Non-Performing Loans in Ghana's 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 who brought very innovative ways of banking never experienced before on our shores.

There has been an intense scramble to attract the large number of the unbanked population. This has seen banks deploying direct sales people to go out to prospect for customers, expansion in bank branch network, the opening of ''cashless'' bank accounts, mobile phone banking and so on. As bank customers and deposits grew, so did the need to give loans to firms and individuals. In order to make profit and outdo each other, many banks have given out loans and advances to customers and not all these loans get re-paid. This has introduced the incidence of Non-Performing Loans (NPLs) onto banks' books and this is gradually becoming a major concern to banks and regulators alike.

A non-performing loan is a loan given by a bank or finance company on which interest and principal repayments are not made on time. According to the International Monetary Fund (IMF), a loan is non-performing if it is 90 days (3 months) overdue. A loan can also be classified as non-performing if it is less than 90 days overdue but repayments are no longer anticipated. Repayment of principal and interest on loans create a stream of cash flows for the bank. It is from these interest repayments that banks make profits. Therefore a high NPL portfolio reduces banks profits and their ability to further lend to borrowers. This ultimately has a negative effect on the economy.

According to a Ghana Banking Survey Report released in 2010 and authored by PricewaterhouseCoopers, between the years 2007 to 2009, the total income of the banking industry more than doubled from GHC 793 million in 2007 to GHC 1.5 billion in 2009. Over the same period however, the rapid deterioration of the industry's loan portfolio negatively affected profit margins. Impairment charges for non-performing loans over the three year period increased from GHC 60 million in 2007 to GHC 266 million in 2009. The Central Bank of Ghana also revealed that the NPL ratio, which measures the ratio of loan losses to gross loan advances, worsened from 16.2% in December 2009 to 17.6% as at December 2010. This high NPL ratio has contributed to reduce the market share of the country's top five banks from 49.5% in 2009 to 45% in 2010 (Bank of Ghana report 2010).

Shifting focus from the traditional banking sector, the non-banking institution Micro-finance and Small Loans Center (MASLOC) has dragged many of its defaulting customers in different parts of the county to court. Meaning the issue of NPLs is widespread across the general financial industry. Across the border in Nigeria, the country's Central Bank in a bid to save the Nigerian banking sector from collapse created the Asset Management Corporation of Nigeria (AMCON) to buy all non-performing loans on the books of the banks that were at risk. Similarly, at the height of the credit crunch in America, the Obama Administration set up the Toxic Assets Recovery Program (TARP) to buy all NPLs or ''toxic assets'' as it was called so that the banks could resume lending.

Ghana's situation has not reached such crisis levels as experienced in Nigeria and America but an NPL ratio of 17.6% in the Ghanaian banking industry is still a cause for concern. Dan Mensah, the Executive Director of the Association of Ghanaian Bankers this year complained that the high rate of NPLs on the books of commercial banks is sparking worries among bankers and industry watchers.

So what factors account for this high default rates on loans in the Ghanaian banking industry?

The harsh economic environment affecting some small and medium scale enterprises (SMEs) and individuals was a factor.  According to the 2010 Budget Statement, The services sector which contributes about 31.8% to the country's GDP, saw a sharp fall from its growth rate of 9.3% in 2008 to about 4.6% in 2009, the lowest growth rate for the past five years. This downward fall according to the 2010 Budget came from the ''Wholesale and Retail, Restaurants and Hotels sub-sector''.  In the same 2010 Budget statement, growth in Industry fell from 8.1% in 2008 to 3.8% in 2009. Wholesale and Retail trade, and Industry mainly rely on loans from banks for their business activities so if both sectors saw sharp falls in growth over the period, then it could explain why default rates on loans increased over the same period. At a news conference recently, Ghana's Central Bank Governor Kwesi Amissah-Arthur observed that the share of NPLs were higher in commerce, finance, manufacturing, services and construction sectors.

Government's indebtedness to the construction sector and others is linked to loan default rates. Dan Mensah, the Executive Director of the Association of Ghanaian Bankers has blamed the government for 20% of bad loans at the country's banks because of arrears to contractors, suppliers and municipal assemblies. According to Mr. Mensah ''the government's failure to repay its loans has led to road projects being halted and has left schools and clinics struggling to pay for supplies''. Dr. Joe Abbey of the Centre for Policy Analysis agreed when he recently revealed ''it is a big factor in the stock of non-performing loans in the banking sector''. Mr. Amissah-Arthur does agree that government must take a chunk of the blame when he revealed that '' ...after long discussions with the banks, we realised that the government has a role in this (NPLs) because a lot of borrowers are those who have done work for the government''. Government indebtedness has also been blamed for high interest rates on loans as a result.

Thirdly, poor credit profiling of borrowers by banks lead to bad loans. A good risk management system will screen potential borrowers to ensure that unsecured loans (loans without collateral) are redeemable. Many banks because of competition for borrowers and pressure from governments to lend more, do not undertake enough due-diligence on the background of borrowers before granting loans.  Competition for customers has also led to Know-Your-Customer (KYC) requirements been relaxed for new customers. All these contribute to loan defaults in the long run.

The lack of a central database system from which credit profiles of potential borrowers can be easily obtained to know their credit worthiness does not help banks. In Europe and North America, it is difficult to obtain a loan or credit card from the banking system if one does not have a good credit history. Every borrowers credit profile is easily searchable in a centralised system and this is strictly adhered to and cannot be manipulated. This acts as a check and balance against loan defaults. In Ghana, the lack of a good address and house numbering system also compounds the problem as it is difficult to trace people to their residences. The managing director of UT bank, Prince Kofi Amoabeng, has been waging a crusade for a better house numbering and address system in Ghana that will enable easy tracking of loan defaulters.

Wrong attitudes on the part of SMEs and small entrepreneurs in particular contribute to non-performing loans. Many SMEs after securing loans use the funds in extravagant ways not stipulated in their loan agreements. Many expend their funds on funerals and other social activities that do not enhance their businesses. This problem is worsened by SMEs lack of basic business skills like book-keeping, working capital management, marketing skills and good customer service, which are ingredients for business growth and profitability.

The problem of non-performing loans cannot be completely solved however there are some solutions. If the finance ministry is able to ensure a continuous trend of  favourable macro economic policies are adopted to keep down inflation; if the government invests in growth-enhancing sectors of the economy; if the the private sector is supported to create jobs; if the central bank continues to enact growth-enhancing policies that will bring down interest rates, most sectors of the economy will do well and repay their loans to financial institutions.

Since government alone accounts for a fifth of all NPLs in the banking sector,  the Ministry of Finance should work closely with their Works and Housing counterpart to ensure jobs undertaken for government are paid on time. In this regard, the Accountant-Generals department (governments pay agency) should be automated as a matter of urgency to reduce bureaucracy and ensure speedy payments of contractors and other suppliers.

In my opinion, banks should strengthen their risk management departments, recruit better risk expertise and tighten credit control policies. This will ensure robust credit profiling of borrowers and screening new customers without driving them away. Indeed in the 2010 Banking Survey quoted above, 64% of directors and bank executives identified risk management as their highest priority after their core missions of profitability and shareholder value. Two-thirds agreed to devote more time to risk management in the coming years.

Ghana enacted a Credit Reporting Act in 2007 to regulate the operations of credit reference bureaus. These bureaus are agencies who will collate credit information on bank customers and would-be borrowers to determine their credit-worthiness. The information can also be used by banks for debt collection purposes. To date only one company, XDS Data Ghana Limited has been licensed to operate and the company and has signed on many Ghanaian banks. It is a good start and its usefulness in reducing bank loan default rates is yet to be known. Additionally, more debt collection agencies should also be licensed to track and collect debts from defaulters. The work of very good debt collection agencies will complement bank efforts and helps banks to concentrate on their core mission.

Lastly, apart from giving loans, banks should complement this by giving advisory services on basic working capital management, book-keeping, marketing and so on to SMEs especially. This will help them to manage their businesses well so they will be able to repay loans they contracted.

The banking industry is getting ever more competitive and although the industry is fairly well regulated, it is still prone to risks. Non-performing loans is one such risk. Thus banks that will take risk management practices seriously will reduce their losses leading to high returns to shareholders. This will also benefit the economy in the long run.