DETERMINING THE CAUSES AND EFFECTS OF NON-PERFORMING LOANS ON

BANKS AND MFI’s IN GHANA. CASE STUDY OF FIRST ATLANTIC BANK AND

SINAPI ABA.
TABLE OF CONTENTS
1.0 BACKGROUND ..................................................................................................................... 1
2.0 PROBLEM STATEMENT. ...................................................................................................... 3
3.0 RESEARCH OBJECTIVES ..................................................................................................... 5
3.1 RESEARCH QUESTIONS .................................................................................................. 6
4.0 LITERATURE REVIEW ......................................................................................................... 6
4.1 EMPIRICAL REVIEW ........................................................................................................ 6
4.2 THEORITICAL REVIEW.................................................................................................... 8
5.0 METHODOLOGY ................................................................................................................. 11
6.0 SIGNIFICANCE OF RESEARCH ......................................................................................... 11
7.0 RESEARCH PLAN ................................................................................................................ 12
8.0 REFERENCES ....................................................................................................................... 13
1.0 BACKGROUND

A country with an efficient banking system and a well-developed banking industry is an advantage

to its financial and economic progression (Schaeck & Cihák,2014). The Financial Sector Strategic

Plan implemented in 2003 by the government of Ghana has seen the vast improvements in the

banking sector (Bawumia, 2010). There are various advantages that are enjoyed from the

implementation of these plans. Some includes, the restriction of financial institutions which are

failing and having in place a stricter and better regulatory and supervisory structures that have been

implemented (Bawumia, 2010). Other advantages which have been seen and enjoyed in the current

banking industry includes the rise in the number of banks which has resulted in the increase of

healthy competition among the financial institutions in Ghana. This competition between banks

has paved way for them to provide better credit deals ad facilities that caters for both short term

loans and long-term loans.

Unfortunately, the credit deals and facilities have resulted in a lot of non-performing loans. This

is a result of the customers who are unable to make payments on time or even make the payments

at all. The results of this is damaging to the financial institutions’ survival. It does not only affect

the banks in question only but also the general banking sector or industry of Ghana and the

economy in itself. Non- performing loans become a barrier to progress among the banking industry

and even small microfinance institutions. Banks are not able to manage their balance sheet

resulting in a domino effect of low profitability, disability to lend to more and for the bank or

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financial institution the possibility of not being able to raise more capital leading to its collapse

(Makri, Tsagkanos and Bellas, 2014).

One incident which has caused the breakdown in most financial institutions in not only Ghana but

in the whole world was the financial crisis that took over in 2007 (Campello, Graham and Harvey,

2010). The financial crisis led to the mounting of many non-performing loans which also led to

bad debts due to customer’s inability to pay back money lent. Non-performing loans have a long-

lasting effect on the financial institution and the advantages they enjoy (Borio, 2014). Studies

conducted by PricewaterhouseCooper in 2010 on the effects of non-performing on the banking

sector as well as the financial institution themselves shows that there is a decrease in the bank’s

ability to provide credit to their customers. In 2010, a survey conducted by PricewaterhouseCooper

revealed that at least 17.6% of outstanding loans which had been given out were considered non-

performing loans. This coupled with the rise in bad debts which had been recoded in the years

2008 and 2009 180.4% and 77.8%. these figures depict a high rise in the occurrence of non-

performing loans and bad debts in the banking sector. The consistent and gradual growth in no-

performing loans in Ghana has a bad effect on the profits enjoyed by the institutions and their

ability to liquidate as well as their growth. One important source of growth that banks enjoy has

to be their loans, as such inability to pay or perform can only mean that they will not be able to

gain capital and thus grow as necessary. First Atlantic Bank was started in Ghana in the year 1996

as Merchant Bank. It was granted universal bank status in 2011 by the Bank of Ghana. Since then,

they have committed themselves to provide top of the range banking services to businesses as well

as individuals in Ghana. Their services include corporate banking, SMS banking and business

banking just to list a few. The Purple experience is a hallmark that they follow to ensure their

customers are left satisfied with their services.

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Sinapi Aba savings and loans is a non-banking financial institution which under the non-bank

financial action Act 2008(act 774) have been authorized to carry out the business of savings and

loans in Ghana as of the year 2013. Their aim to support businesses and lives of individuals in the

country. Hand in hand with Sinapi Aba trust, they work together to transform the economic

situations of people in Ghana.

2.0 PROBLEM STATEMENT.

The gradual decline of quality in loan Payments in Ghana has led to many issues in the financial

sector and in the banking industry as a whole. It had also led to the collapse of some financial

institutions and the loss of jobs. Banks are constantly faced with the possibility of financial

instability and resistance in credit markets. In recent times, non-performing loans has received a

lot of attention in the past decades not only in Ghana but all over the world (Messai and Jouini,

2013, Karim, Chan and Hassan, 2010, Kauko, 2012, Skarica, 2014). A lot of the research

conducted points at the cause of this issue being the lack of quality assets (Barr and Siems, 1994,

Louzis, Vouldis & Metaxas, 2012). Non-performing loans accounts for the stationary and the

stunted growth in the banking industry (Fofack, 2005). With each loan failing to perform and

provide the needed returns for the company, they are driven slowly and gradually into an abyss of

unprofitability and failure.

Critical lowering and reduction in the number of occurrences in non-performing loans have a direct

impact in the consequent revival of a failing banking and financial industry. Economic growth will

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be assured, leading to good credit and the ability of banks to give out more loans to aid a failing

economy (Hou and Dickinson, 2007).

Non-performing loans generate no sort of income for the financial institution. Non-performing

loans can thus be described as loans which have been unpaid for a long period of time other than

stipulated in the loan agreement. The interest and principal have both been unpaid and unaccounted

for. Alton and Harzen (2001) also describe non-performing loans as loans which are past due, and

they are not crating any interest also. Thus, non- performing loans can be described as loans which

have not been paid for past the agreed time and have no possibility of accruing any interest in the

near future.

Several researchers have looked at the cause and effects of non-performing loan on the banking

sector indicating several causes such as poor state of the economy. In Ghana, various researchers

have studied the causes and effects of non-performing loans on banks and MFI’s. (Amuakwa-

Mensah and Boakye- Adjei, 2015; Arko, 2012; Addae-Korankye, 2014). Other studies conducted

simply seek to determine the causes and effects of non-performing loans on banks and MFI’s

separately, disregarding the link between these two (Richard, 2011, Skarica, 2014).

Recent reports from the Bank of Ghana indicates that non-performing loans have risen to over

GHS 8 billion as at April 2018 (Ashiadey, 2018) coupled with this is also the struggle for banks

to meet capital requirements of the central bank. This is very alarming and raises questions such

as what could be the main causes of the rate of growth in non-performing loans. And are banks

struggling to meet the capital requirements because of NPL’s.

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The purpose of this research is to find a link between the causes of non-performing loans and its

effect on banks and MFI’s in Ghana. Previous studies such as that of Alex Addai Korankye (2014)

have delved into the causes and control of non-performing loans and loan delinquency. The

recommendations from the study includes policies to determine clear policies and procedures for

banks when giving out loans to their customers. Also, Messai (2003), points to unemployment and

the depreciation of collaterals collected by the bank. Furthermore, Makri, Tsagkanos and Bellas

(2014) also point at certain macroeconomic variables such as unemployment, Gross Domestic

product growth rate and micro factors such as return on assets and return on equity were use studied

to determine which of these factors determined non-performing loans on an aggregate level. From

the aforementioned studies, none directly tackle link between the causes and its effects. The

previous studies concentrated on how to limit and control non-performing loans and which policy

best helps banks and MFI’s to limit NPL’s. By studying the link between the causes and effects,

this study will help to provide a more conclusive insight into effective remedies which will lead to

precise and efficient solutions to NPLS’s. Consequently, this study seeks to find the link between

the causes of non-performing loans and its effects on banks and MFI’s in Ghana.

3.0 RESEARCH OBJECTIVES

The main objective of the study is to determine the cause of non-performing loans and their effect

on Banks and MFI’s in Ghana.

The following are the research objectives

1. To determine the specific factors that cause non-performing loans.

2. To ascertain the impact of non-performing loans on Banks and MFI’s.

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 3. To determine the effects and solutions to non-performing loans in Ghana.

3.1 RESEARCH QUESTIONS

1. What are the specific factors that cause non-performance of loans?

2. What is the impact of non-performing loans on banks and MFI’s?

3. What are the effects and solutions to non-performing loans in Ghana?

4.0 LITERATURE REVIEW

4.1 EMPIRICAL REVIEW

Addae-Korankye (2014) analysed the causes and control of loan delinquency/default in

microfinance institutions in Ghana. Random sampling technique was used to select twenty-five

microfinance institutions and two hundred and fifty clients for the study. The study found the

causes of loan default to include; high interest rate, inadequate loan sizes, poor appraisal, lack of

monitoring, and improper client selection. Measures to control default were found to include

training before and after disbursement, reasonable interest rate, monitoring of clients, and proper

loan appraisal. It was recommended among others that MFIs should have clear and effective credit

policies and procedures and must be regularly reviewed.

Garmaise (2015) in his study "Borrower Misreporting and Loan Performance" found that

misreporting was most frequent in areas with low financial literacy or social capital. Incorporating

behavioral cues such as threshold effects into a risk assessment model improves its ability to

uncover delinquencies, though at a cost of mischaracterizing some safe loans.

Amuakwa-Mensah (2015) studied “Determinants of non-performing loans in Ghana banking

industry” Using panel regression model, the study found that both bank-specific variables (i.e.,

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previous year’s NPL, bank size, net interest margin (NIM), and current year’s loan growth) and

macroeconomic variables (i.e., previous year’s inflation, real gross domestic product (GDP) per

capita growth and real effective exchange rate) significantly affect NPLs in the banking industry.

Determinants of NPLs have been sorted into macroeconomic components, factors distinct to banks

and MFI's and factors that come as a result of debt crisis. NPLs and its associations with

macroeconomic exhibitions are grounded in hypothetical business cycle models with an

unequivocal job for money related intermediation (Nkusu, 2011). Normally, disparities in

budgetary control and supervision influence banks' conduct and risk administration practices

which are essential in clarifying cross-country contrasts in NPLs. The macroeconomic condition

definitely impacts borrowers' asset reports and their ability to assess and take care of debts.

Therefore, unfavorable financial stuns combined with surprising expense of capital and low

interests (Fofack, 2005) have been identified to cause NPLs. The high rise of NPLs is for the most

part credited to various components which macroeconomic unpredictability, terms of exchange

crumbling, high loan fee and unnecessary dependence on excessively extravagant between bank

borrowings (Clementina and Isu, 2014)

Sudden market changes are likewise observed as components which do represent NPLs. In this

manner, any sudden market change can influence deeply the amount of monies individuals can

afford to take out as loan and how much and how fast they will be able to pay it back to the financial

institution (Misra and Dhal, 2010). In an occasion that the market all of a sudden changes and costs

of things become more expensive because of lack or expanded interest, borrowers will have less

cash to satisfy their credits which can prompt defaults in payments of loans to banks. In Mexico,

the fall in the financial system due to the credit crunch can largely be ascribed to bad loans

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occurring in the country and by the financial institutions. it was realized that the banks in Mexico

were unable to provide more loans to people because they were saddled with too many bad non-

performing loans (Makri, Vasiliki, Athanasios Tsagkanos, and Athanasios Bellas, 2010).

4.2 THEORITICAL REVIEW

4.2.1 Loan Utilization Theory

The theory states that monitoring of loan utilization helps members to take their businesses

seriously and to avoid destroying the business by taking money from the business for their families,

Simanowitz (2000:129). This means: monitoring of loan utilization avoid unplanned usage of loan.

The monitoring also gives an early warning of problems which can then be dealt with.

4.2.2 Minimizing Ex-ante Moral Hazard Theory

Minimizing ex ante moral hazard theory states that, borrowers often have private information of

the amount of effort they exert in making their projects succeed or in the specific projects they

undertake using the borrowed funds Guttman, (2006). Borrowers for example may have a number

of alternative projects in which the borrowed funds can be invested.

4.2.3 Loan Portfolio Theory

Loan portfolio theory states that traditional objectives of maximizing returns for given levels of

risk or minimizing risk for given levels of return have guided effort to achieve effective

diversification of port folios, Markowitz (1959). Since the pioneering work of Markowitz (1959),

portfolio theory has been applied to common stocks. Elton and Gruber (2005) port folio theory is

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concerned with risk reduction when an investor switches from complete commitment on one asset

for example shares in one company or one project to the, position when resources are split between

two or more assets (baisi, 2008).

4.2.4 Liquidity Risk Theory

Liquidity theory states that risk arises when a project is not able to generate sufficient resources to

meet its liabilities or if an entity cannot meet payment when they fall due, Merna and Njiru (2002).

Difficult for the borrowers to payment for the loan if the business is not providing enough profit

for payment. Borrowing at low profit generation rate or selling assets at below market prices,

facing penalty payments under contractual terms.

4.2.5 Fraud Risk Theory

Fraud risk theory states that the primary sources of fraud in microcredit operations include

phantom loan, kickback schemes, bribes and non reporting of client repayments. Merna and Njiru

(2002) Such unethical behavior is not effectively directed by audits of paper traits as the loan

officer alone is responsible for generating and following through on loan disbursement and

recovery. Traditional audit procedures are ill equipped to detect this type of fraud because they do

not usually involve extensive client visits.

4.2.6 Loan Portfolio Testing Process Theory

Loan portfolio testing process theory describes the effective credit policies by listing the elements

of a credit policy. Simanowitz A. (2000), the theory explain the requirements for the borrowers of

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loan which is supposed to have so that to be given the loan, such as to meet members qualification,

should have repayment capacity, the loan size should be based on the business collateral and

previous loan, Interest rate, structure of fee and the action on delinquent loan.

4.2.7 Credit Development and Non-Performing Loans

In the most recent two decades, a noteworthy increment of credit development given by money

related establishments was recorded (Creel, Hubert and Labondance, 2015). This development is

ascribed to the deregulation procedure of money related markets and the advancement of data

innovations in the management of the financial market or industry, which prompted the

improvement of monetary intermediation (Cucinelli, 2015; Laura Rinaldi and Alicia Sanchis

Arellano 2006). Moreover, deregulation process fortified rivalry among banks (Vicente Salas and

Jesus Saurina 2003) both in local and other European markets. All the more particularly, rivalry

was expanded to an extensive and medium degree inside local and European financial institutions

(Makri, Vasiliki, Athanasios Tsagkanos, and Athanasios Bellas, 2014). Research into NPL'S has

found that, the rivalry between the financial institutions has expanded banks' credit hazard, i.e.

influencing their advance portfolios regarding awful advance screening strategies and loosening

up acquiring criteria (Jappelli, Tullio, Marco Pagano, and Magda Bianco, 2005; Wilko Bolt and

Alexander F. Tieman 2004; Sangjun Jeong and Hueechae Jung 2013). A standout amongst the

most well-known markers that is used to recognize credit hazard is the proportion of non-

performing loans (NPL). Since 2008, the time of the start of the worldwide money related crisis,

the levels of NPL have altogether expanded. Actually, as per research, the quantity of NPLs is

expected to increase in a great degree in the imminent years, influencing the liquidity and

gainfulness of banks and subsequently the monetary soundness of the banking system. Albeit

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significant endeavors were performed to control and lessen NPLs, it is still connected to bank

disappointments and budgetary emergencies, particularly in the time of the '90s.

5.0 METHODOLOGY

The study will be conducted from an explanatory perspective as it gives a researcher the

opportunity to provide more insight on a subject matter (Saunders, Lewis and Thornhill, 2009).

The study will make use of the survey strategy to collect data from respondents and purposive

sampling will be used to select them. This will always for respondents who comprehend the

questionnaire and the research topic to be selected for answering the questions. 115 respondents

will thus be selected as the sample size (Hair, Babin, Black, Anderson and Tatham, 2009). The

data collected will be analyzed using the Statistical Package for Social Science (SPSS V20).

6.0 SIGNIFICANCE OF RESEARCH

The financial aspects of the economy are very important to the betterment and progression of any

economy. Thus, this study will help to provide ways which the trend on non-performing loans in

Ghana can be stopped. It will also aid in determining the causes of these issues so as to prevent

them from reoccurring in the economy. The outcome of the research will help financial institutions

better understand how best to solve issues pertaining to non-performing loans. It will also add to

previous literature on MFI’s and provide a clearer perspective into the issue. The study will also

help MFI’s to provide better and more malleable terms of agreement when it comes to giving out

loans so as to avoid the rampant issues associated with non-performing loans.

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7.0 RESEARCH PLAN

The research will be presented in five chapters. Each chapter will aid in better understanding of

the study. The first chapter will contain the background of the research and also the problem

statement as well as the objectives and research questions. The second chapter will look at the

literature review. Relevant literature to the study will be reviewed both theoretically and

empirically. The third chapter contains the methodology of the study. The methodology states how

the data for the study will be collected and how it will be further analyzed and presented. The

fourth chapter will contain the tables and figures which will be used to explain the data collected.

The final chapter, chapter five, will contain the conclusion of the research, summary of the research

and recommendations which will be reached based on the conclusions which have been reached.

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