Effect Of Nonperforming Loans On The Efficiency Of Microfinance Banks (A Case Study Of Gudusisa Microfinance Bank Limited, Adamawa State)

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Effect Of Nonperforming Loans On The Efficiency Of Microfinance Banks (A Case Study Of Gudusisa Microfinance Bank Limited, Adamawa State)


Abstract


This research entitles the effect of nonperforming loans on the efficiency of microfinance banks (a case study of gudusisa microfinance bank limited, adamawa state) and was guided by the following objectives: to examine the effects of interest rates on financial performance of Gudusisa microfinance bank limited, to examine the effects of loans size on financial performance of Gudusisa microfinance bank limited, to determine the effects of repayment installments on financial performance of Gudusisa microfinance bank limited, The study adopted a descriptive research design. The population under this study consisted employees of Gudusisa microfinance bank limited of credit department and finance totaling 25 potential respondents which took randomly. The instrument of the study was self made (questionnaire) and a set of questions was formulated. The findings show that the change of one standard unit on effect on low level of savings will result in a change of 0.056 standard unit in the financial performance, the change of one standard unit on low supply of loan will result in a change of -0.092 standard unit in the financial performance, the change of one standard unit on effect on insufficient competition will result in a change of 0.998 standard unit in the financial performance, about the effects of loans size on financial performance of Gudusisa microfinance bank limited, the findings shows that the standardized coefficients for each technology and it reports that the change of one standard unit on effect on profitability will result in a change of 0.396 standard unit in the financial performance, the change of one standard unit on effect on economic development will result in a change of 0.520 standard unit in the financial performance, the change of one standard unit on effect on loan repayment will result in a change of 0.053 standard unit in the financial performance, about the effects of repayment installments on financial performance of Gudusisa microfinance bank limited shows the standardized coefficients for each technology and it reports that the change of one standard unit on facility in repayment will result in a change of 0.449 standard unit in the financial performance, the change of one standard unit on quick repayment will result in a change of 0.237 standard unit in the financial performance, the change of one standard unit on Credibility opportunity will result in a change of 0.319 standard unit in the financial performance. Nonperforming loan ratio of Gudusisa microfinance bank limited Adamawa state is 1.5% in 2021, 5% in 2022 and 2.9% in 2023. The researcher recommended by saying that Gudusisa microfinance bank limited should credit for equity financing instead of debt financing if it wants to improve on its leverage. This involves funding growth through retained earnings and issuing of shares. The study also recommends that loan approval and monitoring procedures should focus on the borrower’s cash flow and ability to repay in an effort to improve the quality of the loan assets and mitigate future allowances for loan losses. All the relevant data was analyzed and evaluated by using primary and secondary data and the results was interpreted accordingly.


Table of Content


  • Title Page
  • Certification
  • Dedication
  • Acknowledgement
  • Table of Content
  • List of Tables
  • Abstract

Chapter One:

Introduction

  • 1.1 Background of the Study
  • 1.2 Statement of the Problem
  • 1.3 Objective of the Study
  • 1.4 Research Questions
  • 1.5 Research Hypothesis
  • 1.6 Significance of the Study
  • 1.7 Scope of the Study
  • 1.8 Limitation of the Study
  • 1.9 Definition of Terms
  • 1.10 Organisations of the Study

Chapter Two:

Review of Literature

  • 2.1 Conceptual Framework
  • 2.2 Theoretical Framework
  • 2.3 Empirical Review

Chapter Three:

Research Methodology

  • 3.1 Research Design
  • 3.2 Population of the Study
  • 3.3 Sample Size Determination
  • 3.4 Sample Size Selection Technique and Procedure
  • 3.5 Research Instrument and Administration
  • 3.6 Method of Data Collection
  • 3.7 Method of Data Analysis
  • 3.8 Validity of the Study
  • 3.9 Reliability of the Study
  • 3.10 Ethical Consideration

Chapter Four:

Data Presentation and Analysis

  • 4.1 Data Presentation
  • 4.2 Analysis of Data
  • 4.3 Answering Research Questions
  • 4.4 Test of Hypotheses

Chapter Five:

Summary, Conclusion and Recommendation

  • 5.1 Summary
  • 5.2 Conclusion
  • 5.3 Recommendation
  • References
  • APPENDIX
  • QUESTIONNAIRE

Chapter One


Introduction

1.1 Background to the Study

Non-performing loan is among the oldest form of credit risk facing the banking industry. It is often referred to as the risk of default arising from the failure of borrowers to meet their obligations in terms ofloan- repayments. Banks generally function as financial intermediaries between the surplus and deficit units of an economy. According to Kaliu and Kiawa (2015), financial intermediation is very essential in aneconomy and banks are always expected to play crucial role in economic growth, through the provision of loan facilities to Small and Medium-Scale Enterprises (SMEs). However, Brollet al. (2002) assert that credit risk is the most significant risk facing banks in their role as financial intermediaries.
The effect of credit risk on the performance of banks has been identified by many researchers (Salas &Saurina, 2002; Aremu, Suberu&Oke, 2010; Boahene, Dasah&Agyei, 2012; Ameur&Mhiri, 2013). These researchers are of the opinion that credit risk influences the profitability of a bank, if not properly managed. In the Nigerian context, Ayodele and Alabi (2014) assert that credit risk is a major risk affecting banking operations in the country. This assertion has been further buttressed by empirical findings on commercial banks in the country, where scholars have shown that credit risk influences financial performance in the Nigerian banking industry (Kargi, 2011; Kolapo, Ayeni&Oke, 2012; Kayode, Obamuyi, Owoputi&Adeyefa, 2015; Taiwo, Ucheaga, Achugamonu, Okoye&Agwu, 2017).

Microfinance Banks (MFBs) give loan facilities in form of micro-credits to people who lack access to such from commercial banks and they are known as major player in economic growth and development (Otieno, Nyagol&Onditi, 2016). This lending activity is often associated with credit risk. For instance, the Central Bank of Nigeria (CBN) has identified credit risk as a major challenge facing the microfinance banking sub-sector, which has limited lending activities to individuals and enterprises in the country (CBN, 2017).In particular, the apex bank has reported that many of the MFBs have high volume of non-performing loans, which have in turn increased their provisions for loan-loss (CBN, 2018). Situations where MFBs do not have sufficient funds for business usually limit access to loans by customers.
In all businesses, efficiency is a general indicator of performance. Efficiency, according to Jurkonyte-Dumbliouskiene (2016), “can be defined as the maximum potential output-input ratio in the manufacturing procedure”. Allocative as well as technical efficiency are the two main types of efficiency considered.

Allocation efficiency is a firm’s potential to utilize inputs optimally given their prices and productive technology. It is supported by microeconomic theory and its significant in many instances, however, when estimating allocative efficiency for banks one requires; the labour contracts which are often incomplete, the production function which normally is unknown or unspecified and the input prices despite the fact that not all inputs are marketed and if marketed they are not available in equal terms to all buyers (Kereta, 2007).

On the other hand, technical efficiency according to Farrell (1951), is the radian contraction of inputs given output and technology (input orientation) or radian augmentation of outputs given input and technology (output orientation). It is a managerial efficiency because the managers control the inputs and outputs. It is critical in tracking the growth process.
According to Chi, Kilduff & Gargeya (2009), firms are homogenous and some are more efficient than others. Those operating at the technological frontier earn high profits while others are barely able to survive. Efficiency enables banks to be more resilient to shocks, hence, significantly and positively affecting growth, bank efficiency ease credit constraints and enhances the growth of other economic sectors during crisis (Diallo, 2018). The financial sector’s efficiency and economic growth are critical to the country’s long-term growth (Zakaria et al., 2019).

When banks list loans that need to be collected, they incur additional costs from performing the non-value adding activity. The activities include being cautious on collateral value, tracking the monetary value of the debtor among other activities such as renegotiating the repayment (Ezeoha, 2011). According to Mwangi (2012), if management ignores the problem of asset quality, the costs are likely to increase in future hence deteriorating the efficiency of banks.
Hughes and Simpson (1993), as well as Berger and DeYoung (1997), show a linkage in Non- performing loans and efficiency. According to Hughes and Simpson (1993), banks fail to monitor and screen borrowers, which in the short-run lowers operating costs. However, in the long-run it results in higher non-performing loans which require more monitoring efforts that call for higher monitoring costs.

According to Berger and DeYoung (1997), bad-luck or external factors beyond the borrower’s control can result in non-performing loans, leading to additional costs in the financial institution. The added costs are due to increased monitoring, contract renegotiation, and managers’ efforts to reduce loan losses.

According to financial institution research, there is a positive linkage of operating costs and loans that are deemed as non-performing. Kwan and Eisenbeis (1995) investigated inefficiency of US banks using stochastic frontier analysis in relation to NPLs. The study found out that inefficient banks have higher non-performing loans. Efficiency has been a topic of discussion not because high costs endanger the financial sector’s sustainability (Cull et al., 2009), but because high interest rates limit banks’ potential to benefit their clientele, particularly the poor (Mersland and Strom, 2010).


1.2 Statement of the Problem

Majority of the MFBs in Nigeria are owned by private individuals and profit making is a core component of their business (CBN, 2019). Several factors may influence the profitability of a bank but studies have shown that non-performing loans and loan-loss provisions (indicators of credit risk) influence profitability among MFBs (Felix & Claudine, 2008; Crabb & Keller, 2011; Boaheneet al, 2012; Ameur&Mhiri, 2013; Afolabi, Obamuyi&Egbetunde, 2020).In addition,there havebeen limited studies on the causal relationship between these credit risk variables and financial performance among microfinance banks insome countries (Almekhlafi, Almekhlafi, Kargbo&Hu, 2016). However, to the best of our knowledge, there remains a scarcity of such empirical relationship among microfinance banks in Nigeria. The closest research on this was carried out by Onaolapo (2015) on commercial banks in Nigeria.In the light of this, our paperis guided by the following research question: What is the causal nexus between credit risk variables (non-performing loan and loan-loss provision) and financial performance (returns on assets) of MFBs in Nigeria?


1.3 Objectives of the Study

The main objective of the study is to examine the effect of nonperforming loans on the efficiency of microfinance banks; a study of Gudusisa microfinance bank limited, Adamawa state. This study was guided with both general and specific objectives.

  1. To examine the effect of interest rates, loan size and repayment installment on Return on Equity of Gudusisa microfinance bank limited.
  2. To examine the effect of interest rates, loan size and repayment installment on Return on Asset of Gudusisa microfinance bank limited.
  3. To determine the effect of interest rates, loan size and repayment installment on Net Interest Margin of Gudusisa microfinance bank limited.

1.4 Research Questions

  1. What are effects of interest rates, loan size and repayment installment on Return on Equity of Gudusisa microfinance bank limited?
  2. What are the effects of interest rates, loan size and repayment installment on Return on Asset of Gudusisa microfinance bank limited?
  3. What are the effects of interest rates, loan size and repayment installment on Net Interest Margin of Gudusisa microfinance bank limited?

1.5 Hypothesis of the study

  • H01: There is no an effect between non performing loans and financial performance of Gudusisa microfinance bank limited.
  • H02: There are no effects of interest rates, loan size and repayment installment on Return on Asset of Gudusisa microfinance bank limited.
  • H03: There are no effects of interest rates, loan size and repayment installment on Net Interest Margin of Gudusisa microfinance bank limited.

1.6 Significance of the Study

Understanding the impact of NPLs on efficiency of microfinance banks could help in mitigating their causes and could lead to the improved financial performance while lifting a larger number of people out of poverty. Since many financial institutions have collapsed as a result of non-performing loans, this work would benefit not only credit unions but all institutions that give loans. This is because all these institutions are faced with similar external environmental factors and clients who share similar characteristics.

This study contributes to fill the gap in the literature concerning non-performing loans implications in microfinance performances especially the targeted ones. On the other hand, the study uses the banking sector in Nigeria as a case, where economic research is in its early stages; it will thus serve as a reference point for other studies.

This study will help the future researchers to consider the similar study could be done in other institutions within the country in order of augmentation of the findings.


1.7 Scope of the Study

This study is oriented on Effect of Non-Performing Loans and efficiency of microfinance banks. All the relevant data analyzed and evaluated by using primary and secondary data and the results was interpreted accordingly. This study was conducted locally, in Adamawa State specifically in Gudusisa Microfinance Bank Limited, Adamawa State and it was covered a period of 3 years from 2021 to 2023. This research was only concentrate to interest rates, loan size, payment installment and collateral.


1.8 Limitation of the Study

In the course of carrying out this study, the researcher experienced some constraints, which included time constraints, financial constraints, language barriers, and the attitude of the respondents. However, the researcher were able to manage these just to ensure the success of this study.


1.9 Definition of Terms

Data Envelopment Analysis:

A non-parametric efficiency measuring methodology.

Financial Liberalization:

This is the lessening or abolishment of government restrictions and regulations in the financial markets.

Financial Reforms:

The process of enhancing efficiency and effectiveness of the financial organization by giving confidence to clients, ensuring stability and improving allocative efficiency.

Non-Performing Loans:

These are credit advances that are un-serviced in more than 90 days.

Technical Efficiency:

The potential of a firm to optimize the yield for a certain amount of input.


1.10 Organization of the Study

This research work is organized in five chapters, for easy understanding, as follows.

  • Chapter one is concern with the introduction, which consist of the (overview, of the study), historical background, statement of problem, objectives of the study, research hypotheses, significance of the study, scope and limitation of the study, definition of terms and historical background of the study.
  • Chapter two highlights the theoretical framework on which the study is based, thus the review of related literature.
  • Chapter three deals on the research design and methodology adopted in the study.
  • Chapter four concentrate on the data collection and analysis and presentation of finding.
  • Chapter five gives summary, conclusion, and recommendations made of the study.

Chapter Five


Summary of Findings, Conclusions and Recommendations

5.1 Summary of the Study

In this study, our focus was on the effect of non-performing loans on the efficiency of microfinance banks Using Gudusisa Microfinance Bank Limited, Adamawa State As Case Study. The study is was specifically focused, such as To examine the effects of interest rates on financial performance of Gudusisa microfinance bank limited, to examine the effects of loans size on financial performance of Gudusisa microfinance bank limited, to determine the effects of repayment installments on financial performance of Gudusisa microfinance bank limited and to determine the relationship between non- Performing loans and financial performance Gudusisa microfinance bank limited.


5.2 Conclusion

From the study’s findings, the researcher conclude that factors such as leverage, nonperforming loans, and size determines the performance of Gudusisa microfinance bank limited. Nonperforming loans has negative effect on Gudusisa microfinance bank limited performance as loans are assets that need to generate returns and when loans given out are not recovered together with interest then it implies that more resources will need to be committed towards provision for nonperforming loans and additional costs will be used in financing recovery efforts.


5.3 Recommendations

From the findings and conclusions, the study recommends that Gudusisa microfinance bank limited should credit for equity financing instead of debt financing if it wants to improve on its leverage.

  1. The study recommends regular and strategic monitoring of loan portfolios by credit managers/officers in the microfinance bank in order to reduce their credit risk.
  2. Furthermore, microfinance banks should establish a credit limit at the level of individual borrowers, counterparties or group of counterparties, subject to their own unique credit policies and level of risk tolerance. This will serve as a guiding rule in all their loan approvals.
  3. The banks should invest heavily on loan recovery and customer credit score monitoring. Relying on private credit collection agencies, that look into resolving disputes and refer accounts to the credit reference bureau. This will avoid piling of non-performing loans on their financial statements and other long term legal process such as court cases.
  4. Lastly, policy makers in the banking sector should ensure sound macroeconomic policies, such as inflation and interest rates, which will enhance growth in the microfinance sub-sector

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