ABSTRACT
This research assesses the relationship between credit risk and the performance of listed banks in Ghana. The data sample consisted 8 listed banks covering a 7-year period from 2010 to 2016.
Findings from the study reveal that total assets and liabilities on average increased over the seven
(7) years period. But this increase has been almost in the same proportion, leading to an almost constant leverage ratio over the period. On the average, the ROA of most of the banks increased over time. An explanation for this could be that liquid assets, total assets, shareholder’s fund and total comprehensive income have on average augmented over the years. Size formed the highest correlation with ROA, followed by board independence and leverage in that order.
The regression result revealed a negative impact of credit risk on performance. A unit increase in the credit risk of banks will lead to a 0.0324 units decrease in the return on assets. Bank size had a positive impact on performance. The positive relationship implied that larger banks perform better over time than smaller banks.
CHAPTER ONE
INTRODUCTION
Background of Study
Financial institutions play a major role in the development of any country in both developed and developing countries. By mobilizing domestic savings from depositors, banks provide resources to individuals and business units who in turn use these resources for investment and productive activities that promote economic development. Besides this intermediation role, banks continue to provide innovative financial products to investors that lower transaction costs and facilitates payment systems (Maxwell, 1995).
The performance of the financial sector is, therefore, pivotal to the growth of any contemporary economy (Thankom Gopinath Arun & Turner, 2009; T. G. Arun & Turner, 2002; Demirgüç-Kunt, 2004). The activities of financial institutions like banks drive other sectors of the economy particularly through money lending (PWC, 2017). Therefore their performance ripples into economic growth (Ataullah & Le, 2006). Empirical studies have documented a positive relationship between the performance of financial institutions and economic growth and development (Beck & Levine, 2004; Beck, Levine, & Loayza, 2000). The financial sector’s significance is apparent in its substantial contribution to gross domestic product (GDP) (Haldane, Brennan, & Madouros, 2010). In Ghana, for example, the financial and insurance subsector contributed 8.4%, 8.9% and 9.4% to GDP in 2014, 2015 and 2016 respectively(GSS, 2017). In the financial sector, banks are considered the most significant due to the crucial role they play in financial intermediation. Hence, their contribution to the economy cannot be overlooked. The banking sub-sector in Ghana contributed about 75% of the assets of the financial sector in 2011 (Alhassan, 2015). Banks mobilize funds from surplus spending units (depositors) and allocate
them to deficit spending units (borrowers), to enhance economic growth (Ataullah & Le, 2006; Levine, Loayza, & Beck, 2002).
To be able to sustain the performance of these roles in an economy, banks must be able to generate enough earnings in for business survival and continuity. Profitability is a concept that is at the Centre stage of discussion when one talks of how banks should earn enough earnings to remain in business. Profitability is in turn affected by several internal and external factors. Largely, banks have control of internal factors also known as bank specific variables that tend to shape profitability levels. Among other things, liquidity is one of the key internal factors that influence profitability of banks. Generally, the term liquidity refers to the ability to fund increases in assets and meet obligations as they fall due.
Credit risk can be described as the risk of default on the part of borrowers to pay back sums borrowed (Hafsa Orhan Astrom, 2013; Richard, Chijoriga, Kaijage, Peterson, & Bohman, 2008). Since the UT and Capital Bank takeovers, one growing phenomenon taking strides in the banking sector is the credit risk management of banks in Ghana and how they impact their performance. Banks generate more income from credit creation, but this comes with several risks. Amongst those several risks, credit risk proves to be so inevitable in the credit creation process (Eccles, Herz, Keegan, & Phillips, 2001), and can really interrupt the smooth running of a bank’s business. Excessively high level of non-performing loans in the banks can be attributed to poor corporate governance practices, loose and negligent credit administration processes and the absence or non- adherence to credit risk management practices. Bad credit risk management has been identified to be a recipe for disaster, a reason for which some banks go bankrupt. It is for this reason that this study wants to determine the close nexus between credit risk management practices of banks in Ghana and how they ultimately affect performance.
Problem Statement
There are quite a proliferation of studies worldwide that have considered the link between credit risk management (Andreou, Cooper, Louca, & Philip, 2017; Fayman & He, 2011; Freeman, Cox, & Wright, 2006; Hafsa Orhan Astrom, 2013; J. Jin, Yu, & Mi, 2012; Kolapo, Ayeni, & Oke, 2012; Treacy & Carey, 2000) but most of them are on developed economies. There’s only quite a few domestically (Apanga, Appiah, & Arthur, 2016; Boahene, Dasah, & Agyei, 2012). Even though the issue of credit risk and its management is becoming very essential in policy debates, research in the area in developing countries is still in its infancy (Apanga et al., 2016). With the recent bankruptcy issues and recent takeovers involving UT and Capital Banks, the merging of some local banks, the financial soundness of the Ghanaian banking system has been called to question and needs to be carefully assessed. One way of examining the financial soundness of these banks is by examining their credit risk management practices and measuring the general immunity of the banking industry toward such risk, hence further research needed in such sensitive area.
Research Objectives
The overall objective of this research is to assess the relationship between credit risk and the profitability of listed banks in Ghana. The specific objectives include:
To measure the profitability of listed banks from 2010 to 2016.
To determine the linkage between credit risk and non-performing loans.
To evaluate the effect of credit risk and profitability of listed banks from 2010 to 2016.
Research Questions
The study seeks to answer the following questions:
- In what way is credit risk linked with non-performing loans?
- To what extent does credit risk impact bank profitability?
Significance of Study
The outcomes of the research have direct implications for policy, practice and academic works. Findings of the study will make relevant contribution to decision making among banks, investors, and banking industry regulators alike. Among listed banks, findings of the study will serve as a guide in decision making in particularly decision s regarding optimal decision levels that must be held. From the bank perspective, findings of the study will lead to a better understanding of the nature of relationship between credit risk and their performance. This empirical knowledge can help to the formulation of financing decisions pertaining to credit risk that help improve the profitability of banks. For investors, results of the study can enhance decision making regarding which firms to invest. Investors can gauge the liquidity and profitability performance of listed firms by dwelling on the results of the study in order to make informed decisions.
Policy wise, by empirically assessing the performance of the Ghanaian banking industry, regulators, that is, the Bank of Ghana (BOG) is further informed about the financial health of the industry. The BOG is well-informed regarding the trends and patterns as well as the potential drivers of profitability. The analysis may provide insights towards potential avenues for policy prescriptions and enhancement which can then be oriented towards specific less-performing and more-performing banks and the whole industry.
To academic literature, the research contributions are in a few folds. First, the first study contributes to the few credit risk management and performance literature in the Ghanaian banking industry and Africa at large. Second, the study attempts to provide a new empirical evidence on the nexus between credit risk, non-performing loans and bank performance. Again, the study will make relevant contributions to existing literature on the effect of credit risk on performance of
banks. The results of the study consequently will serve as a guide and source of reference material for future researchers.
Research Limitations
Despite the contributions this study makes towards research, policy and practice, it still faces some challenges. First, the performance of banks can be further examined by means of efficiency measures other than ratios, which will be considered in another study. Second, the focus of this study is limited to the banking sector while ignoring the other parts of the financial system such as microfinance institutions, even though there seem to be little research focusing on such areas. Due to data unavailability however, it is difficult to include such institutions in the study. That notwithstanding, the study is representative since the Ghanaian financial system is dominated by banks and is the driving force of the financial system (Buchs & Mathisen, 2005).
Organisation of Study
The study is categorised into five chapters, each with sections and potential subsections. The first chapter focuses on the background of the study, problem statement, objectives, questions, research significance, and the scope within which the study is confined. Chapter two reviews the relevant literature on performance studies in banking in order to provide evidence to support the purpose of the research and seek answers to research questions. It also gives a brief discussion of the industry, the regulations, and the structure of the firms within the industry. In chapter three, the methodology of the research is discussed, detailing main ratios to be deployed. Chapter four entails data presentation, analyses of results, conducting of tests, and making graphical illustrations. The final chapter discuses, summarises, concludes, makes recommendations and proposes directions for further research.
