Abstract

Loan management is one of the most important activities in MFIs and cannot be overlooked by any financial Institution engaged in loan. Sound loan management is a prerequisite for a financial institution’s stability and continuing profitability, while deteriorating loan quality is the most frequent cause of poor performance and condition. As with any financial institution, the biggest risk in microfinance is lending money and not getting it back. The study sought to determine the effect of loan management on the performance of Microfinance Institutions in Buea Municipality. As methodology, primary data was collected from the various MFIs in the study using questionnaires and observation. The data was analyzed using the Pearson Product Moment Correlation Coefficient alongside the statistical package for social sciences program. This study argues that loan management greatly affects the performance of MFIs in the Buea municipality. It also proved that there is a positive relationship between client appraisal, credit terms, and credit risk control and collection policy on the performance of MFIs. MFIs need to invest in managing their loans given that it greatly affects their performance. They should develop an appropriate loan policy used for managing loans in order to match up to the economy they find themselves in so as to reduce loan default and increase performance.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

The concept of credit can be traced back in history and it was not appreciated until and after the Second World War when it was largely appreciated in Europe and later to Africa (Kiiru, 2004). Banks in USA gave credit to customers with high interest rates which sometimes discouraged borrowers hence the concept of credit didn’t become popular until the economic boom in USA in 1885 when the banks had excess liquidity and wanted to lend the excess cash (Ditcher, 2003).In Africa the concept of credit was largely appreciated in the 50’s when most banks started opening the credit sections and departments to give loans to white settlers. In Kenya credit was initially given to the rich people and big companies and was not popular to the poor. In 1990s loans given to customers did not perform which called for an intervention. Most suggestions were for the evaluation of customer’s ability to repay the loan, but this didn’t work as loan defaults continued (Modurch, 1999). The concept of credit management became widely appreciated by Microfinance Institutions (MFI’s) in the late 90s, but again this did not stop loan defaults to this date (Modurch, 1999).

Microfinance institutions fill a needed gap within the financial services industry by offering small loans, or micro-loans, to people unable to access conventional loan services. Microfinance institutions vary in size and function with some organizations focusing entirely on micro financing, while others work as extensions of large investment banks. People living in under-developed areas such as Latin America, Kosovo and countries within the Sub-Saharan region can access needed financial resources through the services provided by microfinance institutions. (Role of MFI by Jacquelyn Jeanty)

Access to credit can play a pivotal role in economic growth. Banks and lending institutions provide the services that allow people to save and invest available assets and a resource, which further supports and strengthens economic activity. Within underdeveloped communities, the role of microfinance institutions provides the credit access and financial services needed to develop income-earning businesses. (Role of MFI by Jacquelyn Jeanty)

It is now widely acknowledged that financial development plays a significant role in economic growth. According to Hamilton (1781), banks are the happiest engines that have ever been invented for spurring economic growth. The relationship of the financial sector to economic growth globally has recently been the subject of considerable empirical and theoretical research. The few works that have been published on Africa, especially in Sub-Saharan Africa, have generally concluded that financial development should lead to economic growth.

Flowing from these studies is the recommendation that African countries need to expand and improve the efficiency of their financial sectors, through appropriate regulatory and policy reforms, in order to promote faster economic growth. The pertinent question to ask is: How can financial sector development affect growth in Sub-Saharan Africa or in an economy as a whole? (Levine et al. (2000), Ghirmay (2004)).

The preponderance of research on MFIs is from economic and finance perspectives. For example, researchers have studied the determinants of the individual micro finance loans, which primarily focus on borrowers’ characteristics, such as the poor’s credit worthiness (Johnson & Morduch, 2008), peer screening (Michels, 2012), monitoring (Karlan, 2007), and joint liability (Ahlin& Townsend, 2007).

Others have studied the economic consequences of MFIs, such as poverty reduction (Khandker, 2005) and entrepreneurship (Bruton, Khavul, & Chavez, 2011). Recently, some scholars have taken the lender’s perspective and investigated how microfinance loans are influenced by MFIs Organizational characteristics. This line of research usually applies agency theory to the relationship between MFIs’ ownership and profitability (Mersland& Strom, 2008), outreach and financial sustainability (Hartarska&Nadolnyak,2007; Im& Sun, 2014; Quayes, 2011), corporate governance (Mersland& Strom, 2009; Charkrabarty& Bass, 2014), and cost efficiency (Caudill, Gropper, &Hartarska, 2009). While many studies have focused on economic dimensions of micro-credit, less considered is the “hybrid” nature of these organizations. That is, MFIs are social enterprises that on one hand pursue a social mission—helping the poor—while on the other hand engage in commercial activities that sustain their operations (Im& Sun, 2014;Mair, 2010). On the social side, MFIs serve the poorest tier of the world’s economic pyramid, which comprises more than four billion people, or around 65 percent of the world’s population, who earn less than $3,000 each per year (Charkrabarty & Bass, 2013). In this regard, evidence suggests that microfinance positively affects social outcomes such as women’s empowerment, social capital, and economic conditions (Zhao & Wry, 2014). On the commercial side, most MFIs worldwide face the challenge of making sufficient profit to breakeven, and frequently have to raise fees, which undermines their social mission of helping the poor (Cull, Demirguc-Kunt, & Morduch, 2007). MFIs’ sustainability as “hybrid organizations” thus depends both on the advancement of their social mission and on their commercial performance (Battliana& Dorado, 2010; Battilana & Lee,2014; Mair, 2010).

1.2 Statement of the Problem

According to Shekhar, 1985, credit plays an important role in the lives of many people and in almost all industries that involve monetary investment in some form. Credit is mainly granted by banks including to several other functions like mobilizing deposits, local and international transfers, and currency exchange service.

According to Gitman (1997), the probability of bad debts increases as credit standards are relaxed. Firms must therefore ensure that the management of receivables is efficient and effective. Such delays on collecting cash from debtors as they fall due has serious financial problems, increased bad debts and affects customer relations. If payment is made late, then profitability is eroded and if payment is not made at all, then a total loss is incurred. On that basis, it is simply good business to put credit management at the front end by managing it strategically. As with any financial institution, the biggest risk in microfinance is lending money and not getting it back. Credit risk is a particular concern for MFIs because most micro lending is unsecured. The people covered are those who cannot avail credit from banks and such other financial institutions due to the lack of the ability to provide guarantee or security against the money borrowed. Many banks do not extend credit to these kinds of people due to the high default risk for repayment of interest and in some cases the principle amount itself. Therefore, these institutions required to design sound credit management that entails the identification of existing and potential risks inherent in lending activities. (Craig Churchill and Dan Coster, 2001).

Hence, the issue of credit management has a profound implication both at the micro and macro level. When credit is allocated poorly it raises costs to successful borrowers, erodes the fund, and reduces banks flexibility in redirecting towards alternative activities. Moreover, the more the credit, the higher is the risk associated with it. The problem of loan default, which is resulted from poor credit management, reduces the lending capacity of a bank. It also denies new applicants’ access to credit as the bank’s cash flow management problems augment in direct proportion to the increasing default problem. In other words, it may disturb the normal inflow and outflow of fund a bank has to keep staying in sustainable credit market.

The very nature of the banking business is so sensitive because more than 85% of their liability is deposits mobilized from depositors (Saunders, Cornett, 2005). Banks use these deposits to generate credit for their borrowers, which in fact is a revenue generating activity for most banks. This credit creation process, if not managed properly, exposes the banks to high default risk which might led to financial distress including bankruptcy. All the same, beside other services, banks must create credit for their clients following prudent credit management procedure to make some money, grow and survive in stiff competition at the market place.

Achou and Tenguh (2008) also conduct research on bank performance and credit risk management found that there is a significant relationship between financial institutions performance (in terms of profitability) and credit risk management (in terms of loan performance). The purpose of this study was to understand the effect of credit management on their financial performance.

There have been attempts in the past to study Micro financing and Micro lending but much focus has been on the impact of MFIs in poverty alleviation, especially in Cameroon but much less has been done to investigate the effect of loan management on the performance of MFIs institutions in Cameroon therefore this research addresses that gap.

This study seeks to answer the following questions;

1. What is the effect of loan management on the performance of MFI?
2. To what extend does client appraisal affects performance?
3. To what extend does loan terms affects performance?
4. To what extend does credit risk affects performance?
5. To what extend does collection policy affects performance?

1.4 Objective of Study

The main objective of this study is to establish the effect of loan management on the performance of MFIs. The specific objective

1. To assess the effect of client appraisal on the performance of MFIs
2. To determine the effect of loan terms on the performance of MFIs
3. To assess the impact of credit risk on the performance of MFIs
4. To examine the extent to which collection policy affects performance of MFIs
5. Identify the problems associated with loan management in MFIs
6. Recommending strategies that effectively address the proper loan management in MFIs.