Abstract

The study is aimed at assessing the effect of loan default on the profitability of NC4D Cooperative Credit Society LTD and determining strategies to enhance the public framework for reducing loan defaults in financial institution. Sample random sampling techniques were separately constructed for each item alongside graphs.

The results of the study shows that, the major causes of loan default by members of NC4D Cooperative Credit society LTD are failure of Credit Officers to effectively monitor the loans they granted to customers and the delay in the approval and disbursement of loans.

It was also established that, loan default causes NC4D to make huge loan loss provisions which had negative impact on the financial performance of the microfinance through reduction in loan interest income, profit and creating liquidity problems for the microfinance which can lead to a run and subsequent liquidation.

The following recommendations were made to reduce loan default by members; Simplified Credit Appraisal report to reduce the delay in appraising loans, Training of Credit and Branch managers on credit management and regular monitoring of loans by Credit Officers.

CHAPTER ONE

INTRODUCTION

1.1 Background to the Study.

The extension of credit facilities is one of the major activities of all micro finance institutions. This is evident by the significant proportion of loans in the overall operating assets of these lending institutions. Healthy loan proportions are therefore vital for lending institutions in view of their impact on liquidity, lending capacity, earnings and profitability (Warue, 2012).

Nonetheless, some of the loans given out by the lending institutions are unfortunately not paid by back as such; eventually results in default with adverse consequences for the overall financial performance of these institutions. Loan default related problems are becoming a significant trade to the sustainability of most microfinance institutions over the world and Cameroon is not an exception (Joanna, 2006).

Data from the banking commission of Central Africa states, industrial sources and various focus groups reveal that the cause of problems are multi-mensional and non-uniform among different literatures.  Financial institutions in Cameroon complain that there is a lack of credit worthy borrowers while at the activities.

Recent data from the banking commission of central Africa states pertaining to micro financial institutions in Cameroon has identified the high incident of loan defaults a major deterrent of lending by most financial institutions. Loan default related problems among bank and micro financial institutions has been discussed in may public lectures as one of the reasons why main stream bank like commercial banks have not shown much interest in financing micro, small and medium enterprises (MSMES) Warue,2001.

The profitability that a microfinance institution (MFI) does not receive its money back from borrowers (plus interest) is a most common threat and most often leads to the vulnerability of financial institutions (Warve, 2012). Since most micro loans are, unsecured delinquency and subsequent default can quickly spread from a hand full of loan to a significant portion of the portfolio. This contagious effect is worsen by the fact that microfinance portfolio often have a high concentration in certain business sectors. Consequently, money clients may be exposed to some external threats such as lack of demand for client’s products, livestock disease outbreak, bad weather and many others.

These factors create risk volatility in microloans portfolio quality, heightening the importance of controlling credit risk. In this regard, MFIs need a monitoring system that addresses repayment problems quickly and clearly so that loan offices and their supervisors focus on delinquency (repayment rate) before it gets out of hand.

Microcredit and microfinance are relatively new terms in the field of development economics first coming to prominence in the 1970s, according to the (Robinson, 2001). Prior to this period that is from the 1950s through the 1970s the provision of financial services by donors or government was mainly in the form of subsidized rural credit programs. This often resulted in high loan default rate, high losses and seriously mitigated the ability to reach poor rural households (Schreiner, 2003).

Robinson, (2001) states that the 1980s represented a turning point in the history of microfinance in like the Grameen bank began to show that they could provide small loans and saving services profitable on a larger scale. As such, they receive on containing subsidies; they were now commercially funded and fully sustainable and could attain wide outreach to client (Robinson, 2001).

It was also at this time that the term “microfinance” came to prominence in the development related issues (Dinos and Ashta, 2010). The difference between microcredit and the subsidized rural credit programs of the 1950s and 1960s was that microcredit insisted on a policy of repayment on charging interest rates that covered the cost of credit delivery and by focusing on clients who were dependent on the informal sector of credit (Craig, 2006). It was now clear for the first time that microcredit could provide large scale outreach profitably.

The 1990s “saw accelerated growth in the number of micro profitably. Institution created and an increase emphasis on reaching scale” (Robinson, 2001) refers to the 1990s as “The microfinance decade microfinance had now turned into an industry according to (Robinson, 2001). Along with the growth in microcredit institutions, attention changed from just the provision of other financial services such as saving and pension facilities when it became clear that the poor had a demand for these other services (Joan, 2006).

The importance of microfinance in the field of development was reinforced with the launch of the microcredit summit in 1997. The summit had a major objective of reaching 175 million of the world’s poorest families, especially the objective of those families with credit facilities that will enhance self-employment and other financial business services, by the end of 2015. More recently, the UN as previously stated declared 2005 as the international year of microcredit.

In Cameroon microfinance services is no longer reserved for the social non-governmental organization (NGOs) as the boundary between microfinance form and commercial banking activities are becoming blurred.

In its traditional microfinance and commercial banking, activities can be traced back in 1960s following the creation of the first cooperative savings and loan institutions (credit union) at Njinikom in the North West Region of Cameroon by a Roman Catholic clergy. Development of microfinance institution and their activities remain blurred until the early 1990s when president Paul Biya in order to incorporate the elites and various interest groups into his new deal policy passed the remarkable law No 90/053 of 19 December 1990 relating to freedom of associations, and law No 92/006 of the 14 of August 1992 relating to cooperatives, companies and common initiative groups.

Another major contributing factor to the growth and development of microfinance activities in Cameroon can be link to the banking crisis in the late 1980s that resulted to the closure of branches of commercial and development bank in rural areas and some cities. Many top exclusives lost their jobs, some were dismissed. Some of these executives and employees form cooperative credit unions that function link mini bank.

As microfinance activities gained sizable relevance in the financial systems of the country, the roles different stakeholders become clearly defined as the supervisory authorities configured MFIs within the nation‘s territory.

Network od MFIs: Made up of institutions developed endogenously such as MCZ, CAMCCUL (Cameroon cooperative credit union league) The self-directed village saving and credit (CVECA) support through the decentralized rural credit project of the Ministry of Agriculture and Rural Development with the support of BICEC and two other French institutions.

The independent MFIs created by individuals and located mostly in urban areas NGOs with development projects, agro industrial activities, and credit component. The case of SODECOTTON and South West Development Authority. With growing interest in the sector in the absence of effective governance mechanism.

The monetary in other words, the Ministry of Finance took control over the microfinance sector initially placed under the Ministry of Agriculture. This leads to a series of texts relating to sub regional integration, supervision, and control of microfinance activities. These texts were adopted unanimously by a council of finance ministries from the Economic and Monetary Community of Central Africa (CEMAC) by 2005. Consequently, the new regulation, which became effective as from April 14 2005, broadly classifies MFIs into these categories.

Since after the classification, commercial banks involvement in microfinancing Cameroon has increasingly become visible. Starting with Afriland First Bank created in MC2, the microfinance brand in 1992, BICEC is another giant in the banking sector created ACEP and CVECA, while from the opposite direction CAMCCUL network created UBC a commercial bank that introduced the Advance microcredit brand and ECOBANK that brought in the EB-ACCION the latest player in the market in 2009.

1.2 Statement of the Problem.

According to Aballey (2009), loan portfolio is typically the largest and the prominent source of income for most financial institutions. In view of the significant contribution of loan of the financial help of micro financial institutions through interest income earnings; these assets are considered the most valuable assets of financial institutions.

In Cameroon, micro financial sector plays an important role in propelling economic development. Huge bad loans could therefore affect micro financial institution negatively as far as accomplishing this important is concerned. When financial institutions gives out loans, and they are unable to recover this loans and profitability on them as a result, this can lead low recovery rate which may cause this financial institution to become bankrupt over the time. Yet, ironically very few studies to the best of our knowledge have scrutinize the studies of loan default among groups and individuals in Cameroon.

1.3 Research Questions.

On the basis of the above background, the major question that arises is; what are the effects of loan default on the profitability of micro financial sector in Cameroon?

In line with this question, we formulated the following specific research questions

1. What are the causes of loan default in micro financial institutions?
2. What is the effects of loan default on the profitability of microfinance institutions?
3. What measures can be employed to control loan default in micro finance institutions?

 1.4 Objectives of the Study.

The main objective of this study is to investigate the effects of loan defaults on the profitability of microfinance institutions in Cameroon. Specific research objectives include:

To investigate the extent to which loan default affects profitability of NC4D Buea Cooperative Credit Union.

1. To identify possible measures to reduce the incidence of loan default.
2. To investigate the causes of loan default in microfinance institutions.
3. Finally, to make recommendations based on the findings.

1.5 Hypotheses of the study

Ho: Loan default has no significant effects on the profitability of micro finance institution.

H1: loan default has a measurable effect on the performance of microfinance institution.