THE EFFECT OF CREDIT MANAGEMENT SYSTEMS ON THE LOAN RECOVERY EFFORTS OF MICROFINANCE BANKS IN AKWA IBOM STATE

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THE EFFECT OF CREDIT MANAGEMENT SYSTEMS ON THE LOAN RECOVERY EFFORTS OF MICROFINANCE BANKS IN AKWA IBOM STATE

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

The banking industry play a vital role in economic development of any nation, they play roles like fund mobilizations, opening of account, letters of credit business guarantees, and mostly give out loans from the part of the money mobilized. Banks are financial institutions are established for lending, borrowing, issuing, exchanging, taking deposits, safeguarding or handling money under the laws and guide lines of a respective country. Among their activities, credit provision is the main product which banks provide to potential business entrepreneurs as a main source of generating income.

Banks and financial institutions mobilize deposits and utilize them for lending. Generally lending business is encouraged as it has the effect of funds being transferred from the system to productive purposes which results into economic growth. The borrower takes fund from bank in a form of loan and pays back the principal amount along with the interest. Sometimes in the non – performance of the loan assets, the fund of the banks gets blocked and the profit margin goes down. To avoid this situation, bank usually engage in credit management.

Credit management is one of the most important activities in any company and cannot be overlooked by any economic enterprise engaged in credit irrespective of its business nature. It is the process to ensure that customers will pay for the products delivered or the services rendered. 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. It is an aspect of financial management involving credit analysis, credit rating, credit classification and credit reporting. Nelson (2002) views credit management as simply the means by which an entity manages its credit sales. It is a prerequisite for any entity dealing with credit transactions since it is impossible to have a zero credit or default risk. Banks are merely custodians of the money they lend; hence interest must be paid to depositors and dividends to the investors. Credit management can be seen as an integral part of lending and as such in its absence, good loans can turn bad. It is expedient to note that the importance of credit management cannot be over-emphasized and good credit management requires the establishment of adherence to and of sound and efficient credit policies of government.

For banks to be successful, their corporate credit appraisal, disbursement, adequate monitoring and repayment must be assured. But experiences over the years have shown that inadequate credit analysis and sound judgment of loans application have resulted in unperforming loans. Provision of credits according to Agu and Basil (2013), which are in the form of loans and advances, are the total amount of money a given bank lends out to its customers at any given period of time. In providing credits for business ventures, banks should as a matter of importance take all necessary steps to ensure that advances are granted to those customers who can and will make judicious use of loans so that repayment will not become a problem. Therefore credits must be made to people who are capable of utilizing it well and repaying the loan at its maturity. The place of loans and advances in the affairs of banks can be explained by referring to the fact that “loans and advances are the largest single item in the assets structures of Nigeria commercial Banks (Ani 2012). It also constitutes the main source of the operating income of banks and also the most profitable assets for the employment of banks funds. Credit management systems include credit appraisal, credit risk control ad collection policy (Knox, 2004).

Over the last decade, many financial institutions were never so serious in their efforts to ensure timely credit recovery and consequent reduction of Non-Performing Assets (NPAs) as they are today. Debt recovery is defined as a 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 (Early, 2006). The role of recovering loans is not an easy task as clients will go out of their way to prove inaccessible to the lender/bank (Garber, 1997). It is important to note that credit recovery management, be of fresh loans or old loans, is central to NPA management.

A key requirement for effective credit management according to Alice and Jaya (2016) is the ability to intelligently and efficiently manage customer credit lines. In order to minimize exposure to bad debt, over-reserving and bankruptcies, companies must have greater insight into customer financial strength, credit score history and changing payment patterns. Credit management starts with the sale and does not stop until the full and final payment has been received. It is as important as part of the deal as closing the sale. In fact, a sale is technically not a sale until the money has been collected. It follows that principles of goods lending shall be concerned with ensuring, so far as possible that the borrower will be able to make scheduled payments with interest in full and within the required time period otherwise, the profit from an interest earned is reduced or even wiped out by the bad debt when the customer eventually defaults. Credit management is concerned primarily with managing debtors and financing debts. The objectives of credit management can be stated as safe guarding the companies‟ investments in debtors and optimizing operational cash flows. Policies and procedures must be applied for granting credit to customers, collecting payment and limiting the risk of non-payments.

Credit management is the method by which you collect and control the payments from your customers. 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. It is an aspect of financial management involving credit analysis, credit rating, credit classification and credit reporting. A proper credit management will lower the capital that is locked with the debtors, and also reduces the possibility of getting into bad debts. According to Edwards (1993), unless a seller has built into his selling price additional costs for late payment, or is successful in recovering those costs by way of interest charged, then any overdue account will affect his profit. In some competitive markets, companies can be tempted by the prospects of increased business if additional credit is given, but unless it can be certain that additional profits from increased sales will outweigh the increased costs of credit, or said costs can be recovered through higher prices, then the practice is fraught with danger. Most companies can readily see losses incurred by bad debts, customers going into liquidation, receivership or bankruptcy. The writing-off of bad debt losses visibly reduces the Profit and Loss Account. The interest cost of late payment is less visible and can go unnoticed as a cost effect. It is infrequently measured separately because it is mixed in with the total bank charges for all activities. The total bank interest is also reduced by the borrowing cost saved by paying bills late. Credit managers can measure this interest cost separately for debtors, and the results can be seen by many as startling because the cost of waiting for payment beyond terms is usually ten times the cost of bad debt losses. Effective management of accounts receivables involves designing and documenting a credit policy. Many entities face liquidity and inadequate working capital problems due to lax credit standards and inappropriate credit policies. According to Pike and Neale (1999), a sound credit policy is the blueprint for how the company communicates with and treats its most valuable asset, the customers.

1.2 Statement of the Problem

Credit risk management practices is an issue of concern in financial institutions today and there is need to develop improved processes and systems to deliver better visibility into future performance. There have been controversies among researchers on the effect of credit management techniques adopted by various institutions.

The success of microfinance banks is largely dependent on the effectiveness of their credit management system. Since these institutions generate most of their income from interest earned on loans extended to small and medium entrepreneurs. The central bank annual supervision report, 2015 indicated high incidence of credit risk reflected in the rising levels of non-performing loans by the commercial banks in the last 10 years, a situation that has adversely impacted on their profitability. This trend not only threatens the viability and sustainability of microfinance banks, but also hinders the achievement of the goals for which they were intended which are to provide credit to the middle and lower income class but also to the rural unbanked population and bridge the financing gap in the mainstream financial sector. Bad credit can be stemmed out by proper risk identification and appraisal. Sound credit management is a prerequisite for a financial institution’s stability and continuing profitability, while deteriorating credit quality is the most frequent cause of poor financial performance and condition. According to Gitman (1997), the probability of bad debts increases as credit standards are relaxed. Firms must therefore ensure that the management of receivables is efficient and effective .Such delays on collecting cash from debtors as they fall due has serious financial problems, increased bad debts and affects customer relations. If payment is made late, then profitability is eroded and if payment is not made at all, then a total loss is incurred. This study therefore aimed at establishing the influence of credit management systems on loan performance of microfinance banks in Akwa Ibom State, Nigeria.

1.3 Purpose of the Study

The general objective for this study was to establish the effect of credit management systems on the loan recovery efforts of microfinance banks in Akwa Ibom State. Specifically, the study sought to

To determine the effect of credit appraisal on loan recovery efforts of microfinance banks in Akwa Ibom State.

To determine the effect of credit risk control on loan recovery efforts of microfinance banks in Akwa Ibom State.

To determine the effect of collection policy on loan recovery efforts of microfinance banks in Akwa Ibom State.

1.4 Research Questions

What is the effect of credit appraisal on loan recovery efforts of microfinance banks in Akwa Ibom State?

What is the effect of credit risk control on loan recovery efforts of microfinance banks in Akwa Ibom State?

What is the effect of collection policy on loan recovery efforts of microfinance banks in Akwa Ibom State?

1.5 Research Hypotheses

The following null hypotheses were tested at .05 level of significance

There is no significant effect of credit appraisal on loan recovery efforts of microfinance banks in Akwa Ibom State.

There is no significant effect of credit risk control on loan recovery efforts of microfinance banks in Akwa Ibom State.

There is no significant effect of collection policy on loan recovery efforts of microfinance banks in Akwa Ibom State.

1.6 Significance of the Study

The findings of this study would benefit a number of stakeholders; the management of various banks and credit managers in particular would benefit by getting an insight on various credit monitoring strategies. This would significantly help them in reviewing credit assessment procedures and policies, credit appraisal techniques among others. In addition, the findings of this study would assist managers in devising appropriate and effective credit recovery strategies. This will positively impact on the overall performance by minimizing the risks associated with non-performing loans.

The study would also benefit the government and Central Bank of Nigeria in particular, by identifying the best credit monitoring and recovery strategies and practices in the Nigerian financial sector. The findings of this study would specifically aid on financial policy formulation and reviewing of the same. Furthermore, the findings would enable the financial consultants to provide sound financial advice to various stakeholders in regard to various aspect of credit risk management. In regard to the scholars; the findings of this study would also add value to the existing knowledge in the strategic management and finance discipline. It would also form the basis upon which other related and replicated studies can be based on and also suggest potential research areas for future researchers.

1.7 Scope of the Study

The study restricts itself to credit management systems which are credit appraisal, credit risk control and credit collection policy. The study was also delimited microfinance banks operating in Uyo metropolis with at least four years of being in the business.

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