CHAPTER ONE

INTRODUCTION

1.1. Background of the Study

The concept of micro finance originated from the field of informal finance in the years 1970 and 1980.

Micro finance involves the provision of financial services such as savings, loans and insurance to poor people living in both urban and rural settings who are unable to obtain such services from banks (Basley 2002).

Micro finance according to Otero (1999.p.8) is the provision of financial service to low income poor and very poor finance self-employed people.

These financial services according to Ledgerwood (1999) generally include micro savings and micro credit, but can also provide other services like micro insurance and money transfer or payment services.

Micro finance institutions also provide non-financial services like education, counseling, health, technical assistance training and many others. They are nine approaches of providing micro credit or finance to customers.

These ones are; the minimalist approach, the integrated approach, the institutional approach, welfarist approach, the commercial approach, the individual approach, the group lending approach, the existing business approach and the creation business approach(Messomo,2012).

When micro finance institutions perform services like micro credit, there is high probability of default. This at times greatly affects the probability of microfinance institutions.

The concept of microfinance was pioneered in Bangladash by MuhammedYunus in the year 1970s in the village of jobra.He experimented by lending to the poor women of the village of Jobra. He also found the Grameen bank and won the noble price in 2006(Helms,2005).Since then, innovation in microfinance services has evolved.

This evolution is aimed at alleviating poverty. Poverty has been the talking point of most political agendas worldwide especially less developed countries like Cameroon. According to International Monetary Fund(IMF)(2003) country report on poverty reduction strategy papers(PRSPS),poverty rate in Cameroon has about was 40.2% in 2001.

According to Ayuk(2012), Cameroon has about 500 microfinance institutions of all categories actively participating in the alleviation of poverty. If alleviation of poverty by MFIs through the granting of micro credit leads to default at times, there is a need to identify this problem. The evolution of microfinance has been the turning point in financing of both entrepreneurial ventures and small businesses.

In a number of European countries micro finance evolved from informal beginnings during the 18th and 19th centuries as a type of banking of the poor, juxtapose to the commercial and private banking sector.

Almost from the unset microfinance meant financial intermediation between micro savings and micro credit and was powered by intermediation. In Germany, the former microfinance institution now accounts for about 50%of banking assets; the outreach is to about 90% of the population. Microfinance in Asia has much longer history, though little seems to known about the early history of hui in China, Chit funds in India, the arisen in Indonesia or the paluwagan in the Philippines to name a few. Financial institutions of indigenous origin, most of them informal are still exceedingly wide spread but had been largely ignored in financial sector developments.

However, there are exceptions on a limited scale, as in India where chit funds are regulated like in Indonesia with its highly diversified rural microfinance sector where various forms of informal financial institutions have been registered and eventually regulated throughout the 20th century (Hans, 2005).

Over time, micro credit programs all over the world improved upon the original methodologies and defiled conventional wisdom about financing the poor.

First, they showed that poor people, especially women, had excellent repayment rate among the better programs, rates that were better than the formal financial sectors of the most developing countries. Secondly, the poor were willing and able to pay interest rate that allowed microfinance institutions to cover their cost.

So, financial service providers have had better understanding of the need of microfinance institutions and of the wide range of financial rate of low income people in both urban and rural areas (Gateway).

These needs might be managing irregular income flows and coping with crisis such as unexpected sickness, natural disasters and death, many financial service providers have broaden their scheme of operations beyond their product of providing only credit services but also offer other services like; savings, insurance and money transfers, to help poor people manage their financial lives (Robert et al, 2004).

New technologies continue to create opportunities to broaden microfinance institutions financial services and to also provide those services at a lower cost to the poor. In Cameroon, the first microfinance institution was created in 1963 by a Dutch catholic father Alfred Jansen in Njinikom, North West Region of Cameroon.

This cooperation is the founding father of CAMCCUL(Cameroon Cooperative Credit Union League).CAMCCUL is the biggest MFI in Cameroon (Banking Commission of Central African States(COBAC),2000,2006).

Financial and economic crisis of the 1980s and early 1990s in Cameroon was real “spring-board” of the movement of MFIs in Cameroon. Many top executives lost their jobs and some were dismissed.

Some of these executives dismissed formed cooperative union that function like mini-bank. MFLs also came into existence following changes to the convention of 12 October 1990 creating COBAC which is the regional supervisory authority for banks, financial institutions such as microfinance institutions.

Based on acceptable banking practices, there are two types of loans. There are performing and non-performing loans. The performing loan is a debt on which the borrower has historically made payments of both the principal and interest on the loans on time.

In some cases, loans in which payments are less than 90days late may be considered performing. On the other hand, a loan is deemed to be non-performing if the interest on the principal is due and unpaid for the period of 90 days or more or interest payment equal to 90 days or more have been capitalized, rescheduled or rolled over into a new loan(Farlex,2012).

Non-performing loans in this research is our main focus since it takes the form of default. When MFIs provide micro credit, the area of focus here will be on the non-performing loans because there is high risk of default with non-performing loans.

Loan default in finance occurs when a debtor has not met his/her legal obligation to the debt contract or has violated a loan covenant of the debt contract.

A debt default is failure to pay back a loan. Default may occur if the debtor is either unwilling or unable to pay his/her debt.

Loan default according to Balogun and Alimi (1990) is the inability of the borrower to fulfill his/her loan obligation as at when due. High default rate and delinquency greatly affects the profitability of most MFLs in Cameroon.

According to Van Pischke (1980), some of the impact associated with default includes the ability to recycle funds to other borrowers or willingness of other financial intermediaries to serve the need of small borrowers and finally the creation of distrust.

As noted by Baku and Smith (1998), the cost of loan delinquency will be felt by both lenders and the borrowers. Thelender (MFI) has a cost in delinquency situation including lost interest, opportunity cost of principal, legal fees and related cost.

This will further affect the profitability of MFI.For the borrower, the decision to default is the trade-off between the penalties in lost reputation from default versus the opportunity cost of forgoing investment due to working out of the current loan.

The field of microfinance has grown substantially overtime with MFIs recognizing the need to achieve financial sustainability while offering financial services to the poor through non collateralized loans (credit).

This has been an innovation in product according to Schumpeter (1934). MFIs also participate in poverty alleviation programs. Non collateralized loans are based on social collateral such as reputation.

Building a good reputation between the customer of MFIs and the MFIs itself means that no default has to exist. That is the MFIs should always be there to provide microcredit to its customers and their customers must always avoid being delinquent and thus avoiding the risk of default and maintaining a continues flow of funds.

Peteren and Rajan (1994,1995) analyze the bank credit relationship and report that primary benefit to a borrower and close ties with a single financial intermediary is an increase in the availability of credit.

The main aim of relationship between the borrower and the MFIs is to reduce information asymmetry and loan default. The MFIs are playing an increasing important role in the Central African Economic and Monetary Community (CEMAC)region particularly in low income house hood and unbanked small and medium size enterprises.

According to IMF (2013), the microfinance sector still represents a small portion of overall financial sector assets but its role is increasing in mobilizing deposits and providing lending. Still in this report, in 2012, there were 783 MFIs in the CEMAC region.

They held franc de la Communaute՛ Franciere de l’ Afrique (FCFA) 636.2 billion of deposits and FCFA 319.8 billion of outstanding credit. Geographically, concentration remains high. However, with Cameroon MFIs mobilizing 72% of total deposit and 75% of credit, whereas the figures are only 24% and 18% respectively for Congolese MFIs.

This uneven geographical distribution across the region reflects historical reasons and the fact that MFIs in Cameroon had started building their network and conducting operation in Cameroon in the early 1970s, earlier than in other countries. Despite the growth rate they still faced challenges that affect their profitability.

Furthermore, the banking commission of central Africa was officially recognized as an authority figure for MFIs, and that was capable of dissolving them if they did not adhere to its regulations (COBAC).

MFIs in Cameroon are classified under three categories, category one, two and three; category one institutions are those that have just members, accept deposit and lent money just from and to members.

The category includes associations, cooperatives and credit unions, category are institutions which accepts deposits from members and third parties (customers) these category groups limited liability companies which functions like micro banks, category three those engaged just in lending do not collects savings and deposits; this include micro credit and projects financing institutions (ZanguiEdouard, “E՜tablissement de microfinance au Cameroun”. P.68).

The extension of credit facilities is one of the, major activities of microfinance institutions that is, the principal economic function of every financial institution to grants loans be it savings or loans companies, finance houses and financial non-governmental organizations (FNGOs).

For most microfinance institutions loans account for half or more of their total assets and half to two-third of their local revenues, since credit to clients is one of the most important function. Healthy loan portfolios are therefore vital for lending institutions in view of their effects on liquidity, lending capacity, earnings and profitability of the MFIs.

Microfinance institutions currently provide financial services to 15% of the country’s total population as compared with 10% for commercial banking sector (J.Obuobi&G.Polio, 2010).

TUCCUL which is one of the microfinance institutions in Cameroon case study of this research started in 1971 with a total of five members and a capital of fifty thousand France. The main aim of TUCCUL is to help poor agricultural population of Tiko and its neighborhood.

This study therefore focuses on the impact of loan default on the profitability of MFIs such as this. Loans are said to be delinquent if installments are delayed and in default if one or more instalments are never repaid (Fotabong,2011) and a proper analysis is needed to alert banks that pertinent delinquency ratios could serve as an opportunity for to put things under control.

1.2 Statement of the problem

MFIs are increasing a central source of credit for the poor in many countries. Micro credit is the most important and profitable product offered by MFIs. Microcredit is associated with problems such as loan delinquency and default.

Loan default is the major problem faced by most MFIs in Cameroon; many MFIs have adopted measures that are very important to solve this problem.

There are many researches which have been carried out on this same problem; Baku and Smith (1998),Okpugie, G (2009), Ameyaw-Amankwah, I. (2011), Kwakwa, p.o(2009), Akinwumi (1990), Balogun, E.D and Alimi, A. (1990).

Even though these researches have been made to minimize loan default, there still exist loan default in most MFIs in Cameroon. This creates a research gap the reason why in my own study, I will be using this researches above but with my case study being Tiko Cooperative Credit Union League (TUCCUL).

Default and delinquency by customers to pay loans tend to affect the profitability an operation of viable MFIs.While repayment of loans by customers lead to sustainability of MFIs. Therefore it is important to investigate the impacts of loan default on the profitability of MFIs using Tiko cooperative Credit Union League(TUCCUL) as case study.

The reason is to find out the impacts of loan default that has impeded MFIs sustainability so as to come out with the means to reduce or eliminate default in MFIs.

The main research question is to what extent does loan default affect the profitability of TUCCUL?

1.3 Objectives of the Study

The main objective of this study is to analyze the impact of loan default on the profitability of MFIs in Cameroon. The specific objective is:

1. To evaluate the impact of loan default on the profitability of TUCCUL.
2. To make recommendations towards reducing loan default in TUCCUL.

Read Also: The Effect Of Loan Default On The Financial Performance Of Microfinance Institutions In Cameroon

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