Abstract

Credit risk is at an increasing rate and is becoming an area of concern to many people and institutions in the lending business globally. This kind of exposure leads to instability and poor financial performance in financial institutions.

However, MFIs are facing risks when they are operating. Credit risk is one of the most significant risks that financial institutions face, considering that granting credit is one of the main sources of income. Therefore, the management of the risk related to that credit affects the profitability of the institution.

The main purpose of the research was to investigate the impact of credit risk management on the profitability of microfinance in Cameroon. In the research model, ROE and ROA were defined as proxies of profitability.

The research collects data from 30 employees and customers of UNICS Plc in Buea and formulates two hypotheses which are related to the research questions. Descriptive and regression are performed in order to test if the relationship exists.

The findings reveal that credit risk management does have positive effects on profitability microfinance It is recommended that MFIs should emphasize more on risk management. In general, MFIs need to maintain an optimum level of credit risk management.

CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

The power of financial institutions especially microfinance to create money is of great importance in business operations. Microfinance is the major financial intermediary in any economy as they are the major provides credits to the household and corporate sector and operates the payment mechanism.

Orua (2009) deal with both retail and corporate customers, have well-diversified deposit and lending book, and generally offer a full range of financial services. The policy of microfinance to make money results in the elastic credit system that is necessary for economic progress at a relatively steady rate of growth.

Particularly, microfinance makes profits by selling liabilities with one set of characteristics (a particular combination of liquidity risk and return) and using the proceeds to buy assets with different sets of characteristics i.e. asset transformation.

Modern financial management defines the business of the financial system as measuring, managing, and accepting the risks. Under the definitions, the most important and uncertain banks and financial institutions must measure, monitor, and manage their credit risk.

This hazard which is called the default risk is the danger that the counterparty will default or not perform. With increased pressure on the financial institutions to improve shareholders’ returns banks have had to assume higher risk and at the same time, manage these risks to avoid losses.

Recent changes in the banking environment (globalization, deregulation, conglomeration, etc.) have posed serious risk challenges for banks but have also have offered productive opportunities (Saunders and Marcia, 2007).

Generally, the aim of risk management is not simply to reduce or even to eliminate risk; it is also the process of recognition, measurement, and control of risk that an investor faces.   This may not be possible given various difficulties of measuring risk and the limitations of the instruments for controlling risks.

Risk management must be of the continuous process the composition of investor’s portfolio and the risk of the assets therein, as well as the objectives and constraints of the investor change over time. However, the need for risk management has increased sharply in the past three decades.

Risk management has the purpose and the scope of ensuring that Risk management ensures that the risk-taking part of investing is being carried out in a controlled and understood manner. It is a continuous process change of the composition the investor‘s portfolio, the risk of the asset in the portfolio and the

The five C’s of credit is a system used by lenders to gauge the creditworthiness of potential borrowers. The system weighs five characteristics of the borrower and conditions of the loan, attempting to estimate the chance of default.

The five C’s of credit are character, capacity, capital, collateral, and conditions. Credit Risk Management is inherent in microfinance and is unavoidable. The basic function of microfinance management is risk management.

Micro finances assume credit risk when they act as intermediaries of funds and credit risk management lies at the heart of the financial institutions. The business of banking is credit and credit is the primary basis on which a bank’s quality and performance are adjusted.

Credit risk is composed of default risk and credit mitigation risk. Default risk is the risk that the counterparty will default on its obligations to the investor. In this risk, the credit quality deteriorates (or default risk increases).

Credit risk is more difficult to measure because data on both default and recovery rates are not extensive, credit returns are highly skewed and fat-tailed, and longer-term time horizons and higher confidence levels are used in measuring credit risks.

Read More: THE EFFECT OF CREDIT RISK MANAGEMENT ON THE FINANCIAL PERFORMANCE OF MICROFINANCE INSTITUTIONS 

1.2 Problem Statement

The aim of every microfinance institution is to operate profitably in order to maintain its stability and improve in growth and expansion. For most people in microfinance, lending represents the heart of the industry.

Loans are the dominant asset at most microfinance, generate the largest share of operating income, and represent their greatest risk exposure. The microfinance sector in Cameroon has faced various challenges that include non-performing loans and fluctuations of interest rate among others, which have threatened their stability.

According to Bessis (2005) credit risk management is important to microfinance management because they are ‘risk machines’ that take risks; they transform them and embed them in banking products and services. Risks are uncertainties resulting in adverse variations of profitability which shows the Financial Performance or in losses that show their failure.

While other researchers have provided valuable knowledge on Credit Risk Management; they have not shown a clear formula in which   Credit Risk Management is properly to improve the profitability of micro finances especially in the economy of Cameroon.

Despite all efforts put in place by MFIs in Cameroon, Most MFI in Cameroon still faces problems such as poor management of non-performing loans and fluctuation of interest which some credit risk management that when properly managed, increases the profitability of these organizations and thus, it is important to conduct the study about credit risk management as it is essential that MFIs manage credit risks so as to reduce losses and ensure continued existence in the long term. It is from this background that Credit risk management is proposed and investigated

Research Questions

1. What is the influence of credit risk management on the return on investment of microfinance in Cameroon?
2. What is the influence of credit risk management on return on equity?

1.3 Objective of the Study   

The main objective of this study is to examine the influence of credit risk management on the profitability of microfinance institutions in Cameroon. The research objective is divided into the following

1. Evaluate the influence of credit risk management on return on investment of MFI
2. Assess the influence of credit risk management on return on equity
3. To make policies

1.4 Hypothesis of the Study

H1: Credit risk management has a significant impact on the profitability of microfinance institutions in Cameroon

H0: Credit risk management has no significant impact on the profitability of micro institution finance in Cameroon.