Abstract

This study investigates the Influence of Credit Risk Management on the profitability of Microfinance institutions in the Buea Municipality, taking Unics Plc Buea as a focus area. It adopts a descriptive research design. A total of 70 respondents were selected for the study using simple random sampling technique. Questionnaire was used to collect primary data and secondary data was also obtained from the institution in the Buea municipality. Data collected was analyzed using descriptive statistics. Hypotheses were tested through regression analysis. Objectives such as to evaluate the influence of credit risk management on return on investment, to assess the influence of credit risk management on return on equity and to find out if credit risk management affects profitability were set and The findings reveal that Credit risk management practices increase profitability in Unics Plc Buea.  It was recommended that The management should leverage information technology in credit risk management by installing information systems that can carry out credit risk assessment and measurement more accurately and for monitoring their risk management program for effectiveness and that the management of MFIs should put in place risk management frameworks such as ERM that confirms to international best practices, There should be efficient and effective communication between and among all categories of employees in MFIs so as to reduce Risking situations and that MFIs should address corporate governance issues in their risk management programs.

CHAPTER ONE

INTRODUCTION

1.1 Background Of The Study 

The power of financial institutions especially micro finance to create money is of great importance in business operations. Micro finance is the major financial intermediaries in any economy and they are the major providers of credits to the household and corporate sector and operate the payment mechanism. They deal with both retail and corporate customers, have well diversified deposit and lending book and generally offer a full range of financial services. The policy of microfinance to make money results in the elastic credit system that is necessary for economic progress at relatively steady rate of growth. Particularly, micro finance make profits by selling liabilities with one set of characteristics (a particular combination of liquidity risk and return) and using the proceeds to buy assets with different set of characteristics i.e. asset transformation. A modern financial management defines the business of financial system as the measuring, managing and accepting of the risks. Under the definitions, the most important and uncertainty banks and financial institution must measure, monitor and manage its credit risk.

This hazard which is called the default risk is the danger that the counter party will default or not perform. With increased pressure on financial institution to improve shareholders return banks have had to assume higher risk and at the same time, manage these risks to avoid losses. Recent changes in the banking environment (globalization, deregulation, conglomeration, etc.) have posed serious risk challenges for banks but has also have offered productive opportunities (Saunders and Marcia, 2007).

Generally, the aim of risk management is not simply to reduce or even to eliminate risk it is also viewed the process of recognition, measurement and control of risk that an investor faces.  Indeed, this may not be possible given various difficulties of measuring risk and the limitations of the instruments for controlling risks. Risk management must be of continuous process the composition of investor’s portfolio and the risk of the assets therein, as well as the objectives and constraints of the investor change overtime. However, the need for risk management has increased sharply in the past three decades.  The risk management has the purpose and the scope of insuring that Risk management ensures that the risk-taking part of investing is being carried out in a controlled and understood manner. It is a continuous process change of the composition the investor’s portfolio, the risk of the asset in the portfolio and the objectives and constraints of investors (Haim and Thierry, 2005).

The goal of credit risk management is to maximize   risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters. Micro finance need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credit risk and other risks. The effective management of credit risk is a critical component of a comprehensive approach to risk management and essential to the long- term success of any micro finance organizations. The fundamental dilemma in managing credit risk is overcoming the agency or incentive problems between lenders as outsiders and borrowers as insiders. Mirco finance that managed to successfully perform its credit risk management finally this had a positive impact on their financial performance what is a reverse in the opposite case (Haim and Thierry, 2005).

The five’s C of credit is a system used by lenders to gauge the creditworthiness of potential borrowers. The system weighs five characteristics of the borrower and conditions of the loan, attempting to estimate the chance of default. The five’ Cs of credit are character, capacity, capital, collateral and conditions. Credit Risk Management is inherent in microfinance and is unavoidable. The basic function of microfinance management is risk management.

Microfinances assume credit risk when they act as intermediaries of funds and credit risk management lies at the heart of financial institution. The business of banking is credit and credit is the primary basis on which a bank‟s quality and performance are adjusted. Credit risk is composed of default risk and credit mitigation risk. Default risk is the risk that the counterparty will default on its obligations to the investor. In this risk, the credit quality deteriorates (or default risk increases). Credit risk is more difficult to measure because data on both default and recovery rates are not extensive, credit returns are highly skewed and fat tailed and longer term time horizon and higher confidence levels are used in measuring credit risks. These are problems in measuring credit risk that have inspired the development of several sophisticated models and commercial software products for measuring portfolio credit risk (Haim and Thierry, 2005).

Due to increasing attention from international bodies, donors and policy makers, microfinance the world over has entered into a principal phase of development. Practitioners of microfinance have referred to it as the last hope for the poor and are currently divided between those who favour profitability and the second camp combining profitability and social dimension. Other major players within the financial system, such as commercial banks until recently looked at microfinance as a market niche. Attitudes continue to evolve as developing countries strife at incorporating microfinance into the mainstream financial system.

In the phase of this global evolution, top performing Microfinance Institutions (MFIs), are being restructured, their income stream widened and are no longer dependent on subsidies to strife. Many have become profit making institutions as a result to transparent and access to different sources of financing.

1.2 Statement Of Problem

The aim of every micro finance institution is to operate profitably in order to maintain its stability and improve in growth and expansion. For most people in micro finance, lending represents the heart of the industry. Loans are the dominant asset at most micro finance, generate the largest share of operating income, and represent their greatest risk exposure. Micro finance sector in Cameroon has faced various challenges that include;

Sound credit management is pre-profitability, while deteriorating credit quality is the most frequent cause of poor financial performance and condition. 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 a particular concern for MFIs because most micro lending is unsecured that is, traditional collateral is not often used to secure micro microloans (Craig Churchill and Dan Coster , 2001). The people covered are those who cannot avail credit from banks and such other financial institutions due to the lack of 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 principal amount itself. Therefore, these institutions required design sound credit management that entails the identification of existing and potential risks inherent in lending activities.

1.3 Objective Of The Study 

The main objective of this study is to find out the influence of credit risk management on the

profitability of micro finance in Cameroon considering the fact that profitability can be analysis

in terms of ROI and ROE. The research objective is divided in to the following;

1. To evaluate the influence of credit risk management on return on investment
2. To assess the influence of credit risk management on return on equity
3. To find out if credit risk management affects profitability