LENDING POLICIES AND RECOVERY STRATEGIES AND ITS EFFECTS ON THE FINANCIAL PERFORMANCE OF CATEGORY ONE MICROFINANCE INSTITUTIONS

Abstract

This thesis titled the effects of lending policies and recovery strategies on the financial performance of category I microfinance institutions:

the case of the Fako Chapter of Credit Unions, specifically sought to investigate the effect of lending policies and recovery strategies on the financial performance of Category 1 MFI.

We employed a survey research design and data were collected using self-administered questionnaires from a realized sample of 84 respondents. Data were analyzed using descriptive and regression analysis.

Our findings showed that collection policy and client appraisal were significant determinants of the financial performance of category I microfinance institutions in the Fako chapter of credit unions.

It was therefore recommended that Credit officers should intensify efforts on their job, routine check on customers and prudent approach to recover loans and advances granted to members.

Management should also monitor the borrower’s loan repayment accounts, make regular review of the borrower’s reports and statements and make regular communication with borrowers at any time they are recognized to be in financial hitches. This will ensure that the loans advanced are paid in time.

CHAPTER ONE

INTRODUCTION

1.1 Background to the study

One of an economy’s most crucial pillars is the financial sector. The sectors serve as a catalyst for long-term economic growth by offering effective monetary intermediation (Paudel, 2005). An efficient financial system encourages investment by financing profitable company ventures and mobilising savings and services. (Ndubuisi, Chinyere, Chidoziem, & Ezechukwu, 2017).
As a result, microfinance institutions have grown in popularity, particularly in less developed countries where businesses have a lower starting capital requirement and so demand smaller loans. These institutions must take into account all the risks they confront every day when lending money.
policy on loaning

An institution’s lending policy is a written document that outlines the company’s philosophy, standards, principles, and criteria for approving and rejecting loan requests. Using the country’s appropriate rules and regulations, these policies define which parts of the industry or business will be authorised loans and which will be avoided. When it comes to microfinance, the primary goal of credit officers is to ensure that borrowers make their payments on time. However, maintaining a recovery rate of 100 percent is not an easy process because some members of the borrowing group may cause various issues due to various conditions (Sarma & Borbora, 2014).

As a result, lending has a high return on equity risk since the borrower’s ability to repay the loan is not always guaranteed and is often dependent on events outside their control. After a thorough and satisfactory evaluation of the project for which money is being requested, financial institutions engage in this risky enterprise. This type of institution focuses primarily on lending money to members. As a result, the management of Microfinance institutions is responsible for the creation and implementation of lending policies.

The lending policy of a microfinance institution (MFI) must be clear on how much money is available to whom, for how long, and for what purpose. Loan policies should be clearly written in this regard so that lending personnel are aware of prohibited and permitted activities. As a result, financial institutions’ lending policies should be reviewed on a regular basis to keep pace with the economy’s shifting dynamics and the competition from other sectors of the economy (Lizal, 2012). As a result, handling loans in a suitable manner has a favourable impact on both the borrower and the economy at large. Non-performing assets are likely to rise if banks fail to properly manage their loans, which account for the majority of their assets. As a result, the financial health of institutions and the economy as a whole might be adversely affected.

Efforts to rehabilitate one

When a borrower fails to pay back a loan, debt recovery is the act of trying to persuade the loanee to make an effort to refund the debt. For the most part, recouping debt is a difficult operation because customers will go to great lengths to avoid communicating with the lender (bank). Typically, banks have a debt recovery team that is responsible for tracking down outstanding loans and attempting to recover them.

There are a number of things that may be done to improve debt collection in African banks, including the use of reminders as a way to urge debtors to pay up. When it comes to paying their bills, some consumers just can’t keep track of when they’re due. To help the client remember their duty to the bank, the bank uses reminders such as short text messages (SMS), email, or a simple phone call. This allows the client to settle their loan. To put it in MIGWI’s words, “

In recent years, lending risk and recovery strategies has gained focal importance because of huge financial losses faced by big international financial organizations (Nikolaidou and Vogiazas, 2014). The commercial banking sector and microfinance institutions in particular have adopted additional steps since the financial crisis to avoid any future financial losses caused by mismanagement in loan allocations and credit recoveries. Commercial banks were the most affected. Such problems can be addressed through the use of credit risk management. In today’s financial institutions, lending policy is an essential part of a comprehensive risk management strategy (Arora and Kumar, 2014). The ability to wisely and profitably control client credit lines is a critical requirement for viable risk management. MFIs must have a better awareness of their clients’ budgetary quality, financial assessment history, and shifting instalment designs in order to limit the introduction of awful debt, over-saving, and liquidation (Nkusu, 2011). An agreement’s credit management will continue until the final instalment is paid in full (Moti et al., 2012). In other words, the bank’s loan policies may alter in response to shifting financial conditions. Despite the fact that numerous studies have been done on credit risk management, this problem has rarely been examined from a Cameroonian viewpoint. Appropriate lending policies and recovery measures have a significant impact on financial performance, and this is becoming increasingly apparent.

The financial results

While supporting day-to-day operations, Bessis (1998) defined financial performance as an effort by management to improve the accuracy and timeliness of financial information. According to Lyman and Carles (1978), the operational strength of a corporation in relation to its revenues and expenditures can be measured through financial statements (Ndubuisi, Chinyere, Chidoziem, & Ezechukwu, 2017).

The fact that managers cannot control some elements means that the Cameroonian Microfinance industry, like any other financial system, has to deal with risks on a daily basis (such as globalization, world changes or market variables like price changes or stock exchange trends). In the past, the Cameroonian financial industry has been plagued by significant dangers, resulting in a slew of financial firms finding themselves in sticky positions (Cofinest, FIFFA, etc.).

The financial sector has always been able to survive thanks to rigorous risk management. For many Cameroonian financial institutions, risk management is an essential part of their everyday operations.

For this reason, Cameroon’s financial system must be properly understood and risk-managed in order to make sound decisions. While it may seem counterintuitive, the country’s financial institutions must have the right policies in place to help them emerge from the current financial crisis.

1.2 Problem Statement

The sources and causes of problem loans cover a multitude of mistakes a microfinance institution may permit a borrower to make, as well as mistake directly attributable to weaknesses in the microfinance credit administration and management. Some well-constructed loans may develop problems due to unforeseen circumstances on the part of the borrower, however, management must endeavor to protect a loan by every means possible in order to preserve it performance measured return on assets, earnings per share, return on equity, dividend per share, market to book value ratio and others.

The success of most MFI largely depends on the effectiveness of their credit management system because these institutions generate most of their income from interest earned on loans extended to small and medium entrepreneurs.

The Central Bank Annual Supervision Report, 2010 indicated high incidence of credit risk reflected in the rising levels of non-performing loans by the MFI in the last 10 years, a situation that has adversely impacted on their profitability. This trend not only threatens the viability and sustainability of the MFI but also hinders the achievement of the goals for which they were intended which are to provide credit to the rural unbanked population and bridge the financing gap in the mainstream financial sector. Sound credit management is a prerequisite for a financial Institution’s stability continuing profitability; while deteriorating credit quality is the most frequent cause of poor financial performance and condition

In 1992 when CEMAC decided to harmonise their banking regulations, new caution rules were published so as to harmonise COBAC monitoring tools and put them as much as possible in compliance with the basic principles as prescribed by the Basel Committee for the efficiency of the banking supervision.

Despite the efforts made by the creation of COBAC for supervision and control of the MFI sectors since 1990 in Cameroon and the CEMAC region as a whole, MFI have continued to fail as a result of mismanagement which probably include inappropriate lending policies, insider lending and others. Besides the principles of lending by Basel, individual MFIs still have laid down principles for the management of risk of default but they still fail.

Nowadays, risks in financial services are larger in scope and scale than ever before. Along with revenue maximization and operational cost minimization, risk management has moved to center stage in defining superior performance. It is averred that all over the world, financial institutions face enormous credit risks (Krestlow, 2013).

However, just like other financial institutions, they experience many cases of default risks, moral hazard and adverse selection. Basel II has set out some directives on the treatment of credit risk management which thus has increased pressure on MFIs (like recapitalization). This risk negates the profitability of financial institutions as they entirely depend on loan lending to increase its portfolios (Haneef et al., 2010). This is due to the fact that, when borrowers default in servicing their loans or in meeting their loan servicing obligations of the loans awarded them. However, many MFIs tend to develop various debt recovery strategies.

Most of the financial institutions utilize debt in different ways to influence the investment made in their assets which influences the return on equity. This influence, the debt equity amount and is considered significant in influencing the investment riskiness; the higher debt per equity, the riskier it is. For both financial institutions, individuals and companies, this increased risk can lead low recovery which impact on the financial performance of the MFI, as the cost of servicing the debt can develop beyond the capacity to repay due to internal difficulties either due to poor resource management or income loss. Ideally, debt recovery techniques have been used as a legitimate and necessary organizational activity where collectors and creditors are able to take reasonable steps and procedures to secure payment from businesses or customers or that are bound legally to repay cash they pay or owe (Kamar & Ayuma, 2016). However, much literature in addressing the loan recovery problem has often concentrated on loan recipient characteristics or farm level causes and largely tends to ignore the FIs role in the recovery process.

With the outbreak of the Anglophone crises in 2016, most MFIs in Fako division have been experiencing an increase in the volume of their non-performing loans as businesses are going bankrupt, crops are getting bad in the farms because many are no longer able to go to their farms and the increasing insecurities that have also displaced thousands within the division while some branches of MFIs have even shutdown their operations in many areas. These have all contributed to the timely intervention of this study in other to investigate on the role of lending policies and recovery strategies on the financial performance of MFI in other to address pertinent issues to avoid worse case scenarios. Therefore, the study has sought to provide answers to the following research questions.

1.3 Research Question

1.3.1 Main Research Question

What is the impact of lending policies and recovery strategies on the financial performance of category I Microfinance institutions?

1.3.2 Specific Research Questions

What is the effect of lending policies on the financial performance of category I Microfinance Intuitions?
To what extent do loan recovery strategies affect the financial performance of category I Microfinance Institutions?