The Effects Of Loan Recovery Strategies On The Performance Of Microfinance Institutions In The Buea Municipality

CHAPTER ONE
INTRODUCTION

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.

1.2 statement of the problem