THE EFFECT OF INTEREST RATES ON LOAN REPAYMENT IN MICROFINANCE INSTITUTIONS IN CAMEROON

ABSTRACT

Microfinance Institutions play a significant role in Cameroon and the growth of the economy. The study strives to appraise the Effects of Interest Rates on Loan Repayment in Microfinance Institutions in Cameroon. Community Credit Company (CCC) was used as a case study for the study. Specifically it seeks to determine the effects of loan duration, loan term, loan amount and inflation on interest rates in microfinance institutions. The research was conducted using structure questionnaires to sample 20 employees of the microfinance institution.

Data was analyzed using. The findings of the research revealed that thou interest rates play a major role in loan repayment, other factors such as loan term and the repayment frequency also influence a large extend of loan repayment. Customers indicated that thou lower rates will enhance loan repayment, the accessibility and availability of funds was paramount Findings confirm that there exists a significant relationship between interest rates and loan repayment in microfinance institutions. To enhance loan repayment, the researcher recommends lower interest rates to ease the burden of loan repayment and loans granted should be an amount that customers can easily service. Micro insurance could be established to protect both the customers and the microfinance institution against any default

CHAPTER ONE

INTRODUCTION

1.1 Background of the study:

An efficient financial sector is efficient for the development of an economy. One of the indicators of financial sector health is loan qualities; the failure of most financial sectors is due to the high level of non-performing loans in an economy.

There are many reasons for loan defaults, such as high interest rate, inflation, depressed economic conditions and lenient terms of credit. Loans are part of the assets of a financial institution since they are meant to earn interest after due time. This is however not always the case since some loans does not perform as expected due to default in repayment.The greatest challenge faced by Microfinance institutions and Banks today is the non-repayment of loans borrowed. Microfinance institution and even banks should ensure that the credit policy is secure to enable them carry out loan transactions smoothly. This was according to Pandey (2010), the author pointed out that given that most Microfinance institutions get their normal annual sales from credit facilities due to loan interest on individuals, the repayment may not be certain. Nowadays, high percentages of loans that are due are the key issues faced by Microfinance institutions. In order for Microfinance institutions to reach a scale and move towards financial and operational sustainability, interest rates on due loans must be reduced. MFI’s must reach at the level of high repayment rates because high loan repayment benefits both the MFI and the borrowers. For borrowers, high repayment rate helps to obtain the next higher amount of loan and if there is a low repayment rate, borrowers will not be able to obtain the next higher amount of loan and lender will also lose their customers. Interest rate is the percentage charged on the total amount borrowed or saved. Interest rates can either be classified as long term or short term. As a general rule short term interest rates turn to be higher than long term interest rates. Interest rate as a cost of cash reflects market information with respect to anticipated changes in the buying influence of cash or future inflation. Banks and MFI’s acquire interest income when they loan out cash and interest is paid for the money borrowed. The measure of interest that a lender gets is as a resultof the measure of cash loaned out and similarly, the measure of interest the borrower pays is as a result of the amount obtained.  As a general rule, short-term interest rates tend to be higher than long-term interest rates. Traditional finance theory argues that as the size of a loan expands, the interest rate on that loan rises to accommodate the increased risk associated with the loan. However, utilizing firm-level data of the Cameroon banking industry, it is observed that the smaller the loan’s size, the greater the interest rate applied, and vice versa. Yet, using a fixed effect panel data framework, this article also shows that the interest rate differences among loan sizes can be mainly explained by the borrower’s characteristics for local banks while for foreign banks, its operating characteristics are the most important factors. Interest rates are a major concern in the banking and lending industry in Cameroon. Financial institutions have been accused of charging high interest rates and exploiting the consumers. This has led to government through the Ministry of Finance passing a Financial Institutions Act with an aim of protecting the consumers. The Act imposes interest rate ceilings on loan finance provided by money lending/financial institutions. These ceilings are proposed to be linked to the prime rate. Given this, it is not possible for them to charge full-cost recovery interest rates. This paper tries to highlight the effects of interest rate charged, on loan repayment.

1.1.1 Interest rate

Rate of Interest is the value a debtor pays for the utilization of money they acquire from a lender/financial foundations or expense paid on obtained assets (Crowley, 2007). It is “rent of money” crucial to an ‘industrialist society’ and regularly communicated as a rate over the time of one. Interest rate as a cost of cash reflects market information with respect to anticipated change in the buying influence of cash or future inflation (Ngugi, 2001). On the use of money in the institutions, a specific aggregate of cash paid or got is referred to as rate of interest. Banks and financial institutions get interest income when he loaned cash and account holder pays interest when he gets. The measure of interest that a lender gets is a level of the measure of cash he loaned and similarly, the measure of interest that a borrower pays is a level of the aggregate sum he obtained (Crowley, 2007). Anybody can make loan to somebody and get the interest or any foundation like bank can acknowledge the deposits and pay the specific measure of interest.

Banks urge the general population to store their cash by offering interest rates which propel the general population to influence stores by opening diverse records with the banks and banks to utilize their resources for influencing loan to other to individuals. For all intents and purposes, when bank makes loan to a client it charges higher rate but pays bring down rates to the depositor. With this distinction of interest rates bank makes benefit consequently of giving these administrations. To acquire much benefit bank charges higher interest rate however much as it is conceivable and then again pays bring down rate as much as could be expected. In any case, to pull in a similar borrower and investor banks are contending to each other which keep up the interest rates in comparable range.Due to the opposition among the banks interest rate stagnates in a similar range. For following and dealing with the critical improvement interest rate is to be tended to a noteworthy financial issue (Boulier, Huang &Taillard, 2001; Laubach, 2009).

Then again, in the profit and loss statement interest rate additionally participate in dealing with the interest segment completely (Buiter and Panigirtzoglou, 2003). What’s more, the interest rate likewise compresses the method for entire business obligation synopsis, including the receipt of obligation, brilliance of the obligation, desires of dreams cooperation extents and fixed floating mixture of the debt (Brigo and Mercurio, 2006; Einav, Jenkins, 2012 and Levin, 2008). Interest rates are associated in various forms like there are particular interest rates for saving record and for taking loan. Interest rate set by Central bank to control the rate charged by commercial banks that changes the interest rates to control the vivacious of financial framework. Regardless, the results of the assortment in the rate of interest are not generally the expected results (Jenkins, 2012). Central bank assumes numerous vital roles in the economy however its significant errand is to manage the interest rates which influence the financial system. For example, this can be finished by directing the inter-bank loan rate. The rates that business banks show for sparing and loaning are impacted by inter-bank interest rates and banks as result display their rates which are underneath or above from the interbank rate in certain rate.

1.1.2 Loan repayment

Repayment is the act of paying back cash previously obtained from a lender. Repayment more often than not appears as periodic payments that ordinarily incorporate part principal in addition to interest in each payment. Failure to keep up with repayments of debt can make a person to be declared bankrupt and severely affect his credit rating. Kimando (2012) posits that sometimes customers fail to pay their loans and the charged interest on the loan which may result to the risk of paying the loans late or not paying at all.

The greatest challenge facing MFIs and Banks today is non-repayment of loans borrowed. Credit reference Bureau in conjunction with financial institutions in Cameroon does blacklisting of all defaulters and prevent them from borrowing in the future from any financial institution and that small facilities advanced accrue more interest rate and thus a bigger risk of default than bigger loans.

Microfinance institutions and even banks are supposed to ensure that the credit policy is secure to enable them carry out their normal duties smoothly, this is according to Pandey (2010) where he recommended that in India financial management is at a down fall. In the same setting, the author pointed out that, given that most of the micro- finance institutions get their normal annual sales from the credit facilities loans interests given to certain individuals and persons with low incomes, the paying back of loans may be not be certain.

In the similar aspects, Ditcher (2013) posited the significance of finances been lend to customer is based on the follow up done by the management which is extensive of the loss which may occur in giving out of giving out such credit advances the may ruin the borrower loan character. However, it may be excused that lending decisions by the various banks and micro finance institutions are more and most of the time based on the feelings which are subjective in nature regarding risk in relation to borrower’s repayment abilities. According to Horne (2007) MFIs’ have been employing this kind of appraisal since it is inexpensive and simple (Horne, 2007).

1.1.3 The Cameroon Banking Sector

The bank of issue is the Bank of the Central African States (Banque des États de l’Afrique Central-BEAC), which replaced the Central Bank of the State of Equatorial Africa and Cameroon in November 1972. Its headquarters are in Yaoundé. In 1993, member states of the BEAC created a supranational supervisory authority, Commission Bancaire de l’Afrique Centrale (COBAC) in order to secure the region’s banking system. The government’s Exchange Control Office controls all financial transactions effected between Cameroon and foreign territories.

Cameroon’s banking system consisted of nine commercial banks with 60 branches in 1999. The major commercial banks, all with important foreign participation, were the Amity Bank, Banque Internationale du Cameroun pour l’Epargne et le Credit (the last bank to be privatized, in 1999), Caisse Commune d’Epargne et d’Investissement, Commercial Bank of Cameroon, Citibank, Societe General de Banque au Cameroun, Standard Chartered Bank, and the Societe Commerciale de Banque Credit Lyonnais-Cameroun. There was also a savings bank and a postal bank. Informal savings and loan systems known as tontines take the place of banks for many tribal members, with repayment enforced by social pressure. The International Monetary Fund reports that in 2001, currency and demand deposits an aggregate commonly known as M1 were equal to $971.3 million. In that same year, M2 an aggregate equal to M1 plus savings deposits, small time deposits, and money market mutual funds was $1.6 billion.

The discount rate, the interest rate at which the central bank lends to financial institutions in the short term, was 6.5%.In April 2003 the Douala Stock Exchange was declared open for business by Cameroon’s prime minister Peter Mufany Musonge, although no exact date was given for the start of trading or the number of companies that will be listed. Cameroon has been criticized for a lack of transparency in its economic institutions and observers question whether the exchange will perform to international standards. The recently privatized electricity company, AES Sonel, is expected to be one of the first companies listed on the exchange when 5% of its shares are offered for sale to its employees; a sale required by an agreement between the company and the government.

1.2 Problem Statement

Microfinance institutions play a mighty role in Cameroon and the growth of the economy. The poor needs financing to grow business and this can only be achieved through MFI funding activities. The interest rates charge by financial institutions in Cameroon have been high hence causes a lot of shyness towards financing options due to high interest rates (Tchakounte, 2018). The loan repayment capabilities is the one that contributes to the profit margin size in every transaction between the MFI and its clients but despite all these there are several high cases of loan repayment defaults in Microfinance institutions.

Charging high interest rates to cover cost is essential for every business survival, thus it is not surprising that successful microfinance institutions charge high interest rates to cover their high cost. However, despite the success of expanding credit to low income earners, most borrowers default repayment. Studies into Microfinance in Cameroon did not only concentrate on the effects of interest rate on loan repayment even when they still find difficulties in collecting loans which have been given to beneficiaries . This creates a research gap of MFI which this study seeks to close. Loan payment ability is normally the driver of the bank and other financial institutions’ financial performance. The loan repayment capabilities are the ones that contribute to the profit margin size in every single transaction between the bank/financial institution and its clients. Despite all this, there are several stated cases of high loan repayment defaults in commercial banks. It is acknowledged that the amount or level of non-performing loans (NPLs) is frequently connected with bank failures and financial crisis in both third world and developed nations (Caprio and Klingebiel, 2002). Actually, there is enough proof that the financial/banking crises in Kenya were preceded by high nonperforming loans (Warue, 2013). When individuals loaned fail to pay the principal amount and interests facilities advanced to them, the institutions or banks concerned will be adversely impacted. If this happens, then, there will be fewer finances to run its normal businesses and also to advance as loan facilities to other borrowers who have potential. If the effect of non-repayment continues to persist for long, the banks will have very huge bad debts; an encounter that would result to generally workforce being cut and branches closure as a means of cutting on costs. These may also result to the stall in its market expansion and ultimately collapse of the bank (Atieno, 2012).The banks and other financial institutions play a significant role in enhancing loan accessibility and other financial services especially to the poor and persons with low-incomes. This indicates that any constraints affecting these banks and financial institutions are more likely to have far reaching effects on the households and the whole economy. In Kenya we have witnessed the cost of loans reduced to 14% in August 24, 2016 from overwhelming 18%.It’s not clear the impact of such reduction on repayment of loans in commercial banks in Kenya (Njoroge, 2016). A study by Samuelson (2009) demonstrated that when interest rate raises it consequently influences the borrowers but does not influence the bank’s execution. The performance of the bank will not be affected by high interest rate but the individual borrowers will try to tolerate the effects of high rate of interest. This is because rate of interest going up will force the commercial banks to charge more on loans advanced than the arrival it pays to investors. Thus, both the debtor and contributor will endure the expense. As per the research of Musleh, (2007), increment in the rate of interest discourages the depositors and borrowers, similar to investment and saving. Therefore, this study sought to evaluate interest rate and loan repayment in commercial banks in Case study. According to Warue (2012), the most common vulnerability in micro finance institutions is the chance of not receiving money bank from borrowers. The sustainability of MFI is the ability to collect their loans efficiently and effectively, in order words to ensure sustainability, MFI must ensure low defaults on loans and high recovery.

In order to maintain sustainability, we need to examine the factors influencing loan repayment because is borrowers do not repay the loans; there may not be sufficient funds to maintain the liquidity position of the MFI.

1.2.1 Research Question

• What are the measures adopted to improve the repayment of loan in Microfinance Institutions?

• What are the effects of interest rates on loan repayment in microfinance institutions?

• What are the effects of loan term on loan repayment in Microfinance Institutions?

• What are the effects of inflation on loan repayment in Microfinance Institutions?

1.3 Objectives of the study

Main Objective:

• The main objective is to examine the effects of interest rates on loan repayment in Microfinance Institutions.

Specific Objectives:

• To appraise the effects of loan term in interest rates in Microfinance Institutions in Cameroon.

• The effects of loan size/amount on interest rates in Microfinance Institutions in Cameroon.

• To determine the effects of inflation on interest rates in Microfinance Institutions in Cameroon.

1.4 Hypothesis

• Ho: Interest rate does not positively affect loan repayment in Microfinance Institutions in Cameroon.

• H2: Loan term does not positively affects loan repayment in Microfinance Institutions in Cameroon.

• H3: Loan size does not positively affect loan repayment in Microfinance Institutions in Cameroon.

• H4: Inflation does not positively affect loan repayment in Microfinance Institutions in Cameroon.

1.5   Significance of the study