ASSESSING THE CREDIT RISK MANAGEMENT PRACTICES AMONG RURAL BANKS IN THE TAKORADI METROPOLIS

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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Item Type: Ghanaian Postgraduate Material  |  Attribute: 99 pages  |  Chapters: 1-5
Format: MS Word  |  Price: GH110 ($20)  |  Delivery: Within 30Mins.
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