Impact of Credit Risk on Bank's Profitability: The Case of Barclays Bank Ghana

GHANA INSTITUTE OF MANAGEMENT AND PUBLIC ADMINISTRATION

“The Impact Of Credit Risk Management On Banks’ Profitability”: The Case of BBG By Godwin Kwabla Ekpe 2011

A Project work presented in part consideration for the award of Master of Business degree in Finance (MBA Finance)

DECLARATION I hereby declare that this project report submitted by me to the Ghana Institute of Management and Public Administration is my own work carried out under the guidance of Dr. George OwusuAntwi towards the MBA-Finance degree. I further declare that, to the best of my knowledge, it contains no material previously published by another person nor material which has been accepted for the award of any degree by any University, except where due acknowledgement has been made in the report.

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DEDICATION Through it all, I have learnt to trust in you, Jesus. Your love for me overcame the cross and the grave to find my soul. You have brought me this far, giving me strength and guidance through the journey. To you be all the glory and adoration now and forever more. Amen To the memory of my late dad, and to my mom, siblings and the family. God bless you for your support. You have been my encouragement.

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ACKNOWLEDGEMENT I wish to express my heartfelt gratitude to Dr. George Owusu-Antwi, my supervisor. Your counsel was very valuable. I appreciate your expert guidance and patience. I thank all my friends and well-wishers who kept encouraging me. God bless you all.

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TABLE OF CONTENTS

DECLARATION ............................................................................................................................................... 2 DEDICATION .................................................................................................................................................. 3 ACKNOWLEDGEMENT ................................................................................................................................... 4 TABLE OF CONTENTS..................................................................................................................................... 5 ABSTRACT...................................................................................................................................................... 9 CHAPTER ONE ............................................................................................................................................. 10 INTRODUCTION ........................................................................................................................................... 10 1.0 BACKGROUND OF THE STUDY........................................................................................................... 10 1.1 JUSTIFICATION OF CHOICE OF INSTITUTION..................................................................................... 14 1.2 STATEMENT OF THE PROBLEM ......................................................................................................... 16 1.3 OBJECTIVE OF THE STUDY ................................................................................................................. 19 1.4 SIGNIFICANCE OF THE STUDY ........................................................................................................... 20 1.5 SCOPE AND LIMITATION OF THE STUDY ........................................................................................... 21 1.5 ORGANIZATION OF THE STUDY ......................................................................................................... 22 CHAPTER TWO ............................................................................................................................................ 23 LITERATURE REVIEW ................................................................................................................................... 23 2.0 INTRODUCTION ................................................................................................................................. 23 2.1 MANAGEMENT OF RISK IN BANKING................................................................................................ 23 2.2 MOTIVATION FOR RISK MANAGEMENT IN BANKING ....................................................................... 25 2.3 RISK MANAGEMENT TYPES ............................................................................................................... 26 2.4 KEY RISKS IN BANKING ...................................................................................................................... 27 2.4.1 Credit Risk .................................................................................................................................. 28 2.4.2 Market Risks ............................................................................................................................... 29 2.4.3 Liquidity Risk .............................................................................................................................. 30 2.4.4 Interest Rate Risk ....................................................................................................................... 30 2.4.5 Foreign Exchange Risk ................................................................................................................ 31 2.4.6 Operational Risk ........................................................................................................................ 31

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2.4.7 Strategic Risk ............................................................................................................................. 32 2.5 Credit and Credit Risk Management ................................................................................................. 33 2.5.1 Credit.......................................................................................................................................... 33 2.5.2 Credit Risk ................................................................................................................................. 35 2.5.3 Approaches To Credit Risk Management .................................................................................. 36 2.6 SUPERVISORY AUTHORITY OF BANK CREDIT RISK MANAGEMENT .................................................. 43 CHAPTER THREE .................................................................................................................................... 47 CONCEPTUAL FRAMEWORK ............................................................................................................... 47 3.0 INTRODUCTION ................................................................................................................................. 47 3.1 FRAMEWORKS FOR IDENTIFYING THE PRESENCE OF A SOUND CREDIT RISK POLICY ...................... 47 3.2 DATA SOURCE ................................................................................................................................... 49 3.3 QUANTITATIVE ANALYTICAL TOOLS.................................................................................................. 49 3.3.1 Financial Ratios ......................................................................................................................... 50 3.3.2 Graphs and Charts ...................................................................................................................... 51 3.4 STANDARDS AND BENCHMARKS ...................................................................................................... 51 3.5.1 Credit Culture............................................................................................................................. 52 3.5.2 Credit Organization .................................................................................................................... 55 3.5.3 Credit Policies ............................................................................................................................ 57 3.6 COMPANY PROFILE ........................................................................................................................... 59 3.6.1 INTRODUCTION OF COMPANY-AN OVERVIEW ............................................................. 60 3.6.2 MISSION/VISION/OBJECTIVES/GOALS.............................................................................. 61 3.6.3 CORE VALUES ........................................................................................................................ 62 3.6.4 PRODUCTS ............................................................................................................................... 64 3.6.5 GENERIC STRATEGY ............................................................................................................ 65 3.6.6 MARKETING ANALYSIS/STRATEGY ................................................................................. 67 CHAPTER FOUR....................................................................................................................................... 69 PROJECT EXECUTION-ASSESSMENT OF BANK............................................................................... 69 4.0 INTRODUCTION ................................................................................................................................. 69 4.1 ENVIRONMENTAL ANALYSIS OF THE BANKING INDUSTRY ............................................................... 69 4.1.1 MACRO-ENVIRONMENTAL FACTORS- THE PESTEL FRAMEWORK .......................... 70

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4.2 THE MICRO-ENVIRONMENTAL FACTORS-THE PORTER’S FIVE FORCES INDUSTRY ANALYSIS MODEL ................................................................................................................................................................ 79 4.2.1 SWOT ANALYSIS OF BARCLAYS BANK OF GHANA LTD (BBG) ................................. 87 4.3 SUMMARY OF INDUSTRY ANALYSIS AND CRITICAL SUCCESS FACTORS IN THE GHANAIAN BANKING INDUSTRY ................................................................................................................................................ 91 4.3.1 Key Highlights from the Ghanaian Banking Industry ............................................................... 91 4.3.2 Key Success Factors of Banking Industry in Ghana .................................................................. 93 4.4 STRATEGY AND PERFORMANCE OF BBG (2006-2010) ...................................................................... 96 4.4.1 Financial Performance Of BBG And Identification Of Managerial Issue (2005-2010) ............ 98 4.4.2 The Managerial Issue of Concern-What Went Wrong in BBG? ............................................. 103 4.5 CREDIT ADMINISTRATION PROCESS AND MATTERS ARISING FROM BBG’S 207/08 AGGRESSIVE LENDING CAMPAIGN - FINDINGS .......................................................................................................... 109 CHAPTER FIVE ...................................................................................................................................... 118 CONCLUSIONS AND RECOMMENDATIONS ................................................................................... 118 5.1 SUMMARY OF FINDINGS AND CONCLUSIONS ................................................................................ 118 5.2 RECOMMENDATIONS...................................................................................................................... 121 REFERENCES ......................................................................................................................................... 129 APPENDIX A: Glossary of key financial terms and ratios ...................................................................... 133 APPENDIX B: Signs of a Distorted Credit Culture ...................................................................................... 135 APPENDIX C: Principles for the Assessment of Banks’ Management of Credit Risk ............................ 137 LIST OF ABBREVIATIONS ................................................................................................................... 139

LIST OF TABLES Table 1.1: Summary of BBG‘s performance in Ghanaian banking industry...................................... 16 Figure 2.5.1. Relationship between Creditor and Debtor (Adapted from Colquitt 2007, 2) .............. 34 Fig 2.5.3 Credit Analysis Process Flow (Caouette, Altman, Narayanan, Nimmo 2008, 108) ............. 37 Table 2.5.3.1.2 Strategies for Reducing and Coping with Portfolio Credit Risk ................................ 40 Table 2.6: Top 10 Least Risky Sovereign Credits Risk Rankings (Least risky countries), Score out of 100 .......................................................................................................................................................... 46 Table 3.1: Ratios in assessing credit risks ............................................................................................... 50 Figure 3.5.2. Credit Cycle (Adapted from Colquitt 2007, 24) ............................................................... 56 Table 3.6.5: SUMMARY OF BBG’S PRIMARY GENERIC BUSINESS STRATEGY .................... 66

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Fig. 4.2.1. Macro-environmental Factors --- The PESTEL (Adapted from Kojo Aboagye-Debrah, 2007) ........................................................................................................................................................... 71 Table 4.2. Performance of Ghana’s Economy in Election Years .......................................................... 74 Table 4.1.1.6. Some Major Banking and Financial Laws in Ghana ..................................................... 78 Fig 4.2.2: Porter’s Five Competitive Forces ........................................................................................... 80 Table 4.4.1. Some Profitability and Asset Quality Ratios-BBG vs. Industry ...................................... 99 Table.4.4.2. BBG’s PBT, IMP CHG, Operating Expense and their Rate of improvement (+)/deterioration (-) ................................................................................................................................. 103 Table 4.4.2.1. BBG’s Gross Loans And Advances in GH¢ '000 ......................................................... 105 Table 4.4.2.2. BBG’s Impairment vs. Profitability............................................................................... 106 Table 4.5. Summaries of credit risk management techniques and practices at Barclays ................ 110 Fig. 4.5. BBG’s Retail Credit End to End Process Flow ...................................................................... 113

LIST OF FIGURES Fig 2.5.1 Relationship between Creditor and Debtor...……………………………….……………….34 Fig 2.5.3 Credit Analysis Process Flow …………………………………………………………...........37 Fig 3.5.2 Credit Cycle (Adapted from Colquitt 2007, 24) ....….………………………………….…...56 Fig. 4.2.1 Macro-environmental Factors --- The PESTEL.....…………………………………………71 Fig 4.2.2 Porter’s Five Competitive Forces ……………………………………………………………80 Fig. 4.5. Retail Credit End to End Process Flow …..…………………………………………………113

LIST OF CHARTS Chart 1.2: Summary of BBG’s performance in terms of profitability ................................................17 Chart 4.1.1.3 Ghana’s Population Growth Rate (%)…..…………………………………….….…….75 Chart 4.2. Market Share Analysis-Dwindling Market share of 1st Quartile Banks in Ghana ……...86 Chart 4.4.1 BBG and Industry comparison of Performance Indicators ……………………………100 Chart. 4.4.1.1. Profitability on Bank Assets …………………………………………………………..101 Chart 4.4.1.2 Trend Analysis of BBG’s Profitability and Efficiency Ratios.. ……………………...102 Chart 4.4.2.2 BBG’s Impairment-Profitability Comparison ….…………………………………….107 Chart. 4.4.2.3. The Relationship between ROE, ROA and IMP ALW/TL, CHG/TL……………...108

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ABSTRACT Banking as a business or subject is a profession whose practice has evolved over the ages from the primordial stone-age, through the Victorian-age to the Technology-based internet-age banking, making use of Point Of Sale (POS) devices, Automatic Teller Machines (ATMs), Credit and Debit Cards. The banking industry across the world is becoming more and more competitive. And as such management of various banks are faced with the arduous task of improving the bank’s competitiveness and profitability. Being a service industry, bank managers seek to optimize profit and service through protection of stakeholders’ investment and provision of consistent and enhanced customer service. However, a major threat to achieving this is Credit Risk which is thought as most serious risk faced by banks as it impacts directly on banks’ net worth. Credit risk is always considered as a great hurdle not only to the banking industry but to all in the business circles as the risk of counterparties not fulfilling their obligations in full on the due date can have severe consequences on operations of any business entity. However credit risk is very inherent in a bank’s lending and trading activities such that if not well managed, it can cause a bank to even go bankrupt, which can be proved by various bank failure cases, most recent examples coming from the 2008 credit crunch. For banks, managing credit risk is not a simple task since comprehensive considerations and practices are needed for identifying, measuring, controlling and minimizing credit risk. The focus of this study is to have a better picture of the foundations through which banks manage their credit risk, right from credit generation through credit administration to problem loan recovery and the overall impact on banks’ profitability. The study uses Barclays Bank of Ghana (BBG) as a model bank and a case study on the Ghanaian Banking Industry. In this light, the study in its first section gives a background to the study and the second part is a detailed literature review on bank credit and credit risk management tools and assessment models. The third part of this study provides the conceptual framework and the analytical tools used in assessing the managerial issue of credit expansion and its inherent risk and impact on profitability, which is the subject matter of the project. Chapter four which is the main part of the project assesses the performance of the bank vis-à-vis its credit operation and credit risk management processes. Chapter Five includes conclusion and proposed recommendations, based on the assessment done. The study revealed the bank lost the balance between profitability and growth on one hand and the basics of sound credit management in banking on the other hand as income considerations overshadowed that of credit risk considerations leading to historic losses in 2008 and 2009. One key conclusion is that banks that adhere to proper implementation of good credit risk management policies have a lower loan default rate and relatively higher interest income based on the observed negative relationship between profitability and impairment charges.

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CHAPTER ONE INTRODUCTION 1.0 BACKGROUND OF THE STUDY Effective management of credit risk in financial institutions (FIs) is extremely crucial for the survival and growth of the FIs. The recent financial meltdown and previous bank failures have lent credence to this in that these failures have been blamed principally on the weaknesses of the regulatory frameworks and the credit risk management practices of the financial institutions1.

Financial institutions primarily serve as intermediaries by channeling funds from those with surplus funds (mostly households) to those with shortages of funds (mostly firms and government units). Examples of financial institutions include: Commercial banks, Thrift intuitions, Insurance companies, Investment companies (operating mutual funds), Pension funds, Finance companies, Securities brokers and dealers, Mortgage companies and Real estate investment trusts.

Banks basically engage in the business of safeguarding money and other valuables for their clients. They also provide loans, credit and payment services such as checking accounts, money orders and cashier’s checks. With the advent of the Financial Services Modernization Act, 1999, banks have the freedom to provide a wide range of financial intermediation services which they 1

As put forward by some professionals and scholars such as Dr Rakesh Mohan, Deputy Governor of the Reserve Bank of India, at the 7th Annual India Business Forum Conference, London Business School, London, 23 April 2009 and Gabriele Sabato (August, 2009).

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previously could not engage in. Some of these include the following: Information production, Asset diversification, Liquidity function, Investment services (indirect transfer), Brokerage services, Asset transformation (unbundling of investments), Reduction of transaction costs, Maturity intermediation, Denomination intermediation (investment size and foreign currencies), Provision of payment services and Risk management (insurance services). The provision of any one or combination of these services comes with an inherent associated risk. Depending on the type of services mix being offered a bank may be faced with any of the following risks generally faced by banks: I. II. III. IV. V. VI. VII. VIII. IX.

Credit risk Liquidity risk Interest rate risk Market risk Off-balance sheet risk Foreign exchange risk Country or sovereign risk Technology and operational risk Insolvency risk

However among the risks that banks are faced with, credit risk is one of greatest concern to most banks since for many commercial/universal banks around the globe, credit creation remains the major income generating activity. Credit risk has proven to be the risk that can easily prompt bank failure. The greatest impact of the financial crisis experience over the years has been on the banking industry, where some banks which were previously performing well suddenly announced large losses with some of them having had to be bailed out by State or National governments.

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Some reasons put forward as accounting for these failures border on the failures in risk management with limited role of risk management in the granting of loans in most banks as they are unable to influence business decisions and the fact that their considerations are subordinate to increased interest incomes or profitability interests and lack of capacity to adequately make timely and accurate forecasts. Often times banks fail to observe good credit due diligence in their credit/lending generation and operations. This has resulted in the breach of basic risk management rules such as avoiding strong concentrations of assets, sub-standard loans and minimizing the volatility of returns.

The growth of the Ghanaian banking industry in 2008 suggests that global financial crisis did not have severe impact on the Ghanaian banking industry in 2008. In spite of the global financial crisis, the Ghana banking industry remained stable. Industry return on equity (ROE) and return on assets (ROA) remained at 22% and 2% respectively. Net interest income and net profit after tax for the industry increased by 38% and 32% respectively.2 However, the deterioration of asset quality (impairment charge / gross loans and advances) of the banks in Ghana, from about 1.5% to 4.2%, over the 2007/2009 period due to significant balances of bad and doubtful debts on their books is an indication that all is not well with the sector. In fact one single most surprising nonperformance in the Ghanaian banking industry in recent times was experienced by Barclays Bank of Ghana Ltd (BBG). The 2009 Banking Survey Report by PricewaterhouseCoopers, Ghana describes BBG as having fallen from grace, recording a profit before tax margin of -6.3% in 2008, a sharp fall from 36.8% in 2007.

2

Contained in the 2009 Banking Survey Report by PricewaterhouseCoopers, Ghana

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It is in this light that the assessment in chapter four will attempt to find out whether BBG’s abysmal performance was significantly caused by the case of an overriding quest for expanded interest income overshadowing strict adherence to basic lending rules that ensure effective credit operations and robust credit risk management practices.

Credit risk arises from the possibility that borrowers, bond issuers, and counterparties in derivative transactions may default (Hull, 2007). Credit risk affects financial institutions (FI) that make loans or buy bonds. It is the risk that the loans or bonds held by the FI will go into default.

It is also the risk that the promised cash flows from loans and other securities held as investment by FI may not be paid on due date or anytime thereafter. It includes the risk that claims made against an insurance policy may not be met.

The fact that credit risk has always been the biggest threat to any bank’s performance and “the principal cause of bank failures” (Greuning & Bratanovic 2009,) cannot be overemphasized. Therefore, a sound credit risk management framework is indispensable to a healthy and profitable banking institution.

Risk management is a structured approach to managing uncertainty and its adverse effects in an organization as well as on the value of financial products. The process includes risk identification, risk measurement, risk monitoring and risk controlling. Controlling risk involves ensuring that policies, processes and procedures to control and/or mitigate material risks are in place. Banks should periodically review their risk limitation and

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control strategies and should adjust their risk profile accordingly using appropriate strategies, in light of their overall risk appetite and profile.

The strategies for managing risk include transferring the risk to another party, avoiding the risk, reducing the negative effect of the risk and accepting some or all of the consequences of a particular risk. In specific instances, an organization may choose to increase exposure to risk in order to take advantage of higher expected yield.

Given the issues that occasioned the global credit crunch in 2008 and its probable impact on the Ghanaian banking industry where the quality of banks’ loans and advances deteriorated in 2009 with the industry’s average impairment charge to gross loans almost doubled from 2.2% in 2008 to 4.2% in 2009, the scope of this project is to take a quick look at credit administration and Credit Risk Management in the Ghanaian banking industry using BBG as prototype/model bank representative of the industry.

1.1 JUSTIFICATION OF CHOICE OF INSTITUTION Barclays Bank of Ghana Ltd (BBG) was chosen for this study because of the uniqueness and the relevance of its experience to this study. Firstly, Barclays as a strong and unique brand has a long standing reputation as being one of the biggest banks in Ghana’s banking industry. In BBG’s over 95 years of operations in Ghana, the bank has consistently posted strong performance in terms of profit, share of industry deposits, net operating assets, net loans and advances etc. Such sterling performance was also exhibited even during the last decade or more when competition in

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the industry soared up with the entrance of more banks and innovation. The bank has therefore maintained a place among the first quartile banks of the industry over the years. According to the 2008 Banking Survey Report released by PricewaterhouseCoopers Ghana in collaboration with the Ghana Association of Bankers, the blue eagle (BBG) finally soared higher than the golden eagle (GCB) – Barclays unseated GCB as Ghana’s biggest bank, a position held by GCB until 2007. BBG is ranked the first largest bank in terms of operating assets contributing 15.42% to total operating assets of the banking industry followed closely by GCB with 15.37% in 2007.

BBG, GCB, SCB and EBG continued to hold a large part of the industry’s deposits as their total deposits constituted about 50% of the industry’s total deposits in 2008. BBG continued to hold the largest share of industry deposits in 2008 although it lost part of its previous year’s share of the industry’s deposits (i.e. A fall from 17.2% in 2007 to 13.3% in 2008). BBG‘s share of industry assets, deposits, and loans and advances, over the last four years, are indicated in table 1.1 below.

The table below shows that BBG has had a strong showing in the industry over the period with rankings alternating mostly between first and second. However, one can also deduce a worsening position in percentage contribution to the industry with the bank losing three places to a 5th position in terms of loans and advances. This phenomenon of falling from grace was evident in the bank’s unprecedented losses in 2008 and 2009 with profit before tax margins (PBTM) of 6.3% and -13.8% respectively having previously posted PBTM of 36.8% in 2007.

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Table 1.1: Summary of BBG‘s performance in Ghanaian banking industry 2010 2009 2008 2007 2006 % % % % Performance Index Cont R % Cont R Cont R Cont R Cont R Share of Industry Gross Loans and Advances 6.50 5 8.80 2 13.30 2 16.52 2 15.78 2 Share of Industry Deposits 10.60 2 12.10 2 15.70 1 18.60 1 15.10 2 Share of Industry Assets 9.80 3 10.80 2 13.40 2 15.67 1 12.68 3 Cont = Contribution. R = Ranking Source: Own construction using data from 2008 to 2011Ghana Banking Survey Reports by PricewaterhouseCoopers Ghana Impairment charge/ gross loans and advances worsened from 0.8% in 2007 to 9.8% in 2009 before subsiding to 3.8% in 2010. These give an indication of some problems with the soundness of its credits. In the light of the above, I consider the bank to be an appropriate case for this study.

1.2 STATEMENT OF THE PROBLEM The advent of the Financial Services Modernization Act of 1999 has led to a broadening of financial services being provided by banks. The fever caught up with banks in the Ghanaian industry with the introduction of the Universal Banking License in 2003 which permitted banks with GH¢7 million in capital to carry out any form of banking. This provides several avenues for banks to diversify their operations to provide myriad of services. But this diversification could be very risky if it is pursued without the necessary prudence.

The very nature of the banking business is so sensitive because more than 85% of their liability is deposits from depositors (Saunders & Cornett, 2005). These deposits are used in their

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money/credit creation activity which is exposed to risk. Though the global economic depression that hit almost all big economies throughout the world in the past 4 years did not have much impact on developing economies such as Ghana, there were some disturbing signals experienced on the Ghanaian banking sector. These signals were more pronounced in BBG as it posted a record successive loss in 2008 and 2009. The Chart below depicts a picture of the BBG story. Chart 1.2: Summary of BBG’s performance in terms of profitability

Profit(Loss) Before Tax (PBT) of BBG PBT in '000s of Ghaba Cedis

100,000.00 80,000.00 60,000.00 40,000.00 20,000.00 (20,000.00) (40,000.00) PBT

2006

2007

2008

2009

2010

45,589.00

52,436.00

(10,240.00)

(23,506.00)

81,349.00

Source: Own construction with PBT figures from BBG annual reports for 2007-2010 The Ghana banking survey 2009 reported that, despite the global financial crisis, the Ghana banking industry remained stable. Whiles this assertion might be true in terms of the general averages of the industry, the picture portrayed by the Chart 1.1 above for a traditionally top most performer as BBG gives cause to worry. Not only did profit erode between the 2007-2009 period but BBG’s asset quality deteriorated considerably over the period with Impairment allowance/ gross loans and advances sky-rocketing from 2.6% in 2007 to 8% in 2008 and then to 17.7% in 2009. Impairment charge/ gross loans and advances over the period had consequently seen

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unprecedented increment over the period, moving from 0.8% in 2007 to 6.0% and 9.8% in 2008 and 2009 respectively. The industry’s average impairment charge to gross loans almost doubled from 2.2% in 2008 to 4.2% in 2009 after increasing from 1.5% in 2007.

A closer look at the financial statements of BBG over the period thus revealed that the losses were largely due to losses incurred on impairment. The source of the impairment losses over the 2007-2009 periods has been traced to a massive expansion undertaken by the bank in 2007/08 spearheaded by an aggressive lending.

As stated earlier, BBG, as a subsidiary of Barclays PLC, is a model bank with great reputation of being a consistent top most performer. As such it is thought to have in place the requisite mechanisms to avoid lending disasters. However such huge losses recorded following its aggressive lending gives cause for a further probe to ascertain what went wrong and whether or not BBG really has the right and robust processes, procedures and policies in place to withstand major shocks that often accompany such massive credit expansion. Also, could the high default rates be due to lack of proper Credit/Borrower Due Diligence? Or was it due to lack of proper macro-economic forecast accompanied by deteriorated economic condition of borrowers?

In order to ascertain what really went wrong, there is the need to do a thorough assessment of the adequacy of BBG’s internal processes of credit generation, administration and risk management practices and frameworks put in place to handle the credit risk it is exposed to as well as the key factors in the external environment that affect its lending business. In addition this assessment

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will also ascertain the extent to which the Bank’s performance (profitability) can be augmented by proper credit risk management policies and strategies.

1.3 OBJECTIVE OF THE STUDY The general objective of this study is to look at a broader picture of how banks approach their lending/credit generation activities to minimize the associated credit risk so as to avoid lending disasters and bank failures. The specific objectives of the study are thus two fold, which are to assess:

I. BBG’s profile of credit generation and administration practices over the 2007-2009 period. This also involves an assessment of the income statement and balance sheet, using various tools (ratios, charts and tables) to ascertain the level of credit risks the bank is exposed to and to identify the extent to which credit risk affects the size of the bank’s profitability.

II. The effectiveness of the bank’s credit risk management framework for managing credit risk it is exposed to. This involves an assessment of: a. the robustness of governance structure in place, b. the adequacy of policies, procedures, tools and skills and people issues, c. the effectiveness of control measures, and d. the available information management systems to support timely and accurate information delivery to manage risk.

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The assessment here also includes an evaluation of the bank’s entire credit cycle and risk management practices vis-à-vis current recommended standards and best practices by the Basel Committee on Banking Credit Risk Management.

1.4 SIGNIFICANCE OF THE STUDY An assessment of BBG’s credit generation cycle and credit risk management framework provided the state of the bank‘s ability to handle the inherent risks in its credit operations. The assessment revealed what went wrong when the bank chose aggressive lending as a growth strategy for its massive expansion. Also deviations from international best practices were also identified and alternatives recommended. The bank’s ability to deal with significant shocks and avoid losses during crisis periods was also tested.

Since there is not much structural and operational difference amongst the banks in Ghana, it is hoped that this study will provide an indication of how credit administration and credit risk management landscape would look like in Ghanaian banking sector when banks decide to pursue growth using massive credit expansion with or without much credit due diligence. In addition, it will provide a guide for further studies on asset quality and credit risk management in the industry.

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1.5 SCOPE AND LIMITATION OF THE STUDY In carrying out a credit risk-based analysis of Barclays Bank of Ghana Ltd, information was mainly gathered from financial statements and other disclosures contained in the bank‘s annual reports and reports by the industry regulator and other watchers/analysts. In this regard, annual reports of the last four years (2010, 2009, 2008, and 2007) were considered to ensure consistency in the value used. This is because the bank shifted from the use of International Accounting Standards (IAS) to International Financial Reporting Standards (IFRS), in conformity with requirements by The Institute of Chartered Accountants (Ghana) for companies to prepare their financial statements for the year ended 31st December 2007 and beyond. The bank’s credit risk and collections management policy manuals and other independent reports on its performance were used to gather relevant information concerning the bank’s past and present credit operations, financial health and capacity to regain its rightful position at the top in the face of the difficulties it faced during the 2007-2009 period and the instability in the industry and the global economy as a whole.

The bank however considers most information, except those contained in the annual report and official releases, sensitive and for that matter detailed but relevant information was not available for use. As such some disclosures gathered through informal interview sections with some staff in the Credit Operations & Collections, Retail Credit Risk and Retail Business Units of the bank were taken into consideration in the analysis.

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Finally, due to lack of adequate comparable data on other players in the Ghanaian banking industry, the study was unable to provide a complete picture of the adequacy and performance of BBG’s risk management framework in relation to peer group trends and industry norms in all cases. However, in cases where industry data was available comparative analysis was undertaken.

1.5 ORGANIZATION OF THE STUDY The project is divided into five chapters. Chapter one deals with the introduction of the study. It focuses on the background, justification of choice of company, statement of the problem, objectives, significance, scope and limitation of the study. Chapter Two is on literature review on commercial banks credit and credit risk management. It provides an integrative review of past studies that relate to the subject matter of credit operations and credit risk management. Chapter Three discusses the Conceptual Framework of the study. The chapter provides the framework/methodology and the analytical tools used in assessing the managerial issue of credit expansion and its inherent risk and impact on profitability which is the subject matter of the project. The Fourth Chapter contains the assessment of the performance of the bank vis-à-vis its credit operation and credit risk management processes. It also contains the analysis of the bank in terms of its vision and mission, environmental and SWOT analyses in the light of the bank’s attempted expansion in 2007. Chapter five concludes the study with a summary describing the major findings of the study, limitations and some useful recommendations based on the assessment done.

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CHAPTER TWO LITERATURE REVIEW

2.0 INTRODUCTION As stated in the introductory chapter, the scope of this project is to study the impact of credit administration and credit risk on banks’ performance. This chapter reviews the literature on credit and the associated credit risk management in banking. It firstly however considers topics on risk management from different points of view in general, touching on other related banking risks. Latter the review is narrowed down to credit administration and credit risk practices in commercial banks and with the view of giving a theoretical basis to the project.

2.1 MANAGEMENT OF RISK IN BANKING According to Schmidt and Roth (1990), risk management involves undertaking activities designed to minimize the negative impact (cost) of uncertainty (risk) regarding possible losses. It is apparent that for such risk management activities to be potent they have to be designed based on a clearly anticipated losses. Redja (1998) therefore defines risk management as an organized method of identification and assessment of pure loss exposure faced by an organization or an individual, and for the selection and execution of the most suitable techniques for treating such exposure. In effect, the process involves: identification, measurement, and management of the risk. Bessis (2010) also indicates that risk management, apart from it being a process also entails the use of a set of tools and models for measuring and controlling risk.

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It is a major task for banks to ensure a sound risk management operating environment, where there is reduced impact of uncertainty and potential losses. Bank managers therefore need dependable risk measures to direct capital to activities with the best risk/reward ratios. They need estimates of the size of potential losses to stay within limits set through careful internal considerations and by regulators. They also need systems to monitor positions and fashion incentives for prudent risk taking by departments, units and individuals within the bank.

Identifying key risks, acquiring consistent, understandable, operational risk measures, choosing which risks to reduce or to increase and by what means, and setting up procedures to monitor resulting risk positions constitute the process by which managers satisfy these needs identified in the paragraph above. This is what Pyle (1997) considers as risk management. Bessis (2010), also points to fact that the objective of risk management is to evaluate risks in order to monitor and control them. According to Bessis, having a firm grip on risk enables the bank to pursue other important functions such as providing reliable forecast and projections, designing appropriate business policy, developing competitive advantages by calculating appropriate pricing and the formulation of other differentiation strategies based on customers‘ risk profiles all aimed towards achieving the bank wide ultimate strategy.

Many banking firms rely on carefully ordered steps to execute a risk management system which usually contain four components. These components include standards and reports, position limits or rules, investment guidelines or strategies, incentive contracts and compensation. According to Santomero (1995), these tools are normally established to evaluate exposure, define

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procedures to manage these exposures, limit individual positions to tolerable levels, and encourage decision makers to manage risk in a manner that is consistent with the firm's goals and objectives.

2.2 MOTIVATION FOR RISK MANAGEMENT IN BANKING Banking business is one of the riskiest worldwide and this demands a vigorous management of all associated risks so as to achieve optimum maximization of shareholder wealth. Many authors including Oldfield and Santomero (1995), Stulz (1984), Smith et al (1990) and Froot et al (1993) have offered reasons why bank managers should constantly engage in the active management of risks in their organizations.

According to Oldfield and Santomero (1995), a review of the literature over the years points to four main reasons for risk management. These are managerial/self-interest; lower tax incentives; avoidance of low profits and prevention of possible financial meltdown.

Managers’ limited ability to diversify their investments in the firm and their quest to boost their own utility in the firm provide the needed urge to ensure stability of the firm’s earnings by minimizing volatility.

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Managers are also motivated to pursue activities which lesson the volatility of reported taxable income since expected tax burden are reduced when income smoothens. This also helps to enhance shareholders’ value and is plausible during progressive tax regimes.

Bank managers also pursue risk management by embarking on profit variability reducing strategies in order to avoid the undesirable option of going for high cost external sources of funding, especially in an imperfect capital markets, owing to low profits.

Finally and arguably the most important rationale for managers to manage risk with the aim of reducing the unpredictability of profits is the cost of potential financial distress which may include loss of confidence by stakeholders the firm‘s operations, loss of strategic position in the industry, withdrawal of license or charter and even bankruptcy.

It is believed that any of the above mentioned rationales is sufficient to motivate management to concern itself with risk and embark upon a careful assessment of both the level of risk inherent with any financial product and possible risk mitigation techniques.

2.3 RISK MANAGEMENT TYPES A key characteristic of the banking business is the bundle and unbundling of risks. Some of these risks are systematic whiles others are unsystematic (Merton, 1989). According to Oldfield and Santomero (1995) risk facing financial institutions can be defragmented into three separable groupings from management perspective: avoidable risks; transferrable risks and internally

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manageable risks. This segregation helps managers in developing the appropriate strategies to mitigate risk. Those risks that can be eliminated by simple business practices such as ensuring customer, borrower and credit due diligence, hedging, reinsurance, and diversification constitute avoidable risks. This project is chiefly about this type of risk management where credit risk is considered to be more proactively managed through credit due diligence and subsequent effective credit administration. Handling some risks internally gives no value-addition or competitive urge to the firm and such risks are better managed by transferring them to third parties.

The third category of risk management applies to risks that by nature put the firm in a competitively disadvantageous position if details on them are divulged to non-firm interests or competitors. Such risk also are central to the firm‘s business purpose because they are the raison d‘être of the firm. Such risks as those inherent with holding complex illiquid and proprietary assets are therefore actively managed internally. As alluded to by Oldfield & Santomero (1995) and Allen & Santomero (1996) banking firms should only accept those risks that are uniquely a part of the bank’s range of unique value-added services and this requires monitoring of such business activities and associated risks and returns.

2.4 KEY RISKS IN BANKING The focus of this project is credit risk. However, it noteworthy to briefly consider other important risks associated with the provision of various banking services. These risks can be classified broadly as financial and non-financial risk. The financial risks include credit risk and

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market risks (which includes liquidity risk, interest rate risk and foreign exchange risk). The nonfinancial risk include operational risks which sometimes include legal risk, technology risk, political risk, people risk and more recently, strategic risk.

2.4.1 Credit Risk

Credit risk is the probability that a debtor or issuer of a financial instrument— whether an individual, a company, or a country— will not repay principal and other investment-related cash flows according to the terms specified in a credit agreement (Greuning and Bratanovic, 2009). Inherent to banking, credit risk means that payments may be delayed or not made at all, which can cause cash flow problems and affect a bank‘s liquidity. The goal of credit risk management is to maximize a bank‘s risk-adjusted rate of return by keeping credit risk exposure within tolerable parameters.

More than 70 percent of a bank‘s balance sheet generally relates to credit risk and hence considered as the principal cause of potential losses and bank failures. Often time, inadequate diversification of credit risk has been the principal culprit for bank failures. The dilemma is that banks have a comparative advantage in advancing credit to entities with whom they have an ongoing relationship, thereby creating excessive concentrations in geographic and industrial sectors.

Credit risk includes both the risk that a obligor or counterparty fails to comply with their obligation to service debt (default risk) and the risk of a decline in the credit standing of the obligor or counterparty. According to Bessis (2010), whilst default triggers a total or partial loss,

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a deteriorated credit standing of a borrower also has a high tendency of resulting in a loss as it elicits an upward shift of the required market yield to compensate the higher risk and this leads to a value decline.

In order to curtail the incidence of both partial and total losses banks normally consider the financial condition and the suitability of any underlying collateral of a potential borrower as key components in assessing the credit risks of obligors or counterparties (Santomero, 1997). Greuning and Bratanovic (2009), also consider as a vital ingredient in credit risk management, formal policies implemented by management as put in place by the board of directors of banks. Consistent with general practice, banking firms rely on credit or lending policies to manage their credit portfolios as these policies outline the scope of investment and financing assets, how they are to be originated, appraised, supervised, and collected.

2.4.2 Market Risks

According to Pyle (1997), market risk is the change in net asset value of a firm owing to changes in underlying economic factors such as interest rates, exchange rates, and equity and commodity prices. Several research works have identified three common market risk factors to banks and these are liquidity, interest rates and foreign exchange rates. In general, market risks consist in the probability of the variability of the value of a portfolio, either an investment portfolio or a trading portfolio, caused by adverse changes in market factors.

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2.4.3 Liquidity Risk

Liquidity is the ability of a bank to fund increases in assets and meet obligations as they become due, without incurring undesirable losses (The Basel Committee on Bank Supervision, June 2008). Bessis (2010), in one his expositions, consider liquidity risk as a situation where shortterm asset values are not sufficient to match short term liabilities or unexpected outflows.

According to Anthony Saunders and Marcia M. Cornett (2009) Liquidity risk arises when depositors demand cash payment from their deposits in unexpected increasing proportions resulting in withdrawals that may require the bank to liquidate its assets in short order and often, at less than market prices. This can set in motion a vicious circle of liquidity crisis which can lead to bankruptcy. The root cause of such bankruptcy is what Greuning and Bratanovic, (2009) consider as potential funding crisis that banks need to guard against by planning for growth of funds and unexpected credit expansion.

2.4.4 Interest Rate Risk For banks, the mismatching of the maturities of assets and liabilities create interest rate risk exposure not only on the bank’s net interest income but also net worth. The potential for changes in interest rates to reduce a bank‘s earnings or value is referred to as interest rate risk. There are two risks associated with changes in interest rates: Income Risk and Investment Risk.

Income Risk refers to loss of net interest income, caused by a mismatch of borrowing and lending rates and Investment Risk is occasioned by loss of net worth, which results when the value of bank assets fall more than liabilities. Most of the assets (receivables) and liabilities

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(payables) of the balance sheet of banks produce revenues and costs that are driven by interest rates and since interest rates are not stable, so are such earnings. According to (Bessis, 2010) interest rate risk does not apply only in variable exchange regimes but also in fixed rate deals due to the opportunity cost that emanates from market movements. Though there are complexities in managing interest rate risk, a more knowledgeable use of interest rate derivatives— such as financial futures and interest rate swaps— can help bank managers to control and lessen the interest rate exposure that is associated with their business (Greuning and Bratanovic, 2009).

2.4.5 Foreign Exchange Risk

Foreign exchange risk is the risk that a bank will suffer a loss due to an adverse movement in the value of a foreign currency on which an international transaction is denominated. An increase in the value of the foreign currency, for example, will increase the cost of money borrowed in that foreign currency – even if interest rates have not changed. In simple terms, Bessis (2010) views foreign exchange risk as incurring losses due to fluctuations in exchange rates. Greuning and Bratanovic (2009) see it as speculative and can therefore result in a gain or a loss, depending on the direction of exchange rate shifts and whether a bank has long or short net positions. To hedge foreign exchange risk, a bank may institute a currency swap, currency futures, or options.

2.4.6 Operational Risk Banks all over the world seek to optimize profit and service through protection of stakeholders’ investment and provision of consistent and enhanced customer service. A major threat to

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achieving this is operational risk which transcends all bank transactions and activities and is at the heart of all other risks faced by banks.

Operational risk is the possibility of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events (The Basel Accord (2007). For (Bessis, 2010), operational risks is a function of failed and malfunctioning information and reporting systems, internal monitoring rules and internal procedures put in place to take appropriate remedial actions, or the non-compliance with the internal risk policy rules. Because of the diverse and complex activities in which modern banks are engaged, the intensity of operational risk in banks has reached alarming heights (Greuning and Bratanovic, 2009). As will be seen in chapter 4 of this work, operational lapses have dire consequences on credit losses that translate in to poor bank performance.

2.4.7 Strategic Risk This is one risk currently considered as having the potential of greatly destroying shareholders’ value and yet bank managers have not yet been able to develop comprehensive and potent tools and techniques to address it. According to Emblemsvåg and Kjølstad (2002), strategic risk arises from the uncertainties inherent in a firm pursuit of its business objectives either by exploiting opportunities and/or reducing threats. These uncertainties are not directly financial in nature and may arise from adverse business decisions, improper implementation of decisions, or lack of responsiveness to industry changes. Slywotzky and Drzik (2005), consider strategic risk as the series of external events and trends that can ravage a company‘s growth course and shareholder value. In effect strategic risk is a function of the compatibility of a firm’s strategic goals, the

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corporate strategy so outlined to realize those goals, the resource allocation against these goals, and the quality of implementation.

In their bid to develop framework for assessing a firm’s strategic risks and develop counter measures to address them, Slywotzky and Drzik (2005) came out with a categorization of strategic risk events which include industry margin squeeze, threat of technology shift which has the possibility of driving some products and services out of the market, brand erosion, emergence of one-of-a-kind competitor to seize the lion share of value in the market, customer priority shift, new project failure and market stagnation. Going by these categorizations, managers should be able to allocate sufficient capital against each risk event according to how risky they consider them.

2.5 Credit and Credit Risk Management A thorough comprehension of credit and credit process, and the source of credit risk in banks are paramount to understanding credit risk management. Such an understanding informs the components of the credit risk management strategy bank managers adopt and what policies and procedures are needed to ensure effective implementation.

2.5.1 Credit According to the Economist Dictionary of Economics, credit is the use or possession of goods or services without immediate payment. Credit serves as conduit between the production and sale of goods. As a result, credit gives rise to a debt that a debtor owes to the creditor. As depicted in the

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figure 2.5.1. below, the debtor/borrower pays the creditor/lender interest on the amount borrowed over time agreed on.

Pays the creditor extra money earned from reinvestments of the credit amount

Debtor

Creditor Gives the debtor time and takes back a return for supplying the credit

Figure 2.5.1. Relationship between Creditor and Debtor (Adapted Colquitt 2007, 2) Figure 2.5.1. Relationship between Creditor and from Debtor (Adapted from

Colquitt 2007, 2)

Largely in every economy there are firms or individuals that provide loanable funds to those who are in need of such funds to finance their businesses/investments. But ordinarily the demand and supply of loanable funds do not automatically satisfy each other. Banks therefore act as bridge between credit suppliers and those who demand it. As stated by Colquitt (2007), many other nonbank financial institutions such as insurance companies, mutual funds, investment finance companies, etc. have joined the credit supplier group. However banks have remained the leading source that both individuals and corporate institutions request credit from.

Individuals may fall under: home mortgages, installment loans (e.g. consumer loans, educational loans, auto loans…etc), credit card revolving loans, revolving credits (e.g. overdrafts), etc. According to Crouhy et al (2006, 207-208), there are two main types of credit services based on customer categories offered by banks. These include retail credit and wholesale credit. While

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retail credit deals with individuals, wholesale lending, on the other hand, involves firms as the borrowers and therefore is of much higher value, more complicated and poses more risk to the banks.

2.5.2 Credit Risk Previous sections of this project have seen credit risk mentioned or even defined. It is however considered in much detail in this section. Credit risk arises when the debtor is unable to repay part or whole of the debt to the creditor as agreed in the mutual contract. As appropriately and professional stated by Colquitt (2007), “credit risk arises whenever a lender is exposed to loss from a borrower, counterparty, or an obligor who fails to honor their debt obligation as they have agreed or contracted”. This loss may derive from deterioration in the counterparty’s credit quality, which consequently leads to a loss to the value of the debt. According to Crouhy et al, the worst case of credit risk is experienced when the borrower defaults when he/she is unwilling or unable to fulfill the obligations.

Bank’s cash flows, liquidity, profit, shareholders’ dividends and net worth are directly and significantly impacted by credit risk. The major bank failures experienced over the years were all mostly due to what banks call ‘bad debts’. Credit risk, occasioned by bad debts, is so critical to banks because most of their business activities, ranging from lending, dealings in treasury products, reinsuring insurance risks, cross-border exposure, and guarantees or bonds are all exposed to some forms of credit risk which is “the principal cause of bank failures” (Greuning & Bratanovic 2009, 161). This therefore calls for banks to put in place a robust credit risk management framework to adequately deal with the threat posed by credit risk.

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2.5.3 Approaches To Credit Risk Management In banking, the importance of credit risk management cannot be overemphasized. A commercial bank can only ignore the inherent risk in its lending business at its own peril. Credit risk management is simply the procedures implemented by organizations with the aim of diminishing or avoiding credit risk. (Luy D. D. 2010)

Credit risk management has been a burning topic of debate as it is one of the fastest evolving practices thanks to institutional developments in the credit market, diversification of financial institutions participating in the lending business and modern technologies. According to Caouette, Altman, Narayanan, Nimmo (2008) credit risk management consist of a specialist analysis system, whose objective is to “look at both the borrower and the lending facility being proposed and to assign a risk rating”. Figure 2.5.3 on the next page shows a summary of the analyzed information. Among the evaluated data, financial ratios are perceived to be very important. The idea espoused by Caouette, Altman, Narayanan and Nimmo is that credit risk management is a kind of engineering in which “models and structures are fashioned that either prevent financial failure or else provide safeguards against it”. Portfolio based approach to banking credit risk management where homogenous product and customers are classified into either retail and commercial portfolio is considered more appropriate by Crouhy, Galai & Mark (2006). According to these authors, this is more time, cost and effort efficient than managing every single customer.

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Does the borrower have a repayment strategy? What other services are needed by the borrower?

Motivation: Why does the company need to borrow?

Does the lender have an appetite for the industry geography? Is the risk reward ratio acceptable? (Credit Culture)

Business and Strategy Review: Does the company have a clear sense of direction and how to get there? Is it doable?

Management Analysis: Competence, integrity, depth

Qualitative arguments to be used in credit memorandum

Loan Administration Set up, Data Systems Funding Schedule

Financial Statement Analysis: Balance Sheet Analysis & Cash Flow Analysis - Efficiency & costs - Profitability - Leverage Assess the financial and competitive strength Assumptions for projections

Financial Simulation Breakeven Pricing Stress Testing

Industry Analysis: Position in the industry, market share, price leadership, innovation trends

Risk Rating, Covenants Loan documentation Legal Opinions

Negotiations Credit Presentation Credit Approval

Loan Documentation Other Legal Work Closing

Fig 2.5.3 Credit Analysis Process Flow (Caouette, Altman, Narayanan, Nimmo 2008, 108)

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2.5.3.1 MODERN PORTFOLIO APPROACHES Modern Portfolio Theory involves the use of some numerical measures such as earnings at risk (EAR) and value at risk (VAR) to manage exposures arising from interest and market risks. According to William Margrabe (2007), despite the fact that credit risk continues to be the principal risk faced by banks, the use of MPT to credit risk has not seen much preeminence.

However, lately Banks have come to realize the adverse effect of credit concentrations on their performance and have consequently been developing tools to measure credit risk in a portfolio framework. In addition, credit derivatives are also being used to transfer risk efficiently while preserving customer relationships. The combination of these developments has become a basis for managing credit risk in a portfolio context over the past several years.

2.5.3.1.1 Asset-by-asset Approach Though banks may have some differences in the method, the asset-y-asset approach involves assessing the credit quality of loans and other credit exposures from time to time by applying a credit risk rating, cumulating the results to help identify a portfolio’s expected losses. It is asserted that a sound loan review and internal credit risk rating system is the basis of the assetby-asset approach. When this approach is properly applied, management is able to identify changes in individual credits and portfolio trends in a timely manner which helps them develop and adapt appropriate strategies to improve their portfolios and also increase the supervision of credits in a timely manner.

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2.5.3.1.2 Portfolio Approach Banks are widely believed to seek to complement the asset-by-asset approach with a quantitative portfolio review using a credit model. This is based on the notion that the asset-by-asset approach does not adequately identify and measure credit concentration. Concentration risk is considered an extra portfolio risk resulting from increased exposure to a borrower, or to a group of correlated borrowers. Since the asset-by-asset approach is incapable of providing a complete view of portfolio credit risk, banks are pursuing the portfolio approach with strategies for reducing and coping with portfolio credit risk as summarized in Table 2.5.3.1.2 below on the next page.

2.5.3.2 Traditional Approaches Much of the literature here seems to suggest that there exists only a very thin line between the traditional approach and the new approaches because the latter contains many of the ideas of the former. The following sub-sections take a brief look at the four classes of models under the traditional approach.

2.5.3.2.1 Expert Systems Under this model, credit officers are empowered to use their expertise and judgment alongside what has come to be known as the five “Cs” in arriving at credit decisions and granting of loans. These five “C” are; Character, Credibility, Capital, Collateral of the borrower and the Cycle of economic conditions. Another critical factor that a credit or lending officer could consider is the interest rate. It is expected that when a good job is done at this stage of the credit cycle, credit risk is proactively minimized as the loans booked would be of high quality.

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2.5.3.2.2 Artificial Neural Networks This is a model designed to simulate the human learning process inferred from the human expert’s decision process. It is designed to overcome the challenges of excessive time consumption and error- prone nature of the computerized expertise system. The Artificial Neural Networks model repetitively samples input/output information to fish out the nature of the link between inputs and outputs.

Table 2.5.3.1.2 Strategies for Reducing and Coping with Portfolio Credit Risk Technique Advantages Disadvantages Implication Geographic Diversification

External shocks (climate,

If the country is small or the

Price, natural disasters, etc.)

Institution is capital

are not likely to affect the entire portfolio if there

constrained, it may not be able to apply this principle. It

will become is spatial vulnerable to diversification. covariate risk, which is high in agriculture. Loan Size Limits (Rationing)

Prevents the institution

Can be carried to the extreme

from being vulnerable to

where loan size does not fit

nonperformance on a few

the business needs of the

large loans.

client and results in

Protects asset quality in the short run but creates client retention problems in the

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suboptimal use and lower positive impact by client.

long run. Inimical to relationship banking.

Client could become dissatisfied Over Collateralization

Assures the institution that

Excludes poor, lowincome

enough liquidation value

clients who are the vast

will exist for foreclosed

majority market.

of

Bank makes clients purchase

recommended technique if goal is

the to better serve the

assets. Credit Insurance

Not a

low- and moderate income clients

Databases and credit bureaus

credit insurance. In may not exist to event of permit default, bank collects from

insurer to engage in this line

insurer.

of business in costeffective manner.

Portfolio Securitization

Lender bundles and sells

Requires well documented

loans to a third party.

loans and long time series of

Transfers default risk and

performance data to permit

Requires a well developed secondary market, standardized underwriting

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improves liquidity so that it can continue to lend.

ratings

practices, and

and reliable construction of

existence of rating companies.

financial projections

Allows lender to develop expertise in analyzing creditworthiness in one sector or niche. Source: Publication of the Inter-American Development Bank, May 2007.

2.5.3.2.3 Banks Internal Rating Banks have developed internal rating codes that they assign to loans at various levels of performance. They make provisioning of reserves against the probability of such performing loans going into default.

2.5.3.2.4 Credit Scoring Systems A credit score refers to a statistical number used to represent the creditworthiness of a borrower. It is derived from statistical analysis of a borrower’s credit history. Lending institutions normally rely on such scores to appraise the potential risk associated with each loan applicant and to mitigate losses due to bad debt. In a nut shell, the use of credit scores helps financial institutions establish the eligibility and suitability of a loan applicant, the rate of interest, the loan tenure and the credit limits that should be extended to the loan applicant.

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2.6 SUPERVISORY AUTHORITY OF BANK CREDIT RISK MANAGEMENT The place of supervision in ensuring quality of credit portfolio has been in the spotlight following the general recognition that credit risk has the potential of causing bank failures. In line with this the Bank of International Settlement (BIS) on November 28th 2005 issued what has come to be known as the ten principles on Sound Credit Risk Assessment and valuation for Loans that is believed when properly observed would greatly mitigate credit risk in the banking industry. They are as follows;

Principle 1: The bank’s board of directors and senior management are responsible for ensuring that the banks have appropriate credit risk assessment processes and effective internal controls to consistently determine provisions for loan losses in accordance with the bank’s stated policies and procedures, the applicable accounting framework and supervisory guidance commensurate with the size, nature and complexity of the bank’s lending operations.

Principle 2: Banks should have a system in place to reliably classify loans on the basis of credit risk.

Principle 3: A bank’s policies should appropriately address validation of any internal credit risk assessment models.

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Principle 4: A bank should adopt and document a sound loan loss methodology, which addresses risk assessment policies, procedures and controls, for assessing credit risk, identifying problem loans and determining loan provisions in a timely manner.

Principle 5: A bank’s aggregate amount of individual and collectively assessed loan provisions should be adequate to absorb estimated credit losses in the loan portfolio.

Principle 6: A bank’s use of experienced credit judgment and reasonable estimates are an essential part of the recognition and measurement of loan losses.

Principle 7: A bank’s credit risk assessment process for loans should provide the bank with the necessary tools, procedures and observable data to use for credit risk assessment purposes, account for impairment of loans and the determination of regulatory capital requirements.

Principle 8: Banking supervisors should periodically evaluate the effectiveness of a bank’s credit risk policies and practices for assessing loan quality.

Principle 9: Banking supervisors should be satisfied that the methods employed by a bank to calculate loan loss provisions produce a reasonable and prudent measurement of estimated credit losses in the loan portfolio that are recognized in a timely manner.

Principle 10: Banking supervisors should consider credit risk assessment and valuation practices when assessing a bank’s capital adequacy.

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I.

Individual Credit Rating: A credit rating evaluates the credit worthiness of an individual, corporation, or even a country. Credit ratings are calculated from financial history and current assets and liabilities. Usually, a credit rating gives a lender or investor an indication of the probability of the borrower being able to pay back a loan. However, in recent years, credit ratings have also been used to adjust insurance premiums, determine employment eligibility, and establish the amount of a utility or leasing deposit.

II.

Corporate credit ratings: The credit rating of a corporation is a financial indicator to potential investors of debt securities such as bonds. These are assigned by credit rating agencies such as Standard & Poor's, Moody's or Fitch Ratings and have letter designations such as AAA, B, CC. The Standard & Poor's rating scale is as follows: AAA, AA, A, BBB, BB, B, CCC, CC, C, D. Anything lower than a BBB rating is considered a speculative or junk bond. The Moody's rating system is similar in concept but the notation is a little different. It is as follows: AAA, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3, Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, C.

III.

A sovereign credit rating is the credit rating of a sovereign entity. The sovereign credit rating indicates the risk level of the investing environment of a country and is used by investors looking to invest abroad. It takes political risk into account. The countries with the least sovereign risk are ranked as follows.

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Table 2.6: Top 10 Least Risky Sovereign Credits Risk Rankings (Least risky countries), Score out of 100 Position Q1

Country

1 2 3 4 5 6 7 8 9 10

Norway USA Switzerland Sweden Hong Kong UK Finland Australia Chile Germany

5 Year CPD (%) 2.0% 2.7% 3.6% 3.8% 5.4% 5.6% 5.7% 6.2% 6.3% 6.4%

CMA Implied Rating CMA_aaa CMA_aaa CMA_aaa CMA_aaa CMA_aa+ CMA_aa+ CMA_aa+ CMA_aa CMA_aa CMA_aa

5 Year CDS Mid (bps) 22.5 30.0 41.1 43.6 61.7 63.5 65.3 72.2 91.6 73.3

Previous Ranking 1 (No change) 2 (No change) 3 (No change) 4 (No change) 7 (Up 2) 9 (Up 3) 5 (Down 2) New Entry New Entry 10 (No change)

Source: CMA Global Sovereign Credit Risk Report March 2012 According to the results (see table 2.6), UK’s country rating has improved from 9th to 6th position while the Finland has dropped to the 7th position from 5th.

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CHAPTER THREE CONCEPTUAL FRAMEWORK

3.0 INTRODUCTION In order not to make the reading and understanding of this project too complex, credit risk management in my bank of choice is assessed in two simple inter-related folds- quantitative and qualitative assessment. The qualitative assessment will seek to relate some financial performance ratios considered as proxies for credit risk and profitability (on which the quantitative analysis is based) to the state of credit risk management in the bank.

3.1 FRAMEWORKS FOR IDENTIFYING THE PRESENCE OF A SOUND CREDIT RISK POLICY This section explains the conceptual framework and the data employed in analyzing the subject matter of this project. Conceptual Framework: This report builds up a framework encompassing two antecedents of credit risk accompanied by other important factors that affect the shareholders’ value. The idea is to evaluate the impact of credit risk on profitability, which is measured by ROE (Return on Equity) and ROA (Return on Assets). Many research findings suggest that banks manage credit risk for two major purposes: to boost interest income (profitability) and to minimize loan losses (bad debts) which results from credit

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default (Sim, 2006). As such I expect that banks with better credit risk management practice to have lower loan losses (non-performing loans). That is to say profitability (ROA, ROE) is considered here as proxy for credit risk management indicators. The assessment treats credit risk as an independent variable. Since shareholders are naturally interested to have an increase in their shares value as well as overall return on equity, the study assumes that these two factors (ROE & ROA) have a critical implication for shareholders’ value. ROE is defined as follows: ROE = ROA * AE …………………………………………. (1) Where ROE = ratio of profit after tax to total equity ROA = ratio of net-interest income plus non-interest income less provisioning to total assets AE = ratio of total assets to total equity Given the above equation, a bank is able to increase ROE by increasing net-interest income and non-interest income and by decreasing loan provisioning. Banks largely depend on credit operations as major sources of income. Interest income therefore plays a crucial role in increasing ROE. Banks’ ROE declines when provisioning is increases, as in case of high credit risk (Sensarma & Jayadev, 2009). Subsequently, credit risk has a strong influence in determining the overall ROE. The product of the credit risk in banking system is Non-Performing Loans (NPLs). NPLs start increasing in times of high credit risk, (Miller and Noulas, 1997). Thus credit risk is also measured with the help of loan loss provision over total loans ratio (LLP/total loans) (Sufian, 2009). An increase in this ratio shows that the bank is facing higher level of credit risk and vice

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versa. The major source of income for a bank is its credit operations, generating interest income (Akhtar, 2007). However, these credit operations are not useful in enhancing shareholders wealth if credit worthiness of the borrowers is not properly assessed (Fatemi & Fooladi, 2006). For instance, if credit issued to a borrower whose credit worthiness is doubtful, then instead of generating income, it may cause a massive loss to the bank and shareholders and thus, casting a slur on the assumption that credit operations always generate income for the shareholders. It is against this backdrop that this project focuses on the credit due diligence in the credit cycle as most crucial component of credit risk management.

3.2 DATA SOURCE The data used in this assessment is mainly secondary data. This was obtained from the annual reports and other reports issued by the bank and other organizations. Some of the external secondary data comes from the regulators, industry watchers and other financial analysts. The bank‘s policy documentations and guidelines concerning the management of the credit risks are also a major source of information for determining whether the bank‘s structures and credit risk management tools and process are adequate in handling inherent risk in its business activities.

3.3 QUANTITATIVE ANALYTICAL TOOLS The quantitative analysis in this project report is based on excel models. Data collected from the secondary sources described above serve as inputs into excel spreadsheet. The spreadsheet allowed for the generation of relevant ratios and graphs which assist in the interpretation and

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analysis of the data collected to help measure the bank‘s performance as well as judge the effectiveness of its risk management process.

3.3.1 Financial Ratios A ratio refers to the mathematical expression of one quantity relative to another. There are many relationships between financial accounts and expected relationships from one point to another. In addition to giving an indication of current situations, ratios also aid in making forward-looking projections. The ratios cover the areas of risk management in varying degrees of detail using the balance sheet, income statement and cash flow schedules. Some of the areas of risk where ratios help in expressing useful relationships include profitability, liquidity, debt and leverage and capital adequacy. But for the purpose of this report only two- Profitability and Credit Risk- are considered. Ratios, however, do not provide a complete picture of a bank‘s performance and are therefore considered contextually in conjunction with other qualitative information. Table 3.1: Ratios in assessing credit risks Category

Ratio

Return on Assets (ROA): Profit After Tax / Average total Assets Profitability Return on Equity (ROE): Profit After Tax / Average total Shareholders' Funds (Equity) Non-performing Loans / Gross Loans and Advances Impairment Charge / Gross Loans and Advances Credit Risk Allowances for Impairment / Gross Loans and Advances Source: Own Construction

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3.3.2 Graphs and Charts Graphs and charts are used in this report to provide visual representations of some of the analytical results of the financial ratios. They provide a quick snapshot of the situation of the bank during the period under review. They also help in comparative and trend analyses of significant aspects of the bank‘s operations and performance.

3.4 STANDARDS AND BENCHMARKS The major benchmarks used for this assessment are the various documents released by the Risk Management Group of the Basel Committee on Banking Supervision regarding principles which ensure sound management of risks in banks. This helped in evaluating the adequacy of the BBG‘s credit risk management framework as the essential components of the recommended guidelines were mirrored to those in the bank’s policies in respect of its structures, processes, procedures and tools put in place to manage risks. According to the main regulators of the banks in Ghana (Bank of Ghana), the Basel principles for ensuring sound management of risks have been incorporated in Ghana‘s Banking Act, Act 673 and should therefore be adhered to by all banks operating in Ghana3 To assist in assessing the performance of BBG vis-à-vis that of the Ghanaian banking industry, the Financial Stability Reports issued by the Bank of Ghana on periodic bases and Ghana

3

This information was confirmed by the Deputy Governor of Bank of Ghana, Mr. L. Van Lare Dosoo at the Regional Seminar on Risk-based supervision on 24 April, 2006 in Accra.

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Banking Survey Reports issued by PricewaterhouseCoopers Ghana in collaboration with Ghana Association of Bankers were relied upon for some peer ratios and industry averages.

As stated elsewhere earlier, preliminary investigations blamed the unprecedented abysmal financial performance of the bank of choice on poor credit operations and risk management practices that occasioned the massive credit expansion in 2006/07 and 2008. As such this project has also adopted a simple but also very comprehensive theory as espoused in Colquitt’s book “Credit Risk Management: How to Avoid Lending Disasters & Maximize Earnings” (2007) to assess the bank’s credit operations alongside the Basel standards.

According to Colquitt, credit risk management is embodied in: - Credit culture - Credit organization - Credit policies - Credit risk management process, i.e. activities in reality

3.5.1 Credit Culture Credit culture gives a general framework to guide day-to-day credit decisions of a lending organization. Credit culture embodies the foundation upon which credit discipline, procedures, attitude and behaviours, policies and systems are established for sound and quality credit portfolio. Most banking groups acknowledge successful control and management of risk require

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a strong credit culture, which seeks to curtail credit losses as well as to boost risk-adjusted returns. Banking groups identify the essential elements of their credit culture follows:



Clear policy and guidance: clear and consistent credit principles, policies, procedures and guidance.



Approval and control: define credit risk management function’s responsibilities.



Credit discipline: the group’s attitude towards risk and risk management, requirements in credit risk officers.



Capital discipline: correct pricing and credit risk management to fulfill economic capital requirements.



Credit systems and methodologies: standard systems and methodologies, some measurements of risk.



Risk appetite: the amount or risk that the group is willing to take on, the degree of risk tolerance.

Colquitt (2007, 31-34), considers an effective credit culture as one encompassing credit assessment standards, desired portfolio composition, targeted returns/earnings, risk appetite and lending authorities.

Nonetheless, from Strischek’s point of view (2002), the key elements of a credit culture are:

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

Top management's commitment: The top managers inside the organization, more than anyone, should strictly comply with the culture.



Credit discipline: Credit discipline is a large thing that comprises credit policies, risk appetite, internal risk rating system, credit administration, loan review and collection, and lender accountability.



Priority-based incentives: “Ideally, incentives are tied to priorities and to performance standards for credit quality and portfolio profitability.”



Risk-managed lines of business: a clear distinction among risks of different lines of business and credit risk management approach towards each of them.



Clear, consistent, and candid communication: “Positive and periodic communication is necessary to reinforce the culture.”

While Colquitt has a tendency for quantitative factors, Strischek is more about qualitative determinants. A credit culture is usually effective for a long period so the numerate targets are somehow unrealistic. The targets are constantly changed depending on various business and market conditions. But Colquitt has good points there when he wants a credit culture to have desired loan portfolio composition (similar to lines of business); standards used in assessing loan requests, risk appetite or the lending authority and approval limits.

To sum up, the credit culture should contain Strischek’s five points plus Colquitt’s four mentioned points.

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In addition, it is important that all credit persons – people related to extending business credit – have solid understanding of the credit culture and process. Ultimately, the credit maker’s performance expressed by earnings and credit quality is the key determinant of a successful credit culture.

3.5.2 Credit Organization The human factor of the credit function in a banking institution is referred to as Credit organization and administration. Each lending organization has its self-designed credit process but basically the processes include the same tasks in a cycle, as depicted on the below.

Credit organization implies the hierarchy of the people participating in the credit cycle. This structure can apply to banks with hierarchies transcending beyond national boundaries. In large banks, each function in the cycle may be carried out by one separate person. In smaller banks, one person can be in charge of several duties. In BBG, for instance, a team each is responsible for: credit generation, credit assessment, loan granting, and credit administration.

Mostly credit risk management function is led by the head of credit risk management with credit underwriters and relationship managers as subordinates.

Management approaches can be centralized or decentralized. The former means credit department is in charge of every credit-related activity from credit generation to policy review.

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The decentralized approach, on the other hand, highlights mutual contribution of both sales and credit units in a kind of maker-checker arrangement.

Credit Generation Credit Culture and Policy Review

Credit Assessment

Problems Loans Recovery

Credit Approval

Credit Administration

Loan Granting

Figure 3.5.2. Credit Cycle (Adapted from Colquitt 2007, 24)

Three essential functions in the cycle that directly affect the quality of credit risk management implementation and should get special concern are credit assessment, credit approval, and credit administration.

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Credit assessment is usually done by the relationship managers or credit officers. This task involves checking the loan applicant’s legal position, aim of borrowing, business or industry and any recorded borrowing information in the past. Credit assessment is one basis for credit approval.

The person in charge of credit approval will also consider the bank’s policy regarding types and amount of collateral, exposure limits of a particular industry, etc. and if possible, gives the borrower some risk ratings to facilitate his decision. In practice, a number of people are responsible for approving loans. The higher position in the credit institution the person stands, the larger value of credit he/she can approve. A Chief Risk Officer certainly has more power than the Branch Manager in authorizing loans.

Credit administration, on the other hand, does the post-approval job of monitoring the loans’ credit quality and the borrowers. A credit controller has to check if the borrowers are still adhering to their commitments in the loan application and if the credit quality has been deteriorated due to some reasons. Besides, internal auditor can give a hand in examining documentation procedures. A small mistake in documentation may be utilized by untruthful borrowers and go against the bank in an unexpected way (Colquitt 2007, 20-30).

3.5.3 Credit Policies A credit policy details the dos and don’ts, or in other words, regulations regarding lending and related activities of a lending institution. Because the lending process could be much of a routine, a well-established policies and procedures are needed to eliminate needless repeated work and

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ensure speed and accuracy. For banks, External Regulatory Policies and Internal Policies constitute the two main categories of policies that directly affect their operations and credit risk management.

External Regulatory Policies are set by the governments and international organizations. The Basel Accords is one of the most famous international legislation worldwide. The banking industry has so far been regulated by Basel I, II and III regulations aiming at preventing bank failures. The Basel Committee on Bank Supervision is particularly concerned with Credit risk. The first of the three pillars of the Basel II deals with minimum capital requirements which are helpful in assisting banks to deal with credit risk and two other types of risk. Currently Basel II requires the capital adequacy ratio of 8% but it is subjected to increase to 14% according to Basel III. This results from the recent financial crisis that hit the world hard in 2008 and 2009. (Wall Street Journal 2010)

National governments and central banks also enact regulatory legislations regarding banking practices, including credit activities. Central banks also ensure strict adherence to those legislations. The Bank of Ghana, for example, has Acts such as Banking Act, Lenders’ and Borrowers’ Act and many others that have regulations on limits on single customer borrowings, reserves or provisions for loan losses etc. Non-compliance with these laws are often attracts sanctions.

Internal Policies of banks are often intended to minimize credit risk and maximize returns. Among several formal written policies related to credit activity, the lending policy (or procedure)

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is by far the most important. The first and foremost requirement for successful credit risk management is a clear and well-structured lending policy. A lending policy should specify how loans are organized, approved, supervised and collected. It should also contain the following fundamental points: 

Lending authority and limits for each credit approver.



Duties of each credit person or sub-unit.



Assessment process and approval criteria.



Regulation on a complete loan application document.



Loan pricing (risk-based) and maturities.



Post-approval supervision and collections control.



Overdue debts and recovery.



Processing time.

Other subsidiary policies on bank’s lending activities may include Policies on Collateral, Internal credit rating system, Asset Classification and Loan Loss provisioning.

3.6 COMPANY PROFILE This section contains an overview of Barclays Bank of Ghana Ltd- the bank of choice for this project. It also contains the analysis of the bank in terms of its vision, mission and the business strategy it pursues to achieve its goals.

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3.6.1 INTRODUCTION OF COMPANY-AN OVERVIEW Barclays has operated in Ghana for ninety-five years. It is a wholly owned subsidiary of Barclays Bank PLC. Its vision is to become the best bank for every customer, in every branch, for every product and every time. Barclays Bank of Ghana Limited is part of the Barclays Africa Group comprising ten (10) African markets under Barclays PLC. Prior to 2011 financial year, Barclays Bank of Ghana Limited has had an expansive retail and commercial banking network in the country with 92 branches and over 130 ATMs in all regional capitals and major towns. Currently the number of branches and agencies stands at 66 following closure of 26 branches in 2010 and 2011. Industries financed by Barclays include cocoa, the backbone of the country’s economy; timber; gold and other minerals as well as business in the manufacturing sector and commerce. The Bank of Ghana in February, 2010 named Barclays Bank of Ghana Limited the biggest foreign bank and also the largest bank in terms of capacity to handle transactions in Ghana4. BBG is a strong brand and is noted to be a strong force to reckon with in the Ghanaian banking industry. This is evident in strong financial results posted over the years coupled with goodwill and good publicity it enjoyed from its publics over the years. The bank has delivered good return on equity, return on assets, net interest margin. The bank has remained most capitalized in the industry and has enjoyed very low (below industry average) impairment charge-to-loan ratios and very high (above industry) loan portfolio profitability until 2008.

4

Source: Joy Business/Myjoyonline.com/Ghana

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In 2008 the bank recorded a historical loss of GH¢ 6,795 million down from the 2007 profit of GH¢ 36,594 million. A proper interrogation of this poor performance is done later in this chapter under situation analysis to identify what went wrong.

3.6.2 MISSION/VISION/OBJECTIVES/GOALS The mission of BBG is “to become the most preferred and leading financial institution in our chosen markets”. As stated above (section 4.1) the bank’s vision is to become the best bank for every customer, in every branch, for every product and every time. This vision therefore emphasizes on bringing world class banking service to the doorsteps of its customers with the ultimate objective of dominating the banking industry in Ghana. The bank’s core objective is to become the best bank in Ghana with specific focus on 

Improving shareholder funds



Penetration of client wallet



Customer acquisition



Asset quality

The above set of goals is highly linked with the resolve to deliver quality service to customers. The bank thus has in its business strategy a customer-focused vision dubbed: LiMME; Lives Made Much Easier.

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3.6.3 CORE VALUES Barclays has a set of values and principles that define how its staffs must behave and conduct themselves in the performance of their duties. Barclays communicates clearly its vision, mission and values through this expected behaviors and guiding principles. Barclays considers the customer to be a key component of its strategy. This is evident in the five key value drivers where customer is weighted as 30%. Below are the key value drivers and the weights assigned to them in the following order: 1) Company - 20%; 2) Customer – 30%; 3) Colleague – 15%; 4) Control – 30%; 5) Community – 5%. The above information was gathered from the Barclays staff handbook, Personal Development Plan (PDP) and from interview with some of their staffs. This determines the overall appraisal of staff performance and their relative contribution toward the achievement of the bank’s strategic objectives. From the above, the 30% weight assigned to Controls also means that there is a lot of emphasis on internal controls to ensure that internal processes are devoid of frauds and staff performed their duties within defined and stated operational policies. An important question that will be addressed in this report is whether the internal controls were adequate or relaxed during the aggressive expansion in 2007/08.

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Barclays’ core values are embodied in the “Barclays Behaviors” and the “Barclays Guiding Principles” which are listed below. The significance of these core values is to properly align corporate objectives with that of individual employees in order to create strategic congruence. This is to ensure that employees are properly directed and focused on key business or strategic areas that are part of the broad corporate strategy of the bank. This also forms the non-financial measures that assess the quality of each individual’s contributions towards the achievement of overall corporate goal, profitability. The Barclays behaviors are given as: a) Drive performance; b) Build pride and passion; c) Delight our customers; d) Grow talent and capability; e) Execute at top speed; and; f) Protect and enhance our reputation;

The Barclays guiding principles are as follows: a) Winning together – how you act in a way to promote Barclays Africa and Indian Ocean as well as own area. b) Customer focused – how you go out of your ways to promote excellent customer service c) Best People – how you actively build relationship and constantly seek to improve both own and colleague performance d) Pioneering – Challenging conventional thinking, try to innovate and hatch new ideas and demonstrate drive and persistence

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e) Trusted – deliver on commitment and act with integrity

3.6.4 PRODUCTS BBG’s products and services are targeted particularly at the business and corporate, as well as retail customers. Barclays offers a wide range of commercial, Retail and Treasury products and services. It also offers local business banking product and services for Small Medium Enterprises and indigenous businesses. In June 2009, Barclays launched its Bancassurance proposition in partnership with Enterprise Life Assurance Company Limited (ELAC) to enhance their product range with insurance product such as Term, Family Funeral Plan and Education Plan for the convenience of its customers. The Bank's Premier Banking offers tailor made solutions and one-on-one banking to its high net worth customers. The Premier proposition amongst others offers; dedicated banking suites, financial planning, lifestyle alliances and global access to Premier lounges (airport branch) among other services. In addition Premier Life, a new service proposition to replace Prestige Banking has been introduced. It is targeted at customers who require convenient banking, quick and efficient service as well as a level of privacy and recognition. The Barclays Offshore Banking Unit, the first of its kind in Ghana and indeed Africa, South of the Sahara, was also introduced to offer world class banking service to non-resident private clients and corporate clients. However, this is currently non-functional as the Ghana Government is reported to have pulled out from the partnership. The bank’s sustainability programme focuses on three pillars. Banking for brighter futures; Looking after local communities and Charity begins at work. Barclays uses these key pillars to

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support developmental projects across Ghana. More than 80% of staff are involved in voluntary community programmes annually. Dubbed "Make a Difference Day", it is deemed the biggest corporate voluntary activity in Ghana.

3.6.5 GENERIC STRATEGY The banking industry in Ghana appears to be an attractive one with lots of opportunities for growth and profitability. The generic strategy considers how a firm would optimally position itself in the industry so as to generate superior returns. A firm positions itself by leveraging its strengths. During the over ninety-four years of operation in Ghana, Barclays Bank of Ghana Ltd have sought to deploy a focused strategy which concentrates on a narrow segment of the industry which comprises high-worth clients/customers. Within this segment the bank seeks to achieve either low-cost or differentiation. For instance, in its lending business, the bank offers facilities with customized terms and highly attractive and competitive rates to clients in the chosen segment. Currently the bank has the biggest market share owing to the use of the focus strategy to defend against the five competitive forces discussed under industry analysis. The table below can be used to describe how this is done.

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Table 3.6.5: SUMMARY OF BBG’S PRIMARY GENERIC BUSINESS STRATEGY INDUSTRY FORCES FOCUS STRATEGY

ENTRY BARRIERS

FOCUSING DEVELOPS CORE COMPETENCIES THAT ACT AS ENTRY BARRIER

BUYER POWER

LARGER BUYERS/CLIENTS HAVE LESS POWER NEGOTIATE BECAUSE OF FEW ALTERNATIVES

SUPPLIERS OF LAONABLE FUNDS/DEPOSITERS HAVE MORE POWER BECAUSE OF THEIR FEW NUMBERS (ie. The banked population); BUT WITH DIFFERENTIATION-FOCUSED STRATEGY, THE BANK IS ABLE TO PASS ON SUPPLIER PRICE INCREASES.

SUPPLIER POWER

THREATS SUBSTITUTE

TO

OF

COMPETITIVE RIVALRY

SPECIALIZED PRODUCTS AND WORLD CLASS SERVICE EXPERIENCE PROTECTS AGAINST SUBSTITUTES RIVALS ARE NOT IMMEDIATELY ABLE TO DIFFERENTIATION-FOCUSED CUSTOMER NEEDS

MEET

Source: Own Construction.

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3.6.6 MARKETING ANALYSIS/STRATEGY Increasingly, financial industry is becoming a market- and customer-driven business. It is fascinating to consider the five Ps of marketing as a strategic-planning framework. BBG has over the years been juggling the five Ps in other to achieve their vision to become the best bank for every customer, in every branch, for every product and every time. •

Product: Is the bank producing the products and services that customers want or need? The bank, which predominantly was focused on developing products for high-worth customer in both retail and corporate segments, has now broadened its scope to capture both low and high income earners.

•

Place: Is the bank in the best places for doing the kinds of business it wants to do? The new motto for the bank is “bringing world class banking to your doorstep”. The bank now has a more broadened approach to delivering excellent banking experience to customers across the country. It was in line with this that the bank embarked on the massive branch network even outside major cities.

•

Price: Is the bank setting its prices appropriately? The bank has adopted price differentiation in some segments. The newest retail product called ‘ALL-IN-ONE’ account has futures traditional current and savings account and also incorporates insurance benefits. Holders pay premium charge monthly and can also access loans from the bank.

•

Promotion: Is the bank getting the most out of its advertising Ghana Cedi? Depending on the product/service and target market, the bank deploys an Integrated Marketing

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Communication (IMC) mix comprising the following: Advertising, Sales Promotion, Personal Selling, Publicity/Public Relations, Direct Marketing, etc. •

People: Are bank employees eager to support bank Promotions? Banking is highly service oriented. The bank seeks to motivate and incentivize its employees to be able to explain the features and benefits of services to customers and the public.

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CHAPTER FOUR PROJECT EXECUTION-ASSESSMENT OF BANK

4.0 INTRODUCTION This chapter focuses on the assessment of the performance of Barclays Bank of Ghana Ltd (BBG) vis-à-vis its credit operation and credit risk management processes against the backdrop of its attempted expansion in 2007. It also contains the analysis of the bank in terms of its vision and mission, environmental and SWOT analyses in the light of the developments witnessed within the industry, the economy of Ghana and the world economy.

4.1 ENVIRONMENTAL ANALYSIS OF THE BANKING INDUSTRY Environmental Analysis is very crucial in strategy formulation and implementation of any organization in any competitive industry. Environment analysis involves scanning information about an organization’s internal and external environment to plan the organization’s future course of action. Environmental understanding helps to avoid shocks, recognize threats and opportunities, and improve long-term and short-term planning. The information compiled from environmental analysis assists top management to effectively plan for future actions. Organizations analyze the environment in order to understand the external forces so that it could help to develop effective responses to secure or improve their positions in the future. This section will attempt a quick snapshot of both the internal and the

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external environmental analysis of Barclays Bank of Ghana Ltd. Issues in the internal analysis (which considers the situation within the firm itself), are discussed in the SWOT analysis of Barclays Bank of Ghana Ltd under its strength and weakness. The external environment has two aspects: the macro-environment that affects all firms and the micro-environment that affects only the firms in a particular industry.

4.1.1 MACRO-ENVIRONMENTAL FACTORS- THE PESTEL FRAMEWORK The macro-environmental analysis includes political, economic, social, and technological, environmental and legal/regulatory factors and sometimes is referred to as a PESTEL analysis. The figure on the next page highlights some of the issues worth considering.

4.1.1.1 Political Environment Politically the country, Ghana has enjoyed about two decades of stable democracy since 1992 and this is expected to continue even though the last few months during election years tend to witness heightened political tension. However successive governments since the inception of the 1992 (Fourth Republican) constitution have fairly proven to be committed to rule of law, democracy and market based economy. There is always a vibrant opposition in parliament and an independent electoral commission which conducts and declares election results and ensures that political parties abide by a code of practice, which is in consonance with democratic governance.

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Fig. 4.2.1. Macro-environmental Factors --- The PESTEL (Adapted from Kojo Aboagye-Debrah, 2007)

Political

 Government stability

 Taxation policy  Foreign trade Legal and Regulatory  Labour Law  Bank of Ghana Act  Banking Act  NBFI Law  Securities Industry Law

Environmental  Environmental protection laws  Waste disposal  Energy consumption

regulations

 Social

responsibility

The Banking Industry

Technological  Government spending on research  Government and industry focus on technological effort  New discoveries/developments  Speed of technology transfer  Product innovation

Economic Factors  Business cycles  GNP trends  Interest rates  Money supply  Inflation  Unemployment  Disposable income  Taxation Policy  Foreign trade regulations  Social responsibility

Socio-cultural factors  Population demographics  Income distribution  Social mobility  Lifestyle changes  Attitudes to work and leisure  Consumerism  Levels of education

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The judiciary is relatively well respected and independent though its reputation and neutrality are sometimes doubted in political circles. There is also vibrant and independent media, which operates freely, demonstrated by the sharp increase in the number of both print and electronic media in the country. With a politically stable environment relative to the African sub-region, the ease of doing business and long-term business planning in Ghana has tremendously improved.

4.1.1.2. Economic Environment Key to corporate goal of maximizing shareholders’ wealth in any industry is a stable and thriving economic environment. Some key macroeconomic indices top managers, especially in the banking industry look out for include growth rate, inflation rate, exchange rates, interest rates and unemployment rate. The introduction of economic reforms and structural adjustment in 1983 helped to stabilize the Ghanaian macroeconomic environment for sustainable economic growth and poverty reduction. The implementation of stabilization, investment, and trade policies helped the economy to move from recession to a positive growth path (Aryeetey and Boateng, 2007). Between 2001 and 2007, Ghana’s GDP grew at an annual rate of 5.4% with a per capita GDP growth of 3% per year. This performance represents an improvement over the previous decade (1991-2000) in which GDP grew at 4.3% and GDP per capita grew at only 1.6% on average per year. Much of the growth was concentrated in the secondary and tertiary sectors. Agriculture, which employs more than 50% of the labour force, grew at a much slower rate of 3.8% in the 2001-2007 period compared with 7.2% and 6.2% for industry and services, respectively. This

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growth performance was attributed to the reforms undertaken after 1983 under the structural adjustment programme (SAP) supported by IMF and the World Bank.5 Inflation and interest rates reduced from 40.5% and 47% in December, 2000 to 12.7% and 24.25% in December, 2007 respectively.

The influx of financial institutions and banks, mostly of Nigerian origin during the 2001-2007 period has been attributed to the improved and relatively stable macro-economic environment coupled with some regulatory reforms that will be highlighted under Legal and Regulatory Environment. The sustained increase in per capita GDP allowed Ghana to make significant progress towards achieving MDG 1, to halve poverty by 2015. According to the 2006 Ghana Living Standard Survey (GLSS), the poverty headcount at PPP$1 per day declined from 51.1 per cent in 1992 to 30 per cent in 2006. This achievement is also attributable to the political, economic and social reforms that were ongoing in the country for more than two decades. However, much progress has often been undone in the election years when the pressure to spend freely has been too tempting. These fiscal lapses during election years have caused the government problems that have proved difficult to resolve in subsequent years particularly during 1996, 2000 and 2008 elections. Already since the beginning of 2012 (another election),

5

According to a World Bank Economic Report On Africa 2010

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the economy has been experiencing erosion of the gains made since 2009. Table 4.2 below depicts this cyclical election experience of the economy.

Table 4.2. Performance of Ghana’s Economy in Election Years Inflation Exchange BOG Policy Mon/Yr Rate Rate($/GH¢) Growth Rate Rate Base Rate Jan-92 8.7 5.0 20 Dec-92 13.3 4.1 30 Jan-96 69.2 0.1465 4.1 45 Dec-96 32.7 0.1722 4.5 45 Jan-00 14.3 0.3507 4.7 27 37.50 Dec-00 40.5 0.6863 4.2 27 47.00 Jan-04 29 0.8623 4.7 21.5 32.50 Dec-04 16.4 0.8900 5.3 18.5 28.75 0.9547 Jan-08 12.8 6.5 13.5 24.25 1.2217 Dec-08 18.1 8.4 17 27.25 1.6716 22.49 Jan-12 8.7 14.4 12.5 1.8709 May-12 9.3 9.4* 15** 20.60 NB: *Projected rate **June rate. Growth rates for January represent preceding year December growth rate. Exchange Rates prior the July, 2007 redenomination of the Cedi are redenominated by a 10000. Source: Own Construction with data from Bank of Ghana, Ministry of Finance, Ghana Statistical Service and other websites and documents including www.oanda.com and World Bank Country Report, 2011.

4.1.1.3 Social Environment It is imperative for banks as well as any other businesses to consider the unique demographical characteristics of the market they intend to operate in. Some key issues to look out for may include population size and growth rate, unemployment rate, literacy rate, poverty rates, income levels and general financial culture of the populace and also traditional social and religious orientation of the populace.

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According to the 2010 Population and Housing Census, Ghana’s population has increased by 30.4 percent from 18,912,079 in 2000 to 24,658,823 in 2010. Ghana’s Population growth rate is depicted in the chart below. Chart. 4.1.1.3 Ghana’s Population Growth Rate (%)

Source: CIA World Factbook

Literacy rates have improved from 64.5% in 1995 to 74.8% in 2003. From the available data unemployment rate reduced from about 20% in 1997 to 11% in 20006 but climbed up to about 23% in 20087. The population below the poverty line is said to have declined from 31.4% in 1992 to 28.5% in 2007. Ghanaians are very religious and the constitution upholds freedom of worship. Arguably, most tribes in Ghana spend a lot on social functions such as marriage rites/weddings, naming ceremonies and funeral rites. Depending on the missions of banks and their generic strategies, these statistics could either be opportunities or threats. 6

According to the CIA World Factbook. Figure curled from a research paper on “Ghana Financial Sector” by NANA WARE, NANA BEDU‐ADDO and ABIMBOLA SALAMI 7

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4.1.1.4 Technological Environment The technological landscape in Ghana has witnessed tremendous improvements with the telecom industry being the driving force though still expensive. There are six service providers, three of which are mobile phones companies. Competition among multiple mobile-cellular providers has spurred growth with a subscribership of more than 70 per 100 persons and rising (according to CIA World Factbook). Recent statistics by the National Communication Authority (NCA) puts the Total Cellular/Mobile Voice Subscriber Base in Ghana as at May, 2012 at 22,453,907, representing about 90% penetration rate. Internet services providers are mushrooming as well as computer hardware and software vendors. All banks use SWIFT technology. VSAT and satellites communications infrastructure have also been introduced to the market. According to information from the Government of Ghana Official Portal, Internet penetration in the country has increased from 5.2 per cent in 2010 to about 10 per cent in 2011. These statistics provide good grounds for the surge in Mobile and Internet banking services being witnessed in the Ghanaian Banking Sector. Further, a national Information Technology Agency has been established in 2008 to provide a framework for the development and implementation of information technology and related activities in Ghana.

4.1.1.5 Environmental Factors Environmental protection laws have seen some improvement with the establishment of Environmental Protection Agency.

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Service provision of utilities such as Water and electricity is still poor with a lot of power fluctuation which have had adverse effect on industries. A major energy crisis hit the country in 1998 as a result of a fall in the water level from The Akosombo Dam. Though some efforts have been made to augment Electricity production and supply, the country still experiences load shedding, power rationing, fluctuations and incessant outages. The source of energy in Ghana is hydro and thermal and this is not likely to change in the next decade.

4.1.1.6 Legal and Regulatory Environment The banking sector is governed by the Banking Act 2004 which was passed in 2004 to replace Banking Law 1989, PNDC Law 225. It requires banks to submit periodic returns to the Banking Supervision Department of the Bank of Ghana and stipulates capital adequacy, liquidity, stated capital and lending requirements for banks. Bank of Ghana, the Central Bank is the only institution mandated in the country to grant banking licenses to new banks wishing to operate in the country. The table on the next page contains some of the major Banking and Financial Laws of Ghana. With the introduction of Universal Banking which provides all banks with equal opportunities to widen their product offerings, all existing banks which wanted to convert to Universal Banking have had to increase their minimum capital to GH¢7 million. This threshold also became the amount that all new banks have had to raise to be granted an operating license henceforth. Presently the bar has been raised to GH¢25 million (for local banks) and GH¢60 million (for foreign banks).

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In 2003, maintenance, transaction, and transfer fees charges by commercial banks were abolished. The Secondary deposits reserves requirement (15%) was also abolished in 2006 and 2007 saw the abolishment of the National Reconstruction Levy. A 5% fiscal stabilization levy Bill was passed by Parliament in 2009. Companies earmarked to pay for the levy included Banks (excluding Rural Banks), Non-Financial Institutions, Insurance companies, Mining companies and Communication companies. The levy was deducted for the year 2009 and 2010. Following the passage of the Credit reporting Act, Ghana now boasts of credit reference bureau. The first credit reference bureau in Ghana and West Africa, known as XDS Data Ghana Limited, commenced operations over two years ago. Hudsonprice Data Solution Limited became the second credit reference bureau after it received the license to operate from Bank of Ghana in November, 2011. In all, all these legislations are expected to provide a more effective supervision of the banking system by the Bank of Ghana and also to modernize the legal framework as well as improve the efficiency of the financial and payments system in the country. Table 4.1.1.6. Some Major Banking and Financial Laws in Ghana 1 Bank of Ghana Act 2002, Act 612 2 Banking Act 2004, Act 673 3 Financial Administration Act 2003, Act 654 4 Internal Audit Agency Act 2003, Act 658 5 Long-Term Savings Scheme Act 2004, Act 679 6 Payment Systems Act 2003, Act 662 7 Public Procurement Act 2003, Act 663 8 Venture Capital Trust Fund Act 2004, Act 680 9 Financial Administration Regulations 2004, L.I. 1802 10 Anti-Money Laundering Act, 2008, Act 749 11 Banking (Amendment) Act, 2007, Act 738

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12 13 14 15 16 17 18 19 20

Borrowers and Lenders Act, 2008, Act 773 Central Securities Depository Act, 2007 Act 733 Credit Reporting Act, 2007, Act 726 Fair Wages and Salaries Commission Act, 2007 Act 737 Whistle Blowers Act 2006 (Act 720) Foreign Exchange Act, 2006, Act 723 Home Mortgage Finance Act, 2008, Act 770 Non-Bank Financial Institutions Act, 2008, Act 774 ARB Apex Bank Ltd. Regulations, 2006 L.I. 1825

Source: Banking and Financial Laws in Ghana, 1998-2006 & 2006-2008 by IDPS Department, Bank of Ghana

A New Labour Law, Labour Act 2003, (Act 651) came to replace the Industrial Relations Act 299 of 1965 and the Labour Decree of 1967, NLCD 157 which were the laws governing industrial relations in Ghana, as well as other laws scattered in various pieces of legislation. During the pre-Labour Act 2003, (Act 651), industrial relation matters and disputes settlement were done by the Ministry of Labour who did this through its Labour Department headed by the Chief Labour Officer. On the judicial front, though there is improvement in the judiciary, there are lapses in the judgment delivery system as cases delay for at times more than four years.

4.2 THE MICRO-ENVIRONMENTAL FACTORS-THE PORTER’S FIVE FORCES INDUSTRY ANALYSIS MODEL An important aspect of the micro-environmental analysis is the industry in which the firm operates or is considering operating. Industry analysis reviews the complexity of a particular industry; its market and competitive forces that influence the way the industry develops.

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Michael Porter devised a five forces framework that is useful for industry analysis. Porter's 5 forces include barriers to entry, customers, suppliers, substitute products, and rivalry among competing firms. Thus using the Porter’s Five Competitive Forces model, the major factors in the Banking Industry include the power wielded by suppliers and buyers, the intensity of existing competitive rivalry, availability of substitutes and the likelihood/threat of new market entrants. Porter’s 5 forces framework is depicted in Fig 4.2.2 below. Fig 4.2.2: Porter’s Five Competitive Forces

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

Threats of New Entrants/ Potential Competitors

The easier it is for new companies to enter the industry, the more cutthroat competition there will be. Factors that can limit the threat of new entrants are known as barriers to entry. Some examples include: Existing loyalty to major brands, high fixed/overhead costs, scarcity of resources, high costs of switching companies, and government restrictions or legislation.

One major barrier to entry into the Ghanaian Banking industry is the new minimum capital requirement of GH¢ 60 million and GH¢ 25 million set by the industry regulator, Bank of Ghana (BOG) for foreign and local banks respectively. Another factor that may be a disincentive to new entrants is the concentration of market share of operating assets, deposits and advances within only six (6) top banks. In 2010 the top 6 banks (1st quartile banks) accounted for about 53% of the industry’s total operating asset. Their deposits and advances amounted to 54.1% and 47.9% of industry total respectively. Obviously switching cost for customers will be high.

However, though the average individual cannot come along and start up a bank, there are services such as internet bill payment, on which entrepreneurs can capitalize. Banks are fearful of being squeezed out of the payments business, because it is a good source of fee-based revenue. This is evident in the shrinking growth of fee and commission income of the Ghanaian Banking Industry in recent times. In 2007 fee-and commission based income grew by 44.8% but dipped to 29.1% in 2008. Contribution of fees and commissions as a proportion of total income

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declined from 23% in 2009 to 19% in 2010. Unfunded income in the form of commission and fees from transaction only grew by 14%.8 Another trend that poses a threat is non-bank institutions offering other financial services. What would it take for an insurance company to start offering mortgage and loan services? Not much. Also in recent times in Ghana, we have seen mobile communication companies such as MTN, Tigo, Airtel, Vodafone and Globacom, engaging in provision of financial services such as utility bill payments and money transfers. This poses huge threat to Banks’ profitability and market share in these business areas. 

Threats/Availability of Substitutes.

The influx of non-banking financial institutions is thought as a welcome service as it is hoped that they would reach the unbanked and mainly informal sector of the economy and provide a healthy competition to the banking sector. But even established Banks such as Barclays, Stanchart, GCB, Ecobank, Zenith Bank etc are also faced by generic/secondary competition from over 35 non-bank financial institutions including NDK Financial services, Opportunity International, Pro-Credit Savings & Loans, Eximguaranty Company (GH) LTD, etc.

There are plenty of substitutes in the banking industry. Banks offer a suite of services over and above taking deposits and lending money, but whether it is insurance, mutual funds or fixed income securities, chances are there is a non-banking financial services company that can offer similar services.

8

This information is per the 2011 Ghana Banking Survey by PricewaterhouseCoopers

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On the lending side of the business, the banking industry is seeing competition rise from savings and loans companies, mortgage and leasing companies and other unconventional companies. If car companies are offering 3-10% financing, why would anyone want to get a car loan from the bank and pay 20-30% interest? Banks must therefore, develop new business models with deeper focus on alternative revenue streams and transformation of customer segmentation. 

Power of Suppliers.

The suppliers of capital might not pose a big threat, but the threat of big rival banks luring away human capital does. With more and more banks and financial institutions working toward gaining grounds in the Ghanaian Financial sector talented individuals can easily be enticed away by rival banks, investment firms, etc.

The industry in Ghana has witnessed several of such cases and Barclays Bank of Ghana Ltd has been in the spotlight of losing very key management staff to its competitors. The current MD of GCB, Mr. Simon Dornoo and his Deputy MD- operations, Mr. Kojo Addae-Mensah were poached from Barclays as well as many senior managers at Fidelity Bank, Stanbic, UBA, and Merchant Bank Ghana Ltd. In addition, the banking industry’s customer base is very narrow. The 2011 Ghana Banking Industry Survey by PricewaterhoueseCoopers puts the unbanked population at 80%. An earlier report by Alliance for Financial Inclusion puts the figure at 84%. This means that banked population is no more than 20% of Ghana’s population. Efforts by the numerous banks and other financial institutions to mop up deposits from this narrow base will mean the bank with the

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highest deposit rate will win the competition. Generally savings deposits rates have been very low compared to lending rates, giving rise to huge interest spread for the banks. This is increasingly becoming the ire of the banking public. The average savings deposit rates increased by 45 basis points to 5.5 per cent in May 2012, while average base rates of banks declined to 20.6 per cent from 22.4 per cent in the same period. The average lending rate declined to 25.9 per cent in May 2012, from 27.5 per cent a year earlier. Similarly, the Annual Percentage Rates (APR) of banks declined by 47 basis points to 28 per cent in May 2012, relative to a year earlier (Bank of Ghana Monetary Policy Committee Press Release, June 13, 2012). 

Power of Buyers.

The individual doesn't pose much of a threat to the banking industry, but one major factor affecting the power of buyers is relatively high switching costs. If a person has a mortgage, car loan, credit card, checking account and mutual funds with one particular bank, it can be extremely tough for that person to switch to another bank. In an attempt to lure in customers, a bank may try to lower the price of switching, but many people would still rather stick with their current bank. On the other hand, large corporate clients have banks wrapped around their little fingers. Financial institutions - by offering better exchange rates, more services, and exposure to foreign capital markets - work extremely hard to get high-margin corporate clients. More and more banks have adopted marketing strategies with specialized services to capture and dignify high net-worth clients. GCB dubbed theirs Royal Banking, Barclays has Prestige and Premier Banking, Zenith Bank calls it Platinum Banking. However the services are not very differentiated.

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In another breadth, with about 27 banks and close to 40 non-bank financial institutions in Ghana offering various forms of lending products, individual and corporate borrowers are becoming more price sensitive and thereby forcing the various banks to engage in competitive pricing of loan facilities. For example until August 2011, Barclays had the lowest base rate of 18%. This position has been toppled by Agricultural Development Bank (ADB) and Stanchart (SCB) with base rates of 16.75% and 16.95% as at January 6, 2012. In line with the new Bank of Ghana guidelines, SCB has adopted the new base rate methodology and accordingly their minimum lending rate applicable for all loans, effective 1st May 2012, is 14.50%. 

Competitive Rivalry

The banking industry is a sub-set of the broader financial sector. The financial sector comprises the banking and non-bank financial industries such as insurance, stock brokerage firms, mortgage firms, savings and loans companies etc. According to Alliance for Financial Inclusion (AFI) the unbanked population in Ghana is 84%. This does not seem to make the banking industry very competitive in that the 84% unbanked population means that there is vast virgin opportunities’ uncovered and as such competing banks could easily avoid rivalry by moving to new grounds to craft new niches for themselves. However, this is not the case. What prevails in the Ghanaian Banking Industry is that the Banks rather compete among one another over the 16% banked population. Competition among the banks is basically direct/primary in nature due to similarity in the financial products and services fashioned to meet homogeneous needs of the 16% banked population. As such competition is very intense as they try to lure clients from competitor banks.

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There is increasing competition resulting from new entrants from Nigeria e.g. Zenith Bank, Guaranty Trust, Access Bank Plc, Energy Bank etc. Research results on the Ghanaian Banking Industry by Kojo Aboagye-Debrah reveals that there exists intense competition among interbank categories as the big banks are losing market share to the medium and small banks particularly in key market segments such as advances, deposits and profit after tax. (see Competition, Growth And Performance In The Banking Industry In Ghana by Kojo Aboagye-Debrah, 2007). Data from the Ghana Banking Survey 2011 report by PricewaterhouseCoopers shows that the top 3 banks lost 3.4% of their total assets market share. The chart below depicts the rest of the story where the first quartile banks (including GCB, Stanchart, Barclays, ADB, Ecobank and Merchant bank, and in some instances, Stanbic and SGSSB) have been experiencing a decline in their market shares in recent times. Chart. 4.2. Market Share Analysis-Dwindling Market share of 1st Quartile Banks in Ghana

Market Share (%)

Industry share of top 6 banks 65

55

45

2008

2009

2010

asset

57.7

56.5

52.7

deposit

58.2

56.4

54.1

advances

61.7

57.4

47.9

Source: Own Construction with Date from Ghana Banking Survey 2011 by PricewaterhouseCoopers

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4.2.1 SWOT ANALYSIS OF BARCLAYS BANK OF GHANA LTD (BBG) SWOT analyses take into account the strengths, weaknesses, opportunities and threats facing a business, organization or operation, in terms of serving customers, stakeholders and their own employees. An analysis of the Strengths and Weaknesses, of Barclays Bank of Ghana Ltd (BBG) as well as Opportunities and Threats of the Ghanaian banking sector reveal the following; Strengths 

BBG has earned a strong reputation in its operation in the banking industry in Ghana. Its continuous provision of excellent customer services coupled with provision of world class financial solutions would continue to ride on the back of the very strong brand (i.e. Barclays Brand) BBG has been associated with.

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As a multi-national, BBG has the luxury of sourcing highly qualified management personnel from the international market with rich skill and experience that is well blended with local talents and thereby able to stay on top of the competition.

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Being a subsidiary of Barclays Plc, BBG is able to assess adequate funds from the mother company to support its operations and investment in new projects/products. References can be made to the funds used for the aggressive lending during its attempted expansion in 2007/08, the injection of funds to meet the new Bank of Ghana GH¢60 million stated capital requirements and funds for settlement package of staff affected by the redundancy programs implemented from 2010 up to date. It currently has a stated capital of GH¢150 million and has been so since 2009.

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

BBG has also earned the reputation of being highly efficient and profitable. Barclays has consistently posted one of the highest industry profits over the years until the historic losses in 2008 and 2009. Of course, BBG’s 2011 financial results shows that it is one of the most profitable banks in 2011 having made a remarkable record high profit of GH¢ 115.4 million, a 35% increase over the 2010 profit number.



As a multi-national, it is also thought to have a strong risk management capability than locally-owned banks. This will be interrogated alongside the poor performance in 2008/09 where impairment charges rose astronomically by 746% from GH¢ 5,540 million in 2007 to GH¢ 46,890 million in 2008 and then to GH¢ 60,882 million in 2009 leading to historic losses.

Weakness 

BBG is a wholly owned subsidiary of Barclays Bank PLC. As such most of its policies are group-wide policies, sometimes with little or no flexibility to adapt to local environment. This does not only limits BBG from swiftly taking advantages of new growth opportunities but also affect its ability to respond to local contingencies that will position BBG to better serve its customers.



BBG is not enlisted on the Ghana Stock Exchange (GSE); thus making it not able to spread risk.



BBG is famously seen to be following a very regressive human resource policy that favours patronage and cronyism at the expense of competence and performance. Progression on the job is seen to be virtually non-existent. The bank prefers to appoint

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top management staff from outside the bank. Most staff are extremely underemployed, unhappy and unmotivated because whether you work hard or not there is little or no promotion or job progression for you. It appears the only way to move up is to leave the bank and try to re-enter by applying for a higher role and even that depends on your “links”. 

There is the perception that its mode of operations is skewed in favour of the rich and expatriate. Its relatively higher initial deposit requirement is skewed against low income group. During its attempted expansion in 2007/08 the bank decided to go along with the competition by the Nigerian banks by allowing cashless accounts and in some cases reducing its minimum balance requirement to GH¢ 40 (Aba Pa Account). But by 2010/11 all account holders were notified to maintain a minimum balance of GH¢ 200.

Opportunities 

In general and from all indicators, the macro-economy over the past few years presented the banking industry with a very good environment for conducting profitable business. The BOG reduced its Prime (Policy) Rate from 24.5% (2002) to 12.5% (2006) and to 11.5% (2010); and abolished the 15% secondary reserve requirements in August 2006. The abolition of the secondary reserve requirement frees up significant liquidity for lending business.

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

The bank has great potential for expansion in order to penetrate to unbanked population of over 80%, being the most capitalized bank in Ghana.



Also in line with the above the bank has the capital leverage needed to take up opportunities in the emergent oil (exploration) industry in Ghana.



The bank’s strategy is to offer a full portfolio of services drawing on workable best practices from group members worldwide, providing a wide range of cross-selling opportunities. BBG thus has word-wide class franchise to leverage on.

Threats 

The current LIBOR fixing scandal that rocked Barclays Plc which saw the resignation chairman Marcus Agius, and CEO Bob Diamond and fines to the tune of £290 million by UK and US regulators is bound to affect the reputation of all its subsidiaries including BBG.



BBG faces fierce competition from established brands (household names) such as Stanchart, Ghana Commercial Bank Ltd and ECOBANK and also new but aggressive new banks such as Fidelity Bank, Zenith Bank, HFC, UT Bank etc.



Barclays acquired a reputation for closing branches because of a high incidence of this in the past and also recently following their expansion in 2006/07/08, and competitors have been able to position themselves as more consumer-friendly through a strategy of keeping branches open. The Bank in recent times have closed down over 20 branches and outlets; an inconvenience to customers and also making redundant some of its employees.

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

BBG is also accused of lethargic human resource policies that make it almost difficult for employees to rise to strategic management positions in the bank. At least in the recent history of the bank, appointments for almost all management positions (including that of managing director) have been made outside the bank. This does not encourage staff to give of their best. More importantly there is a growing preference among young graduates and professionals for other banks over BBG.



The bank recently sold its custody business to its fiercest multi-national rival, Standard Chartered Bank Ghana. This does not auger well for the bank’s competitiveness.



Shareholders of BBG are likely to be worried about the impact of local currency (Ghana Cedi) depreciation on their earnings’ value



Declining interest rates also implies lower interest margins for banks including BBG.

4.3 SUMMARY OF INDUSTRY ANALYSIS AND CRITICAL SUCCESS FACTORS IN THE GHANAIAN BANKING INDUSTRY 4.3.1 Key Highlights from the Ghanaian Banking Industry From the external and internal analysis conducted on the Banking Industry and BBG, the following can be deduced; 

Huge potential banking market, given the large un-banked informal sector and high margins-hence entry by new banks. This also provides opportunity for local product development.

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

Introduction of universal banking-Universal Banking License (which enables all banks to engage in commercial as well as merchant banking) likely to intensify competition especially for the retail sector high net worth.



Abolishment of secondary deposits reserves requirement (15%) frees up banks capital for more lending business.



Multi banking by corporates – intense price competition and adverse impact on margins.



As interest margins and spreads collapse, the industry would generally look to noninterest income and rigorous cost management for its profit.



Predominantly cash based payment system which is very expensive provides banks opportunity for Cards business and Money Transmission Service.



Increasing competition resulting from:

 New entrants from Nigeria e.g. Energy Bank, Zenith Bank, Guaranty Trust, Access Bank.  Potential entrants e.g. First National Bank of South Africa, Citibank.  New product launches – similar product offerings  The fact that all banks have full functional Wide Area Network, Networked channels.  Numerous non-bank financial institutions and even non-financial institutions offering financial services. 

Increasing profitability of the industry provides opportunity for expansion into the West African Sub-region.

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

Increasing trend in impairment charges (from 1.5 % in 2007 to 4.7% in 20109) coupled with lower loan portfolio profitability (below 17%10) is an indication that there is the need to strengthen credit administration and recovery procedures.

4.3.2 Key Success Factors of Banking Industry in Ghana Given the nature of the landscape and the nature competition of the Ghanaian Banking Industry, the following can be considered as key success factors which are important to future competitive success of industry players;



Technology

Currently the level of service and product differentiation is very low. Latest technology will play a very important role in the banking industry. It is instructive to note that at the just ended annual Ghana Banking Awards, there was no winner for the ‘Best Bank-Product Innovation” category. Sophisticated technology helps in introducing innovative products according to the demand of consumers. Technology can be used to lower down the cost of transaction and improve the quality of products. For example when the banks realized that they could lower down their transaction cost by installing ATMs and debit cards they did so. It saved the overhead cost and improved convenience for customer by providing 24/7 service. Online banking is increasing tremendously due to rapid technological change. Technology can help to inject efficiency in banks operations which will eventually reduce cost.

9, 10

See pages 45 and 46 of Ghana Banking Survey, 2011 by PricewaterhouseCoopers

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

Best Rates

One major issue that has been the ire of the banking populace in Ghana is the seeming unwillingness of banks to reduce their lending rates, despite relatively stable macro-economic environment. Pricing is a huge part of what makes a consumer choose one bank or product over the other. Customers are therefore willing to switch banks or products where they can get lower rates. Thus to survive and be more successful in the industry low and competitive rate is very important. 

Product Innovation

Product Innovation is one of the major success factors in the banking industry. Since all the banks are offering similar products therefore differentiation is very important for the future survival. Banks are trying to come with different innovative products in order to differentiate themselves from other banks but so far not much heterogeneity has been seen.  Quality of Service Service Quality includes all the dimensions of quality which the consumers want. The competition is getting keener as all the banks are creating specialized service offerings to their customers, most especially the high net-worth. In the future banks that are able to put up more and more personalized or customized services and swiftly resolving customer issues will carry the competition. 

Brand Image (Recognition)

Brand image plays an important role in selecting the product or bank. For example Barclays Bank, Stanchart, Ecobank, Ghana Commercial bank, and Stanbic are five major players in the industry with huge resources and they have major market share as well. That’s why most of the

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people wish to be their customers. The five together accounted for 48.7% of total industry deposits. In this way, market share and brand awareness within the banking industry is a major concern for them. 

Size Of The Bank

The size of the bank is an important key success factor. In banking industry size of bank refers to the total market share, total assets, total number of branches and ATM’s, total number of customers etc. In recent times, even banks with international Brand are seeking to grow in size irrespective of their generic strategies. Stanchart and Barclays which are traditionally known to be focused on only the elite and high net-worth in society and thereby operated fewer branches have in recent times expanded their branch networks and ATMs. Between 2007 and 2008 Barclays’ branches grew from 34 to 140 and agencies; though a good number were closed subsequently. 

Location And Convenience

It is important to note that convenience attracts consumers. Here again, if a bank has wider network, then it will be convenient for the customers to make transactions easily. In this case, in addition to number of branches and their strategic location, banks with more developed mobile and online banking will be the preferred choice for the customer. The growth of the internet in the last few years, has forced many banks to consider and develop online banking. 

Management

Management plays a key role in ensuring success in almost any initiative within an organization. Nothing makes greater impact on an organization than when leaders model the behavior they are

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trying to promote among employees. For banks to succeed in their operations, good management practices must be employed. 

Human Resource

This refers to the individuals within the firm and to the portion of the firm’s organization that deals with hiring, firing and other personal issues. The strategic human resource is based on the deep knowledge of the organization’s processes procedures and the business strategy. A wellmanaged human resource will lead to success in the banking industry.

4.4 STRATEGY AND PERFORMANCE OF BBG (2006-2010) How did BBG take advantage of the seemingly attractive Ghanaian banking industry with lots of opportunities for growth and profitability, especially with the apparent conducive macroeconomic environment coupled with favorable regulatory developments from 2004 to 2008? And how did BBG fare? This section will consider how BBG fared given the industry environment and success factors for-discussed during the 2006- 2010 period. The analysis will be done from the perspective of financial performance. Also because this project is about the impact of credit administration and credit risk on banks’ profitability, the analysis will be skewed towards financial ratios that relate to BBG’s loans portfolio. Prior to 2007, during the over ninety years of operation in Ghana, BBG was largely seen to have deployed a focused strategy which concentrates on a narrow segment of the industry comprising high-worth clients/customers. Within this segment the bank seeks to achieve either low-cost or differentiation. BBG was considered a bank for the elite only with ordinary Ghanaians and even

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students 'technically' debarred from doing business with the bank because of the high initial deposit and minimum balance required to operate an account with BBG at the time. However, with key developments in the economy in general and the financial regulatory environment in particular, coupled with the emergence of stiff competition in the industry posed by new entrants, the bank (BBG) in 2007 sought to adopt a broad differentiation and cost leadership strategy with the view of reaching out to the masses with broadly differentiated low cost products. With this, the bank embarked on an expansion programme and the manner and fashion of this roll-out was unprecedented in the history of banking in Ghana. Speaking at the inauguration of the (Accra) Spintex road branch of the bank, the then MD, Margaret Mwanakatwe said their new mission was to become the leading contributor to Ghana's economy and would therefore not remain lean and thin on the ground. According to her, the bank “does not want to stay out from key commercial centres in the country. It also wants to take their financial agenda to another level by increasing access to their banking facilities irrespective of the region”. This expansion saw the number of branches grow from 34 at the beginning of January, 2007 to 140 by 2009.

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4.4.1 Financial Performance Of BBG And Identification Of Managerial Issue (2005-2010) According to PricewaterhouseCoopers’ 2008 Ghana Banking Survey Report, BBG, overall, in average terms, was the most profitable bank over the 2003-2007 survey period. The previous year’s survey (Ghana Banking Survey 2007, which covered a five-year period from 2002 to 2006) also determined BBG, on the overall, as the most profitable bank for that survey period. For the period between 2003 and 2007, BBG had the industry’s best average scores for Return on Assets (ROA) (5.5%), Profit before Tax Margin (PBTM) (52%), and Profit after Tax Margin (PATM) (34%). SCB came second place for all three metrics – ROA (4.8%), PBTM (51%), and PATM (34%). (Ghana Banking Survey 2008, pp. 47). The above findings clearly highlight the enviable track record of BBG being most profitable and successful bank over the years prior to 2007/8 (i.e. pre-expansion era). The financial analysis in this section will therefore seek to compare the pre and post-expansion era performance of BBG in the wake of its historic losses in 2008 and 2009. As stated earlier, for the purpose of this project, the performance indicators contained in the table below which relate to profitability and loan portfolio quality will be used to analyze the financial performance of BBG. This analysis will be in two forms: trend and comparative analysis covering a five-year period (2005-2010) using BBG financial ratios and Industry averages.

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Table 4.4.1. Some Profitability and Asset Quality Ratios-BBG vs. Industry Ratio/Yr

2005

PBTM

2006

BBG 2007 2008

2009

2010

50.53 36.80

-6.30

-13.80

38.10

2005

INDUSTRY AVERAGE 2006 2007 2008 2009

2010

35.70 30.40 26.10 19.70 27.70

ROA

5.5

5.50

2.55

-0.53

-1.24

3.62

ROE

51.4

54.30 32.20

-6.00

-11.20

24.45 28.40 28.40 22.20 21.70 12.10 16.70

IMP CHG/TL

2.64

0.92

0.80

6.00

9.80

3.80

2.79

1.72

1.50

2.20

4.20

4.70

5.86

3.44

2.60

8.00

17.70

20.10 11.24

6.65

4.60

5.20

8.20

8.00

IMP ALW/TL Notes:

3.50

3.50

2.00

3.20* 2.10* 2.70*

PBTM = Profit before tax margin = Profit after extraordinary items but before tax / Total operating income ROA = Return on assets = Profit after tax / Average total assets ROE = Return on equity = Profit after tax / Average total shareholders' funds (Equity) IMP CHG/TL = Impairment charge/ gross loans and advances IMP ALW/TL = Impairment allowance/ gross loans and advances *Annualized returns from BOG Financial Stability Reports (2009-2011) SOURCE: Own construction with data from BBG Annual Report (2007, 2008, 2009&2010), Ghana Banking Survey by PricewaterhouseCooppers (2008, 2009, 2010&2011) and BOG Financial Stability Reports (2009-2011)

A Comparative Analysis The data from table 4.4.1 above, covering the pre-expansion period (2005-2007) clearly portrays BBG as a top performer among its peers. Comparing PBTM, ROA, and ROE of BBG with the industry averages for the three years under review, it clearly shows that BBG outperformed the industry, achieving profitability numbers above the industry average in previous years prior to 2008. On the other hand, the story is not different when it comes to impairment charges and allowances to total loans which are indicators of non-performing loans and loan loses. As depicted in the

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Chart below the results shows BBG has had numbers below industry average during the preexpansion period. Chart 4.4.1. BBG and Industry comparison of Performance Indicators

Profitability vs. Impairment (BBG compared with Industry Averages)

25

Impairment as percentage of Total Loans

60.00

50.00

Profitability Margins in percentages

20

40.00

30.00

15

20.00

10

10.00

0.00 2005

2006

2007

2008

2009

2010

2005

2006

BBG

-10.00

2008

2009

2010

5

INDUSTRY AVERAGE

-20.00 PBTM

2007

ROA

Years ROE

0 IMP CHG/TL

IMP ALW/TL

Source: Own Construction with data from table 4.4.1

However, a negative PBTM of 6.30% recorded in 2008 raises questions about how a big bank of the stature BBG could slip form significant profits into after-tax losses of about GH¢ 7,350 million at the end of 2008.

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Similarly Return On Asset (ROA) -which indicates the profitability on the assets of the bank (after all expenses and taxes) - for the first time fell below industry average in 2008. Chart. 4.4.1.1. Profitability on Bank Assets

ROA-BBG vs. Industry Average 5.75

ROA in percentages (%)

4.75 3.75 2.75 bbg industry

1.75 0.75 -0.25

2005

-1.25

2006

2007

2008

2009

2010

Years

Source: Own Construction with data from table 4.4.1

In sum, a comparative analysis of the other indicators (i.e. PBTM, ROE) will produce same result in similar fashion as the story depicted in Chart 4.4.1.1 above.

A Trend Analysis A review of BBG’s profitability ratios prior to the expansion era revealed a continued decline in its operating performance, though it had been most profitable bank in Ghana prior to the 2007/08 period. The Chart below summarizes the story.

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Chart 4.4.1.2 Trend Analysis of BBG’s Profitability and Efficiency Ratios

60.00

5.75

50.00

4.75

40.00

3.75

30.00 2.75 20.00 1.75 10.00

ROA in Percentages (%)

PBTM & ROE in Percentages (%)

BBG's Profitability Trends

0.75

0.00 2005

2006

2007

2008

2009

2010 -0.25

-10.00 -20.00

-1.25

Years PBTM

ROE

ROA

Source: Own Construction with data from table 4.5.1

Banks in general are highly leveraged and as such an ROA above 1% indicates huge profits. A cursory look at the Chart 4.5.1.1 above points to the fact the industry as a whole uses its assets more efficiently to produce profits as its ROA has been above 1% though it seems to be dwindling. BBG on the other hand had always been at top of the ROA league table until 2008. PBTM, ROE and ROA all consistently declined from 2006 to 2009. But as stated earlier (and as depicted by Chart 4.4.1.0 and Chart 4.4.1.1), the declining trend was experienced throughout the industry.

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However what was mind-boggling was the unprecedented loss recorded by BBG in 2008. This seemed to have dazzled many industry watchers and they began to ask questions; “how has the mighty fallen?” What went wrong?

4.4.2 The Managerial Issue of Concern-What Went Wrong in BBG? A negative PBTM of 6.30% recorded in 2008 raises questions about how a big bank of the stature BBG could slip form significant profits into pre-tax losses to the tune of GH¢ 10,240 million at the end of 2008. A critical look at the income statement revealed that two major issues - rising impairment charges and a hike in Operating Expenses - accounted for the loss. The results are summarized in the table below. Table.4.4.2. BBG’s PBT, IMP CHG, Operating Expense and their Rate of improvement (+)/deterioration (-) PBT Year

Amount

IMP CHG % Change

Amount

% Change

3,448

OPERATING EXP Amount

% Change

2006

45,589

41,179

2007

43,485

-4.6%

5,540

-60.7%

69,177

-68.0%

2008

(10,240)

-76.5%

46,890

-746.4%

125,634

-81.6%

2009

(23,506)

-129.6%

60,882

-29.8%

141,584

-12.7%

2010

81,349

246.1%

20,815

65.8%

114,576

19.1%

Note: Amount in ‘000 GH¢ Source: Own Construction with absolute figures from BBG’s Annual Report 2007-2010

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The table above clearly indicates that BBG witnessed a negative trend within 2007-2009 financial years. In 2007, Operating Expenses increased significantly by 68%, a total of 6800 basis points. It further rose by 81.6% to GH¢ 125,634,000 in 2008. This obviously eroded a good chunk of any profits that the bank was able to generate from its operations. Further interrogation revealed there was a massive expansion in branch network during 2007/08 that saw BBG’s branches shot up from 34 to 140. Unfortunately the expansion was characterized by lots of operations management failures with its attendant sky-rocketing cost with no immediate dividends. The expansion seems to have brought in its wake historical increases in the bank’s expenses on impairment charge and operations. In 2008, the bank’s Return On Equity (ROE) dropped to -6.00% from 32.20% in 2007 having dropped from 54.30% in 2006. Since ROE is stated as Net Profit after Taxes /Shareholders’ Equity, it is apparent that management activity has been out of order relative to 2007/2008. In response to such poor returns, management was changed. The first year of the new management team headed by Benjamin Dabrah saw further deterioration as the bank recorded a net loss of GH¢17,991 million with ROE of -11.2%. While the issues of the rate of increases in operating expenses outweighing that of operating income may be pardoned during such expansions, the unprecedented sharp increases in impairment charges that occasioned the expansion drive certainly points to the fact that something went wrong with the expansion.

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One thing that was evidently clear is the fact that the expansion, which was dubbed “Barclays, bringing world class banking to your door step”, was spearheaded by an aggressive lending that was unprecedented in the Ghanaian Banking Industry. BBG which had always trailed GCB in terms of market share of industry deposits and loans toppled GCB at the end of 2007. In 2007, BBG grew its deposits by GH¢478.85million, an 87% increase over its 2006 deposits. This was the largest increase by one bank in a single year in the industry. It was 83% higher than GCB’s deposit increase of GH¢262.21million, which was the second largest of the industry, and made BBG the bank with the largest deposits in the industry. As revealed by the 2008 Ghana Banking Survey report, at the center of BBG’s deposits growth strategy was a robust drive to give the bank a very visible retail network presence. The bank added 63 new branches to its network in 2007 alone and another 59 in 2008. As can be seen from the table below, in terms of gross loans and advances, BBG in the first year of the expansion grew its loan portfolio by 63% from GH¢444,105 million in 2006 to GH¢722,302 million in 2007. In the second year, 2008 the portfolio grew by another 18%.The Bank’s performance over the 2007/08 period however puts the quality of the loans and advances portfolio in doubt. Table 4.4.2.1. BBG’s Gross Loans And Advances in GH¢ '000 Year

Banks

Customers

Total

Change

%Change

2006

81,125

362,980

444,105

2007

81,634

640,668

722,302

278197

63%

2008

131,426

718,598

850,024

127722

18%

2009

110,751

513,717

624,468

-225556

-27%

2010

166,312

435,918

602,230

-22238

-4%

Source: Own Construction with figures from BBG’s Annual Reports (2007-2010)

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By end of 2008, BBG’s cumulative loan loss ratio (IMP CHG/TL) rose astronomically by 650% from 0.8% in 2007 to 6.0% which was worse than industry average of 2.2%. This performance was very unusual given that traditionally, it had a high ranking in the quality of its loan book. In 2008, its impairment charge to financial assets increased more than seven fold, from a 2007 figure of GH¢5.5 million to GH¢46.9 million in 2008. (Ghana Banking Survey 2009). In 2008, one major contributive factor to the general decline in ROA across the industry was a 40% rise in impairment charges in 2008 with BBG’s impairment charge seeing a phenomenal rise of 746.4% having increased by 60.7% in 2007. This clearly shows that quality of loans booked in 2007/2008 (i.e. expansion era) was not the best. The hikes in IMP CHG/TL and IMP ALW/TL as shown in the table below are indications of the presence of a huge Non-performing Loan portfolio. It is important that a more stringent credit operations measures are put in place and vigorous debt collections and recoveries strategy is adopted to arrest this situation. Table 4.4.2.2. BBG’s Impairment vs. Profitability YEAR S

PBTM

2005

ROA

ROE

IMP CHG/TL

IMP ALW/TL

5.5

51.4

2.64

5.86

IMP AMT(GH ¢ ’000)

% Change in IMP AMT

2006

50.53

5.50

54.30

0.92

3.44

3,448

2007

36.80

2.55

32.20

0.80

2.60

5,540

-60.7%

2008

-6.30

-0.53

-6.00

6.00

8.00

46,890

-746.4%

2009

-13.80

-1.24

-11.20

9.80

17.70

60,882

-29.8%

2010

38.10

3.62

24.45

3.80

20.10

20,815

65.8%

Source: Own Construction with figures from BBG’s Annual Reports (2007-2010)

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A trend analysis of the data from the above table seems to suggest that whenever impairment figures are kept down, the bank’s profitability goes up and vice versa. This is clearly depicted by the Chart 4.4.2.2 below. Evidence and results from some past researches have shown that a regression of ROA and ROE (which are proxies of profitability) on NPL/TL (indicated by IMP CHG/TL and IMP ALW/TL, which are also proxies of credit risk management) show that non-performing loan of banks is significantly negatively related to their profitability. In one of such researches, the results show that 1% increase in non-performing loans decreases ROE by 1.506% and ROA by 0.4168%. The results verified the hypothesis that better credit risk management results in better bank performance11. Chart 4.4.2.2. BBG’s Impairment-Profitability Comparison

Profit Margins in percentages

60.00

25

50.00 20

40.00 30.00

15

20.00 10

10.00 0.00 -10.00

2005

2006

2007

-20.00

2008

2009

2010

0

Years PBTM

ROA

ROE

5

IMP CHG/TL

Impairment as percentage of total loans

Profitabilty vs. Impairment

IMP ALW/TL

11

An example of such result can be found in “BANK PERFORMANCE AND CREDIT RISK MANAGEMENT” by Takang Felix Achou Ntui Claudine Tenguh

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Source: Own Construction with figures from BBG’s Annual Reports (2007-2010)

The data on BBG so far analyzed, also shows a negative correlation between ROE and IMP ALW/TL and also between ROA and IMP CHG/TL. This is vividly pictured below. Chart. 4.4.2.3. The Relationship between ROE, ROA and IMP ALW/TL, CHG/TL ROE vs. Impairment Allowance/Total Loans

ROA vs. Impairment charge/Total Loans

60

12

50

10

8

30

Percentage(%)

Percentages (%)

40

20 10

6

4

2 0 2005 2006 2007 2008 2009 2010 0

-10

2005 2006 2007 2008 2009 2010 -2

-20

Years

Title ROE

IMP ALW/TL

ROA

IMP CHG/TL

Source: Own Construction with figures from BBG’s Annual Reports (2007-2010)

Since Non- performing loans is an indicator of poor credit risk management, the above relationship so observed therefore suggests that there has been poor credit risk management at

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BBG which became more pronounced and exposed especially during the period it embarked on the expansion campaign spearheaded by the unprecedented aggressive lending. The next section therefore will take a quick review at the credit delivery process at BBG from credit generation through to collections and recoveries stage with particular focus on what might have gone wrong during the aggressive lending era.

4.5 CREDIT ADMINISTRATION PROCESS AND MATTERS ARISING FROM BBG’S 207/08 AGGRESSIVE LENDING CAMPAIGN - FINDINGS As stated earlier, BBG is a wholly owned subsidiary of Barclays Plc and many of its policies and practices including its Credit Risk Management Framework are group-wide in nature. A study conducted on Barclays Plc’s credit risk management techniques and practices in comparison with major Basel (1999a, 2000) regulations on Principles for the Assessment of Banks’ Management of Credit Risk revealed that the bank has comprehensively met most of the Basel regulations of: Establishing an appropriate credit risk environment; operating under a sound credit granting; process; maintaining an appropriate credit administration; measurement and monitoring process; ensuring adequate controls over credit risk and the role of supervisors. A summary of the findings which was based on Barclays 2006 Annual Report are summarized in the table below.

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Table 4.5. Summaries of credit risk management techniques and practices at Barclays Credit risk management governance Credit Risk Function carries direct responsibilities and a five-step risk management process is followed. Credit granting

N/A

Credit risk measurement

PD, EAD and LGD models are used and a selfdeveloped measure named Risk Tendency is also adopted for estimating expected losses. A 21-grade internal rating system, together with external ratings, is used for assessing credit risk.

Credit exposure management

Analysis on credit exposure is made according to geographical area, industry and maturity. Credit concentration is given attention to and limits to sub-investment grade countries are clarified.

Credit quality management

Potential credit risk loans are identified as either nonperforming loans or potential problem loans. Impairment is measured either individually or collectively.

Credit risk mitigation techniques

All kinds of traditional techniques are used, including netting agreements and diversification. Loan sales, asset securitization and credit derivatives are also adopted for managing credit risk.

Source: Adapted from Credit Risk Management in Major British Banks (Xiuzhu Zhao, 2007)

What seems missing from the table above is information on the credit granting process which was not contained in the 2006 annual report used by the researcher. However there is a comprehensive information on the credit administration process contained in Barclays Africa &

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Middle East Retail Credit Manual which is the standard operational process used by all the Barclays subsidiaries including BBG as shown in Fig 4.6 on the next page below. The bank also has a group-wide comprehensive and detailed credit risk management policy document that addresses how credit risk is organized, identified, measured, monitored & controlled and reported within the bank. This 92 pager manual known as the Group Retail & Commercial Bank (GRCB) Retail Credit Risk Management Principles, Framework and Policy Manual which was purposefully designed to identify risk management principles and minimum standards by which all GRCB retail businesses must comply has clear guidelines on credit governance and control; regulatory compliance; risk appetite; risk governance structures; limit authority; impairment methodology, forecasting, loss recognition and conformance; collections & recoveries strategies and other relevant policies regarding the bank’s lending business.

Based on the above and other pieces of information from other internal policy documents, it is clear that bank from group level has a comprehensive credit risk management framework in place. Judging from the Basel regulations which are well mirrored by the comprehensive theory as espoused in Colquitt’s book “Credit Risk Management: How to Avoid Lending Disasters & Maximize Earnings” (2007), the bank seems to portray it has a strong Credit Culture for minimizing credit losses and upon which credit discipline, policies, and systems are established.

However, as stated elsewhere earlier, the phenomenal increases in BBG impairment charges recorded during 2006/07 and 2007/08 period clearly tells of the poor quality of its loan portfolio.

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The reason for the unprecedented abysmal performance of the bank can therefore be attributable to the fact that there were problems probably associated with the massive credit expansion process right from credit facilitation stage in 2006/07 and 2008.

From the Retail Credit End to End Process Flow depicted by Fig. 4.5. below, it is clear that the credit organization process at BBG is largely in synch with Colquitt’s model (see chapter 3) and the Basel guidelines (see APPENDIX C) which when well followed could have largely prevented the lending disaster experienced by BBG.

My interrogation of the issues from internal sources revealed that the main cause of this abysmal performance was BBG’s imprudent venture in to retail expansion largely by use of credit as a bait to increase customer base and to make the bank more visible in the country in order to take advantage of the seemingly ripe opportunities in the economy at the time; basically driven by anxiety over income with little regard to adherence to sound credit principles. The expansion which was to increase customer base was driven by new products such as Aba pa accounts for petty traders, Barclay loan for salary account holders and Scheme loans for both non-customers and customers. In deed by end of 2007, the bank’s loan book grew by 63% and 52.54% of the loan portfolio was made up of personal loans.

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Fig. 4.5. BBG’s Retail Credit End to End Process Flow

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Disclosures from sources available to me from within the bank (Credit Operations & Collections and Retail Banking Unit) revealed some serious hitches that inhibited the success of the expansion drive. The issues can be categorized under two broad areas: People/Personnel issues and Operational/Systemic issues. A typical valid credit cycle involves six (6) key functional areas;  Credit facilitation (comprising activities from credit generation to approval)  Pre-billing management (billing and invoicing)  Remittance processing ( payment reconciliations)  Collections management  Dispute management (root cause identification, refunds processing)  Reporting and analysis (exception reporting, customer intelligence management (MI) information and portfolio risk MI.

All these functional areas require effective human and adequate systems infrastructure resource capacity planning to be successful. However there was the problem of inadequate capacity to effectively deal with the huge volumes of loan applications that were churned out on a daily basis. The bank adopted the use of temporary staff especially at the facility generation stage. These temporary staff- referred to as Direct Sales Agents (DSAs) but subsequently called Lead Generators (LGs)- who had little or no training and were remunerated on commission basis ensured that large volumes of low-worth customers were recruited leading to high volumes of low quality loans (with high default risk) being booked. For example it came to light that even

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factory hands, ‘watchmen’ and other menial job workers who lived at most on minimum wages were also given loans with large amounts whose repayments they hardly could afford. Management at Scheme Loans Desk and Credit Operations Unit (COU) were under intense pressure to process and book a minimum of 1,000 loans a day. Staffs in these two departments were overwhelmed with the work load as they were understaffed. The result was that the quality of the vetting, scoring and assessment suffered as most guidelines and requirements were relaxed or overlooked resulting in the booking of huge volumes of sub-standard loans. The above phenomena directly affected the integrity of the work done at the billing and remittances stage and which eventually made a dumping ground out of the Collections and Recoveries sections. In fact even Barclay Loans collections which did not have much to do with billing and remittance processing in that Standing Order payments were automatically directed from customers’ salary accounts on to the loan, was not spared as in some cases Standing Orders were inadvertently set on wrong accounts. Scheme Loans which constituted over 50% of the retail book, suffered the most and the huge impairments were mostly coming from this sector as most of the beneficiaries were non-Barclays account holders. Data integrity was nothing to write home about which led to a flawed billing and remittances management with lots of errors such as wrong billing/invoicing, wrong reconciliation of repayments and crediting of wrong loan accounts among other things; leading to high delinquency and default rates. Whilst credit assessment and poor documentation ensured recruiting and booking of poor quality loans, the post-approval job of credit administration (of ensuring on time payments, monitoring of the loans’ credit quality and ensuring that borrowers’ complaints are adequately and timely addressed to ensure borrowers’ continued commitment to payment) was not gotten right. Until

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September, 2008 there was no well-structured and dedicated team with clear responsibilities to ensure avoidance of First Installment Defaults (FID), late payments, non-payments and underpayments/incomplete payments from Scheme Companies who either undertook or guaranteed to do ‘from source’ deductions for the Bank from their employees who were beneficiaries of the Barclays Scheme Loans. The Scheme Loan Desk which was already overwhelmed by their pre-vetting and documentation work volumes seemed to be tacitly tasked with all these tasks. From all indications, the assumption was that the Scheme Companies would on their own volition do correct deductions and then bring the remittances to Barclays. The result of this was a piling up of payment cheques with Scheme Companies, and even in few cases where companies brought in their remittances; they were left un-reconciled and unprocessed for right crediting of the individual loan accounts. The Collections Team (over 80% being contract staff) which was set up mid-2007 to manage and normalize overdue loan accounts, per policy were to have a monthly Accounts-Collector-Ratio (ACR) of 200. However by the last quarter of 2007, Collections Officers were getting ACRs of over 1500 delinquent accounts which were mostly Scheme Loans; owing to the deterioration of the credit administration activities at the Scheme Loan Desk. The result was a grave deterioration of the credit portfolio leading to such impairments charges and allowances of a gargantuan magnitude witnessed in the history of the bank in particular and the banking industry in general. The people and systemic operational hiccups were not limited to the Scheme Loans Desk and Credit Operations Unit (COU) alone. As the ACRs began to skyrocket, more Collections Officers were recruited on contract bases. The number of the new recruits out-numbered the available equipment like computers, work stations, telephones and even work desk space. This

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led to running of a shift system whereby a set of the Collection team operated between 7 am to 2 pm and the other set came in at 2 pm and closed at 9 pm each week day. Additionally, there was also weekend duty in which the two sets rotated every Saturday and Sunday. Judging from the socio-cultural orientation of the typical Ghanaian, one could really doubt if any meaningful dividends came out of these work policy. The Ghanaian would be more than uncomfortable with calls from a bank in the night asking him/her to pay their loan arrears; not to even talk about weekends where they get busy with socio-cultural and religious events and activities such as ‘child-naming ceremonies’, funerals, weddings and church programs. Inappropriate and inadequate systems infrastructure needed for prioritizing collections activities, printing of customer accounts statements, re-printing of invoices for the Scheme Companies and collector activity logs were not immediately available. Collections Officers bemoaned their inability to access comprehensive information on debtors; some accounts did not even have physical address, and telephone or mobile numbers on them and some contact numbers were either wrong or perpetually unreachable. This is suggestive of non-adherence to proper Know Your Customer (KYC) and Know Your Borrower (KYB) due diligence during the aggressive lending campaign embarked on by BBG in 2007-2008 period.

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CHAPTER FIVE CONCLUSIONS AND RECOMMENDATIONS Among all the books and articles about bank management, almost all of them have declared credit risk to be the major risk faced by the banking sector. Evidence in literature is clear that only few banks have been left untouched by the consequence of poor lending and other credit risk management practices. Although it should be understood that perhaps banks can never fully know their customers or borrowers as well as they should, an appropriate credit risk management can help to minimize losses, while on the contrary, a poor one can be extremely damaging; leading to lending disasters and bank failures.

5.1 SUMMARY OF FINDINGS AND CONCLUSIONS From the environmental analyses, one could deduce that the massive expansionist campaign embarked on by BBG between 2006 and 2008 was a clear attempt by Bank Management to take advantage of the seemingly attractive Ghanaian banking industry with lots of opportunities for growth and profitability, especially with the seeming conducive macro-economic environment coupled with favorable regulatory developments from 2004 to 2008. Growth within the economy coupled with relatively lower interest and inflation rates gave cause to believe all was well and the average Ghanaian could afford credit and its repayment. More so, the abolishing of the 15% secondary reserve requirement freed bank capital for lending business. A review of BBG’s Credit Risk Management Framework shows the bank leveraging on its group-wide policies has adequate policy guidelines in place to ensure effective credit risk

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management. The bank’s GRCB Retail Credit Risk Management Manual and Retail Credit End to End Process Flow Manuals all together have ensured that an appropriate and conducive environment has been established, which if thoroughly adhered to would ensure a sound and effective managing of credit risk. This include, a solid governance structure with clear obligations and lines of authority and policy documents approved by the board containing procedures, processes and techniques for handling credit risk which largely follow the Basel guidelines.

However, from the issues arising from BBG’s aggressive lending expansionist campaign during the 2006-2008 period, it is evidently clear that this sound credit risk management policies have in most part been breached or compromised advertently and/or inadvertently. The reasons for the compromise was chiefly due to anxiety over income and competitive pressures in the bank‘s key markets.

Lack of proper anticipation of work volumes associated with the lending targets exposed the bank’s poor resource capacity planning and readiness for the expansion. The use of untrained and unmotivated contract staff (Direct Sales Agents) mostly remunerated on commission basis contributed greatly to acquisition of poor quality (high risk) loans. Under resourced teams at the credit facilitation and assessment stages of the credit cycle ensured that proper credit due diligence was not done leading to booking and granting of sub-standard loans.

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Credit administration-post approval suffered from the lack of proper customer and borrower due diligence- KYC and KYB - at the credit scoring, vetting and assessment stages as inaccurate and incomplete information bedeviled data compilation at those stages.

Additionally inadequate systems infrastructure coupled with poorly structured and ill-equipped teams at the collections department ensured further deterioration of the retail loan portfolio. Consequently, inadequate management of collections and recoveries of overdue/delinquent loans gave rise to skyrocketing impairment charges & allowances culminating into historic losses in 2008 and 2009.

This study shows that there is a significant relationship between bank profitability (in terms of ROA and ROE) and credit risk management (in terms of loan performance indicated by the ratio of impairment charges and allowances to gross loans). The observed negative relationship (correlation) between BBG’s ROA and ROE on one hand and the ratio of impairment charges and allowance to gross loans on the other hand; against the backdrop of the myriad of signs of a distorted credit culture explained above, leads me to conclude;



That better credit risk management practices result in better bank performance (profitability) and poor credit risk management practices translate into poor bank performance (profitability)



That whilst having sound and comprehensive Credit Risk Management Frameworks Manuals in place is important, non-compliance and non-enforcement of the laid down principles in such manuals (most especially at the credit generation and assessment

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stages) coupled with grave credit operational lapses would lead to poor loan portfolio quality which constitutes poor credit risk management and hence poor bank performance.

5.2 RECOMMENDATIONS BBG is a strong brand. My findings have shown that over the 94 years of its operation in Ghana, BBG has largely been a market leader in terms of profitability, capital adequacy, market share of deposits and assets. Despite BBG has a fairly comprehensive credit risk management framework in place to adequately manage the risk associated with the bank’s lending business, the historic losses made in 2008 and 2009 which accompanied the massive credit expansion drive in 2007/08 suggest that the bank lost the balance between profitability and growth on one hand and the basics of sound credit management in banking on the other hand. To turn the table around, management must adopt a disciplined approach with much focus on addressing the key functional areas of the credit cycle with much integration of credit risk management considerations in lending decisions by business units. I would therefore like to propose the following recommendations as measures that bank management could undertake to prevent the reoccurrence of credit failure experienced by the bank and to minimize credit risk exposure in the future. 1. Ensure proper and strict integration of risk management considerations in to business and credit expansion decisions.

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

The BBG experience shows that credit risk management function’s role was so limited in the granting of loans over the period as they were unable to influence business decisions and the fact that their considerations were subordinate to increased interest incomes or profitability interests. A well-equipped credit risk function with capacity to adequately make timely and accurate forecasts; when properly harmonized with business generation units would often times ensure the bank observes good credit due diligence in their credit/lending decisions, generation and operations. This would prevent the breach of basic risk management rules such as avoiding strong concentrations of assets, substandard loans and minimizing the volatility of returns.



Also, Internal Audit and Compliance teams should be empowered to do auditing of the credit operational activities right from the credit facilitation stage to ensure strict adherence to controls.

2. Adapt and enforce group-wide Credit Risk Management Framework (CRMF) to address prevailing local conditions. 

BBG is a wholly owned subsidiary of Barclays Plc and as such group-wide policies and guidelines are expected to be adhered to. Despite Barclays has a fairly comprehensive Credit Risk Management Framework in place, I think BBG’s country risk committee should be able to put together a complementary credit facilitation and administration framework that will address pertinent issues within the local market that are not comprehensively dealt with by the group-wide policy. By so doing loopholes within the group-wide policy that impacts BBG adversely can be dealt with.

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3.

Address People Issues that plagued the entire credit management cycle. 

The use of Direct Sales Agents (Contract Staff) at the credit generation phase should be stopped and in their stead the bank’s relationship managers who are permanent staff should be responsible for the recruiting of loans. DSAs do not feel they are part of the BBG family. There is the natural tendency to become unmotivated to do proper due diligence during the initial contact with the potential client in order to study the character, capacity and condition of the potential borrower. Since the DSAs are mostly remunerated based on commission on volumes/value sold, their only motivation will be the quantity sold and not the quality. They therefore tend to engage in “sweet-marketing” where some untenable terms or promises are verbally given to borrowers which later result in nonperforming loans. On the other hand, the use of relationship managers will more likely result in recruiting of quality loans. Since they are permanent employees who are more likely to stay at post months after the loans are booked, they will be more responsible in doing some due diligence on their prospective borrowers. And also more importantly, with relationship managers, priority and performance-based incentives schemes can be operated where incentives are tied to priorities and to performance standards for credit quality and portfolio profitability. This will ensure high quality loans are recruited.



Management should ensure staffs at the vetting and underwriting/assessing stage are giving requisite quality training and are of the highest caliber, highly meticulous with great analytical aptitude and good sense of judgment. Contract staff at this stage of the cycle with no hope of attainment of permanent status may not offer their best. Since

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information and documentation at this stage constitute the working data for collections and recoveries team, any act of oversight or recklessness could lead to wrong data input and sanctioning loans that ought to be declined and vice versa which eventually will impede the work of collections and recoveries teams. A small mistake in documentation may be utilized by untruthful borrowers and go against the bank in an unexpected way. 

Adequate supervision should be provided at the credit facilitation stage to ensure individual assessors/underwriters do not compromise standards for any reason whatsoever.

4. Address Systems-Infrastructural Deficiencies that plagued the entire credit management cycle 

Management should invest in automated credit scoring systems that would limit the use of discretionary powers by various lines of authorities in the credit granting process.



Management should invest in customer data verification and validation systems to minimize, if not prevent, fraudulent and duplicated loan applications. For instance, systems should be in place to detect forged National IDs, employees ID numbers etc.

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Ensuring accurate and error-free customer data collection is only a means and not an end in itself. How the data is organized and managed is most important in ensuring an effective credit administration. Management should therefore invest in an integrated Customer Data Management system that would harmonize pre-billing, billing/invoicing and post billing data and activities on each individual customer/scheme company’s loans. Such a system will provide accurate and timely information which is important not only

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for internal credit and collections officers but also for customers. Credit officers or relationship managers need information to help prioritize activities, to provide information to customers, and to back-up critical decisions and conversations. For example, a credit manager should be able to easily see payment history for a customer/scheme company when determining whether or not to increase credit limits or offer refinancing options. A collections officer should be able to quickly see late invoices and recent payments in order to determine the status of each account in their collections queue. Customers on the other hand need timely and accurate invoice and statement information. Most at times customers do not intend to pay late. However, internal issues result in late delivery of invoices or incorrect charges leading to lengthy invoice disputes that result in late payments or non-payment. 5. Adopt and implement effective lending market segmentation and discreet lending policy. 

From experience shared by some collections officers, it is clear that the bank indiscreetly sold loans to just any company employee who wanted to access credit facility as long as they were in some form of employment with the institutions recruited on the scheme loan. Loans were given to some temporary staffs, daily wage earners and some junior staffs whose incomes were either not guaranteed or could not sustain the loan repayments. Against this backdrop, a clear policy should be in place which will ensure that credit is extended to credit-worthy (high net-worth) employees of the scheme companies and where necessary, differentiated terms and limits should be applied to

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various categories of industries and grades of workers even in same company. This will greatly minimize credit loss exposure and the incidence of default. It is however important to note that BBG might have started putting in place some of these suggestions given the fact that the bank has begun to make profit as disclosed in the bank’s 2010 annual report. A cursory look at the 2010 financial statement revealed that the profit was mostly induced by cost cutting measures undertaken by management. Interest and fees & commission expenses fell more than 50%. Net trading income however fell by 140% from the 2009 figure of GH¢17,539 million. Though the ratio of impairment charge to total loans (IMP CHG/TL) has improved by 61% in 2010 that impairment allowance to total loans (IMP ALW/TL) has worsened by 14%; indicating a poor quality loan portfolio and thus still much has to be done in terms of credit risk management. Blending the external and internal environmental analyses together, some key lessons that have been learnt and which hopefully should be applied in future credit expansions in the Ghanaian Banking Industry include the following: 1. Need for good analysis and forecasting of the economic trends and environment. 

Bank management must have a good awareness of the economic environment in which they operate. I believe if BBG were to do a good assessment of both the Ghanaian and the world economic situation, they would have been more discreet in their credit expansion in 2007/08. A trend analysis shows that Ghana’s economic landscape has always had upturns and down turns most especially when election is approaching. BBG seemed to try to take advantage of the seemingly conducive macro-economic

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environment in Ghana (where inflation was down to 10.5% in 2006 from a high of 40.5% in 2000 and BOG Policy rate falling from 17% in 2000 to 12.5% in 2006) to lend at very low rates and even in some cases at fixed rates. 

Meanwhile from early 2007 signals of a world economic melt-down were crystal clear, which would surely affect economies and earning capacities of workers and hence their capacity to service debts. It was not surprising to learn that by early 2009 the bank (BBG), having lulled lending activities, was embarking on an upward re-pricing of the existing loans which also had adverse implications on customers’ commitment to a continuous repayment of their loans.

2. Need for a good awareness of the infrastructural environment 

Key ingredients in doing a good KYC and KYB due diligence is having a verifiable and reliable contacts to your customers/borrowers. It is commonplace that Ghana has infrastructural defect or deficit which should throw caution to banks to be very prudent in their lending business. For instance, Ghana’s housing/physical addressing system is very poor or mostly non-existent and also until 2011 when telephone/mobile phone numbers were registered fraudulent borrowers could not be traced as the addresses they provided in applying for loan facilities could not be traced. Similarly some of such borrowers could easily do away with the mobile numbers they provided and go in for new ones. This hampered collection efforts by the BBG collections and recoveries team.

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3. Need for good awareness of the cultural environment. There is also the need for banks’ management to integrate the socio-cultural setting of the country within which they operating in their policies. Granting loans to people who are more spendthrift in nature will mean much exposure to default. But more importantly is the issue of how the social, cultural and religious setting influence work habits of employees. The essence of collections should be to collect arrears and also retain customers. Making collections officers to call debtors in the night and at week-ends has two adverse implications; collections officers may not be at their best at such times and also debtors may feel harassed and the collectors’ goal of deepening relationships, maintaining high client retention levels, and converting loan recovery issues to customer loyalty opportunities would not be achieved.

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Altman, E. I. and Saunders, A. (1998), Credit risk measurement: Developments over the last 20 years. Journal of Banking & Finance, 21, 1721-1742.



Bessis, J. (2010), Risk management in banking, Wiley, Third edition.

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Caouette, J. B., Altman, E. I., Narayanan, P. and Nimmo, R. (2008), Managing credit risk: The great challenge for the global financial markets. 2nd Edition. John Wiley & Sons Inc. New Jersey, USA.

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Colquitt, J. (2007), Credit risk management: How to avoid lending disasters & maximize earnings. 3rd Edition. McGraw-Hill. USA.

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Crouhy, M., Galai, D. & Mark, R. (2006), The essentials of risk management. McGrawHill. USA.

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Culp, C. L. (2001), The risk management process: Business strategy and tactics. John Wiley & Sons Inc. USA.

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Duffie, D. and Singleton, K. J. (2003), Credit risk: Pricing, measurement and management. Oxford. Princeton University Press.

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Greuning, H. V. and Bratanovic, S. B. (2003), Analyzing banking risk: A framework for assessing corporate governance and risk management, World Bank Publications.

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Heffernan, S. (1996), Modern banking in theory and practice, Chichester: John Wiley & Sons Ltd.

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John C. H. (2007), Risk management and financial institutions. Person Int. Edition, New Jersey.

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Hull, J., Nelken, I. and White, A. (2004), Merton’s model, credit risk, and volatility skews. Journal of Credit Risk, 1(1), 3-28.



Jorion, P. (1997), Value at Risk. Richard D. Irwin Inc., Burr Rudge, IL.



Rejda, G. E. (1998), Principles of risk management and insurance, USA: Addison Wesley, Sixth Edition, New York, NY.



Ross, S. A., Westerfield, R. W., and Jordan, B. D (2008), Fundamentals of corporate finance. Ninth edition. McGraw-Hill.

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

Santomero, A. M. (1997), Commercial banking risk management: An analysis of the process. The Wharton Financial Institutions Center. USA.

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Saunders, A. and Cornett, M. M. (2006), Financial institutions management: A risk management approach. London: McGraw Hill.

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Saunders, A. (1997), Financial institutions management: A modern perspective. Richard D. Irwin, Inc., Second Edition, Burr Ridge, IL.

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Smith, C., Smithson C. and Wilford, D. (1990), Strategic risk management. Institutional Investor Series in Finance. Harper and Row, New York.

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Basel Committee on Banking Supervision (1999), “Principles for the Management of Credit risk”, Bank for International Settlements, Basel.

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Basel Committee on Banking Supervision (2001), “Principles for the Management and Supervision of Interest Rate Risk”, Bank for International Settlements, Basel.

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Basel Committee on Banking Supervision (2003),”Sound Practices for the Management and Supervision of Operational Risk”, Bank for International Settlements, Basel.

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Basel Committee on Banking Supervision (2003), “Trends in risk integration and aggregation”, Bank for International Settlements, Basel.

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Basel Committee on Banking Supervision (2006), “Corporate Governance for Banking Organizations (Enhancing Corporate Governance for Banking Organizations)”, Bank for International Settlements, Basel.



Dam D. L. (2010), “Evaluation Of Credit Risk Management Policies And Practices In A Vietnamese Joint-Stock Commercial Bank’s Transaction Office” Business Economics and Tourism, Research Work, 2010 Vaasan Ammattikorkeakoulu (VAMK), University of Applied Sciences.

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Aboagye-Debrah K. (2007), “Competition, Growth And Performance In The Banking Industry In Ghana.” Strategic Management Research, St Clements University, August 2007



Asare-Bekoe K. M. (2010), “A Risk-Based Assessment Of Ecobank Ghana Limited (EBG)” CMFSM - Finance & Strategic Management, Research Work, October 2010 Copenhagen Business School

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

Ware N., Bedu‐Addo N., and Salami A. (2010) “Ghana Financial Sector”. A research Paper.

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Achou T. F., Tenguh N. C. (2008), “Bank Performance And Credit Risk Management” Finance Research Work, 2008. University of Skovde, School of Technology and Society.



Zhao X. (2007) “Credit Risk Management in Major British Banks”, Finance and Investment Research Work, 2007. University of Nottingham.

Internet Links 

Bank for International Settlements: http://www.bis.org/bcbs/about.htm



Bank of Ghana: http://www.bog.gov.gh/



Bank

of

Ghana

Financial

Stability

Report

February

2011:

http://www.bog.gov.gh/privatecontent/Monetary_Policy/2011/financial%20stability%20r eport%20-%20february%202011.pdf 

Barclays: http://www.barclays.com



Barclays Bank of Ghana Ltd: http://www.barclays.com/africa/ghana/barclays_in.htm



Barclays

LIBOR

Fixing

Scandal:

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/9374118/Barclayslibor-fixing-scandal-timeline.html 

CIA World Factbook: http://www.indexmundi.com/ghana/



CMA

Global

Sovereign

Credit

Risk

Report

March

2012:

http://www.cmavision.com/learning/sovereign-risk-reports/ 

Ghana

Banking

Act

2004,

Act

673:

http://www.bog.gov.gh/privatecontent/File/IDPS/Banking%20Act%20673.pdf 

Ghana Ministry of Finance and Economic Planning: http://www.mofep.gov.gh/



Ghana Statistical Service: http://www.statsghana.gov.gh/



National

Communications

Authority

Market

Share

Report

May

2012:

http://www.nca.org.gh/downloads/MarketShare/May2012.pdf

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

Government

of

Ghana

Official

Report

on

Internet

Penetration

Rate:

http://www.ghana.gov.gh/index.php/news/features/11725--internet-penetration-grows-to10 

Parliamentary

debate

on

National

Stabilization

Levy

Bill:

http://www.ghanadot.com/news.ghanadot.sule.071709a.html 

2009

Annual

Report

of

Bank

of

Ghana:

http://www.bog.gov.gh/privatecontent/public/File/Research/Annual%20Reports/AnnRep 2009/Bank%20of%20Ghana%20Annual%20Report%202009.pdf 

2007

Annual

Report

of

Barclays

Bank

of

Ghana

Ltd:

Ghana

Ltd:

Ghana

Ltd:

Ghana

Ltd:

Ghana

Ltd:

http://www.barclays.com/africa/pdfs/statement_of_account_2a1.pdf 

2008

Annual

Report

of

Barclays

Bank

of

http://www.barclays.com/africa/pdfs/financial_statement_2008.pdf 

2009

Annual

Report

of

Barclays

Bank

of

http://www.barclays.com/africa/pdfs/financial_statement_2009.pdf 

2010

Annual

Report

of

Barclays

Bank

of

http://www.barclays.com/africa/pdfs/financial_statement_2010.pdf 

2011

Annual

Report

of

Barclays

Bank

of

http://www.barclays.com/africa/pdfs/financial_statement_2011.pdf 

2008 Ghana Banking Survey by PricewaterhouseCoopers in collaboration with Ghana Association of Bankers: www.pwc.com/en_gh/gh/pdf/ghana-banking-survey-2008.pdf



2009 Ghana Banking Survey by PricewaterhouseCoopers in collaboration with Ghana Association of Bankers: www.pwc.com/en_gh/gh/pdf/ghana-banking-survey-2009.pdf



2010 Ghana Banking Survey by PricewaterhouseCoopers in collaboration with Ghana Association of Bankers: www.pwc.com/en_GH/gh/pdf/ghana-banking-survey-2010.pdf



2011 Ghana Banking Survey by PricewaterhouseCoopers in collaboration with Ghana Association of Bankers: www.pwc.com/en_gh/gh/pdf/ghana-banking-survey-2011.pdf

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APPENDIX A: Glossary of key financial terms and ratios Capital adequacy ratio is the ratio of adjusted equity base to risk adjusted asset base as required by the Bank of Ghana (BoG), i.e. Total regulatory capital / Total risk weighted assets. Core capital adequacy ratio (Basel I capital adequacy): Total tier 1 capital / Total risk weighted assets. Cash assets include cash on hand, balances with the central bank, money at call or short notice, and cheques in course of collection and clearing. Core Customer Deposits includes current accounts, cash collateral account, individual consumer savings, and money market accounts. Cost income ratio = Non-interest operating expenses / Operating income. Impairment Charge Interest Rates Sensitive Assets refers to assets principally of loans with maturity within a year. Interest Rates Sensitive Liabilities refers to liabilities principally of deposits with maturity within a year. Liquid assets include cash assets and assets that are relatively easier to convert to cash, e.g., investments in government securities, quoted and unquoted debt and equity investments, equity investments in subsidiaries. Loan loss provisions = (General & specific provisions for bad debts for + Interest in suspense) / Gross loans and advances. Long term Assets includes securities which mature beyond one year, other real estate owned and net loans Net interest income = Total interest income - Total interest expense Net interest margin = Net interest income / Average assets Non-performing loans refers to loans and advances with payments of interest and principal past due by 90 days or more, or at least 90 days of interest payments have been capitalized, refinanced or delayed by agreement, or payments are less than 90 days overdue, but there are other good reasons to doubt that payments will be made in full. Profit after tax margin = Profit after tax / Total income Profit before tax margin = Profit after extraordinary items but before tax / Total income Qualifying capital includes share capital, regulatory risk reserves, statutory reserves, retained earnings, non-controlling interest, subordinated debt and other reserves. Return on assets = Profit after tax / Average total assets

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Return on equity = Profit after tax / Average total shareholders' funds Risk-weighted assets refer to banks assets adjusted for risk. Shareholders' funds comprise paid-up stated capital, income surplus, statutory reserves, and capital surplus or revaluation reserves. Short term Investments includes government securities + loans to bank with maturity less than 1 year + trading assets + investments securities. Volatile Liabilities refers to short term borrowed funds and short term non-core deposits normally from institutional investors. Volatile Liability Dependency ratio = (Volatile liability - Short Term Investments) / (Long Term Assets)* 100

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APPENDIX B: Signs of a Distorted Credit Culture I. Self-dealing: An overextension of credit to directors and large shareholders, or to their interests, while compromising sound credit principles under pressure from related parties. Selfdealing has been the key issue in a significant number of problem banks. II. Compromise of credit principles: Arises when loans that have undue risk or are extended under unsatisfactory terms are granted with full knowledge of the violation of sound credit principles. The reasons for the compromise typically include self-dealing, anxiety over income, competitive pressures in the bank‘s key markets, or personal conflicts of interest. III. Anxiety over income: A situation in which concern over earnings outweighs the soundness of lending decisions, underscored by the hope that risk will not materialize or lead to loans with unsatisfactory repayment terms. This is a relatively frequent problem because a loan portfolio is usually a bank‘s key revenue-producing asset. IV. Incomplete credit information: This indicates that loans have been extended without proper appraisal of borrower creditworthiness. V. Complacency: This is a frequent cause of bad loan decisions. Complacency is typically manifested in a lack of adequate supervision of old, familiar borrowers, dependence on oral information rather than reliable and complete financial data, and an optimistic interpretation of known credit weaknesses because of survival in distressed situations in the past. In addition, banks may ignore warning signs regarding the borrower, economy, region, industry, or other relevant factors or fail to enforce repayment agreements, including a lack of prompt legal action. VI. Lack of supervision: Ineffective supervision invariably results in a lack of knowledge about the borrower‘s affairs over the lifetime of the loan. Consequently, initially sound loans may develop problems and losses because of a lack of effective supervision. VII. Technical incompetence: This includes a lack of technical ability among credit officers to analyze financial statements and obtain and evaluate pertinent credit information. VIII. Poor selection of risks: This tendency typically involves the following: a. The extension of loans with initially sound financial risk to a level beyond the reasonable payment capacity of the borrower. This is a frequent problem in unstable economies with volatile interest rates. b. Loans where the bank-financed share of the total cost of the project is large relative to the equity investment of the owners. Loans for real estate transactions with narrow equity ownership also fall into this category. c. Loans based on the expectation of successful completion of a business transaction, rather than on the borrower‘s creditworthiness, and loans made for the speculative purchase of securities or goods. d. Loans to companies operating in economically distressed areas or industries.

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e. Loans made because of large deposits in a bank, rather than on sound net worth or collateral. f. Loans predicated on collateral of problematic liquidation value or collateral loans that lack adequate security margins. Source: Commercial Bank Examination Manual Board of Governors Federal Reserve System Division of Banking Supervision and Regulation (December, 1985)

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APPENDIX C: Principles for the Assessment of Banks’ Management of Credit Risk A. Establishing an appropriate credit risk environment Principle 1 - The board of directors should have responsibility for approving and periodically reviewing the credit risk strategy and significant credit risk policies of the bank. The strategy should reflect the bank‘s tolerance for risk and the level of profitability the bank expects to achieve for incurring various credit risks. Principle 2: Senior management should have responsibility for implementing the credit risk strategy approved by the board of directors and for developing policies and procedures for identifying, measuring, monitoring and controlling credit risk. Such policies and procedures should address credit risk in all of the bank‘s activities and at both the individual credit and portfolio levels. Principle 3: Banks should identify and manage credit risk inherent in all products and activities. Banks should ensure that the risks of products and activities new to them are subject to adequate procedures and controls before being introduced or undertaken, and approved in advance by the board of directors or its appropriate committee. B. Operating under a sound credit granting process Principle 4: Banks must operate under sound, well-defined credit-granting criteria. These criteria should include a thorough understanding of the borrower or counterparty, as well as the purpose and structure of the credit, and its source of repayment. Principle 5: Banks should establish overall credit limits at the level of individual borrowers and counterparties, and groups of connected counterparties that aggregate in comparable and meaningful manner different types of exposures, both in the banking and trading book and on and off the balance sheet. Principle 6: Banks should have a clearly-established process in place for approving new credits as well as the extension of existing credits. Principle 7: All extensions of credit must be made on an arm‘s-length basis. In particular, credits to related companies and individuals must be monitored with particular care and other appropriate steps taken to control or mitigate the risks of connected lending. C. Maintaining an appropriate credit administration, measurement and monitoring process Principle 8: Banks should have in place a system for the ongoing administration of their various credit risk-bearing portfolios. Principle 9: Banks must have in place a system for monitoring the condition of individual credits, including determining the adequacy of provisions and reserves.

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Principle 10: Banks should develop and utilize internal risk rating systems in managing credit risk. The rating system should be consistent with the nature, size and complexity of a bank‘s activities. Principle 11: Banks must have information systems and analytical techniques that enable management to measure the credit risk inherent in all on- and off-balance sheet activities. The management information system should provide adequate information on the composition of the credit portfolio, including identification of any concentrations of risk. Principle 12: Banks must have in place a system for monitoring the overall composition and quality of the credit portfolio. Principle 13: Banks should take into consideration potential future changes in economic conditions when assessing individual credits and their credit portfolios, and should assess their credit risk exposures under stressful conditions. D. Ensuring adequate controls over credit risk Principle 14: Banks should establish a system of independent, ongoing credit review and the results of such reviews should be communicated directly to the board of directors and senior management. Principle 15: Banks must ensure that the credit-granting function is being properly managed and that credit exposures are within levels consistent with prudential standards and internal limits. Banks should establish and enforce internal controls and other practices to ensure that exceptions to policies, procedures and limits are reported in a timely manner to the appropriate level of management. Principle 16: Banks must have a system in place for managing problem credits and various other workout situations. E. The role of supervisors Principle 17: Supervisors should require that banks have an effective system in place to identify measure, monitor and control credit risk as part of an overall approach to risk management. Supervisors should conduct an independent evaluation of a bank‘s strategies, policies, practices and procedures related to the granting of credit and the ongoing management of the portfolio. Supervisors should consider setting prudential limits to restrict bank exposures to single borrowers or groups of connected counterparties. Source: Basel Committee on Banking Supervision (Issued on November 30, 1999)

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LIST OF ABBREVIATIONS ABG- Access Bank (Ghana) Limited ADB- Agricultural Development Bank Limited BBG- Barclays Bank of Ghana Limited BOG- Bank of Ghana CAL- CAL Bank Limited EBG- Ecobank Ghana Limited FBL- Fidelity Bank Limited GCB- Ghana Commercial Bank Limited GDP- Gross Domestic Product GTB- Guaranty Trust Bank (Ghana) Limited HFC- HFC Bank (Ghana) Limited IMP CHG- Impairment Charge IMP ALW- Impairment Allowance MBG- Merchant Bank Ghana Limited PAT- Profit after tax

PBT- Profit before tax PBTM- Profit before tax margin PwC- PricewaterhouseCoopers ROA- Return on assets ROCE- Return on capital employed ROE- Return on equity SCB- Standard Chartered Bank Ghana Limited SG-SSB- SG-SSB Bank Limited Stanbic- Stanbic Bank Ghana Limited TL- Total gross Loans & advances TTB- The Trust Bank Limited UBA- United Bank for Africa (Ghana) Limited UGL- UniBank Ghana Limited UTB- UT Bank Limited ZBL- Zenith Bank (Ghana) Limited

[MBA Degree Project: The Impact of Credit Risk Management on Banks’ Profitability, 2011]

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