ABSTRACT
The study was to assess the credit risk management
practices among rural banks in the Takoradi metropolis. The study was a
descriptive design which targeted workers and management of Lower Pra Rural
Bank, Ahantaman Rural Bank Ltd, and Fiaseman Rural Bank. Questionnaires were
administered to thirty workers while structured interview was conducted for
three general managers of the various rural banks. Moreover, the data were
analyzed with the aid of Statistical Product for Service Solution (SPSS version
21.0) by using percentages and frequencies and presented by using tables, and
charts. On the other hand, the interviews were transcribed verbatim, coded into
themes and discussed concurrently with the aid of the research objectives. It
was found out that, although the rural banks face similar risk in the credit
environment, there is disparity as to the degree of importance attached to the
various risk elements by the various banks. Moreover, each bank has its own
credit philosophy, basis for lending and the critical areas of credit
assessment. Furthermore, despite differences in credit policies, rural banks in
Ghana adopt similar approaches to mitigating the risk involved in credit
lending. Therefore, the study recommends that all lending institutions should
establish a unit to handle their VAF product to minimise losses as a result of
financing poor quality vehicles and machinery which end up in repayment
defaults. Also, all other financial institutions which can afford should
establish collections unit to closely monitor and recover all problematic
credit facilities. Moreover, there is the need for rural banks to ensure that
their staff receive periodic on-the-job training to apprise themselves with new
ways of doing things.
CHAPTER ONE
INTRODUCTION
This is the first chapter of the study, and it thus
introduces the study to readers. The chapter has the background of the study,
the problem statement, the research objectives, research questions, significance
of the study, the scope of the study, limitations of the study and the
organization of the study. The chapter gives the essence of the study.
Background of the Study
Most banks face various risks during their operations flow
that they are not able to remove them but just manage them. Therefore, banks
should control risks and reduce them for their survival. One of the most
important related risks is liquidity risk (Mazarizadi, Baghvamian &
Kakah-Khani, 2013). Therefore, the main task of banks is to make a balance
between short-term financial commitments and long-term investments. The banking
institutions had contributed significantly to the effectiveness of the entire
global financial system as they offer an efficient institutional mechanism through
which resources can be mobilized and directed from less essential uses to more
productive investments (Wilner, 2000).
Even though one of the major causes of serious banking
problems continues to be ineffective credit risk management, the provision of
credit remains the primary business of every bank in the World. For this
reason, credit quality is considered a primary indicator of financial soundness
and health of banks. Interests that are charged on loans and advances form a
sizeable part of every bank’s revenue. Default of loans and advances poses serious setbacks
not only for borrowers and lenders but also to the entire economy of a country.
Studies of banking crises all over the world have shown that poor loans (asset
quality) are the key factor of bank failures. The strength of the banking
industry is an important prerequisite to ensure the stability and growth of an
economy (Halling & Hayden, 2006).
The significant role played by rural banks in a developing
economy like Ghana (where access to capital market is limited) cannot be
overemphasized. In fact, well-functioning banks are known as a catalyst for
economic growth whereas poorly functioning ones do not only impede economic
progress but also exacerbate poverty (Barth, Schumacher and Herrmann-Lingen,
2004). However, banks are exposed to various risks such as credit, market and
operational risk. Although all these risks militate against the performance of
banks in several ways, Chijoriga (1997) argues that the size and the level of
loss caused by credit risk as compared to others were severe to collapse a
bank.
Amongst all the services provided by banks and rural banks,
credit creation is the main income generating activity for the banks. But this activity
poses extremely high risks to both the lender (financial institution) and the
borrower (customer). The risk of a trading partner not fulfilling his or her
obligation as per the contract can greatly hinder the smooth functioning of a
bank’s operation. On the other hand, a bank with high credit risk faces
potential insolvency and this does not give depositors confidence to place
deposits with it (Chijoriga, 1997).
Some financial institutions have collapsed or experienced
financial problems due to inefficient credit risk management systems typified
by high levels of insider loans, speculative lending, and high concentration of
credit in certain sectors among other issues. Bad credit risk management practices
and poor credit quality continue to be a dominant cause of bank failures and
banking crises worldwide (Gil-Diaz, 2008).
Financial institutions have faced difficulties over the years
for a multitude of reasons, the major cause of serious banking problems
continues to be directly related to lax credit standards for borrowers and
counterparties, poor portfolio risk management, or lack of attention to changes
in economic or other circumstances that can lead to a deterioration in the
credit standing of a bank’s counterparties (Gil-Diaz, 2008).
Credit risk management is one of the significant risk
management practices of rural banks by the nature of their activities. Through
effective management of credit risk exposure, rural banks not only support the
viability and profitability of their own business but also contribute to
systemic stability and to an efficient allocation of capital in the economy
(Psillaki, Tsolas, & Margaritis, 2010, p.873). “The default of a small
number of customers may result in a very large loss for the bank” (Gestel &
Baesems, 2008, p. 24).
In order to minimize loan losses as well as credit risk, it
is crucial for rural banks to have an effective credit risk management system
in place (Santomera 1997; Basel 1999). Derban, Binner and Mullineux (2005) on
information theory recommended that borrowers should be screened especially by
banking institutions in form of credit assessment. As a result of asymmetric
information that exists between banks and borrowers, banks must have a system
in place to ensure that they can do analysis and evaluate default risk that is
hidden from them. Information asymmetry may make it impossible to differentiate
good borrowers from bad ones (which may culminate in adverse selection and
moral hazards) have led to huge accumulation of non-performing accounts in
banks (Bester, 1994).
Effective credit risk management system involves establishing
a suitable credit risk environment; operating under a sound credit granting
process, maintaining an appropriate credit administration that involves
monitoring, processing as well as enough controls over credit risk (Greuning
& Bratanovic 2003). Rural banks that have higher loan portfolio with lower
credit risk improve on their profitability. Angbazo (1997) stressed that rural
banks with larger loan portfolio appear to require a higher net interest margin
to compensate for a higher risk of default.
Cooper, Jackson, and Patterson (2003) adds that variations in
credit risks would lead to variations in the health of banks’ loan portfolio
which in turn affect bank performance. Meanwhile, Ducas and McLaughlin (1990)
had earlier argued that volatility of bank profitability is largely due to
credit risk. Specifically, they claim that the changes in bank performance or
profitability are mainly due to changes in credit risk because increased
exposure to credit risk leads to a fall in bank performance and profitability.
The bank of Ghana credit manual for rural banks maintains
that credit facilities may be granted for the purpose of conducting or carrying
on, developing or improving farm, fishing, and commercial operations to benefit
the community. It continues that credit facilities may also be extended to
maintain the efficiency of eligible borrowers in connection with their health,
education and subsistence. Writing on the importance of the lending as a
function of rural banks, Crosse and Hempel (1980) argued that, traditionally
and practically, the foremost obligation of a rural bank is to supply the
credit need of individuals and business enterprises.
Affirming this stance, Rose and Korari (1995) touched on its
significance of the quantitative contribution of lending to the bank income, as
well as the important role it plays in the social function that rural banks
perform in the economy.
For a full realization of the above benefit, the bank’s first
type or forms of credit is a loan. The second type is the overdrafts. This is
the amount a customer is allowed to overdraw over and above his or her normal
deposit with the bank. Interest is charged only to the excess amount. All these
points above come to support the fact that credit risk management is very
important to the survival of rural banks as well as their customers. If the
risk associated with lending is greatly reduced, the banks will be relieved of
the burden of carrying and using part of their profits to pay off bad debts and
the interest of banks in granting credit will rise thereby bringing down the
interest on loans and other forms of credit.
In the case of rural banks in the western region of Ghana,
the issue of credit risk is even of a greater concern because of the higher
levels of perceived risk resulting from the growing city and business because
of the oil-find as well as behaviour of customers and the type of risky
business activities they finance. It has thus become relevant to assess the
credit risk management on the performance of rural banks in Sekondi-Takoradi.
Statement of the Problem
Banking institutions are very important in any economy; their
role is similar to that of blood arteries in the human body since banks pump
financial resources for economic growth from the depositories to where they are
required. Many researchers have proposed that banks are the key providers of financial
information to the economy. They play even a more critical role in emerging
economies where borrowers have no access to capital markets (Greuning &
Bratanovic, 2003). Lending has been, and still is, the mainstay of banking
business, and this is truer to emerging economies like Ghana where capital
markets are not yet well developed.
To most of the developing economies, however, and Ghana in
particular, lending activities have been controversial and very difficult. This
is because business firms especially Small and Medium Scale Enterprises (SMEs)
on one hand complain about lack of credit and the excessively high standards
set by banks while banks, on the other hand, have suffered large losses on bad
loans (Tschemernjak, 2006).
Rural Banks in Ghana have the primary motive of enhancing the
financial welfare of their clients by granting them several types and forms of
loans that are available on their desks. However, financial institutions are
faced with the problem of employees’ turnover in an attempt at redeeming their
loans granted to their clients (Kwafo, Amenyo, Opuni, Arthur &
Nuhu-Appiadu, 2013). Many clients do migrate and change their jobs without
informing these financial institutions, which makes it very difficult for the
financial institution in question to trace them when they default in the
payment of their loans.
This situation of job insecurity gives a headache to
financial institutions after granting loans to their clients. One of the most difficult
situations and exercises for financial institutions is the cost of monitoring
their clients after providing them with their requested loans. It falls on the
shoulders of some financial institutions to do a follow-up monitoring whether
the loans granted to their clients are used for their intended purposes (Kwafo,
Amenyo, Opuni, Arthur & Nuhu-Appiadu, 2013).
It also costs financial institutions to trace loan defaulters
especially when they are difficult to be traced because of the informal
settlements and difficult contacts of these clients. This results in high
operational expenses by financial institutions (Krakah & Ameyaw, 2010). The
bank has specific conditions with which they give out loans to their clients
for the intended use. However, a number of these clients veer off from the
particular reason why they were given the facility.
Some go to extent of using it for their personal benefit and
not what the loan was acquired for.
To this end, it has been found out that in order to minimize
loan losses and hence credit risk, it is essential for banks to have an
effective credit risk management system in place to combat the evolution of
credit risk problems (Basel, 1999; Santomero, 1997). In Ghana, banks and
non-bank financial institutions face a lot of problems in granting credit to
Small and Medium Enterprises (credit risk). Over the years, there have been
persistent complaints by the private sector of a squeeze in credit.
There have been some policy interventions such as the Basel
II//III which have established a credit risk management framework for banks.
Such policies and procedures including; Know Your Customer (KYC), Credit Bureau
Referencing (CBR) and the Borrowers and Lenders ACT (2008) introduced by the
Central Bank of Ghana. Locally, banks are expected to operate within this
framework but in practice, Rural and commercial banks have their specific
credit risk areas of interest. Some focus on asset-based lending; some on the
cash flow from the borrowers’ business operations; while others make clean
lending (i.e. lending without underlying security) (Pricewaterhouse, 2013).
Furthermore, the banking industry sensitivity to credit risk
is because banks’ significant income is generated from credit given to their
customers. This credit creation process exposes the banks to high credit risk
which sometimes lead to losses. Saunders and Cornett (2005), asserts that the
very nature of the banking business has become so sensitive because more than 85% of
their liability is in form of deposits. Banks use these deposits to generate
credit for their borrowers, which in fact is a revenue-generating activity for
most banks. Banks must thus, create credit for their clients to make some
money, grow and survive stiff competition at the marketplace.
Non-performing loans still remain a high phenomenon in the
Ghanaian banking industry. In spite of the efforts by the Bank of Ghana to encourage
rural banks to manage their risks to acceptable levels, percentage of
non-performing loans is still on the higher side. According to the Monetary
Policy Committee of the Bank of Ghana, Non-Performing Loans (NPL) ratio
deteriorated from 17.6% in December 2010 to 36.17% between February 2016 (BoG,
2017); with most banks having written-off huge loans since the global financial
crisis, (Price Water House Coopers, 2012). This arising from credit risks.
There are a number of studies in Ghana on the effects of
credit risk on banks performance. Krakah and Ameyaw (2010) examined the drivers
of banks profitability using Lower Pra Ltd and Merchant Bank Ltd. They found
interest-bearing liabilities (loans), non-interest expense, bank’s capital
strength, total assets, growth of money supply, and annual rate of inflation as
significant drivers of banks profitability. Given the fact that there are about
27 banks in Ghana, a generalization of the result on the sector could be
misleading.
Mills and Amowine (2013) also studied the determinants of
Rural and Community Banks’ (RCBs) financial profitability using a secondary
data of 26 Rural and Community Banks for the period 2002 to 2011. Given
the varied characteristics (such as credit risk, loan portfolios among others)
between Rural and Community Banks and the Deposit Money Banks (DMBs), there is
the need for a study in this regard.
The current study sought to analyse the credit risk appetite,
major credit policies, credit risk management systems and procedures to be able
to know clearly what happens in the credit functions of rural banks.
Furthermore, credit Risk Management in today’s deregulated market is a big
challenge. Increased market volatility and domestic banking sector competition
has brought even loosening of the credit system. Hence the need for a serious
interest in credit risk management, specifically the case study of Rural Banks
to assess the practices and Bank’s profitability and performance.
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