Memoire Online - The assessment of the impact of risk management in reducimg the risks of financial institutions in Cameroon

This is to certify that this Project entitled « Assessing the Impact of Risk Management in Reducing the Risks of Financial Institutions in Cameroon » presented by Cédric DALLE Paul (UB 021149) meets the project requirements and regulations governing the Award of a Bachelor of Science (B.Sc.) degree in Banking and Finance at the University of Buea and is Therefore approved for its contributions to scientific knowledge and literacy presentation.

I cannot start this section without giving a SPECAL THANK to the ALMIGHTY GOD for his blessing on me and my family.

Special acknowledgements go to my supervisor Mr MBU S. Agbor for all his efforts and devotion to make sure that the Researches will be carried out effectively.

My uncle DIHEPE Alain is not left out; he helped me in giving me advice on how to carry out my researches.

Exclusive acknowledgement to my friends of the group FUTUREX, Guyzo, Stef, le Fotue, le Kalbe, Baisetcha, Didier and Lucile, lets build together.

Special thank to Mathe and Jo for their moral support and assistance. Thanks ladies.

I also would like to thank my programme coordinator for the convivial atmosphere that exists during his lectures, thanks Mr NDENKA.

I would like to thank all the persons that contributed a lot not only in my life but also in the realisation of this Project, especially the NJOH family.

I will this tome express my thanks to all my friends: NJALEU Alain, TCHENA NDJENG Theodore, ESSAM J.P.B, Emilie NKOUEMOU, Charlise MINKEU, Carole KAMGUIA, Hermine FOKEM, SANAMA, Caroline, Charlotte, EDU Nora, Claude, EBOLE Annick, Charline, METCHETCH, Claude-Maurelle, WEMBE Cyrille, Eric and Arlette, Laura, Alice, Amina, Guy-franck and Romy.

Any thanks go to my Cousin EPOTO SONGA Ange Annick, for her assistance in all aspect of my life in UB.

I am specially indebted to my great friend Winnie NZOUATCHA for her spiritual support, spiritual encouragement and for being there when she was needed

Finally I would like to thanks all those who participated directly or indirectly to the realisation of this project especially the Staff of the Library of the University of Buea.

I hereby declare that this project is written by me and it represents a record of my own research efforts. It has not been presented before in any application for a degree or any reputable presentation. All borrowed ideas have been duly acknowledged by means of references and quotation marks.

ABSTRACT

This work «Assessing the Impact of Risk Management in Reducing the Risks of Financial Institutions in Cameroon» seeks to study and evaluate the relationship between Risk Reduction strategy and the profitability of Financial Institutions in Cameroon for the period 1997-2005.

Given the problem statement, does risk management have an impact on risky shift through reduction of bad loans in the Cameroonian financial system? The study was aimed at finding out whether Risk Management relates negatively with profitability of financial institutions in Cameroon. The null hypothesis were raised from the problem statement; Risk Management does not affect effectively returns in financial institutions

Most of the data was collected through secondary sources found in publications, books and internet. These data were analysed using the trends analysis, table analysis, ratio analysis and standard deviation analysis to verify the relationship between Risks Management and Return of Financial institutions in Cameroon.

Risks Managers should try to keep adequate liquidity level in order to meet some uncertain issues related to the withdrawals of funds or bankruptcy.

CERTIFICATION..........................................................................i

DEDICATION ............................................................................ii

ACKNOWLEDGEMENTS ............................................................iii

DECLARATION .........................................................................iv

ABSTRACT ................................................................................v

TABLE OF CONTENTS ...............................................................vi

2.1 Definitions of Financial Institution .................................................5

2.2 types of Financial Institutions and their associated functions ..................7

2.3 Financial Institutions in Cameroon ...............................................12

2.4 The Concept of Risk ................................................................17

2.4.1 The Nature of Risk ...............................................................17

2.4.2 Type of Risk .......................................................................18

2.4.3 Evaluating Risks ..................................................................19

2.4.4 Forms of Risks encountered in the Financial Milieu .........................19

2.4.4.1 Liquidity Risk ...................................................................20

2.4.4.2 Credit Risks .....................................................................20

2.4.4.3 Inflation or Price risks .........................................................20

2.5 Understanding Risk Management .................................................20

2.5.1 Scope and Objectives ............................................................21

2.5.2 The Role of Risk Management ..................................................21

2.6 Theoretical Literature Review .....................................................22

2.6.1 The Use of Financial Instruments in Risk Reduction ........................22

2.6.2 The Management of Price Risk in Finance .....................................23

2.6.3 Theories of Credit Risk ..........................................................24

2.6.4 Risky Shift Theories ..............................................................25

2.7 Empirical Evidence .................................................................26

3.1 Introduction ..........................................................................28

3.2 Background Information to the Study Area .....................................28

3.3 Data Collection and Data Sources ................................................31

3.4 Sampling Design ....................................................................32

3.5 Method of Analysis .................................................................32

3.6 Variables of Interest ................................................................33

4.0 Introduction ..........................................................................35

4.1 Qualitative Analysis ................................................................35

4.1.1 Assessing the Impact of Risk Management on Credit Risk .................35

4.2 Quantitative Analysis ...............................................................40

4.2.1 Investigating the impact of risk Management on the Profitability of Financial Institutions ....................................................................41

4.2.2 Assessing the Impact of Risk Management on the Overall Credit Risk Policy ......................................................................................43

4.2.3 Relationship Between Credit Risks and Profits: the case of Afriland First Bank .......................................................................................44

4.24 Investigating the Impact of Risk Management on the Liquidity Position of Financial Institutions ....................................................................45

5.1 Summary of Findings ...............................................................48

5.2 Recommendations ..................................................................49

5.3 Conclusion ...........................................................................50

BIBLIOGRAPHY ....................................................................51-52

CHAPTER 1

INTRODUCTION

1.1BACKGROUND INFORMATION

The path of financial activity, which concerns banking, insurance, savings and loans associations, etc, had always been paved with numerous contingencies. Contingencies are referred to here as risks that symbolises a situation that cannot be controlled or perfectly foreseen (S.R. DIACON, 1984). These risks cannot be predicted accurately and this therefore gives rise to the involvement of a careful management.

The Cameroonian financial framework, as any other financial system in the world, deals highly with risks in its every day management. As a reason for this, we can mention the fact that there are factors that are not under the control of managers such as globalisation, world changes or market variables like price changes or stock exchange trends.

Historically the banking and finance management in Cameroon has always been subject to some major risks, the careful management of which has always led to survival in the financial sector. Many Cameroonian financial houses handle these risks on a daily basis in order to grow and encounter rapid changes. Therefore, risks must be understood and carefully managed for a proper decision making in the Cameroonian financial system.

1.2 PROBLEM STATEMENT

In 2005, 7 of 11 banks were found to be in a good or solid standing (CEMAC, surveillance report, 2005).Furthermore, the liquid ratio of the whole financial system was 2 in 2004 and 0.58 in 2005. This information highlights the problem of liquidity risks encountered by banks in Cameroon.

Furthermore the amount of bad/non-performing loans was 13.1 billions in 2004 and an increase in 2005 (COBAC and staff calculations) and an increase in the amount from 2004 to 2005 by 0.8 billions.

An analysis of these statistics shows an increase in the banking and finance activity in Cameroon. For the past three years as a result of a fall in the amount of bad debt from 2004 to 2005. This may imply that the minimisation of credit risks has increased the amount in savings accounts by 0.8 billions. Here we have mentioned the level of bad loan in relation to the risk analysis. This therefore helps us in asking ourselves the following fundamental questions four our study.

- Is there any relationship between the risk management and the growth of financial institutions in Cameroon?

- Does risk management have an impact on risky shift through reduction of bad loans in the Cameroonian financial system?

1.3 OBJECTIVES OF THE STUDY

The main objective of this study is to investigate the impact of risk management in reducing the risks of financial institutions in Cameroon. To better cope with main objective, we may need to focus on the following specific objectives.

- Investigating the impact of risk management on financial institutions profitability.

- Assessing the impact of risk management on the overall credit policy of financial institutions.

- Studying the effect of risk management on the liquidity level of financial institutions.

- Making necessary recommendations on how to minimise risks in the financial environment.

1.4 HYPOTHESIS OF THE STUDY

Ho: there is no relationship strategy between risks management or risk reduction strategy and the growth of financial constitutions in Cameroon.

H1: there is a relationship between risk management in risk reduction strategy and the growth of financial institutions in Cameroon.

1.5 SIGNIFICANCE OF THE STUDY

The study on the impact of risk management in reducing the risk of financial institutions in Cameroon is an important study, attractive and actual. This is because it helps us in finding how and what is the impact of risk management in the financial industry of our country

More so this study will help in answering actual question about the way in which risks are inherent in every aspect of the life especially in the financial area. Furthermore, a study of this importance will help us to find how financial institutions in Cameroon prevent or handle calamity in order for us to give advices on how these materials can better be improved.

The topic under study may not be easy to conduct and therefore may not be properly achieved. This is merely because of the fact the there are a number of obstacles encountered in gathering data, ranging from limitations of time and finance, to deliberate boarding of information poor documentation bureaucracy doubtfulness of available data etc.

The relationship between risk management and the growth of financial institutions in Cameroon will be investigated from the period 2000 to 2005.

CHAPTER 2

LITERATURE REVIEW

In this section of our work; we are concerned with coming along with all necessary theories that suggest the possibility of the existence of a relationship between risk management and the risk reduction strategy of financial institutions in Cameroon. Here we are making a survey of borrowed academic materials, which might help us in better understanding the core issue of our research project.

2.1 DEFINITION OF FINANCIAL INSTITUTION

According to Millard F. Long (1919), financial institutions make use of a widely accepted medium of exchange which reduces the cost of transaction, facilitate trade and encourage specialisation as well as production efficiency. In addition, Ndenka Aaron (2005) add by saying that financial institutions or financial intermediaries are simply economic units whose main function is to handle the financial assets of the households and firms in our society.

In other words, they are business entities that specialises in managing deposits from savers or depositors and give these deposits out as loans to borrowers. Their main tool of raising financial profits is through credit, which is the process by which loanable funds are allocated to borrowers from lenders. The use of credit by financial institutions that enters in a legal course of action, of course, need or necessitate the establishment of legal instruments called credit instruments. The most commonly used credit instruments are of two types: promises to pay and order to pay. They include letter of credit, bills of exchange, cheques, bonds, stocks and securities.

Furthermore, credit instrument confer to its owner the three following characteristics that are a yield, liquidity and safety (Aaron Ndenka, 2005).

The following diagram represents a summary of the functioning of financial institutions in their lending process.

2.2 TYPE OF FINANCIAL INSTITUTION AND THEIR ASSOCIATED FUNCTIONS

The term financial institutions can be applied to a variety of institution some of which are:

2.2.1 THE CENTRAL BANK

The central bank is the most important institutions in a financial system. It occupies a unique position in the monetary and banking system of the country in which it operates. The central bank is always inspired by the principle of national welfare and in order to achieve this it must be done not under the influence of government, the reason being that the economy problem of the country cannot be satisfactorily solved without the fullest co-operations between the central bank and the government (Foundations of banking, 2005)

The central bank should under no circumstances compete with other banks that is receiving deposits from the public or extending loans to needy borrowers. If it competes with other banks, this will conflict with its important function of being the bankers' bank, controller of credit and lender of last resort (comparative banking systems, 2005).

Furthermore, the special powers of the central bank are designed to help it to control the volume and availability of currency and demand deposit in the best interest of the economic life of the nation. The group of special powers comprises the power to issue legal tender currencies, to control the volume of reserves available at the commercial banks and to cat as the principal financial adviser to the national government (Ndenka Aaron, 2005).

Kaufman George, Larry Mote and Harvey Rosenblum stated during a conference in 1982 in Chicago that the means as tools used by central banks in carrying out their duties in order to control the money in circulation can include the granting or refusing to grant loans to the commercial banks. This will affect their reserve requirements and therefore the credit. Secondly, by presenting a reserve ratio, a central bank can influence the amounts of reserves available to commercial banks. Thirdly, by buying and setting securities in an open market operation (OMO). The central bank can also affect the size of reserves of commercial banks. Here heavy reliance is put on loans to commercial banks because of the narrowness of financial markets.

2.2.2 COMMERCIAL BANKS

These are credit establishments which has as a focus enhancing financial services to the public, they have as goal the collection of deposits in order to give them out as loans in order to finance the economic activity (Microsoft Encarta, 2006)

- They promote market efficiency (D. Carter, 2004) commercial banks are easily the largest and the most diversified of the financial intermediaries in terms of assets and liabilities. About the only major asset that they do not hold is corporate stock, which law prohibits them for acquiring (Foundations of Banking,2005)

2.2.3 INVESTMENT BANKS AND DEVELOPMENT BANKS

These are financial institutions which are concerned with giving out loans which has to do with the financing of infrastructure in a given area (Microsoft Encarta, 2006)

Investment banks are often compared with development banks. Both institutions are specialised in investment. But their difference in the range of their activities but it is important to note that investment banks are concerned primarily where there are infrastructural problem while development banks refers to the financing of industrial project in geographical areas where there are development problems (Barth J.L, 1999)

2.2.4 RECONSTRUCTION BANKS

Reconstruction banks are financial institutions which enhance funds for reconstruction and development to the country which they are engaged (Rendall, 1978)). In today's world there are many calamities that can occur and hamper the infrastructures of a country such as war, Tsumani, volcanic eruption... it is the role of a reconstruction bank to allow loans to countries in order for the lathers to reconstruct their country and develop necessary industries achieve economic growth. Examples of reconstruction banks include IBRD (international banks for reconstruction and development).

2.2.5 SAVINGS AND LOANS ASSOCIATIONS

For Bonacossi di Patti (2001), savings and loan or building and loan associations are financial intermediaries, which accept savings from the public and invest those savings mainly is mortgages loans. Today, savings and loans associations (S and Ls) are very similar to bank. They have continuous life as some loans are paid off, new loans are made. Traditional distinction between banks and S and Ls are steadily blurring. Banks are today more than ever before turning to real estate loans. The S and Ls are now acquiring more liquidity than they formerly had and their system resembles the banking system in a number of aspects. As explained below, they have their own central banks from which they may borrow. Most S and Ls are growing in popularity and this may be due to their low interest rate on borrowed funds.

2.2.6 MUTUAL SAVINGS BANKS

Honotran P.(1997) address that mutual savings banks issue claims against themselves in the form of relatively small savings and time deposits, and the recent years in form of negotiable orders of withdrawal (NOW) accounts, which are legally payable on short notice. Their assets are predominantly long term, with real estate mortgages comprising about two thirds of their assets. They also hold modest amount of corporate bonds and united values of Cameroon bonds of government.

2.2.7 LIFE INSURANCE COMPANIES

They issue claims in the form of life insurance and annuity policies and acquire long-term direct securities such as real estate mortgages and corporate bonds and notes. Although nearly three fourths of their assets presently are held in these instruments, the composition of their portfolio has changed markedly (Foundations of banking, 2005)

2.2.8 CREDIT UNION

Credit union promotes thrift among their members and makes loans to them mainly for the purchase of consumers' goods such as automobiles. Credit union issue savings deposit claims against themselves (Foundations of banking, 2005)

2.2.9 FACTORS

Companies that finance the accounts receivable (not instalment contract) of the borrowers are important sources of credit for some businesses, and the factor manage their receivable so that they could recover them (Foundations of banking, 2005).

2.2.10 SECURITY EXCHANGES

Stock exchange does not distribute new issue but they facilitate trading in issues already outstanding (Foundations of banking, 2005). These security exchange may be primarily local concerns, dealing mostly in the stocks of company in the vicinity that rare primarily owned by local residents. However, security exchange companies are the case with the NYSE (New York Stock Exchange).

2.2.11 TRUST INSTITUTIONS

They include the trust companies and the trust departments operated by many banks. The principal function of any trustee is to hold properly and administer it for the benefit of others (Foundations of banking).

2.3. FINANCIAL INSTITUTIONS IN CAMEROON

In this section of our study, we are going to come about with concrete examples of the above-mentioned type of financial institutions in Cameroon and how they function, the basis on which the business is carried out and the legal framework of finance regulations in Cameroon.

2.3.1 CENTRAL BANKING

Cameroon's banking system is closely related to the development of banking in the central African sub-region that is set out to perform his function of a central bank and controller of the monetary and banking policies of the sub-region.

The central bank of central African states (BEAC) is the bank that performs the role of central bank in Cameroon ( www.beac.int). The structure of its management and administration includes a committee of six member's countries (i.e. Cameroon, Equatorial Guinea, Gabon, Central Africa Republic, Congo and Chad). The BEAC also comprise a governor appointed at the conference of the heads of states for CEMAC. The governor and this staff are responsible of the monetary policies of the monetary union of the central Africa sub-region. Monetary policy in Cameroon is conducted by BEAC and its aim is to maintain the external and internal value of currency (comparing banking systems, 2005). The banking commission of central African states (COBAC) is an organ of the code with regard to accountability and public assurances of integrity COBAC assures bank supervision and the coverage of non-blank deposits taking financial institutions by the commercial banks is their accounts and establish necessary reserves requirements.

Commercial banking in Cameroon is controlled by the BEAC. The BEAC is also the institute of emission of the FCFA and controls the stability of the currency (Mark Debels, 2003)

2.3.2 COMMERCIAL BANKING IN CAMEROON

The economic crisis of the 80s has highly affects the banking sector and this has led to the strengthening plan of 1989-19925. The liquidation of the banks and the creation of the SRC (Societe de Recouvrement des Creances du Cameroon), the re-foundation of BICIC (Banque Internationale du Commerce ET de l'Industrie du Cameroun) and of the SGBC (Societe Generale des banques au Cameroun). After the devaluation of the franc CFA in 1994, new reforms were undertaken. After a wave of liquidation (First investment banks, Meridien BIAO bank Cameroon, Credit agricole du Cameroun, closings or failure (International Bank Africa Cameroon, BICIC now BICEC) and recapitalisation (SGBC, Standard Chartered Bank), new banks have been created (Mission economique de Yaounde, 2003).

- BICEC; (Banque Internationale du Cameroun pour l'Epargne ET le Credit) has been privatised in 2000 by the French group Natexis- Banques populaires.

- CBC, commercial bank of Cameroon, whose capital is owned at 90 % by Cameroonians and at 10 % by the German Cooperation

- Credit Lyonnais Cameroon, 65 % Credit Lyonnais France and 35 % of Cameroonians state. But this bank has been liquidated in March 2007. Now it is CA-SCB which is Credit Agricole Societe Camerounaise de Banque (Cameroon Tribune, March 2007).

- ECOBANK, holding Ecobank Transnational Togo Citibank 100 % Citibank USA standard bank, 66% standard chartered 34 % state of Cameroon.

- SGBC (Societe Generale de banques au Cameroun) 74 % French group societe generale and associates, 26 % by Cameroon state.

- Union bank of Cameroon, which comes from a group of cooperative credit union (CAMCUL) they are represented in other countries of the sub-region such as Gabon, Congo Brazzaville, Chad and Equatorial Guinea.

According to investigation carried out by Economia in the classification of the firsts' African banks, it appears that among the 25 first banks, 6 are Cameroonians (Economia, 2002).

2.3.3 DEVELOPMENT BANKS

In Cameroon, the African development bank (ADB) is in charge of development and reconstruction plans. But since the Cameroonian member state of the World Bank, the international bank for reconstruction and development (IBRD) can also play that role (Microsoft Encarta, 2006)

2.3.4 SAVINGS AND LOANS ASSOCIATIONS AND CREDIT UNIONS

Savings and loans associations and credit union are know in Cameroon as microfinance institutions, in 2001 the Cameroon has registered 652 microfinance institutions, but only 601 were actually existing in 2003( COBAC surveillance, 2003). Furthermore the microfinance sector was actually touching more than 300 000 clients i.e. 7% of the potential market. The mobilised savings were 35.9billions of FCFA, and 25.4 billions CFA of credit were granted by those institutions.

- CAPCOL. They were having on their account more than 62% of the collected savings in Cameroon by the microfinance institutions and 64% of client (BIM n°- 09 Mai 2006).

2.3.5 STOCK EXCHANGE COMPANIES

In the Cameroonian financial sector, it is the Douala stock exchange which plays the role of stock exchange in Cameroon since 2002(COBAC surveillance, 2003). It focuses transferring shares of companies from buyers and sellers. And these transactions occur in a legal framework.

2.3.6 INSURANCE COMPANIES

Insurance companies in Cameroon account for the most important activity in the CEMAC zone. They specialise in issuing insurance policies to the public and government:

Are the most important ones since they capitalise 63% of the policy issue in Cameroon (Economia, 24). The insurance activity is regulated by the CIMA code which is the constitution of insurance activity in central Africa.

2.4 THE CONCEPT OF RISK

2.4.1 THE NATURE OF RISKS

For S.R.Diacon (1988). Risks are present whenever human beings are unable to control or perfectly foresee the future. For example, risk of theft, firing, natural disaster. Similarly, there are risks in running a business, because no business man can guarantee that he will make profits rather than losses. But although we cannot measure the risks we can to some extend measure it the term uncertainty is used where future alternatives and hence are not known, such as in speculative ventures like the outcome of space research or of possible new inventions.

2.4.2 TYPES OF RISKS

Fundamental risks affects either society in general or of people and cannot be controlled (in partially by any one person where as particular risks refers to those future out come that we can control partially (though not predictably) (S.R.Diacon, 1988).

Speculation risks are present if either beneficial or adverse outcomes could stem from a specific event whereas if possible harm is the only alternative to the present status quo, the situation is known as pure risk (S.R. Diacon, 1988).

In practise, not all risks can be insured. The insurability of risks depends on number of factors which are:

2.4.3. EVALUATING RISKS

Measuring risks is difficult, and even experts are not agreed on exactly how it should be done. Several tools of analysis exist but the most used ones are:

Probability in the chance of occurrence of a particular event over a total range on number of event its mathematical formula is:

Pr = B/Ù; where B is the outcome of one event and Ù is the total possible outcomes.

It is symbolised by and it is found by adding the squared of the deviation by the individual values from the mean of the distribution.

Where X is the actual variable, u is the mean of all the variables and N is the total of all the variables.

2.4.4. FORMS OF RISKS ENOUNTERED IN THE FINANCIAL MILIEU

Since financial institutions deals in the money market, they have to be liquid at any point in time in order to cover their debt in the short term. The following are risks that the financial institution can face.

Also called bankruptcy risks, it is the risks that a firm will be unable to repay depositors therefore leading to insolvency or default ( www.specialinvestors.com).

This is the most common type of risk faced by financial institutions in the money market. It is the risk that an issuer of debt securities or a borrower may default on his obligations or that the payment of the interest or the principal or both may not be made on a negotiable instrument ( www.specialinvestors.com).

This is the risk that arises when the values of a portfolio (security) will decline in the future or a type of mortgage pipeline risk created in the product segment when loans terms are set for the borrower in advance of terms being set for secondary market sale. If general level of rate rises during the product cycle, lender may have to sell his original loan at discount and this could lead to a loss ( www.specialinvestors.com) specialised financial dictionary online.

These three forms of risk will be the central importance in our study, although not all forms have been highlighted in this study.

2.5 UNDERSTANDING RISK MANAGEMENT

2.5.1 SCOPE AND OBJECTIVES

Risk management introduces the modern theory of planning or decision making under uncertainty that is contingency planning (S.Schwartz, 2001).managers in the past have always use financial ratios is quantifying risks. Decision making involve making decision now about what will happen in the future. In this light, decisions in the future may turnout to have a negative effect on actual result or vice-versa or actual results can prone to be very different from expected results. Risk management is therefore concerned with the identification of potential problems and eliminating or reducing the damage which they may result in if the problem materialises.

The objectives of risk management is an efficient planning for risks and this therefore formally addresses the identification, which may alter the implementation of company's policy (ies) yet towards achievement of company objectives. Risk management is a proactive approach rather than a reactive approach.

2.5.2 THE ROLE OF RISK MANAGEMENT

Risks management is a staff function; in a management environment it helps an organisation in the following ways:

a- It identifies, captures, processes and communicates risks management information to management concerning the operation of the organisation.

b- It helps to analyse the nature of the cost associated with the management of risks.

c- It allows the management team the opportunity to achieve its objectives as planned. In a company environment where risks management is absent, management plans is disrupted by the occurrence of some unseen events.

d- It disposes management of all situation of risks which may prevent a company of achieving its objectives

e- It is therefore presented with careful planning, arranging and controlling of operations and resources in order to minimise the impact of risks.

2.6 THEORETICAL LITTERATURE REVIEW

The theoretical aspect of our L.R. stresses the relevant theories that have been elaborated concerning the risk management in financial institutions and its relation with risk reduction. This will be done by highlighting the research of various authors in order to come out with an objective analyses of the topic understudied.

2.6.1 THE USE OF FINANCIAL INSTRUMENTS IN RISK REDUCTION

Stijn Claessens and Ronald C. Duncan (1993) highlighted the starting point to manage commodity risks, including any the uses financial instruments is by setting clear objectives which do not interfere with efficient allocation of resources within the country. Financial risks management instruments always above is one of the condition for successful price stabilisation.

Hugher-Harlettand and Ramanujan (1990) pointed out that instrument for managing commodity risks hedge only against price risks therefore leaving quantity risks and that buffer stock hedge against revenue risks. Furthermore, CLaessens and Duncan (1993) added that the financial commodity risks in the absence of a directly available matching counter swap, manage the price risks on the swap by using short-dated futures and option markets. By dynamic hedging, through the use of short dated instruments, the intermediary can duplicate a long term hedge risk arising from changes in the relation between spot and future prices. That is: Basis risk = 1 - correlation coefficient (spot and future price coefficient)

2.6.2 THE MANAGEMENT OF PRICE RISKS IN FINANCE

Christopher L. Gilbert (1993) stated that the first 3 measures aiming at insulating the economy against price shocks are either by stabilizing international commodity prices( first measure) or by transferring risks to third parties. The transfer of risks could be accomplished either by hedging (second measure) or by transferring funds i.e. borrowing or lending (third measure). The last measure aims at reducing the impact of commodity price changes on a certain domestic sector by forms or self insurance or domestic diversification.

One approach that has been stressed up is the use of financial derivatives instruments (forward, future option) to reduce the revenue variability. It is suggested the producers could directly via dealer use the market to offset their exposure to price risks.

Toshiya Masouka (1998) added that for financial institutions and corporations, assets liability management includes these activities that attempt to control exposure to financial and other price risks. Institutions and corporations examine the risk exposure of their assets and liabilities to future price movements to develop their risk exposure profile because risk management operations reduces the possibility of unanticipated deviations from initial projection on economic variables.

2.6.3 THEORIES OF CREDIT RISK

For Millard F. Long (1989) the origin of financial distress can be traced as far back the 1950s and 1960s when developing countries decided to take over foreign investors' financial institutions then, mostly commercial banks provided short-term command trade credits. Yet they were faced with directed credit programs by the governments these latter were said to borrow too much from banks risk concentration. Thus they were forced to become insolvent or actually fell. E.g.: credit agricol bank in Cameroon and other banks suffer large losses and actually failed. In Cameroon we are faced with the problem of insolvency and thee most recent case was the liquidation of BICIC which has been changed into BICEC. The causes of this failure might be related to risk concentration or connected lending.

2.6.4. RISKY-SHIFT THEORIES

Michael and Frenkel Ulrich Heemmet (2000) argue that a trade off between risks and returns has always exists so much so that more risks yield more returns. If a bank takes more risks by investing in a credit facility, the bank might have returns to the extend of the degree of risk they have taken. But this will only be done when there is a good risk management strategy to alleviate the effect of pure risks. For that reason banks must avoid the following situation in order to earn higher returns:

This means making loans representing a high proportion of banks capital to one single borrower or group of borrowers or to given sector of the industry (Foundations of banking, 2005). This practise may by the result of pour lending policies or of the free will of the banker (who believes in the external health of a given borrowers).

This means a situation where the bank lends to companies owned (totally or partially) by the banker or by the bank (Foundations of banking, 2005). Lending to connected borrowers to the banker beyond certain limits is fraudulent. In most cases, that kind of lending contains a high risk because of the banker's tendency to use the bank as an instrument to finance his businesses irrespective of their ability to repay and concentrate large proportion of the bank lending on them.

This means lending sum on money that are not in proportion of the bank's capital (as a cushion for potential losses), or diversifying activities to geographical or business areas. The bank is not well equipped to manage (Ndenka Aaron, 2005).

An effective management of banks and financial institutions requires a careful handling of possible risky outcomes. In order to handle this, the management should summarize policies and strategies in a guideline for business management. The policies which a manager can refer are as follows:

- The use of capital rationing and ratio analysis. (Managing Banks, 2005 by Aaron Ndenka)

2.7. EMPERICAL EVIDENCE

In empirical literature review, we examine some empirical analysis made in risk and liquidity management and then consider the performance of banking under the growing influence of globalisation.

In a research carried pout on the guiding principles of risk management for U.S. commercial banks (2002), by the sub-committee on risk management principles of a financial service roundtable aimed at testing how active management of credit risk (as proxies by loans sales and purchases) affects financial institutions growth (capital structure, sending profits ad risks) detailed loan level data for a broad cross section of U.S. banks was not from aggregate data and aggregate actions the data obtained includes the sale and purchases of all loans originated by banks from June 1987-1995 including residential real state and consumer loans.

The dependant variables were capital and liquidity variables (capital/assets ratios, liquidity ratio).

The lending variables were commercial and individual real state lending to asset ration.

The risk variables were time series standard deviation of each banks return on equity (ROE), loan loss provision to total assets.

The profit variables were time series mean of each bank's ROE. The researchers came to the conclusion that large internal capital markets do allow banks to operate with a smaller liquidity level. Thus the risk management plays a role in the growth of financial institutions according to that committee.

CHAPTER 3:

METHODOLOGY OF THE STUDY

3.1 INTRODUCTION

Having reviewed much of this work with regards to the study in chapter 2, this chapter on methodology will analyse the methods and procedures that will be employed in the course of the study. In this section, the methods to be used in analysing the collected data are of great importance. This work which examines the impact of risk management in reducing the risks of financial institutions in Cameroon will involve both qualitative and quantitative data, as the collected data will be used to testify the hypothesis and the objectives underlying the study while tables are mostly used with qualitative data, it will also be accompanied with charts like bar charts as well as percentages and averages. It will also be accompanied by quantitative statistical tools like standard deviation. The use of ratios will be done on passed financial statements of randomly sampled selected financial institutions to analyse the impact of risk on investment decision making in financial institutions.

3.2 BACKGROUND INFORMATION TO THE STUDY AREA

3.2.1 SOCIAL BACKGROUND

Cameroon is a central African country open upon the world through its sea and the Atlantic Ocean. It is a bilingual country where English and French are coexisting in harmony as official languages. The political capital is YAOUNDE and the Cameroon is a member of the commonwealth. In 2005, the Cameroonian population was estimated to 16.4 millions inhabitants. The annual growth rate of the population reaches 1.93%. In 2005 the fecundity indices was high (43.5 children/woman) whereas the infant death rate was estimated to 68%o and the life expectancy was 48 years. About 51% of Cameroonians live in town in 2003. The major towns are YAOUNDE (1372800 inhabits) Douala (1448300 inhabits) in 1999. (Microsoft Encarta 2006.)

3.2.2 EDUCATIONAL BACKGROUND

More than 60% of the population has less than 25 years. The school is compulsory from 6 to 11 years. In 2002, 33 per cent of children were registered in secondary education and only 5% had access to the higher education. The University of YAOUNDE built in 1962, coexists with four other universities such as BUEA, DOUALA, NGAOUNDERE and DSCHANG. Religious schools are also of great influence in the country since they are subsidised partly by the government. The alphabetisation rate was 81.1% in 2005 for the entire population.

3.2.3 POLITICAL BACKGROUND

Since 1990 and the instalment of multipartism, Cameroon has encountered a hard democratisation of the regime. The president AHMADOU AHIDJO in 1966, the CPDM (Cameroon popular democratic movement) whose actual leader is Paul BIYA is the president of the country since 1982. The main opposition parties are SDF (Social Democratic Front), Anglophone, and the CDU (Cameroon Democratic Union). The political system is regulated by the constitution of 1972, revised in 1996. (Microsoft Encarta 2006)

3.2.4 CULTURAL AND RELIGIOUS BACKGROUND

About one quart of the population is animist. The Muslims (22%) are living principally in the north whereas the Christians (33% Catholics, 17% protestants) are living in the south. The francophone (78%) are greater in number than Anglophones (22%). Sudanese languages are talked in the north whereas Bantus languages are talked in the south.

3.2.5 ECONOMIC BACKGROUND

Cameroon has vast resources, may it be agricultural as well as mining and petroleum. It has witness an important growth between 1977 and 1985 (more than 10%/year) due to the valorisation of its oil resources and its agricultural exportations. After an economic crisis period and durable due to the degradation on general accord on trade (downswing of 44% between 86-89) and due to the competition with its closest neighbour NIGERIA. Parallely to an increase of public expenditures the country has engaged since1988 a structural adjustment program under the supervision of the International Monetary Fund (IMF). The devaluation of the FCFA in 1994 has enabled an increase in exportations and stabilization of the economy. Cameroon has benefits from the HIPC initiative in favour of highly indebted poor countries which has led to an alleviation of debt in favour of the fight against poverty (in 2001, 40.2% of the population was under the poverty level). Cameroon has reconciled with economic growth from the period 1990 till now. The growth rate of the GDP was 2.70%. In 2003 GDP was estimated at 12.49 billions of dollars, and the per capita GDP was 780 dollars.

3.3 DATA COLLECTION AND DATA SOURCES

3.3.1 SECONDARY SOURCES

This will be the source of the bulk of our data. The data will be collected from the web search. The data used for our investigation will come mostly from BEAC publications, COBAC and Staff calculations and the use of local and specialised press. We will also make use of financial statements from AFRILAND FIRST BANK and SOWEFCU in order to run our analysis about the risk evaluation.

3.4 SAMPLING DESIGN

Given a research of this nature we are intended to work with samples of value since we cannot cover the entire financial industry in Cameroon. To do so we are going to make use of purposive random sampling since we are going to work with organisations which have a branches in almost every province of the country. The sampling was made according to the level of activity of the commercial banks such as AFRILAND FIRST BANK. We also noticed the importance of micro-financial credit unions that is why our sampling technique allowed us to work with SOWEFCU-KUMBA. Having sampled our target of interest, we are now going to talk about the method of analysis.

3.4 METHOD OF ANALYSIS

In analysing our information we will make use of the following tools of analysis:

3.4.1 RATIOS ANALYSIS

Ratio analysis is an important technique in assessing the financial condition of a company and the relative attraction of its securities. They are useful because they can briefly summarize relationships between items in the financial statement which are significant.

We have for instance what is meant as profitability ratios within which we can fund the liquidity ratio which is given as follows:

It attempts to measure the ability of a company to meet its short-term commitments. Ratios are generally expressed in percentages and they express the degree of variation or relationship between financial indicators of the company.

3.4.2 STANDARD DEVIATION (ó)

Standard deviation is a statistical tool of analysis usually computed to determine the risk figures. It is merely used in measuring the time series deviations between two variables. It quantifies the risks in mathematical terms and its expression is given as follows:

3.5 VARIABLES OF INTEREST

3.5.1 INDEPENDENT VARIABLES:

3.5.2 DEPENDANT VARIABLES

CHAPTER FOUR

DATA PRESENTATION AND ANALYSIS

4.0 INTRODUCTION

The main focus of this chapter is the presentation and analysis of the data collected from the secondary sources. This chapter embodies presenting and analysing the data collected qualitatively and quantitatively following the objectives of the research stated in Chapter one. Our analysis will be organised in two main parts: Analysis of the data collected and Policies suggestion to financial body to reduce their risks and increase their profitability level.

This refers to the use of tables and graphs to show how variables have evolved over the years. This will be done for the period 2002-2005.

4.1.1 ASSESSING THE IMPACT OF RISK MANAGEMENT ON CREDIT RISKS

The qualitative analysis made in this part of the study will be a study which analyses the evolution of non performing loans as an indicator to credit risks in the overall Cameroon Banking system.

The following table represents the evolution of non performing loans and provision for bad loans as an indictor to credit risks.

Years	2002	2003	2004	2005
Non performing loans	15.7	13.9	13.1	12.6
Provisions ( % of bad loans)	81.1	81.2	85.3	85.4

The table above represents the key indicators of the banking sector in Cameroon given as aggregates. More so it shows the evolution of non performing loans over the years 2002-2005. The amount of non performing loans are represented here as a percentage of the sum total of loans given out by the banking sector. Going by the diagram, we can see that over the years the amount of non performing loans (credit risk) is reducing .In 2002, the credit risk was 15.7 and in 2005 it was 12.6 indicating a reduction of credit risks of 3.1%. This decrease can be explained by the action of the management team in their effort to risk reduction.

In this section, we are going to represent graphically the data in the table 4.1 above in relation to the amount of non performing loans which is presented as a percentage.

This rate should be as low as possible since it the goal is to minimise risks in order to make investments more profitable. The following illustrates diagrammatically the evolution of credit risks.

Source: Banking Commission of Central Africa and Staff Calculations (COBAC), 2005.

The slope of this curve is negative showing that over the years the amount of non performing loans is reducing. This therefore means that the risk management has an impact on the credit risk, by reducing the size of the non performing loans. This can be achieved for instance through an effective credit policy.

4.1.2 ASSESSING THE IMPACT OF RISK MANAGEMENT ON LIQUIDITY RISKS

Our analysis in this part of our study will be based on the table below, which represents the evolution of maturity transformation defining the liquidity level of Cameroonian banks over the long run.

Years	2002	2003	2004	2005
maturity transformation	3	3	5	4

The maturity transformation is the ratio of the overall solvency of the banking sector. By this ratio a company can determine how liquid it is and how far it is coping with its long term obligations based on its assets.

The trick of this ratio is that organisations and of course financial institutions must keep this ratio greater than one. This indicates that if this ratio is higher it is a sign of solvency of the organisation, since it can meet its long term obligations.

Going by the table above, we can say that the solvency ratio in 2002 was 3 and that it has increased to 5 in 2004 and 4 in 2005, which means that over the years the organisations are getting more solvent by increasing their liquidity level.

Here the liquidity risk is lesser since it is expressed when the solvency ratio tends to 0 or to a negative value. We ca therefore affirm that the risks management of Banks in Cameroon is aware of the negative impact of liquidity shortages and keep a high liquidity ratio in order to avoid illiquidity. In brief the higher the liquidity ratio, the lesser the liquidity risks.

The figure below is represented on the data given in table4.2 above, which represents the evolution of maturity transformation for the entire banking sector in Cameroon for the Period 2002-2005.

The curve drawn above represents the evolution of the liquidity ratio of the Cameroon Banking sector over the years 2002-2005. In 2002 and 2003 the curve is constant meaning that the liquidity level remains unchanged. But due to the action of risks managers in their tasks to maintain adequate liquidity level, the ratio will increase in 2004 to 5 and decrease to 4 in 2005 while remaining higher than in 2002 and 2003. Given that the curve is positive, the liquidity risks are diminished since adequate liquidity is kept n Banks and Bankers can meet sudden upsurge withdrawals of creditors while not affecting the overall profit of the financial institutions.

4.2 QUANTITATIVE ANALYSIS

In this section, we are going to make use pf practical analytical tools such as ratio analysis and standard deviations analysis for the period of past incomes and expenses. Since standard deviation will help us to estimate the degree of risks, we will compare the evolution of these degrees to the ratios of return on equity (ROE) and return on investment in order to monitor the changes in risk level. For this to be feasible, we will make use of two case studies in Cameroon which are SOWEFCU (south West Farmers Cooperative Credit Union) with headquarters located in Kumba and Afriland First Bank which is a commercial Bank operating in Douala and Yaoundé with several branches in other provinces of Cameroon and all over Central Africa. The information provided by these financial institutions will be provided in appendixes.

4.2.1 INVESTIGATING THE IMPACT OF RISK MANAGEMENT ON THE PROFITABILITY OF FINANCIAL INSTITUTIONS.

In this section of our study, we are going to rely on the case of Afriland first Bank, which gives information in Appendix 2.

We all know that Banks make their profits on interests from loans and advances granted. The profit margin will therefore be computed as the amount of profit per amount of loans.

31/12/2004

31/12/2003

Profitability margin =

2, 061,664 + 15,73384, 008, 693

X100

=2.5%

PM = 2.5 %

Profitability margin =

1, 727,147 + 8,086 68, 773, 187

X 100

= 2.48 %

PM = 2.48 %

By the end of the year 2004, more loans are given out and the corresponding profits were 2, 077, 377 whereas by the end of year 2003 the profits are (1, 727, 147 + 8, 086) = 1, 733, 233 Fcfa, which is less than in year 2004. The explanation of this increase in profitability is that risks management applies an adequate credit risk policy since more loans are repaid by debtors and this will enhance profits. We can further investigate the impact of risk management on credit risk and establish a relationship with the profitability level, all of this applied to the same case study which is Afiland First Bank.

4.2.2 ASSESSING THE IMPACT OF RISK MANAGEMENT ON THE OVERALL CREDIT RISK POLICY OF FINANCIAL INSTITUTIONS.

In our analysis, we are going to use provisions as the amount of bad loans, since they represent amount kept by the enterprise in order to overcome defaults payments.

31/12/2004

31/12/2003

Credit Risk:

13, 110, 61597, 119, 308

CR = X 100

= 13.5 %

Credit Risk:

11, 632, 69580, 405, 883

CR = X 100

= 14.5 %

At the end of year 2003, the credit risk was evaluated at 14.5 % of the total amount of loans. This percentage has reduce by 1 % by the end of year 2004, thus decreasing to 13.5 % of the total amount of Loans. Now let's have a look at the effect of this risky-shift on the profitability of the Afriland First bank.

4.2.3 RELATIONSHIP BETWEEN CREDIT RISKS AND PROFIT: THE CASE OF AFRILAND FIRST BANK

As seen above the calculations were made for the period 2003 to 2004. The following table summarizes the relationship between default risk and profit.

Years

Variables

31/12/2004

31/12/2003

Changes

Credit Risks

(% of bad loans)

13.5 %

14.5 %

- 1 %

Profit Made

(Profit Margin ) % of Loans

Fcfa

2, 077, 377

(2.5 %)

Fcfa

1, 735, 133

(2.48 %)

+ 342, 114

+ 0.02 %

Going by the table above, we can see that since credit risks are minimised, more profits are made on loans thus a 1 % reduction in credit risk has led to an increase in profit of 342, 114 Fcfa. This therefore helps s in rejecting H_{0 :} there is no relationship between the risk management and profitability of financial institutions in Cameroon and accept the H_1.

4.2.4 INVESTIGATING THE IMPACT OF RISK MANAGEMENT ON THE LIQUIDITY POSITION OF FINANCIAL INSTITUTIONS IN CAMEROON

In order to make this investigation possible, we are going to rely on data given in Appendix 1, relating to the financial ratios of SOWEFCU, and its financial statements.

For us to compile the liquidity risks of SOWEFCU, we need to assess the deviations between the liquidity ratios for various years in order to determine the degree if liquidity risks.

This will be the adequate liquidity level; the deviations from this level will represent the risks of illiquidity.

furthermore, the operating income increased from Fcfa (4 millions) in 1996/1997 to Fcfa 1 million in 98/99, with a spike Fcfa 2 million in 1997/1998, yielding a rate of return that ranged from -17% to 4% and profitability rates from 13% to 21%.

Once more we can see that from years 96/97 till 98/99 the risks are reducing from 14.7 to 4.43 and the corresponding results are the increase in Returns On Equity (ROE) from -17% to 4% and profitability margin rates from 13% to 21%.

Table 4.6: Relationship Between Liquidity Risks, Profitability and Return On Equity: The Case of SOWEFCU

Years variables	96/97	97/98	98/99
Liquidity risk (ó)	14.7	10.2	4.43
Return On Equity ROE	-17	13	4
Profitability Rates (net incomes/sales)%	13	21	/

When the risk management of SOWEFCU succeeded in reducing the liquidity risks, the correspondent results were an increase in profitability rates and Return on Equity thereby confirming the H₁: there is a relationship between risk Management and the growth of Financial Institutions in Cameroon, while rejecting the H₀.

CHAPTER FIVE

SUMMARY, RECOMMENDATIONS AND CONCLUSION

This chapter will summarize findings of the analyses of the data collected. it will also involve proposals of possible recommendations with a conclusion pertaining to the whole study will be drawn.

- It has been found that the relationship between risk management and the profitability of financial institutions in Cameroon is strong over the period 2002-2005.

This is explained by the fact that an increase in liquidity position of the firm is related to a shift in credit as explained in figures 4.2 above:

- It has also been found that the higher the liquidity ratio, the lower the liquidity risks and the higher profit margin and return on equity.

- Another funding was that when the liquidity risks are high, the return on equity is low due to the fact that as the assets of the firm are not liquid, they can not make enough loans in order to get more profits and since the exposure to risk is too high, borrowers will be discouraged to request loans from the bank. This was proves from the period1996/1997 to 1998/1999 in SOWEFCU where liquidity risks was a negative function of profitability.

- During the period of analysis, 2003-2004, we found that when credit risks re reduced in commercial banks, the side effect is the increase in profit margin. Since credit is the main tool of raising finance for the commercial banks, any default will tend to reduce profit, hence yielding a loss.

5.2 RECOMMENDATIONS

Based on the findings of this study that state that risk management and profitability of financial institutions are perfectly related over the period of study 2002-2005, the following recommendations can be made:

· Financial institutions, may it be central bank, commercial banks, micro financial houses, should practise a sound risk management policy is their organisation. This will facilitate the handling of risk and enhance huge profits to be made thus fostering growth in the industry.

· The risk management of financial institutions must set adequate liquidity level which will be as a standard over the years for the sake of profitability, expansion financial worthiness and the public credibility.

· Financial institutions must carefully plan for risks, identifies, analyses and assess the potential trouble which may alter the implementation of company's policy.

· Concerning credit risks, financial institutions must investigate the credit demand from borrowers and assess whether they are financially able to repay the loan in due terms in an optic of reducing credit risk.

5.3 CONCLUSION

During the course of this study, a theoretical framework was established to illustrate the theoretical relationship that exists between variables involved in the study. This involved a brief review of related literature, empirically the relationship between these variables was tested to verify the influence of risk management on profitability and risk reduction from 2002-205. After conducting the necessary data and carrying out the necessary analysis, it was discovered that risk management has a strong impact on the profitability of financial institutions from 2002-2005 in Cameroon.

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