The Impact of Credit Risk Management on the Profitability of Microfinance UNICS Buea
Department: Banking and Finance
No of Pages: 62
Project Code: BFN9
References: Yes
Cost: 5,000XAF Cameroonian
: $15 for International students
ABSTRACT
Credit
risk is on an increasing rate and is becoming an area of concern to many people
and institutions in the lending business globally. This kind of exposure leads
to instability and poor financial performance in financial institutions.
However,
MFIs are facing risks when they are operating. Credit risk is one of the most
significant risks that financial institutions face, considering that granting
credit is one of the main sources of income.
Therefore,
the management of the risk related to that credit affects the profitability of
the institution. The main purpose of the research was to investigate the impact
of credit risk management on profitability of microfinance in Cameroon.
In
the research model, ROE and ROA were defined as proxies of profitability. The
research collects data from 30 employees and customers of Unics Plc in Buea and
formulates two hypotheses which are related to the research questions.
Descriptive
and regression are performed in order to test if the relationship exists. The
findings reveal that credit risk management does have positive effects on
profitability microfinance It is recommended that MFIs should emphasize more on
risk management. In general, MFIs need to maintain an optimum level of credit
risk management.
CHAPTER ONE
INTRODUCTION
1.1 Background to the
Study
The
power of financial institutions especially micro finance to create money is of
great importance in business operations. Micro finance is the major financial
intermediary in any economy as they are the major provide credits to the
household and corporate sector and operate the payment mechanism.
Orua
(2009) deal with both retail and corporate customers, have well diversified
deposit and lending book and generally offer a full range of financial
services. The policy of micro finance to make money results in the elastic
credit system that is necessary for economic progress at relatively steady rate
of growth.
Particularly,
micro finance makes profits by selling liabilities with one set of
characteristics (a particular combination of liquidity risk and return) and
using the proceeds to buy assets with different set of characteristics i.e.
asset transformation.
A
modern financial management defines the business of financial system as the
measuring, managing and accepting of the risks. Under the definitions, the most
important and uncertainty banks and financial institution must measure, monitor
and manage its credit risk.
This
hazard which is called the default risk is the danger that the counter party
will default or not perform. With increased pressure on financial institution
to improve shareholders return banks have had to assume higher risk and at the
same time, manage these risks to avoid losses.
Recent
changes in the banking environment (globalization, deregulation,
conglomeration, etc.) have posed serious risk challenges for banks but has also
have offered productive opportunities (Saunders and Marcia, 2007).
Generally,
the aim of risk management is not simply to reduce or even to eliminate risk;
it is also the process of recognition, measurement and control of risk that an
investor faces. This may not be
possible given various difficulties of measuring risk and the limitations of
the instruments for controlling risks.
Risk
management must be of continuous process the composition of investor’s
portfolio and the risk of the assets therein, as well as the objectives and
constraints of the investor change overtime. However, the need for risk
management has increased sharply in the past three decades.
The
risk management has the purpose and the scope of insuring that Risk management
ensures that the risk-taking part of investing is being carried out in a
controlled and understood manner. It is a continuous process change of the
composition the investor‘s portfolio, the risk of the asset in the portfolio.
The five C's of credit is a system used by lenders to gauge the creditworthiness of potential borrowers. The system weighs five characteristics of the borrower and conditions of the loan, attempting to estimate the chance of default.
The
five C's of credit are character, capacity, capital, collateral and conditions.
Credit Risk Management is inherent in micro finance and is unavoidable. The
basic function of micro finance management is risk management.
Micro
finances assume credit risk when they act as intermediaries of funds and credit
risk management lies at the heart of financial institution. The business of
banking is credit and credit is the primary basis on which a bank’s quality and
performance are adjusted.
Credit
risk is composed of default risk and credit mitigation risk. Default risk is
the risk that the counterparty will default on its obligations to the investor.
In this risk, the credit quality deteriorates (or default risk increases).
Credit
risk is more difficult to measure because data on both default and recovery
rates are not extensive, credit returns are highly skewed and fat tailed and
longer term time horizon and higher confidence levels are used in measuring
credit risks.
The
aim of every micro finance institution is to operate profitably in order to
maintain its stability and improve in growth and expansion. For most people in
micro finance, lending represents the heart of the industry.
Loans
are the dominant asset at most micro finance, generate the largest share of
operating income, and represent their greatest risk exposure. Micro finance
sector in Cameroon has faced various challenges that include non-performing
loans and fluctuations of interest rate among others, which have threatened
their stability.
According to Bessis (2005) credit risk
management is important to micro finance management because they are ‘risk
machines’ they take risks; they transform them and embed them in banking
products and services.
Risks
are uncertainties resulting in adverse variations of profitability which shows
the Financial Performance or in losses that show their failure. While other
researchers have provided valuable knowledge on Credit Risk Management; they
have not shown a clear formula in which Credit Risk Management is properly to improve
the profitability of micro finances especially in the economy of Cameroon.
Despite all efforts put in place my MFIs in Cameroon, Most MFI in Cameroon still faces problems such as poor management of non-performing loans and fluctuation of interest which some credit risk management that when properly managed, increases the profitability of these organizations and thus, it is important to conduct the study about credit risk management as it is essential that MFIs manage credit risks so as to reduce losses and ensure continued existence in the long term. It is form this background that Credit risk management is proposed and investigated.
1.3. Research Questions
- What is the influence of credit risk management on return on investment of micro finance in Cameroon?
- What is the influence of credit risk management on return on equity?
1.4 Objective of the
Study
The
main objective of this study is to examine the influence of credit risk
management on the profitability of micro finance institution in Cameroon.
The
research objective is divided in to the following
- Evaluate the influence of credit risk management on return on investment of MFI
- Assess the influence of credit risk management on return on equity
- To make policies
