Research Key

The effect of banker customer relationship on the performance of micro finance institution

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Banking and Finance
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International: $20
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This study seeks to ascertain effect of accounting information on lending decision of commercial banks in Cameroon. This study aimed at determining the effect use of financial statement in making lending decisions has on the level of NPLs among Cameroon banks. The study collected data on perceptions of importance of financial statements in lending decisions of Cameroon bank officers, the characteristics of banks, use of financial statements in the banks and their levels of NPLs from a total of 7 commercial banks in Buea. Descriptive statistics were used to characterize banks staff respondents and the banks they worked for. Ordinary least squares regression model was used to analyze the data for the effect of financial statement use in making lending decisions on the level of NPL. The study findings indicate that key bank staffs in lending sections view financial statements as not very useful in making lending decisions. The effect of use of financial statement information in decision making was not statistically significant. However, tier 3 and tier 4 banks have significantly higher levels of NPL than tier 1. The study recommends that accounting and banking experts implement measures to help SMEs raise the reliability of financial statements to improve their utilization in lending decisions.



1.1 Background of the study

          Sumerian temples actually went on to function not as place of worship but as banks-and this is where the very first large-scale systems of loans and credit the city grow, so did the complexity of the people’s needs and lending agreements and so the idea of charging interest was developed. Silver at this time began gaining popularity, but unlike calves and grain, did not naturally gain interest. This is where the code of Hammurabi (issued by the 6th Babylonian king) came in; defining the price of silver and how the interest charged on silver loans was to be regulated.

         One of the earliest ever recorded examples of a bill of exchange were in India. A bill of exchange involved a written order that is issued to bind individual to another instructing the payment of a fixed sum of money at a predetermined date.

In the Maurya dynasty, merchants of large towns would give letters of credit to one another which also helped issue bills of exchange to foreign countries for seaborne trade.

         One of the oldest lending methods can be found in ancient Greece where pawnbrokers lent money by collecting collateral from a borrower and reducing the risk of lender. This is something we still use today with when it comes to secured business loans. If you are looking for a loan and not wanting to use collateral, however, you would need to use an unsecured business loan.

         In this period, the largest form of authority comes from religion, be it the Christian bible throughout Europe or the Qu’ran in the Middle East. Both regions banned the practice of lending (or lending with interest outright) however, the Jew’s Tarah permitted lending, though only allowed for interest to be charged with non-Jews.

With Jews being the only people allowed to lend money, they soon gained a rather nasty reputation which is arguable what lead to their persecution. This continued into the 18th century and over time, the huge economic benefits of lending were slowly realized. This led to the dilution of restrictions and the traditional banking functions that we know and appreciate today.

       By the 18th century, lenders still used collateral but there was a big shift to indentured loans. In this practice, the rich lent to the poor and the borrower then had to work off their debt. With international trade becoming, the backing world had some catching up to do. Greater controls were needed, and Rothschild is largely responsible for pioneering international finance through the establishment of centralized banks. He cleverly shipped his sons off across the major European cities of the time to set up banks in each city.

       The 1800’s went onto usher in a new era of lending to make loans more widely available to the available to the average Joe. In 1816, the Philadelphia savings fund society in the US opened its doors as a loan resource and become the very first saving bank in the US.

         Mid-20th century saw yet another shift in modern day lending but this time, to financial data. In 1950, McNamara made history when he paid a restaurant bill with a cardboard card, now known as a Diners club card. A few years later the bank of America started lunching the BankAfricard, the good old fashion Visa. By 1959 FICO scores were wide-spread and used by lenders to evaluate Mortgage loan.

1980’s; Online lending is born with hundreds of hours of paperwork involved in filling and handling loans combined with a rising population and need for loans, computers came to the rescue just in time. With the evolution of the computer and electronic data, the ways of lending to evolved.

        Quicken loans in Detroit drastically sped up the lending process in 1985 by offering most of their application and review process online jump forward to 1999 and online banking is a thing and borrowers no longer need to step outside their house or ever have any social interactions to apply for a loan.

        This immense technology jump has eliminated the enormous amount of paperwork and headache of traditional loans making way for a totally new era of online lending. Prospa is seen as the pioneer of alternative lending, launching in 2006, it allowed borrowers to skip the bank altogether and get their loans from online leaders. Their ‘peer to peer’ lending system allows the average person to both invest and lend. This not only greatly sped up the process but opened a huge window of opportunity.  Other companies such as On Deck and many more caught onto the idea and here, we are today.

 In finance the term recovery refers to collection of amounts due. The normally recovery depends on the purpose, time and condition, business running process etc. normally loan amount will be recovered on installment basis. The manager can fix installment period based on nature of their business.

         Interest earned is the income for the corporation, this shows payments, the entire expenses and plough back requirement therefore, and recovery of money is one of the major sources of funds for the corporation. The health of the corporation is judged by the extent of recovery that if can affect. All source of funds carry cost, if the cost of borrowings is higher, it reduces the margin profit, further the profit is subjected to payment of income tax as per applicable laws. The corporation also is bound by minimum dividend obligation irrespective, whether it makes profit or not out of the post-tax and post dividend income. The memos are retained in the corporation by ways of reserves. Plough back of funds into system is emerging as one of the very important source mixes, if the corporation must retain sufficient money for the business operations; it must generate more income. More income obviously improving the recovery (Annabelle, 2018).

           In recent year, loan recovery problems have been of the main problems that the Nigerian commercial bank has had to face. Those problems have been made target of policy measures all these years, though at a time it become focus on policy on which was retarded as more pressing and serious each time. Today the situation in Nigeria have become very serious seemly intractable.

 The problem of loan recovery in the pigovain sense refers to a situation in which there is a major breakdown in the repayment agreement resulting in an undue delay in recovery or collection and in which it appears that legal actions may be required to affect recovery for in which they appear to be potential loss. Such a loan therefore required special attention on the part of the lender if it is to be collected in full within a reasonable period after maturity.

A truism in a commercial bank lending situation is that unless the commercial bank accesses lending risk and devices and effective way of lending against risk related to the borrowers, industry, and management

        The competitive nature of business environment in recent times calls for judicious use of resources by any business entity. Banks as financial intermediaries assist in channeling funds from surplus economic units to deficit units to facilitate business transactions and economic development. The funds involved in this intermediation process are largely owned by third parties. It is only proper that such funds be efficiently managed to sustain the confidence of depositors and shareholders in the banking system. This will in tum ensure the continuing soundness of the system itself and thereby, minimizing the risk of bank failure (Ojo, 2019).

       According to a study conducted by Obara and Oyo (2014), bank lending provides the main avenue for banks profitability, but the exercise is a part of asset and liability management, which is a primary focus of commercial banks fund management. It deals with the acquisition of funds from savers (liability management) and the allocation of funds to borrowers (assets management), the basic objective being the attainment of high profitability consistent with liquidity, solvency and regulatory constraints.

       The Cameroonian financial system being the largest in the Economic and Monetary Community of Central Africa and accounting for almost half of regional financial assets, according to the Cameroon financial profile, make commercial banks and other financial institutions occupy a very important position in the Cameroonian economy.

         Accounting information provides the yardstick for measuring the performances of borrowing companies. Information communicated by accounting records serves as a basis for corrective actions when outcomes deviate from pre-determined goals. Such information provides explanations of performance to stakeholders like shareholders, depositors, creditors, potential investor, and regulatory authorities.

        Accounting information fully plays its role only if it meets the quality criteria of relevance and reliability defined by the Financial Accounting Standard Board (FASB). Accounting Information is relevant if it has a predictive value, feedback value and is timely. It is reliable when it meets the criteria of verifiability, representational faithfulness, and neutrality. It is only when these criteria are met that accounting information can be credible and gain the confidence of the users of the financial statements. In practice, banks are, just like the tax administration, regular users of accounting information. However, there is usually an existence of an informational asymmetry between the accounts and the managers of borrowing companies. It is likely that the leaders are tempted to manipulate this information to change the perception of the financial situation of the enterprise that the other stakeholders have, according to Takoudjou et al. (2013), a study conducted on the implications of the accounting data management on the exercise of loans discretion by banks in Cameroon wherein they found out that more than 75% of the respondents think that the financial statements contained in the loan request files of Small and Medium size Enterprises  very often or always are manipulated by their managers. These results are in line with those of some earlier studies on the determinants of loan supply (Ambassa, 2014), especially as far as the importance of physical collaterals when taking the decision to grant a loan is concerned.

      Commercial banks act as major component of economic development of any country in the world. How well developed a country’s financial system is, determines the level of economic development of the country concerned. Suffice to say therefore that the stability of a country’s banking sector acts as the nerve center for economic development of that country. One of the key functions of commercial banks is mobilizing deposits from those with surplus funds and on-lending the funds in form of loans and advances to entities with fund deficits either for production or consumption. This facilitates industries such as agribusiness, manufacturing, service industry as well as private persons and governments to carry on with their businesses. In recent years however, banks have taken a cautious approach in extending loans due to increase in levels of non-performing assets in the industry (Sontakke and Tiwari, 2013).

        The key role banks occupy in any economy as financial intermediaries calls for all stakeholders in the industry to understand their operations (Dell’ariccia & Marquez 2006). Studies have shown that there have not been many research works carried out about the information needs that lenders require in their operations. (Allen & Cote 2005, Billings & Morton 2002). One such area that has had little research on is on relevance of financial statement information to lenders. This is so because information from financial statements plays an important role and especially in market-based economies. The data from this information is essential for lenders of funds as well as the investors because first it makes it possible for owners of capital and lenders to estimate return from their investment portfolios and additionally, it also enables them to monitor the use of capital once committed to a particular venture (Beyer etal. 2010). It is imperative for decision makers such as business analysts, credit analysts and investment analysts to analyze a companies’ financial information as an important tool for making decision as to whether the company’s financial performance meets their decision threshold. One such important tool used in computation and analysis of financial ratios to gauge the financial strength of a company (Kwok 2002; Delen etal. 2013). In recent times, strong emphasis on the need for information to be transparent has provoked thoughts to further understand the creditors’ use of financial statement information. Yap (1997) in his study on the need for cash flow statements concluded that financial statements take a central role in a creditor’s decision to lend or not.

      An entity’s financial statements (FS) act as important tools that provide vital information that helps its users in making different business decisions. The usefulness of the information derived from these financial statements by its user determines whether the accounting information is of good quality or not. It is for this reason that has given rise to early studies on the usefulness of information from financial statements.

      Corporate Annual Report (CAR) information has many users among them; investors, creditors, and different government agencies such as the regulators and tax authorities. A common perception among many people has been that CAR information is produced for usage primarily by the shareholders. This is however not the case as other groups such as venture capitalists, financial analysts and others also use CAR information (Chang etal., 1983; Vergoossen, 1993) and so does creditors such as banks and other categories of lenders (McCaslin and Stanga, 1986; Danos etal., 1989). Arnold and Izer (1984), Day (1986), Gniewosz (1990), and Vergoossen (1993) have also extensively studied this area and assert that investment analysts also use CAR information. Wolk etal. (2003) noted also that CAR information is useful when it come to the market valuation of firms. Some studies have however downplayed the usefulness of CAR information in lending decisions. Magness (2003), for example, argues that they do not include environmental values neither do they provide valuable information to external users in absence of effective reporting guidelines. Chen and Hsu (2005) also did a study in Hong Kong in which they concluded that users of CAR information prefer that financial statement information is supplemented by additional, preferably non-financial information as it is inadequate on its own. However, despite these dissenting views, CAR information has been and still is widely being used in making different business decisions.

       In his study, Nichols (1997) found out that quality concerns of financial reporting have resulted to financial statements being less useful in decision making among lenders in Vietnam which was in contrast to previous studies that had showed that information from financial statements play a significant role in decision making among lending institutions in developed countries. In USA, commercial banks consider a company’s financial statements to be the major source of information for making lending decisions (Stanga & Benjamin, 1978). Information communicated by financial statements can change the decisions of a commercial bank as to whether to lend or decline a loan proposal (Danos etal, 1989). A study by the Independent Evaluation Group (IEG) demonstrated that use of operating cash flow has a close relationship with credit risk among companies with high long-term rates and low business risks (IEG, 2010).

      The definition of non-performing loans differs from one country to another. What is considered to be a non-performing loan in one country may not necessarily be so in another country. These different definitions have however given rise to some common grounds on this issue. Consequently, the International Monetary Fund has come up with a definition in its Compilation Guide on Financial Soundness Indicators that has come to be widely accepted as what constitutes an NPL account. Thus, NPLs is defined as: “An account whose repayment of either interest due, principal portion or both are overdue by ninety (90) days or more, or interest charged equivalent to ninety days or more has been restructured, capitalized or customer has negotiated with the lender to delay payment. An account will also be categorized as NPL due to other instances such as borrower filing for bankruptcy rendering the possibility of collecting the loan improbable.” (IMF, 2005).

        Sharon (2007) underpins the important contribution made by loans in the development of an economy. However, she also notes that its non-payment can also lead to huge losses by banks in particular and country in general. People establish businesses with the principal objective of making profits (Rawlin etal. 2012). The principle of wealth maximization is still the key motivation for any business to exist. For this reason, assets acquired in the course of business should generate income for the business. Since loans constitute the main assets for all the lending institutions, there is need for banks to put in place efficient mechanisms to manage loan book portfolios so as to generate revenues among lending institutions (Daniel and Wandera, 2013).

    There are many users of financial statements information including shareholders of a company, management, tax authorities as well as bank credit officers. Although it is largely accepted that financial statements prepared largely to help external, primarily investors and creditors in their business decisions, (FASB, 1978), there has not been adequate empirical work that that has been carried out to examine how this information is useful in processing lending decision and how or whether this has effect on the levels of non-performing loans.

      Danos etal., (1989) discuss how lenders grow in confidence on a loan proposal from the initial contact with the customer and how their confidence is likely to increase or diminish as more and more information is processed. A lender makes use of a customer’s background information and highlights of their financial statements in the decision process. There is plenty of information that one can use when making a decision to lend. The role played by these different information types vary from country to country and from institution to another. Lenders in USA regard a borrower’s credit history, business financial reporting, cash from business operations, types and state of non-current assets, and income from other sources other than core business as the most important (Catanach & Kemp, 1999). A study done in Hong Kong found that banks first pay key attention to notes accompanying financial statements (FS) while cash flow analysis takes the next concern (Kwok, 2002; Marian etal, 2002).

      In Australia, the three financial statements that is, cash flow, balance sheet and income statements are analyzed for three distinct purposes. Whereas cash flow statement is analyzed to gauge the repayment ability of a borrowing entity, balance sheet is analyzed as for assessment and monitoring roles and the income statement is used to understand an enterprise’s business operations (Jones, 1998; Kitindi etal, 2007). Although these studies seem to concur that FS are widely used in making lending decisions, the studies fail to determine the effect use of these financial statements has on non-performing banks. This is what this study seeks to determine.

1.2 Statement of the Problem

           Existing literature in banking recognize the importance and relevance of accounting information in bank lending decision making. The relationship between accounting information and bank lending system form the fact that financial statements are among the most important sources of credit information available to bank lending officers (Emeni, 2014)

           However, some researchers hold that accounting information is most often tempered with. The managers can be tempted to present an “advantageous” financial situation that reveal a low default risk to finance themselves at a lower cost (Takoudjou et al., 2013). The freedom enjoyed by borrowing enterprises’ managers not only allows them to shape the accounting information in the respect of the legal setting, but also to carry out stealing operations or hide information that can bring the banker into error. According to Mai Thi H. (2015), Vietnamese company’s financial Statements have faced many issues together with problems, in which faithful representation is most underrated. This implies less reliability to company financial statements. Also, Takoudjou et al (2013), articulated that banks prefer non-accounting indicators to accounting indicators, which is explained by the lack of confidence by the banks in the financial statements communicated by borrowing enterprises.

      Financial Accounting information constitutes for the banker an important element in the appreciation of the risk of default of the borrower. For the manager of borrowing enterprise, it represents an instrument of communication strategy. This difference in view of accounting information led to the rationing of credit by the bankers (Takoudjou et al., 2013).

       This study is therefore aimed at addressing the difficulties faced by commercial banks in rationing funds to borrowing enterprises considering their financial information as presented by the financial statements they present.

The importance of managing bad loans by lending institutions cannot be overemphasized. The problem of bad loans is a common phenomenon in most countries which makes banks’ ability to make loans and grow greatly compromised (Petersson and Wadman, 2004). Prudent management of loan-book portfolio results to increased profitability by the banks and enhances the confidence of the people including investors and depositors in the sector. On a similar note, inability to manage credit risk well has been cited as the major threat to a lending institution’s survival (MacDonald, 2006). Kroszner (2002), opines that there is a close relationship between non-performing loans banking crises. Sultana (2002) supports this as he links the Japanese financial crisis to non-performing loans. According to him, Japanese banks still struggle and suffer under the weight of thousands of billions of Yen of bad loans that occurred as a result of collapse in asset prices a decade ago in the country’s financial system

      Evidence shows that both large as well as small banks use financial statement variables in making lending decisions (Cole etal. 2004), (Barret 1990). However, though many researchers have been able to prove that use of financial statements is important in making lending decisions, the studies done have not validated FS importance by measuring whether use or non-use of financial statements has impact on NPLs. Majority of the studies done have been on the global determinants of NPLs which have been studied by different countries by different scholars such as Mileris (2012), Tomak (2013), Ahmed and Bashir (2013) and Shingjerji (2013).

      Studies carried out previously have indicated that information from financial statements play an important role in making lending decisions among banks in developed countries. Krueger and Tornell (1999) attribute the credit crunch in Mexico after the 1995 crisis partially to the bad loans. Since banks are more likely to be exposed to moral hazard and adverse selection when advancing loans to borrowers, credit assessment of loan is inevitable. This should be done with a clear mind that there is great potential that most borrowers default.

Studies done recently in Kenya also seem to agree with past researches done elsewhere. Muriithi (2013) found that non-performing loans are one of the major causes of the economic stagnation problems. Matu (2001) showed that the high levels of nonperforming loans put pressure on the banks to retain high lending rates to minimize losses associated with these loans. Kiayai (2003) showed a combination of different techniques enticing defaulting customers yield better results. Kioko (2008) and Ngare (2008) focused on credit risk management techniques in commercial banks. Otieno (2013) did a study focusing on the credit policies of commercial banks and its effects on NPLs. As the above studies show, none of these researchers have looked deeper into the actual inputs that lead to making a lending decision. One such key input in making lending decision is analysis of financial statements and it is the basis of this study. This study would answer the question: does the use of financial statements in making lending decisions have any effect on the level of NPLs?

1.3 Research Question 

1.3.1 Main Research Question

What is the effect of accounting information on the lending decisions of commercial banks?

1.3.2 Specific Question



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