Abstract

Loan management is a critical activity for Microfinance Institutions (MFIs) and should not be neglected by any lending institution. Effective loan management is vital for the financial stability and continuous profitability of a financial institution, as declining loan quality is a typical source of poor performance and financial trouble. One of the most serious dangers in the microfinance market is loan money and then failing to retrieve it.

This study aimed to investigate the impact of loan management practices on the performance of MFIs in Buea Municipality. To achieve this objective, data was collected using questionnaires distributed to staff working in local MFIs. A total of 62 completed questionnaires were returned to the researcher. A multivariate linear regression model was used to analyze the data and address the study’s objectives.

The results show that loan management has a substantial impact on the performance of MFIs in Buea Municipality. Client evaluation, lending conditions, credit risk control, and collection strategies all had a positive and substantial impact on MFI performance, according to the research. This suggests that MFIs need to invest in effective loan management practices to enhance their overall performance. MFIs should develop and implement appropriate loan policies tailored to the local economic environment to mitigate loan defaults and improve their financial performance.

CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

The history of loans dates back quite a while, but their significance was particularly recognized after World War II, especially in Europe, before spreading to Africa (Kiiru, 2018). In the United States, banks offered high-interest credit to customers, which often deterred potential borrowers. Thus, credit did not acquire traction until the economic boom of 1885, when banks found themselves with extra cash and a willingness to lend it (Ditcher, 2003).

In Africa, credit appreciation increased considerably in the 1950s, coinciding with the formation of credit departments in banks to give loans to European settlers. In Kenya, credit was predominantly available to wealthy individuals and large corporations, leaving the poor largely excluded. During the late 1990s and early 2000s, many loans extended to customers performed poorly, prompting calls for intervention.

Although suggestions were made to assess customers’ repayment capabilities, loan defaults persisted (Modurch, 2005). The appreciation for credit management practices emerged among Microfinance Institutions (MFIs) by the late 1990s, yet loan defaults remain a challenge to this day (Modurch, 2005).

In Europe, Nwankwo (2013) notes that “credit constitutes the largest single income earning asset in the portfolio of most financial institutions.” This underscores the significant resources that financial entities allocate to assessing, monitoring, and managing credit quality. Such practices greatly influence the lending behavior of banks and financial institutions due to the substantial resources involved.

In the UK, Chodechai (2014) highlights the need for banks to carefully consider their pricing decisions regarding lending. He states that if banks set loan rates too low, the revenue generated from interest may not cover the costs associated with deposits, operational expenses, and losses from borrowers who default (Chodechai, 2014).

In Africa, various advancements that enhance liquidity within loan portfolios carry implications for price risk. Historically, lending activities in Ghana were not susceptible to price risk, as loans were typically held until maturity under conventional accounting practices. However, as banks have adopted more dynamic portfolio management strategies and as the loan market has expanded and matured, the sensitivity of loan portfolios to price risk has increased (Nnanna, 2015). It is now widely recognized that effective loan management significantly contributes to the performance of MFIs. According to Hamilton (2011), MFIs are the most effective engines for driving economic growth ever created.

Studies conducted in Africa, particularly in Sub-Saharan countries, generally affirm that efficient loan management practices correlate with improved MFI performance and economic development. Based on these findings, there is a recommendation for African MFIs to enhance their loan management practices’ efficiency through suitable regulatory and policy reforms to foster accelerated economic growth. This leads to the critical inquiry: How do good loan management techniques affect the success and growth of MFIs in Sub-Saharan Africa, or the economy as a whole? (Levine et al., 2018, p. 8).

Microfinance institutions serve as vital tools for advancing financial inclusion and combating poverty in developing nations. Their significance has expanded from their start, which is credited to Professor Muhammad Yunus, who founded the Grameen Bank experiment in 1979.

Russell, Cabrieal, and Singh (2016) illustrate this development, as the establishment of Grameen Bank laid the groundwork for microfinance institutions (MFIs) (Armendariz & Murduch, 2009). MFIs vary in size and function; some focus only on microfinance, while others serve as extensions of bigger investment banks. Individuals in disadvantaged regions, such as Latin America, Kosovo, and Sub-Saharan Africa, can have access to crucial financial resources through microfinance firms (Jeanty, 2015).

The overall performance of financial institutions relies heavily on their loan management practices, with declining performance often tied to deteriorating credit quality. Loan portfolios constitute the primary assets for lending institutions. If MFIs experience significant losses from loans issued, it can devastate their loan portfolios and ultimately lead to poor financial outcomes such as losses, bankruptcy, and economic downturns. In financial entities, credit risk significantly impacts financial performance.

While managing loans has long been an integral component of business planning in large firms, it represents a crucial source of revenue for these institutions. It also poses substantial risk to the safety and soundness of MFIs. Consequently, managing loan portfolios becomes one of the most costly initiatives for financial institutions, with consequences that are more pronounced than other risks since it directly threatens their solvency (Chijonga, 1997).

Client appraisal is a critical function for any organization, particularly for those involved in credit activities. Several variables must be considered throughout the appraisal process, including the client’s intents, the legality of their demands, the borrower’s repayment capacity, loan amount, and collateral (security). Effective loan evaluation is critical for reducing loan losses; hence, if loan officers lack appropriate expertise, the likelihood of lending to ineligible consumers increases dramatically (Hadi & Kamaluddin, 2015).

Furthermore, credit risk controls—central to credit management practices—encompass the design of loan products, credit committees, and delinquency management (Ahlin & Waters, 2016). Another aspect of loan management involves the policy framework guiding lending, monitoring, and loan collection. Hence, loans should be disbursed systematically, adhering to established credit policies and procedures (Crabb, 2015).

A well-structured loan program is advantageous for the overall performance of financial institutions. It aids in achieving effective risk control and ensuring compliance with regulations. Regular loan reviews are vital as they help management identify issues promptly, ensuring that loan officers adhere to established policies. Grace periods, penalty specifications, repossession timelines, delinquency turnover dates, loan tracking systems, peer monitoring, rescheduling, loan default rates, inflation considerations, and liquidity risk premiums are just a few of the components that should be included in loan collection efforts (Hadi & Kamaluddin, 2015).

When advancing loans, it is critical to emphasize credit requirements. This allows the credit provider to keep a reasonable guarantee of extending the entire amount of credit at the lowest possible cost.

Stifler (2017) explored the impact of debt collection policies, noting that these policies establish the terms and guidelines borrowers must follow before and after receiving loans. Such terms are fundamental to any financial institution and are essential for any enterprise engaged in lending, regardless of its operational context. These regulations are intended to help borrowers meet their responsibilities with the least amount of expense to the organization. They include interest rates, deadlines, and the steps the lender will take to get the borrower to pay back the whole amount owing.

Effective loan management practices are essential components of the overall management systems governing loan policies in microfinance institutions (MFIs). MFIs’ financial success is largely founded on the profits earned from their operations; hence, the loan portfolio is a major asset, which regrettably exposes these institutions to many financial risks, including credit, market, and liquidity risks. According to Scheufler (2002), managing loan portfolios is crucial for MFIs, as it significantly impacts the crediting process by enhancing the institution’s risk-adjusted return through vigilant monitoring of credit risk exposure to mitigate adverse effects.

Loan management, defined by Bert et al. (2003) in Mafumba (2020), involves the processes of granting loans, defining the terms, and recovering these loans when they are due. This necessitates careful planning, control, and coordination of the financial institution’s loan portfolio. To minimize losses and maintain control, MFIs establish loan policies that involve assessing the creditworthiness of customers, including appraising their financial situations and determining their ability to repay loans. For the purposes of this study, credit management practices encompass loan appraisal, monitoring, and recovery processes.

The efficacy of loan management methods is a major problem, underlining the need for enhanced processes and tools to give greater insights into credit unions’ future profitability. According to Saunders and Cornett (2002), using appropriate risk monitoring selection procedures leads to improved product pricing based on estimated risks, which has a major impact on profitability. Wambugu (2008) performed a research on credit risk procedures by MFIs in Cameroon, and discovered that most MFIs had clearly defined credit policies that were reviewed yearly, with lending committees and a loan control department setting the objectives (Mohammad, 2014).

Mwangi (2012) claims that financial organizations use loan management to administer loans to borrowers. This is accomplished through well-developed lending mechanisms and procedures, such as credit evaluation, staff training, and the implementation of credit criteria to reduce possible losses and improve financial performance.

According to Chua et al. (2000), effective management of credit risk is a fundamental task within microfinance institutions, which, once identified, becomes essential for the institution’s safe and sound operation to improve performance. Ahmed and Malik’s (2015) study, which used multiple regression analysis, discovered that credit terms and client appraisal had a positive and significant impact on loan portfolio performance, while collection policy and credit risk controls had a positive but insignificant impact.

Traditional microfinance in Cameroon dates back to 1963, when Father Anthony Jansen, a Roman Catholic priest from Holland, founded the first cooperative savings and lending organization (Credit Union) in Njinikom (Yuh, 2013). Traditional microfinance in Cameroon began in 1963, when Father Anthony Jansen, a Dutch Roman Catholic priest, established the first cooperative savings and lending organization (Credit Union) in Njinikom (Yuh, 2013)..

The principle of progressive savings accumulation has now resulted in a flourishing microfinance sector in Cameroon, which is mostly governed by the Cameroon Cooperative Credit Union League. However, aside from CAMCCUL, the construction of additional MFIs in Cameroon remained limited until the financial crisis of the 1980s, which resulted in the bankruptcy of several commercial and developmental banks, as well as the closure of many commercial bank branches in rural and semiurban regions.

Unfortunately, the late 1990s saw some of the most significant losses among Cameroon’s MFIs, primarily due to errors such as under-pricing the risks associated with unsecured loans provided to low-income individuals, compounded by aggressive competition for customers through extensive office openings throughout the country. This led in high rates of loan defaults and bad debts, which accounted for around a quarter of the total loan portfolio, causing significant losses in the industry (Elle, 2012). This situation instigated necessary reforms in the regulation, supervision, monitoring, control, and governance of MFIs in Cameroon.

Despite extensive research on loan management practices, this issue has seldom been examined from a Cameroonian perspective. The influence of well-designed lending policies and recovery initiatives on financial performance is becoming clearer. As a result, this study tries to fill these gaps by examining the link between credit management and financial performance profitability. The goal of this study is to determine how loan management strategies affect the functioning of microfinance institutions in Buea.

1.2 Statement of the Problem

According to Shekhar (2015), credit is important in many people’s lives and in practically every industry that involves monetary investments in some kind. Banks typically provide loans, but they also mobilize deposits, facilitate local and international transfers, and offer currency exchange services. Gitman (2017) observes that when credit rules loosen, the chance of bad debts increases.

Firms must ensure that their receivables management is efficient and effective. Delays in collecting payments from creditors when they are due can cause considerable financial problems, increasing bad debts, and strained customer relationships. Late payments reduce profitability, and outright nonpayment leads to total losses.

Businesses should thus address credit management strategically. The major risk in microfinance is lending money without promise of recovery. Credit risk is especially important for MFIs because the majority of microloans are unsecured. Individuals who lack collateral and are unable to obtain loans from traditional banks and other financial institutions are the target population. As a result, these banks must employ effective credit management methods that include recognizing current and potential lending risks (Churchill and Coster, 2016).

Credit unions’ financial performance and general success are mainly determined by their ability to manage credit risk. These institutions get more than 80% of their revenue from loans to small and medium-sized enterprises. The Central Bank Supervision Report (2010) found a significant incidence of credit risk, as reflected by the increase in nonperforming loans from MFIs over the preceding decade.

While some credit unions have effectively managed their credits and reduced loan delinquency, others face significant challenges in controlling their delinquent credit portfolios. These challenges stem from market competition, the introduction of long-term credit products, environmental factors, and geographical expansion.

After reviewing the annual reports of several MFIs in Buea, it became apparent that many credit unions are grappling with credit risk issues, which have adversely impacted their financial performance. The effects of credit risk include increased loan delinquency rates, inadequate liquidity holding ratios, poor income realization, unsatisfactory net results, reduced interest returns to net savers, and higher provisions for bad and doubtful debts. These concerning trends raise the important question of the underlying reasons for the ineffective credit risk management in MFIs in Cameroon.

The majority of research looking at the link between credit risk management procedures and the financial success of microfinance institutions have focused on developed countries, with only a few addressing the issue in developing countries.

For example, Ndiviga (2012) investigated the influence of credit risk management on the financial performance of microfinance institutions in Cameroon. To our knowledge, no direct examination has been conducted into how loan management procedures impact the financial performance of MFIs in Buea Municipality. This study intends to overcome this knowledge gap in Cameroon, highlighting the importance of credit risk management in maximizing the financial performance of microfinance organizations.

1.3 Research Questions

1. To what extent does client appraisal affects the performance of MFI’s in the Buea municipality?
2. To what extent does loan monitoring and reporting affects the performance of MFI’s in the Buea municipality?
3. To what extent does credit collection policy affect performance of MFI’s in the Buea Municipality?

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