Investigate The Management Of Credit Risk In Financial Institutions In Ghana

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Abstract

The purpose of this study is to identify the challenges financial institutions and customers of those financial institutions go through in obtaining credit and loan facilities and their repayment. Financial institutions are increasingly facing credit risk in various financial instruments other than loans, including acceptances, trade financing, foreign exchange transactions, financial futures, options, bonds, equities, swaps and in the extension of commitments and guarantees.. This study uses Ghana Commercial Bank as a case study with particular reference to the Risk Department. Credit risk management in a financial institutions starts with the establishment of sound lending principles and an efficient framework for managing risk. Policies, industry specific standards and guidelines, together with risk concentration limits are designed under the supervision of risk management committees and departments. The findings may be useful in strengthening the credit practices of Ghana Commercial Bank Limited and other financial institutions in the country Ghana. Keywords: Credit risk management, financial institutions, financial instruments

CHAPTER 1

BACKGROUND OF THE STUDY

1.1 GENERAL INTRODUCTION

The purpose of this study is to investigate the management of credit risk in financial institutions in Ghana. The study will be basically approached descriptively, as it aims to present descriptive and sound evidence representative of Ghana Commercial Bank Limited. This study will be based on quantitative research and data. The purpose of this study will be explained further as the study progresses, along with the list and explanations of the study’s problems and objectives, the hypothesis and other details about the methods it will use.

However, it briefly presents and discusses the background of the study. Credit risk management in a financial institutions starts with the establishment of sound lending principles and an efficient framework for managing risk. Policies, industry specific standards and guidelines, together with risk concentration limits are designed under the supervision of risk management committees and departments.

Credit risk, also known as counterparty risk is the risk of loss due to a debtor’s non-payment of a loan or other line of credit (either the principal or interest (coupon) or both). Also, credit risk is most simply defined as the potential that a loan borrower or counterparty will fail to meet its obligations in accordance with agreed terms. In most banks, loans are the largest and most obvious source of credit risk. However, other sources of credit risk exist throughout the activities of a bank.

They include activities in the banking and trading books, and those both on and off the balance sheet. Banks are increasingly facing credit risk or counterparty risk in various financial instruments other than loans. These include bankers’ acceptances, interbank transactions, trade financing, foreign exchange transactions, financial futures, swaps, bonds, equities, options and the settlement of transactions. Credit risk analysis (finance risk analysis, loan default risk analysis) and credit risk management are important to financial institutions which provide loans to businesses and individuals.

Credit can occur for various reasons: bank mortgages (or home loans), motor vehicle purchase finances, credit card purchases, installment purchases, and so on. Credit loans and finances have the risk of default. To know the risk level of credit users, credit providers normally collect vast amount of information on borrowers. Statistical techniques can be used to analyze or determine risk levels involved in credits, finances, and loans, thus default risk levels.

While 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, lack of attention to changes in economic factors (interest rates, inflation rates, etc.) In recent times, the flow of credit in global financial markets has slowed from a glacial pace to a virtual standstill and credit markets threaten to stay that way despite immense amounts of cash being pumped into various economies by their governments and central banks around the world.

Credit risk is a problem faced by banks all over the world and the question mostly asked is “what will it take for banks to regain enough confidence in the financial system to get credit markets moving again?” Research Journal of Finance and Accounting www.iiste.org ISSN 2222-1697 (Paper) ISSN 2222-2847 (Online) Vol.5, No.23, 2014 68

1.2 PROBLEM DEFINITION
A look at the Auditor –General’s report in recent years in Ghana raises serious concerns about how banks manage the credit (loans) they issue out to customers with particular emphasis on the loans they give and how effectively they manage to recover such loans when the time is due. Most of these financial institutions have departments which supervise the issuing and recovery of loans. However, there are still gross financial improprieties going on in these areas.

One would ask whether it is a problem of incompetent personnel, or is it a question of their independence that is hampering their effective operation or the blame should be fully apportioned to customers and beneficiaries who deliberately fault when it comes to the repaying of credit facilities they have enjoyed. Most of these credit risk improprieties have adverse effects on many economies.

This is evident by the low liquidity rate, low capital reserve of most of our financial institutions and the subsequent weak nature of our economy; the credit crunch plagued economy we are witnessing today. It has come to the realization of the central bank and most financial institutions that there is the need for effective credit risk management in financial institutions in Ghana. Solving these problems noted above will help ensure good corporate governance.

The main problem we are interested in, is to know ‘The extent to whichfinancial institutions in Ghana have been managing the credit facilities issued out to its customers and membersof the public’, with Ghana Commercial Bank Limited as the focal point. This study will delve into these matters comprehensively.

1.3 OBJECTIVES OF THE STUDY

The main objective of the study is to have a bigger picture of how Ghana Commercial Bank Limited manages its credit risk. Thus the study is to, • Ascertain the extent to which Ghana Commercial Bank Limited manages their credit risk, the models and practices adopted by this financial institution to manage its credit risk and what tools and equipments are at their disposal.

• Examine the types of loans issued at Ghana Commercial Bank Limited
• Know if higher interest income in Ghana Commercial Bank Limited can also lead to lower bad loans.
• Ascertain the type of committees that approve the different category of loans in Ghana Commercial Bank Limited.

1.4 HYPOTHESES.

The hypotheses to be investigated by the study are:

• There is an inverse relationship between interest income and defaulted loans in Ghana Commercial Bank Limited.
• Different levels of committees approve different loans at Ghana Commercial Bank Limited.

1.5 RESEARCH QUESTIONS

In the course of the study, we shall answer these important questions.

• What steps does Ghana Commercial Bank Limited take in retrieving its bad loans?
• Does high interest rate in Ghana Commercial Bank Limited reduce bad loans?
• What types of loans are issued at Ghana Commercial Bank Limited?
• How does Ghana Commercial Bank Limited determine when a loan has been defaulted?

1.6 IMPORTANCE OF THE STUDY

This study is a step in the right direction as it comes at the time when there is a public outcry against financial mismanagement and the failure of many debtors of various financial institutions to honor their obligations thus, paying monies they have enjoyed from these financial institutions as a result of loans granted to them for various reasons.

The recent financial crisis that have engulfed the globe should give us cause to worry about how our various financial institutions plan and take steps to recover loans granted out. This study will add to existing knowledge and contribute to the building of literature on this topic. Also, the hypothesis would help examine the effectiveness of risk management departments and the processes in granting of credit (loans, etc) in Ghana.

This study will  especially be useful to customers and other stakeholders in the corporate world who have interests either directly or indirectly with banks. It will give an insight into how management is offering quality for their assets and how they are maintaining the health of the business through their risk intermediation function. Research Journal of Finance and Accounting www.iiste.org ISSN 2222-1697 (Paper) ISSN 2222-2847 (Online) Vol.5, No.23, 2014 69

1.7 LIMITATIONS OF THE STUDY

The prime challenge was in the area of finance as the financing of this study involved a lot when it came to the visiting of the various branches, the printing of questionnaires, resources used in the surveys amongst others. Also, the researcher was heavily constrained by the time available for the completion of the research. The researcher intended to visit many branches in the Accra metropolis but due to the busy nature of most of the banks’ branches and members in the risk department, data collection was delayed. Also, due to the scanty nature of relevant literature on the credit activities of Ghana Commercial Bank Limited foreign documentation was also relied on as part of information needed for the study.

However, these limitations in their entirety did not reduce the accuracy of the findings since several measures were put in place to ensure that relevant facts were reached. Several statistical measures such as increasing the sample size of the data collected in years (annual reports) to reduce the sampling error to an appreciable level was included.

1.8 ORGANIZATION OF STUDY

The study is organized in five chapters which are as follows;

• Chapter One: Background of the Study
• Chapter Two: Literature Review
• Chapter Three: Methodology
• Chapter Four: Data Analysis of Research Findings
• Chapter Five: Summary and Recommendations

The first chapter covered the background to the study, thus a general introduction, problem definition, and objectives of the study. It also entails the hypotheses statement, research questions, the importance and limitations of the study.

Chapter Two is entirely on the literature review. This chapter contains reports and reviews made by people and firms on credit risk management including the gaps and loopholes identified in their reports and reviews. The chapter concludes with an assessment of how this study fills the gaps that has been created by the study of others.

Chapter Three and Four are respectively on the methodology and research findings and analysis of the data gathered. The methodology contains the general construction of ordinary least square regression from which our hypothesis will be tested. The fourth chapter is on the analysis of our research findings and data gathered during the study. Chapter Five is the summary of findings of the study, conclusion, useful suggestions and recommendations to the research findings made and avenues for further study by other researchers.

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