CHAPTER ONE INTRODUCTION 1.

1 Background of the Study The financial landscape of Ghana has gone through significant changes over the past three decades. In the 1970s and the early 1980s the economy of Ghana was characterised by a steady decline with hyperinflation and exchange rate depreciation being major features. The malaise that afflicted the economy took its toll on the banking and financial system of the country. Among ills bedeviling the financial system, the following may be mentioned as prominent: low capital base of banks, high risk concentration, large portfolio of nonperforming loans, weak accounting and management information systems, weak internal controls and weak supervision and deficiencies in the legal and regulatory framework. Before 1983, the formal banking system in the country was dominated by state owned banks that had a monopoly in terms of their spread and operations (Hinson and Hammond, 2006). The current banking environment has however changed. Hinson and Hammond (2006) report that, with the passage of the universal banking law however, all types of banking can be conducted under a single corporate banking entity and this greatly reorganises the competitive scopes of several banking products in Ghana. Thus reform and deregulation has brought the banking sector into the competitive arena in terms of customers and products.

Standard Chartered Bank Ghana Limited (SCB) has been operating in Ghana since 1896 and is one of the countrys first and oldest international business institutions in the country. The bank opened its first branch in Accra in June 1896. Its core business was being the sole distributor of silver coins to the Gold Coast now Ghana. The bank is currently situated in 19 locations all over Ghana and still maintains Accra as head office. SCB employs over 700 people nationwide and has a customer base of two million. The company offers varied

products and services mainly in the context of personal banking, small and medium-sized enterprise banking and corporate or wholesale banking. These products and services have made the company attractive to both personal account holders as well as private investors in Ghana. The bank is listed on the Ghana stock exchange and has consistently remained the highest-priced stock on the local bourse with a share price of GH38 per share as of October 2, 2008. The bank is also one of the first financial institutions to be involved in financing import and export trade in products like cocoa, gold, bauxite and timber.

Lending is one of the main activities of banks in Ghana and other parts of the world. This is evidenced by the volume of loans that constitute banks assets and the annual substantial increase in the amount of credit granted to borrowers in the private and public sectors of the economy. According to Comptroller (1998), lending is the principal business for most commercial banks. Loan portfolio is therefore typically the largest asset and the largest source of revenue for banks. In view of the significant contribution of loans to the financial health of banks through interest income earnings, these assets are considered the most valuable assets of banks. Loan portfolio is typically the largest asset and the predominant source of income for banks. In spite of the huge income generated from their loan portfolio, available literature shows that huge portions of banks loans usually go bad and therefore affect the financial performance of these institutions (Comptroller, 1998). The Bank of Ghanas classifications of advances of the Banking industry indicated that unsecured loans in the loss category increased from GH125, 196,732 in December 2007 to GH204, 978,569.00 in December 2008, indicating over 63% jump in bad loans. A report on the performance of banks in 2006 indicated that among other factors, higher loan loss provision accounted for a decline in the profitability of banks in 2005 (Bank of Ghana, 2006). The issue of unsecured loans can fuel banking crisis and result in the collapse of some of these

institutions with their attendant repercussions on the economy as a whole. Kane and Rice 2001) stated that at the peak of the financial crisis in Benin, 80% of total bank loans portfolio which was about 17% of GDP, was non-performing in the late nineties. Indeed unsecured loans can lead to the collapse of banks which have huge balances of these non-performing loans if measures are not taken to minimize the problem. In Ghana, the banking industry plays an important role in the development of the economy. Huge unsecured loans could therefore affect banks in the performance of this important role.

1.2 Statement of the Problem The current credit crunch has affected the performance of many banks globally. Thus institutions that adopt strategies to compete better are more likely to survive in the long run. The credit crunch poses a grave threat to the economies of the developed and developing world. The global banking industry, which was by far the most profitable sector in 2006, is in severe difficulty and the threat that this poses to the real economy is profound. The world has experienced remarkable numbers of banking and financial crises during the last thirty years. Caprio and Klingebiel (1997) identify 112 systemic banking crises in 93 countries since the late 1970s. Demirguc-Kunt and Detragiache (1998) have identified 30 major banking crises that are encountered from early 1980s and onwards. According to the above researchers most of these banking crises were experienced in the developing countries such as Ghana. Interestingly, the majority of the crises were caused by unsecured loans. Persistent loan defaults have become an order of the day in developing countries such as Ghana. There has been hardly any bank in Ghana which has not experienced persistent loan default. This is evidenced by the under-capitalisation of the banking sector in 2009. Healthy loan portfolios are vital assets for banks in view of their positive impact on the performance of banks. Unfortunately, some of these loans usually do not perform and eventually result in

bad debts which affect banks earnings on such loans. These unsecured loans become cost to banks in terms of their implications on the quality of their assets portfolio and profitability. This is because in accordance with banking regulations, banks make provisions for nonperforming loans and charge for bad loans which reduce their loan portfolio and income. For example in February, 2009, a Bank of Ghana report revealed that non-performing loans ratio increased from 6.4% in 2007, to 7.7% in 2008. In the light of the above, the issue of unsecured loans has raised some concerns among stakeholders in the banking industry. The study therefore seeks to find out how unsecured loans affect financial performance of banks in Ghana using Standard Chartered Bank, Ghana.

1.3 Objective of the Study The study has a general objective of establishing the main impact of unsecured loans on the financial performance of Standard Chartered Bank, Ghana. Specifically, the study has the following objectives: To establish the trend of unsecured loans of Standard Chartered Bank, Ghana during the past five years To identify the factors that account for unsecured loans in Standard Chartered Bank, Ghana. To come out with recommendations that can address the issue of unsecured loans in the Ghanaian banking sector

1.4 Research Question Evolving from the problem statement discussed above, the study aims at providing answers to the following questions:

 Which key areas of the Banks financial performance are affected by unsecured loans? What is the trend of Standard Chartered Bank Ghana unsecured loans over the last five years? What factors account for unsecured loans in the bank?

1.5 Significance of the Study The study would contribute significantly to the development of the banking industry which plays a pivotal role in the development of the economy. This is because the study seeks to identify causes of unsecured loans in banks and recommend some measures that can solve these problems. The findings would also enable management of banking institutions come out with pragmatic policies for loan portfolio management aimed at improving the quality of their loan portfolios. The findings are expected to remind credit staff about the implications of their credit duties in creating quality loan portfolio for their banks. The findings of this study could be seen as a contribution to existing works on unsecured loans. Indeed, this would contribute immensely in building up academic knowledge in a wide range of issues. The study would also play a significant role of engineering further research into other aspects of the topic under consideration or other related topics in the banking sector.

1.6 Scope of the Study The study focuses on the Standard Chartered Bank, Ghana; one of Ghanas largest and oldest banks. This is premised on the fact that the Bank has been operating long enough to give the kind of academic insight the study seeks to offer. Besides, the bank lends to almost all the major sectors of the economy and as such the data needed to accomplish the work would be

obtained without any hindrance. Conceptually, the study looks at all categories of unsecured loans and their impacts on financial performances of the Standard Chartered Bank, Ghana. Specifically, the impact of unsecured loans on loan interest income, profitability and liquidity of the bank is assessed. The study also considers the sector that is prone to unsecured loans.

1.7 Limitation of the Study Time was a major constraint in this study. As a result of limited time within which to complete this work, the study was carried out using a case study approach. There was therefore the possibility that some issues regarding the topic might not come up if such issues are peculiar to some banks that were not covered in the study. The study was further narrowed down to some loan officers and some management staff of the bank, from whom primary data was obtained. This also posed a limitation since there could be some biases regarding the information obtained.

1.8 Organisation of the Study This study is divided into five main chapters. The first chapter contained introduction of the study including the statement of the problem of the study, research objectives and questions, significance of the study, scope of the study and the limitations associated with the study. Chapter two focused on review of literature on the previous works related to unsecured loans. Performing and nonperforming loans, bad loan provisioning, loan-making procedures and monitoring of loans were also considered in this section of the study. The details of research method and organizational profile were captured under chapter three. Chapter four entails data presentation and analysis. The Last chapter covered summary, conclusions and recommendations of the study.

CHAPTER TWO LITERATURE REVIEW 2.1 Introduction This chapter focuses on the review of relevant literature on loans and other core aspects of the topic under study. The chapter thus presents the conceptual and theoretical basis for the study.

2.2 Meaning of Banks Over the years it has been a difficult task to find an acceptable definition of a bank or a banker. Several attempts have been made to offer a comprehensive and acceptable definition. Starting from the time of J W Gilbart(1847), he defined a banker as a dealer in capital, or more appropriately, a dealer in money. Gilbart(1847), regarded banks as intermediate parties between the borrower and the lender (Iganiga, 1998). This is because the banks borrow from one party and lend to another. It will be observed that this definition emphasizes the two traditional functions of a bank i.e. the mobilization of deposition and the granting of loans and advances. But in recent time banks business has been expanded considerably and as a result Gilbarts definition cannot be regarded as complete or comprehensive. In 1969, the Banking Act of England defined Banking by the following activities. I. The business of receiving money from outside sources as deposit irrespective of the payment of interest. II. The granting of loan, acceptance of credit or the purchase of bills, cheque and sales of securities. III. The purchase and sales of securities on behalf of customers. (Isedu, 2001).

Umole, (1985), points out that this definition fits better into the modern day role of banks in the economy, because the definition goes beyond mere collection of depositors fund. The banks, be it central, clearing merchant, saving or whatever form, pursue similar goals. They contribute significantly to achieve the stated macroeconomic objective of economic transformation.

2.3 Functions of Banks 2.3.1 Offering liquidity According to Freixas and Rochet (2008), liquidity in Banking refers to assets that can easily be converted into cash. Money in the form of cash is regarded as the most liquid asset in the banking Industry. Historically, the existence of Banks is credited to this unique function of providing liquidity to people and corporate bodies to carry out their daily business activities. In order to perform this role banks offer saving, deposit and current account facilities to the public. When a customer decides to operate an account, and pay a minimum amount as specified by the banks, the amount deposited on the various account is held by the bank as deposit liability. In addition to this, banks help in keeping other convertible equities, like certificate of occupancy, share certificate, deeds of conveyance etc. The bank is therefore requested by law to make a certain percentage of their deposit liabilities and capital funds available to the bank customers, to meet customer demand (Idahosa, 2000).

2.3.2 Payment Service A Bank is under obligation to pay back to the customer any amount as specified by the customer according to the value of the account held (Freixas and Rochet, 2008). A bank customer may also want his cheque cashed up to a stated amount and within a specified period, at another branch of the bank or another bank. Conversely, the customer can also

receive money through the bank when a debtor has decided to pay from a distance with crossed or open cheque.

2.3.3 Lending Services Idahosa (2000) asserts that the deposits kept in banks need not be left idle, because from experience banks are aware that depositors may not need all the deposits at a time. It is therefore prudent of the banker to lend such money to investors at a higher rate which brings some revenues to them. They achieve this through overdraft, loan, bills discounting or through direct investment. Guilford (2008), points out that the significance of bank lending cannot be overstated. Bank loans drive the economy. Bank loans provide the capital for businesses to start and expand. According to Guilford (2008), the first step in attaining a bank loan is for a bank customer to fill out a loan application. The application will include personal information, financial information and questions about the purpose of the loan. Once submitted, the application will go into underwriting, where the bank will make a decision on whether or not to loan the money and at what rate of interest. The bank will investigate the customer's credit rating. If it is acceptable, the bank will issue the loan.

2.3.4 International trade services Isedu (2001) emphasizes that banks help to provide the link through which payments for goods and services bought or sold by importers and exporters can be settled. In addition to this, they provide guarantee to exporters who need such guarantees before they can release their goods. Banks trade on foreign currencies. They engage competitively in foreign

currency transaction as it provides them a significant source of revenue. However, foreign exchange transactions laws in every country are very stringent.

2.4 Definition of Loan According to Guttentag (2007), loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower. In a loan, the borrower initially receives or borrows an amount of money, called the principal, from the lender, and is obligated to pay back or repay an equal amount of money to the lender at a later time. Typically, the money is paid back in regular installments, or partial

repayments; in an annuity, each installment is the same amount. The loan is generally provided at a cost, referred to as interest on the debt, which provides an incentive for the lender to engage in the lending. In a legal loan, each of these obligations and restrictions is enforced by contract, which can also place the borrower under additional restrictions known as loan covenants.

2.5 Types of loans 2.5.1 Secured Loan A secured loan is a loan in which the borrower pledges some asset for example a car or property as collateral for the loan. A mortgage loan is a very common type of debt instrument, used by many individuals to purchase housing. In this arrangement, the money is used to purchase the property. The financial institution, however, is given security a lien on the title to the house until the mortgage is paid off in full. If the borrower defaults on the loan, the bank would have the legal right to repossess the house and sell it, to recover sums owing to it. In some instances, a loan taken out to purchase a new or used car may be secured by the car; in much the same way as a mortgage is secured by housing (htt://en.wikipedia.org/wiki/loan).

2.5.2 Unsecured Loan Unsecured loans are monetary loans that are not secured against the borrower's assets. These may be available from financial institutions under many different guises or marketing packages: credit card debt, personal loans, bank overdrafts, credit facilities or lines of credit and corporate bonds . The interest rates applicable to these different forms may vary depending on the lender and the borrower. In finance, unsecured debt refers to any type of debt or general obligation that is not collateralised by a lien on specific assets of the borrower in the case of a default. In the event of the bankruptcy of the borrower, the unsecured creditors will have a general claim on the assets of the borrower after the specific pledged assets have been assigned to the secured creditors, although the unsecured creditors will usually realize a smaller proportion of their claims than the secured creditors. In some legal systems, unsecured creditors who are also indebted to the insolvent debtor are able (and in some jurisdictions, required) to set-off the debts, which actually puts the unsecured creditor with a matured liability to the debtor in a pre-preferential position (wikipedia.org/wiki/loan).

An unsecured loan is a financial instrument where there is no collateral for the lender to have for security in case of default from the borrower. Most loans that you get from friends or family where there is no collateral is an unsecured loan. The borrower signed a binding contract to the lender, promising to repay the loan according to the terms and that is what the borrower needs to do. Unpaid debt can cause many problems for the borrower, the lender and the economy, so all credit given to the borrower, secured or unsecured should be treated how they would like to be treated if they were the lender for someone else

(wikipedia.org/wiki/loan).

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2.5.3 Performing Loans Legally, a loan or credit facility refers to a contractual promise between two parties where one party, the creditor agrees to provide a sum of money to a debtor, who promises to return the said amount to the creditor either in one lump sum or in installments over a specified period of time. The agreement may include provision of additional payments of rental charges on the funds advanced to the borrower for the time the funds are in the hands of the debtor. (htt://en.wikipedia.org/wiki/loan). The additional payments that are in the form of interest charges, processing fees, commissions, monitoring fees among others, are usually paid in addition to the principal amount lent. Indeed these additional payments when made in accordance with the loan contract constitute income to the lender or the creditor. A loan may therefore be considered as performing if payments of both principal and interest charges are up to date as agreed between the creditor and debtor. Bank of Ghana classifications of loans indicate that loans that are current are those for which the borrower is up to date in respect of payments of both principal and interest. It further shows that an overdraft would be

considered as current or performing if there were regular activity on the account with no sign of a hardcore of debt building up (Bank of Ghana, 2008). The foregoing reveals that loans that are up to date in terms of principal and interest payments are described as performing facilities. These types of loans constitute quality asset portfolio for banks in view of the interest income generated by such assets.

2.5.4 Non-Performing Loans Generally, loans that are outstanding in both principal and interest for a long time contrary to the terms and conditions contained in the loan contract are considered as nonperforming loans (Bank of Ghana, 2008). This is because going by the description of performing loans above, it follows that any loan facility that is not up to date in terms of payment of both

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principal and interest contrary to the terms of the loan agreement, is nonperforming. Available literature gives different descriptions of bad loans. Some researchers noted that certain countries use quantitative criteria for example number of days overdue scheduled payments while other countries rely on qualitative norms like information about the customers financial status and management judgment about future payments (Bloem and Gorter, 2001). Alton and Hazen (2001) describe non-performing loans as loans that are ninety days or more past due or no longer accruing interest. Caprio and Klingebiel (1990), consider non-

performing loans as loans which for a relatively long period of time do not generate income, that is the principal and or interest on these loans have been left unpaid for at least ninety days. A non-performing loan may also refer to one that is not earning income and full payment of principal and interest is no longer anticipated, principal or interest is ninety days or more delinquent or the maturity date has passed and payment in full has not been made. Critical appraisal of the foregoing definitions of bad loans points to the fact that loans for which both principal and interest have not been paid for at least ninety days are considered non-performing. According to Berger and De Young (1997), such loans could be injurious to the financial performance of banking institutions.

2.6 Loan Classification and Provision 2.6.1 Loan Classification Loan portfolios of banks are classified in order to determine the level of provisions to be made in line with banking regulations. Loans are classified into five categories including Current, other loans especially mentioned (OLEM), substandard, doubtful and loss (Bank of Ghana, 2008). The classifications indicate the level of provisions banks are required to make to reflect the quality of their loan portfolio. Indeed the various classifications clearly group

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loans into performing and nonperforming, in line with banking regulations. These categories further help banks to know the structure of their loan portfolio and for that matter their assets quality.

2.6.2 Loan Provisioning In Ghana, a major factor considered in making loans is the ability of the borrower to repay the loan. However, to mitigate the risk of default, banks ensure that loans are well secured. Though advances shall be granted on the basis of the borrowers ability to pay back th e advance and not on the basis to pledge sufficient assets to cover the advance in case of default, it is highly desirable for all advances made to customers and staff to be well secured. This means that in the event of default the bank shall fall on the collateral used in securing the facility to mitigate the effect of loss of principal and interest (Banking Act, 2004).

In view of the above, banks take into account the assets used in securing the facility to determine the level of provision to be made. Bank of Ghana regulations indicate that certain amount of provisions are made on the aggregate outstanding balance of all current advances, and aggregate net unsecured balance of all other categories. The review of the above literature on classifications and provisioning implies that the higher the non-performing loan category the higher the provisions and charges for such bad loans (Bank of Ghana, 2008).

2.7 Implication of Unsecured Loans for Banking Institutions Loans generate huge interest for banks which contribute immensely to the financial performance of banks. However, when loans go bad they have some adverse effects on the financial health of banks. This is because in line with banking regulations, banks make adequate provisions and charges for bad debts which impact negatively on their performance.

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Bank of Ghana regulations on loan provisioning indicate that loans in the non-performing categories that is loans that are at least ninety days overdue in default of repayment will attract minimum provisions of 25%, 50% and 100% for substandard, doubtful and loss, respectively( Bank of Ghana Act, 2004).

According to Bloem and Gorter, (2001), though issues relating to non-performing loans may affect all sectors, the most serious impact is on financial institutions such as commercial banks and mortgage financing institutions which tend to have large loan portfolios. Besides, the large bad loans portfolios will affect the ability of banks to provide credit. Huge nonperforming loans could result in loss of confidence on the part of depositors and foreign investors who may start a run on banks, leading to liquidity problems. The provisions for bad loans reduce total loan portfolio of banks and as such affects interest earnings on such assets. This constitutes huge cost to banks. Study of the financial statement of banks indicates that unsecured loans have a direct effect on profitability of banks. This is because charge for bad debts is treated as expenses on the profit and loss account and as such impact negatively on the profit position of banks (Price Water-House Coopers, 2009).

Berger and De Young (1997), indicate that failing banks have huge proportions of bad loans prior to failure and that asset quality is a statistically significant predictor of insolvency. Fofack (2005), also reported that during the banking crisis in Indonesia, non-performing loans represented about 75% of total loan assets which led to the collapse of over sixty banks in 1997. This means that banks holding huge bad loans in their books can run into bankruptcy if such institutions are unable to recover their bad debts. A possible effect of bad loans is on shareholders earnings. Dividends payments are based on banks performance in terms of net profit. Thus since bad loans have an adverse effect on profitability of banks, it can affect the

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amount of dividend to be paid to share holders. The Banking Act of Ghana spells out that a bank shall not declare or pay dividend on its shares unless it has, among other things, made the required provisions for non-performing loans and other erosions in assets value [Section 30 (1) of Banking Act, 2004]. The effect of bad loans on the amount of dividend paid to shareholders can also affect capital mobilization because investors will not invest in banks that have huge non-performing loans portfolio. Elebute (2009) identifies among other things, foreign direct investment and domestic capital mobilisation as some of the options available to Ghanaian banks to source funds to meet the minimum capital requirement of Bank of Ghana which is pegged at GH60,000,000.00 (Asamoah, 2009). It is evident that non-performing loans with their attendant negative impact on investors earnings can affect the Ghanaian banks in meeting the minimum capital requirement. The foregoing discussions show the implications of unsecured loans on banks performance in Ghana and other parts of the world.

2.8 Factors Accounting for Unsecured Loans Research findings and publications show that bad loans occur as a result of some factors. Berger and De Young (1997) identified poor management as one of the major causes of problem loans. They argue that managers in most banks with problem loans do not practice adequate loan underwriting, monitoring and control. A World Bank policy research working paper on Non-performing Loans in Sub-Saharan Africa revealed that bad loans are caused by adverse economic shocks coupled with high cost of capital and low interest margins (Fofack, 2005).

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Goldstein and Turner (1996) states that the accumulation of non-performing loans is generally attributable to a number of factors, including economic downturns and macroeconomic volatility, terms of trade deterioration, high interest rate, excessive reliance on overly high-priced inter-bank borrowings, insider lending and moral. Rouse (1989)

indicates in his work that problem loans can emanate from overdrawn account where there is no overdraft limit, overdraft taken on an account which has not been actively operated for some time and overdraft taken in excess of reasonable operational limits. He also identified lack of good skills and judgment on the part of the lender is a possible cause of bad loans. Bloem and Gorter (2001) indicate that non-performing loans may rise considerably due to less predictable incidents such as the cost of petroleum products, prices of key export products, foreign exchange rates or interest rates change abruptly. They also stated that deficient bank management, poor supervision, overoptimistic assessments of creditworthiness during economic booms, and moral hazard that result from generous government guarantees are some of the factors that lead to bad loans. It is worth noting that though the literature obtained from foreign sources indicate some causes of bad loans, some of these may not apply to banks in the Ghanaian environment.

2.9 Loan Processing in Banks Rouse (1989) explained that a lender lends money and does not give it away. There is therefore a judgment that on a particular future date repayment will take place. The lender needs to look into the future and ask whether the customer will repay by the agreed date. He indicated that there will always be some risk that the customer will be unable to repay, and it is in assessing this risk that the lender needs to demonstrate both skill and judgment. The lender should aim at assessing the extent of the risk and try to reduce the amount of uncertainty that will exist over the prospect of repayment. The lender must therefore gather

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all the relevant information and then apply his or her skills in making judgment. Though there might be pressures from customers and elsewhere which may sway away the lenders judgment, the lender must seek to arrive at an objective decision. In view of these credit risks that might lead to bad loans, banks have some loan request procedures and requirements contained in their credit policy documents to guide loan officers in the processing of loans for customers. The following are some of the factors considered in granting loans: applicants background, the purpose of the request, the amount of credit required, the amount and source of borrowers contribution, Repayment terms of the borrower, security proposed by th e borrower, location of the business or project and Technical and financial soundness of the credit proposal. Among the criteria outlined above, credit vetting or appraisal is one of the crucial stages in the loan processing procedures. This is because this stage analyses information about the financial strength and creditworthiness of the customer.

Kay Associate Limited (2005) identified five techniques of credit vetting known as the five Cs framework used in assessing a customers application for credit. Firstly, the character of the customer is assessed. This determines the willingness of the customer to pay the loan and may include the past credit history, credit rating of the firm, and reputation of customers and suppliers. Secondly, the capacity of the customer which is described as his or her ability to pay in terms of cash flow projection is critically assessed. Besides, the capital or soundness of the borrowers financial position in terms of equity is assessed. The conditions such as the industry and economic conditions of the business are also assessed. These are important because such conditions may affect the customers repayment ability. The last C is collateral. This is referred to as the secondary source of repayment. This is considered in appraising the customers request.

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2.10 Monitoring and Control of Loans According to Rouse (1989) this is an area which many lenders pay little attention but, if it is properly carried out, the occurrence of bad debts can be reduced considerably. He identified internal records, visits and interviews, audited accounts and management accounts as some of the things that help in the monitoring and control process. Monitoring can minimize the occurrence of bad loans through the following major purposes that it serves: Ensure the utilization of the loan for the agreed purpose. Identify early warning signals of any problem relating the operations of the customers business that are likely to affect the performance of the facility. Ensure compliance with the credit terms and conditions. It enables the lender discusses the prospects and problems of the borrowers business.

Bad loans can be restricted by ensuring that loans are made to only borrowers who are likely to be able to repay, and who are unlikely to become insolvent. Credit analysis of potential borrowers should be carried out in order to judge the credit risk with the borrower and to reach a lending decision. Loan repayments should be monitored and whenever a customer defaults action should be taken. Thus banks should avoid loans to risky customers, monitor loan repayments and renegotiate loans when customers get into difficulties (Kay Associates Limited, 2005).

2.11 Effect of Unsecured Loans Hempel and Simonson (1999) state that the main activity of bank management is not deposit mobilization and giving credit. Effective credit administration reduces the risk of customer default. The competitive advantage of a bank is dependent on its capability to handle credit

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risk valuably. Unsecured loans cause bank failure. Palubinskas and Stough (1999), noted that the failure of a bank is mainly seen as a result of mismanagement because of bad lending decisions made with respect to wrong appraisal of credit status, or the repayment of nonperforming credits and excessive focus on giving loans to certain customers. Goodhart et al. (1998) also state that poor credit control, which results in undue credit risk, causes bank failure. Chimerine (1998) adds that a bad lending tradition leads to a large portfolio of unpaid loans. This results in insolvency of banks and reduces funds available for fresh advances, which eventually causes a financial crisis. Goodhart et al. (1998) add connected lending to the causes of bank failure. Again, Palubinskas and Stough (1999) note that lack of dependable financial information on borrowers to help in assessing creditworthiness causes a bank failure. Yet mismanagement is not a result of immaturity all the time. Most of the time, principals and agents know that major faults in the banking regulation in respect of internal changes permit them to exploit a banks funds. Sometimes these two groups of stakeholders attempt to accomplish their short term earnings objectives by acquiring high risks in the bank. Spollen (1997) states that irregular meetings of loans committees, false loans, large treasury losses, high sums of unrecorded deposits and money laundering in large amounts, contribute to bank failure. He adds that some lending decisions involving high amounts of money are made by an individual worker because of the status of the recipients of the loans. Hempel and Simonson (1999) conclude that all banks incur certain loan losses when some borrowers default in repaying their loans. Irrespective of the extent of the risk involved, good credit management can reduce the default.

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CHAPTER THREE RESEARCH METHODOLOGY 3.1 Introduction This chapter focuses on methods that were employed in the study, the target population, sample size and sampling techniques as well as the various and appropriate sources of data and how the data were collected and analysed.

3.2 Research Design The case study design was employed to find answers to the research questions. The justification for this method is that it generated answers to the questions such as why, what and how, which helped in answering the research questions. The researcher adopted exploratory and explanatory approaches. Exploratory was used to help the researcher find out more about the problem of unsecured loans, especially the adverse effects of these loans on bank performance as well as factors that lead to unsecured loans. Explanatory study approach was employed to establish how unsecured loans impact on bank performance and also to show how the loan making procedures and rules, as well as other factors can result in unsecured loans. Thus, a combination of this approach with in depth interviews and the use of questionnaire as data collection techniques were very useful in the study of unsecured loans.

3.3 Sources of Data The data collected for the study comprised of primary and secondary data. The type of data, their sources and the instruments used in gathering them are discussed as follows:

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3.3.1 Primary Data Both structured questionnaires and interview guides were used in the data collection. While the structured questionnaires were used to get the unbiased opinion of respondents, the interviews were used for clarifications of some unclear issues. These data collection

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

3.3.2 Secondary Data The secondary data were sourced from the published annual reports and financial statements of the bank. The information covered a period of two years from 2008 to 2009. This category of data was both in quantitative and qualitative form. Access to the data was not a problem as these were published annually in the print and electronic media for public consumption.

3.4 Population of the Study The target population for the study consists of credit officers of Standard Chartered Bank, Ghana head office and two branch managers from Opeibea branch and Madina branch.

3.5 Sample and Sampling Technique In conducting a research, it is often impossible, impracticable or too expensive to collect data from all the potential units of analysis (population). Hence a smaller number of units (sample) are often chosen to represent the whole population. Fifteen credit officers were conveniently drawn from the entire population of the credit Officers of the bank. This forms about 15% of the total population of credit officers of the bank. These were people who had the expertise in loan administration issues. The sampling method chosen for this dissertation was convenience sampling, which belong to the non-probability sampling techniques. Convenience sampling means that the researcher

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find respondents that were willing to participate in the study. This method led to the easy and convenient access to the data needed to achieve the objectives of the research

3.6 Research Instruments 3.6.1 Questionnaires This method was used to gather definite answers to specific questions related to the area of study. This method was to seek the respondents opinions and views on specific areas of the study, hence the need to provide definite answers and suggestions where necessary. In all,

the researchers distributed fifteen (15) questionnaires to the credit officers selected for the study. One kind of question was phrased in descriptive statements. As recommended by Parasuraman (1991), a 5-point Likert-scale (1= Lowest, 5= Highest) was used. Another was the closed-ended questions where the respondents can choose one or more alternative answers. This made the questionnaires easy to complete in a short space of time by the

respondents.

3.6.2 Interviews This method was used to gain an understanding of the loan policies and procedures of Standard Chartered Bank, Ghana. To achieve this the researchers interviewed two bank managers of the Standard Chartered Bank. It is worth stating that the form of interview was face to face interview technique conducted at the offices of the bank officials. The researcher prepare interview guide to assist them asked relevant questions.

3.7 Administration of Research Instruments Questionnaires were administered personally to respondents by the researchers. In the

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

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respondents to distribute the questionnaires at their work place. All the fifteen questionnaires distributed to the respondents were answered and collected back. A pre-testing activity of the data collection instruments was carried out to test the construction of the English language, validity and reliability of the questions.

3.8 Data Analysis Spread sheet and simple excel were used to process the data for the analysis. Tables and statistical diagrams like bar charts, pie charts and line graphs also aided in the data presentation. The primary data were presented by some of these statistical tools and by way of narration. Presentation of the data on these statistical tools made the analysis very easy. The statistical tools used conveyed the meaning of the figures captured and as such made the analysis straight forward.

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CHAPTER FOUR DATA PRESENTATION AND ANALYSIS 4.1 Introduction This chapter presents the analysis of field data collected and the discussions of findings by the researcher. This stretches through the analysis of questionnaires sent to credit officers, interviews conducted with branch managers and the discussions of findings.

4.2 Presentation and Analysis of Data from Credit Officers 4.2.1 Gender Distribution of the Respondents Figure 4.1 Gender Distribution

Female 7%

Male 93%

(Source: Field Data, 2010) From the figure 4.1 above, 93% of the credit officers selected for the study were male. On the other hand, 7% of the sampled population were female. The above result depicts that majority of the Standard Chartered Bank Ghana Limited credit officers are male.

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4.2.2 Age Distribution of the Respondents Table 4.1 Age Distribution Response Between 20 and 30 Between 30 and 40 Between 40 and 50 Between 50 and 60 Total (Source: Field Data, 2010) Table 4.1 above illustrates that, 5 credit officers representing 33% of the sampled population were between 20 years and 30 years. In addition, 7 credit officers representing 47% of the sampled population were between 30 years and 40 years. Also, 2 credit officers representing 13% of the sampled population were between 40 years and 50 years. The above findings portray that majority of Standard Chartered Bank, Ghana Limited credit officers are between the ages 30 and 40. This implies that Standard Chartered Bank, Ghana Limited used mature people as its credit officers. Frequency 5 7 2 1 15 Percentage 33% 47% 13% 7% 100%

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4.2.3 Educational Level of the Respondents Figure 4.2 Educational Background

Master Degree 7% Diploma/HND 13%

Bachelors Degree 80%

(Source: Field Data, 2010) Figure 4.2 above illustrate that 80% of the credit officers sampled for the study had bachelors degree. In addition, 13% of the sampled credit officers had diploma or Higher National Diploma. Finally, 7% of the sampled credit officers had masters degree. This signifies that about 80% of the Standard Chartered Bank Ghana Limited had completed their bachelors degree. Also, the educational background of the credit officers means that Standard Chartered Bank Ghana Limited employees qualified people as its credit officers.

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4.2.4 Period of Services of the Respondents Table 4.2 Period of Service Response Under one year Between 1 and 3 years Between 3 and 5 years Above 5 years Total (Source: Field Data, 2010) From the table 4.2 above , 1 credit officers corresponding to 7% of the sampled population had worked for Standard Charter bank less the a year. Additionally, 4 credit officers representing 27% of the sampled population had worked in Standard Chartered bank between 1 year and 3 years. Other 4 credits officers had worked with the bank between 3 and 5 years. Finally, 6 credit officers corresponding to 39% of the sampled credit officers had worked for the bank more than 5 years. The above findings illustrate that majority of Standard Chartered Bank credit officers are very experience because they had worked as credit officers for very long time. Frequency 1 4 4 6 15 Percentage 7% 27% 27% 39% 100%

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4.2.5 Factors Accounting for Unsecured Loans Table 4.3 Causes of Unsecured Loans Response Delayed loan approval Poor credit appraisal Marketing problems Diversion of loans Ineffective monitoring (Source: Field Data, 2010) Table 4.3 denotes that 10 out of 15 credit officers selected for the study indicated that delayed in loans approval was the cause of unsecured loans. In addition, all the 15 credit officers sampled for the study indicated that poor credit appraisal was a cause of unsecured loans. Furthermore, 12 credit officers indicated that marketing problem was a cause of unsecured loans. Finally, 13 and 14 credit officers respectively indicated that unsecured loans are caused by diversion of loans and ineffective monitoring. Frequency 10 15 12 13 14 Percentage 67% 100% 80% 87% 93%

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4.2.6 Sectoral Distribution of Unsecured Loans Figure 4.3 Sectoral Distributions of Unsecured Loans

60

50

40

30

20

10

0 Frequency Percentage Agriculture 9 60 Manufacturing 4 27 Service 2 13

(Source: Field Data, 2010) From figure 4.3 above, 9 credit officers representing 60% of the sampled population indicated that most of the bank unsecured loans are in the agricultural sector. Additionally, 4 credit officers representing 27% of the sampled population indicated that most of the bank unsecured loans are in the manufacturing sector. Finally, 2 credit officers representing 13% of the sampled population indicated that most of the bank loans are in the service sector.

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4.2.7 Hindrances of Loans Monitoring Figure 4.4 Hindrances of Loans Monitoring

60 60

50
40 30 20 10 0 Lack of logistics Under staffing Ineffective supervision 4 2 27

13 9

Frequency

Percentage

(Source: Field Data, 2010) Figure 4.4 above shows that 4 credit officers corresponding to 27% of the credit officers selected for the study indicated that lack of logistics were the major hindrances to loans monitoring. Also, 2 credit officers corresponding to 13% of the sampled population indicated that under staffing were the major hindrances to loans monitoring. Finally, 9 credit officers corresponding to 60% of the sampled population indicated that ineffective supervision were the major hindrances to loans monitoring

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4.2.8 Reasons for Loans Diversion Table 4.4 Reasons for Loans Diversion Response Lack of proper monitoring Anticipation of high gains in other business ventures Ignorance of terms and conditions attached Inadequate financing (Source: Field Data, 2010) From table 4.4 above, 8 credits officers indicated that lack of proper loan monitoring was the cause of loan diversion by clients. Another 9 credit officers indicated that clients anticipation of higher gains in other business venture was the cause of loan diversion. Also, all the 15 credit officers indicated that clients ignorance of the terms and the conditions of the loan caused loans diversion. Finally, 12 credit officers indicated that inadequate financing caused loans diversion. The above finding signifies that ignorance on the part of clients about the terms and the conditions of the loans is the major reasons why clients divert loans. Frequency 8 9 15 12 Percentage 53% 60% 100% 80%

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4.3 Analysis of the Interview with Managers 4.3.1 Ratio analysis of the bank performance Figure 4.5 Ratio analysis of the SCB performance
50.0%
40.0% 30.0% 20.0% 10.0% 0.0%

2009 4.1% 6.1% 44.7%

2008 5.3% 4.0% 25.8%

Return on Assets
Bad Debt Percentage Asset Utilization

(Source: Field Data, 2010) Figure 4.5 shows some financial ratio used to assess the effect of unsecured loans on the performance of the Standard Chartered Bank. The ratios are explained below: Return on Assets (ROA) Return on Assets which shows how effective the bank turns a cedi of revenue into a cedi of bottom line profit. It is highest in 2008 (5.3%) and decreased to 4.1% in year 2009, which is and indication of high provision for bad and doubtful debts. This signifies that unsecured loans had an inverse relationship with the profitability of the bank. This means that, all other things been equal, high unsecured loans lead to lower profitability and vice versa.

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Percentage of Provision for bad and doubtful debts From the figure 4.5 above, bad debt percentage was 4.0% in the 2008. This increased to 6.1% in 2009. This means that most debts or loans where unpaid and went bad in 2009.

Asset Utilization (AU) Asset Utilization is also another aspect of banks performance which measures how effectively the bank converts its assets to revenue. Too high AU indicates that the bank invest in very risky loans. This is portrayed in year 2009 where AU is highest (44.7%) and consistent with the high provision for bad and doubtful debts same year.

4.3.2 Effect of unsecured loans on loan interest income Table 4.5 Bad Loans and Loan Interest Income Year Interest Income ( 000) 2009 2008 2007 182,500 89,139 62,154 Bad Debt ( 000) 26,074 13,735 9,108 Percentage ( 000) 14.2% 15.4% 16.6%

(Source: Field Data, 2010) Table 4.2 shows that there was a consistent increase in the interest income generated by the banks loan portfolio. However, this was reduced by bad debts charges which are shown by the ratios 14.2%, 15.4%, and 16.6% in 2009, 2008 and 2007 respectively. The huge reduction in loan interest income was due to high bad debts provisions caused by agriculture sector loans, and ineffective loan recovery attributed to understaffed credit offices and inadequate logistics. The ratios of bad debts to loan interest income declined from 16.6%% in 2007 to

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

4.3.3 Credit Appraisal procedures According to the branch managers, loans will be disbursed only to the client after his or her identity has been verified and legal formalities, collateral creation, promissory notes signed and completed. The contents of legal formalities are explained clearly and completely to the client in official language before necessary signature of the client/guarantor is obtained in the documents. The client will sign the documents in the branch office after ensuring that necessary details have been filled up. Terms and conditions of the loan along with relevant instructions should be explained clearly and completely to the client/guarantor in the official language. Important points to be explained to the client include the repayment schedule, mechanism for repayment, penalty for overdue, benefits and incentives for good repayment record. The bank will grant loan to the customer once the above conditions are satisfied.

4.3.4 Impairment of Loans and Advances The branch managers pointed out that, the bank assesses at each balance sheet date whether there is objective evidence that a loans are impaired. A loan is impaired and impairment losses are incurred only if there is objective evidence of impairment as a result of one or more events that occurred after initial recognition of the loan. Objective evidence that a loan is impaired includes observable data that comes to the attention of the bank about the following loss events: significant financial difficulty of the borrower; a breach of contract, such as default or delinquency in interest or principal repayments; it becoming probable that the borrower will enter bankruptcy or other financial reorganisation; and adverse changes in the payment status of borrowers. When a loan is uncollectible, it is written off against the related

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provision for loan impairment. Such loans are written off after all the necessary procedures have been completed and the amount of the loss has been determined.

4.4 Discussion of Findings The study has a general objective of establishing the main impact of unsecured loans on the financial performance of Standard Chartered Bank, Ghana. As indicated by the findings above, unsecured loans had negative effect on the financial performance of Standard Chartered Bank. The findings revealed that high unsecured loans resulted in high provision for bad debt in the income statement of the bank. This high provision for bad debt reduces the profit of the company since it reduces the interest income. loans indicate that the bank invest in very risky loans. On the factors that caused unsecured loans, the study revealed that many factors caused unsecured loans. Among them are delayed in loans approval, poor credit appraisal, marketing problem, diversion of loans and ineffective monitoring. Poor credit appraisal was found out to be the major cause of unsecured loans. Finally, the study shows that unsecured loans in Standard Chartered Bank had been increasing since 2007 to 2009. As indicated in table 4.5, provision of bad debt in 2007 was 9,108,000, this increase to 13,735,000 in 2008 representing 50.8% increase in unsecured loans. In 2009, provision for bad debt increased to 26,074,000, representing 89.8% increase in unsecured loans. This signifies that unsecured loans in Standard Chartered Bank had been increasing from year to year. Additionally, high unsecured

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CHAPTER FIVE SUMMARY CONCLUSION AND RECOMMENDATIONS 5.1 Introduction This chapter provides a summary, conclusion and recommendations on the findings made in the study.

5.2 Summary of the Findings 5.2.1 Causes of Unsecured Loans The study reveals that delayed in loans approval, poor credit appraisal marketing problem and ineffective monitoring on the part of credit officers were the major cause of unsecure loans in Standard Chartered Bank.

5.2.2 Sectoral Distribution of Unsecured Loans The study also reveals that most of the Standard Chartered Banks unsecured loans are in the agricultural sector. This confirms the reason why banks in Ghana are unwilling to channel majority of their loans to the Agricultural sector.

5.2.3 Effects of Unsecured Loans The findings of the study show that unsecured loans had an inverse relationship with the profitability of the bank. This means that, all other things been equal, high unsecured loans lead to lower profitability and vice versa. This is because when a loan is uncollectible, it is written off against the related provision for loan impairment which reduces the interest income of the bank.

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5.3 Conclusion It is evident from the findings that the banks loan portfolio contained huge amounts of unsecured loans. These unsecured loans reduce the loan interest income, operating profit and lending funds, therefore it can be concluded that unsecured loans seriously affect the financial performance of the bank. Considering the factors that account for unsecured loans as established by the research findings, it can also be concluded that agriculture sector credit is heavily exposed to unsecured loans than other sectors. Management therefore needs to put in place pragmatic measures to mitigate the risk in this sector so as to improve the quality of the overall loan portfolio of the bank. The foregoing findings reveal a worrisome situation about the effect unsecured loans on banks financial performance. In view of the important role the bank plays in the economic development of Ghana, it is very essential for all stakeholders, especially management to adopt pragmatic measures to minimize the problem of unsecured loans in the bank.

5.4 Recommendations 5.4.1 Regular Training Programmes for Credit Staff It is recommended that management should organise regular training programmes for credit staff in areas like credit management, risk management and financial analysis. This would sharpen the knowledge and skills of credit officers so as to improve on the quality of credit appraisal, prevent delayed loan approvals, enable credit officers appreciate the need to comply with credit policy and further enhance monitoring of credit.

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5.4.2 Regular Monitoring and Supervision Another important way of minimizing unsecured loans is through regular monitoring and supervision of loan facilities. This would prevent diversion of funds into business ventures other than the agreed purposes.

5.4.3 Provision of Logistics To ensure effective monitoring, management should ensure that credit offices at all branches and area offices, are adequately resourced in terms of, vehicles and other logistics, to support monitoring activities.

5.4.4 Provision of Adequate Security for Credit Loans granted to customers should be well secured in terms of adequacy of the collateral provided and also ensure that proper legal documentation is put place. This would reduce the losses arising from problem loans and minimise the effects of such loans in the form of bad debt provisions, on the financial performance of the bank

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BIBLIOGRAPHY Alton, R. G. and Hazen J. H. (2001), As Economy Flounders, Do We See A Rise in Problem Loans?, Federal Reserve Bank Journal, Vol. 142, pp. 9.

Berger, N. A. and De Young R. (1997), Problem Loans and Cost Efficiency in Commercial Banks, Washington DC, Journal of Banking and Finance, Vol. 21.

Bloem, M. A. and Gorter, N. C. (2001), Treatment of Non-Performing Loans in Macroeconomic Statistics, IMF Working Paper, WP/01/209.

Caprio, G. and Klingebiel, D., (1999), Episodes of Systemic and Borderline, Financial Crises, http://www1.worldbank.org/finance/assets/images/Crisistableproduct.doc, Accessed 2010-072.

Demirguc-Kunt, A. and Detragiache, E. (1998), Banking on the Principles: Compliance with Basel Core Principles and Bank Soundness, Journal of Financial Intermediation, Vol. 17, pp. 511-542.

Fofack, H. (2005), Non-Performing Loans in Sub-Saharan Africa: Causal Analysis and Macroeconomic Implications, World Bank Policy Research Working Paper No. WP 3769.

Freixas, X. and Rochet, J. (2008), Microeconomics of banking, London, MIT press. Gilbart J. W.(1847), The History, Principles And Practice Of Banking, London, George Bell and Sons. Goodhart, C.A.E., Sunirand, P. and Tsomocos, D.P. (1998), A model to analyse financial fragility, Oxford Financial Research Centre Working Paper, Vol. 13.

Hempel, G. H., and Simonson, D. G. (1999), Bank Management Text and Cases, U.S.A., John Wiley and Sons, Inc. 39

Hinson, R. and Hammond, B. (2006), Service Delivery in Ghanas Banking Sector in African Marketing Practice: Cases from Ghana, Ghana, Sedco Publishing Limited.

Idahosa, N. (2000), Principle of Merchant banking and Credit Administration, Benin City, Rasjel Interbiz group.

Kay Associate Limited (2005) John Kay Associates Limited (2005), In-House Training in Accounting for Non- Accountants for Credit Officers, Accra

Price Water House Coopers (2009), Annual Report and Financial Statement of Barclays Bank Ghana, Daily Graphic, Monday, 30th March. Rouse, C. N. (1989), Bankers Lending Techniques, London, Chartered Institute of Bankers.

Spollen, A. L., (1997), Corporate Fraud: The Danger from Within, Ireland, Oak Tree Press.

Umole, M. (1983), Monetary and Financial system in Nigeria, London, A.I.B Publishers

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APPENDICES Questionnaire for Credit Staff Dear respondent, I am students of Regent University College conducting a study on the topic: Effect on unsecured loans on performance of a bank. Therefore, I wish to request you to spare

some time and answer the questions below as honestly as possible by ticking or filling in the spaces provided. The information given will be solely used for academic purpose and will be treated confidentially.

1. Gender Male [ ] Female [ ]

2. What is your age? 20 30 [ ] 30 40 [ ] 40 50 [ ] 50 60 [ ]

3. Educational Background Diploma/HND [ ]

Bachelors Degree [ ] Master Degree Other [ ] [ ] Specify __________________________________

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4. How long have you worked at Standard Chartered Bank? Under one year Between 1 and 3 years Between 3 and 5 years Above 5 years [ ] [ ] [ ] [ ]

5. In your opinion, which of the following factors account for unsecured loans? Delayed loan approval Poor credit appraisal Marketing problems Diversion of loans Ineffective monitoring [ ] [ ] [ ] [ ] [ ]

6. Do you think non-compliance with credit policy accounts for unsecured loans? Yes [ ] No [ ]

7. Which sector record higher unsecured loans? Agriculture [ ]

Manufacturing [ ] Service [ ]

8. How would you rank the following factors as causes of unsecured loans using a scale of 1 to 5 with 5 being the highest and 1 the lowest? Poor credit appraisal Diversion of loans [ ] [ ]

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Ineffective monitoring

[ ]

Non-compliance with credit policy [ ] Marketing problems [ ]

9. Which of the following factors hinder effective monitoring of loans? Lack of logistics Under staffing [ ] [ ]

Ineffective supervision [ ] Others [ ] Specify

10. Which of the following reasons account for loan diversion by customers? Lack of proper monitoring Anticipation of high gains in other business ventures Ignorance of terms and conditions attached Inadequate financing [ ] [ ] [ ] [ ]

11. What measures should management put in place to reduce unsecured loans? _____________________________________________________________________ _____________________________________________________________________ ______ Thank you

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Interview Guide for Interviewing Branch Managers 1. What is the effect of unsecured loans on profits? 2. What is the effect of unsecured loans on loan interest income? 3. What is the effect of unsecured loans on the lending capacity of the bank? 4. What factors account for unsecured loans? 5. What are the procedures in appraising credit request? 6. Which of the sectors of the banks lending activities is associated with high unsecured loans? 7. What are the factors that account for this? 8. How can the incidence of unsecured loans be minimised?

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