Page 1 of 8

Journal for Studies in Management and Planning

Available at http://edupediapublications.org/journals/index.php/JSMaP/

e-ISSN: 2395-0463

Volume 02 Issue 3

March 2016

Available online: http://edupediapublications.org/journals/index.php/JSMaP/ P a g e | 89

Credit Risk and Bank Profitability: Evidence from Ghana

Stock Exchange

Richard Takyi Opoku ; Peter Lawer Angmor ; Lawrence Asare Boadi

Department of Banking and Finance Faculty of Accounting and Finance University of Professional

Studies, Accra, Ghana

o.takyi@yahoo.com

Department of Accounting and Finance Faculty of IT Business Ghana Technology University College,

Accra, Ghana

aplawer@yahoo.com

Department of Finance and Accounting ASN Investment Ltd, Accra, Ghana

Correspondence: aplawer@yahoo.com

Abstract

This study analyzed the relationship between

credit risk and profitability of banks on the

Ghana Stock Exchange. A secondary data in

a panel form of seven banks listed on the

Ghana Stock Exchange was examined over a

period of nine years, using a linear multiple

regression model. One key measure of

profitability was analyzed in this study that is

return on equity. The independent variables

included in the regression model were non- performing loan to total loans and advances,

and loans and advances to total deposits,

bank size, leverage and growth. The results

for the study indicate that non-performing

loan to total loans and advances and loans

and advances to total deposits have

significant negative relationship with return

on equity. Furthermore, a negative

insignificant relationship was established

between size and return on equity but

significant positive relationships were found

between growth and leverage and

profitability.

It was recommended that Credit officers

should ensure that customers looking for

loans meet all the necessary requirements

through proper due diligence.

Key words: Credit risk, Profitability, Ghana

Stock Exchange, panel data, regression

1.0 Introduction

Banks are relevant to economic development

through the financial services they provide.

Their intermediation role can be said to be a

catalyst for economic growth. The efficient

and effective performance of the banking

industry over time is an index of financial

stability in any nation. It is believe that the

extent to which a bank extends credit to the

public for productive activities accelerates

the pace of a nation’s economic growth and

its long-term sustainability (Funso et al

2012).

Credit creation is the main income generating

activity for banks, but this activity involves

huge risks to lenders. A bank with high credit

risk has high bankruptcy rate and that puts

depositors in a dangerous state and may even

lead to bad reputation, withdrawal of license

or even the collapse of the bank. However, in

a bid to survive and maintain adequate profit

level in this highly competitive environment,

banks tend to take excessive risks, yet, the

increasing tendency for high risk taking has

resulted in insolvency and failure of a large

number of banks all over the world.

Page 2 of 8

Journal for Studies in Management and Planning

Available at http://edupediapublications.org/journals/index.php/JSMaP/

e-ISSN: 2395-0463

Volume 02 Issue 3

March 2016

Available online: http://edupediapublications.org/journals/index.php/JSMaP/ P a g e | 90

The banking industry in Ghana is no

exception to the issue of loan defaults.

Indeed, a Bank of Ghana study in 2011

clearly established that non-performing loans

ratio which directly affects credit risk

increased from 16.2 percent in 2009 to 17.6

percent in 2010. In spite of that, profitability

in the banking industry still went up over the

same period. On the basis of such revelation

by the central bank’s study, the question that

arises is does credit risk affect the

profitability of banks in the country?

The banking industry in Ghana has

experienced massive growth in the last

decade and that has also increased the level

of credit risk in the sector. Banks in the

country are spending a lot of money in

managing credit risk. However, the effect

that credit risk is having on the profitability

of banks has not been fully explored, hence

the present study.

Although many studies have been done on

credit risk and profitability outside Ghana,

for instance (Franklin, 2012, Funso et al,

2012 and Epure and Lafuente, 2012), not

many studies has been done in Ghana.

Moreover, the few existing studies on Ghana

relied on data that was in existence before the

implementation of the Basel II. For instance

Amidu and Hinson (2006), used data from

1998-2003 whiles Boahene et al (2012) used

data from 2005-2009. However, a lot of

changes have occurred in the Ghanaian

economy since then, issues such as the

commercial production of oil and the

rebasing of the economy have affected the

banking sector. This study therefore has the

main objective to investigate the influence of

credit risk on bank profitability using data

from 2007 to 2014 and focusing on banks

listed on the Ghana Stock Exchange.

As the concept of credit risk management is

gaining roots among the stakeholders of

Ghanaian banks, it is hoped that the findings

of this study will be useful to regulators and

management of banks as it provides evidence

on the relationship between credit risk and

banks’ profitability. This will help them to

come out with relevant policies to protect

banks and their customers in the industry. It

will also help understand why good credit

risk management is vital to the sustainability

of banks, especially emerging banks that

want to be listed on the Ghana Stock

Exchange (GSE).

2.0 Literature Review

Epure and Lafuente (2012) examined banks’

performance in the presence of risk for Costa- Rican banking industry during 1998-2007.

The results showed that performance

improvements follow regulatory changes,

risk explains differences in banks and non- performing loans negatively affect efficiency

and return on assets while the capital

adequacy ratio has a positive impact on the

net interest margin.

Also, Benedikt et al (2007) examined credit

risk management policies for ten banks in the

united states using a multivariate model and

found that banks that adopt advanced credit

risk management techniques (proxies by the

issuance of at least one collateralized loan

obligation) experience a permanent increase

in their target loan level of around 50%.

Partial adjustment to this target, however,

means that the impact on actual loan levels is

spread over several years. The findings

confirm the general efficiency- enhancing

implications of new risk management

techniques in a world with frictions

suggested in the theoretical literature.

An earlier study conducted by Macaulay

(1988) in the United States found that credit

risk management is the best practice in the

bank and above 90% of the banks in the

Page 3 of 8

Journal for Studies in Management and Planning

Available at http://edupediapublications.org/journals/index.php/JSMaP/

e-ISSN: 2395-0463

Volume 02 Issue 3

March 2016

Available online: http://edupediapublications.org/journals/index.php/JSMaP/ P a g e | 91

country have adopted the best practice.

Inadequate credit policies are still the main

source of serious problem in the banking

industry and as result; effective credit risk

management has gained an increased focus in

recent years. The main role of an effective

credit risk management policy must be to

maximize a bank’s risk adjusted rate of return

by maintaining credit exposure within

acceptable limits. Moreover, banks need to

manage credit risk in the entire portfolio as

well as the risk in individual credits

transactions.

It is believed that private Banks are more

serious to implement effective credit risk

management practice than state owned

banks. A study conducted by Kuo and Enders

(2004) of credit risk management policies for

state banks in China and found mushrooming

of the financial market; the state owned

commercial banks in China are faced with the

unprecedented challenges and tough for them

to compete with foreign bank unless they

make some thoughtful change. In this

thoughtful change, the reform of credit risk

management is a major step that determines

whether the state owned commercial banks in

China would survive the challenges or not.

In another study, Kargi (2011) evaluated the

impact of credit risk on the profitability of

Nigerian banks. Financial ratios as measures

of banks’ performance and credit risk were

collected from the annual reports and

accounts of sampled banks from 2004-2008

and analyzed using descriptive, correlation

and regression techniques. The findings

revealed that credit risk management has a

significant impact on the profitability of

Nigerian banks. It concluded that banks’

profitability is inversely influenced by the

levels of loans and advances, non-performing

loans and deposits thereby exposing them to

great risk of illiquidity and distress.

In a related study, Kithinji (2010) assessed

the effect of credit risk management on the

profitability of commercial banks in Kenya.

Data on the amount of credit, level of non- performing loans and profits were collected

for the period 2004 to 2008. The findings

revealed that the bulk of the profits of

commercial banks are not influenced by the

amount of credit and non-performing loans,

therefore suggesting that, variables other than

credit and non-performing loans impact on

profits.

In Ghana, Amidu and Hinson (2006)

examined how credit risk affects a bank’s

capital structure, profitability and lending

decisions of banks in Ghana. The study

employed panel regression analysis to

investigate the relationship between credit

risk exposure and bank capital structure,

profitability and lending decisions. The

results indicate that less than 1% of Ghanaian

banks are exposed to credit risk, and that

more than 86% of their assets are financed by

debts. The banks’ average lending rate is

around 28%. The results also showed that

capital structure (equity to total assets) of

banks is positively related to banks’ credit

risk, profitability and risk and negatively

related to banks’ size, liquid assets and

lending.

Similarly, Boahene et al (2012) conducted a

study on credit risk and profitability of

selected banks in ghana and concluded that,

credit risk (non-performing loan rate, net

charge-off rate, and the pre-provision profit

as a percentage of net total loans and

advances) has a positive and significant

relationship with bank Profitability.

However, it must be indicated that data for

the above studies were there before the

implementation of the Basel II in the country.

Moreover, a lot of changes have occurred in

the Ghanaian economy since 2010. The

present study is therefore necessary to assess