ASSESSMENT OF LOAN DEFAULT AND ITS IMPACT ON THE PROFITABILITY OF COMMERCIAL BANKS IN CAMEROON. CASE STUDY; AFRILAND FIRST BANK YAOUNDE.

Abstract

The history of banking is intertwined with the history of money which came as a result of the activities of the gold smith who safeguarded gold on behalf of gold owners, in their vault and had to issue receipt to them and also used it for granting of loans to those who needed this gold. The research is aimed at investigating the impact of loan default on the profitability of commercial banks in Cameroon, case study Afriland First Bank Yaoundé. Descriptive research design was used for this study. Secondary data which was gotten form the banks’ financial statements (balance sheet and income statement) for a period of 5 years ranging from 2012 to 2016. The data was neatly arranged for analysis using Statistical Package for Social Sciences (SPSS). Correlation coefficient and regression were used to test the relationship and hypothesis between loan default and profitability of Afriland Bank respectively. The results show that loan default has a significant positive and negative impact on the profitability of Afriland Bank as the P-value obtained is0.038 which is less than 0.05 at 95% confidence level. We reject the null hypothesis which states that Loan Default has no significant impact on profitability of Afriland First Bank. It is necessary to conclude based on the results obtained that loan default has a negative impact on profitability of Afriland Bank. As a result of the evidence and results obtained, there is need for recommendation that for fraud and fraudulent practices needs to be reduced and avoided from the personnel involved with issues of loan. Banks should seek to create a loan and credit department of highly competent and honest individuals.

CHAPTER ONE

INTRODUCTION

1.1 Background To The Study

The history of banking is intertwined with the history of money which came as a result of the activities of the gold smith who safeguarded gold on behalf of gold owners, in their vault and had to issue receipt to them and also used it for granting of loans to those who needed this gold said (Davies, 2002). The Babylonia age of 2000BC, people depositing gold were required to pay amount as much as one sixtieth of the total deposit. The thirst for profit, longing to become rich instilled daring into the goldsmith” why not become a gold lender” and payment of interest on the gold and that’s how the goldsmith put money into circulation through lending, (Louis, 1936).

The development of banking spread from Northern Italy throughout the Holy Roman Empire and in the 15th and 16th century to the Northern Europe. During the 20th Century, development in telecommunication and computing caused major changes in the size and geographic spread. The Ordinance N° 85/002 of 31 August 1985 relating to the establishment of Credit Institutions or Loan Houses is one of the most important Texts regulating the Banking Sector in Cameroon. This Ordinance has been ratified by Law N° 88/006 of July 1988 and Law N° 90/019 of August 10, 1990.  The financial crises of 2007-2008 caused many bank failures, including some of the world’s largest banks according to Antiochus.

Before the evolution of banking in Cameroon, small association of contributions existed in which money circulated amongst members providing credit or loans and savings facilities on interest. Such small groups were called ‘Njangi’ or ‘Tontine’ groups. As a result, to come out with a Bank-like institution, microfinance institutions were created which accepted deposits, as well as granted loans out to customers thereby transferring funds from the surplus unit to the deficit unit, (Tegwi, 2012).

The first bank was created in Cameroon when trade started at the coast of Cameroon. An attempt to explain the operation of commercial banks began with the inception of banking institution. Lending has become a vital role in banking operation because of its direct effect on the economic growth and business departments. Banks like any other business, have the commercial objective to maximize profit, through granting of loan which generate interest. (Tegwi, 2012)

The major assets of banks are the loans to individuals, businesses and other organizations and the securities that it holds while it major liabilities are it deposits and money it borrows. When banks give out loans to customers and the customer fails to repay the loan and the interest, the loan is said to be delinquent, which means the borrower has defaulted payment. Clark (2009), points out that the problems of loans arise as a result of default in the payment agreement caving from undue delay. Adedapo (2007), defined loan default as the inability of a borrower to fulfil his/her loan obligation as and when due. Hence, credit institution attempts to prevent loan default and delinquency because if the loan is not paid, the lender’s capital is lost and the institution will no longer be sustainable. For banks to exactly ascertain their default rate, portfolio at risk ratio must be measured. Macro’s (2000), defined portfolio at risk ratio as a measure of the potential for future losses based on the current performance of the portfolio. Ahmad (1997), brings out the causes of loan default which include; lack of willingness to pay loans coupled with diversion of funds by borrowers, willful negligence and improper appraisal by credit officers. After surveying different bank in India, Beger and de Young (1995), identified the main causes of default loans from industrial sectors as improper selection of an entrepreneur, deficient analysis of profitability, inadequacy of collateral security against loans, unrealistic terms and schedule of repayments, lack of follow up measures and default due to natural calamities.

One of the fundamental functions of any bank is its profitability, since all its strategies designed and activities performed are geared towards realizing this grand objective. Profitability measures the bank’s ability to generate revenue in excess of expenses, an accomplishment that is necessary if the bank is to be considered as going concern (Coleman, 2007). At the macro level, a sound and profitable banking sector is able to better withstand negative shocks and contribute to the stability of financial sectors Banks profit profits an important source of equity especially if reinvested into the business. This should lead to a safe and as such high profit could promote financial stability (Flamini et al., 2009).

There appears to be a consensus that bank profitability is directly related to the quality of assets on the balance sheet; that is, poor credit quality has a negative impact on the bank’s profitability and a good credit quality has a positive impact on its profitability. This relationship exists because an increase in the doubtful assets, which do not accrue income requires a bank to allocate significant portion of it gross margin to provision to cover expected credit loss, thus, profitability will be low (Alexiou and Sofoklis, 2009).

1.2 Problem Statement

The sustainability of commercial banks in Cameroon depends largely on their ability to collect loans as efficiently and effectively as possible. In order words, to be financially viable or sustainable. Commercial banks must ensure high portfolio quality based on 100% repayment, or at worst loan default cost recover and efficient lending.

However, there have been complains by commercial banks regarding high rate of default by their clients, which presupposes that most commercial banks are not achieving the internationally accepted standard portfolio at risk of 3% which is a cause for concern because of its consequences on business, individual and the economy of Cameroon at large. Loan default has started creeping deeply into the operation of commercial banks in Cameroon. Hence, the study seeks to examine the reasons behind the defaulted loans and how this can be controlled or minimize.

1.2.1 Research Questions

The research seeks to find answers to the following questions;

1. What is the impact of loan default on the profitability of commercial banks, case study Afriland first bank Yaoundé?
2. What are determinants of profitability in Afriland first bank Yaoundé?

1.3 Objective Of The Study

1. This study aims at determining the effect of loan default on the profitability of Commercial Banks in Cameroon, using Afriland First Bank Yaounde as a case study.
2. To find practical means of minimizing the incidence of default on loans in Afriland First Bank Yaounde.

ASSESSMENT OF LOAN DEFAULT AND ITS IMPACT ON THE PROFITABILITY OF COMMERCIAL BANKS IN CAMEROON. CASE STUDY; AFRILAND FIRST BANK YAOUNDE.