CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

The financial landscape of Ghana has gone through significant changes over the past three

decades. In the 1970’s and the early 1980’s the economy of Ghana was characterised by a

steady decline with hyperinflation and exchange rate depreciation being major features. The

malaise that afflicted the economy took its toll on the banking and financial system of the

country. Among ills bedeviling the financial system, the following may be mentioned as

prominent: low capital base of banks, high risk concentration, large portfolio of non-

performing loans, weak accounting and management information systems, weak internal

controls and weak supervision and deficiencies in the legal and regulatory framework.

Before 1983, the formal banking system in the country was dominated by state owned banks

that had a monopoly in terms of their spread and operations (Hinson and Hammond, 2006).

The current banking environment has however changed. Hinson and Hammond (2006)

report that, with the passage of the universal banking law however, all types of banking can

be conducted under a single corporate banking entity and this greatly reorganises the

competitive scopes of several banking products in Ghana. Thus reform and deregulation has

brought the banking sector into the competitive arena in terms of customers and products.

Standard Chartered Bank Ghana Limited (SCB) has been operating in Ghana since 1896 and

is one of the country’s first and oldest international business institutions in the country. The

bank opened its first branch in Accra in June 1896. Its core business was being the sole

distributor of silver coins to the Gold Coast now Ghana. The bank is currently situated in 19

locations all over Ghana and still maintains Accra as head office. SCB employs over 700

people nationwide and has a customer base of two million. The company offers varied

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products and services mainly in the context of personal banking, small and medium-sized

enterprise banking and corporate or wholesale banking. These products and services have

made the company attractive to both personal account holders as well as private investors in

Ghana. The bank is listed on the Ghana stock exchange and has consistently remained the

highest-priced stock on the local bourse with a share price of GH¢38 per share as of October

2, 2008. The bank is also one of the first financial institutions to be involved in financing

import and export trade in products like cocoa, gold, bauxite and timber.

Lending is one of the main activities of banks in Ghana and other parts of the world. This is

evidenced by the volume of loans that constitute banks assets and the annual substantial

increase in the amount of credit granted to borrowers in the private and public sectors of the

economy. According to Comptroller (1998), lending is the principal business for most

commercial banks. Loan portfolio is therefore typically the largest asset and the largest

source of revenue for banks. In view of the significant contribution of loans to the financial

health of banks through interest income earnings, these assets are considered the most

valuable assets of banks. Loan portfolio is typically the largest asset and the predominant

source of income for banks. In spite of the huge income generated from their loan portfolio,

available literature shows that huge portions of banks loans usually go bad and therefore

affect the financial performance of these institutions (Comptroller, 1998). The Bank of

Ghana’s classifications of advances of the Banking industry indicated that unsecured loans in

the loss category increased from GH¢125, 196,732 in December 2007 to GH¢204,

978,569.00 in December 2008, indicating over 63% jump in bad loans. A report on the

performance of banks in 2006 indicated that among other factors, higher loan loss provision

accounted for a decline in the profitability of banks in 2005 (Bank of Ghana, 2006). The issue

of unsecured loans can fuel banking crisis and result in the collapse of some of these

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institutions with their attendant repercussions on the economy as a whole. Kane and Rice

2001) stated that at the peak of the financial crisis in Benin, 80% of total bank loans portfolio

which was about 17% of GDP, was non-performing in the late nineties. Indeed unsecured

loans can lead to the collapse of banks which have huge balances of these non-performing

loans if measures are not taken to minimize the problem. In Ghana, the banking industry

plays an important role in the development of the economy. Huge unsecured loans could

therefore affect banks in the performance of this important role.

1.2 Statement of the Problem

The current credit crunch has affected the performance of many banks globally. Thus

institutions that adopt strategies to compete better are more likely to survive in the long run.

The credit crunch poses a grave threat to the economies of the developed and developing

world. The global banking industry, which was by far the most profitable sector in 2006, is in

severe difficulty and the threat that this poses to the real economy is profound.

The world has experienced remarkable numbers of banking and financial crises during the

last thirty years. Caprio and Klingebiel (1997) identify 112 systemic banking crises in 93

countries since the late 1970s. Demirguc-Kunt and Detragiache (1998) have identified 30

major banking crises that are encountered from early 1980s and onwards. According to the

above researchers most of these banking crises were experienced in the developing countries

such as Ghana. Interestingly, the majority of the crises were caused by unsecured loans.

Persistent loan defaults have become an order of the day in developing countries such as

Ghana. There has been hardly any bank in Ghana which has not experienced persistent loan

default. This is evidenced by the under-capitalisation of the banking sector in 2009. Healthy

loan portfolios are vital assets for banks in view of their positive impact on the performance

of banks. Unfortunately, some of these loans usually do not perform and eventually result in

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bad debts which affect banks earnings on such loans. These unsecured loans become cost to

banks in terms of their implications on the quality of their assets portfolio and profitability.

This is because in accordance with banking regulations, banks make provisions for non-

performing loans and charge for bad loans which reduce their loan portfolio and income. For

example in February, 2009, a Bank of Ghana report revealed that non-performing loans ratio

increased from 6.4% in 2007, to 7.7% in 2008. In the light of the above, the issue of

unsecured loans has raised some concerns among stakeholders in the banking industry. The

study therefore seeks to find out how unsecured loans affect financial performance of banks

in Ghana using Standard Chartered Bank, Ghana.

1.3 Objective of the Study

The study has a general objective of establishing the main impact of unsecured loans on the

financial performance of Standard Chartered Bank, Ghana.

Specifically, the study has the following objectives:

To establish the trend of unsecured loans of Standard Chartered Bank, Ghana during

the past five years

To identify the factors that account for unsecured loans in Standard Chartered Bank,

Ghana.

To come out with recommendations that can address the issue of unsecured loans in

the Ghanaian banking sector

1.4 Research Question

Evolving from the problem statement discussed above, the study aims at providing answers to

the following questions:

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Which key areas of the Bank’s financial performance are affected by unsecured

loans?

What is the trend of Standard Chartered Bank Ghana unsecured loans over the last

five years?

What factors account for unsecured loans in the bank?

1.5 Significance of the Study

The study would contribute significantly to the development of the banking industry which

plays a pivotal role in the development of the economy. This is because the study seeks to

identify causes of unsecured loans in banks and recommend some measures that can solve

these problems. The findings would also enable management of banking institutions come

out with pragmatic policies for loan portfolio management aimed at improving the quality of

their loan portfolios.

The findings are expected to remind credit staff about the implications of their credit duties in

creating quality loan portfolio for their banks. The findings of this study could be seen as a

contribution to existing works on unsecured loans. Indeed, this would contribute immensely

in building up academic knowledge in a wide range of issues. The study would also play a

significant role of engineering further research into other aspects of the topic under

consideration or other related topics in the banking sector.

1.6 Scope of the Study

The study focuses on the Standard Chartered Bank, Ghana; one of Ghana’s largest and oldest

banks. This is premised on the fact that the Bank has been operating long enough to give the

kind of academic insight the study seeks to offer. Besides, the bank lends to almost all the

major sectors of the economy and as such the data needed to accomplish the work would be

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obtained without any hindrance. Conceptually, the study looks at all categories of unsecured

loans and their impacts on financial performances of the Standard Chartered Bank, Ghana.

Specifically, the impact of unsecured loans on loan interest income, profitability and liquidity

of the bank is assessed. The study also considers the sector that is prone to unsecured loans.

1.7 Limitation of the Study

Time was a major constraint in this study. As a result of limited time within which to

complete this work, the study was carried out using a case study approach. There was

therefore the possibility that some issues regarding the topic might not come up if such issues

are peculiar to some banks that were not covered in the study. The study was further

narrowed down to some loan officers and some management staff of the bank, from whom

primary data was obtained. This also posed a limitation since there could be some biases

regarding the information obtained.

1.8 Organisation of the Study

This study is divided into five main chapters. The first chapter contained introduction of the

study including the statement of the problem of the study, research objectives and questions,

significance of the study, scope of the study and the limitations associated with the study.

Chapter two focused on review of literature on the previous works related to unsecured loans.

Performing and nonperforming loans, bad loan provisioning, loan-making procedures and

monitoring of loans were also considered in this section of the study. The details of research

method and organizational profile were captured under chapter three.

Chapter four entails data presentation and analysis.

The Last chapter covered summary, conclusions and recommendations of the study.

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CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

This chapter focuses on the review of relevant literature on loans and other core aspects of the

topic under study. The chapter thus presents the conceptual and theoretical basis for the

study.

2.2 Meaning of Banks

Over the years it has been a difficult task to find an acceptable definition of a bank or a

banker. Several attempts have been made to offer a comprehensive and acceptable definition.

Starting from the time of J W Gilbart(1847), he defined a banker as a dealer in capital, or

more appropriately, a dealer in money. Gilbart(1847), regarded banks as intermediate parties

between the borrower and the lender (Iganiga, 1998). This is because the banks borrow from

one party and lend to another. It will be observed that this definition emphasizes the two

traditional functions of a bank i.e. the mobilization of deposition and the granting of loans

and advances. But in recent time banks business has been expanded considerably and as a

result Gilbart’s definition cannot be regarded as complete or comprehensive.

In 1969, the Banking Act of England defined Banking by the following activities.

I. The business of receiving money from outside sources as deposit irrespective of the

payment of interest.

II. The granting of loan, acceptance of credit or the purchase of bills, cheque and sales of

securities.

III. The purchase and sales of securities on behalf of customers. (Isedu, 2001).

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Umole, (1985), points out that this definition fits better into the modern day role of banks in

the economy, because the definition goes beyond mere collection of depositor’s fund. The

banks, be it central, clearing merchant, saving or whatever form, pursue similar goals. They

contribute significantly to achieve the stated macroeconomic objective of economic

transformation.

2.3 Functions of Banks

2.3.1 Offering liquidity

According to Freixas and Rochet (2008), liquidity in Banking refers to assets that can easily

be converted into cash. Money in the form of cash is regarded as the most liquid asset in the

banking Industry. Historically, the existence of Banks is credited to this unique function of

providing liquidity to people and corporate bodies to carry out their daily business activities.

In order to perform this role banks offer saving, deposit and current account facilities to the

public. When a customer decides to operate an account, and pay a minimum amount as

specified by the banks, the amount deposited on the various account is held by the bank as

deposit liability. In addition to this, banks help in keeping other convertible equities, like

certificate of occupancy, share certificate, deeds of conveyance etc. The bank is therefore

requested by law to make a certain percentage of their deposit liabilities and capital funds

available to the bank customers, to meet customer demand (Idahosa, 2000).

2.3.2 Payment Service

A Bank is under obligation to pay back to the customer any amount as specified by the

customer according to the value of the account held (Freixas and Rochet, 2008). A bank

customer may also want his cheque cashed up to a stated amount and within a specified

period, at another branch of the bank or another bank. Conversely, the customer can also

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receive money through the bank when a debtor has decided to pay from a distance with

crossed or open cheque.

2.3.3 Lending Services

Idahosa (2000) asserts that the deposits kept in banks need not be left idle, because from

experience banks are aware that depositors may not need all the deposits at a time. It is

therefore prudent of the banker to lend such money to investors at a higher rate which brings

some revenues to them. They achieve this through overdraft, loan, bills discounting or

through direct investment.

Guilford (2008), points out that the significance of bank lending cannot be overstated. Bank

loans drive the economy. Bank loans provide the capital for businesses to start and expand.

According to Guilford (2008), the first step in attaining a bank loan is for a bank customer to

fill out a loan application. The application will include personal information, financial

information and questions about the purpose of the loan. Once submitted, the application will

go into underwriting, where the bank will make a decision on whether or not to loan the

money and at what rate of interest. The bank will investigate the customer's credit rating. If it

is acceptable, the bank will issue the loan.

2.3.4 International trade services

Isedu (2001) emphasizes that banks help to provide the link through which payments for

goods and services bought or sold by importers and exporters can be settled. In addition to

this, they provide guarantee to exporters who need such guarantees before they can release

their goods. Banks trade on foreign currencies. They engage competitively in foreign

currency transaction as it provides them a significant source of revenue. However, foreign

exchange transactions laws in every country are very stringent.

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2.4 Definition of Loan

According to Guttentag (2007), loan is a type of debt. Like all debt instruments, a loan

entails the redistribution of financial assets over time, between the lender and the borrower.

In a loan, the borrower initially receives or borrows an amount of money, called the principal,

from the lender, and is obligated to pay back or repay an equal amount of money to the lender

at a later time. Typically, the money is paid back in regular installments, or partial

repayments; in an annuity, each installment is the same amount. The loan is generally

provided at a cost, referred to as interest on the debt, which provides an incentive for the

lender to engage in the lending. In a legal loan, each of these obligations and restrictions is

enforced by contract, which can also place the borrower under additional restrictions known

as loan covenants.

2.5 Types of loans

2.5.1 Secured Loan

A secured loan is a loan in which the borrower pledges some asset for example a car or

property as collateral for the loan. A mortgage loan is a very common type of debt

instrument, used by many individuals to purchase housing. In this arrangement, the money is

used to purchase the property. The financial institution, however, is given security a lien on

the title to the house until the mortgage is paid off in full. If the borrower defaults on the

loan, the bank would have the legal right to repossess the house and sell it, to recover sums

owing to it. In some instances, a loan taken out to purchase a new or used car may be secured

by the car; in much the same way as a mortgage is secured by housing

(htt://en.wikipedia.org/wiki/loan).

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2.5.2 Unsecured Loan

Unsecured loans are monetary loans that are not secured against the borrower's assets. These

may be available from financial institutions under many different guises or marketing

packages: credit card debt, personal loans, bank overdrafts, credit facilities or lines of credit

and corporate bonds . The interest rates applicable to these different forms may vary

depending on the lender and the borrower. In finance, unsecured debt refers to any type of

debt or general obligation that is not collateralised by a lien on specific assets of the borrower

in the case of a default. In the event of the bankruptcy of the borrower, the unsecured

creditors will have a general claim on the assets of the borrower after the specific pledged

assets have been assigned to the secured creditors, although the unsecured creditors will

usually realize a smaller proportion of their claims than the secured creditors. In some legal

systems, unsecured creditors who are also indebted to the insolvent debtor are able (and in

some jurisdictions, required) to set-off the debts, which actually puts the unsecured creditor

with a matured liability to the debtor in a pre-preferential position (wikipedia.org/wiki/loan).

An unsecured loan is a financial instrument where there is no collateral for the lender to have

for security in case of default from the borrower. Most loans that you get from friends or

family where there is no collateral is an unsecured loan. The borrower signed a binding

contract to the lender, promising to repay the loan according to the terms and that is what the

borrower needs to do. Unpaid debt can cause many problems for the borrower, the lender and

the economy, so all credit given to the borrower, secured or unsecured should be treated how

they would like to be treated if they were the lender for someone else

(wikipedia.org/wiki/loan).

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2.5.3 Performing Loans

Legally, a loan or credit facility refers to a contractual promise between two parties where

one party, the creditor agrees to provide a sum of money to a debtor, who promises to return

the said amount to the creditor either in one lump sum or in installments over a specified

period of time. The agreement may include provision of additional payments of rental

charges on the funds advanced to the borrower for the time the funds are in the hands of the

debtor. (htt://en.wikipedia.org/wiki/loan). The additional payments that are in the form of

interest charges, processing fees, commissions, monitoring fees among others, are usually

paid in addition to the principal amount lent. Indeed these additional payments when made in

accordance with the loan contract constitute income to the lender or the creditor. A loan may

therefore be considered as performing if payments of both principal and interest charges are

up to date as agreed between the creditor and debtor. Bank of Ghana classifications of loans

indicate that loans that are current are those for which the borrower is up to date in respect of

payments of both principal and interest. It further shows that an overdraft would be

considered as current or performing if there were regular activity on the account with no sign

of a hardcore of debt building up (Bank of Ghana, 2008).

The foregoing reveals that loans that are up to date in terms of principal and interest

payments are described as performing facilities. These types of loans constitute quality asset

portfolio for banks in view of the interest income generated by such assets.

2.5.4 Non-Performing Loans

Generally, loans that are outstanding in both principal and interest for a long time contrary to

the terms and conditions contained in the loan contract are considered as nonperforming

loans (Bank of Ghana, 2008). This is because going by the description of performing loans

above, it follows that any loan facility that is not up to date in terms of payment of both

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principal and interest contrary to the terms of the loan agreement, is nonperforming.

Available literature gives different descriptions of bad loans. Some researchers noted that

certain countries use quantitative criteria for example number of days overdue scheduled

payments while other countries rely on qualitative norms like information about the

customer’s financial status and management judgment about future payments (Bloem and

Gorter, 2001).

Alton and Hazen (2001) describe non-performing loans as loans that are ninety days or more

past due or no longer accruing interest. Caprio and Klingebiel (1990), consider non-

performing loans as loans which for a relatively long period of time do not generate income,

that is the principal and or interest on these loans have been left unpaid for at least ninety

days. A non-performing loan may also refer to one that is not earning income and full

payment of principal and interest is no longer anticipated, principal or interest is ninety days

or more delinquent or the maturity date has passed and payment in full has not been made.

Critical appraisal of the foregoing definitions of bad loans points to the fact that loans for

which both principal and interest have not been paid for at least ninety days are considered

non-performing. According to Berger and De Young (1997), such loans could be injurious to

the financial performance of banking institutions.

2.6 Loan Classification and Provision

2.6.1 Loan Classification

Loan portfolios of banks are classified in order 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 (Bank of

Ghana, 2008). The classifications indicate the level of provisions banks are required to make

to reflect the quality of their loan portfolio. Indeed the various classifications clearly group

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loans into performing and nonperforming, in line with banking regulations. These categories

further help banks to know the structure of their loan portfolio and for that matter their assets

quality.

2.6.2 Loan Provisioning

In Ghana, a major factor considered in making loans is the ability of the borrower to repay

the loan. However, to mitigate the risk of default, banks ensure that loans are well secured.

Though advances shall be granted on the basis of the borrower’s ability to pay back the

advance and not on the basis to pledge sufficient assets to cover the advance in case of

default, it is highly desirable for all advances made to customers and staff to be well secured.

This means that in the event of default the bank shall fall on the collateral used in securing

the facility to mitigate the effect of loss of principal and interest (Banking Act, 2004).

In view of the above, banks take into account the assets used in securing the facility to

determine the level of provision to be made. Bank of Ghana regulations indicate that certain

amount of provisions are made on the aggregate outstanding balance of all current advances,

and aggregate net unsecured balance of all other categories. The 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 (Bank of Ghana, 2008).

2.7 Implication of Unsecured Loans for Banking Institutions

Loans generate huge interest for banks which contribute immensely to the financial

performance of banks. However, when loans go bad they have some adverse effects on the

financial health of banks. This is because in line with banking regulations, banks make

adequate provisions and charges for bad debts which impact negatively on their performance.

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Bank of Ghana regulations on loan provisioning indicate that loans in the non-performing

categories that is loans that are at least ninety days overdue in default of repayment will

attract minimum provisions of 25%, 50% and 100% for substandard, doubtful and loss,

respectively( Bank of Ghana Act, 2004).

According to Bloem and Gorter, (2001), though issues relating to non-performing loans may

affect all sectors, the most serious impact is on financial institutions such as commercial

banks and mortgage financing institutions which tend to have large loan portfolios. Besides,

the large bad loans portfolios will affect the ability of banks to provide credit. Huge non-

performing loans could result in loss of confidence on the part of depositors and foreign

investors who may start a run on banks, leading to liquidity problems.

The provisions for bad loans reduce total loan portfolio of banks and as such affects interest

earnings on such assets. This constitutes huge cost to banks. Study of the financial statement

of banks indicates that unsecured loans have a direct effect on profitability of banks. This is

because charge for bad debts is treated as expenses on the profit and loss account and as such

impact negatively on the profit position of banks (Price Water-House Coopers, 2009).

Berger and De Young (1997), indicate that failing banks have huge proportions of bad loans

prior to failure and that asset quality is a statistically significant predictor of insolvency.

Fofack (2005), also reported that during the banking crisis in Indonesia, non-performing

loans represented about 75% of total loan assets which led to the collapse of over sixty banks

in 1997. This means that banks holding huge bad loans in their books can run into bankruptcy

if such institutions are unable to recover their bad debts. A possible effect of bad loans is on

shareholders earnings. Dividends payments are based on banks performance in terms of net

profit. Thus since bad loans have an adverse effect on profitability of banks, it can affect the

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amount of dividend to be paid to share holders. The Banking Act of Ghana spells out that a

bank shall not declare or pay dividend on its shares unless it has, among other things, made

the required provisions for non-performing loans and other erosions in assets value [Section

30 (1) of Banking Act, 2004].

The effect of bad loans on the amount of dividend paid to shareholders can also affect capital

mobilization because investors will not invest in banks that have huge non-performing loans

portfolio.

Elebute (2009) identifies among other things, foreign direct investment and domestic capital

mobilisation as some of the options available to Ghanaian banks to source funds to meet the

minimum capital requirement of Bank of Ghana which is pegged at GH¢60,000,000.00

(Asamoah, 2009).

It is evident that non-performing loans with their attendant negative impact on investors’

earnings can affect the Ghanaian banks in meeting the minimum capital requirement.

The foregoing discussions show the implications of unsecured loans on banks performance in

Ghana and other parts of the world.

2.8 Factors Accounting for Unsecured Loans

Research findings and publications show that bad loans occur as a result of some factors.

Berger and De Young (1997) identified poor management as one of the major causes of

problem loans. They argue that managers in most banks with problem loans do not practice

adequate loan underwriting, monitoring and control. A World Bank policy research working

paper on Non-performing Loans in Sub-Saharan Africa revealed that bad loans are caused by

adverse economic shocks coupled with high cost of capital and low interest margins (Fofack,

2005).

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Goldstein and Turner (1996) states that the accumulation of non-performing loans is

generally attributable to a number of factors, including economic downturns and

macroeconomic volatility, terms of trade deterioration, high interest rate, excessive reliance

on overly high-priced inter-bank borrowings, insider lending and moral. Rouse (1989)

indicates in his work that problem loans can emanate from overdrawn account where there is

no overdraft limit, overdraft taken on an account which has not been actively operated for

some time and overdraft taken in excess of reasonable operational limits. He also identified

lack of good skills and judgment on the part of the lender is a possible cause of bad loans.

Bloem and Gorter (2001) indicate that non-performing loans may rise considerably due to

less predictable incidents such as the cost of petroleum products, prices of key export

products, foreign exchange rates or interest rates change abruptly. They also stated that

deficient bank management, poor supervision, overoptimistic assessments of creditworthiness

during economic booms, and moral hazard that result from generous government guarantees

are some of the factors that lead to bad loans. It is worth noting that though the literature

obtained from foreign sources indicate some causes of bad loans, some of these may not

apply to banks in the Ghanaian environment.

2.9 Loan Processing in Banks

Rouse (1989) 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

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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, location of the business or project and Technical and financial soundness of the

credit proposal. Among the criteria outlined above, credit vetting or appraisal is one of the

crucial stages in the loan processing procedures. This is because this stage analyses

information about the financial strength and creditworthiness of the customer.

Kay Associate Limited (2005) 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.

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2.10 Monitoring and Control of Loans

According to Rouse (1989) this is an area which many lenders pay little attention but, if it is

properly carried out, the occurrence of bad debts can be reduced considerably. He identified

internal records, visits and interviews, audited accounts and management accounts as some of

the things that help in the monitoring and control process.

Monitoring can minimize the occurrence of bad loans 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.

Bad loans can be restricted by ensuring that loans are made to only borrowers who are likely

to be able to repay, and who are unlikely to become insolvent. Credit analysis of potential

borrowers should be carried out in order to judge the credit risk with the borrower and to

reach a lending decision. Loan repayments should be monitored and whenever a customer

defaults action should be taken. Thus banks should avoid loans to risky customers, monitor

loan repayments and renegotiate loans when customers get into difficulties (Kay Associates

Limited, 2005).

2.11 Effect of Unsecured Loans

Hempel and Simonson (1999) state that the main activity of bank management is not deposit

mobilization and giving credit. Effective credit administration reduces the risk of customer

default. The competitive advantage of a bank is dependent on its capability to handle credit

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risk valuably. Unsecured loans cause bank failure. Palubinskas and Stough (1999), noted that

the failure of a bank is mainly seen as a result of mismanagement because of bad lending

decisions made with respect to wrong appraisal of credit status, or the repayment of non-

performing credits and excessive focus on giving loans to certain customers.

Goodhart et al. (1998) also state that poor credit control, which results in undue credit risk,

causes bank failure. Chimerine (1998) adds that a bad lending tradition leads to a large

portfolio of unpaid loans. This results in insolvency of banks and reduces funds available for

fresh advances, which eventually causes a financial crisis. Goodhart et al. (1998) add

connected lending to the causes of bank failure. Again, Palubinskas and Stough (1999) note

that lack of dependable financial information on borrowers to help in assessing

creditworthiness causes a bank failure. Yet mismanagement is not a result of immaturity all

the time. Most of the time, principals and agents know that major faults in the banking

regulation in respect of internal changes permit them to exploit a bank’s funds. Sometimes

these two groups of stakeholders attempt to accomplish their short term earnings objectives

by acquiring high risks in the bank. Spollen (1997) states that irregular meetings of loans

committees, false loans, large treasury losses, high sums of unrecorded deposits and money

laundering in large amounts, contribute to bank failure. He adds that some lending decisions

involving high amounts of money are made by an individual worker because of the status of

the recipients of the loans.

Hempel and Simonson (1999) conclude that all banks incur certain loan losses when some

borrowers default in repaying their loans. Irrespective of the extent of the risk involved, good

credit management can reduce the default.

20

CHAPTER THREE

RESEARCH METHODOLOGY

3.1 Introduction

This chapter focuses on methods that were employed in the study, the target population,

sample size and sampling techniques as well as the various and appropriate sources of data

and how the data were collected and analysed.

3.2 Research Design

The case study design was employed to find answers to the research questions. The

justification for this method is that it generated answers to the questions such as why, what

and how, which helped in answering the research questions.

The researcher adopted exploratory and explanatory approaches. Exploratory was used to

help the researcher find out more about the problem of unsecured loans, especially the

adverse effects of these loans on bank performance as well as factors that lead to unsecured

loans. Explanatory study approach was employed to establish how unsecured loans impact

on bank performance and also to show how the loan making procedures and rules, as well as

other factors can result in unsecured loans.

Thus, a combination of this approach with in depth interviews and the use of questionnaire as

data collection techniques were very useful in the study of unsecured loans.

3.3 Sources of Data

The data collected for the study comprised of primary and secondary data. The type of data,

their sources and the instruments used in gathering them are discussed as follows:

21

3.3.1 Primary Data

Both structured questionnaires and interview guides were used in the data collection. While

the structured questionnaires were used to get the unbiased opinion of respondents, the

interviews were used for clarifications of some unclear issues. These data collection

instruments made it very convenient for respondents to give the data needed for the analysis.

3.3.2 Secondary Data

The secondary data were sourced from the published annual reports and financial statements

of the bank. The information covered a period of two years from 2008 to 2009. This category

of data was both in quantitative and qualitative form. Access to the data was not a problem

as these were published annually in the print and electronic media for public consumption.

3.4 Population of the Study

The target population for the study consists of credit officers of Standard Chartered Bank,

Ghana head office and two branch managers from Opeibea branch and Madina branch.

3.5 Sample and Sampling Technique

In conducting a research, it is often impossible, impracticable or too expensive to collect data

from all the potential units of analysis (population). Hence a smaller number of units

(sample) are often chosen to represent the whole population. Fifteen credit officers were

conveniently drawn from the entire population of the credit Officers of the bank. This forms

about 15% of the total population of credit officers of the bank. These were people who had

the expertise in loan administration issues.

The sampling method chosen for this dissertation was convenience sampling, which belong

to the non-probability sampling techniques. Convenience sampling means that the researcher

22

find respondents that were willing to participate in the study. This method led to the easy and

convenient access to the data needed to achieve the objectives of the research

3.6 Research Instruments

3.6.1 Questionnaires

This method was used to gather definite answers to specific questions related to the area of

study. This method was to seek the respondents opinions and views on specific areas of the

study, hence the need to provide definite answers and suggestions where necessary. In all,

the researchers distributed fifteen (15) questionnaires to the credit officers selected for the

study. One kind of question was phrased in descriptive statements. As recommended by

Parasuraman (1991), a 5-point Likert-scale (1= Lowest, 5= Highest) was used. Another was

the closed-ended questions where the respondents can choose one or more alternative

answers. This made the questionnaires easy to complete in a short space of time by the

respondents.

3.6.2 Interviews

This method was used to gain an understanding of the loan policies and procedures of

Standard Chartered Bank, Ghana. To achieve this the researchers interviewed two bank

managers of the Standard Chartered Bank. It is worth stating that the form of interview was

face to face interview technique conducted at the offices of the bank officials. The researcher

prepare interview guide to assist them asked relevant questions.

3.7 Administration of Research Instruments

Questionnaires were administered personally to respondents by the researchers. In the

administration of the questionnaires, the researchers personally paid a number of visits to the

23

respondents to distribute the questionnaires at their work place. All the fifteen questionnaires

distributed to the respondents were answered and collected back. A pre-testing activity of the

data collection instruments was carried out to test the construction of the English language,

validity and reliability of the questions.

3.8 Data Analysis

Spread sheet and simple excel were used to process the data for the analysis. Tables and

statistical diagrams like bar charts, pie charts and line graphs also aided in the data

presentation. The primary data were presented by some of these statistical tools and by way

of narration. Presentation of the data on these statistical tools made the analysis very easy.

The statistical tools used conveyed the meaning of the figures captured and as such made the

analysis straight forward.

24

CHAPTER FOUR

DATA PRESENTATION AND ANALYSIS

4.1 Introduction

This chapter presents the analysis of field data collected and the discussions of findings by

the researcher. This stretches through the analysis of questionnaires sent to credit officers,

interviews conducted with branch managers and the discussions of findings.

4.2 Presentation and Analysis of Data from Credit Officers

4.2.1 Gender Distribution of the Respondents

Figure 4.1 Gender Distribution

(Source: Field Data, 2010)

From the figure 4.1 above, 93% of the credit officers selected for the study were male. On the

other hand, 7% of the sampled population were female. The above result depicts that majority

of the Standard Chartered Bank Ghana Limited credit officers are male.

Male93%

Female7%

25

4.2.2 Age Distribution of the Respondents

Table 4.1 Age Distribution

Response Frequency Percentage

Between 20 and 30 5 33%

Between 30 and 40 7 47%

Between 40 and 50 2 13%

Between 50 and 60 1 7%

Total 15 100%

(Source: Field Data, 2010)

Table 4.1 above illustrates that, 5 credit officers representing 33% of the sampled population

were between 20 years and 30 years. In addition, 7 credit officers representing 47% of the

sampled population were between 30 years and 40 years. Also, 2 credit officers representing

13% of the sampled population were between 40 years and 50 years.

The above findings portray that majority of Standard Chartered Bank, Ghana Limited credit

officers are between the ages 30 and 40. This implies that Standard Chartered Bank, Ghana

Limited used mature people as its credit officers.

26

4.2.3 Educational Level of the Respondents

Figure 4.2 Educational Background

(Source: Field Data, 2010)

Figure 4.2 above illustrate that 80% of the credit officers sampled for the study had

bachelors’ degree. In addition, 13% of the sampled credit officers had diploma or Higher

National Diploma. Finally, 7% of the sampled credit officers had masters’ degree.

This signifies that about 80% of the Standard Chartered Bank Ghana Limited had completed

their bachelors’ degree. Also, the educational background of the credit officers means that

Standard Chartered Bank Ghana Limited employees qualified people as its credit officers.

Diploma/HND 13%

Bachelors Degree 80%

Master Degree 7%

27

4.2.4 Period of Services of the Respondents

Table 4.2 Period of Service

Response Frequency Percentage

Under one year 1 7%

Between 1 and 3 years 4 27%

Between 3 and 5 years 4 27%

Above 5 years 6 39%

Total 15 100%

(Source: Field Data, 2010)

From the table 4.2 above , 1 credit officers corresponding to 7% of the sampled population

had worked for Standard Charter bank less the a year. Additionally, 4 credit officers

representing 27% of the sampled population had worked in Standard Chartered bank between

1 year and 3 years. Other 4 credits officers had worked with the bank between 3 and 5 years.

Finally, 6 credit officers corresponding to 39% of the sampled credit officers had worked for

the bank more than 5 years.

The above findings illustrate that majority of Standard Chartered Bank credit officers are

very experience because they had worked as credit officers for very long time.

28

4.2.5 Factors Accounting for Unsecured Loans

Table 4.3 Causes of Unsecured Loans

Response Frequency Percentage

Delayed loan approval 10 67%

Poor credit appraisal 15 100%

Marketing problems 12 80%

Diversion of loans 13 87%

Ineffective monitoring 14 93%

(Source: Field Data, 2010)

Table 4.3 denotes that 10 out of 15 credit officers selected for the study indicated that delayed

in loans approval was the cause of unsecured loans. In addition, all the 15 credit officers

sampled for the study indicated that poor credit appraisal was a cause of unsecured loans.

Furthermore, 12 credit officers indicated that marketing problem was a cause of unsecured

loans. Finally, 13 and 14 credit officers respectively indicated that unsecured loans are caused

by diversion of loans and ineffective monitoring.

29

4.2.6 Sectoral Distribution of Unsecured Loans

Figure 4.3 Sectoral Distributions of Unsecured Loans

(Source: Field Data, 2010)

From figure 4.3 above, 9 credit officers representing 60% of the sampled population

indicated that most of the bank unsecured loans are in the agricultural sector. Additionally, 4

credit officers representing 27% of the sampled population indicated that most of the bank

unsecured loans are in the manufacturing sector. Finally, 2 credit officers representing 13%

of the sampled population indicated that most of the bank loans are in the service sector.

0

10

20

30

40

50

60

Agriculture Manufacturing Service

Frequency 9 4 2

Percentage 60 27 13

30

4.2.7 Hindrances of Loans Monitoring

Figure 4.4 Hindrances of Loans Monitoring

(Source: Field Data, 2010)

Figure 4.4 above shows that 4 credit officers corresponding to 27% of the credit officers

selected for the study indicated that lack of logistics were the major hindrances to loans

monitoring. Also, 2 credit officers corresponding to 13% of the sampled population indicated

that under staffing were the major hindrances to loans monitoring. Finally, 9 credit officers

corresponding to 60% of the sampled population indicated that ineffective supervision were

the major hindrances to loans monitoring

0

10

20

30

40

50

60

Lack of logistics Under staffing Ineffective supervision

42

9

27

13

60

Frequency Percentage

31

4.2.8 Reasons for Loans Diversion

Table 4.4 Reasons for Loans Diversion

Response Frequency Percentage

Lack of proper monitoring 8 53%

Anticipation of high gains in other business ventures 9 60%

Ignorance of terms and conditions attached 15 100%

Inadequate financing 12 80%

(Source: Field Data, 2010)

From table 4.4 above, 8 credits officers indicated that lack of proper loan monitoring was the

cause of loan diversion by clients. Another 9 credit officers indicated that clients’ anticipation

of higher gains in other business venture was the cause of loan diversion. Also, all the 15

credit officers indicated that clients’ ignorance of the terms and the conditions of the loan

caused loans diversion. Finally, 12 credit officers indicated that inadequate financing caused

loans diversion. The above finding signifies that ignorance on the part of clients about the

terms and the conditions of the loans is the major reasons why clients divert loans.

32

4.3 Analysis of the Interview with Managers

4.3.1 Ratio analysis of the bank performance

Figure 4.5 Ratio analysis of the SCB performance

(Source: Field Data, 2010)

Figure 4.5 shows some financial ratio used to assess the effect of unsecured loans on the

performance of the Standard Chartered Bank. The ratios are explained below:

Return on Assets (ROA)

Return on Assets which shows how effective the bank turns a cedi of revenue into a cedi of

bottom line profit. It is highest in 2008 (5.3%) and decreased to 4.1% in year 2009, which is

and indication of high provision for bad and doubtful debts. This signifies that unsecured

loans had an inverse relationship with the profitability of the bank. This means that, all other

things been equal, high unsecured loans lead to lower profitability and vice versa.

2009 2008

Return on Assets 4.1% 5.3%

Bad Debt Percentage 6.1% 4.0%

Asset Utilization 44.7% 25.8%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

33

Percentage of Provision for bad and doubtful debts

From the figure 4.5 above, bad debt percentage was 4.0% in the 2008. This increased to 6.1%

in 2009. This means that most debts or loans where unpaid and went bad in 2009.

Asset Utilization (AU)

Asset Utilization is also another aspect of banks performance which measures how

effectively the bank converts its assets to revenue. Too high AU indicates that the bank invest

in very risky loans. This is portrayed in year 2009 where AU is highest (44.7%) and

consistent with the high provision for bad and doubtful debts same year.

4.3.2 Effect of unsecured loans on loan interest income

Table 4.5 Bad Loans and Loan Interest Income

Year Interest Income

(¢ 000)

Bad Debt

(¢ 000)

Percentage

(¢ 000)

2009 182,500 26,074 14.2%

2008 89,139 13,735 15.4%

2007 62,154 9,108 16.6%

(Source: Field Data, 2010)

Table 4.2 shows that there was a consistent increase in the interest income generated by the

bank’s loan portfolio. However, this was reduced by bad debts charges which are shown by

the ratios 14.2%, 15.4%, and 16.6% in 2009, 2008 and 2007 respectively. The huge reduction

in loan interest income was due to high bad debts provisions caused by agriculture sector

loans, and ineffective loan recovery attributed to understaffed credit offices and inadequate

logistics. The ratios of bad debts to loan interest income declined from 16.6%% in 2007 to

34

15.4% in 2008 and dropped further to 14.2% in 2009. This was due to improved loan

monitoring and recovery.

4.3.3 Credit Appraisal procedures

According to the branch managers, loans will be disbursed only to the client after his or her

identity has been verified and legal formalities, collateral creation, promissory notes signed

and completed. The contents of legal formalities are explained clearly and completely to the

client in official language before necessary signature of the client/guarantor is obtained in the

documents. The client will sign the documents in the branch office after ensuring that

necessary details have been filled up. Terms and conditions of the loan along with relevant

instructions should be explained clearly and completely to the client/guarantor in the official

language. Important points to be explained to the client include the repayment schedule,

mechanism for repayment, penalty for overdue, benefits and incentives for good repayment

record. The bank will grant loan to the customer once the above conditions are satisfied.

4.3.4 Impairment of Loans and Advances

The branch managers pointed out that, the bank assesses at each balance sheet date whether

there is objective evidence that a loans are impaired. A loan is impaired and impairment

losses are incurred only if there is objective evidence of impairment as a result of one or more

events that occurred after initial recognition of the loan. Objective evidence that a loan is

impaired includes observable data that comes to the attention of the bank about the following

loss events: significant financial difficulty of the borrower; a breach of contract, such as

default or delinquency in interest or principal repayments; it becoming probable that the

borrower will enter bankruptcy or other financial reorganisation; and adverse changes in the

payment status of borrowers. When a loan is uncollectible, it is written off against the related

35

provision for loan impairment. Such loans are written off after all the necessary procedures

have been completed and the amount of the loss has been determined.

4.4 Discussion of Findings

The study has a general objective of establishing the main impact of unsecured loans on the

financial performance of Standard Chartered Bank, Ghana. As indicated by the findings

above, unsecured loans had negative effect on the financial performance of Standard

Chartered Bank. The findings revealed that high unsecured loans resulted in high provision

for bad debt in the income statement of the bank. This high provision for bad debt reduces the

profit of the company since it reduces the interest income. Additionally, high unsecured

loans indicate that the bank invest in very risky loans.

On the factors that caused unsecured loans, the study revealed that many factors caused

unsecured loans. Among them are delayed in loans approval, poor credit appraisal, marketing

problem, diversion of loans and ineffective monitoring. Poor credit appraisal was found out

to be the major cause of unsecured loans.

Finally, the study shows that unsecured loans in Standard Chartered Bank had been

increasing since 2007 to 2009. As indicated in table 4.5, provision of bad debt in 2007 was

¢9,108,000, this increase to ¢13,735,000 in 2008 representing 50.8% increase in unsecured

loans. In 2009, provision for bad debt increased to ¢26,074,000, representing 89.8% increase

in unsecured loans. This signifies that unsecured loans in Standard Chartered Bank had been

increasing from year to year.

36

CHAPTER FIVE

SUMMARY CONCLUSION AND RECOMMENDATIONS

5.1 Introduction

This chapter provides a summary, conclusion and recommendations on the findings made in

the study.

5.2 Summary of the Findings

5.2.1 Causes of Unsecured Loans

The study reveals that delayed in loans approval, poor credit appraisal marketing problem

and ineffective monitoring on the part of credit officers were the major cause of unsecure

loans in Standard Chartered Bank.

5.2.2 Sectoral Distribution of Unsecured Loans

The study also reveals that most of the Standard Chartered Bank’s unsecured loans are in the

agricultural sector. This confirms the reason why banks in Ghana are unwilling to channel

majority of their loans to the Agricultural sector.

5.2.3 Effects of Unsecured Loans

The findings of the study show that unsecured loans had an inverse relationship with the

profitability of the bank. This means that, all other things been equal, high unsecured loans

lead to lower profitability and vice versa. This is because when a loan is uncollectible, it is

written off against the related provision for loan impairment which reduces the interest

income of the bank.

37

5.3 Conclusion

It is evident from the findings that the bank’s loan portfolio contained huge amounts of

unsecured loans. These unsecured loans reduce the loan interest income, operating profit and

lending funds, therefore it can be concluded that unsecured loans seriously affect the financial

performance of the bank. Considering the factors that account for unsecured loans as

established by the research findings, it can also be concluded that agriculture sector credit is

heavily exposed to unsecured loans than other sectors. Management therefore needs to put in

place pragmatic measures to mitigate the risk in this sector so as to improve the quality of the

overall loan portfolio of the bank. The foregoing findings reveal a worrisome situation about

the effect unsecured loans on banks financial performance. In view of the important role the

bank plays in the economic development of Ghana, it is very essential for all stakeholders,

especially management to adopt pragmatic measures to minimize the problem of unsecured

loans in the bank.

5.4 Recommendations

5.4.1 Regular Training Programmes for Credit Staff

It is recommended that management should organise regular training programmes for credit

staff in areas like credit management, risk management and financial analysis. This would

sharpen the knowledge and skills of credit officers so as to improve on the quality of credit

appraisal, prevent delayed loan approvals, enable credit officers appreciate the need to

comply with credit policy and further enhance monitoring of credit.

38

5.4.2 Regular Monitoring and Supervision

Another important way of minimizing unsecured loans is through regular monitoring and

supervision of loan facilities. This would prevent diversion of funds into business ventures

other than the agreed purposes.

5.4.3 Provision of Logistics

To ensure effective monitoring, management should ensure that credit offices at all branches

and area offices, are adequately resourced in terms of, vehicles and other logistics, to support

monitoring activities.

5.4.4 Provision of Adequate Security for Credit

Loans granted to customers should be well secured in terms of adequacy of the collateral

provided and also ensure that proper legal documentation is put place. This would reduce the

losses arising from problem loans and minimise the effects of such loans in the form of bad

debt provisions, on the financial performance of the bank

39

BIBLIOGRAPHY

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Banks, Washington DC, Journal of Banking and Finance, Vol. 21.

Bloem, M. A. and Gorter, N. C. (2001), Treatment of Non-Performing Loans in

Macroeconomic Statistics, IMF Working Paper, WP/01/209.

Caprio, G. and Klingebiel, D., (1999), Episodes of Systemic and Borderline, Financial Crises,

http://www1.worldbank.org/finance/assets/images/Crisistableproduct.doc, Accessed 2010-07-

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Demirguc-Kunt, A. and Detragiache, E. (1998), Banking on the Principles: Compliance with

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John Wiley and Sons, Inc.

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Hinson, R. and Hammond, B. (2006), Service Delivery in Ghana’s Banking Sector in African

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41

APPENDICES

Questionnaire for Credit Staff

Dear respondent,

I am students of Regent University College conducting a study on the topic: Effect on

unsecured loans on performance of a bank. Therefore, I wish to request you to spare

some time and answer the questions below as honestly as possible by ticking or filling in the

spaces provided. The information given will be solely used for academic purpose and will be

treated confidentially.

1. Gender

Male [ ] Female [ ]

2. What is your age?

20 – 30 [ ]

30 – 40 [ ]

40 – 50 [ ]

50 – 60 [ ]

3. Educational Background

Diploma/HND [ ]

Bachelors Degree [ ]

Master Degree [ ]

Other [ ] Specify __________________________________

42

4. How long have you worked at Standard Chartered Bank?

Under one year [ ]

Between 1 and 3 years [ ]

Between 3 and 5 years [ ]

Above 5 years [ ]

5. In your opinion, which of the following factors account for unsecured loans?

Delayed loan approval [ ]

Poor credit appraisal [ ]

Marketing problems [ ]

Diversion of loans [ ]

Ineffective monitoring [ ]

6. Do you think non-compliance with credit policy accounts for unsecured loans?

Yes [ ]

No [ ]

7. Which sector record higher unsecured loans?

Agriculture [ ]

Manufacturing [ ]

Service [ ]

8. How would you rank the following factors as causes of unsecured loans using a

scale of 1 to 5 with 5 being the highest and 1 the lowest?

Poor credit appraisal [ ]

Diversion of loans [ ]

43

Ineffective monitoring [ ]

Non-compliance with credit policy [ ]

Marketing problems [ ]

9. Which of the following factors hinder effective monitoring of loans?

Lack of logistics [ ]

Under staffing [ ]

Ineffective supervision [ ]

Others [ ] Specify ……………………………………………

10. Which of the following reasons account for loan diversion by customers?

Lack of proper monitoring [ ]

Anticipation of high gains in other business ventures [ ]

Ignorance of terms and conditions attached [ ]

Inadequate financing [ ]

11. What measures should management put in place to reduce unsecured loans?

_____________________________________________________________________

_____________________________________________________________________

______

Thank you

44

Interview Guide for Interviewing Branch Managers

1. What is the effect of unsecured loans on profits?

2. What is the effect of unsecured loans on loan interest income?

3. What is the effect of unsecured loans on the lending capacity of the bank?

4. What factors account for unsecured loans?

5. What are the procedures in appraising credit request?

6. Which of the sectors of the bank’s lending activities is associated with high unsecured

loans?

7. What are the factors that account for this?

8. How can the incidence of unsecured loans be minimised?