A CRITICAL EVALUATION OF THE EFFECT OF CREDIT MANAGEMENT ON THE PERFORMANCE OF FINANCIAL INSTITUTIONS IN CAMEROON

CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

Credit Management is one of the most important activities in financial institutions. Credit creation is one of the main income generating activities in a financial institution. But this activity involves great risk both to the financial institution and the debtor which has to be managed especially by the financial institution. Sound credit management is a prerequisite for a financial institutions stability and continuing profit.

Hermann (2008) indicates that when seeking improved operational performance and profitability, financial institutions are seeking ways to improve their performance in operation in a bid to increase profitability competitions has risen up as new technologies and new structures crop up. In the same way, financial institutions performance is determined in terms of their profitability and returns on investments.

Myers and Brealey (2003) describe credit management as methods and strategies adopted by a firm to ensure that they maintain an optimal level of credit and its effective management. Credit management practices are the strategies used by an organization to ensure that the level of credit in the firm is acceptable and it is managed effectively. It is part of financial management that comprises of all analysis of credit, rating of credit, classification and reporting of credit. Financial institutions collect savings from their members and grant loans on this savings so the financial institution need to see into it that this loans are paid back and on time by the debtors.

Euler Hermes (2021) defines credit management as a company’s action plan to guard against late payments or defaults by your customers. An effective credit management plan uses a continuous, proactive process of identifying risk, evaluating their potential for loss and strategically guarding against the inherent risk of extending credit.

Timely identification of potential credit default is important as high default rates lead to decreased cash flows, lower liquidity levels and financial distress. In contrast, lower credit exposure means an optimal debtors’ level with reduced chances of bad debts and therefore financial health. According to Scheufler (2002), in today’s business environment risk management and improvement of cash flows are very challenging. With the rise in bankruptcy rates, the probability of incurring losses has risen. Economic pressures and business practices are forcing organizations to slow payments while on the other hand, resources for credit management are reduced despite the higher expectations.

Therefore, it is necessary for credit professionals to search for opportunities to implement proven best practices. By upgrading your practices five common pitfalls can be avoided. Scheufler summarizes these pitfalls as failure to recognize potential frauds, underestimation of the contribution of current customers to bad debts, getting caught off guard by bankruptcies, failure to take full advantage of technology, and spending too much time and resources on credit evaluations that are not related to reduction of credit defaults.

The higher the amount of accounts receivables and their age, the higher the finance costs incurred to maintain them. If these receivables are not collectible on time and urgent cash needs arise, a firm may result to borrowing and the opportunity cost is the interest expense paid. Nzotta (2004) opined that credit management greatly influences the success or the failure of financial institutions. This is because the failure of financial institutions is influenced by the quality of credit decisions and thus the quality of the risky assets. He further notes that credit management provides a leading indicator of the quality of financial institutions credit portfolios.

A key requirement for effective credit management is the ability to intelligently manage customer’s credit lines. To minimize the bad debts, over reserving, and bankruptcies, the financial institutions must have greater insight into customer’s financial strength, credit score history, and changing payment patterns.

Nelson (2002) views credit management as simply the means by which an entity manages its credit sales. It is a prerequisite for any company dealing with credit transactions since it is impossible to have a zero credit or default risk. In the recent years, financial institutions have developed sophisticated systems to manage risk. Many financial institutions have been exposed to more risk of loan defaulting due to the increase of the amount of loans advanced. In addition to the system, management has had to step up their game in securing their assets. Financial institutions have policies which guide on the process of advancing credit.

These policies define on who should access credit and the collaterals involved. In addition it guards its back through insurance.

A critical objective of credit management is to ensure that a business identifies its needs in good time to avoid cash flow crisis. An efficient credit management system reduces the amount of capital tied up with debtors and minimizes bad debts. As noted by Horner (2004) there exists a positive correlation between credit management and profitability. 

The performance of financial institutions in any economy influences economic growth as they are responsible for mobilizing savings for productive investments through facilitating capital flows towards various sectors of the economy. According to Aminu (2003), credit management seeks to accelerate     cash inflows, delay cash outflows, and invest excess cash to earn a return, borrow cash at the best rates available and maintain an optimal cash level. With better credit and cash flow management practices, a business is capable of holding the right amount of cash and allows the business to make and receive payments in time.

Stoner (2003) defines financial performance as the ability to operate efficiently, profitably, survive, grow and react to the environmental opportunities and threats. Performance is measured by how efficient the enterprise is in use of resources in achieving its objectives. Financial institutions earn financial revenue from loans and other financial services in the form of interest fees, penalties, and commissions. Financial revenue also includes income from other financial assets, such as investment income. Bank financial activities also generate various expenses, from general operating expenses and the cost of borrowing to provisioning for the potential loss from defaulted loans. 

1.2 Statement of the problem