MichaelFinancial distress has afflicted numerous local banks IN Cameroon, many of which have been closed down by the regulatory authorities or have been restructured under their supervision. In
Cameroon banks such as the B.I.C.I.C. Meridian B.I.A.O. Cameroon Bank were closed
Many more local banks were distressed and subject to some form of
“holding action”. Failed local banks accounted for as much as 23 per cent of total commercial
bank assets in Cameroon.
The cost of these bank failures is very difficult to estimate: much of the data is not in
the public domain, while the eventual cost to depositors and/or taxpayers of most of the
bank failures which occurred between the 1988 to 2004 period will depend upon how much of the failed banks’ assets are eventually recovered by the liquidators. The costs are almost certain to be substantial.
Most of these bank failures were caused by unprofitable loans. Areas affecting more
than half the loan portfolio were typical of the failed banks. Many of the bad debts were
attributable to moral hazard: the adverse incentives on bank owners to adopt imprudent
lending strategies, in particular insider lending and lending at high interest rates to borrowers
in the most risky segments of the credit markets.
Insider lending
The single biggest contributor to the bad loans of many of the failed local banks was
insider lending. In at least half of the bank failures referred to above, insider loans accounted
for a substantial proportion of the bad debts. Most of the larger local bank failures in Cameroon,
such as the Cameroon Bank, B.I.A.O. Bank and B.I.C.I.C. Bank, involved extensive insider
lending, often to politicians. Insider loans accounted for 65 per cent of the total loans of
these local banks, virtually all of which was unrecoverable.
Almost half of the loan portfolio of one of the local banks local banks had been extended to its directors and employees .The threat posed by insider lending to the soundness of the banks was exacerbated because many of the insider loans were invested in speculative projects such as real estate development, breached large-loan exposure limits, and were extended to projects which could not generate short-term returns (such as hotels and shopping centres), with the result that the maturities of the bank assets and liabilities were imprudently mismatched.
The high incidence of insider lending among failed banks suggests that problems of moral
hazard were especially acute in these banks. Several factors contributed to this.
First, politicians were involved as shareholders and directors of some of the local banks.
Political connections were used to obtain public-sector deposits: many of the failed banks,
relied heavily on wholesale deposits from a small number of firms.
Because of political pressure, the small banks which made these deposits are unlikely to have
made a purely commercial judgement as to the safety of their deposits. Moreover, the
availability of micro deposits reduced the need to mobilize funds from the public. Hence
these banks faced little pressure from depositors to establish a reputation for safety.
Political connections also facilitated access to bank licences and were used in some cases to
pressure bank regulators not to take action against banks when violations of the banking laws
were discovered. All these factors reduced the constraints on imprudent bank management.
In addition, the banks’ reliance on political connections meant that they were exposed to
pressure to lend to the politicians themselves in return for the assistance given in obtaining
deposits, licences, etc. Several of the largest insider loans made by failed banks in Cameroon
were to prominent politicians.
Second, most of the failed banks were not capitalized, in part because the minimum
capital requirements in force when they had been set up were very low. Owners had little of
their own funds at risk should their bank fail, which created a large asymmetry in the
potential risks and rewards of insider lending. Bank owners could invest the bank deposits
in their own high-risk projects, knowing that they would make large profits if their projects
succeeded, but would lose little of their own money if they were not profitable
The third factor contributing to insider lending was the excessive concentration of
ownership. In many of the failed banks, the majority of shares were held by one man or one
family, while managers lacked sufficient independence from interference by owners in
operational decisions. A more diversified ownership structure and a more independent
management might have been expected to impose greater constraints on insider lending,
because at least some of the directors would have stood to lose more than they gained from
insider lending, while managers would not have wanted to risk their reputations and careers.
The high cost of funds meant that the local banks had to generate high earnings from
their assets; for example, by charging high lending rates, with consequences for the quality of
their loan portfolios. The local banks almost inevitably suffered from the adverse selection of
their borrowers, many of who had been rejected by the foreign banks (or would have been
had they applied for a loan) because they did not meet the strict creditworthiness criteria
demanded of them. Because they had to charge higher lending rates to compensate for the
higher costs of funds, it was very difficult for the local banks to compete with the foreign
banks for the “prime” borrowers (i.e. the most creditworthy borrowers). As a result, the
credit markets were segmented, with many of the local banks operating in the most risky
segment, serving borrowers prepared to pay high lending rates because they could access no
alternative sources of credit. High-risk borrowers included other banks which were
short of liquidity and prepared to pay above-market interest rates for inter bank deposits and
loans. We all experienced in Douala and Yaounde how some of the local banks were heavily exposed to finance houses which collapsed in large numbers in the 1990s.
Consequently, bank distress had domino effects because of the extent to which
local banks lent to each other.
Within the segments of the credit market served by the local banks, there were probably
good quality (i.e. creditworthy) borrowers as well as poor quality risks. But serving
borrowers in this section of the market requires strong loan appraisal and monitoring
systems, not least because informational imperfections are acute: the quality of borrowers’
financial accounts are often poor, many borrowers lack a track record of successful business,
etc. The problem for many of the failed banks was that they did not have adequate
expertise to screen and monitor their borrowers, and therefore distinguish between good and
bad risks. In addition, credit procedures, such as the documentation of loans and loan
securities and internal controls, were frequently very poor. Managers and directors of these
banks often lacked the necessary expertise and experience.
Recruiting good staff was often difficult for the local banks because the established banks
could usually offer the most talented bank officials better career prospects. Moreover, the
rapid growth in the number of banks outstripped the supply of
experienced and qualified bank officials.
Macroeconomic instability to an extent contributed to these failures;
The problems of poor loan quality faced by the local banks were compounded by
macroeconomic instability. Periods of high and very volatile inflation occurred in Cameroon, just before the devaluation of the FCFA. With interest rates liberalized ,nominal lending rates were also high, with real rates fluctuating between positive and negative levels, often in an unpredictable manner, because of the volatility of inflation .
Macroeconomic instability would have had two important consequences for the loan
quality of the local banks. First, high inflation increases the volatility of business profits
because of its unpredictability, and because it normally entails a high degree of variability in
the rates of increase of the prices of the particular goods and services which make up the
overall price index. The probability that firms will make losses rises, as does the probability
that they will earn windfall profits .This intensifies both adverse selection and adverse incentives for borrowers to take risks, and thus the probabilities of loan default.
The second consequence of high inflation is that it makes loan appraisal more difficult for
the bank, because the viability of potential borrowers depends upon unpredictable
developments in the overall rate of inflation, its individual components, exchange rates and
interest rates. Moreover, asset prices are also likely to be highly volatile under such
conditions. Hence, the future real value of loan security is also very uncertain.
Conclusively ,we should not be scared when we see micro financial houses multiplying in the economic capital of Cameroon, Douala, and Yaounde today, all, heavily involved in the banking sector, it is merely as a result of these huge bank failures recorded in the past years.