A Proposal on Credit Risk Management in Rural and

community banks (RCBs) in Ghana

(A case study of Akuapem rural bank limited)

BY A GROUP OF JS.ADDO BUSINESS SCHOOOL OF MARSHALLS

UNIVERSITY COLLEGE
 BENEDICT GOMADO
(JSABS/BKF/13/01/0017)
ABOAGYE EMMANUEL
(JSABS/BKF/13/01/0001)
OPARE ALFRED MARSHALL
(JSABS/BKF/13/01/0005)
SHARON GARBRAH
(JSABS/BKF/13/01/0014)
ABSTRACT

This study examined the diverse types of risk and the credit risk
management practices of rural and community banks in Ghana. Credit
Risk Management holds a positive relationship with credit monitoring,
reliability and assurance factors. All these factors play important role in
the mitigation process of credit risks. Risk mitigation process starts from
sourcing loan applications and the loan application goes through several
screening process where reliability and assurance factors are very
important. Now, knowledge of practical world and product program are
vital to identify risks related to loan proposals. With the rural and
community banking system, AKUAPEM RURAL BANK deals with a
systematic lending procedure which follows a straightforward policy.
This type of policy helps the analysts to analyze loan proposals very
easily. However, there are some loopholes of this straightforward policy
and guidelines which deny any type of distinct proposals which may have
better creditworthiness and repayment capacity.

In a nutshell, credit risk management is all about ensuring repayment

capability of the customers who are provided with loans and advances.
Minimizing Credit Risk is subject to proper framework of risks and
justification with historical trend and other assurance factors.

Keywords: Credit Risk Management, AKUAPEM RURAL BANK, Credit

Monitoring, Reliability, Assurance factors.
INTRODUCTION

Many institutions such as banking and enterprises are well-known to its

wise usage of financial resources. The effective management of the
financial resources makes it competitive for the organization to endure
the different economic uncertainties and threats. In addition, the
strategy on managing the risks can be the most desirable strategy of the
company that cannot be deteriorated but can be passed through the
next generations of other managers.

1.1 Background of study

Risk is the potential that a chosen action or activity will lead to a loss.
According to Wikipedea.org, risk can be defined as; a probability or
threat of damage, injury, liability, loss or occurrence that is caused by
external or internal vulnerabilities and that may be avoided through
preemptive action and in finance risk as the probability that the actual
return on an investment will be lower than the expected return. This
means that it can result into loss due to default risk, interest rate risk,
operational and political risk, refinancing risk, sovereign risk and foreign
exchange risk.

Risk management is defined by ISO 31000 as the identification,

assessment and prioritization of the effects of uncertainty; followed by
coordinated and economical application of resources to minimize,
monitor and control the probability and/or impact of unfortunate events
or maximizes the realization of the opportunities. Donald et al (1996)
defines credit risk as the potential that a bank borrower or counterpart
will fail to meet its obligation in accordance with agreed terms. Credit
risk a e defi ed as the risk that a fir ’s usto er s a d parties to
which it has lend out money will delay or fail to make promised
payments. The exposure to credit risk is large particularly to financial
institutions such as Rural and Community banks, which routinely make
loans that are subject to risk of default by borrowers. Rural and
Community banks must make successful loans that are paid back in full
in order to earn high profits. The economic concept of adverse selection
and moral hazard provide a frame work for understanding the principle
that financial institutions have to follow to reduce credit risk and make
successful loans (Mishkin, 1997). Adverse selection in loan markets
occurs because bad credit risks are the ones who usually line up for loans;
in other words, those most likely to produce an adverse outcomes are
most likely to be selected. Borrowers with very risky investment projects
have much to gain if their projects are successful, and so they are the
most eager to obtain loans. Clearly however, they are the least desirable
borrowers because of the greater possibility that they will be unable to
pay back their loans, Mishkin asserts.

Moral hazard exists in loan market because borrowers may have

incentives to engage in activities that are lenders point of view. In such
situation it is more likely that the lender will be subjected to the hazard
default. Once borrowers have obtain a loan, they are more likely to
invest in high risk investment projects- projects that pay high return to
the borrowers that are successful. He asserts further that the high risk;
however, make it less likely that they will be able to pay the loan back.

To be profitable, financial institutions must overcome the adverse

selection and moral hazard problems that make loan default more likely.
The attempts of financial institutions to solve the problems help to
explain a number of principles for managing credit risk; screening and
monitoring, establishment of long-term customer relationship, loan
commitments, collaterals, compensating balance requirements and
credit rationing. Credit risk management is very important to banks as it
is an integral part of loan process. It maximize bank risk-adjusted rate of
return by maintaining credit risk exposure with a view to shield the bank
from the adverse effect of credit risk.

Various risks prompt management to put in place adequate internal

o trols to itigate the i pa t the out o e ay ha e o the a k’s
earnings. While some risk factors are visible others are hidden and
therefore may not be obvious to the bank management to put in some
prudent internal controls and measures to prevent or minimize their
potential adverse effect. Hence credit risk management is an important
and inevitable and any financial institution seeking to grow its returns
has to put in place measures to curb such losses.

1.2 Statement of the problem

Sound financial management is a prerequisite for financial institution

stability and continuing profitability. Credit risks are enhanced by poor
management policies. Therefore, adequate management of risk
exposure by rural and community banks is critical for their growth and
survival. The fundamental idea in banking sector is the relationship
between credit risk and return -meaning that the greater the risk
premium a bank is willing to take on, the greater the potential return,
but such a situation exposes the bank to a greater potential of credit risk
or loan default. The banks therefore need to identify the optimal level
which they must hold as their portfolio in order to curb such possible
defaults in loans.

Therefore it is absolutely imperative for rural and community banks to

employ effective credit risk management strategies to reduce default
rate and gross non-performing loans to as low as 1% of the total amount
lent.

1.3 Objectives of the Study

The general objective of the study is to examine the diverse types of risk
and the credit risk management practices of AKUAPEM RURAL BANK. The
study seeks to:

 Measure the effect of the risk management practices of AKUAPEM

RURAL BANK in respect to revenue generation and its cost
effectiveness.
 Estimate the credit risk management practices implemented by
AKUAPEM RURAL BANK
 Rough draft the risk factors associated with the loan portfolio of
AKUAPEM RURAL BANK.
 To make policy recommendations based on the findings from the
thesis.
1.4 Research Questions

The study seeks to address the following questions:

 To what level has risk management practices implemented by

AKUAPEM RURAL BANK reduces the associated risk factors?
 What are the various risk factors linked with AKUAPEM RURAL
BANK?
 To what level have these credit risk practices influence the profit
levels of AKUAPEM RURAL BANK?

1.5 Justification for the Study

Effective risk management is critical to the long-term sustainability
of any Banking Institution since it protects the interest of
shareholders and prevent bankruptcy. It also plays the vital role in
the performance of a financial institutions as it analyses the
creditworthy abilities of borrowers. However, if there is any
loophole in credit risk assessment, then recovery of the provided
loans and advances are challenged greatly. Therefore it is justifiable
because the findings of the present study will help financial
institutions to verify whether demographic and behavioral
characteristics such as occupation, marital status, gender, age
distributions among others determines the credit worthiness of
borrowers and also identify some of the common risks faced by
rural and community banks (RCBs) to aid them improve upon their
service delivery and in so doing strengthen their support for
indigenes of Akuapem and beyond. The findings of the study will
also serve as policy recommendation to policy makers and the
Association of Rural Banks (ARB) Apex Bank in designing and
 implementing effective risk management policies for the Rural and
Community Banks in Ghana.

1.6 Literature Review

Mark (2007) says that risk management is the logical process used by
business firms and individuals to deal with their exposure to loss. It is a
strategy of pre-loss planning for post-loss resources. Risk management
describes an ongoing process for dealing with the possibility to loss. The
main purpose of the credit risk management is to lessen or diminish the
effects of the non-performing loans came from the consumers. The
procedures and processes of the banks and their affiliates create a great
impact in the flow of the financial resources. However, various economic
uncertainties, international markets, or financial constraints can cause
the financial status to be unstable. Aside from the financial deficiencies,
the other causes of the financial constraints are the lack of confidence
among the financial market to provide external help for the needed
consumers, lack of capability to gather the information of the
consumers, and the lack of push to have an aggressive debt collecting.
The non-performing loans can definitely cause too much stagnation of
the financial sources. To provide the credit risk management effectively,
the banks and other financial institutions should asses the credibility of
the loaners. In terms of an enterprise, the assessment of their credit
portfolio is enough to provide a system that continuously promotes the
reviewing the risks and the capability of the business enterprise to pay.

. The economic theory in banking encompasses the interest and income

theory in which is the basis of the cash flow approach in bank lending
(Akperan, 2005). The importance of the credit risk management is
recognized by banks for it can establish the standards of process,
segregation of duties and responsibilities such as policies and procedures
endorsed by the banks (Focus Group, 2007).

Credit risks appear in banking institution because of the uncertainties

plagued by the financial system. The uncertainties remain a major
challenge in country. Still, the major approaches applied by the banks are
the continuing efforts on research and close monitoring. Banks believe
that the research and monitoring are the key sources of uncertainties
like data generating institutions and the treasury (Uchendu, 2009). The
market structure is important in banking for it influences the
competitiveness of the banking system and companies to access to
funding or credit investment. The economic growth affects the structure
and development of the banking system. In addition, the vast knowledge
in risk assessment and managerial approach is recognized as part of the
development. Moreover, because the banks and the processes are highly
regulated, it became very useful in assessing the effects or impact of the
credit risk management in the banks and even in other financial sources
(Gonzalez, 2009).

1.7 methodology

1.7.1 Conceptual framework

Conceptual framework presents diagrammatically and discusses the

interrelationship among the variables that are integral to the dynamics
of the situation. This conceptual framework has been developed by the
researcher to help in the analysis of the critical factors that affect credit
risk management in rural and community banks; it also helps one to
assume and test certain relationships and thus improve the
understanding of the situation. In this framework, lending activities and
the effectiveness in managing credit risk depends on the credit risk
exposure and credit risk management strategies employed by rural and
community banks. Government policies such as taxes and central bank
regulations; and environmental factors such as political and financial
affect both independent and dependent variables. The conceptual
framework is presented in figure 1.0

Figure 1.0

Dependent variable Independent variable Intervening variables

Effectiveness of reducing Credit risk management  Government

credit risk: strategies: policies e.g. central

 Lending frequency 
bank regulations

 Default 
Risk based pricing
 Environmental
and taxes.


and Covenants

 Bank 
exposure. Diversification factors e.g. political
lending Loan sales and financial
activities activities.

1.7.2 Data and Sampling Techniques

The study will engage both primary and secondary data for its analysis.
For the primary data collection, interviews and questionnaires will be
directed to only clients and staff (branch managers, credit analyst and
loan officers) of Akuapem Rural bank. Secondary data will be sourced
from their annual reports and the official website.

Due to budget limitations and time, a sample size of 50 clients will be

selected for the study. Haphazard sampling technique will be used in
selecting the clients. Thus, the researcher will be present at the premises
of Akuapem Rural Bank at random time periods and questionnaires will
be administered to clients who visits bank at the time the researcher will
be around. Gyemibi et al (2011) argues that this sampling technique
helps to reduce bias in sampling as the researcher has no a priory
information of the respondents (clients) who will be selected.

Empirical Analysis
The study will employ descriptive statistics (graphs, charts and tables) to
investigate the risk factors associated with the loan portfolio of the bank
and to help identify the most significant risks factors.

1.8 Organization of the Study

The study will be organized as outlined below:

 Chapter o e……I trodu tio to the study

 Chapter t o…...Literature review

 Chapter three….De elop e t of ethodology

 Chapter four……A alysis of results

 Chapter fi e …..Co lusio a d Poli y Re o e datio

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