The Effects Of Loan Recovery Strategies On The Performance Of Microfinance Institutions In The Buea Municipality
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1.1 Background to the study
Over the last decade, many financial institutions were never serious in their efforts to ensure timely credit recovery and consequent reduction of non-performing assets (NPAS) as they are today. Debt recovery is defined as a process of pursuing loans which have not been repaid and managing to recover them by convincing the loanies to make attempts to repay their outstanding loans early, 2006.
The role of recovering loans is not an easy task as clients will go out of their way to prove inaccessible to the lender/microfinance institutions (Garber, 1997). It is important to note that credit recovery management, be of fresh loans or old loans, is central to NPA management. This management process needs to start at the loan initiating stage itself. According to Swanson et al (2008), effective management of credit recovery and NPAS comprise two pronged strategy. First relates to arresting of the defaults and creation of NPA thereof and the second is to handling of loan delinquencies.
The tenets of financial sector reforms are revolutionary which have created a sense of urgency in the minds of staff of MFI and has given them an opportunity to perform or incur losses. MFI in Cameroon have intensified credit recovery strategies in order to reduce bad debts and improve their loan books MFI in Cameroon, 2013. Over 76% of the commercial microfinance institutions in Cameroon in the year 2013 noted that they had focused their credit monitoring and recovery strategies on personal or household loans while 56%had focused their credit recovery strategies on the trade sectors.
The concept of microfinance is not new in the world. Savings and credit groups that have operated for centuries include the “Susus” of Ghana, “Chit funds” in India, “Tandas” in Mexico, “Arisan” in Indonesia, “Cheetu” in Sri Lanka, “Tontines” in West Africa, and “Pasanaku” in Bolivia, as well as numerous savings clubs and burial societies found all over the world. Formal credit and savings institutions for the poor have also been around for decades, providing customers who were traditionally neglected by commercial microfinance institutions a way to obtain financial services through cooperatives and development finance institutions.
One of the earlier and longer-lived micro credit organizations providing small loans to rural poor with no collateral was the Irish loan fund system, initiated in the early 1700s by the author and nationalist Jonathan swift. Swift’s idea began slowly but by the 1840s had become a widespread institution of about 300 funds all over Ireland. Their principal purpose was making small loans with interest for short periods. At their peak they were making loans to 20% of all Irish households annually.
Loan recovery refers to process and the rate at which the clients pay back the principal plus interest amount extended to them in form of loans, it is determined by repayment rate, portfolio quality ratios, profitability ratios, productivity and efficiency ratios and scale of depth of outreach. Credit/ loan management is the processes involves qualifying the extension of credit to a customer, monitors the reception and logging of payments on outstanding loans, the initiation of collection procedures, and the resolution of disputes or queries regarding charges on a customer loan. When functioning efficiently, credit management serves as an excellent way for the microfinance institution to remain financially stable.
A good credit management system will help the micro finance institution (MFI) reduce the amount of capital tied up in loans and minimize the MFIs exposure to bad debts. Good credit management is vital to your cash flow. It is possible to be profitable on paper and but lack the cash to continue operating your business. According to Pauline, (1907), the process of credit management begins with accurately assessing the credit-worthiness of the customer based on the 6cs of credit which include; capital, character, capacity, condition, collateral and control.
This is particularly important if the microfinance institution chooses to extend some type of credit line or revolving credit to certain customers. Proper credit management calls for setting specific criteria that customers must meet before receiving this type of credit arrangement. As part of the evaluation process, credit management also calls for determining the total credit line that will be extended to a given loan applicant.
Several factors are used as part of the credit management process to evaluate and qualify a customer for the receipt of a loan. This includes gathering data on the potential client’s current financial condition, including the current credit stand with other financial institutions. The current ratio between income and outstanding financial obligations will also be taken into consideration, and the credit applicant’s willingness to repay. Competent credit management seeks to not only protect the microfinance institution from possible losses, but also protect the customer from creating more debt obligations that cannot be settled in a timely manner. After establishing the credit limit for a customer, credit management focuses on providing the client with accurate and timely statements or information on loan performance.
The information must be delivered to the customer in a reasonable amount of time before the due date, thus providing the customer with a reasonable period to comply with the credit terms. The period between delivery of the information and the due date should also allow enough time for the customer to review the payment schedule and contact his or her loans officer for any information. Loan recovery is a process involving the procedures the MFI uses to collect its money from debtors and this may take the form of calling clients by telephone, sending reminders letters, contracting collection agencies, and legal actions (Pandey, 1997).
This study is premised on the theory of competitive advantage. Barney (1991) defines competitive advantage as the implementation of a value creating strategy which is not simultaneously being implemented by any current or potential competitors; whereas sustainable competitive advantage is viewed as an implementation of a value creating strategy not simultaneously being implemented by any current or potential competitors and when these other firms are unable to duplicate the benefits of this strategy. In the recent years, the theory of sustainable competitive advantage has emerged as one of the most promising theoretical frameworks in the management literature especially in the field of strategic management.
Kafelnikov (2004), identified three parts of competitive advantage. First part is basic competitive advantage which is described as firm’s ticket to the global hyper competition game. Second part is revealed competitive advantage) which is reflected by a firm’s market share, and third is sustainable competitive advantage which allows a firm to maintain and improve its competitive position in the market. In 1990s, the concepts of the “resource-based views (Darney, 1991) and “intangible resources” (Hall, 1993) became dominant themes in the studies concerning sources of sustainable competitive advantage. The concepts mainly focused on the element of “intangibility of resources” as source of competitive advantage.
As the microfinance institutions sector in Kenya expands at an increasing rate and become intensely competitive, every financial institution needs to adopt some sound strategies which will enable it to have competitive edge over other. As competition intensifies, many businesses continue to seek profitable ways in which to differentiate themselves from the competitors. Strategies are at ends and these ends concern the purpose and the objectives of the organization.
They are things that organizations do, the paths they follow and the decisions they take in order to achieve a certain performance. One of the challenges facing many microfinance institutions is nonperforming loans. Increased lending competition amongst financial institutions has led to extension of loans which are unsecured. The greatest challenge that microfinance institutions faces is loan default by the customers.
Microfinance according to Otero (1999) is “the provision of financial services to low-income poor very poor self-employed people”. These financial services according to Lidgerwood (1999) generally include savings and credit but can also include other financial services such as insurance and payment services. Schreiner and Colombet (2001) define microfinance as “the attempt to improve access to small deposits and small loans for poor households neglected by microfinance institutions”. Therefore, microfinance 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 access such services from the formal financial sector.
The beginnings of the microfinance movement are most closely associated with the economist Muhammed Yunus, who in the early 1970s was a professor in Bangladesh. In the midst of a country-wide famine, he began making small loans to poor families in neighboring villages in an effort to break their cycle of poverty. The financial services that allow poor people to save in times of prosperity and borrow or collect insurance when necessary allow them to maintain a consistent level of consumption without selling off income-producing assets.
Microfinance can also provide an opportunity for expanding or pursuing new business opportunities that allow poor people to increase or diversify the sources of their income .the terms microcredit and microfinance are often used interchangeably, but it is important to highlight the difference between them because both terms are often confused.
Sinha (1989) states that “microcredit refers to small loans, whereas microfinance is appropriate where ngos and MFIs supplement the loans with other financial services (savings, insurance, etc)”. Therefore microcredit is a component of microfinance in that it involves providing credit to the poor, but microfinance also involves additional non-credit financial services such as savings, insurance, pensions and payment services (Okiocredit, 2005).microcredit and microfinance are relatively new terms in the field of development, first coming to prominence in the 1970s, according to Robinson (2001) and Otero (1999). Prior to then, from the 1950s through to the 1970s, the provision of financial services by donors or governments was mainly in the form of subsidized rural credit programs.
These often resulted in high loan defaulters, high lose and inability to reach poor rural households (Robinson, 2001).Robinson states that the 1980s represented a turning point in the history of microfinance in that MFIs such as Grameen microfinance institutions began to show that they could provide small loans and savings services profitably on a large scale. They received no continuing subsidies, were commercially funded and fully sustainable and could attain wide outreach to clients (Robinson, 2001).
It was also at this time that the term, microcredit came to prominence in development (Mix, 2005). The difference between microcredit and the subsidized rural credit programs of the 1950s and 1960s was that microcredit insisted on repayment, on charging interest rates that covered the cost of credit delivery and by focusing on clients who were dependent on the informal sector for credit (ibid). It was clear for the first time that microcredit could provide large-scale outreach profitability.
The 1990s “saw accelerated growth in the number of microfinance institutions created and an increased emphasis on reaching scale”(Robinson, 2001). Ditcher (1999) refers to the 1990s as “the microfinance decade”. Microfinance had now turned into an industry according to Robinson (2001). Along with the growth in microcredit institutions , attention changed from just the provision of credit to the poor (microcredit), to the provision of other financial services such as savings and pensions (microfinance) when it became clear that the poor had a demand for these other services (Mix, 2005).
As highlighted, one of the key roles microfinance has to play in development is in bringing access to financial services to the poor, to those who are neglected by the formal microfinance institution sector. This is their social mission. Mainstream microfinance institutions target clients that have collateral. The poor do not have assets to act as collateral, therefore they are ignored by the formal financial sector. These microfinance institutions tend to be found in urban centers while the majority of the poor in the developing world live in rural areas, where financial services are not provided. Therefore, if MFIs are to fill this void they must reach the rural poor. However, according to most studies, microfinance is only reaching a small fraction of the estimated demand of the poor for financial services (Littlefield and Rosenberg, 2004).
Microfinance institutions provide a wide range of financial services to low-income clients, including self-employed and low earning individuals who are working in informal sectors. The core objective of microfinance institutions is to create a favorable environment for the low income self-employed and near poor households, in which they have permanent access to an appropriate range of high quality financial services, including not just credit but also savings, insurance and microfinance institution services. Microfinance institutions provide a comprehensive range of financial services to the “microfinance institutions people” working in informal sectors which best fits their needs and affordability.
The MFIs subsequently provides different services to a client, most commonly in the form of a loan. These services lead to the client modifying his/her microenterprise activities which in turn lead to increased or decreased microenterprise income. The change in microenterprise income causes changes in household income which in turn leads to greater or lesser household economic security.
The modified level of household economic security leads to changes in the morbidity and mortality of household members, in educational and skill levels and in future economic and social opportunities. Loans are delivered following the minimalist approach where the requirements for loans are not often difficult to meet by customers; little collateral, character and co-signing for loans between members. These loans are usually within the savings of the member (Schmidt, 1997).
According to Montana (2012), the following are some of the recommended MFI debt recovery measurers, which are likely to help increase their debt collection performance; flexible repayment plans for customers experiencing financial difficulty, well formulated hardship programs for borrowers that are late on their repayment, extend or lower payments, interest rates, or lower fees when you anticipate customer payment problems, create communication channels where customers can openly discuss their issues. By proactively reaching customers early, you can prevent larger problems later.
This can be done by microfinance institutions organizing regular pipelines of customer with issues and working towards assisting them make repayments through discussions, and outsourcing microfinance institutions debt recovery to collection agencies in extreme circumstances when the debt is not likely to be recoverable by the microfinance institutions staff.
The following can be used to reduce debt recovery problems in African MFI; use of reminders has proved to be a good measure to encourage debtors to pay up their debts. Some customers are genuinely not able to remember when their debts are due. In this case, reminders such as short text (SMS), email or a simple telephone call does the magic and enable the client remember their obligation to the microfinance institutions thereby making them in a position to repay their debts.
The advent of credit reference bureau (CRB) has brought a lot of relief to the microfinance institution sector. Serial defaulters have been denied a chance to default across microfinance institutions as microfinance institutions now have a chance to report defaults and therefore lock out these defaulters from approaching other microfinance institutions and taking loans from them therefore continuing with the loan default culture across microfinance institutions.
In Cameroon, many microfinance institutions in their credit policy now check with CRB before issuing loans to borrowers (Nyaoke, 2007). There exist multiple means of keeping in touch with borrowers. Microfinance institutions have continued to employ products such as direct debits, mobile microfinance institution loan repayment platforms, Mpesa, Airtel money, orange money and agent microfinance institutions among other methods to add onto the traditional loan repayment techniques such as direct deposits, standing orders, checking system as well as salary check off system by employers. These channels have made it easy for borrowers to access the microfinance institutions and therefore make good of their repayments.
The microfinance institutions industry has also over years continued to introduce a wide range of new products, prompted by increased competition, embracing ICT and enhanced customer needs. As a marketing strategy, the new products offered in this segment of market, continue to assume local development brand names to suit the domestic environment and targeting the larger segment of local customer base. Among the products, include Islamic microfinance institutions which was introduced in 2005, tailored in line with “Shariah” principles. Many microfinance institutions have so far introduced Islamic microfinance institutions products in the market.
All the above clearly indicate that, Cameroon’s MFIs has great developments like any other microfinance institutions market in the world. The major challenges facing many microfinance institutions today is stiff competition, which has forced the microfinance institutions to redesign their services and products to introduce new services like e-microfinance institutions, online microfinance institutions, mobile microfinance institutions and consumer in an endeavor to retain their market share. Among the rapidly growing applications is internet microfinance institutions or e-microfinance institutions, which allows customers to monitor transactions of their accounts at the leisure of their offices (Kiarie, 2006). There has also ben emerging competition from MFI’s, Sacco’s, and other non-microfinance institutions financial institutions.
The increased competition in the microfinance institutions sector has led to many microfinance institutions offering a variety of new products as they keep in line with product differentiation strategy. As a result, many clients are currently attracted to those microfinance institutions which can offer credit facilities that can finance their businesses. This has consequently led to introduction of unsecured loans by many microfinance institutions as they attempt to outwit each other in attracting more clients.
Unsecured loans together with the current harsh economic conditions has resulted into severe losses to the many MFIs as a result of nonpayment of the borrowed loans which has led to high loan default rates. Due to these challenges, this study therefore seeks to identify some of the loan recovery strategies that can be adopted by many MFIs to mitigate the credit risks associated with loan advancement.
Despite the above impressive credit management and loan recovery procedures employed by the microfinance institutions evaluating, monitoring and recovering loans, most of this institutions have reported high credit write off in the recent years as client do not fulfill their obligations, planet rating (2008). The same report indicates that most microfinance institutions report a loan write off of between 3% – 15% on average of the loans disbursed between 2010 to 2021. Therefore, it’s upon this background that the researcher found it necessary to study the effects of loan recovery strategies on the performance of micro finance institutions in the Buea.