Lenders grant loans to borrowers under agreed repayment conditions or terms. Whenever the borrowers default in the repayment of loan for a period of time the loan is said to be non-performing. Thus, a nonperforming loan (NPL) is a loan in which the borrower is in default on both interest and principal for a specified period. Whenever borrowers are unable to honor both interest and principal payments for a period of time usually 90 days in most cases, the loan is considered as a non-performing loan. Indeed, as per the 2019 audited financials reports released by the 23 banks in Ghana and published in various print media, a lot of banks NPLs were above the industry average.
The International Monetary Fund considers loans as non-performing when the borrower defaults in loan repayments in at least 90 days or more and also when there are high uncertainties surrounding future payments.
To assess the health of any banking system, the percentage of NPL is used in the analysis. A Bank with a higher percentage of NPL over their total loan portfolio suggests that they have difficulty in recovering interests and principals on their loans. This has adverse effect on the health and profitability on the institution. If this situation persists for long without recovery strategies in place, it could have adverse effects on the health of the Bank which could finally result in corporate failure or possible collapse of the Bank. Reports on the Ghana banking sector clean-up also revealed that most of the collapsed banks had very high NPLs which made them insolvent. This article delves into why some banks record high NPLs in Ghana and how that challenge can be curbed.
Data from the World Bank on Ghana banking sector NPL
Data from the World Bank on Ghana banking sector NPL from 2008 to 2018 revealed that the average NPL ratio was 14.94 percent with a minimum of 7.68 percent in 2008 and a maximum of 21.59 percent in 2017.
Table 1, Non-Performing Loans trend from 2008 – 2018
What gives rise to NPLs?
The incidence of Non-Performing Loans arise as a result of some factors that the borrower has control over which is termed as internal and factors that are outside the control of the borrower known as external factors. Also the default may be as a result of the activities of the lender or bank and these I have referred to as bank factors.
Internal Factors that Give Rise to Non-Performing Loans
Poorly Managed loans
One of the key factors that can lead to a loan going bad is diversion of loaned funds into other ventures instead of the purpose for which the loan was granted or intended for. Usually before loans are granted to a company or an individual, the bank would establish the purpose of the loan or the intended use of the loan through their own thorough analysis before finally giving approvals for disbursement of the loan facilities. When the borrower upon receiving the approved credit decides to divert the funds into other undisclosed business or personal ventures, the probability of the loan going bad is high. This can happen to individual borrowers and corporate borrowers as well.
In recent times, the Ghanaian Fixed Income market recorded a case of default from a quasi-government organization. The company floated a bond and it is alleged that the Board used the funds for some other business venture not stated in the prospectus and this action has led to them defaulting on the repayment of their coupons and principals. This report was also published on myjoyonline.com.
Financial mismatch has contributed a lot to NPLs in Ghana. Most companies go in for short term loans to fund long dated capital expenditures. Most often entrepreneurs in the manufacturing, real estate sectors and even some contractors find themselves entangled in such arrangements. They start paying for the loans when the business for which they secured the loan has not yet started to generate enough revenue for both interest and principal repayments.
This kind of arrangement makes it difficult for them to even do proper working capital management and thus fall on overdraft for their working capital, further worsening their already bizarre financial position.
Choice of Financing, mostly debt rather than Equity
Some businesses typically need to be funded with equity but most companies prefer using loans because they are unwilling to dilute their shareholding. In some cases, the Ghana Fixed Income Market provides a platform for companies to raise funds that can be listed and traded on the secondary market. Some companies do not meet the requirement to list and some others that meet the requirement may not be willingly be subjected to scrutiny by the Regulators of the Securities Industry and would thus go for short term loans instead. When long terms funds are sourced for long terms projects be it equity or debt funding, it gives businesses some time to generate enough revenue to repay their stakeholders.
Character of borrower
Though subjective, the character of the borrower is very important in credit risk management. When the borrower is a willful defaulter, irrespective of the conditions that exist, the loan would go bad.
External Factors which Cause Non-Performing Loans
Change in government and government policies
More often than not, when there is a change in government, some sectors get affected especially if the manifestos of those governments are not in tandem with those sectors. The strategies of a particular government tend to be the main driving force in the development of policies. For example, contractors who have executed government projects and have their funds locked up with government suffer undue delays in the payment of their contract sums especially when there is a change in government. In some cases, payments are put on hold due to government audits and reconciliation and sometimes contracts are repriced leading to loan defaults. This is a factor that is not within the control of the borrower and can give rise to loan defaults when the borrower has no other means of funding to defray their loans.
Exchange rates fluctuations
Some companies take loans to fund businesses whose key raw materials are imported. At the point of contracting the loans, they probably had a projection on the direction of exchange rate movements. So when the cedi depreciates outside the band of their forecast, it affects the entire financial projection. For instance, when a company projects to import items worth USD200,000 at GHS5/1USD an upward adjustment in the exchange rate to GHS5.5/1USD technically affects its projections. This is a clear case of exchange rate fluctuation which the company has no control over.
High interest rate regimes
In Ghana, interest rates on loans are generally on the high side. These high interest rates make it very difficult for a company to honour its credit obligations as they fall due. A clear example is when a company borrows funds at a rate of 27 percent to finance a business venture. If the company does not make enough returns above 27%, it would be very difficult for them to repay the loan. In the early stages, they may just be able to meet their obligations but would struggle to stay afloat and honor their obligations in the medium to long term.
Natural disasters give rise to conditions that make it difficult for businesses to repay their loans. Some common natural disasters in Ghana are flooding and fire outbreaks. In recent times, the Covid-19 pandemic has proved a force to recon with in keeping businesses afloat. This has in most cases brought businesses to a standstill or even collapsed thereby leading to loan defaults. A clear case of the adverse effect of natural disasters is the aftermath of the implementation of lockdowns and its disturbing effect on profitability in the airline industry. This prompts the need to have insurance covers for businesses to take care of future uncertainties. Companies without proper insurance covers on their businesses tend to default when hit with natural disasters according to studies.
Cost of doing business and other macroeconomic indicators.
When government creates an enabling business environment, the cost of doing business would be low. On the contrary, when macroeconomic indicators are not fundamentally solid, it leads to high cost of doing business. Cost of doing business includes fuel prices, taxes and labour rates. Generally, when the cost of doing business is high, it has an adverse effect on borrower’s ability to repay their loans.
These are factors that make it easy for a bank’s customers to default in their loan repayments.
Improper Credit Risk Management Framework
Most credit officers are often concerned about their loan budgets and may be driven to ignore some red flags that can lead to future loan defaults when the loan is eventually disbursed. The credit risk analysis may not be properly done. In some cases, the credit officer may not understand the business line of the client which makes it difficult to carry out the right due diligence in assessing the health of the company. When poor due diligence is done, chances of defaults are high.
Poor loan monitoring
Loans should be handled on a case by case basis. For instance, funds should be given in tranches in the case of constructions for the various phases. When a contractor applies for a loan from the bank, the credit can be arranged in such a way that funds would be made available in tranches. There should be monitoring after loans have been credited to the account of the client to ensure that the funds are actually being used. If poor monitoring is done, funds can be diverted. Monitoring involves inspection of collateral, work in progress etc. Monitoring helps you see early warning signs so corrective action can be taken.
Unethical bank staff colluding with borrower to dupe the bank
Some clients are unethical and same can be said of some bank staff too. Some staffs of banks collude with customers to take loans they know those clients would not be able to pay off. Once granted, possibility of default is high which would eventually lead to high NPLs.
High non-performing loans are not good for any bank, banking industry and shareholders even if the loans are legacy debts. When there is a widespread of NPLs with all banks, the health of the banking sector is shaky. The regulator has some allowable threshold to NPLs and some banks also have their internal targets on NPLs. In order for banks to record low NPLs, they need to work with their clients and themselves to make it happen. Proper due diligence, with improved credit risk management framework has to be done before loans are approved, there should be proper monitoring of loans by credit officers and recovery department, so early signs of default can be seen and dealt with. Banks are expected to recruit and train their staff to be ethical so they do not collude with clients to dupe the bank.
Companies should also learn to choose the right sources of fund for all projects and should not divert funds into other projects. The banking sector would be very solid and well equipped to perform their financial intermediation role if all the stakeholders play their respective roles. A healthy financial services sector would help boost economic development because of its ability to support other sectors of the economy and provide good jobs for the citizenry.
Disclaimer: Disclaimer: The views expressed are personal views and doesn’t represent that of the media house or institution the writers work for.
About the Authors
Carl Odame-Gyenti is a final year PhD (Financial Management) candidate, a Finance and Telecom enthusiast, managing local and global Investors, Intermediaries, Banks and Non-Bank Financial Institutions relationships with an International Bank in Ghana. Contact: [email protected], Cell: +233-204-811-911
Sophia Kafui Teye Author of the under listed Books; Start Right- A guide to financial investments in Ghana, Overcoming Infertility- What to do when childbirth delays, Contemporary Parenting, Stepping up your Life Email Address: [email protected] Cell: +233-242-913-562