AGYAKWA KUSI SENIOR.Pdf

KWAME NKRUMAH UNIVERSITY OF SCIENCE AND TECHNOLOGY

KUMASI

COLLEGE OF ARTS AND SOCIAL SCIENCES

DEPARTMENT OF ACCOUNTING AND FINANCE

SCHOOL OF BUSINESS

THE EFFECT OF LOAN DEFAULT ON THE PROFITABILITY OF COMMERCIAL

BANKS IN GHANA

AGYAKWA KUSI SENIOR. (BA. ECONOMICS)

(PG9613313)

A thesis submitted to the Department of Accounting and Finance, Kwame Nkrumah

University of Science and Technology in partial fulfilment of the requirements for the

degree of

MASTERS OF BUSINESS ADMINISTRATION (FINANCE OPTION)

JULY, 2015

DECLARATION

I hereby declare that this submission is my own work towards the Masters of Business

Administration (Finance Option) Degree and that, to the best to my knowledge, it contains no material previously published by another person nor material which has been accepted for the award of any other degree of the University, except where due acknowledgement has been made in the text.

Agyakwa Kusi Senior ………………………………… …………………

(PG9613313) Signature Date

Certified by:

Michel Adusei ………………………………... ………………..

Supervisor Signature Date

Certified by:

Dr. K.O. Appiah ………………………………. ………………..

Head of Department Signature Date

ABSTRACT

The focus of this study was to ascertain the effects of loan default on the profitability of commercial banks in Ghana. Secondary data in the form of end of year financial statements from 2007 to 2014 was acquired from four commercial banks in Ghana (UT bank, Ecobank, CAL bank and Fidelity bank,. The Ordinary Least Square regression was employed to estimate the effect of loan default on profitability. It was discovered from the

OLS results that, loan default, cost income ratio, total revenue and liquidity ratio were statistically significant. The liquidity risk was not statistically significant. Loan default and cost income ratio had a negative influence on the profitability whereas total revenue and loan recovered had a positive effect on profitability. The study recommends that securities or collaterals must be perfected before an advance is approved to ensure that in the event of default, the bank would not have any impediments in realizing the security.

DEDICATION

I dedicate this work to my Parents, Mrs. Comfort Adomako and to all my Siblings for the prayers and encouragement. God Bless you.

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ACKNOWLEDGEMENT

I wish to express my sincere gratitude to God Almighty for preserving my life through this period and making this research a success. To Him be the Glory and Honour. Amen!

I am grateful to Mr. Michael Adusei my supervisor for his valuable counsel and guidance towards the successful completion of this study.

Finally am also thankful to my Mum and Dad and all my Siblings for their support in prayer and encouragement. The same goes for all my friends and well-wishers. God be with you all.

TABLE OF CONTENTS

DECLARATION ...... i ABSTRACT ...... ii ACKNOWLEDGEMENT ...... iv LIST OF TABLE ...... vii CHAPTER ONE ...... 1 1.0 INTRODUCTION ...... 1 1.1 BACKGROUND TO THE STUDY ...... 1 1.2 STATEMENT TO THE PROBLEM ...... 2 1.3 OBJECTIVES TO THE STUDY ...... 3 1.4 RESEARCH QUESTION ...... 3 1.5 SIGNIFICANCE TO THE STUDY ...... 3 1.6 SCOPE TO THE STUDY ...... 4 1.7 ORGANIZATION TO THE STUDY ...... 4 CHAPTER TWO ...... 5 LITERETURE RVIEW ...... 5 2.0 INTRODUCTION ...... 5 2.1 OVERVIEW OF THE GHANAIAN BANKING INDUSTRY ...... 5 2.2 MEANING OF LOAN DEFAULT ...... 7 2.3 CAUSES OF LOAN DEFAULTS ...... 8 2.4 How Macroeconomic Variables Contributes to Loan Default ...... 9 2.5 WAYS OF REDUCING LOAN DEFAULT ...... 12 2.6 LOAN ADMINISTRATION PROCESS TO REDUCE LOAN DEFAULT ...... 13 2.6.1. CREDIT ANALYSIS ON LOAN ...... 13 2.6.2 MONITORING OF LOANS ...... 15 2.7. LENDING ...... 16 2.8 PRE-LENDING INFORMATION ...... 19 2.9 OTHER FACTORS TO CONSIDER WHEN LENDING MONEY ...... 21 2.9.1 INTEREST RATES ...... 21 2.9.2 SECURITY ...... 23 2.9.3 MONITORING OF LOANS ...... 24 2.10 CLASSIFICATION OF LOANS ...... 25

2.11 LOAN PROVISIONING ...... 27 2.12 COMPETITION IN THE BANKING INDUSTRY ...... 28 2.13 EMPIRICAL REVIEW OF EFFECT OF LOAN DEFAULTS ON PERFORMANCE OF BANKS ...... 29 2.14 THEORETICAL REVIEW OF LOAN DEAFAULTS AND FINANCIAL PERFORMANCE .... 32 2.14.1 THE MORAL HAZARD THEORY ...... 32 2.14.2 ADVERSE SELECTION THEORY ...... 33 CHAPTER THREE ...... 35 METHODOLOGY ...... 35 3.1 INTRODUCTION ...... 35 3.2 Research Design and sampling Technique ...... 36 3.6 Data Collection Instrument ...... 36 3.7 Data Analysis ...... 36 3.7.1Estimating the Effect of Loan Default on Financial Performance ...... 37 3.7.2 The generalized functional form is specified as; ...... 37 3.7.3 Empirical Model for the study is specified as; ...... 37 Table 3.1 Description of Variables ...... 37 DATA PRESENTATION, ANALYSIS AND DISCUSSION ...... 38 4.0 INTRODUCTION ...... 38 4.1 PRESENTATION OF RESULTS ...... 38 Table 4.3: OLS Results for the Effect of Default Loans on Bank’s profitability (Dependent: Return on Equity (ROE) ...... 41 CHAPTER FIVE ...... 46 FINDINGS, CONCLUSIONS AND RECOMMENDATIONS ...... 46 5.0 INTRODUCTION ...... 46 5.1 SUMMARY OF FINDINGS ...... 46 5.2 CONCLUSIONS ...... 47 5.3 RECOMMENDATIONS ...... 47 REFERENCE ...... 49 APPENDIX 2 ...... 56 APPENDIX 3 ...... 57 APPENDIX 4 ...... 60

LIST OF TABLE

Table 2.1 Provisions required for various classifications of loans…………………………….27

Table 3.1 Description of Variables……………………………………………………………37

Table 4.1 OLS Results for the Effect of Default Loans on Bank‟s Financial

Performance (Dependent: Return on Equity (ROE)……………………………………..38

Table 4.2 Variance Inflation Factor Results……………………………………………………39

Table 4.3: Correlation Matrix Results…………………………………………………………...40

Table 4.4: OLS Results for the Effect of Default Loans on Bank‟s profitability (Dependent:

Return on Equity (ROE)…………………………………………………………….41

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CHAPTER ONE

1.0 INTRODUCTION

1.1 BACKGROUND TO THE STUDY

Loan default according to Balogun and Alimi (1990), simply defined loan default as incapability of someone to fulfil his loan obligation as at when due. In the same way the inability to pay a debt when due as stipulated in a contract,

Oxford Advance Dictionary defines default as, “the inability to do something that must be done by law, especially paying a debt”. ”According to the central Bank of Ghana, the rate of loan default has increased significantly over the two years from 2009 to 2010, with a variance or an increase of 1.4 percent which constitute non-performing loans leading to profit deterioration”.

”The central bank of Ghana monetary policy committee (MPC) report on the economy indicated that the Non-performing ( NPL) ratio deteriorated from 16.2 percent December 2009 to 17.6 percent as at December 2010, consequently , most projects executed by contractors has led to a high indebted to banks , due to the inability to repay back .when this happen banks are not solvent enough and hence face liquidity problem . Banks experienced a sound financial indication in the last quarter of the year 2010. Similarly, access to credit also experienced an improvement in January 2011 according to banking sector development report”. Credits were made available by commercial banks to SMEs and large enterprises.

The outcome showed a fundamental improvement in credit allocation to both the individuals and households and enterprises. However, credit facilities for mortgage were sealed through an additional requirement which is collateral. ”In 2011 Mr. D.K. Mensah an Executive Secretary

with good standing at Ghana Bankers Association explained his worries on the bad trending high rate of non-performing loans. This was so because loan default automatically raises the level of cost for financial institution and sometimes banks are not able to recoup their loans given, thereby leading to a collapsed of most or several financial institutions.” Hence commercial banks must review their policies on loans, as well as having a strong. Internal control system, in effect this study seeks to analyse and assess the loan administration and default in commercial banks.

1.2 STATEMENT TO THE PROBLEM

According to (Aballey, 2009). the largest asset and major source of income for banks comes from loan portfolio Regardless of the income involved in this loan portfolio, literature has shown that large portions of these loans do not go well and consequently affects the performance of these banks. Loan defaults have brought a great impediment to commercial banks in Ghana.

These banks are suffering due to clients inability to do due diligence whenever they take loans from these banks. In Ghana, the banking industry plays a very important role in the economy.

They provide loans to potential investors and entrepreneurs to start their business. Therefore huge bad loans could affect the bank‟s profitability.

Ironically, causes and effects of loan defaults on the profitability of commercial banks does not have many academic study. With the above, the causes and effect of profitability is eminent.

This is what inspired the researcher to embark on the journey of finding out the causes and effect of loan default on banks profitability and to find appropriate remedies to prevent them. Banks have been struggling for years to find remedies to these problems. Since the loan is what gives them more income, it is difficult to stop giving out loans. There is the need to know why customers do not pay their loans as promised and the solutions to that problem, (Aballey, 2009).

1.3 OBJECTIVES TO THE STUDY

The main objective of this study is the effects of loan defaults on the profitability of commercial banks in Ghana.

The specific objectives of the study are;

1. To identify relationship between loan default and profitability of commercial banks and

2. To ascertain the impact of loan default on the profitability of these commercial banks in

Ghana.

1.4 RESEARCH QUESTION

1. What is the relationship between loan default and profitability of commercial banks?

2. What is the impact of loan default on profitability of commercial banks?

1.5 SIGNIFICANCE TO THE STUDY

The motivation for this research study is to have a practical overview of loan defaults among financial institutions and investigate the effect of loan default in the Ghanaian Banking Industry.

This is very important in the spate of the surge in non-performing loans in the Ghanaian banking industry in recent times which is not a debacle only to banks but regulators alike. In Ghana and

Africa, there have been limited studies on loan defaults in banks in particular, the reason being that, developing nations such as Ghana suffer from the absence of information on relevant data.

Other factors could be lack of skilled scholars from nations who are interested in undertaking project work. Generally, this study is expected to increase our knowledge of the significance of

loan defaults in developing countries and add to the limited literature available in Ghana. In addition, the research will help to suggest alternatives to improve the operation of financial institutions in Ghana.

The study will also bring to the fore the extent of bad debts suffered by banks in Ghana, and the result of non-payment of loans on the bank‟s profitability. This is also expected to throw light on the weaknesses in the lending practices adopted by the banks to guide policy makers.

1.6 SCOPE TO THE STUDY

This study focuses on Commercial Banks in Ghana. The specific banks of interest will be: CAL

Bank, Fidelity Bank, UT Bank and Ecobank. These banks were chose because they are performing well in Ghana and also they all give out loans.

The main work will be on loan defaults in Commercial Banks as reported by financial statement of these banks. The period of study will be from 2007-2014 for various types of loans across each bank.

1.7 ORGANIZATION TO THE STUDY

The study consists of five chapters. Chapter one looks at the introduction, statement of the problem, objectives of the study, research questions, significance of the study, scope of the study, limitations of the study area and chapter organization. Chapter two gives the review of available literature on the researched topic. Chapter three looks at the methodology used in these studies to achieving the research objectives. Chapter four looks at the data presentation and analysis. Chapter five also present a summary of discussions looked at in the research work as well as the empirical and theoretical conclusion and recommendations made.

CHAPTER TWO

LITERETURE RVIEW

2.0 INTRODUCTION

This chapter focuses on the review of relevant literature on effects of loan defaults and other core aspects of the topic under study.

2.1 OVERVIEW OF THE GHANAIAN BANKING INDUSTRY

Banking has in modern times experienced a remarkable growth in all sectors with the commercial savings and loans sector been the busiest, fastest and the most dynamic. “According to the Ghana Banking Survey (2011), the financial sector is well exploited, very liquid, advantageous and experiencing a strong asset growth. Financial sector strength is a priority to the central bank of Ghana. Indeed, the growth in commercial banks was led by increase in deposit mobilization and credit, the system is becoming gradually sounder, due to determined regulation, significant technological advances in the sector and more prudent risk management by commercial banks. These trends offer good prediction despite the persistent challenges like high cost of borrowing, credit risk, market risk, operations risk and liquidity risk to a larger extent. Interest income continues to comprise the most significant component of income derived from operations though in recent years, interest margins are steadily decreasing as struggle becomes strong”. The central bank of Ghana supervises all commercial banks in the Ghanaian economy.

The central bank of Ghana is charged with the full responsibility of ensuring the Ghanaian financial or banking system is firm. “The central bank of Ghana also ensures the safe keeping of

depositor‟s funds as it exercises its authorization power over all banks in Ghana. Furthermore, the central bank of Ghana ensures that commercial banks are solvent, they keep proper and quality assets and also the maintenance of satisfactory profit”. It is the full responsibility of the central bank of Ghana to seek to the adherence of all regulatory requirements as well as the maintenance of efficient payment system.

Ghanaian banks have gone through several changes adaptations as well as government interventions. “Recent development in the banking sector in Ghana is the acceptance and adoption of the international financial reporting standards, although the Ghana Accounting standard is still applicable. They are all used together in the preparation of final accounts to foster harmonization globally so that final accounts prepared all over the world by banks as well as financial institutions can be compared and well interpreted, since accounting is a language, it should be able to communicate to the outside world in general. So in effect the adaptation of the

International Financial Reporting Standard (IFRS) in connection with the International

Accounting Standards (IAS) is very relevant. The effect of financial sector reform was to free the financial system from extreme government directive in order to promote a free market-base system, set prices right, develop regulatory framework, strengthen commercial banks supervision, and clean up non-performing loans on their balance sheet.

The annual comparative profitability analysis reported in the Ghana Banking Survey (2012) indicates that, Ghanaian universal banks have experienced slow increase in profitability in the past years though the degree of profitability varies. This gives a clear indication that banks management of liquidity risk amongst other risk such as credit risk, market risk, operations risk has greater implications on their profitability, especially on net interest margins.

2.2 MEANING OF LOAN DEFAULT

In finance default occurs when a debtor has not met his or her legal obligations according to the debt contract, example has not made a scheduled payment, or has violated a loan covenant

(condition) of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either unwilling or unable to pay their debt. This can occur with all debt obligations including bonds, mortgages, loans, and promissory notes, (Wikipedia, 2011). A loan default occurs when the borrower does not make required payments or in some other way does not comply with the terms of a loan, (Murray, 2011).

BusinessDictionary.Com gives five definitions of default as follows:

General: Failure to do something required by an agreement, in the performance of a duty, or under a law.

Borrowing: Failure to meet the terms of a loan agreement. Its two types are (1) Fiscal: Failure to make repayment on the due date. Generally, if a payment is 30 days overdue, the loan is in default. (2) Covenantal: Failure to live up to one or more covenants of the loan agreement such as exceeding the prescribed total borrowings.

Computing: Attribute, option, or value assumed by a computer when a user has not chosen or supplied any. Computer's choice is based on how the elements of software or the settings of hardware have been arranged by the manufacturer, or customized by the user.

Contractual: Failure to comply with the terms of a contract. Most contracts make provisions for handling defaults by including the conditions or procedures for arbitration, compensation, or litigation.

Legal: Failure to do something required under legislation or as ordered by a court, such as not making an appearance to answer charges.

Default is the inability to repay the loan by either failing to complete the loan as per the loan agreement or neglect to service the loan. (Wakuloba, 2003).

Consultative Group to Assist the Poor (CGAP) 2009 also defined loan default as when a borrower cannot or will not repay a loan, and the Microfinance Institution (MFI) no longer expects to be repaid (although it keeps trying to collect).

Moreover, Pearson and Greeff (2006) defined default as a risk threshold that describes the point in the borrower‟s repayment history where he or she missed at least 3 instalments within a 24 month period. This represents a point in time and indicator of behaviour, wherein there is a demonstrable increase in the risk that the borrower eventually will truly default, by ceasing all repayments. The definition is consistent with international standards, and was necessary because consistent analysis required a common definition. This definition does not mean that the borrower had entirely stopped paying the loan and therefore been referred to collection or legal processes; or from an accounting perspective that the loan had been classified as bad or doubtful, or actually written-off. Loan default can be defined as the inability of a borrower to fulfil his or her loan obligation as at when due (Balogun and Alimi, 1990).

2.3 CAUSES OF LOAN DEFAULTS

Ahmad, (1997) clearly indicated lack of willingness to pay loans coupled with funds diversion by the borrower, improper appraisal by credit officers and willful negligence as some of the important factors that might cause loan default in the banking industry. In the same way, Hurt and Fesolvalyi (1998), cited by Kwakwa, (2009) indicates that, when a country experience a

sharp decrease in its gross domestic product (GDP), it will consequently lead to an increase in corporate loan default. Borrowers‟ ability to pay back loans are deeply affected by the exchange rate depreciation in the economy. Futhermore, Balogun and Alimi (1998) also made known poor supervision, loan shortages and delay in time of loan delivery as well as high interest rate as some of the possible causes of loan defaults. Olomola (1999) is of the view that high interest rate in a country can significantly increase the borrowing transaction cost and definitely have an impact on loans repayment.

Berger and De Young (1999) also highlighted natural disasters or unforeseen circumstances, lack of follow up by monitoring officers, insufficient collateral used as securities in securing the loan and improper selection of personnel as the possible causes of loan defaults. The natural disaster could be attributed to factors such as fire outbreak, demolition, rain storm, theft or robbery and even death. Loan default can also arise due to relocation of customers business or residence hindering the consistency of repayment.

In the same way, Sheila (2011) outlined inadequate assessment by the bank officers during the loan process. This happens when the officers do not take careful steps to assess the credit worthiness of the applicant. When this happen the loan facility will be granted to unqualified person.

2.4 How Macroeconomic Variables Contributes to Loan Default

The importance of the macro economy is captured in the words of Jimenez and Saurina (2006) who observe that savings and loans‟ lending mistakes are common during upturns than in the midst of decline. Bashir (2000) observes that favorable macroeconomic conditions impact performance measures positively. In the same way, Al-Smadi and Ahmed (2009) also expose

that at macro level, conditions connected with good economic periods contribute in decreasing the savings and loans‟ credit risk exposure. Ramlall (2009) considers the following macroeconomic factors in his research: interest rate, cyclical output, the level of economic development and stock market capitalization. Cyclical output and the level of economic development are frequently used to symbolize the business cycles since savings and loans‟ profits are expected to be interconnected with the business cycles, being higher in case of upswings and lower in case of downswings (Demirguc-Kunt & Huizinga 1998 and Bikker & Hu,

2002).

This study investigates the following variables and their effect on credit risk: the Treasury bill rate, the discount rate, Government borrowing, inflation, the GDP and the required reserve.

Generally, not much study work has investigated the relationship between most of these macroeconomic variables and credit risk.

This is what has made this study very exceptional. However, there are research works in related subjects such as the effect of these macroeconomic factors on the interest rate spread and the interest margin. Treasury bill and other bond rates fall when the government lowers interest rates, which means that the value of Treasury bill rises. Lower rates also signify lower interest payments for individual investors and businesses, which may lead to more consumer spending and business investment. Treasury bills in Ghana are categorized on the maturity period like

91days, 182days and 364days respectively. In this research the 91day bill has been adopted as a standard for measuring the cost of doing business in Ghana. The discount Rate is an instrument of Discount Policy, and is used by the Savings and Loans to influence the flow of money and credit in a desired direction. Adjusting the interest rate is a tool normally used during a period of

inflation. The discount rate was highly significant in the models of Folawewo and Tennant

(2008), where it is positively correlated with savings and loans sectors spreads. Boyd et al.

(2001) show that countries with high inflation have undersized financial systems and that savings and loans with higher inflation rates are currently associated with net interest margins. According to Athanasoglou et al. (2006) Demirguc-Kunt and Huizinga (1998), a widely used proxy for the effect of the macroeconomic environment on savings and loans profitability is inflation. And in their respective works find a positive relationship between inflation and savings and loans profitability. Voridis (1993) on the other hand claims that increased uncertainty in the economy causes the savings and loans to ration credit and lead to disequilibrium in credit markets. Al-

Smadi and Ahmed (2009) associate high inflation with decrease in credit risk.

Savings and loans companies normally withhold some portions of their funds all because they want to raise their reserves. While lowering requirements works the opposite way to increase the money supply. The reserve requirement sets the minimum reserves each savings and loans must hold to demand deposits and savings and loan notes. The reserve requirement in the savings and loans sector may constrain credit supply and for that matter savings and loans profitability.

Navneet et al. (2009) maintain that increase in non-interest bearing reserve requirements results in a widening of savings and loans spread as savings and loans face reduced liquidity.

Sarong et al (2011) also confirm that in Ghana, commercial savings and loans respond to increases in reserve requirements by increasing the boundary between lending and deposit rates.

In the view of Kwakye (2010), the fact that the reserves are unremunerated constitutes a cost to the savings and loans, as they have to pay interest to depositors, however low that may be.

Investigating Government borrowing, Looney and Frederiken (1997) suggest crowding out might occur if the government uses the limited physical or financial resources or produces an output to compete with the private sector. If the Government competes with the private sector for credit this may lead to an increase in cost of loans. Thus, the net effect of government investment on private investment depends on the extent of crowding out on the one hand and the complementarily of public and private investment on the other hand.

We have two types of Government borrowing takes two forms-Government direct borrowing from savings and Government indirect borrowing through the issues of Government securities, which is represented by the amount of Treasury bills. An increase in GDP signals growth in the economy and tends to transform as an increase in productivity Real per capita GDP should have a negative effect on interest rate spread, as it is included as a general index of economic development, and should reflect differences in savings and loans technology and mix of savings and loans opportunities (Demirguc-Kunt and Huizinga,1998).A higher GDP is an signal of increase in purchasing power and for that matter the ability of borrowers to forfeit their loans. It also means the ability of savers to increase their savings. It is supposed to have a negative relationship with credit risk which is represented by loan loss provision.

2.5 WAYS OF REDUCING LOAN DEFAULT

Kohansal and Mansoori (2009) are of the view that, lenders have various strategies and mechanism in reducing loan default in an economy. Some of these control measures include insisting the pledging of collateral for all loans, guarantors, and the use of credit rating and collection agencies and so on. Furthermore, Kay Associates Limited (2005) cited by Aballey

(2009) states that in order to cease bad loans, loans should be made available to only those who

can pay back when due and whose business are likely to operate in the coming weeks, months years and very solvent as well.

In order to reach a reliable borrower who can pay back his loan when due, credit analysis of all potential borrowers should be carried out. Ameyaw-Amankwah (2011) clearly states that loan repayments should be monitored carefully, so that whenever a customer defaults in its payment the necessary action could be taken. This simply means that banks should desist from granting loans to risky customers and renegotiate when customers find problems in its payment.

Furthermore, loan default may be reduced through call visits. This is the method of maintaining constant and surveillance over the credit facility. Desk monitoring as well as Field monitoring could be used as mechanism to reduce loan default. This can be done through weekly examination of the loan portfolio and moving to the premises or site of the loan customer.

2.6 LOAN ADMINISTRATION PROCESS TO REDUCE LOAN DEFAULT

2.6.1. CREDIT ANALYSIS ON LOAN

Investorwords.Com (2011) defined credit analysis as the process of evaluating an applicant‟s loan request or a corporation‟s debt issue in order to determine the likelihood that the borrower will live up to his/her obligations.

The Credit Policy of Cal Bank, (2009) identifies Credit analysis to be in two-phases: phase one is a preliminary credit evaluation to determine whether the applicant will be able to qualify for a loan of the desired amount. This phase includes a review of preliminary plans and specifications, project cost breakdown, feasibility studies, financial projections for the completed project, and an analysis of the borrower‟s most recent budgets, financial statements, bond

ordinances/resolutions, and rate structure. Various factors are considered during the preliminary credit review. These factors include the feasibility of the project, the borrower‟s financial condition, its ability to cover its existing and potential debt payments, current and projected user rates, and other revenue sources and the economic stability of the borrower.

While bank has final responsibility to determine whether the loan applicant‟s credit history and security is sufficient to be able to approve the loan, it works closely with the stakeholders on the project cost estimates and the economic pro-formal for the proposed project.

In some situations, projects are modified so the loan applicant can handle the project and still meet the minimum credit requirements. Applications passing the preliminary credit review move on to the second phase of the credit approval process. Borderline applicants are advised of their status and are free to continue in the process if they so choose, with the understanding that the bank has concerns that need to be addressed. There are no guarantees at this point that any of the projects will be granted a loan. That decision only comes after a more detailed final credit evaluation is completed.

Phase two of the credit evaluation takes a closer look at the project and the borrower. The banks also complete a more extensive analysis of the financial status of the applicant. This will include additional financial information such as the last four years‟ financial statements (audited, if available), detailed debt information, budgets, system data, local economic characteristics and other information deemed necessary. Staff will prepare ratio and trend analyses, projections, review rate structures, and review the local industry information to determine the borrower‟s ability to repay the loan. While all applicants are subjected to the preliminary credit review, communities with existing loans that are being repaid according to the loan terms can quickly

pass through review process. For those communities, the credit analyses will simply be updated to ensure that the community can repay the increased debt service.

2.6.2 MONITORING OF LOANS

Monitoring is an integral part of loan administration processes. This enables the bank to acquaint itself with the progress of work. Monitoring is important. It guides credit officers to know the status whether repayments are made as contained in the loan agreement.

Constant monitoring prevents loan diversion. Rouse (1989) recognizes that regular monitoring of loans enhances the lenders image in the eyes of the customer but it is an area where many lenders ignore but if carried out properly, the occurrence of loan defaults will reduce drastically. Small

Business Administration‟s proposed a loan monitoring system that would use technology and new processes to manage its loan portfolios, identify and effectively mitigate risks incurred through loans guaranteed by SBA, implement oversight of internal and external operations, and calculate subsidy rates (Koontz, 2001). Muller (1987) cited by Agyemang (2010) maintains that loans should be monitored during the repayment period of the loan. The banks should ensure that the loan is being used for eligible purposes; the quality of the loan will be maintained in the future and its repayment sources are protected in order to guard against unacceptable deterioration of the credit and the corpus of the bank. Should a borrower show signs of such deterioration, the Bank should be able to take action before a loss would result.

Aballey, (2009) observed that, monitoring of loans can minimize the occurrence of loan defaults through the following major purposes that it serves:

Ensure the utilization of the loan for the agreed purpose.

Identify early warning signals of any problem relating the operations of the customer‟s business that are likely to affect the performance of the facility.

Ensure compliance with the credit terms and conditions.

It enables the lender discusses the prospects and problems of the borrower‟s business.

2.7. LENDING

Lending is defined as the offer of money to a person or entity with the expectation that repayment would be made with interest either by instalments or in one amount by a specified date, where necessary a lender will protect himself, by asking the borrower to provide some collateral (Ribeiro 2006). From the point of view of the writer on the collateral, some banks grant credit without taken any collateral with the intention to win customers for the bank. This trend has emerged as a result of competition amongst banks when lending issues arise.

The legal framework has not changed much but as the years go by the laws which regulate lending continue to be revised, amended or even replaced entirely to make way for more current and relevant ones. Rouse (1989) perceives lending as an art rather than science because it involves experience and common sense. This assertion to some extent is true. These two factors alone can perfect some aspect of lending, but not to its entirety. It is through science that lenders come out with accounting procedures, credits and risk‟s analysis to assess customer‟s ability to pay, regulatory framework etc. He explained that a lender lends money and does not give it away. There is therefore a judgment that on a particular future date repayment will take place.

The lender needs to look into the future and ask whether the customer will repay by the agreed date. He indicated that there will always be some risk that the customer will be unable to repay, and it is in assessing this risk that the lender needs to demonstrate both skill and judgment.

The lender should aim at assessing the extent of the risk and try to reduce the amount of uncertainty that will exist over the prospect of repayment. The lender must therefore gather all the relevant information and then apply his or her skills in making judgment. Though there might be pressures from customers and elsewhere which may sway away the lender‟s judgment, the lender must seek to arrive at an objective decision.

In view of these credit risks that might lead to bad loans, banks have some loan request procedures and requirements contained in their credit policy documents to guide loan officers in the processing of loans for customers. The following are some of the factors considered in granting loans:

 Applicant‟s background.

 The purpose of the request.

 The amount of credit required.

 The amount and source of borrower‟s contribution.

 Repayment terms of the borrower.

 Security proposed by the borrower.

 Valuation of the security by a professional

 Location of the business or project.

 Technical and financial soundness of the credit proposal.

Biney (1995), also defines lending as an amount of money provided by a lender and taken by a borrower, payable at some future date on specific terms and conditions and governs by legal contract. The ability of the bank to lend depends on its deposit mobilization. The higher the deposits mobilized, the better the position of the bank to give out loans. Incoom (1998) indicates that the requirements of lenders and borrowers are diverse and conflicting. Lenders expect high

returns on the loanable funds whilst borrowers expect to pay less on monies advanced to them.

Depositors expect to earn higher income in the form of interest. For the bank to balance these conflicts of interest is to ensure profit maximization while taking into accounts the potential environment risk as well as the liquidity of the bank. It is worth examining whether the abolition of secondary reserve on 1st August, 2006, a requirement of the banks by Bank of Ghana will impact on bank lending due to increase in bank‟s assets or they will be reluctant to expand their lending, instead of investing in government securities where risk is perceived to be lower. In the view of Anaman, Bank of Ghana decision would allow banks to gain access to additional funds that could be channeled into the private sector to accelerate economic growth. (Business and

Financial Times, 2006)

The abolition of the secondary reserve rather comes with mix feeling from financial chieftains.

Dwumah (2006) maintains the view that, the abolition of the secondary reserve was a piece of good news, for the banks considering the fact that most banks will still invest in government securities. Lending is core in banking activities and the riskiest aspect of banking business.

Banks have over the years helped customers to augment capital for most businesses and make them financially strong to accelerate nation building. Anaman (2006) maintains that much as banks‟ lending help business to flourish banks also has its fair share in the forms of fees and incomes to sustain its operations. Bank lending has been a major source of funding for most businesses. There is the need therefore for banks and other financial institutions to be careful in their loan administration to prevent the inherent risk associated with the product in order to maximize shareholders returns and enhance the image of the institution.

Awuah (2007) cited by Agyemang, (2010) argues that due to the risk nature of the bank lending, a thorough appraisal needs to be done to establish the true position of the state of affair before a

decision is taken. It is against this background that most banks are unwilling to fund small scale businesses with the reasons such as; lack of collateral, weak and inexperience management and lack of proper book keeping and physical remoteness of many informal sector enterprises.

With regards to big companies, records are easily accessible because of tax purpose and for loan appraisal. This however, is subject to scrutiny because in some cases customers prepare separate accounts for different purposes which do not give the true picture of the affairs of the entity. The historical cost used in the preparation of accounts makes it difficult to predict the success of bank lending. Although a project cash flow is requested to serve as a measure of the overall well-being of an entity, other factors such as social, economic, legal and political environment affecting the systems makes it difficult to predict repayment.

2.8 PRE-LENDING INFORMATION

To ensure loan repayment and guard against non-payment of loan, certain information about clients need to be known prior to the granting or disbursement of the loan. These are personal and business details which determine the ability and willingness of the borrower to repay.

Rouse (1989), outlines seven cannon of lending: character, ability, margin, purpose, amount, repayment and insurance. In short „CAMPARI‟, the mnemonic is analyzed as follows:

Character- Can the customer be trusted? What is the track record? Historical actions will be considered.

Ability - What key skills does the organization‟s management possess for the proposal presented? Are there areas of weaknesses in the management team?

Margin - Refers to the Interest, commissions and fees to reflect the risk involved in the lending.

The banker should remember that to make money, it is important to consider the rate of interest at which you are prepared to lend.

Purpose - The customer must specify the purpose of the loan. This is a requirement for both personal and business loans. A banker should not lend money, unless he knows what is going to be used for.

Amount- Refers to the amount requested for by the borrower. The question here is, is the borrower asking for either too much or too little? A good borrower would have allowed for contingencies. The amount requested for should be in proportion to the customers‟ own resources.

Repayment - Refers to the source of repayment. The lender needs projections to ensure that there are surplus funds to cover repayment after meeting other commitments.

Insurance/Security - Refers the security that the banks needs to take against the possibility that the loan will not be repaid.

Kay Associate Limited (2005) cited by Aballey (2009) identified five techniques of credit vetting known as the five Cs framework used in assessing a customer‟s application for credit. Firstly, the character of the customer is assessed. This determines the willingness of the customer to pay the loan and may include the past credit history, credit rating of the firm, and reputation of customers and suppliers. Secondly, the capacity of the customer which is described as his or her ability to pay in terms of cash flow projection is critically assessed. Besides, the capital or soundness of the borrower‟s financial position in terms of equity is assessed. The conditions such as the industry and economic conditions of the business are also assessed.

These are important because such conditions may affect the customer‟s repayment ability. The last C is collateral. This is referred to as the secondary source of repayment. This is considered in appraising the customer‟s request.

2.9 OTHER FACTORS TO CONSIDER WHEN LENDING MONEY

2.9.1 INTEREST RATES

Interest rate is the price that borrowers pay in order to consume resources now rather than in the future (Incoom, 1998). It is appropriate to look at cost and return on lending. The classical theorist focuses on the supply and demand for loanable funds to determine interest rate. The monetarist focuses on liquidity preference theory; supply and demand for money to determine interest rates.

Ghana has in recent times seen new developments in interest rate determination. After years of controlled interest rates which culminated in a regime of financial regression, interest rates are now de-regulated and are allowed to be influenced by market forces recognised (Sowa, 1996).

Banks pay interest on depositors funds used to grant loans to the deficit units and as such an appreciable amounts of rates needs to be charged in order to cater for Deposits Liability (interest cost) as well operational cost for the bank to stay in business. Interest rates are also determined by the risk factors associated with the loan, such as default, duration cost of funds, other operational cost, and maturity pattern of deposit and the probability of default overtime.

Essentially, any profit motivated financial institution will mostly try to widen the gap between lending and deposit rates of interest to make a margin or to break-even. Normally interest charges for high risk area may be higher due to the risk of non-payment of principal and interest.

Bruck (1997) claims that to be able to cover the cost of mobilizing funds and pay for their cost of operation, financial institutions have to charge higher rate on their loan than what it pays on borrowed funds.

Theoretically, loan defaults occur when borrowers are not willing and or able to repay loans

(Hoque 2004). This paper focuses on the borrowers‟ ability to repay loans. Among the many factors, high interest rates are the most important one which influences borrowers‟ ability to

repay loans. It widely reported (that high interest rates has devastating effect on investment and growth of an economy though McKinnon (1973) and Shaw (1973) underscored the important of higher real interest rates during inflationary pressure to promote savings and investment in financially repressed economies. Rittenburg (1991) found that too high interest rate was detrimental to investment and growth. Keynesian economists recommended that interest rates should be kept low in order to speed the growth of investment and economy at large (Roe 1982).

The virtues of low interest rates are: it will increase borrowing, reduce inflation, increase job opportunities and stimulate national economy. The opposite happens with high interest policy though Roe (1982) found that South Korea and Taiwan immensely benefited from high interest rates (which were as high as 20% on deposit) policy during 1950s and 1960s.High interest rates cause inflation which increases the cost of production or costs of goods sold.

Generally, banks do charge high interest rates in developing countries where financial market is imperfect as information asymmetry between borrower and lender prevails, creditworthiness of borrowers is doubtful, value of collaterals is overstated and inefficiency is the common features at institutional level. Nobody precisely knows the degree of such imperfection but all banks are addicted to the policy of high interest rates. This is counterproductive as high interest rates may contribute to loan default. This indicates that banks should determine appropriate lending rates on the basis of proven, not hypothetical, degree of market imperfection.

Again, lending rates should be lowered or adjusted very frequently with the level of real world imperfection which decreases with pace of economic development and growth of an economy.

Roe (1982) suggested that real rate of interest must be lower than real return on capital.

It means that as the financial market becomes more and more efficient with the process of development, lending rates should be lowered than before which may contributes towards

reduced level of loan defaults. Failure to do this may result in persistent loan defaults in developing countries.

2.9.2 SECURITY

Security which is another prerequisite of lending serves as a cushion for financial institution in case of non-payment of loan. The banks insist on security because of unrealistic nature of some financial statement presented for the loan. This is due to the fact that different financial statements are prepared by borrowers depending on the purpose. This renders the statement unreliable for managers during loan appraisal and makes decision making by managers very difficult and therefore demand security. Care must also be taken when taking collateral for loan especially the legal aspect governing it in order to accurately perfect the security. The demand for security has the tendency to discourage borrowers who have no security to back their demand and also to minimize the rate of default. Tshribi (1996) cited by Agyemang (2010) is of the view that the prominence of security as an ingredient for bank lending emphasizes the circumspection with which banks treat security matters in the knowledge that security for any particular loan should not only be safe but must on realization generates proceeds to fully settle the outstanding debts. Apart from security been legally perfect, it is necessary to consider other factors like accessibility, valuation, realization in case of default, ownership title and controls. Banks lend against security not only out of business sense but also in compliance with regulatory requirements.

2.9.3 MONITORING OF LOANS

Constant monitoring prevents loan diversion.

Rouse (1989) recognizes that regular monitoring of loans enhances the lenders image in the eyes of the customer but it is an area where many lenders ignore but if carried out properly, the occurrence of loan defaults will reduce drastically. Small Business Administration‟s proposed a loan monitoring system that would use technology and new processes to manage its loan portfolios, identify and effectively mitigate risks incurred through loans guaranteed by SBA, implement oversight of internal and external operations, and calculate subsidy rates (Koontz,

2001). Muller (1987) cited by Agyemang (2010) maintains that loans should be monitored during the repayment period of the loan. The banks should ensure that the loan is being used for eligible purposes; the quality of the loan will be maintained in the future and its repayment sources are protected in order to guard against unacceptable deterioration of the credit and the corpus of the bank. Should a borrower show signs of such deterioration, the Bank should be able to take action before a loss would result. Aballey, (2009) observed that, monitoring of loans can minimize the occurrence of loan defaults through the following major purposes that it serves:

Ensure the utilization of the loan for the agreed purpose.

Identify early warning signals of any problem relating the operations of the customer‟s business that are likely to affect the performance of the facility.

Ensure compliance with the credit terms and conditions. It enables the lender discusses the prospects and problems of the borrower‟s business.

2.10 CLASSIFICATION OF LOANS

Loan classification refers to the process banks use to review their loan portfolios and assign loans to categories or grades based on the perceived risk and other relevant characteristics of the loans. The process of continual review and classification of loans enables banks to monitor the quality of their loan portfolios and, when necessary, to take remedial action to counter deterioration in the credit quality of their portfolios. It is often necessary for banks to use more complex internal classification systems than the more standardized systems that bank regulators require for reporting purposes and that are intended to facilitate monitoring, (Laurin et al, 2002).

Loan portfolios of banks are classified into various classifications to determine the level of provisions to be made in line with banking regulations. Loans are classified into five categories including Current, other loans especially mentioned (OLEM), substandard, doubtful and loss

(Kone, 2006).

THE BANK OF GHANA HAS THE FOLLOWING CLASSIFICATIONS OF LOANS:

Current: Advances in this category are those for which the borrower is up to date (i.e. current) with repayments of both principal and interest. Indications that an overdraft is still current would include regular activity on the account with no sign that a hard-core of debt is building up.

Other Loans Especially Mentioned (OLEM): Advances in this category are currently protected by adequate security, both as to principal and interest, but they are potentially weak and constitute an undue credit risk, although not to the point of justifying the classification of substandard. This category would include unusual advances due to the nature of the advance, customer or project, advances where there is a lack of financial information or any other advance where there is more than a normal degree of risk.

Substandard: Substandard advances display well-defined credit weaknesses that jeopardise the liquidation of the debt. Substandard advances include loans to borrowers whose cash flow is not sufficient to meet currently maturing debt, loans to borrowers which are significantly undercapitalized, and loans to borrowers lacking sufficient working capital to meet their operating needs. Substandard advances are not protected by the current sound worth and paying capacity of the customer. Non-performing loans and receivables which are at least 90 days overdue but less than 180 days overdue are also classified substandard. In this context advances become overdue when the principal or interest is due and unpaid for thirty days or more.

Doubtful: Doubtful advances exhibit all the weaknesses inherent in advances classified as substandard with the added characteristics that the advances are not well-secured and the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors, which may work to the advantage and strengthening of the advance, its classification as in estimated loss is deferred until its more exact status may be determined. Non- performing loans and receivables which are at least 180 days overdue but less than 365 days overdue are also classified as doubtful

Loss: Advances classified as a loss are considered uncollectible and of such little value that their continuation as recoverable advances is not warranted. This classification does not mean that the advance has absolutely no recovery value, but rather it is not practical or desirable to defer writing off this basically worthless advance even though partial recovery may be affected in the future. Advances classified as a loss include bankrupt companies and loans to insolvent firms

with negative working capital and cash flow. Banks should not retain advances on the books

while attempting long-term recoveries.

Losses should be taken in the period in which they surface as uncollectible. Non-performing

loans and receivables which are 365 days or more overdue are also classified as a loss.

2.11 LOAN PROVISIONING

Farlex Financial Dictionary (2009) defined loan provisioning as a non-cash expense for banks to

account for future losses on loan defaults. Banks assume that a certain percentage of loans will

default or become slow-paying. Banks enter a percentage as an expense when calculating their

pre-tax incomes. This guarantees a bank's solvency and capitalization if and when the defaults

occur. The loan loss provision allocated each year increases with the risks of the loans a given

bank makes. A bank making a small number of risky loans will have a low loan loss provision

compared to a bank taking higher risks.

Bank of Ghana regulations requires Banks to make provisions on the aggregate outstanding loan

balance of all current loans and aggregate net unsecured balance of all other categories as shown

in the table below.

Table 2.1 Provisions required for various classifications of loans

Loan Category Provision Required Number of days Overdue

Current 1% 0-30

OLEM 10% 31-90

Substandard 25% 91-180

Doubtful 50% 181-365

Loss 100% Over 365

Source: Section 53(1) of the Banking Act 2004

A review of the above literature on classifications and provisioning implies that the higher the non-performing loan category, the higher the provisions and charges for such bad loans and the higher its effect on the operations of the Bank.

2.12 COMPETITION IN THE BANKING INDUSTRY

The banking industry in Ghana has seen very strong competition in the last decade. This competition is mainly as a result of the entry of banks from the sub-region, particularly Nigeria, which brought very innovative ways of banking never experienced before on our shores. There has been an intense scramble to attract a large number of the unbanked population. There is a big contest among banks, securities firms, supermarkets, computer companies, post offices, etc.

The reason is that non-bank institutions are moving increasingly into providing banking services.

Financial sector is transforming. Building societies are converted into banks. The traditional barriers between banks, building societies, insurance companies, are melting away.

Another competition for banks is due to the consolidation of the banking industry. Due to the fierce competition in the financial sector, the newcomers in the retail industry force the others to become bigger and consequently more competitive. (Blanden, 1996). By consolidation, not only they can face the growing competition more effectively, but the participants can also cut costs and achieve a broader spread of their risks.

There is now little that banks can provide exclusively. Most of the banking services are now offered by non-bank financial institutions. One of the main competitors is, without a doubt, the capital market. Many banks‟ best corporate customers deserted them, preferring to raise money directly from the capital markets by issuing bonds and shares, (Giles, 1996). Generally, competition has great impact on any industry.

But in this case, it is easier for nonbank financial institution to diversify into banking than for banks to diversify in areas different than traditional financial services. This is mostly due to the developments in technology that enable a variety of institutions to enter into the banking industry. According to Colgate (1997), deregulation has been the main catalyst for today‟s increasing competition in this industry, for example, a few restrictions on product offerings.

Day (1997) argues that it is a little wonder that banks are facing intense competition from this new breed of competitors which are taking advantage of the strength of their brand names and their understanding of customers, to gain a growing share of the market. Meanwhile, the majority of banks are neglecting their brand images and missing the opportunity to project strong brand values. Banks are expected to focus on the areas that they feel to have a competitive or comparative advantage. What is extremely likely is that services will break into component parts, so as to be able to be supplied by different institutions. Each component will be priced and different banks will be specialized in different services.

Many changes in the environment of banking will take place. Non-banking institutions such as supermarkets or big stores will use more the strength of their network and their name‟s liability for promoting their products, such as consuming loans, credit cards, insurance etc.

Some examples are the Marks & Spencer and Virgin Direct.

2.13 EMPIRICAL REVIEW OF EFFECT OF LOAN DEFAULTS ON PERFORMANCE OF BANKS

This section is concerned with the review of previous studies regarding the determinants of profitability. Most of the previous studies divide the factors of profitability into two categories i.e. internal factors and external factors. Since this study is major concerned with the internal

factor like loan loss provision therefore the documentation of previous studies has been made regarding both factors of profitability. Samy Ben Naceur (October 2003), using bank level data for Tunisia in the 1980-2000 period, provide statistics on size and decomposition of bank‟s interest margin and profitability. The paper uses regression analysis (panel data with random effects) to find the underlying determinants of Tunisian banking industry performance. To this end, a comprehensive set of internal characteristics is included as determinants of bank‟s net interest margin and profitability. In his study he found that bank loans have a positive and significant impact on profitability. The size has mostly negative and significant coefficients on the profitability. This latter result may simply reflect scale inefficiencies. While the study by

Abreu and Mendes (2000) documents a positive relationship between the loan ratio and profitability. Bashir & Hassan (2003) and Staikouras& Wood (2003) show that a higher loan ratio actually impacts profits negatively.

The latter study notices that banks with more non-loan earnings assets are more profitable than those that rely heavily on loans. Pilloff and Rhoades (2002) discuss the positive relationship of the size with bank‟s profitability. The bank-size also affected by the operating efficiency.

Molyneux and Seth (1998); Ramlall (2009); Sufian (2009) found the positive relationship of banks size with banks profitability and examine that bank size depends the economies of scale because the larger banks were more profitable than smaller banks, Whereas the empirical evidence also discuss the negative relationship of bank size with profitability (Koasmidou, 2008;

Spathis, Koasmidou & Doumpos, 2002). Demirguc-Kunt and Maksimovic (1998) identified a positive relationship between size and profitability. They found that higher the funds can easily meet their rigid capitals so that they can have extra funds for giving loans to borrowers and thereby increase their profits and earning levels. Ramlall (2009) & Miller and Noulas (1997)

stated the negative relationship between credit risk and profitability. It shows that whenever there is negative relationship between them, then it signify that greater risk linked with loans, higher the level of loan loss supplies which thereby and create a trouble at the profit-maximizing strength of a bank. Vong & Chan (2005) conducted a research on determinants of banking profitability in which the bank-specific variables examined, with a sample of five different banks. He found that a higher loan-to-total assets ratio may not necessarily lead to a higher level of profits. Due to the competitive credit market condition and the successive cuts in interest rate, the interest spread, i.e. the important determinant of profitability, becomes narrower. A lower spread together with a higher loan-loss lead to lower profitability.

Therefore, instead of loan size, it is the spread and the quality of the loan that matter. Lastly, his study shows that smaller banks, on average, achieve a higher return on assets than larger ones.

Naceur and Goaied (2001) find out the factors that affects the Tunisian bank‟s performances during the period 1980-1995. They determine that the best developing banks are those who have effort to get better labour and capital productivity, those who have balanced a high level of deposit accounts comparative to their assets and finally, those who have been able to strengthen their equity for the banks performance. Chirwa (2003) determines the relationship between market structure and profitability of commercial banks in Malawi by using time series data during1970 and 1994. He finds a long-run relationship between profitability and concentration, capital asset ratio, loan-asset ratio and demand deposits-deposits ratio. Bashir (2000) analyses the factors of Islamic bank‟s performance across eight Middle Eastern countries for 1993-1998 periods. A various number of internal and external determinants were used to forecast the profitability and efficiencies. Controlling for macroeconomic environment, financial market situation, the consequences show that higher leverage and large loans to asset ratios, lead to

higher profitability. He also reports that foreign-owned banks are more profitable than the domestic one. Ataullah et al. (2004) made a comparative analysis of commercial banks in India and Pakistan during 1988-1998. They found that the efficiency score in loan based model was much higher as compared to the income based model. Both countries banks have needed to improve their efficiency. The above discussion confirms a strong linkage between bank specific

& non-bank specific factors and bank‟s profitability. The paper addresses the gap in the literature by using challenging econometric techniques to testify the bank‟s profitability in terms of the individual banks operating in Pakistan. According to the nature and purpose of each study mentioned in literature review, a number of explanatory variables have been proposed for bank specific and non-bank specific determinants of bank‟s profitability. We have taken loan loss provisions to total assets (LLP_TA); current liabilities to total assets (CL_TA); Natural log of total assets (SIZE); advances to total assets(ADV_TA); deposits to total assets (DEP_TA); current assets to total assets (CA_TA) and political instability (PII) factor separately.

2.14 THEORETICAL REVIEW OF LOAN DEAFAULTS AND FINANCIAL PERFORMANCE

2.14.1 THE MORAL HAZARD THEORY

Moral hazard refers to the risk in which a party to a transaction provides misleading information about its assets, liabilities or credit capacity, or has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles. Usually a party to a transaction may not enter into the contract in good faith, thus providing misleading information about its assets, liabilities or credit capacity. It is postulated that, moral hazard problems may be occasioned by asymmetric information which makes it difficult to distinguish between good and bad borrowers

Richard (2011). It is also noted that moral hazard has led to substantial accumulation of Loan defaults Bofondi and Gobbi (2003). Problems of moral hazard in financial institutions are evident at many stages of the recent financial crises. This theory is considered relevant in this study since borrowers and lenders tend to conceal crucial information pertaining to the lending and borrowing agreement. Yet in modern macroeconomic theory economic growth rate depends, crucially, on the efficiency of financial institutions. The financial systems themselves depend on accurate information about borrowers and the project the funds are used for. Though it is asserted that Loan defaults may be caused by less predictable incidents Bloem and Gorter (2001), they indicated that moral hazards resulting from generous government guarantees could lead to loan default. Consistent with earlier assertions regarding moral hazard Klein (2013), it is arguable that microfinance banks with relatively low capital, just like other mainstream financial institutions, may respond to moral hazard incentives by increasing the riskiness of their loan portfolio. The foregoing is bound to result in higher non-performing loans on average in the future. As further reinforced by another study‟s argument Jimenez and Saurina, (2005), microfinance banks that tend to take more risks, including in the form of excess lending ultimately incur losses. Still in tandem with moral hazard, higher equity-to-assets ratio results in lower Loan defaults. Given that, moral hazard incentives such as low equity tend to aggravate Loan defaults Klein (2013), and then microfinance banks and other financial institutions ought to avoid such moral hazard incentives in order for them to mitigate losses through Loan defaults.

2.14.2 ADVERSE SELECTION THEORY

The theory rests on two main assumptions: that lenders cannot distinguish between borrowers of different degrees of risk, and that loan contracts are limited. This analysis is restricted to involuntary default, that is, it assumes that borrowers repay loans when they have the means to

do so. In a world with simple debt contacts between risk-neutral borrowers and lenders, the presence of limited liability of borrowers imparts a preference for risk among borrowers, and a corresponding aversion to risk among lenders. This is because limited liability of borrowers implies that lenders bear all the downside risk. On the other hand, all returns above the loan repayment obligation accrue to borrowers. It is further asserted that, just like moral hazard, adverse selection can lead to significant accumulation of Loan defaults Bofondi and Gobbi

(2003). Raising interest rates would affect the profitability of low risk borrowers disproportionately, causing them to drop out of the application pool. However, excess demand in the credit market may persist even in the face of competition and flexible interest rates. In the adverse selection theory, the interest rate may not rise enough to guarantee that a loan applicants secure credit, in times when loanable funds are limited. Therefore, in line with this theory, microfinance banks may find themselves in dilemma; whether to increase interest rates and lower the number of applicants, or reduce the rates and have many applicants some of which may default in servicing their loans. It is argued that in line with stipulations of the adverse selection theory, information sharing is said to reduce adverse selection by enhancing banks‟ information on credit applicants. It is argued that, ordinarily, each banking institution has private information about local credit applicants, but has no information about foreign applicants.

In this light, it is reasoned that if banks were to share information about their clients‟ credit worth, they can assess the quality of foreign credit applicants as carefully as they would assess their local customers. As such, minimizing information asymmetry between lenders and borrowers, loans are extended to borrowers with lower credit risk Auronen (2003)

As such non-performing loans are likely to be reduced. In the context of Kenya‟s microfinance banking sector, the issue of adverse selection is being handled by CRBs that minimizes information asymmetry.

CHAPTER THREE

METHODOLOGY

3.1 INTRODUCTION

The research design employed for this study involves the collection of data from the selected commercial banks on default loans. Panneerselvam (2004) provided a definition to research methodology which stated it is as a system of models, techniques and procedure employed to find the results of a research problem. The study was addressed through single case study. The chapter dealt with research design, population for the study, sample and sampling procedure, the research instrument and its administration. It also indicated the statistical tools for the analysis of the data. The second part also discussed the bank and its environment, entire profile of the bank, legal capacity of the bank.

3.2 Research Design and sampling Technique

Research Design is steps used to gather and evaluate information in order to increase understanding on an essential topic. “The study consists of two steps, namely selection of selected banks financial statement for a period of eight year and using data collected to work out ratios for analysis. Also a descriptive analysis was use to undertake this sturdy since such approach gives accurate profile of the instructions selected event or situations.

The study was quantitative in nature. The selection of the four commercial banks as the unit of analysis was motivated by the fact that, the banks were among the satisfactory commercial banks with good standing and well organised among other numerous institution in the in the industry

Financial statements from four Major Banks over a period of 8 years (2007 to 2014) were selected for the purpose of the study.

3.3 Source of Data

This study conducted relied on only secondary data. Secondary data is defined as “data from publications and collections of the past in a form of books, journals and article. The secondary data used for the study were collected from financial statements of Cal Bank, Ecobank, UT Bank and Fidelity Bank for a period of eight years (from 2007-2014).

3.6 Data Collection Instrument

This research employed quantitative methods in the analysis. Quantitative method is predominantly used for any data collection technique or data analysis procedure,

3.7 Data Analysis

Stata software version 13 was employed by the study for the analysis. The software was employed to estimate the influence of loan default on the commercial banks‟ profitability.

3.7.1Estimating the Effect of Loan Default on Financial Performance

In achieving the above objective, Ordinary Least Squares regression model was employed by the researcher to ascertain the effects of loan default on the financial performance of selected commercial banks (Ecobank, CAL bank, UT bank and Fidelity bank) as successfully employed by Mwangi (2012).

Panel data was employed for this analysis, the Return on equity (ROE) was used as a proxy for the financial performance which served as the regress and and the explanatory variables were; loan default which was the variable of interest, Loan recovered (LR) which was measured using loans recovered as a percentage of the loan booked, liquidity risk (LR) of the company, cost income ratio and the total revenue (TR) of the company.

The study log transformed the variables to scale them into elasticities.

3.7.2 The generalized functional form is specified as;

= + 1LnLDit + 2LnLORit + 3LnTORit +4LnLiqRit +5LnCORit (1.1)

3.7.3 Empirical Model for the study is specified as;

ROEit0   1 LnLD it   2 LnLOR it   3 LnTOR it   4 LnLiqR it   5 LnCOR it   it (1.2)

Table 3.1 Description of Variables Variable Interpretation Measurement Exp. sign

- LnLD Log of loan default Non-performing loans amount + LnLOR Log of loan recovery rate Loan recovered as a ratio of the total loan + LnTOR Log of total revenue Sum of interest income and non-interest income + LnLiqR Log of liquidity risk Total loan divided by deposits

- LnCOR Log of cost income ratio Operating expenses divided by operating income

ROE Return on equity Net income divided by shareholder‟s equity n/a Stochastic Error Term n/a it

Source: Author’s Computation (2015)

CHAPTER FOUR

DATA PRESENTATION, ANALYSIS AND DISCUSSION

4.0 INTRODUCTION

This section presents the findings obtained from the secondary data. The findings are as a result of application of several statistical tool and techniques.

4.1 PRESENTATION OF RESULTS This section presents the results from the analysis undertaken by the study.

Table 4.1: Descriptive statistics of Variables used for the Panel Analysis

Variable Mean Std. Dev Min. Max ROE 2.807 1.340 2.076 4.682 Loan default 3.772 9.541 35.999 109.973

Cost income ratio 2.792 1.323 2.076 4.683

Total revenue 16.259 3.460 34.751 45.834

Loan recovered 3.754 1.620 19.012 49.892 Liquidity risk 3.809 2.484 10.012 20.661

Source: Author’s Computation (2015)

The Table 4.1 indicates the mean of Return on Equity (ROE) was 2.807 with a standard deviation of 1.340, minimum of 2.076 and maximum of 4.682. Mean of loan default was 3.722 with a standard deviation of 9.541, minimum of 35.999 and maximum of 109.973. The mean of cost income ratio was 2.792, with a standard deviation of 1.323, minimum of 2.076 and maximum value of 4.683. The total revenue had a mean of 16.259, with standard deviation of

3.460, minimum of 34.751 and maximum of 45.834. The loan recovered had a mean of 3.754, maximum of 49.892, minimum of 19.012 and a standard deviation of 1.620. The liquidity risk had a mean of 3.809, standard deviation of 2.484, minimum of 10.012 and a maximum of

20.661. It can be inferred from the Table that total revenue had the highest mean followed by liquidity risk. Loan default had the largest standard deviation followed by total revenue.

TESTS FOR MULTICOLINEARITY

The Variance Inflation Factor approach was employed to test for whether the independent variables are highly correlated. The decision rule is that if any of the individual VIF or the mean

VIF computed is greater than 10, then it implies that there is the presence of multicollinearity and vice versa. The result is presented in Table 4.2.

Table 4.2: Variance Inflation Factor Results

Variable VIF 1/VIF Loan Default 8.41 0.118 Cost income ratio 3.08 0.324

Total Revenue 2.42 0.413 Loan Recovered 1.75 0.572 Liquidity Risk 1.26 0.797 Mean VIF 3.384 Source: Author’s Computation (2015)

The result indicates that there was no multicollinearity in the model. This is due to the fact that none of the individual VIF was greater than 10 and also the overall VIF was also less than 10.

Table 4.3: Correlation Matrix Results

Variable Loan Cost- Total Loan Liquidity default income Revenue recovered ratio ratio Loan Default 1.000 Cost-income ratio -0.223 1.000 Total Revenue 0.214 -0.112 1.000 Loan Recovered -0.513 -0.312 -0.553 1.000 liquidity Risk -0.082 -0.436 -0.384 -0.068 1.000 Source: Author‟s Computation (2015)

The Table 4.3 depicts the test of multicolinearity among the variables. All the variables were included in the analysis. This is due to the fact that none of them was found highly correlating.

The empirical result indicates that none of the coefficients was above +/-0.800

4.2 ESTIMATING THE EFFECT OF LOAN DEFAULT ON PROFITABILITY

This section reports estimated result of the effect of loan default on profitability of selected commercial banks in Ghana. The empirical results is presented in Table 4.3.

Table 4.3 indicates R-squared is equal to 0.9679, this implies that about 96.79 percent of the changes that occurred in the dependent variable (ROE) was jointly influenced by the independent variables (loan default, cost income ratio, total revenue, liquidity risk and loan-recovered). The adjusted R-squared of 0.9582 also implies that there is about 95.82 percent assurances that the changes that occurs in the dependent variables is jointly caused by the independent variables.

The F-statistic is used to decide whether the model as a whole has statistically significant predictive capability, that is, whether the regression sum of squares (SS) is big enough, considering the number of variables needed to achieve it. The null hypothesis states that the model is not statistically significant whiles the alternatives states otherwise. The decision rule is that if F-statistic is statistically significant or exceeds F-critical from the statistical table reject the null hypothesis, otherwise do not reject. Since the empirical model produced prob>F to be statistically significant at less than 1 percent (0.01), the study rejected the null hypothesis. The study therefore concluded that the model for the analysis was well specified.

Table 4.4: OLS Results for the Effect of Default Loans on Bank’s profitability (Dependent: Return on Equity (ROE)

Variables Parameters Marginal Effect Std. Error T-statistic[P-Value]

Loan Default -0.048** -0.012 0.023 -2.06[0.040]

Cost income ratio -0.158* -0.131 0.095 -1.66[0.096] Total revenue 0.436*** 0.212 0.042 10.39[0.000] Loan recovered 0.534 0.321 0.604 0.88[0.377] Liquidity risk 0.017* 0.011 0.009 1.81[0.071]

Intercept -2.687 - 1.183 -2.27[0.023] R2 = 0.9679 Adjusted R2 =0.9582 F(10, 33) = 99.62 Prob > F = 0.000 A . Serial CHSQ(1) = 1.3730[0.241] F(1,32) = 1.0307[0.318] correlation B . Functional form CHSQ(1) = 1.8184[0.173] F(1,32) = 1.3795[0.249] C . Normality CHSQ(2) = 1.4538[0.271] Not applicable D CHSQ(1) = 0.0949[0.890] F(1,42) = 0.0184[0.893] Heteroscedasticity *, **, *** indicates significance level at 10 percent (0.1), 5 percent (0.05) and 1 percent (0.01) respectively.

(A): Lagrange Multiplier test of residual serial correlation (B): Ramsey‟s RESET test using the square of the fitted values (C): Based on a test of skewness and kurtosis of residuals (D): Based on the regression of squared residuals on squared fitted values

The serial correlation assumption is also tested through the use of Lagrange Multiplier test for serial correlation. The null hypothesis states that there is no serial correlation whereas the alternative hypothesis states otherwise. The decision rule is that if the probability value of the

LM or F-statistic is not statistically significant at any significant levels (0.01, 0.05 and 0.1) do not reject the null hypothesis, otherwise reject. Since the empirical model produced non- significant probability values (0.241 and 0.318) for the LM and F-statistic respectively, the study rejected the null hypothesis and concluded that there is no serial correlation among the variables.

The Ramsey RESET specification error test is employed to test for omitted variables in the model. The decision rule is that if the probability value of the LM or F-statistic is not significant do not reject the null hypothesis, otherwise reject. Since the empirical model produced non- significant probability values (0.173 and 0.249) of the LM and F-statistic respectively, the null hypothesis was not rejected. This implies that there are no omitted variable in the model.

The Lagrange Multipliers test for heteroscedasticity is employed by the study to test for the presence of heteroscedasticity in the model. The empirical results indicates that there is no heteroscedasticity within the model since the probability values (0.890 and 0.893) for the LM

and F-statistic respectively are not statistically significant at any significance level (0.01, 0.05 and 0.1)

The normality assumption is also tested through the employment of skewness and kurtosis. The normally assumption was not violated in the empirical model. This is due to the fact that the probability of value (0.271) of the F-statistic (1.4538) was not statistically significant at any significance level (thus, neither at 0.01, 0.05 nor 0.1).

From the model it can be deduced that, loan default, cost-income ratio, total revenue and liquidity risk were statistically significant. The loan recovered was not statistically significant at any significance level (1 percent, 5 percent and 10 percent).

Loan default is statistically significant at 5 percent (0.05) significance level. It has a negative effect on profitability (ROE as a proxy) with marginal effect of (0.012). The empirical result indicates that 1 percent-point increase in the loan default will lead to 0.012 percent-point decrease in profitability (ROE). The empirical result corroborates with the expectation of the study which stated that there is a negative effect amongst loan default and profitability of the selected commercial banks in Ghana. The empirical result corroborated with study such as

Tracey and Leon (2011) who reported a negative profitability and loan default.

Cost income ratio is statistically significant at 10 percent (0.01) significance level. It has a negative effect on profitability (ROE as a proxy) with marginal effect of (0.131). This implies that 1 percent-point increase in the cost to income ratio will lead to 0.131 percent-point decrease in profitability. The empirical result corroborated with the study‟s expectation which stated there is a negative relationship between cost-income ratio and profitability (ROE). This empirical result corroborates with Mathuva (2009) who reported a negative correlation between cost-

income ratio and profitability in Kenya. This empirical result again corroborate with Mombo

(2013) who revealed a negative relationship between cost-income ratio of banks and profitability.

Total revenue is statistically significant at 1 percent (0.01) significance level. Total revenue has a positive relationship with profitability (ROE as a proxy) with marginal effect of (0.212). The empirical result indicates that 1 percent point increase in total revenue will lead to 0.212 percent- point increase in profitability (ROE) in the selected commercial banks. The empirical result corroborated with study‟s expectation which stated that there is a positive relationship between total revenue and profitability. The empirical result is consistent with Mombo (2013) who revealed a positive correlation between profitability and total revenue of banks.

Liquidity risk is statistically significant at 10 percent (0.01) significance level. It has a positive correlation with profitability with marginal effect of (0.011). The empirical result implies that one percent-point increase in liquidity risk will lead to 0.011 percent-point increase in profitability (ROE). It sign corroborated with the expectation of the study, which hypothesized a positive relationship between liquidity ratio and profitability. The result is consistent with Al-

Khouri (2011) who reported a positive relationship between liquidity risk and ROE. It is also consistent with Ongore and Kusa (2013) who reported a positive relationship between liquidity risk and ROE.

The empirical result indicates that loan recovered is not statistically significant. However, it is consistent with the study‟s expectation which hypothesized a positive relationship between loan recovered and profitability (ROE as a proxy). This can be explained based on the fact that, as more loans are recovered by the rural banks the money can be channelled into other areas or loan

to other potential customers which will increase their profitability. This empirical result is consistent with Mombo (2013) who revealed a positive correlation between profitability and total loan recovered by banks.

CHAPTER FIVE

FINDINGS, CONCLUSIONS AND RECOMMENDATIONS

5.0 INTRODUCTION

The chapter presents the summary of the findings of the study, main conclusions and policy recommendations based on the findings of the study.

5.1 SUMMARY OF FINDINGS

This study is carried out to assess the effect of loan default on profitability of the selected four commercial banks in Ghana. Secondary data is employed for analysis in this study. The data collected were from 2007-2014. Seven variables were used for the analysis they include, loan default, loan recovery rate, total revenue, liquidity risk, cost income ratio and return on equity

(dependent variable). The data was sourced from end of year financial statements.

In estimating the effect of loans default on profitability of the selected commercial banks, the empirical results showed that; Cost income ratio and liquidity risk were statistically significant at

10 percent significance level respectively whereas loan default and total revenue were statistically significant at 5 percent (0.05) and 1 percent significance levels respectively. The loan recovery was statistically insignificant although it was consistent with the study‟s expectation. Furthermore, loan default and cost income ratio has a negative influence on the profitability whereas total revenue and liquidity risk has positive influence on profitability.

The directions of the sign of both default loan and cost-income ratio were consistent with the study‟s expectation. The empirical results indicated that increase in any of these variables will cause a reduction in the profitability of the selected commercial banks whereas liquidity risk and

total revenue had a positive effect on the banks‟ profitability. It was also consistent with the study‟s expectation. This implies that increase in liquidity risk and total revenue leads to increase in profitability.

5.2 CONCLUSIONS

(dependent variable). The data was sourced from end of year financial statements.

The result shows results that loan default has a negative statistically significant effect on profitability on commercial banks. This implies that the higher the loan default the lower the profit of the selected commercial banks. The cost-income also has a negative statistically significant influence on profitability. This also implies that higher cost-income ratio of the selected commercial banks results to lower profit. Total revenues and liquidity risk has a positive statistically significant influence on profitability. This implies that as total revenue and liquidity risk of the selected commercial banks increase, profit also increases.

On the basis of the above, we concluded that loan default has negatively affected the profitability of the study banks

5.3 RECOMMENDATIONS

Base on the above findings the following recommendations are made. The study has found that loan default has a negative impact on profitability and thus commercial bank should perfect their securities or collaterals before an advance is approved to ensure that in the event of default, the bank would not have any impediments in realizing the security.Again,

Banks should establish a system that could help to identify problem loans ahead of time where more options for remedial measures would be available.

Secondly, based on the fact that liquidity risk has a positive influence on profitability as shown in the empirical result. Commercial banks should put measures in place to reduce their liquidity risks level so as to increase their profit.

Moreover, commercial banks should develop a mechanism to decrease their operating expenses and increase their operating income to avoid a fall in their profit. This is based on the empirical result that showed that a higher cost income ratio had a negative impact on profitability.

Lastly, commercial banks should put measures in place to recover higher percentage of the loan disbursed so as to increase their profitability. This is based on empirical result which showed that Loan recovery rate had a positive influence on profitability.

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APPENDIX 2 CAL BANK FINANCIAL STATEMENT ANALYSIS

CALBANK

YEARS 2007 2008 2009 2010 2011 2012 2013 2014 NET PROFIT 6,022,000 7,976,000 8,878,000 8,810,000 18,338,000 49,517,000 92,010,000 60,096,000

TOTAL ASSET 233,064,000 335,649,000 450,470,000 499,751,000 786,063,000 1,159,345,000 1,558,963,000 2,093,326,000 INTERET EXPENSES 12,625,000 21,707,000 41,714,000 32,800,000 34,477,000 61,209,000 123,398,000 75,006,000 INTERST INCOME 24,043,000 38,059,000 64,215,000 69,635,000 75,138,000 145,991,000 265,747,000 152,952,000 OPERATIN EXPENSES 13,483,000 20,702,000 24,654,000 27,367,000 33,670,000 47,505,000 72,121,000 44,007,000 CREDIT IMPAIREMENT 1,115,000 2,186,000 3,476,000 12,849,000 11,465,000 17,461,000 17,516,000 6,789,000 TOTAL EQUITY 28,941,000 35,408,000 57,014,000 76,519,000 92,921,000 204,044,000 381,193,000 313,225,000 TOTAL INCOME 35,135,000 55,306,000 81,662,000 85,337,000 104,722,000 191,587,000 340,515,000 213,133,000

LOANS 113,953,000 190,938,000 214,715,000 256,634,000 412,565,000 747,385,000 981,160,000 1,148,211,000

NPM = NPAT 17.14 14.42 10.87 10.32 17.51 25.85 27.02 28.20

TOTAL INCOME

ROE = NPAT 20.81 22.53 15.57 11.51 19.74 24.27 24.14 19.19 TOTAL EQUITY

LOAN LOSS PROVISION RATIO CREDIT IMPAIRMENT 0.98 1.14 1.62 5.01 2.78 2.34 1.79 0.59 LOANS TO CUSTOMERS

COST TO INCOME RATIO 38.37 37.43 30.19 38.44 32.15 24.80 21.18 20.65 OPERATING EXPENSES TOTAL INCOME

APPENDIX 3

UT BANK

YEARS 2007 2008 2009 2010 2011 2012 2013 2014 NET PROFIT 4,471,000 5,300,000 7,621,000 9,905,000 13,065,000 20,931,000 9,757,000 10,955,000

TOTAL ASSET 74,801,000 74,801,000 201,111,000 516,632,000 712,864,000 986,905,000 1,336,336,000 1,628,412,000 INTEREST EXPENSES 8,687,000 14,803,000 36,738,000 40,429,000 50,232,000 72,621,000 116,231,000 154,022,000 INTERST INCOME 28,731,000 43,568,000 67,612,000 74,706,000 99,901,000 134,110,000 187,888,000 226,346,000 OPERATIN EXPENSES 9,102,000 14,074,000 16,996,000 26,530,000 47,413,000 64,802,000 187,888,000 99,962,000 CREDIT IMPAIREMENT 7,520,000 12,161,000 8,673,000 7,003,000 14,244,000 13,153,000 24,110,000 26,934,000

TOTAL EQUITY 7,964,000 16,878,000 22,279,000 510,986,000 61,229,000 128,435,000 128,670,000 138,421,000

TOTAL INCOME 31,372,000 48,588,000 72,012,000 86,122,000 129,189,000 177,284,000 240,804,000 259,573,000

LOANS 52,805,000 98,116,000 138,281,000 315,297,000 475,232,000 679,648,000 240,804,000 1,197,423,000

NPM = NPAT 14.25 10.91 10.58 11.50 10.11 11.81 4.05 4.22 TOTAL INCOME

ROE = NPAT 56.14 31.40 34.21 1.94 21.34 16.30 7.58 7.91 TOTAL

EQUITY

LOAN LOSS PROVISION RATIO CREDIT IMPAIRMENT 14.24 12.39 6.27 2.22 3.00 1.94 10.01 2.25 LOANS TO CUSTOMERS

COST TO INCOME RATIO 29.01 28.97 23.60 46.94 36.70 36.55 78.03 38.51 OPERATING EXPENSES TOTAL INCOME

APPENDIX 4 FIDELITY BANK

YEARS 2007 2008 2009 2010 2011 2012 2013 2014 NET PROFIT 399,805 2,325,953 2,027,677 4,833,101 1,699,351 27,674,000 43,877,000 81,912,000

146,331,02 219,265,05 362,088,64 650,318,22 1,029,926,98 1,333,031,00 253,345,00 3,020,283,00 TOTAL ASSET 6 6 2 7 6 0 0 0

INTEREST 135,938,00 EXPENSES 10,201,588 14,976,180 36,190,151 45,231,091 55,426,383 93,944,000 0 166,324,000

INTERST 253,345,00 INCOME 14,287,365 21,982,228 51,340,324 74,262,993 103,265,106 174,320,000 0 352,566,000

OPERATIN 116,131,00 EXPENSES 6,852,383 12,114,361 21,033,822 33,486,905 53,674,196 85,889,000 0 182,709,000 CREDIT IMPAIREMEN T 514,476 96,432 1,587,802 5,904,261 11,634,256 16,353,000 16,709,000 30,841,000

TOTAL 154,003,00 EQUITY 6,968,460 9,475,726 31,850,169 36,982,979 55,568,448 120,612,000 0 384,826,000

TOTAL 332,426,00 INCOME 17,961,983 29,724,831 61,822,789 91,453,902 135,009,440 232,823,000 0 495,886,000

LOANS 34,293,379 86,424,961 17,523,797 212,046,83 409,578,026 636,763,000 805,967,00 1,559,530

3 0

NPM = NPAT 2.23 7.82 3.28 5.28 1.26 11.89 13.20 16.52

TOTAL INCOME

ROE = NPAT 5.74 24.55 6.37 13.07 3.06 22.94 36.38 21.29 TOTAL EQUITY

LOAN LOSS PROVISION RATIO CREDIT IMPAIRMENT 1.50 0.11 9.06 2.78 2.84 2.57 2.07 1977.58 LOANS TO CUSTOMERS

COST TO INCOME RATIO 38.15 40.76 34.02 81.20 39.76 36.89 36.84 OPERATING EXPENSES TOTAL INCOME