A CASE STUDY OF NATIONAL INVESTMENT BANK LIMITED (GHANA) 21
RISKMANAGEMENT AND BANK PERFORMANCE: A CASE STUDY OF NATIONAL INVESTMENTBANK LIMITED (GHANA)
Masterof Business Administration (MBA)
Thisresearch has not been previously accepted for any degree and is notbeing currently considered for any other degree at any otheruniversity.
Ideclare that this Dissertation contains my own work except wherespecifically acknowledged
StudentName and Number
Riskmanagement practise has been widely adopted by organisations with afocus on reducing the incumbent risks as well as taming andcurtailing imminent risks that are predicted to affect theirbusinesses. The Ghana banking sector has recently experienced aturbulence in their operations which has led to most of thecommercial banks record a decline in their profit in the year 2012.This observation puts into question the risk management approachesbeing applied by these banks as well as their effectiveness. Toeffectually manage risks, there are basic principles applied on ageneral scenario while more detailed and specific practises apply tobanks in different risk situations. This dissertation takes intoaccount the risks that banks face and how they affect theirprofitability. The risk mitigation processes that are applied to thebanks are being probed to establish whether they are linked to thebank’s performance. When querying the management process forunderlying risks to a bank, the management of that bank is alsoqueried on the basis of their leadership. The dissertation thus takesthe form of questioning the leadership processes in a bank, theireffects on risk management processes and also the effectiveness ofthe processes to the bank’s performance.
1 Chapter One 7
1.1 Introduction 7
1.1.1 Background to the study. 7
1.1.2 Overview of the study institution. 9
2 Chapter Two 14
2.1 Literature Review 14
2.1.1 Introduction to the literature review. 14
2.2 Definition of Risk 14
2.3 Risk Management 16
2.4 Risk Management in Banking 17
2.5 Rationales for Risk Management in Banking 19
2.6 Key Risks Faced by Banks 20
2.6.1 Market Risk. 20
2.6.2 Credit Risk. 26
2.6.3 Operational Risk. 27
2.7 Risk Management Process 28
2.8 Measures of Bank Performance 29
2.9 Risk Management and Bank Performance 33
2.10 Summary 36
3 Chapter Three 37
3.1 Methodology 37
3.1.1 Introduction. 37
3.1.2 Strategy and Design. 37
3.1.3 Population and Sample. 38
3.1.4 Instrument. 40
3.1.5 Data collection and Analysis. 41
4 Chapter Four – Data Analysis 43
4.1 Balance Sheet Risks 43
4.1.1 Assets. 43
4.1.2 Liabilities. 44
4.1.3 Equity and Capital Adequacy. 46
4.2 Income Statement Risks 47
4.3 Credit Risk 48
4.4 Liquidity Risk 51
4.5 Interest Rate Risk 53
5 Chapter Five 56
5.1 Conclusion 56
6 Chapter Six 62
6.1 Recommendation 62
7 Chapter Seven 64
7.1 Evaluation 64
8 BIBLIOGRAPHY 66
Background to the study.
Thefinancial market crisis that happened in 2007 is still considered thebiggest financial shock since the Great Depression, causing heavydamage on markets and institutions at the core of the financialsystem (IMF, 2008). Evidence suggests that the banking sector was themost affected sector in the financial industry during the crisis.Estimations prior to the demise of Lehman Brothers recommended thatU.S. banks and investment banks stood lose up to $250 billion fromtheir exposure to household mortgages securities (IMF, 2008). As aneffect, the banking sector became a regular target for tougherregulations, public anger and academic critics.
Severalfactors were identified to contribute to the current financialcrisis. Amidst them involved improvement in innovation linked withfinancial products and their evolving complexity. It also includedunseemly administration and supervision of financial markets as wellas poor or slack risk mitigation practices at banks and otherfinancial institutions. Other issues noted included the increasedcomplexity of financial systems, financial market speculation,predatory lending practices, and a combination of cyclical andstructural factors (Daianu & Lungu, 2008). There is a nearlyunanimous view among the regulators that lapses in risk managementplayed a critical role in worsening the current crisis. For instance,the President’s Working Group on Financial Regulation (2008),writing in March just before the Bear Stearns collapse, cited riskmanagement weaknesses at some large U.S. and European financialinstitutions as one of the primary underlying reasons of the uproarin financial markets. That report faulted regulatory policies,including capital and disclosure requirements that failed to mitigaterisk management weaknesses. Similarly, Hull (2007) argued that manyof the disastrous losses of the 1990s, such as those of OrangeCountry in 1994 and Barings Bank in 1995, would have been avoided ifgood risk management practices have been in place. Thus, riskmanagement has become an important tool, from which banks try toachieve legitimacy in the eyes of the public and regulators.
Followingthis risk management discourse, policy makers and stakeholders in thebanking industry in the world, including Ghana have emphasized riskmanagement, rather than the returns made from the sector. The effectof the current financial crisis on developing countries includingGhana was minimal largely because the banking sector in thesecountries has little exposure to complex financial instruments.However, it served as a necessary prompt to all financialinstitutions. Ackah, Aryeetey and Aryeetey (2009) identified twochannels through which the crises may affect developing countries.The first-round effects are expected to occur in financial sectorsand then spread to the real sectors of the affected countries. Thefinancial sector outcomes involve those emerging via channels such asstock markets, banking sectors and foreign direct investment (FDI).The real sector influence could be propagated through effects ontransmittals, trade, and aid.
Althoughthere has been an improvement in the asset quality of the Ghanaianbanking industry in the past four years, estimates byPricewaterhouseCoopers (2013) has it at 2.3%, which has remained thesame as in 2012 estimate. This improvement has been attributed tobetter origination, monitoring and aggressive remediation fordefaulting customers which are risk management measures. What thenis risk management? According Kaen (2005) risk mitigation is definedin the financial literature as being concerned with recognizing andthe management of an organization`s exposure to financial risk. Thisexposure is defined as the variability in cash flow and market valueresulting from random changes in the products prices, interest rateand the exchange rate. Risk can be controlled in one of the twoessential but differing methods. These strategies are either as onerisk at a time approach, which is based largely on compartmentalizedand decentralized basis or, all risks viewed together within acoordinated and strategic framework. The latter approach to riskmanagement is often called enterprise risk management (ERM). Noccoand Stulz (2006) argued that companies that succeed in creatingeffective ERM have the long-run competitive advantage over those thatcontrol and supervise risks as an individual approach. This meansthat, by managing their risks systematically, and by giving itsbusiness managers the information and incentives to optimize thetrade-off between risk and return, a company strengthens its abilityto carry out its strategic plan. This study contributes to theliterature on ERM by conducting a thorough examination of theframeworks used to manage risk in the Ghanaian banking sector, usingNational Investment Bank Limited as a test case. In addition, thestudy will have the implication in the current global regulation thatfocuses on the need for banks to show strong risk management andcapital adequacy strategies. The importance of this dissertation isits immense contribution towards the application of my knowledge inrisk management practises by assessing the systems that are laid outby NIBL. The bank is ideal since it is located in my hometown and isknown to be one of the several banks that have recorded an incrementin profit in the year 2012 when many banks recorded a drop in theirprofit margin.
Overview of the study institution.
TheNational Investment Bank Ltd. is marked as the first developmentalbank in Ghana that was established in 1963 to encourage and empowerrapid industrialization in Ghana. The bank now operates as auniversal bank focusing on development/commercial banking activities.The bank has its financial and other regulatory reports published,making it easy to access basic information on its operations. Thebank is currently among the first 12 banks in Ghana with a totaloperating asset of GH₵ 836, 798 as of the end of the year 31stDecember, 2012 (PwC, 2013). The NIBL bank was bestowed theprestigious Euro Market Award in 1994 and 2003 Best Bank of the yearfor long Term Long Financing. Current estimates show that NIB hasexperienced a decline in the growth of its market share of loans andadvances over the period of 2009 to 2012. In addition, there has beena decline in its contribution to the industry deposit between 2011and 2012 from 4.7% to 3.2% leading to a loss of market share of 1.1%.
Thereis deterioration in its assets quality ratio from 4.5% in 2011 to7.3% in 2012 (PwC, 2013).NIB continues to improve the quality of itsloans it still appears to have a relatively poor quality loanportfolio compared to its peers in the second quartile category. Thisimprovement has been partly attributed to the inherent riskassociated with its core business. As part of its businesstransformation, NIB is aggressively pursuing recovery ofnon-performing loans. The bank set up an asset recovery trust in 2010to recover loans from defaulters. Further, NIB has focused onenhancing its risk management and credit administration practices(PwC, 2014).
1.1.3Statement of the problem.
Theprior two decades have witnessed a dramatic transformation in therole of risk management practises in financial institutions. Ofcourse, the literature is clear on the role played by risk managementin determining the success and failure of institutions. Nocco andStulz (2006) argued that risk management creates stakeholder value byits effects on organizations at both the company-wide level and thebusiness-unit level. At the macro level, risk management createsvalue by enabling senior managers to quantify and manage risk-returntrade-off that faces the entire firm. This practice helps the firmmaintain access to the capital markets and other resources necessaryto implement its strategic and business plan. At the micro-level,risk management becomes a way of life for managers and employees atall levels of the company. A well-designed risk management systemensures that all material risks are ‘owned’, and risk-returntrade-offs carefully evaluated throughout the firm.
Despitethe importance of risk management, not much is known about thechannels of risk management and bank performance in Ghana. The lackof knowledge is mainly because there is a common assumption that thebanking sector in Ghana is comparatively stable with different bankshaving good risk profiles and valid risk management frameworks.Although the banking industry in Ghana has not experienced majorshocks in the face of the global financial crisis, the sector haswitnessed worsening asset quality due to weak macroeconomic factors.There is, therefore, a gap in knowledge between the general beliefand empirical evidence of the risk position of Ghana bankingindustry. Estimates from the Ghana Banking Survey indicate that thereis an inherent risk associated with the core business of NIB (PwC,2013). This risk is causing its relative poor performance in relationto its peers in the second quartile category. The objectiveunderlying this study is to examine the causes of the risk and howthis can be anticipated and managed to improve the performance of thebank. This exploration will involve a thorough assessment of the riskprofiles of the bank as well as evaluating the adequacy of the riskmanagement framework employed by it to handle risks it isexposed(PwC, 2014).
Theprincipal research issue of the study is a hypothetical questionposed as: ‘How does risk management affect a bank’s performance?’The dissertation addresses a case study of the National InvestmentBank of Ghana.
1.1.5Aim and objectives.
Themain aim of the study is to develop the understanding of the roleplayed by risk management in the performance of banks in thefinancial industry. The specific objectives are:
• Researchthe arguments/theories/concepts of risk management and performance.
• Investigatemodels of risk management and how they apply to NIB.
• Identifythe methodologies used by banks to identify, assess and mitigaterisk.
• Explorethe relationship between risk management and bank performance.
• Analysethe risk management practices and make recommendations.
1.1.6Perceived value of the study.
Thefindings of the study will provide an indication of how the riskmanagement landscape looks like in Ghana’s banking industry, giventhat there are no significant differences in the risk managementmodels being applied in Ghana. In addition, the study will contributeto the literature on enterprise risk management and its importance inenhancing performance in an organization. Also, it will contribute tothe recent global regulation that focused on the need for banks todemonstrate strengthened risk management and capital adequacy (i.e.stress testing). Everyone should understand it has an implication onincreased share price and shareholders’ premium, thereby enhancingtheir competitive advantage over their existing and potentialcompetitors. Last but not least, lecturers and students who wish toconduct research in this area are expected to benefit from thefindings of this study by serving as a benchmark for risk managementand performance relationship researches.
1.1.7Overview of the Dissertation Chapter Contents.
Chapter2: this chapter covers the literature review. It begins withdeliberations and explanations of concepts and arguments of riskmanagement and channels it to bank performance, after which models ofrisk management will be explored. In addition, methodologies of riskmanagement processes will be outlined. Some empirical studies on riskmanagement and corporate performance will also be highlighted.
Chapter3: this chapter covers the research methods that comprise theresearch philosophy and strategy, data collection, selection of datacollection method, sampling, tools of data analysis and ethicalconsideration.
Chapter4: this chapter deals with the presentation of the findings andanalysis of secondary data collected and also a general assessment ofthe risk profile of NIB. It also presents the primary data on riskmanagement processes of the study organization as a supplement to thesecondary data.
Chapter5: highlights the gives the conclusions drawn on the basis of thefindings and the objectives of the study. This section explores ananswer the research question of the study.
Chapter6: deals with the recommendations for use by the various stakeholdersincluding managers of banks, shareholders, regulators and bankclients to enhance risk management practices as a way of improvingperformance.
Chapter7: This last chapter deals with the evaluation of the research. Thechapter aims at assessing the strengths and weaknesses of the studyand gives suggestions for future research in risk managementpractices and bank performance.
Introduction to the literature review.
Theliterature review is the process of exploring all the available ordocumented information regarding the topic under study. Suchinformation will be available in journals, magazines, officialcompany websites, government websites and other public informationsystems, news media, and other related information libraries. For thepurpose of this study, the review is organized into three broadareas: definitions and expositions on basic concepts as used in riskmanagement, as well as highlighting the key risks faced by bankstheories and models that provide the rationale for risk managementand how they apply to the banking sector and empirical evidence ofthe relationship between effective enterprise risk management andbank performance.
Definition of Risk
Therisk is everywhere and always has been. Although industrial risks,environmental risks and health risks seem new, they have been aroundsince the origin of humanity. Human have always tried to be safethat is, to capitalize on their safety, or at least the feeling ofsafety. Thus, the aim has always been to minimize and manage risksthem where possible (Ale, 2009). He further recorded that so as toget why risk management looks so distinctive today and why there issuch pressure in formulating an organized policy on risk, one has toknow the risk, how to measure it, and assess it. What then is risk?Diverse scholars have given us various views about risk yet virtuallyall acknowledge that it is difficult to measure risk since there areno specific limitations to define it (Ale, 2009 Power, 2007).
Willett(1901, cited in Ale 2009, p.4) defined risk as “Theobjectified uncertainty regarding the occurrence of an undesiredevent”and Knight (1921, cited in Ale 2009) as “Measurableuncertainty”.Ale (2009) argued that in financial markets, the risk is customarilycorrelated with wasting money as an outcome of investments becomingbad, mortgages going unpaid back or fraudulent bookkeeping. Accordingto Oxelheim and Wihlborg (1997) risk is a measure of the magnitudeand timing of the unanticipated changes estimated relative to theanticipated changes in the variables. Unexpected changes, therefore,constitute an inherent quality of the word risk. Anderson and Terp(2006) mention that risks can be defined according to the occurrenceof unwanted, harmful effects based on various forms of uncertainty.Whereas, he explained, the nature and extent of risks theorganization may meet are based on such elements as size and theforms of the business operations. Al-Tamimi and Al-Mazrooei (2007)state that risks are either classified as systematic or unsystematic.In this case, the systematic risks are those that are universallypresent in the market segment and cannot be conventionally avoidedthrough, for instance, diversification. Unsystematic risks arepersonal and unique to the business.
Andersonand Terp (2006) identify that common types of risks are market,credit, business, financial, operational, and reputational risks.However, according to Robertson (2005), risks are classified intotwo, the realistic risk, and the potential risk. Realistic risks aregrounded on the identified threats, for instance, the loss ofprofits, overseas regulations, and legislative decisions. Potentialrisks may take place or not, but there is the need for an emergencyplan to be in place to help reduce or stop the impact. Examples ofpotential risks include poor decision-making by the executive, stockmarket crisis, terror attacks, natural calamities, and employeesleaving the company. However, whereas the potential can arise fromeither external or internal forces, most of the real world risks arefrom the external forces and may not be easily handled. According toTcankova, (2002) companies should have it in their policies tocounter such risks through undertakings such as proper regulations,checks, and formation of alliances with other partners.
Althoughscholars had sought to answer the question concerning what risk is?Power (2007) argued that defining risk is less important than thequestion that bothers on how we get to know risk and the social andeconomic institutions which embody that knowledge. Similarly, Laneand Quake (2001) opinionated that in an effort to perceivecross-organizational ramification in the bank managerial tradition ofrisk assessment, it is crucial to consider the institutionalenvironment in which these associations are implanted. Therefore, ina broader perspective, this study’s theoretical framework isanchored in the recent acknowledgment of social and cultural elementsof risk management (Talyor-Gooby & Zinn, 2006).
Riskmanagement can be defined in different ways by different academicsources. Anderson and Terp (2006) define risk management as theentire process of trying to control, mitigate or absolutely removerisks, whereas increasing the benefits, and blocking detriments thatcould emerge from speculative vulnerabilities in businessoperations. The operative importance of risk management in thisconcept is the idea of minimizing all likelihoods of realising lossesin the future, while at the same time increasing the profitability ofa business of company.The Committee of Sponsoring Organizations of the Treadway Commissiondefines managing risk as
“……….aprocess effected by the body’s management, board of directors, andother personnel, implemented in strategy setting within the company,designed to identify some of the potential threats the company faces,and manage such risks to be within the company’s control andgenerate a reasonable assurance as with regards to the attainment ofthe company’s goals and objectives…” (Committeeof Sponsoring Organizations of the Treadway Commission, 2004, p. 1).
Redja(1998) also describes risk management as a well-organized method forthe classification, evaluation of absolute loss vulnerability facedby a company, and for the selection and implementation of the mostsuitable techniques for managing such exposures. The method requiresidentification, determination, and control of the risks. Bessis(2010) also adds that in addition to it being a process, riskmanagement also involves a set of tools and models for measuring andcontrolling risk. According to SBP (2003) management of risk, entailshaving in place an effective combination of processes, as well aspeople and procedures that act in tandem to the process of minimizingthe risk. In this regard, Funston and Galloway (2004) highlight thata good risk management process should bring a strategic alignment ofpeople, resources, processes, knowledge and technologicaladvancements with the ultimate purpose of managing risk outcomes inthe process of creating value within a business framework. Altman andCooper (2004) consider risk management as a field that “goes beyondregulatory compliance and crisis management to generate a structuredand tangible approach to tackling both the financial andorganizational risks, having the ultimate aim of enhancing thecompetitive advantage and shareholder value (Altman & Cooper,2004)”. If management procedures are properly formulated,businesses are going to realize better profits while reducing risksand all risk-related losses.
Risk Management in Banking
Riskmanagement is outlined in the financial history as being involved inrecognizing and managing a firm’s vulnerability to financial risk.Financial risk can thus be regarded as the variability in cash flowand market value brought about by random changes in the commodityprice, interest rate and exchange rate (Kaen, 2005). Financial riskmanagement has become a booming industry in the 90s as an outcome ofthe increased volatility of financial markets, financial innovations,the expanding role performed by the financial product in the processof financial intermediation, and significant financial deprivationsexperienced by the corporations without risk management systems (forexample, Enron and WorldCom). Thus, risk management developed from astrictly banking activity to a very elaborate set of methods andinstruments in the recent financial environment. Each transactionthat a bank undertakes, however, changes the risk profile of the bankthereby making it a near impossibility to provide real-time riskupdate and profile of the institution.
Itmust be emphasized that some risk management practices in the bankingand financial institutions in recent years are driven by the need tomeet the regulatory requirements requirement as set by suchinitiatives as Basel II. The objective of Basel II is to form aglobal model that banks could use when making rules about how muchcapital they need to put aside to guard against numerous types ofrisks. Basel II seeks to develop on the existing rules by bring intoline regulatory capital requirements more closely to the primaryrisks that banks face. It rests on three pillars: minimum capitalrequirements, the supervisory review process, and market discipline(Cornalba & Giudici, 2004 Chapelleet al. 2004 Bonson et al.2007 Moosa 2008). Basel II rules urge banks to focus on thefollowing three important risk areas credit risk, market risk andoperational risk. Phyle (1997) argued that it is a serious error tothink that meeting regulatory requirements are the single or mostsignificant purpose for the establishment of sound, scientific riskmanagement systems. For banks to be able to operate in a sound riskmanagement environment with the reduced impact of potential anduncertainty losses, managers need consistent risk measures to directcapital to activities with the best risk/reward ratios. Managementneeds estimates of the size of potential losses to stay within limitsset by careful internal considerations and by regulators. They alsoneed mechanisms to screen positions and create incentives for prudentrisk taking by divisions and individuals. He further noted that theseneeds can be met by establishing a risk management system that aimsto identify key risks, obtains consistent understandable operationalrisk measures, chooses which risks to be reduced and which to beincreased and by what means and establishes procedures to monitor theresulting risk profile.
Bessis(2010) further designates that the objective of risk managementpractices is mainly to measure risks in order to observe and regulatethem as well as enable it to help other significant roles in a bank.These functions constitute supporting in the implementation of thebank‘s terminal policy by equipping it with a greater view of thefuture and thus defining relevant business system and aiding ingenerating competitive advantages. This competitiveness comes throughthe calculation of relevant pricing and the formulation of otherdifferentiation approaches based on the customer’s risk profile.
Rationales for Risk Management in Banking
Itis often expedient for any discussion of risk management to commencewith the question: why do institutions manage risk? According totypical economic theory, managers of value exploiting firms ought tomaximize expected revenue without regard to the variability (risk)around its expected value. Nevertheless, there is now a growingliterature on the explanations for active risk management includingthe work of Sharfstein and Frootand Stein (1993) Stulz (1984),Wolford (1990), and Smith, Smithson, to name but a few of the morenotable contributions. In reality, the recent review of riskmanagement stated in Santomero (2005) lists dozens of contributionsto the area and at least four distinct rationales offered for activerisk management. These include managerial self-interest, thenon-linearity of the tax structure, the costs of financial distressand the existence of capital market inadequacies.
Ineach case, the volatility of profit causes a lower value to at leastsome of the firm’s shareholders. In the first case, it is notedthatadministrators have limited capability to diversify their venturein their own firm, due to inadequate wealth and the concentration ofhuman capital revenues in the firm they manage. This fosters riskaversion and a partiality for stability. In the second case, it isnoted that, with progressive tax schedules, the expected tax burdenis reduced by reduced instability in reported taxable income. Thethird and fourth explanations focus on the fact that a decline inproductivity has a more than proportional impact on the firm’sprosperities. Financial distress is costly and the cost of externalfinancing upturns rapidly when firm viability is in question. Any oneof these explanations is sufficient to motivate management to concernitself with risk and get on a careful assessment of both the level ofrisk relatedto any financial potential risk and product mitigationtechniques.
Key Risks Faced by Banks
Inthe process of offeringfinancial services, banks assume a number offinancial risk. It must be stressed that these risks differ by thetype of service rendered. Risk, in this study, may be defined asreductions in firm value due to changes in the business environment.Phyle (1997) identified some major sources of value loss whichincluded: market risk, credit risk, and operational risk. These formthe focus of this study, and they are discussed in the subsequentsubheadings.
Phyle(1997) defined market risk as the difference in net asset value dueto fluctuations in underlying economic circumstances such as interestrate, exchange rate, and equity and commodity price. Banks aresubject to market risk in both the management of their balance sheetsand in their trading operations. Thus, it is defined as the risk of abank’s profits and capital brought about by in the market level ofinterest rate or prices of securities, foreign exchange and equities,as well as the volatilities, of those prices. Consequently, there arethree common market risk factors to banks, and these are liquidity,interest rates, and foreign exchange rates and these are explainedbelow.
BankDeposits have a much shorter contractual maturity than loans, andliquidity management needs to provide a cushion to cover anticipateddeposit withdrawals. According to Kanchu and Kumar (2013), Liquidityis the ability to accommodate efficiently deposit as also the declinein liabilities and to fund the loan growth and probable funding ofthe off-balance sheet claims. A bank faces liquidity threat when itdoes not able to accommodate the redemption of deposits and otheraccountabilities and to cover funding increments in the loan andinvestment securities (Kanchu and Kumar, 2013). A bank’s assetsand liabilities are key to balancing their liquidity risk andcreation.
Thereare three main sources of funds for banks: deposit accounts, borrowedfunds, and long term funds. Sources of funds undoubtedly affect howmuch risk a bank has and the extent of the liquidity it can create.The easiness of funding lowers the risk it has and, the larger amountof funds it holds the more liquidity it can create. Consequently,Santomero (2005) argued that liquidity risk is defined as the risk ofan investment crisis. Some people include the requirement to plan forgrowth and sudden expansion of credit, yet, the risk here is moreprecisely seen as the inherent for a funding crisis. This situationwould necessarily be connected with an unforeseen event, such as ahuge charge-off, lack of confidence, or a national proportion crisis.In any case, risk management must focus on liquidity tools anddocuments structure. Understanding liquidity risk leads the bank toidentify liquidity itself as an asset and responsibility in the faceof liquidity matters as a hurdle.
Interest rate risk.
Therisk is the potential negative influence on the net interest income.It refers to the vulnerability of an organization’s financialsituation to move with interest rates. Most of the loans andreceivables of the balance sheet of banks and saving deposits producerevenues and costs that are motivated by interest rates and sinceinterest rates are unstable, so is such earnings. Although interestrate risk is obvious for lenders and borrowers with variable rates,those engaged in fixed rate trades are not exempt from interest raterisks because of the opportunity cost that arises from marketmovements (Bessis, 2010). According to the report from the BaselCommittee on Banking Supervision (2004) interest rate risk, can haveunfavourable consequences both on a bank`s earnings and itscommercial significance. This variability has given rise to twoseparate, but interrelated, perspectives used to assess a bank`sinterest rate risk exposure.
Inthe earnings prospect, the centre of critique is the impact ofchanges in interest rates on the accrual or reported earnings. Thisprospect is the common strategy to interest rate risk assessmentpracticed by most of the commercial banks (Bessis, 2010). Change inearnings is an essential focal point for interest rate risk studybecause lessened earnings can threaten the economic stability of anorganization by undermining its capital adequacy and by decreasingmarket certainty. With this regard, the component of incomes that hascommonly gathered the most recognition is net interest income(Valencia, 2010, cited in Hassan, Sidiqi &Tahiri, 2010). Thisfocus shows both the value of net interest income in banks` overallearnings and its link to changes in interest rates. Nevertheless, asbanks are expanding increasingly incorporating activities thatproduce fee-based and several non-interest income, a wider focus onoverall net income has become more common. Non-interest revenue isstemming from several activities, such as loan servicing and variousassets securitisation plans, can be extremely sensitive to, and havecomplicated relations with, market interest rates. Inequality inmarket interest rates can also influence the commercial value of abank`s position in the market. Thus, the subtlety of a bank`sfinancial value of fluctuations in interest rates is an unusuallycritical concern of stakeholders, executives, and superintendentsalike. The financial value of an instrument symbolizes an estimationof the modern value of its anticipated net cash flow, discounted toshow current market rate. Through extension, the commercial value ofa bank can be seen as their current value of their anticipated netcash flows (Valencia, 2010, cited in Hassan, Sidiqi &Tahiri,2010). The latter is determined by the cash flow returns on assetsminus the cash flow returns on liabilities plus the net cash flowfrom OBS positions. In this spirit, the commercial value perspectivereflects a view of the sensitivity of the net value of the bank tofluctuations in interest rates. Given these adverse consequencesresulting from changes in interest rates a more detailed view of thepotential long-term effects of such interest rates changes on itseconomic value is used to assess the interest risk exposure(Valencia,2010, cited in Hassan, Sidiqi &Tahiri, 2010).
Greuningand Bratanovic (2009) hypothesises that banks encounter interest raterisk from four main sources namely reprising risks, basis risks,yield curve risks, and optionality. The primary and most oftendiscussed the form of interest rate risk arises from timingdifferences in the maturity (for fixed-rate) and re-pricing (forfloating-rate) of bank assets, liabilities, and OBS positions. Whilesuch re-pricing mismatches are requisite to the business of banking,they can reveal a bank`s income and underlying financial value tounanticipated fluctuations as interest rates fluctuate. For example,a bank that funds a long-term fixed-rate loan using a short-termdeposit might face a deterioration in both the future income flowingfrom the position and its underlying cost if interest rates rise.These deteriorations arise because the cash flow of the credit arefixed over its life, while the interest repaid on the funding ischangeable and improves after the short-term deposit matures.Re-pricing mismatches can also endanger a bank to variations in theslope and shape experienced over the yield curve. Yield curve risksoccurs when unplanned for shifts of the yield curve have adverseeffects on a bank`s income or underlying economic value. Anothersignificant origin of interest rate risk, referred to as basis risk,arises from the incomplete relationship in the adjustment of therates received and paid on various instruments with contrarilysimilar repricing attributes. When interest rate changes, thedifference that occurs can lead to an abrupt increase the cash flowand earning the spread between assets, liabilities and OBSinstruments of the same maturities or re-pricing rates.
Anextra and frequently important source of interest rate risk resultsfrom the alternatives embedded in many bank assets, liabilities, andOBS securities. Formally, an option affords the holder the power, butnot the necessity, to buy, sell, or in some way alter the cash flowof an instrument or financial liability (Kaen, 2005). Benefits may bestand-alone means such as exchange-traded choices andover-the-counter (OTC) contracts, or they may be fixed withinotherwise conventional instruments. Bonson, Escobar & Flores,(2007) indicates that instruments with set options are important innon-trading activities that reduce risks. Examples of instrumentswith fixed options include various sorts of bonds and notes with callor put terms, loans that give borrowers the right to prepay balances,and several varieties of non-maturity security instruments which giveclients the right to remove funds at any time without any fines. Ifnot appropriately managed, the asymmetrical payoff components ofinstruments with optionality traits can pose important riskespecially to those who sell them, both explicit and embedded(Bonson,Escobar& Flores, 2007). Furthermore, an increasing array ofoptions can involve significant leverage that can expand theinfluences (both negative and positive) of alternative positions onthe economic condition of the organisation.
Foreign Exchange Risk.
Thisrisk is the uncertainty that a bank may experience loss as a resultof unfavourable exchange rate change during a season that it has anopen position in some foreign currency. Bessis (2010) describesforeign exchange risk as incurring losses due to fluctuations inexchange rates. Such loss of earnings may occur due to a mismatch inthe value of assets and that of funds and liabilities indenominations of foreign currencies. It can also be due to a mismatchbetween foreign receivables and foreign payables that are stated indomestic currency. According to Bratanovic and Greuning (2009),foreign exchange risk is speculative. Thus, it can result in a gainor a loss, dependent on the direction the exchange rate shifttowards, and whether a bank is net long or net short in the foreigncurrency.
Inprinciple, the variations in the value of domestic currency thatproduce currency risk result from long-term macroeconomic aspectssuch as changes in foreign and domestic interest rates and thedirection and volume of a country‘s trade and capital flows.Short-term factors, such as expected or unexpected political events,changed expectations on the part of market participants orspeculation based currency trading may also give rise to foreignexchange changes. All these factors can affect the supply and demandfor a currency and consequently the day by day changes of theexchange rates in the currency market.
Foreignexchange risk is considered to comprise of transaction risk, economicrisk, and evaluation risk. Transaction risk is the price-based impactof exchange rate changes on foreign payablesandforeign receivables,that is, the difference in price at which they are collected or paidand the price at which they are recognised in local currency in thefinancial statements of a bank or corporate entity. Alternativelyknown as business risk, economic risk relates to the impact ofexchange rate changes on a country‘s long-term or a company‘scompetitive position. With increasing globalization, capital movesquickly to take the benefit of changes in exchange rates andtherefore deflations of foreign currencies can lead to increasedcompetition in both overseas and domestic markets. This phenomenonmakes this component of foreign exchange risk very critical for itsmanagement. The third component, re-evaluationor translation riskarises when a bank‘s foreign currency positions are re-evaluated indomestic currency, and when a parent institution conducts financialperiodic consolidation or reporting of financial statements. Banksconducting foreign exchange operations are also exposed to foreignexchange risk in forms of credit risks like the default of thecounterparty to a foreign exchange contract and time-zone-relatedsettlement risk.
AcAccording to Phyle (1997), credit risk is defined as the change innet asset value due to changes in the perceived capacity ofcounterparties to meet their contractual responsibilities. There isalways scope for the borrower to default on his commitments for oneor the other reason resulting in the crystallization of credit riskto the bank. These losses could take the form outright default or,losses from changes in securities value arising from actual ordistinguished decline in credit quality that is short of default.Furthermore, Santemero, (2005) posts that credit risk results fromnon-performance by a loanee. It can arise from either an incapacityor unwillingness to act in the pre-committed contracted method. Thiscan affect the lender handling the loan contract, as well as otherbankers to that particular creditor. Consequently, the economiccondition of the loanee as well as the current value of anyunderlying security is of essential interest to the bank. Accordingto Greuning and Bratanovic (2009), formal policies lay down by theboard of directors of a bank and applied by management plays a vitalpart in credit risk management. As a matter of fact, a bank uses alending or credit policy to outline the scope and allocation of abank‘s credit amenities and the manner in which a credit portfoliois managed— that is, how investment and financing assets areoriginated, appraised, supervised, and collected. Credit risk isintrinsic to the business of lending funds to the enterprises linkedclosely to market risk variables (Kanchu and Kumar, 2013). Theintention of the credit risk management is to lessen the risk andmaximize bank’s risk-adjusted rate of return by finding andmanaging credit exposure within the admissible parameters. Themanagement of credit risk includes risk analysis through creditrating, quantification through the estimation of expected loanlosses, pricing on a precise basis, and regulating through effectiveLoan Review Mechanisms.
Bankslive with several risks arising from personal errors, businessfrauds, and natural hazards. The recent incidents such as WTCcatastrophe, Barings debacle, etc. has highlighted the possible losson account of operational risk. Increased growth in the use oftechnology and rise in global economic inter-linkages are the twoprincipal changes that contribute to such risks. The Basel Accord II(Bank for International Settlements, 2005) defines operational riskas the risk of direct or indirect loss emerging from inadequate orneglected internal processes, people, and systems or external events.Similarly, Santemero (2005) argued that operational risks result fromcosts acquired through mistakes made in carrying out activities suchas settlement omissions, failures to meet regulatory obligations, anduntimely collections.
Operationalrisk includes a breakdown in intrinsic controls and corporategovernance resulting to errors, fraud, performance collapsing, andcompromise on the interest of the bank resulting in financial loss.Putting in place proper corporate governance practices by itselfwould serve as an effective risk management tool. It must be stressedthat operational risks are difficult to manage because it isdifficult to establish universally applicable causes or risk factorsthat can be used to develop standard tools and systems of itsmanagement since the events are largely interior to individual banks.Additionally, the magnitude of potential losses from specific riskfactors is frequently not easy to project. Finally, it is difficultdesigning an effective mechanism for systematic reporting of trendsin a bank‘s operational risks because very large operational lossesare rare or isolated. Because of the data and methodologicalchallenges raised by operational risk, the first stage of developingan effective framework to manage it is to set up a commonclassification of loss events that should serve as a repository fordata collection process on event frequency and costs. The datagathered is then analysed (risk mapping) with various statisticaltechniques such as graphical picture of the probability and severityof risks. This helps to find the links amid various operationalrisks. The process then ends with some approximations of worst-caselosses due to events risks. Modelling of loss circulations due tooperational risks will permit the right capital charges to be madefor operational risk as made obligatory by current regulations(Bessis, 2010).In order for the purposes of setting up an operationalrisk management framework to be accomplished, it may require a changein the behaviour and culture of the firm. Management must also notonly ensure compliance with the operational risk policies establishedby the board, but also regularly report to senior executives. Acertain sum of self-assessment of the panels in place to manage andmitigate operational risk will be helpful.
Risk Management Process
Toeradicate risk and to make banking functions run well, there is aneed to manage all kinds of risks correlated with the banking. Riskmitigation becomes one of the main purposes of any bankingco-operation. Risk management consists of recognizing the risk andmanaging them means keeping the risk at admissible level. Theselevels are different from one institution to another and from onecountry to another. The basic objective of risk management is toimprove stakeholders’ value by maximizing the profit and optimizingthe capital funds for ensuring the long-term solvency of the bankingorganization.
RiskIdentification. Thisis the first step to successful risk management practices. Itinvolves writing down the risks and making them visible to allindividual involved in an organisation.
RiskAnalysis. Therisk exposure is expressed as a technique for risk analysis anddescribes some procedures for determining the probability and thesize of a decline.
RiskPrioritisation. Dealingwith the most significant risks first is crucial and important formitigation to succeed. There is often a good deal of obscurity inpredicting the probability or loss connected with a risk. The amountof uncertainty is itself a principal source of risk that should bereduced as early as practicable.
Risk-ManagementPlans. Thefocus of risk management devising is to realize a plan to controleach of the high-priority risks recognized during the precedingactivities. The plan should be recorded and situated around answeringthe standard issues of why, what, when, who, where, and how.
RiskResolution and Monitoring. Afterascertaining a good set of risk management plans, the risk resolutionprocess consists of implementing the risk reduction techniques asidentified in the plans. Risk monitoring ensures that this is aclosed-loop process by tracking risk reduction process and utilizingwhatever improving action is essential to keep the risk resolutionprocess on track.
Measures of Bank Performance
Thedetermination of bank performance individually commercial banks iswell researched and has received increased concentration over thepast years (Seiford & Zhu, 1999). There has been a large figureof experimental studies on commercial bank execution around the world(see Yeh, 1996 Webb, 2003 Tarawneh, 2006). Nonetheless, little hasbeen done on bank performance in Ghana financial sector.Notwithstanding, with the deteriorating health of the bankingorganizations and the recent surge of bank collapses as a result ofthe existing global economic crisis, it is justified that bankperformance holds extended investigation from both scholars andindustry specialists.
Bergerand Humphrey (1997) affirm that the whole idea of regulating bankachievement is to separate banks that are functioning well from thosewhich are performing defectively. They moreover showed that,
“evaluatingthe execution of financial institution can inform government policyby evaluating the effects of mergers,deregulation, and marketstructure on efficiency” (Bergerand Humphrey, 1997 p.175).
Bankregulators screen banks by assessing banks’ liquidity, stabilityand overall production to enable them to intervene when there is needand to estimate the potential for difficulties (Casu, Molyneux &Girardone, 2006). On a micro‐level,bank production measurement can also help improve managerialperformance by recognizing best and worst practices associated withhigh and low systematic efficiency.
Thereare a multitude of measures used to assess bank performance, witheach group of stakeholders having its own focus of interest (Yeh,1996).Amongst the large set of performance measures for banks used byscholarly and practitioners same, a distinction can be made amongtraditional, economic and market-based standards of performance.According to the European Central Bank (2010) the traditionalperformance standards are similar to those realistic in otherindustries, with profits on assets (RoA), return on equity (RoE) orcost-to-income degree being the most extensively used (ECB, 2010). Inextension, given the significance of the intermediation role forbanks, net interest margin is typically monitored(Yeh,1996).The income on assets (RoA) is the net income for the year divided bytotal assets, usually the normal value over the year. RoE is aninternal representation measure of stockholder value, and accordingto European Central Bank, (2010) it is by far the utmost popularscale of performance, since: (i) it proposes a direct charge of thefinancial return of a shareholder’s property (ii) it is easilyavailable for analysts, only relying upon state information and(iii) it allows for separation between different companies ordifferent sectors of the economy. RoE is sometimes decomposed intoseparate drivers: this is called the “DuPont analysis”. The firstcomponent is the net profit margin and the last corresponds to thefinancial leverage multiplier. The cost-to-income ratios confirms thestrength of the institution to generate gains from a given revenuestream. Impairment costs are not included in the numerator. Lastly,the net gain boundary is a proxy for the earnings generation capacityof the intermediation function of banks(ECB, 2010).
Thefinancial measures of production take into report the development ofshareholder value creation and aim at assessing, for any providedfiscal time, the financial results generated by a firm of itseconomic assets mostly as part of its steadiness sheet (SBP 2003).These proposals mainly focus on effectiveness as a central part ofproduction, but regularly have high same of information demands. Twosets of pointers can then be identified amid economic measures ofperformance: 1) Indicators related to the total profit of aninvestment, based on the model of an
“Opportunitycost” the most popular one being economic value added (EVA) (SBP,2003). EVA uses into account the contingency cost for stockholders tohold equity in a bank, measuring whether a firm generates a financialrate of return higher than the price of invested money in order togain the business value of the firm. 2) Indicators related to theunderlying level of opportunity connected with banks’ action.Corresponding to Kimball (1998), for a bank to be successful in itsactions, administrators must weigh complex trade-offs betweengrowths, return and risk, promoting the adoption of risk-adjustedmetrics. RAROC (risk-adjusted income on capital, i.e. the demandedresult above economic capital) allows banks to allocate capital toindividual business members according to their individual businessrisk. As a review evaluation tool, it then assigns capital tobusiness units based on their expected economic use added (Kimball,1998).
Thegeneral RAROC can be derived from the one-factor CAPM as the surplusreturn on the business per unit of market risk (the market price ofrisk). This measure shares in common with the EVA that it takes intoaccount the bank’s cost of capital. But RAROC goes additionalbecause it adjusts the value-added in relation to the money needed.However, writing is quite critical of this measure as a tool toanalyse performance, essentially due to its thorough accountingbasis, while it is difficult to calculate RAROC without having accessto internal data (see Weissenrieder, 1997 Fernandez, 2002 cited inECB, 2010). Furthermore, it appears that RAROC may be suitable forexercises with healthy techniques for measuring statistical risk,such as credit enterprise. On the contrast it may be less suitablefor market activities, given that the value-at-risk (VaR) is still avery incomplete measurement of risk(ECB, 2010).
Market-basedmeasures of performance describe the approach the capital marketsvalue the activity of any given firm, associated with its estimatedaccounting or financial value (Weissenrieder, 1997). According to theEuropean Central Bank, (2010) the most commonly used metrics include:
• The“total share return” (TSR), the ratio of dividends and increaseof the stock value over the business assets price
• The“price-earnings ratio” (P/E), a rate of the financial decisionsof the business over its allowance price
• The“price-to-book benefit” (P/B), which compares the market value ofstockholders’ equity to its book value
• The“credit error swap” (CDS), which is the cost of insuring anunsecured bond of the business for a given time period.
• Thereturn on Assets (ROA), ratio that measures company earnings beforeinterest & taxes against its total net assets.
Thesemetrics among other ratios are the basis of ratio analysis techniquesthat are employed in measuring risk mitigation performance for banks(Musyoki & Kadubo, 2012). It must be stressed here that theglobal monetary crisis shown that the traditional performancemeasures had certain deficiencies and reinforced the need to rethinksome alternative metrics to be used by the financial community (ECB,2010). These alternative measures of performance try to reintroducedrisk culminating from on and off balance sheets of banks(Weissenrieder, 1997).
Risk Management and Bank Performance
Studieson the association between risk management and financial performanceof banks mostly have been conceptual in quality, often drawing thegeneral link between good risk administration practices and improvedbank execution. Schroeck (2002) and Nocco and Stulz (2006) emphasizethe significance of good risks management methods to maximize firms’value. In particular, Nocco and Stulz (2006) suggest that efficiententerprise risk administration (ERM) have a long-run competitiveprofit to the particular (or banks) correlated to those that manageand monitor risks alone. It is, consequently suggested that companiesto control risks strategically by watching all the risks togetherwithin a synchronisedmethod. In connection to this, Stulz (1996)connects practices of good risk management with the removal of costlybut yet lowly performing practises by suggesting “full-cover”risk management as contrasted to “selective” risk management. Theresearch suggests that judicious risks management is important inlimiting the costsof bankruptcy. Moreover, in the case of the UnitedStates, there are possible benefits that risk management could alsodecreasetaxes.
Severalother researches draw the link among good risk management practiceswith enhanced financial performances. Good examples of these studiesinclude Smith, (2000) and Schroeck, (2002) who both look deeply intothis context. In particular, these studies propose that judiciousrisk management practices reduce the instability in banks’financial administration, specifically operating income, earnings,firm’s market value, share return and statement on equity. Schroeck(2002) proposes that ensuring best trainings through prudent riskmanagement result in renewed earnings. Drzik (2005) points that bankinvestment in chance management during 1990s helped to reductionprofits and decay volatility during the 2001 recession. Pagach andWarr (2007) measured cases in so change the firm flat of ERM andfinds that the more established the firms are, the more unstable aretheir profits. Using the danger model to investigate factors thatdetermine firms’ permissions of the ERM, the study reports firmsthat are more levered, extra volatile profits, and poorer stockperformances, are more likely to adopt ERM. In extension, greaterCEO’s option and increasing stock portfolio volatility alsoincrease the possibility for the selection of ERM. The studyrecommends that the ERM is being adopted beyond the essential riskcontrol plan, with balancing CEO risk taking motives and seeking toimprove operating performance as other main reasons to adopt ERM.
Anotherdimension of analysing the relationship between risk management andfinancial performance is offered by Angbazo, (1997) in the study onimpact of risk factors on profitability to a bank. By examining theimpact of risk factors in determining banks’ profitability, thestudy observes that default opportunity is a determinant of banks’net profit border (NIM) and the NIM of super-regional banks and localbanks are susceptible to credit rate danger as well as lapse risk.The study by Saunders and Schumacher (2000) presents extra guide tothe significance of managing risks to economic performance. Bystudying the determinants of NIM for 614 banks of 6 Europeancountries and US from 1988 to 1995, the research finds that attentionrate volatility has a positive significant force on the banksprofitability.
Hakimand Name (2001) examine the correlation between credit risk andbank’s production of Egypt and Lebanon bank in 1990s. Handling datafor banks from the two nations over the period 1993-1999, the studypredicts a fixed impressions model of bank return with varyingappropriate and coefficients. The decisions show that credit variableis positively related to profitability, while liquidity changeable isirrelevant across all banks and have no influence on profitability.The study also finds a powerful link between capital enough andcommercial bank records, with high capitalization being the barrierto return. The research concludes that the capital is a sunk costwith big banks receiving high profits in total but not in interestterms. As a policy connection, the study presents importantinformation for the policy makers in the MENA area to set muchperformance objectives, and enable bank administrators to allocateresources more efficiently across their enterprise units.
Toconclude, this chapter examined the concepts, arguments and theoriesthat provide the justification of the expediency of risk managementin the financial industry as it has an implication on performance.The conclusion gathered from the review underscores the need forbanks to establish an effective risk management framework in order toenhance performance. The dissertation will thus focus on the studiesthat have been carried out to establish the effect that riskmanagement practises in a bank to its performance. There will be afocus on different parameters that assist in measuring the effectsthat risk management practises has on the bank’s profitability. The different ratios applied in risk management studying will also belooked at. The dissertation employs a systematic literature reviewapproach for the research on the risk management effects on Ghanabanks.
Thestudy context in this research is the study of risk factors that areassociated with the banking sector while focusing on a particularbank. The study thus encompasses the use of data that has beencollected on the National Investment Bank of Ghana on approvedprevious studies, past and current surveys that dig into the effectsof risk management to the bank, and a research on the applicabilityof several risks management practices to the banking sector in Ghana.The study also focuses on the general factors that contribute to therisks in any banking sector, the causes and occurrence of such risks,the effects of these risks to the banking sector, and the severalmitigation strategies employed in mitigating these risks.
Ina general observation, the research covers the definitions andexpositions on basic concepts as used in risk management andhighlights the key risks faced by banks the theories and models thatprovide the rationale for risk management and how they apply to thebanking sector and an empirical evidence of the relationship betweeneffective enterprise risk management and bank performance. This willhence call for an extensive literature compilation process so as tosample and obtain information on these risks.
Strategy and Design.
Thestudy on how risk management practices can affect a bank’sperformance uses a descriptive research design. The strategy involvedin the research is mainly dependent on data collected from otherdescriptive and qualitative works and publications. This will involvevast data and information collection from previous studies concerningthe risks that banks are prone to and the effect of managing theserisks in relation to the banks performance. The data used on thisresearchwas obtained mainly from secondary data sources. These sourcespreviousstudies, past and current surveys,provides valuable data that is processed to obtain the finalconclusive results for the study.
Thedescriptive approach of the study is basically involves obtaininginformation that is of concern to the present status of thephenomena, to define the prevailing situation, in terms of riskmanagement, with respect to variables or conditions of leadership andrisk mitigation processes in a particular situation, which in thiscase is the National Investment Bank Limited (Gardner et al 2004).This design helps in bringing out the relevant data that applies tothe risk management practises and their effect on a bank’sfinancial performance. This strategy assists the research to provideempirical evidence on the link between risk management practices andthe bank’s financial performance. The approach also comes in handyand is adequately supportive in describing the pattern of credit riskof National Investment Bank of Ghana in the past, also to empirically examine the quantitative effect of credit riskmanagement on the commercial banks performance in Ghana.
Thestudy also employs the use of Correlation analysis a technique usedto assess the strength of a correlation between the mean scores ofeach risk management practice employed by the NIB with the financialperformance in the Ghanaian banks so as to establish the relationshipbetween risk management practices and financial performance (Ostleand Malone, 1988). Correlationis a technique for examining the association between twoquantitative, continuous variables, in this case the risk managementpractices and the bank’s performance.
Population and Sample.
Thereare twenty six commercial banks in Ghana which have either local offoreign origins. These banks serve the Ghanaian population withindividual as well as corporate banking services. Of these twenty sixbanks, our research focusses on the National Investment Bank of GhanaLimited. The bank is a medium-sized commercial service provider basedin Ghana. By December 2011, their total valuation of their assets wasapproximated at US$468.5 million. They have a shareholders stock ofabout US$47 million that are fully owned by the Government of Ghana.Being the primary bank that serves other banks as well as severalindividuals, the NIB is usually encountered by with several risksthat are commonly associated with a bank performance index. Theserisks include poor business strategies, personal negligence by staff,and currency instability in the international money market amongothers. Studying this bank is thus essential since it gives arepresentative view of how banks in Ghana undertake their riskmitigation processes as well as the effects of the processes on theperformance.
Thecrucial finding noted form the Ghana banking survey (2010) is that inThe National Investment Bank of Ghana there is a board of directorsthat are not directly responsible for the risk management. Only theseniors in the bank and risk owners are directly responsible for riskmanagement. The findings on risk management practices indicate theimportance of board of directors to support the overall policies andto ensure that the management takes necessary actions to manage therisks. There are risk management strategies that are adaptedspecifically in risk identification in The National Investment Bankof Ghana according to the research by Asare-Bekoe(2010).These include: risk survey, process analysis, scenario analysis,financial statement analysis, SWOT analysis and internalcommunication, such as internal conversation with the employees. Theimportant types of risks in The National Investment Bank of Ghanawere credit risk, interest rate risk, solvency risk,operating risk,and liquidity risk.
Whilethis research describes the risks that are commonly associated withthe banking sector it also carries out a study case of the NationalInvestment Bank of Ghana and the practises employed by the bank’smanagement in mitigating the risks they face. This sets thepopulation under review to be the Ghanaian residents who are involvedin the day to day banking operations of this bank. The targetpopulation of this study also includes the management staff workingin commercial banks of the top, middle and low level managementranks because the research shall look into their contribution torisk mitigation processes. These individuals, who are the onesinvolved in the management of the bank’s operations are consideredto be a resourceful pack for information that is mainly included inthe reports and surveys produced periodically. They are thus veryimportant in the study of risks that are evidenced in the bankingsector. In the 2009 “What Directors Think” studydone by CorporateBoard Member magazineandPricewaterhouseCoopers, risk management wasone of the principal concerns that bank directors outlined asimportant and sensitive part of the management process(PricewaterhouseCoopers, 2010). The bank workers are also consideredto be a possible source of risk if they engage in unacceptable bankpractises that makes them personally liable to mistakes conducted intheir place of work (Apps, 1996).
Secondarysources are used to achieve the study’s aim and objectives and tocomplete the theoretical framework that asses the risks that mostbanks are prone to. The secondary data will include annual reportsand reports issued by the bank and other organizations, policydocumentations and guideline on risk management of the bank.
Qualitativedata collected from secondary sources as well as the annual reportsand banking sheets was analyzed through descriptive statistics, andpresented through percentages means, standard deviations andfrequencies. In order to attain the objective of examining thestrength of relationships between risk management practices andfinancial performance, the obtained data from the reports and policyguidelines is subjected to analysis. The information is used inanalyzing the correlation between the mean scores of each riskmanagement practices with the financial performance of the NationalInvestment Bank of Ghana. For this study, the researcher wasinterested in measuring the effect of credit risk management on thefinancial performance of commercial banks and in particular to thecase of the national banks of Ghana, with a focus on NIB of Ghana.
Data collection and Analysis.
Empiricalanalysis of the data from the annual reports is used to derivedescriptive data such as standard deviation, mean and reliabilityfigures such as the constant of variation, which expresses thetypical deviation as a percentage of the mean. The latter is usefulbecause the standard deviation of data must always be understood in the context of the mean of the data that was used to give a summary of the common risks that are prevalent to the bankthroughout. With coefficient of variation between different risks andthe bank’s profitability, the greater the coefficient means higherthe variability and the lesser the coefficient means fewer erraticismand therefore makes the results reliable of this study reliable andeffective in establishing the relationship between these factors.
AsCabadisli et al. (2014) theoretically suggested, there exists asubstantial correlation between the semantic resemblance ofstatistical dataset designations and the correlation in the midst ofthose datasets, because dataset labels can indicate rich connectivityfor all the variables being compared in the correlation analysis.
Ratio analysis comprises attempts to put ratios, such as Return OfAssets (ROA) Ratio and Cost per loan asset (CLA) ratio, into viewpoint and make them more relevant and expressive to the topicof the study. The ratios are calculated by use of data obtained fromthe four-year period information from the PriceWaterHouse Coopersreports. Common-size analysis converts all financial statement itemsinto a percentage of a given financial statement item to reveal theircomposition and structure. These items are comprised of creditrecords, profit margins, asset records, operating costs as well asfinancial incomes. This comparison is because these items areinfluenced by the risk management decisions put forward by the bank.These items are thus a crucial in assessing the bank’s riskprofile. The trend analysis strategy is used to show whether therewas an improvement or a decline in an amount or a ratio assessed inthe ratio analysis strategy (Asare-Bekoe, 2010).
Chapter Four – Data Analysis
Thenational investment bank of Ghana is inventoried by collectingsecondary data on its performance as well as analyzing other studiesthat take into consideration the effects their methods of riskmanagement. Data on performance of the bank is obtained from theirannual reports. The data was analyzed by calculating the profit ability ratio for each year for the period of study, trendanalysis was done by comparing the profitability ratio to default rate, costs of debt collection and cost per loan asset.
Balance Sheet Risks
Thecomposition and organization of any bank‘s assets risk is animportant factor to ascertain any intrinsic risks in them. Over theyears of analysis that spans from 2009 to 2014, the NIB expanded atan average of 12% per annum. This expansion was mostly due to thegrowth in the amount of government securities that they possessed aswell as the operating account balances and placement with othercommercial banks of Ghana. It is worth to make an observation that,the progress in the expansion of the Ghana banking sector‘s balancesheet was comparatively slower as the 31.3% growth it presented in2009 fell behind the 37.2% growth it observed in 2008. Thiswas mainly due to reducing of the growth rates of the total loans andfixed assets. The general banking industry trend in Ghana monetarysector also showed quite a similar situation where all the banks‘investments in bills as well as securities in 2009 grew by 93% paralleled to the 13% growth in 2008. This brings their stakein total assets to 21% from 15% in 2008, a n increase fromprevious years.
The bank-specific determinants used in the modeling include thecredit to that of the so called total asset ratio which isdefined as a measure of the counterparty acquaintances of banks.Credit risk management is the concept that is commonly used to givean explanation of a banking firm’s loan portfolio. Interestsensitivity ratio is also included in regression model where it helpsin the measure sensitivity of a bank’s reprievable belongings alsoreferred to as the assets and liabilities. The interest sensitivitygap, is used to provide a general overview of their interest raterisk profile. The outcome of interest rate changes on the assets andliabilities of a financial institution may be examined by scrutinizing the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring an institution’s interest rate sensitivity gap. An asset orliability is said to be interest rate sensitive within a specifictime period if it will mature or be reprised within that time period.Other than the discussed determinants, also profitability isfundamental in the determinants. It is measured by Thomas (1997) asthe return on asset (ROA). A market risk was taken as the NationalInvestment Bank Limited for the general study. It was induced thatwhen the cost of fund is higher, then the management will take anoption of liquidating a certain portion of the assets it owns insteadof increasing its liabilities for the purpose of financing itsoperations.
Thedeposits of the NIB bank accelerated in its growth by about 33% in2010 paralleled to the 30% growth documented in 2009. This increasewas in dissimilarity with the industry tendency which saw anaggregate slowdown in the anticipated growth of total deposits. Thetotal deposits of the industry grew by some 29.1% which fell short ofthe growth of 41.4% recorded in year 2008. Deposits, however,preserved the position as the chief source of capitalof both the National Investment Bank and the sector‘s funding source correspondingly. These funds are regarded to as being unstableand prone to funding risks, which therefore, increase in its volumeand value over the past one year, signified an growth in corefunding risk but their comparatively low percentage in the bank‘sfunding base retained the risk under control. A trend analysis ofthe balance sheet objectsconfirmed a 27.5% increase in the borrowings of the bank in year 2010. The banking sectorinGhana alsoshowed a general growth of 37.6% in total lending at theend of year 2009 compared with 29.5% growth in 2008. After a longglobal economic crisis, banks all over have aided in the adoption ofthe best credit risk management and the managerial skills. In thecurrent state, affairs about banks has been taken into a seriousaccount and every bank managers need a way forward in order toovercome the current challenges that are encountered.
Riskmanagement is an out coming effort on its own where there should bethe need of identifying the risk itself, then its evaluation thatshould be followed by the development of policies that will be usedto make a control over it. In risk management, there will be thefollow up of the loans that are given by the bank. There will be apossibility of the loaned has a high chance of not repaying back theloan. This situation is known as the default rate, where it has adefinition the possibility that a borrower will fail to payback theprincipal and interest in a situated and the agreed terms andconditions. The National Bank investment of Ghana has had a hard timein the dwindling values of its credit assets. This difficulty resultsfrom the large population in the Ghana and mostly for the peopleusing the banking systems as most of the Ghanaian citizens us theNational Investment Bank. The concept of the risk management isobtained from the collecting deposits from businesses and otherbusiness institutions that include households and the governmentfirms. Credit management is therefore a major setback that should betaken great care of because of its concern with the rewards of risksthat have to be objective through the cautious and careful riskmanagement failure of which can bring about legal action togetherwith economic loss.
Equity and Capital Adequacy.
Thebank took steps to increase its capital considerably through a rightsissue in August 2010 in its effort to meet the new capitalnecessities of GHS60 million set by the Central Bank of Ghana‘s forprofitable banks operational in the country. Subsequently, the bankhas been capable to uphold a good balance amid regulatory capitalnecessities and its total chattels and risk-weighted assets.
Bankprofitability has had a major threat from the credit sector. As aresult of this risk, it has motivated many of the researchers to comeup with studies and theories that will help in the elimination ofthese credit effects. Shawn (1998), who employed the multi-variantregression, gave a conclusion that the loan loss provision has asignificant positive impact on the non-performing loans. This theoryimplies that the loan loss provision gives an elevation in the creditrisk and yields up the decomposition in the value of the loans whichleads to the bank performance going down to the poor levels. Ahmad(2007) who used the regression analysis to establish the importantdeterminant of credit risk of commercial banks in emerging economies.Bank systems weighted against the developed economies. In an effortof the study attempt of the bank regulations, capitalization and bankrisks have considerable and had positive influence on the netinterest margin and the profitability of banks. Al-khouri (2011)further gave an evaluation on the effects of the bank’s specificcharacteristics and took an overall bank environments in his studywhere he came up with a final outcome that liquidity risk, creditrisk and capital risk are the main aspects that give an impact to thebank profitability. Kithinji (2010) did a study in the Kenyan banksthat gave a measure of the effect of the credit risk management onthe profitability of the Kenyan banks through the method of theregression model. The study used the existing records of the totalcredit, profits for the last five years and the level ofnon-performing loans.
Income Statement Risks
Theincome statement delivers information on a bank‘s success,discloses the fonts of the bank‘s incomes and their excellence andmagnitude.The Bank documented an after-tax profit of GH7.5m for theyear ended December 31, 2011which shows that the bank’sprofitabilitythus inched up by 213% from the previous after-tax profit of GH2.4mrecorded the year that ended on December 31, 2010.The bank gave alittle difference with the main study which is the Investment Bank inGhana. The study gave findings that the banks in Ghana enjoyed a moreprofitability regardless of its high credit risks that itexperiences. This study yields an opposing view to the others suchthat in many studies the credit risks indicators are negativelyrelated to profitability. The outcomes of the several studiesreviewed that the outcomes are always diverse outcomes. Based on allthe studies, those determinants that are most common include thelevels of the non-performing loans, the problem loans and thefrequently used proxy. This literature review further is evaluatedby the means of the use of the recently collected information fromthe various studies that are conducted. Studies that are conducted onAfrican counties and those that are not African gives an equaloutcome of the reviewed studies. Shows that banks on the Africancontinent have the same risks as compared to those that are outsideworld.
Ithad a conclusion that the accumulated profits of all the banks thatthe study was taken were not influenced by the quantity of credit andnon-performing loans. He proposed that there should exist othervariables that have effects on the bank profitability other than theknown credit and the non-performing loans. In a study that wasconducted in the Taiwan, Chen and Pan (2012) took a four year studyof the credit risk efficiency of the banks that were involved. Thestudy employs financial ratio to measure the risks an analyzed thedata using the method of Data envelopment analysis. The overallfindings gave a suggestion that only a single is competent in all theforms of efficiencies over the assessment periods that are given.Boahene et al. (2012) who was a Ghanaian did a study that used theregression analysis in a major attempt to give an outcome of theconnectivity between the credit risks and the profitability of banksthat were investigated.
Accordingto the studies, the credit risk management gives a certain percentageof every aspect. About half of the studies indicates a negativerelationship where 17% yields a positive relationship, another 17%gives a mixed relationship and 16% shows no relationship at all inthe studies.*
Figure2. Evaluation of the results of the studies.
Themethods of the study by the various scholars can also be evaluated.Most of the researchers used the regression method to come up withthe risk management analysis. This percentage amounts to 92% which isway more than half of the researchers while the remaining 8% usedother methods to come up with the evaluations.
Figure3. Evaluation of the methods used by the scholars.
Themethod that is used to study the risk management and the bankperformance is the ex-post facto research design. The operation ofthe study was targeted on the Investment Bank of Ghana. A certainstudy population of the working stuff of the bank was taken so as tocome up with the analysis. The secondary data of the bank was used.All the historical transactions were made available and the variablestogether with their measurements made. Then the ratio which is namedas return on assets (ROA) used to measure the bank’s profits. Theratio is used to give an overall view of how a bank used its assetsto generate profits. It has a formula of,
Wherethe ROA gives the strengths of the company in the banking industry.Age is taken into account in the above evaluation because it willdetermine how the bank has been fairing on from time to time. Loan isdefined as a measure of the total facilities that are given from thebanks to its trusted customers and other members of staff in theterms of advances or credits. The econometric formula that was usedby the scholars during the study can be given as:
Wherethe Y is a dependent variable and the rest are the coefficients ofexplanatory variables. After the adoption of the econometric model, ageneral equation of the form below is adopted:
Wherethis formula it is the final formula for the calculation of theprofitability.
Theaverage of the dependent variable ROA gives a clear indication of thelack of a substantial variation. The other variables from the tableshows the existence of a certain level of variability. Also evidentfrom the table, as the standard deviation goes higher, there is atendency of a rise in the risk exposure of the bank’sprofitability. In order to show the nature of the correlation of thedependent and the independent variables, and whether there is anexistence of a multi-collinearly, the table below is by use of SPSSand is as presented below:
Figure5. Table showing correlation matrix.
Whenboth the correlations are negative, the profitability of the banksdecreases in a large margin while if the correlation is positivethere is a possibility that the relationship is not strong. In theabove discussion, it is seen that the credit risk management willhave an effect on the profitability of the National Investment Banklimited in Ghana. Also the regression model aids in the clearstatement of the relationships that exist between the riskmanagements in banks and other factors that determine bank successand the bank in this case is the National Investment Bank of Ghana.There are the dependent variables that has to be given a way head inthe analysis as discussed above. One of the dependent variables isthe set of capital adequacy. It stands as a prudential requirementfor the risk operations in the banking sector which determines theexistence of efficiency of the internal based risk models. Taking anexample and in quotes, ‘if a bank’s charter value in terms of itscapital holding to risk portfolio falls short of the acceptableminimum, the system of internal risk management in that institutioncan categorized as inefficient’. The capital as a major factor canbe defined as a function of both the micro and the macrodeterminants. Micro-determinants are the bank’s specific factorswhich are mainly influenced by the banking firm’s policy and theirrequirements. Macro determinants are the factors which are mainlyassociated with the changing nature such as the inflation andeconomic growth.
Anassessment of the liquidity risk of NIB Ghana limited involves anvaluation of the bank‘s aptitude to efficiently put up the recoveryof deposits and other liabilities as well asto cover funding upsurgesin the loan and asset portfolio. In addition to partaking enoughfunding to assist as cushion for predictable and unanticipatedfluctuations in the balance sheet, the bank is said to havesufficient liquidity if it is able to obtain needed funds punctuallyand at a sensible cost. In most of the time of economic recession,the problem of the loan defaults are very common. This issue comes updue to the fact that most of the customers will be having more loansand a difficulty in paying them. The reaction of the banks and inthis case the national investment bank in the Ghana depends on itsprinciples which are mostly peculiar to other banks. Macroeconomicfactors, a large change of the global financial markets adverselytransmits business cycles which as a result slows down the businesstransactions that are to be done by the banks. For most of theeconomic growth, the growth rate is said to be a proxy ofcyclicality.
Alsothe inflation rate is given as a way head in the control variable forthe macroeconomic risk and management. This way head is given by thestudies carried out by Huizinga (1999). The panel econometrics areapplied in order to intensify a perspective of the study which is therisk management. Kennedy (1998) states that the estimation of thepanel’s data regression allows for a major control in theindividual heterogeneity and reduces the general biasness that couldbe experienced hence aid in the improvement of the efficiency of themodel by encouraging the use of data that is more variable based andhas a reduced collinearity. The ratio that is used in the estimationof the model is computed based on the data that is collected from thesample bank’s annual reports and other institutional databases suchas the World Bank that touches on the daily activities of theNational Investment Bank limited in Ghana. The descriptive statisticsthat is majorly aimed at the reviling of a bank’s characteristicsis also used in the overall study. This use will enable the easieridentification of a bank according to its own characteristics. Thereis a large gap in liquidity position among several banks. This gapmay arise due to the randomness of the cross section variables thatare used to compute the tables. So as to ensure that there is thecorrect estimating parameters, there should a surety of the rightchoice of the model that is used and the model is well analyzed. Ininstances where the variance is statistically significant thereshould be a likelihood that the individual heterogeneity beinguncorrelated to the independent variables.
Themicro-unit effects are felt when there is repressors and are alluncorrelated which has an implication that the random effect modelestimates are preferred. Other scholars who include Hausman, failedto reject the null hypothesis that the unobserved firm specificheterogeneity are uncorrelated. In terms of liquidity, it is alwaysimportant for a bank to ensure that it existing and the currentassets are well maintained and are well matched by the currentliabilities. A bank with a low liquidity is easily prone to havingthe problem of untimed operational misadventure whereby it cannotfulfill its short term obligations that are stated for it. When suchan adventure is experienced, the bank has to liquidate part of itsassets or take an action of giving its capital to other services.This obligation can be given to the national investment Bank of theGhana. The important part of the panel to be used for the dataanalysis is the so called ROA which is used to incorporate the bankprofitability as a bank which has been specified to determine therisk management and the efficiency of the bank. This efficiency willbring about the visual that the bank is better performing in all itscorners and have the best comments.
Interest Rate Risk
Aninterest reprising plan is used to produce simple pointers of theinterest rate risk sensitivity of both remunerations and economic value to fluctuating interest rates.It is theaccountability of the bank in this respect to struggle to accomplish a balance between plunging risk to earnings fromadversative movements in interest rates, and augmenting net interest revenue through preciseanticipation of the course and magnitude on interest rate variations.Empirically, there is anegative impact of the ROA which goes against the theoreticalexpectation and the contradicting findings from several scholars.Within the context of the National Investment Bank of Ghana, theother banks have been exposed to market risks and has to have a bankspecific determinant that encourages their risk managementefficiency. Interest sensitivity ratio gives a ratio of the interestsensitivity liabilities. When the ratio is higher than the unity, theincreasing rate will have positive impact on bank earnings. Aregressive table shows always a positive coefficient for theparameters that are available under the random effect model.
Therobustness test can also be used for the purpose of analyzing thecoefficient of the multi-determination. This test is the DurbinWatson test for auto correction and the covariance analysis formulti-collinearity. The so called autocorrelation result supportsthat error terms are not correlated and series could be adjudgedstationary. The main reason behind this study is to come up with aninvestigative conclusion of what are the key determinants of bankrisk management efficiency in Ghana where the specific bank is theNational Investment Bank Limited. There will be the need to examine along run equilibrium among the financial ratios which comes withuncertain coefficients that are mostly undefined, macroeconomic variables, and capital ratio which acts as the most fundamentalproxy for risk management efficiency. The Panel regressionmethodology was applied in order to envelope both bank-specific andall the macro-determinants.
Takinginto consideration the NIB limited, the findings from the panel usingthe regression analysis shows that the general macro-determinanteconomic growth, has got a positive impact on the risk managementefficiency among in the National Investment Bank Limited of Ghana,inflation is negatively related to the overall bank’s capitaladequacy which is in accordance to the overall appropriatetheoretical expectation that should be designed. For a more dataapplicability, there should be an application of the annual data fora certain period of time, say from a certain year to another year.This analysis will ensure that there is an accurate information for apurpose of the empirical investigation of the extent relationshipbetween dependent and explanatory variables which should beundertaken using the regression model. In the National InvestmentBank Limited of Ghana, the results from the regression analysis founda minimal causation between the Deposit exposure as surrogate ofcredit management efficiency and the performance indicators and afterall this, there was a greater dependency of the OperationalEfficiency parameters. The empirical investigation shows that all thevariables were non-stationary at both level and the first difference.It is evident that the undue emphasis of the regulatory authoritieson bail out might not after all be necessary where there is policystructure that is designed to reduce high mortality of a businessbased on the study of the NIB limited of Ghana.
Increasein credit risk in the National Investment Bank Limited of Ghana willalways tend to bring down the bank’s performances, both of thediscussed indicators which are the micro and macro have produced thenegative coefficients which tends to lower the profit level. It isnot always a bad situation on the side of credit risk rather it is arelation to the bank returns that are expected after a certain periodof time. The bank has a high value to maintain its substantial amountof capital reserve to absorb credit risk in event of failure and inthis case needs to enhance lending criteria to its customers, theportfolio grading and the credit mitigation techniques to reduce thechance of default.
InGhana there is an impressive financial performance in bankingindustry coupled with absenteeism of any main complaints or adversefinding against banks in Ghana give impression that the banks arenormally stable. The insinuations of this credence are that the banksin Ghana have good risk profiles as well as sound outlines formanaging risks characteristic in their business activities. Theextent to which this can be confirmed relies on thorough valuationsof the quantum and nature of risks confronting the numerous banks inthe country and an assessment of their risk management structures andsystems. The study provides an observed indication of the types andlevels of risks that The National Investment Bank of Ghana is visibleto and its capacity to successfully manage them as at the end of thefinancial year 2009.The evidence from the study proposes that therisk profile of the bank was good since there was a significantgrowth of the size of the bank balance sheet, the resultingstructural changes led to a healthy asset mix balancing liquiditywith profitability.
Theimportance of risk management in The National Investment Bank ofGhana is overstated. Awareness of risk is common among peopleoperating in the bank. This is as a result of less stable economicand political environment. Making a sound environment for business inThe National Investment Bank of Ghana and having a strong riskmanagement is still a question that is unanswered since they have totake risk on how much significance should be placed on avoiding lossfrom a tragedythat might never happen. Nonetheless it is usuallyagreed that the costs of risk management failure can be dire justlike in any other organization can do. In the National InvestmentBank of Ghana there is a development of a strong, consistent,enterprise wide risk management program as most risk will eitherremain at current levels or increase.
Riskmanagement and corporate governance involves understanding of risksand risk management, risk identification, risk assessment andanalysis, risk monitoring and controlling them in the NationalInvestment Bank of Ghana. The study found that the major riskmanagement process in the National Investment Bank of Ghana to beefficient. The study aims at providing the link between riskmanagement practices and financial performances of NationalInvestment Bank of Ghana. Findings show how all the overallobjectives are communicated in The National Investment Bank of Ghana.This indicates that the governance structure must be in place tocater and control all the needs .There is a positive connectionbetween risk management practices and comprehending the risk, riskidentification and risk monitoring control, while risk assessment andrisk analysis is positively related to the risk management practicesin The National Investment Bank of Ghana.
Thebanking authorities of National Investment Bank of Ghana should putin place measures and policies that will ensure all staffs areinvolved in risk management practices to overcome the problems found.Under risk management practices, it is shown that The NationalInvestment Bank of Ghana regularly assesses the positions of profitand loss. In order to mitigate risks, there are credit limits thatare for individual counterparty item that has the highest mean. TheNational Investment Bank of Ghana have also good risk monitoringsystem with regard to compilation of maturity ladder char accordingto the settlement date and monitor cash position gap. Moving tointernal control, the National Investment Bank of Ghana bankers inthe study perceived that the bank has backups of data filesandsoftware.
Withregard to risk management practices The National Investment Bank ofGhana is found to have a better risk observing practices followed byrisk extenuation practices and internal control as compared to riskmeasurement and risk environment policies and the procedures.
TheNational Investment Bank of Ghana should distinguish betweenpredominantly downside risks and those that are predominantlyvariable risks in order to pursue the goals of their bank in doing sothey will do even better than they are at the moment. While bothcategories deserve attention, the bank may discover the efficiency oftheir risk management programs are most operational if they devotemore of their attention to regulate risk rather than transferring itto an insurance company that will cater for their risks. The risksthat can be most directly controlled are the downside risks, the verymost risk that is most likely to threaten the National InvestmentBank of Ghana’s top revenue drivers. When downside risks are mostdealt with first through prevention and control, it enables seniormanagement of the bank to deal more aggressively with variablerisks.in short they become more proactive and strategic with theirrisks management approach.
Thegeneral objective of the study was to establish the impact of creditrisk management on financial performance of The National InvestmentBank of Ghana and the specific objectives were to establish impact ofdefault rate, bad debt cost per loan asset on the bank financialperformance. The result of the study showed that the credit riskmanagement is an important predictor of bank financial performancethus the success of the National Investment Bank of Ghana dependsmostly on risk management to the extent of approximately 36%.Thestudy results has showed that default rate as one of the riskmanagement indicator is a major predictor of the bank financialperformance to the extent of 54% and followed by bad debt cost at9.3% and lastly slightly influenced by cost per loan asset up to3.7%.Credit risk management is crucial on the banks performance sinceit have a significant relationship with the bank performance andcontributes up to 35.6% of the bank performance. Among the riskmanagement indicators default rate management is the single mostimportant predator of the bank performance since it influences 54% ofthe total credit risk influence on bank performance.
Riskmanagement indicators such as bad debt cost and cost per loan assetare not significant predicators of bank performance. In general riskmanagement has a very significant contribution to The NationalInvestment Bank of Ghana performance, the bank should put moreemphasis on risk management .In order to reduce risk on loans andachieve maximum performance the National Investment Bank of Ghananeed to allocate more funds to default rate management and reducespending on bad debt cost and cost per loan asset .according to thestudy other factors not studied in the research has a significantcontribution to the bank performance therefore require furtherresearch to efficiently manage the credit risk hence improve bankfinancial performance.
Expandedcredit exposure with significant concentration levels of a few largecorporate in the service sector of the economy generates some worryfor the National Investment Bank of Ghana credit risk. However theloan quality improved as the level of non-performing loans in theloan portfolio declined within tightened lending processes andincreased monitoring and recovery activities. The bank’s capacityto absorb credit losses was also improved with adequate collateralcover and allowances made for impairments.
Thehigh level of profitability in The National Bank of Ghana ensuredthat the bank had enough liquid assets to meet short termdisparities. With a funding structure conquered by core customerdeposits coupled with mainstream of its cash flow generated fromoperating activities, the liquidity condition of the bank was healthas at the end of financial year 2009.
Bykeeping more short term of interest sensitive assets compared toshort term interest sensitive liabilities in the face of fallinginterests rate levels the National Investment Bank of Ghana incurredloss of interest income. The level of the bank’s acquaintance tointerest rate risk is revealed to be high GAP to total assets ratiothat fell outside the overallsensible limits. The bank howeverappears to have adequate equity to mitigate it against any threatsfrom adverse interest rate movements.
Anappropriate atmosphere has been established for managing risk in TheNational Investment Bank of Ghana. This comprised a solid governanceconstruction with clear obligations and lines of policy and authoritydocuments approved by board encompassing procedures, processes andtechniques for handling various risks. Relevant tools and managementinformation systems have been provided to ensure adequate andconsistent identification, measurement and monitoring and controllingas well as reporting on the various risks the bank is exposed to.
Strongrisk culture in the National Investment Bank of Ghana as all stuffare conscious about the risks essential in their activities are atall times on the lookout to avoid or minimize the occurrence of risk.This has been made probable through extensive regular education andtraining on risk matters in the bank coupled with the central rolerisk responsiveness play in the performance base payment system. Theinterventions made by the bank to ensure sound risk management arealso in line with globally accepted principles for managing threatsas put forward by Basel Committee for banking Supervision andexpected to be implemented by The National Investment Bank of Kenya.
Thisstudy used primary and secondary data to examine risk managementpractices in The National Investment Bank of Ghana and financialperformance of this bank.in addition the study also aims to providethe link between management practices and financial performance ofThe National Investment Bank of Ghana using correlation analysis.
Generally,the findings on risk management practices show the significance ofboard of directors to approve the general policies and to ensure thatmanagement takes necessary actions to manage the risks. Total assetsare important only in capital risk management where bigger banks arelikely to have relatively more capital.one may therefore concludethat bigger banks are less efficient in deploying shareholder funds.
Thestudy revealed that The National Investment Bank of Ghana hadadequate risk management structures that ensured sound management ofcredit, liquidity, interest rate currency and operational risks. Thisis premised by the fact that:
An appropriate environment has been built for managing risk. These included a solid governance structure with clear obligations and lines of authority and policy documents approved by board containing procedures, processes and techniques for handling various risks.
Relevant tools and management information systems have been provided to ensure adequate and consistent identification, monitoring,measurement, and controlling as well as reporting on various risks that The National Investment Bank of Ghana is exposed to.
Effective control have also been put in place to safeguard compliance to the principle of the bank’s risk management structure by linking portions of the bank reward and punishment system to the extent of adherence to risk issues and this has made The National Investment Bank of Ghana to perform effectively.
TheNational Investment Bank of Ghana made these interventions to ensuresound risk management and they are also in line with theinternationally accepted principles for managing risks as proposed bythe Basel Committee for Banking Supervision and expected to beexecuted by the National Investment Bank of Ghana which is operatingin Ghana as they have incorporated in the Ghana Banking act 2004, Act673.
Iwould like to make a couple of recommendations despite a fairly goodrisk management framework put in place in The National InvestmentBank of Ghana to manage the various types of risks it faces.
TheNational Investment Bank of Ghana should adopt an integrated approachto risk management .that is the risk management should have aframework that allows for specific related decisions to be multiplelevels of the bank. Likewise, different approaches are used inmanaging the altered risk types at various units in the bank. Thisresult in fragmented risk management practices and a fragmentedapproach for dealing with the risks the bank is exposed to. There istherefore the need for the bank to develop an integrated system whichensures a systematic and comprehensive approach to managing riskacross the bank. Integrated risk management system is necessarybecause activities becomes more varied, the probability of havingmore than one type of risk characteristic in an activity or one typeof riskactivating other risks is quite great. Management willconsequently need a selection view of all the various risks andevolving a strategy to manage them with the view of profiting fromdiversification effects. Such integrated approach can help seniormanagement see the relationships between the various risk exposuresas well as their multidimensional effect on the. The probability ofsome risks not being suitably covered is abridged.
Ina current world, there is a chance of high changing rates, thischangings are come about in order to discourage microenterprises froman easy access to loans from commercial banks. This situation that isheld at hand will have an effect of the creation of the so calledloan-losses high-interest cycle. Hence, there is a highrecommendation for the banks as studied the NIB of Ghana that theyshould establish a sound and a competent credit risk managementsystems in order to overcome all the risks that are concerned withit. The study also showed a high chance of the bank having a highcapital adequacy ratio can be a better institution to give moreadvance loans and absorb credit losses whenever they crop up andhence they can record a better profitability. A recommendation thatthe regulatory authority should have more attention on the banks’compliance and cooperation in order to have control in bankprovisions and the application of its laws that should govern them. Abetter risk management in terms of the funds that are involved shouldbe made in such a way that there is the reduction of cost togetherwith the debt equity results in a better bank management. TheNational Investment Bank of Ghana should practice safe riskmanagement skills in order to protect investors that are concerned.
TheNational Investment Bank in Ghana should employ the corporategovernance on risk taking. This governance will be accompanied by theskills such as remunerated policies which will largely aid in thereduction of financial crisis in the bank that is involved. In theother hand, the corporate governance does not affect the risk takingcontradicts which give risk management a new power of the board ofdirectors. There is the responsibility of the management and theboard of governance that ensures that the correct risk managementsystem are at place. Hence if there is the lack of governance on theNational Investment Bank Limited, there would be a big failure on therisk management prospective. Risk taking in the banking sector is amajor problem where its effects are felt during the time of financialcrisis. Using the financial risk return theory, there is thestatement that the risks affects the earnings of that period of time.Another recommendation that should be taken into account is that ofthe combination of the managers and the shareholders. It is evidentthat the bank’s governance did not affect the risk taking.
Thesection aims at assessing the strengths and weaknesses of the studyand gives suggestions for future research in risk managementpractices and bank performance. In this study, the data and toolsused to produce and test the results of the study are considered tobe quite effective. The fact that a descriptive approach was taken upin the research makes the data and information portrayed in thisstudy to be credential and is largely supported in other studies thatwere carried out previously. The study reveals that the riskmanagement practices that are employed in any bank are a huge factorin determining the bank’s performance. This is supported by severalother studies focusing in risk management and bank performance. Astudy by Musyoki & Kadubo, (2007) that focused on commercialbanks in Kenya concluded that credit risk management has asignificant relationship with bank performance since it contributesup to 35.6 % of the bank performance. It is an accurate observationthat mitigation practices for liquidity risk, credit risk, andoperational risk, have a negative and substantial financial influenceon the bank’s performance while market risk management practicesaffect the performance positively (Imane, 2014).
Bearingin mind the broad findings of this study, a future research mightfocus on tentative risk management methodologies. They may also lookdeeply into the tools used in the mitigation process or risk analysisfor all phases of risk management practices. It should also focus onthe difficulties encountered in risk management for financialinstitutions in Ghana particularly covering the period of the worldeconomic meltdown since the 2007 financial crisis.The NationalInvestment Bank of Ghana is thus recommended to establish sound andcompetent credit risk management unit that is run by best practices.These risk management practices such as instituting a clear loanpolicy and the adherence to underwriting authority and restrictionsassists in limiting and eradicating the risks that result from poorbanking operations.
Bankingexperts should put in place procedures or policies to ensure that allstaffs are involved in risk management practices since bank staff forthe credit units such as project and advance managers, loan officersand field officers perform a range of functions essential in riskmitigation. These functions ranges from project appraisals throughcredit disbursement, loan monitoring to loans collection. Inconclusion the National Investment Bank of Ghana should identify and assess the operational risks that are inherent in all material products, activities, processes and systems institute aprocess of regular monitoring of operational risks and establishpolicies to mitigate these risks.
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