THE EFFECT OF INTEREST RATES ON LOAN PERFORMANCE IN MICROFINANCE INSTITUTIONS IN BAMENDA CITY: CASE OF AZIRE COOPERATIVE CREDIT UNION LIMITED
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Interest rates are ordinarily the drivers of financial institutions‟ financial performance. They are the ones that determine the size of the profit margin for every transaction between a financial institution and its customers. Yet, there are many reported cases of defaults in loan repayment in Micro Finances in Cameroon in general and Bamenda in particular. In fact, there is plenteous confirmation that the financial emergencies in AZICUL were preceded by high nonperforming loans. When borrowers default on in repaying the credit facilities advanced to them, the micro finance concerned will be negatively affected. There will be limited finances to run its operations and also to loan out to other potential borrowers and also increasing bad debts and collapse of MFIs. The purpose of this study was to determine the effects of interest rate and loan performance in AZICUL micro finances in Bamenda. The study is guided by the following objectives; examine the effect of low interest rate on loan performance in AZICULL, assess the effect of medium interest rate on loan performance in AZICULL and establish the effect of high interest rate on loan performance in AZICULL. Descriptive methodology was used. Primary and secondary data was used in this survey. The secondary data in quantitative form was sourced from information like the annual financial reports, and other from research articles, books and casual interviews. The study targeted 86 clients and 14 employees of AZICUL Nkwen and AZICUL Ntarikon. The primary data was collected through a questionnaire with structured questions and a few unstructured questions. Data collected from the field was analyzed by both descriptive and inferential statistics through statistical package for social sciences. The respondents agreed that low interest was that it leads to high lending rates, timely repayment of loans, increase borrowers‟ capacity to pay loans, high returns on assets and high loan recovery rate. It was strongly admitted that many customers default in loan repayment and that interest rate on loans was high. Further, the study found that low interest rates had a strong positive (r = 0.934) correlation with the loan performance. It was concluded that high interest rates contributed to the low performance of loans. Government policies should be put in place to reduce interest rates in micro finances by way of increasing subsidies.
1.1 Background to the Study
Microfinance has become a global phenomenon that is still growing and does not seem to be showing any signs of slowing its progress in the near future. Today, there are estimated to be approximately ten thousand microfinance institutions throughout the world. The worldwide amount of foreign investment in microfinance sectors is currently estimated to be about 10 billion USD. This is more than double the amount of 4 billion USD reported at the end of 2006, which itself had more than tripled since the beginning of 2004 (Anne, 2007). Due to increasing attention from international bodies, donors and policy makers, microfinance the world over has entered into a principal phase of development and practitioners of microfinance have referred to it as the last hope for the poor and are currently divided between those who favor profitability and the second camp combining profitability and social dimension (Fotabong, 2012). 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 Cameroon microfinance services is no longer reserved for the social Non-Governmental Organizations (NGOs) as the boundary between microfinance and commercial banking activities are becoming blurred (Fotabong, 2012). In its traditional microfinance form, the route of formal microfinance activities can be traced back in 1963 following the creation of the first cooperative savings and loans institution (Credit Union), at Njinikom in the North West region of Cameroon by a Roman Catholic clergy. Development of microfinance institutions and their activities remain blurred until the early 1990s when President Paul Biya in order to incorporate the elites and various interest groups into his New Deal Policy passed the remarkable law No. 90/053 of 19 December 1990 relating to freedom of associations, and Law No. 92/006 of 14th August 1992 relating to cooperatives, companies and common initiative groups (Fotabong, 2012).
In 2000, the banking Commission estimated the number of microfinance institutions operating in Cameroon at 652 and today, the number is estimated to be about 645 for both registered and unregistered MFIs (Fotabong, 2012). MFIs in Cameroon are classified under three categories; categories one, two and three. Category one or class one-institutions are those that have just members, accept deposit and lend money just from and to the members, this category includes associations, cooperatives and credit unions. Class two –those accepting deposits from members and third parties (customers), this category groups limited liability companies that function more like micro banks and category three those engaged just in lending do not collect savings and deposits. They include micro credit and project financing institutions. Majority of MFIs offer principally three services. These institutions accept micro savings, grant micro credits, and carry out money transfers.
One of the major roles of financial institutions is to advance credit facilities to their customers at a specified interest rate. Indeed, the primary source of revenues for financial institutions such as commercial banks, Saving and Credit Cooperatives (SACCOs), microfinance banks (MFBs) and microfinance institutions (MFIs) is the interest they charge on the loans they lend their customers (Kariuki and Ngahu, 2016). MFIs ordinarily thrive on the interest they charge borrowers; a fact that underpins the importance of the subject of interest rates to these firms. However, the interest rates are capped by specific regulations. Usury laws and restrictions on interest rates could affect the operations of MFIs (Avgouleas, 2007). The afore stated laws are put in place purposely to protect customers from MFIs by placing a ceiling above which interest rates should not be charged (Kariuki and Ngahu, 2016). This, however, is argued could negate the financial performance and viability of MFIs (Delfiner et al., 2006).
Micro finances play an important role in job creation and also fuel employment by providing credit and other financial services that help businesses set up, trade and expand- and by working with governments to remove barriers to economic activity (Pulkol, 2019). When one gets a loan from the bank or credit union, interest rate is charged. Interest rate can either be high or low depending on the type of interest rate agreed upon. For example, fixed interest rate is unchanged regardless of the changes in other exchange rates. Higher interest rate is good for the lender while lower interest rate is good for the borrower (Sichinga, 2019).
Pandey (2010) in a study on financial management in India opined that MFIs and other financial institutions are required to develop a credit policy to govern their operations. In the same light, the author noted that, given that MFIs obtain their revenue from interest accruing from advancing credit facilities to low income persons, the loan repayment may be uncertain. In the same respect, Ditcher (2003) advised that the success of lending out finances is based on an extensive appraisal of the risk of extending such facilities and also the characteristics of the borrower. Yet, it is lamented that lending decisions by these financial institutions are more often than not based on the subjective feelings regarding risk in relation to repayment by the borrower. The MFIs‟ justification of employing this appraisal is that it is both simple and inexpensive (Horne, 2007). Gashaw (2014) analyzed MFIS in Ethiopia, Uganda and Kenya in regard to loan outreach to the poor and the quest for financial viability. The author notes that the concern of enhancing financial inclusion to the poor is exceedingly relevant to developing countries that go for right policies towards financial inclusion. However, it is acknowledged that even the microfinance sector faces challenges in its strife to reach the wider poor. Statistics indicate that regarding microfinance operations, Kenya and Uganda are ranked first and second respectively in Africa and fifth and eighth in the world in that order. Ethiopia is also fast emerging though it lies outside of the ranking (EIU, 2013). In spite of this feat in microfinance in the afore stated countries, Gashaw observes that, the credit accessibility falls short of the escalating demand. According to Atieno (2001), there has been a challenge to credit accessibility in the country which is blamed on supply-side constraints, that is, the financial institutions. The author observes that, the MFIs emerged purposely to address the foregoing problem by targeting the hitherto unbanked population. In spite of the statistics that the number of MFIs has been growing in leaps and bounds since the 1980s, their capacity to grow has significantly been affected by their failure to operate within legal provisions (Republic of Kenya, 2005). The major challenge to their financial growth has been high default rates. Notably, MFIs in Kenya have over the time been witnessing high levels of non-performing loans which are, needless to say, occasioned by high default rates. The foregoing trend is a threat to their financial performance and very existence (Moti, Masinde, Mugenda & Sindani, 2012). It has been established that, the major challenges facing the MFIs in Kenya include funding, default in loan repayment, and government regulations (Githinji, 2008).
Loans are either long term or short term with respect to interest rate. For example, you take out a home loan with the interest rate fixed for 10 years or more. It is therefore considered a long-term interest rate. You make the same payments every year until your loan is completely paid, regardless of whether interest rate rises or falls. Alternatively, when you use your visa card (credit) or take out a personal loan you are borrowing money at an interest rate that is constantly going to be changing is called short term. As a general rule, short-term interest rates are said to be higher than long-term interest rates. Traditional finance theory states that as the size of a loan expands, the interest rate on that loan rises to accommodate the increased risk associated with the loan (Sichinga, 2019). However, utilizing firm-level data of the all the loanable banks, it is observed that the smaller the size of the loan, the higher the interest rate is given, and vice versa. Yet, using a fixed effect panel data framework, this study also shows that the interest rate differs among loan sizes can be mainly explained by the borrower’s features for local banks while for the foreign banks, its operating features are the most important factors.
Rate of Interest is the value a debtor pays for the utilization of money they acquire from a lender/financial foundations or expense paid on obtained assets (Crowley, 2007). It is “rent of money” crucial to an ‘industrialist society’ and regularly communicated as a rate over the time of one. Interest rate as a cost of cash reflects market information with respect to anticipated change in the buying influence of cash or future inflation (Ngugi, 2001). For all intents and purposes, when bank makes loan to a client it charges higher rate but pays bring down rates to the depositor. With this distinction of interest rates bank makes benefit consequently of giving these administrations. To acquire much benefit bank charges higher interest rate however much as it is conceivable and then again pays bring down rate as much as could be expected. In any case, to pull in a similar borrower and investor banks are contending to each other which keep up the interest rates in comparable range.
Loan performance is the measurement of the returns on loans issued by financial institutions in form of loan premium repayment, interest repayment as well as other costs and charges (Rukundo, 2018). Loan performance is not only considered as a largest asset as well as pre-dominate source to generate revenue but one of the biggest risk source for the financial institution‟s soundness and safety as well (Richard et al., 2008). Despite of the efforts made by the financial institutions, in recent years, a number of problems increased significantly in both, emerging as well as matured economies of the world (Basel, 2004). Most important of all the risks associated to financial institutions is weak credit management, being a threat for the banking sector (Chijoriga, 2011). Well formulated loan policy is beneficial for institutional performance. Hence it helps organizations to follow the same for risk management as well as fulfilling regulatory requirements. Loan review is a part of policy and is crucial, helping management in problem identification on regular basis to check either loan officers are following the policy in true letter and spirit or not. The review policy is better implemented by commercial bank hence they were easily able to top up loans in no time through use of modern technology unlike institutions (Craig, 2006). Loan appraisal is an application/request for funds, evaluated by financial institution. The aspects to be focused in appraisal includes: purpose of the client, need genuineness, repayment capacity of the borrower, quantum of loan and security. Loan appraisal plays important role to keep the loan losses to minimum level, hence if those officers appointed for loan appraisal are competent then there would be high chances of lending money to non-deserving customers (Boldizzoni, 2008). Collection procedure is a systematic way required to recover the past due amount from clients within the lawful jurisdiction. The collection aspects may vary from institution but those should be complaint to existing laws such as third party collection agencies may involve in a collection process. It does not just involve in collection procedure details provided by the institution but also the procedure in which the lawful collection takes place (Latifee, 2006). Well administered collection is needed for better performance of the loan. If financial institutions do not follow well administered collection procedures, this would result in loan defaults (Boldizzoni, 2008). Previous studies indicate that microfinance institutions need to have strong and effective credit risk management policies for ensuring consistent recoveries from clients (Frank et al., 2014).
1.2 Statement of the Problem
Interest rates are the biggest concern in the micro finance sector in Cameroon. Financial institutions have been accused of charging high interest rates and exploiting the consumers‟ resources. This has led to government passing a Finance Law with an aim of protecting the consumers‟ interests. The Act imposes interest rate controls on loan finance provided by money lending/financial institutions. These controls are proposed to be linked to the favorable rate. Given, it is not easy for them to charge full-cost recovery of interest rates. The study tries to explore the effects of interest rate charged, on loan repayment. It argues that the major component of loaning financial institutions cost is administration costs and not the cost of capital, thus hiking the interest charged on loan to unfavorable rate is illogic.
In the utilization of money, the one who is giving out loans known as the lender normally charges a rate called interest rate (Wanjau, 2011), the rate of interest is normally charged as a percentage of the amount of money advanced which is usually referred to as principal. In general, interest rates ascend in the midst of rise in prices, more noteworthy interest for loans and advances, supply of money, or because of higher save prerequisites of banks. An ascent in rates of interest has a tendency of decreasing business movements since credit turns out to be more expensive and money markets thereby making investors get improved bank deposits returns or returns on the bonds recently issued than from stocks purchase.
Most micro finances consider giving out loans is the major business activity. The credit portfolio is ordinarily the biggest resource and the prevail wellspring of income. Accordingly, loans are the most important wellsprings of risk to a bank’s well-being and determinants of performance.
According to the comptroller‟s hand book (1998), bank‟s interest rates has a risk level credited from giving out loans exercise depending mostly on the organization of its advance portfolio and how much the terms of its advances (e.g., development, structure rate, and implanted alternatives) may render the income streams to the rate of interests which are varying. From the beginning of modern microcredit (CGAP. 2010) its most controversial dimension has been the interest rates charged by micro-lenders often referred to as microfinance institutions (MFIs) (Hoepner et al., 2011). These rates are higher, often much higher, than normal bank rates, mainly because it inevitably costs more to lend and collect a given amount through thousands of tiny loans than to lend and collect the same amount in a few large loans and higher administrative costs have to be covered by higher interest rates (Rosenberg et al., 2013). Also, most microloans are backed by no collateral, or by collateral that is unlikely to cover a defaulted loan amount once collection expenses are taken into account. As a result, outbreaks of late payment or default are especially dangerous for the borrowers, because they can spin out of control quickly. The borrowers are mostly the poor who cannot afford bank loans which have cheaper interest rates. This consequently will lead to poor performance of these loans hence will lead to bad debts and can eventually lead to the collapse of the micro finance institution. The level of performance of these loans as affected by interest rates is poorly documented.