Factors leading to non performing loans

INTRODUCTION
Lending is one of the main activities of banks in Ghana. This is evidenced by the volume of loans that constitute bank assets and the annual volume of credit granted to borrowers in the private and public sectors of the economy. Loans are therefore, typically, the largest and the most important asset and source of revenue for banks through significant interest income earnings. A survey in 2006 on the Ghanaian Banking Sector revealed that loans account for about 50% of total bank assets. In 2007, the figure increased to 53% of the industry’s total assets of GH₵7,795.60 million. (Infodata Associates, 2009). The facts above give ample evidence that healthy loan portfolios are vital assets for banks in view of their positive impact on the performance of banks. Unfortunately, some of these loans do not perform and are defaulted and eventually result in bad debts which affect banks earning on such loans. These types of loans are on-performing loans or simply bad loans. In February, 2009, a Bank of Ghana report revealed that the non-performing loans ratio had increased from 6.4% in 2007 to 2008. These bad loans become cost to banks and can fuel banking crisis and result in the collapse of these institutions with their attendant repercussions on the economy as a whole considering the fact that the banking industry plays an important role in the development of the economy. Due to the negative relationship between bad loans and financial performance of banks in Ghana and the economy as a whole, the prevailing high non-performing loans ratio in Ghana has raised some concerns among the
stakeholders of these institutions.

This study therefore mainly seeks to fish out the causes of bad loans in the Ghanaian banking industry and how they affect the financial performance of banks in Ghana. Again, the study aims at making recommendations to minimize the problem of bad loans. The study focuses on UT Bank and Ghana Commercial Bank (GCB). Ghana Commercial Bank (GCB) is one of the Ghana’s largest and oldest banks and has been operating long enough to give the kind of academic insight the study seeks to offer. Besides, the nationwide operation of the bank presents an opportunity for a national outlook of the issues under the study. UT Bank on the other hand, is a very young bank with the primary purpose of lending at very short notice. This bank provides a fresh perspective to the whole issue. The study would make use of both primary data from the two banks mentioned above as well as secondary data. The work is divided into 5 chapters. The first section is the introductory section, the second comprises a literature review on the issue at hand, the third chapter provides an overview of the banking sector in Ghana, the fourth focuses on the analysis of our findings and the last section is composed of the conclusion and recommendations

 LITERATURE REVIEW
This chapter focuses on the review of the body of literature on the subject matter of problem loans and its impact on the performance of banking industries in the country and the world as a whole to formulate a theoretical framework to investigate the main determinants of nonperforming loans in Ghana’s banking industry. This chapter presents the conceptual and theoretical aspect for the study. Keeton and Morris (1987) present one of the earliest studies to examine the causes of loan losses. In the latter paper the authors examined the losses by 2,470 insured commercial banks in the United States (US) over the 1979-85. Using NPLs net of charge-offs as the primary measure of loan losses Keeton and Morris (1987) shows that local economic conditions along with the poor performance of certain sectors explain the variation in loan losses recorded by the banks. The study also reports that commercial banks with greater risk appetite tend to record higher losses. A loan is said to be performing if payments of both principal and interest charges are up to date as agreed between the creditor and the debtor. Bank of Ghana’s groupings of loans indicate that loans that are current are those for which the payments are up to date. (Bank of Ghana, 2008). This reveals that loans that are up to date in terms of principal and interest payments are described as performing facilities and also non-performing loans as described by Berger and De Young, (1997) as “problem loans” and also by Basu (1998) as those loans whose principal and interest are outstanding for a long time contrary to terms and conditions in the loan contracts.

Non-performing loans has been described by available literature as: Caprico and Klingebiel (1990) cited in Fofack (2005), that non-performing loans are those that do not generate income over a long period of time. That is, the principal and interest on these loans have not been paid for at least ninety days. Alton and Hansen (2001) described non-performing as loans that are ninety days or more due or no longer accruing interest. Loans in this country are classified to determine the level of provisions to be made in line with banking regulations. These classification are current, other loans especially mentioned (OLEM), substandard, doubtful and loss (Bank of Ghana, 2008).The classification indeed shows the quality of the portfolio and how to mitigate the risk of default, thereby falling on collateral used to prevent the loss of the principal and interest. Bank of Ghana regulations indicate that certain amounts of provisions are made on the aggregate outstanding loans. The net unsecured balance of all other categories is shown in the table below.