ABSTRACT

The study sought to analyze the effect of credit management on financial performance of Adansi Rural Bank Ltd, Fomena, Ashanti. A descriptive research design was used for the study. Qualitative data was gathered in order to establish the relationship between credit risk and performance of Adansi Rural Bank Ltd, Fomena, Ashanti. The study collected data from Adansi Rural Bank Ltd staff from the period 2012 to 2016. The target population was the bank financial bankers, branch bankers and credit/loan officers in Fomena, Ashanti. The study was based mainly on both primary and secondary data which was collected from questionnaires sent to the bank mangers and from the annual reports of bank and it was presented using tables and charts. The study findings concluded that the credit risk had an inverse effect on performance in Adansi Rural Bank Ltd, Fomena, Ashanti. It was recommended that rural banks should put consideration on non-performing loans which increases credit risks thus decreasing the bank’s performance, they should have effective techniques of measuring and intimidating credit risk such as the use of ratios like non-performing loans ratios, liquidity and operational cost efficiency ratios, they should have effective and efficient strategies to manage credit risks which might increase the performance in rural banks.

 

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

The banking industry today plays a very important and significant role in the economic development of the country due to the variety of services and opportunities it provides for the populace and nation at large. Banks are distinguished from other types of financial firms because, they accept deposits and provide credit facilities to its clients. Thus Bossone, (2001) suggests that banks are special intermediaries since they have unique capacity to finance production by lending their own debt to agents that are willing to accept it. Banks manage liabilities, also lend money and thereby create bank assets.

Credit risk is the risk that promised cash flows from loans and securities and financial institutions may not be paid in full (Cornett (2003). Credit risk is recognized in today’s business as an integral part of good management practice. In its broadest sense, it entails the systematic application of management policies, procedures and practices to the tasks of identifying, analysing, assessing, treating and monitoring credit risks, (Bikker and Metzmakers, 2005; Buttimer,2001). Credit risk is important for the success of banks since they determine its performance, liquidity, solvency and quality of the loan portfolio. When rural bank bankers are aware of the effect credit risk towards performance, then they are bound to take care of their credit decision and adopt best credit risk mechanisms which will be good for the bank. The importance of credit risk is increasing with time because of some reasons like; economic crises and stagnation, company bankruptcies, infraction of rules in company accounting and audits, growth of off-balance sheet derivatives, declining and volatile values of collateral, borrowing more easily of micro finance institutions.

According to commercial-loan theory, also known as real bills doctrine, argues that rural banks have a problem described as liquidity-earnings dilemma. It states that if a rural bank wants to be a safe haven for all its depositors’ funds, it would simply hold all those funds in its safe as perfectly liquid assets; then whenever a depositor requested cash from the rural bank, the banker would simply open the safe and give the money back to the customer. This would ensure that there is no credit risk. However, this presents the problem that no earnings would be generated for the rural bank (Woolcock, 1999). On the other hand, agency theory developed by Jensen and Mackling, (1976) states that conflicts of interest resulting from principal agent relationships between rural bank’s owners and management, and between bank’s creditors and owners, are incurring agency costs to the bank’s as the credit risk of these agency conflicts is transferred to performance. While loan pricing theory states that if rural banks set interest rates too high, they may induce adverse selection problems because high-risk borrowers are willing to accept these high rates.

Ghana’s banking sector involves 43 registered and licensed rural banks providing banking and financial services to customers (CBG, 2014). The bank had assets worth KES: 223 billion as at June 2014 (CBG, 2014). Rural banks in Ghana play an important role in mobilizing financial resources for investment by extending credit to various businesses and investors, and are the oldest and most diversified of all financial intermediaries.  Rural banks have in the past 10 years made tremendous growth profits and asset growth. Rural banks like other business enterprises aim to earn profits and grow their balance sheet. They earn profits principally by obtaining funds at relatively low interest rates and then lending the funds or investing in securities at higher interest rates. The balance sheet of the bank means that sits assets indicates what the bank owns or claims that the bank has on external entities (individuals, firms, governments and other banks). A rural bank’s liabilities indicate what the bank owes, or claims that external entities have on the bank (Onkoba 2014).

 

1.2 Statement of the Problem

Good credit management systems result into increased performance due to reduced loan defaults. Thus management should adopt and practice prudent credit management so as to safeguard the assets of the bank. This suggests that better credit management generates income that is partly channeled to bank profits. On the other hand, if credit risk bankers put in place stringent measure which will bar many from borrowing the bank will be denied one of its main streams of income hence negatively affect performance (Mille, 1997).

The Central Bank Supervision Report (2005) on the Ghanaian banking system indicted that most banks that collapsed in the late 1990s were as a result of poor management of credit risks which were portrayed in the high levels of nonperforming loans. The liberalization of the Ghana banking industry in 1992 marked the beginning of intense competition among rural banks in Ghana, which saw banks extend huge amounts of credit with the main objective of increasing performance. Due to extending huge amounts of credit, many of the bank have failed, this is because there have been many loan defaulters, poor management techniques and high competition in banking industry. Rural banks have been offering high quality loans, medium quality loans and low quality loans. The qualitiness of loans is in terms of their returns generation to the bank. The low quality loans led to high level of non-performing loans and subsequently eroded profits of banks leading to some rural banks failing to meet their objectives. Despite the efforts made to address poor credit management, rural banks still have difficulties resulting from the credit management processes undertaken and changes in customer base leading to decreasing performance. The banking industry recognizes that rural banks need not engage in business in a manner that unnecessarily imposes risk upon it; nor should it absorb risk that can be efficiently transferred to other participants. Li yuqi (2007) examined the determinants of banks performance and its implications on credit risk in the United Kingdom. The study employed regression analysis and found that liquidity and credit risk have negative impact on bank’s performance.

Buttit (2010) carried out a study with the aim of establishing the relationship between credit risk and performance of micro finance institutions in Ghana. Data was analysed using simple linear regression analysis. The ranking of each MFI based on credit risk it adopts was then compared with its financial performance using the simple linear regression model. The findings of the study showed that credit risk was extremely important since it gives assurance about the reliability of the operations and procedures being followed.

Oretha (2012) did a study on the relationship between credit risk and financial performance of bank in Liberia. The researcher found that there was a positive relationship between credit risk and the financial performance of bank in Liberia. All of the above studies did not include management strategies of managing credit risk of bank as an explanatory variable to measure rural banks’ financial performance(performance). This study therefore sought to fill this gap by including management strategies of managing credit risk among other measures such as operational cost efficiency ratio, liquidity ratios and nonperforming ratios to establish the relationship between credit risk and performance of Adansi Rural Bank Ltd, Fomena, Ashanti. In addition, no convincing study has been done on the credit risk identification, monitoring and evaluation relating to financial performance in Adansi Rural Bank Ltd, Fomena, Ashanti. Taking into consideration of this evaluation, there comes a gap in literature that warrants a research to be conducted in this industry. Therefore, this research tends to cover the gap.

 

1.3 Objectives of the Study

The aim of the study is to establish the effect of credit risk on the financial performance of Adansi Rural Bank Ltd, Fomena, Ashanti.

 

1.3.1 Specific Objectives

The following strategically designed objectives guided the study:

1. To find out the effectiveness of bank bankers in managing and identifying credit risk. ii. To establish whether the strategies of managing credit risk have an effect on the financial performance.

• To analyse how the management challenges of credit management affect the financial performance.

1. To find out the perception of bank bankers towards controlling and managing credit risk.

 

1.4 Research Questions

The study aimed at answering the following questions:

1. What is the effectiveness of bank bankers in managing and identifying credit risk?
2. Are the strategies used by bankers in managing credit risk have an effect on the financial performance?
3. How are the management challenges of credit management affect the financial performance of bank?
4. What kind of perception does the bank bankers have towards controlling and management of credit risk?