CHAPTER ONE

INTRODUCTION

1.1     Background to the Study

Microfinance is a development tool used to create access and financial services for the economically active poor at a sustainable affordable price. The issue of micro-financing was hitherto understood only in terms of working capital. The practice of microfinance in Nigeria is culturally rooted and dates back to several years ago. The traditional micro-finance institutions provide access to credit for the rural areas, urban low income earners and so on (Ikpefan, Taiwo, Oladeji, & kazeem, 2014). They were mainly the informed Self Help Groups (SHGs) or Rotating Savings and Credit Associations (ROSCAs). Other providers of microfinance include savings collectors and cooperative societies (Berger, 2010).

The growing awareness of the potentials of Microfinance Banks (MFBs) in poverty reduction, increased access to financial services and economic development has been established in Nigeria and around the globe (Berger, 2010). Beyond making credit facilities available to micro, small and medium enterprises (MSMEs) and the promotion of savings culture; MFBs also serve as veritable means of employment generation, enhancing financial inclusion, economic growth and development (CBN, 2012).

Microfinance Institutions (MFIs) like other Deposit Money Banks (DMBs) have undergone the recapitalization scheme over the years. The         latest being in 2012 by the Central Bank of Nigeria. One of the biggest achievements in the financial sector in the Nigerian economy has been the upward review of the capital base of banks. This has resulted in bigger, stronger and more resilient financial institutions. According to Ikpefan (2013:2938), “bank capital can be seen as the amounts contributed by the owners of the bank (paid-up share capital) that gives them the right to enjoy all future earnings of the bank which also includes reserve”.

Capital structure describes how firms finance their overall operations and growth by employing various sources of funds. Capital structure decision is the mix of debt and equity that a company uses to finance its business (Damodaran, 2001). Firms can use either debt or equity or both to finance their assets. Generally, firms can choose the aforesaid alternative capital structure (Abor, 2005). There are various alternatives of debt-equity ratio, these includes; 100% equity: 0% debt, 0% equity: 100% debt and X% equity: Y% debt (Dare & Sola 2010). From these three alternatives, option one is that of the unlevered firm, that is, the firm that shuns the advantage of leverage (if any). Option two is that of a firm that has no equity capital. This option may not actually be realistic or possible in the real life economic situation, because no provider of funds will invest his money in a firm without equity capital. This partially explains the term “trading on equity”, that is, it is the equity element that is present in the firm’s capital structure that encourages the debt providers to give their scarce resources to the business. Option three is the most realistic one in that, it combines both a certain percentage of debt and equity in the capital structure and thus, the advantages of leverage (if any) is exploited. Hence, the best choice of capital structure is a mix of debt and equity (Shubita & Alsawalhah, 2012). This mix of debt and equity has long been the subject of debate concerning its determination, evaluation and accounting.

One of the importances of capital structure is that it is tightly related to the ability of firms to fulfill the needs of various stakeholders. Capital structure represents the major claims to a corporation’s assets which includes the different types of both equities and liabilities (Riahi-Belkaonui, 2009). According to Cull (2007), microfinance institutions (MFIs) premise their activities on profitability and poverty alleviation. Since early 90s, these firms have indeed facilitated financial inclusion of people who have hitherto been excluded from the banking sector. It is noted that most microfinance institutions (MFIs) obtain funds inform of grants, equity, deposits and various forms of debt from different investors such as commercial banks and other lending institutions (Bogan, 2012). It is therefore the duty of microfinance institution (MFIs) to ensure the best mix of the funds in its capital structure that brings forth maximum returns. According to Ngo (2012) different funding sources of microfinance institutions (MFIs) in Nigeria have their associated costs which impact on the performance of the institutions. It is noted that large microfinance institutions rely more on debts and are therefore highly leveraged which enables them to achieve higher efficiency, profitability, sustainability and outreach than smaller institutions which presumably have no access to large debts. The applicability of any given scenario at any particular point in time, however, depends largely on the cost of financing particularly of the borrowed funds. This study is an attempt to empirically examine the relationship between capital structure and the profitability of selected microfinance banks (MFBs) in Nigeria.

1.2     Statement of the Problem

The microfinance institutions (MFIs) have been facing numerous challenges which have threatened the survival and growth of the very industry. The fact that many MFIs are not deposit-taking, a departure from other financial institutions, yet they give out loans to their customers implies that they rely heavily on debt and possibly retained earnings. This is a huge challenge due to the inadequacies of retained earnings and exorbitant interest rates charged by commercial banks when lending to MFIs. This then implies that when there are challenges on capital structure of Microfinance Institutions (MFIs), these firms will have inadequate funds to loan out to their customers. Interest charged on credit advanced to borrowers is the spine of MFIs. Therefore, when MFIs lack sufficient funds to give their customers in form of loans is likely to lead to foregone profits, losses, and ultimately collapse of these institutions (Berger, 2010).

It can thereby be inferred from the above that an appropriate capital structure decision is critical for the survival of every business organization. There is the need to determine whether high, low or zero leverage, will be the most adequate to enhance profitability. Predicting the level of gearing that can influence Return on Assets (ROA), Return on Equity (ROE) and Return on Capital Employed (ROCE) has been the problem researches have tried to address over the years. Therefore, the study was set up to examine the relationship between capital structure and profitability of selected microfinance banks in Nigeria.

1.3     Objectives of the Study

Generally, the objective of the study is to examine the relationship between capital structure and profitability of selected microfinance banks (MFBs) in Nigeria. Specifically, the study is designed to achieve the following objectives:

1.       To examine the extent of relationship between equity capital and Return on Equity (ROE) of selected Microfinance Banks (MFBs) in Nigeria.

2.       To examine the extent of relationship between short term debt and Return on Equity (ROE) of selected Microfinance Banks (MFBs) in Nigeria.

3.       To examine the extent of relationship between long term debt and Return on Equity (ROE) of selected Microfinance Banks (MFBs) in Nigeria.

4.       To examine the extent of relationship between total debt and Return on Equity (ROE) of selected Microfinance Banks (MFBs) in Nigeria.

1.4     Research Questions

          The following research questions are raised for the study:

1.       What is the extent of relationship between equity capital and Return on Equity (ROE) of selected Microfinance Banks (MFBs) in Nigeria?

2.       What is the extent of relationship between short term debt and Return on Equity (ROE) of selected Microfinance Banks (MFBs) in Nigeria?

3.       What is the extent of relationship between long term debt and Return on Equity (ROE) of selected Microfinance Banks (MFBs) in Nigeria?

4.       What is the extent of relationship between total debt and Return on Equity (ROE) of selected Microfinance Banks (MFBs) in Nigeria?

1.5     Research Hypotheses

The following research hypotheses have been formulated in the null form:

H01:  There is no significant relationship between equity capital and Return on Equity (ROE) of selected Microfinance Banks (MFBs) in Nigeria.

H02:  There is no significant relationship between short term debt and Return on Equity (ROE) of selected Microfinance Banks (MFBs) in Nigeria.

 H03: There is no significant relationship between long term debt and Return on Equity (ROE) of selected Microfinance Banks (MFBs) in Nigeria.

 HO4:          There is no significant relationship between total debt and Return on Equity (ROE) of selected Microfinance Banks (MFBs) in Nigeria.

1.6     Significance of the Study

This study is expected to be of help to various groups as follows:

Regulators and Policy Formulators: The result of this study will be of significant help to the regulators and policy formulators of microfinance banks in Nigeria such as the government, Central Bank of Nigeria (CBN) and the Nigeria Deposit Insurance Corporate (NDIC) as it will aid them in formulating sound and considerable policies, supervisory and regulatory frameworks given their challenges.

Stakeholders of Microfinance Institutions (MFIs): To the stakeholders of Microfinance Institutions (MFIs), this study will seek to highlight the effect of capital structure mix as it affects the performance of the bank. Similarly, the outcome of this study will be of benefit to the managers of various microfinance banks as workable strategies will be suggested to control the capital inadequacy, manage liquidity risks and the problem of a growing non-performing loans portfolios in the institution and thereby improve its financial performance and profitability, thereby contributing to financial sustainability of  their institutions and ultimately wider and better outreach to the poor whom these institutions serve. This study will also help investors make informed decisions regarding investments in microfinance Institutions, among other investment in their portfolios, in a manner that is most beneficial in enhancing performance of the microfinance Institutions.

Micro Credit Client and Micro Entrepreneur: To the micro credit client and micro entrepreneur, this study will bring to limelight the roles of microfinance institutions in the growth and development of the Nigerian economy.

Students and Researchers: Finally, to the students and researchers alike, this study will add to the body of knowledge and also serve as a reference tool to researchers on related fields.

1.7     Scope of the Study

The study is centered on examining the relationship between capital structure and profitability of selected Microfinance Banks (MFBs) in Nigeria from 2011-2015. The study used data sourced from the financial statements of two (2) selected Microfinance Banks in Nigeria, Abucoop Microfinance Bank, Abuja and NPF Microfinance Bank, Lagos State, covering the period of 2011-2015.

1.8     Limitations of the Study

The major limitations encountered when undergoing this research are:

Short time factor which did not give time for thorough research work, hence gathering adequate information becomes very difficult.

Distance and its attendant cost of travel in order to obtain information for this study was a major limitation.

Another limitation was access to adequate information as not much research has been done with regards to microfinance institutions (MFIs) and also the unwillingness of the staff in disclosing information to the researcher for fear of breach of oath of secrecy (duty of confidentiality) to its competitors.

1.9     Definition of Terms

To avoid misconception, the following terms are defined as used in this study.

Microfinance Bank (MFB):     This is otherwise referred to as Microfinance Institution (MFI). According to CBN (2012:7), a microfinance bank (MFB) is any company licensed to carry on the business of providing financial services such as savings and deposits, loans, domestic fund transfers, other financial and non-financial services to microfinance clients.

Microfinance Bank Target Client:     A microfinance bank target client include the economically active low-income earners, low income households, the unbanked and under-served people in particular, vulnerable groups such as women, physically challenged, youths, micro-entrepreneurs, informal sectors, subsistence farmers in urban and rural areas.

Micro-enterprise: A micro-enterprise is a business that requires microcredit/loans to operate. The operation and management are often built around the sole owner or micro-entrepreneur.

Microfinance Loan:        A micro loan is a facility granted to operators of microenterprises.

Return on Equity (ROE): This is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested. It is one of the best ways of measuring financial performance.

Debt Ratio: Debt ratio is a financial ration that indicates the percentage of a company’s assets that is provided via debt.

Return on Investment (ROI): Return on investment is a performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. It is calculated as the ratio of benefit (return) of an investment (profit before interest and tax) and total capital employed.