The Effects of Lending Policies and Recovery Strategies on the Financial Performance of Category One Microfinance Institutions: The Case of Fako Chapter of Credit Unions
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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.
1.1 Background to the study
The financial sector is believed to be one of the important backbones of an economy. The sectors work as a facilitator for achieving sustained economic growth through providing efficient monetary intermediation (Paudel, 2005). A strong financial system promotes investment by financing productive business opportunities, mobilizing savings & services (Ndubuisi, Chinyere, Chidoziem, & Ezechukwu, 2017).
To this end, microfinance institutions have become very popular especially in less developed societies with little capital requirement and usually need little loans for their startups. Because of this significance, MFIs have to evaluate the risk, which it faces daily while lending.
A lending policy is lending institutions statement of its philosophy, standards, guidelines and criteria developed and used by its employees to be observed in granting or refusing a loan request. These policies determine which sector of the industry or business will be approved loans and which one to avoid based on the country’s relevant laws and regulations. In microfinance operation, credit officers basically target to collect timely repayment. However, it is not an easy task to maintain 100 percent recovery rate, since some of the borrowing group members may create a number of problems with different circumstances (Sarma & Borbora, 2014).
Lending is very risky in that repayment of the loans is not always guaranteed and most of the times depend on other factors not within the control of the borrower hence affecting return on equity of the shareholders. It is a risky venture which financial institutions engage only after a rigorous and satisfactory analysis of the project for which lending is being made. The main pre-occupation of category 1 Micro finance institutions is extending loans to their members. Thus, the formulation and implementation of such lending policies are some of the important responsibilities of the Microfinance institutions management.
The lending policy of a MFI must be specific on how much loan will be made available to whom, what period, and purpose of the loan. For this reason, lending policies should be well documented so that lending officers will be able to know areas of prohibition and areas of operation. In addition, the lending policies should be subjected to periodic review to make the financial Institutions keep abreast with the dynamic and innovative nature of the economy as well as the competitive environment with other changing economic sector (Lizal, 2012). Therefore, managing loans in a proper way not only has positive effect on financial performance but also on the borrower and the country’s economy as a whole. Failure to manage loans which makes up the largest share of banks assets would likely lead to high levels of non-performing assets. And this in turn affects the financial performance of institution and the economy at large.
Debt recovery is the 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. Normally, this role of recovering loans is not an easy task as clients will go out of their way to prove inaccessible to the lender (bank). The banking industry in most cases has a debt recovery unit which is in charge of following loans before they become delinquent and make attempts to recover the loans.
The following can be used to reduce debt recovery problems in African banks; 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 bank thereby making them be in a position to repay their debts. (MIGWI, 2013)
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). Since the financial crisis, financial organizations like the commercial banking sector that were mostly affected and microfinance institutions in particular have taken special measures to mitigate any forthcoming financial losses caused by mismanagement in loan allocations and credit recoveries. Credit risk management offers a viable solution to such challenges. Today, lending policy in financial institutions constitutes a critical component of a comprehensive approach to risk management in every financial institution (Arora and Kumar, 2014). A key necessity for viable risk management is the capacity to sagaciously and productively oversee client credit lines. To minimize the introduction to terrible obligation, over-saving and liquidations, MFIs must have more prominent understanding into client budgetary quality, financial assessment history and changing installment designs (Nkusu, 2011). Credit management for a loan deal does not stop until the full and last installment has been recovered (Moti et al., 2012). Hence, as financial conditions change, the credit approach of the bank may likewise change. Although several previous studies have been conducted regarding credit risk management, but this issue has rarely been covered by researchers from the perspective of Cameroon context. It is now increasingly becoming clear that appropriate lending policies and recovery strategies impact on financial performance.
Bessis (1998) defined financial performance as a management initiative to upgrade the accuracy and timeliness of financial information to meet required standards while supporting day to day operations. Lyman and Carles (1978) also defined it as the operational strength of a firm in relation to its revenue and expenditure as revealed by its financial statements (Ndubuisi, Chinyere, Chidoziem, & Ezechukwu, 2017).
The Cameroonian Microfinance sector, as any other financial system in the world, deals highly with risks in its every day management due to the fact that there are factors that are not under the control of managers (such as globalization, world changes or market variables like price changes or stock exchange trends). Historically the finance sector in Cameroon has always been subject to some major risks that led many financial institutions to difficult situations (Cofinest, FIFFA, etc.). The careful management of these risks has always led to survival in the financial sector. Many Cameroonian financial houses handle these risks on a daily basis in order to grow and encounter rapid changes. Therefore, risks must be understood and carefully managed for a proper decision making in the Cameroonian financial system. In fact, there is a need for an appropriate loan policy and every financial institution and adequate recovery strategies set particularly as the crisis worsens in the country.
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 does loan recovery strategies affect the financial performance of category I Microfinance Institutions?