CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

Traditional finance theory argues that as the size of a loan expands, the interest rate on that loan rises to accommodate the increased risk associated with the loan. However, utilizing firm level data of the banking industry, it is observed that, the smaller the loans size, the greater the interest rate applied and vice versa. Yet, using a fixed effect panel data framework, this article also shows that the interest rates differences among loan sizes can be mainly explained by the borrowers’ characteristics are the most important factors.

In the banking and lending industry in Cameroon, interest rates are a major concern. Here, Financial Institutions have been accused of charging high interest rates and exploiting the consumers. The Finance Ministry controls all Banking activities in Cameroon especially!

Terms and conditions for Banking services, receives applications for licensing and the appointment of General Managers for banks and financial institutions and passes same to COBAC for approval and rejection. The Government passes a financial institutions act through the ministry of finance with the main aim of protecting the consumers. The act imposes interest rates ceilings on loan finance provided by money lending and financial institutions. An interest rate ceiling is a regulatory measure that prevents banks or other financial institutions from charging more than a certain level of interest. It argues that, the biggest cost component of loaning financial institutions is administration cost and not the cost of capital.

Interest rate is the cost the debtor pays for taking a facility from financial bodies or fees paid for on loan assets (Crowley 2007). Interest rates helps in determining the current market and provides information about future inflation. Classical theory of interest, Keynes liquidity theory, Rational Expectations theory and Loanable funds theory. These theories contributions were discussed in the understanding of interest rate. In classical theory, interest rate is price paid for supply of savings, Keynes theory states that interest rate cost paid for borrowed funds whereas in Loanable funds theory, interest rate is equated to intersection between supply of loanable funds and credit demand.

Repayment is the act of paying back money previously borrowed from a lender. Typically, the return of funds happens through periodic payments which include a portion of the principal plus interest. Failure to keep up with debt repayments can force an individual to declare bankruptcy, which will negatively affect their credit rating. Common types of loans that many people need to repay are auto loans, mortgages, education loans, and credit card charges which are also a type of loan.

When consumers take out loans, the expectation by the lender is that they will ultimately be able to repay them. Interest rates are charged to account for the time that passes between when a loan was given out and when the borrower returns the money in full. Interest is what is charged in exchange for borrowing money, usually expressed as an annual percentage (APR). Some borrowers who cannot repay loans may turn to bankruptcy protection. However, borrowers should explore every alternative before declaring bankruptcy as doing so can affect a borrower ability to obtain financing in the future.

Alternatives to bankruptcy are earning a additional income, refinancing and negotiating with creditors. Individuals may also work with a professional to set a reasonable budget and commit themselves to keep within the budget. The small print on most loan applications will specify what the borrower should do if they are unable to make a scheduled payment. Let the lender know of any setbacks such as health events or employment problems which may affect your ability to pay them back. The longer it takes to pay back your loan, the more interest will accrue and increase the overall cost of your loan.

1.2 Problems Statement

The number of micro-financial institutions in Cameroon has continued to increase day by day at a high rate, which has aggravated the competition between the government and the private sectors for loanable funds.

Despite the increased competition especially amongst many financial institutions, interest rates have remained high. This has reduced the customer’s borrowing and loan repayment capacity leading to an increased number of loan defaulters.

High interest rates pushes borrowers to repay promptly to avoid additional interest but with MFIs, high interest rate may mean placing a high burden on low income customers who form the bulk of micro finance. Making it difficult for them to repay their loan.

1.3 Objectives of the Study

1.3.1 The main objective

The main objective of the study was to establish the relationship between interest rates and loan repayment in micro-financial institutions in Cameroon with Tiko Central Saving and Loan Cooperative Credit Union being a case

study.

1.3.2    Specific Objectives

The specific objectives of the study were,

1. To study the effect of interest rates ceiling on loan repayment in Cameroon financial institutions with specific regard to Tiko central saving and loan cooperative credit union.
2. To analyze the impact of interest rates fluctuation (rising and falling interest rates) on loan repayment in Cameroon financial institutions with a case study of Tiko central saving and loan cooperative credit union.
3. To analyze the effects of interest rates on the supply of loans

Read More: Banking & Finance Project Topics with Materials