk factors is the non-performing loans granted by these banks. This is why the issue of non-performing loans cannot be over-emphasized.  Non-performing loans are those loans that are not paid up as at when due. Caprio and Klingebiel (1996)), suggest that non-performing loans are those loans that do not generate income for a relatively long period of time that is, the principal and or interest on these loans have been left unpaid after due the dates of repayments.

1.2 Problem Statement

Hennie (2003) argued that non-performing loans are loans that are not generating income. Mostly the banks make their profits from interest paid on loans granted to the deficit units of the economy. Yet some of the customers granted these loans fail to meet their contractual obligations of repaying the loans or even paying the interest element of the loan.

A crucial problem faced by financial institutions in Cameroon is credit risk because of defaulters not repaying credits. The failure to manage bad debts leads to insolvency and losses among financial institutions (Abiola & Olausi, 2014).

The growing trend of loan defaults is becoming a concerning issue not only for the banking sector but also for the national economy of Cameroon; it hinders the financing capacity of the banks and, therefore, harms the overall socio-economic development of the country. Among the various services provided by the bank, lending has been the primary activity for a decade.

Non-performing loans or default loans can be described in an actual sense as bad loans, which banks are not proficient to earn from, it is uncertain in determining whether the debtors would be able to make their installments in regards to the amount owed or borrowed.

Customers of banks in Cameroon consist of business persons and women, civil servants, contractors, and even the state itself, and all are accountable for the poor performance of loans in the banking system.

Non-Performing Loans have a direct impact on the financial performance of commercial banks by diluting Returns on Assets (ROA), as well as Return on Equity (ROE), which are all measurements of profitability. Non-performing Loans Assets have opportunity costs, in that the non–interest-earning assets could have been invested elsewhere and provide earnings.

Managers also may use provisions for losses on non-performing loans for their own objectives which could include profits smoothening.  There are other factors that affect the financial performance of commercial banks which include but are not limited to CAMEL factors.

Cameroon commercials Banks have had the challenge of reducing non-performing loans that is considered to have effects on the financial performance of Commercial Banks. Despite actions that have been taken to reduce non-performing loans that include licensing of Credit reference Bureaus, non-performing loans have continued to grow and commercial banks have recently reported both increases in nonperforming loans and profits of the banks in the same periods.

Non-performing loans (NPLs) have maintained an increasing trend in commercial banks in the world, especially in the less developed world. For example, in Kenya, CBK (2013), reported that the ratio of non-performing loans to gross loans increased from 4.7 percent in December 2012 to 5.2 percent in December 2013, the pre-tax profit for the sector increased by 16.6 percent from Ksh. 107.9 billion in December 2012 to Ksh. 125.8 billion in December 2013.

Berger et al., (1997) study Problem Loans and Cost Efficiency in Commercial Banks, study linked Problem Loans with Cost efficiency, which in turn affects profitability. Batra (2003) noted that in addition to the influence on profitability, liquidity, and competitive functioning. Michael et al., (2006) emphasized that NPA in loan portfolio affect operational efficiency which in turn affects profitability, liquidity, and solvency position of banks.

Kithinji (2011), study Credit risk management and profitability of commercial banks and found out that there is no relationship between profits, amount of credit, and the level of non-performing loans. Macharia (2012) study the relationship between the level of non-performing loans and the financial performance of commercial banks.

The study found that the bulk of the profits of commercial banks is not influenced by the amount of credit and non-performing loans suggesting that other variables other than credit and non-performing loans impact profits.

Kithinji (2011), and  Macharia (2012), did not consider other CAMEL factors affecting the profitability of commercial banks as control variables and did not use non-performing loans coverage ratio as a measure of non-performing loans and used only non-performing loans ratio as a  measurement of non-performing loans in their studies.

Loss is facilities with outstanding arrears that are regarded as being uncollectable and where security is nugatory or has been disposed of, the proceeds of which have not covered the total debt and the balance remaining is unlikely to be recovered.

The banking sector is an important part of any country’s economy and is a major contributor to economic well-being. Ishaq et al. suggested that like all other organizations, performance evaluation is important for banks. Banks are no exception to this.

The fierce competition between members of the industry and damaging macroeconomic policies of Governments are causing lots of strains on the banks’ performance. Consequently, this becomes important that one should evaluate the current performance of banks along with factors that are influencing bank’s performance.

1.3 Research Questions

1.3.1 Main Research Question

do non-performing loans have effects on the financial performance of commercial banks?

And as well, some of these specific troubling questions to be answered and resolved by the study are as follows:

1.3.2 Specific Research Questions

1. To what extent have non-performing loans affected commercial bank’s wealth maximization of shareholders’ funds in Cameroon?
2. To what extent have non-performing loans affected commercial banks’ profitability, as well as savings of depositors in Cameroon?

1.4 Working Hypotheses

H1: Non-performing Loans (NPL) have an effect on the Return on Equity (ROE) of Commercial Banks in Cameroon.

H2: Non-performing Loans (NPL) have an effect on the Return on Assets (ROA) of Commercial Banks in Cameroon.

 

Further Readings

THE EFFECTS OF NON-PERFORMING LOANS ON FINANCIAL PERFORMANCE OF TOLE TEA COOPERATIVE CREDIT UNION (TTCCUL) IN CAMEROON