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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 By 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 1 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 i 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. ii DEDICATION I dedicate this work to my Parents, Mrs. Comfort Adomako and to all my Siblings for the prayers and encouragement. God Bless you. iii 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. iv 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 v 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 .............................................................................................
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