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PROJECT TOPIC: CREDIT RISK AND PROFITABILITY OF LISTED BANKS IN GHANA

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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.


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