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I, Prosper Mintah hereby declare that this dissertation consists entirely of my own work and
that the authors of the references made have been dully acknowledged. No part of this
…………………..
Prosper Mintah
(STUDENT)
…………………………
Mr James Doku
(SUPERVISOR)
1
DEDICATION
I dedicate this work to my family especially my wife Dora Mintah, my daughter Benedicta
Mintah, my son Joy Mintah and my parents Mr Ephraim Kofi Mintah and Aurelia Mintah
whose encouragement brought me this far and make realization of this dream a reality. I also
dedicate this work to my dear aunt Emma Akorli and the husband Mr Seth Latey for
2
ACKNOWLEDGEMENTS
First of all, I give thanks to the Almighty God for seeing me through the Economic Policy
Management Program, and also praise him for the strength, wisdom, good health and the
I am indebted to several persons and organizations not only for the successful completion of
this dissertation, but also for making the write up a challenging and rewarding experience.
of the faculty of business of the Methodist University Ghana for the invaluable help he
provided in shaping the topic and for the help and support he provided throughout the entire
exercise. Secondly, I would like to thank Mr Ernest Gabrah of Bank of Ghana for his support
in this study.
Last but not the least; I would like to express my gratitude to the people who are closest to
me, especially Mabel Goza for her great assistant offered in typing the write up for me, and
in the office that allowed me to gain excused duties to perused the course. The views
expressed in this study, and all the potentially remaining errors are the sole responsibility of
the author.
3
ABSTRACT
This study investigates the determinants of Banks’ performance among Ghanaian banks. The
main objectives of the study are: to examine the main determinants of bank profitability, to
explore the impact of key macroeconomic variables on bank performance, and to examine the
impact of bank-specific control variables on bank Performance. Using data covering a period
2005-2009 with ten banks within a panel data methodology, the results from the study
indicate that the key determinants of bank performance in Ghana are bank size, equity-to-
asset ratio (a proxy for bank capital), bank credit risk (provision for bad debt/advances), bank
expenses out of income and returns on earnings assets. Macroeconomic variables such as
inflation and GDP growth rate and inflation rate were also discovered as determinants of
bank performance.
The findings show that efficient management is likely to enhance bank performance whereas
inefficient management will increase bank cost and lower profit. Thus, for bank managers
aiming at enhancing the bottom line for their shareholders, the solution is a conscious attempt
to minimise cost. The study also highlights the role of effective credit administration on bank
performance. Large banks in Ghana can enhance their performance by exploiting the
economies of scale associated with large size in terms information processing, research and
development as well as better monitoring and screening credit applicants at low cost. The
findings also indicate that increase in inflation if not anticipated and banks being sluggish in
adjusting their interest rates adversely affect bank performance. The comparative
performance of the selected domestic and foreign banks shows no significant difference in
the results.
4
Table of Contents
Declaration……………………………………………………………………………………..i
Dedication………………………………………………………………………………..........ii
Acknowledgement…………………………………………………………………………… iii
Abstract………………………………………………………………………………………..iv
DECLARATION.......................................................................................................................1
DEDICATION...........................................................................................................................2
ACKNOWLEDGEMENTS.......................................................................................................3
ABSTRACT...............................................................................................................................4
Table of Contents.......................................................................................................................5
CHAPTER FOUR....................................................................................................................33
Research Methodology.............................................................................................................33
CHAPTER FIVE......................................................................................................................41
5.0 Introduction................................................................................................41
CHAPTER SIX........................................................................................................................50
Conclusions/Recommendations...............................................................................................50
6.1 Conclusion..................................................................................................50
6.2 Recommendations......................................................................................52
References................................................................................................................................54
5
CHAPTER ONE
Ghana had well developed banking systems that businessmen and women rely so much upon
and the government and allocating them among demanders of funds. Financial experts have
conducted several investigations that have established a direct relationship between financial
development and economic growth (Levine, 1996). Levine investigated the efficiency of
commercial banks and their performance and came out with revelation that financial
institutions are capable of making great impact on the development of the nation. Existing
studies on commercial banks performance have focused their analysis on the returns on bank
assets, return on equity and net interest margins. Some earlier studies have also delved into
the effects of bank characteristics on bank performance and other macroeconomic factors. Al-
6
commercial banks performance in Sub Saharan African countries macroeconomic variable
them, lower market concentration ratios lead to lower margins and profitability hence poor
performance on the part of most commercial banks. He finds that credit risk and operating
inefficiencies explain most of the variations in net interest margins across the region.
According to him, macroeconomic risk has only limited effect on net interest margins.
Demirgue-Kunt and Huizinga (1998) investigated the impact of bank characteristics and the
overall banking environment on both interest rate margins and bank returns. Their
investigation reveals that there is a direct link between bank characteristics, bank
commercial banks performance in Sub- Sahara Africa, macro economic variable and
lower market concentration ratios lead to lower margins and profitability hence poor
Clarinda and Friedman (1984) demonstrate that relative to the predictions of a structural
model, bank performance in Ghana especially among the local banks has not been
encouraging. Osei (2008) questions the reasons behind the poor performance of most banks
in Ghana in spite of the gains in the microeconomic stability. He concluded by saying that the
activities of most financial institutions in this era of competition rather increases their
operating cost, limits their investment and retards growth of most sectors of the economy.
Gelos (2006) studies the determinants of commercial banks performance in Sub Sahara
African countries. His empirical findings reveal that the spreads are large because of very
high interest they charge, less efficient banking procedure high reserve requirement and poor
of banks in south eastern European banking industry. Their research revealed that the effect
7
of market concentration is positive whereas macro economic variables are not very clear to
identify.
Recent literature has focused on analyzing bank performance however most of the studies
conducted were on advanced economies such as those of the United States of America and
Europe with very little on the developing economies such as Ghana. My research paper will
contribute towards bridging the gab. The study will go to every extent to answer the question
Every policy towards economic growth and economic development in Gahanna is centered
on the banks and other financial institutions within the financial market. One of the reasons
that can be attributed to the importance attached to banks is that they play a very important
role towards economic development and towards raising the living standard of people in
Ghana. This is evident in their basic or fundamental role of mobilizing funds and giving out
these funds in the form of loans to individual, firms, corporate bodies and even government
agencies. From the earlier illustration, it is very clear that the banks within the financial
market of Ghana have the ability to alter the path of economic progress of the nation. Of
recent times many researchers have become interested in investigating into determinants of
bank performance in Ghana because of the proliferation of banks and their important role in
economic development .Financial sector reforms in Ghana which lead to increases in foreign;
especially Nigerian Banks in Ghana is a direct call for investigations into bank performance
in Ghana. There is therefore the need for inquiry into bank performance with special
8
reference to ownership and chacteristics.This research paper will also extend its boundaries to
investigate whether there is any difference at all between the operations of the foreign banks
and that of the local banks, and if there is to examine the impact of the differences in
This research paper seeks to explore into bank performance in Ghana’s financial market. The
development of Ghana.
Based on the objectives clearly stated above the following questions are worth asking:
Ghana?
Existing studies established the fact that for an economy to grow there is the need to for a
well developed banking sector with high performance standards. According to Levine (1996),
financial intermediation can affect economic development hence the standard of living of the
factors, bank specific and regulatory policies within the environment. The aim of this study is
to provide an illumination on the key macroeconomic variables that affect commercial banks
9
performance in Ghana. It will also serve as a foundation for further studies into banking
activities and performance in Ghana. , it will add to academic knowledge in the area of
banking in Ghana and finally it will be of great importance to those responsible for
This research paper will extend its boundaries to cover commercial banks in Ghana so that
the researcher will be in the position to fully explain the impact of key macroeconomic
variables on bank’s performance. Due mainly to logistic, financial and data availability
problems, the study will be limited to those banks that have the required financial data. The
banks that do not have accurate financial and other non financial data will be eliminated. This
will likely affect the efficiency of the econometric and regression models to be employed in
analyzing the findings; however, the researcher believes the object of the work would be
achieved.
Chapter one: This chapter provides the background, objectives of the study, significance and
Chapter two: This chapter provides an overview of the banking sector in Ghana.
Chapter three: This chapter makes a complete review of the relevant literature.
Chapter five: This deals with the analysis of the economic data and the discussion of the
findings.
Chapter six: This chapter provides a summary of the findings, conclusion and
10
CHAPTER TWO
2.0 Introduction
This part of the research is focused on recent development in the arena of banking in Ghana.
It is devoted to discussing the reforms in the banking sector of the Ghana banking policies
and their administration in Ghana and also the recent development in the banking landscape
in Ghana.
The reforms in the financial sector of Ghana have to do with establishment of banks by the
government, banking administration and regulation through the use of prudential policies.
Establishment of public sector banks was one of the early initiatives of the government of
public sector banks was one of the early initiatives of the government who took office after
the colonial administration. During the post independendence era there was full involvement
11
of the government in developing a vibrant financial market. According to Gockel (1995)
interest rates were administratively controlled by the bank of Ghana (BOG) and a variety of
controls were imposed on asset allocation role of the banks. The main reason why the then
government came out with policies to regulate the banking sector was due to the fact that the
intervention in the financial market which was inherited from the colonial masters. There
were two main reasons for the establishments of local commercial banks during the post
• The believe that certain sectors like industry and agriculture are key to national
needs.
• The believe that the operational focus of the foreign banks were too narrow
According to Gockel and Browbridge (1996), the Ghana Commercial Bank (GCB) was set up
in 1953 to improve people’s access to credit. The commercial banks then expand their
operations and assume the status of the largest bank with 36% of the total bank deposit in the
late 1980s .Following the high standard performance of the Ghana commercial bank, three
development banks were established in 1963 to provide long term finance for industry. These
banks were: The National Investment Bank (NIB) established in 1963 to provide long term
finance for industry, the Agriculture Development Bank (ADB) was also established in 1965
to provide financial support to the agricultural sector and finally the Bank for Housing and
Construction (BHC), established in 1974 to provide loans for the housing industrial
12
The act that regulates the activities of the banks in Ghana is the Banking act (1970).This act
provides policy and framework for banking sector regulation and supervision in Ghana. The
Act imposes minimum paid up capital of 2 million and 5million cedis respectively for all
foreign and local banks respectively in the country. This requirement had to be adjusted from
time to time to cope with the level of inflation in the country. At the end of 1983, the
minimum paid up capital for all local banks was equivalent to 16000 dollars. Banks were also
required to maintain capital and reserve adequacy of at least 5% of their total deposit (Gockel
and Brownbridge, 1996). The banks examination Department (BED) of the bank of Ghana
was charged with the banking act and bank of Ghana directives. BED was also charged with
the banking act of ensuring that banks comply with directive and monetary policy directives
such as sectoral credit directives and reserve requirements Gockel (1997). BED however was
faced with several problems which made their operations and activities very difficult. Some
of the problems were lack of resources to monitor and inspect the banks. Bank supervision
and examination was infrequent and bank reporting was impeded because of improper
In 2004 the Bank of Ghana (BOG) directed all commercial banks in the country, to abolish
and in some instances reduce, what it described as unfair bank charges and fees being
The directive also required the banks to bridge the gap between lending and savings rates.
The BOG’s directive was described at the time by sections of the Ghanaian public as a feeble
attempt to clear a mess it has created through its own ineffective supervision of the banks.
Some bankers Public Agenda interviewed at the time expressed the view that the BOG’s
directive, like the several that had preceded it, will only be another whirlwind that subsides
13
just as quickly as it swirls. Six years on, BOG has been urged to conduct a thorough
investigation into the high lending rate charged by banks in Ghana as against low deposit
rates, suggesting that a major anomaly that the 2004 directive had sought to cure still persists.
Dordunoo (2006) observed that, it is difficult to find reasons for Ghana’s high lending rate as
against very low deposit rate. According to him the wide spread is incomprehensible. He
described the situation as unfair, arguing that, the banks are the only ones benefiting, leaving
the poor masses to languish in poverty. "The spread between lending rate and deposit rate in
Ghana has been widening over the years and has earned Ghana the reputation of having the
highest lending rate in sub-Sahara African," ( Dordunoo,2006) . He noted that, the situation
accounts for the slow growth rate of the economy, as private businesses are unable to borrow
at the current interest rate to expand their businesses so as to create employment to absorb the
unemployed masses. He recalled that whereas European countries and the US reduced their
rates in order to absorb the shocks during the financial crunch, he noted with regret that Bank
of Ghana rather increased prime rate creating a rather difficult situation for businesses. He
urged government to use other measures rather than monetary instruments to control inflation
Dordunoo (2006) again revealed that the banking population of Ghana is about 15% to 20%
and regretted that many Ghanaians do not save with the banks because of the low interest
returns. He explained lending rate to mean the cost incurred when one borrows money from
the bank, non-banking institution or a person. Banking experts are of the view that there is
high rate of loan default in the country; however the ongoing national identification will help
drop the high rate of default which is a major problem for the banks.
With regards to the private sector, most of the small scale and medium enterprises are not
well organized, for example in the areas of documentation, record keeping and planning.
Such imprudent practices are not innovative to encourage the banks to assist them financially
14
Gockel (2005). In an interview with a private entrepreneur on bank performance in Ghana,
Mensah (2004) suggested that government should force banks to reduce the lending rates and
Currently Bank of Ghana is using moral suasion to encourage the commercial banks to
respond to the diminishing inflationary expectation and the reduction in the prime rate by
reducing their lending rate. However, moral suasion has its own limitation, especially in a
deregulated- lending rate environment. The wake-up call to the Bank of Ghana(BOG) by
some entrepreneurs, is to be up and doing, and to ensure that the commercial banks do not
constitute themselves into cartels, to exploit customers, and putting very little back into the
economy ,(Dordonoo ,2008). Lending rates of banks continue to remain high despite Bank of
Ghana (BOG) adjusting its policy rate-the prime rate from 18 percent to 16 percent in
15
CHAPTER THREE
3.0 Introduction
Financial sector development in Ghana has become very necessary since the main agenda of
most of the past colonial governments was to enhance economic growth and development.
This they realised cannot be achieved without a vibrant financial market Osei (2004).
Financial institutions like banks channel huge amounts of money into productive ventures.
The efficiency and profitability of these institutes is thus very important to ensure
3.1 Relationship between commercial banks performance and interest rate movement
According to Fin, (2001), the "quality" structure of interest rates affects the performance of
commercial banks. In the face of uncertainty about payments, lenders would demand a higher
rate of return or "risk premium". The interest rate to a particular borrower would be the sum
of a "risk-free" rate plus the risk premium. Default risk is not simply the failure to pay
16
principal, but is rather a matter of degree. There are many possibilities short of complete loss,
sometimes as small as a "skipped" or late payment. Loan arrangements with little probability
According to Enrico (2005), the higher the severity and probability of a problem, or the lower
the quality, the higher would be the risk premium. Hull (2005) continues that this quality
structure is also apparent in bank loan interest rates. The prime rate is the rate charged to
large customers with established relationships. Borrowers with less admirable credit records
(or smaller accounts that are comparatively more expensive) would pay a higher rate.
Collateral is also important. Unsecured personal loans, such as credit card credit, would
ordinarily pay a higher rate than car loans, which would in turn pay more than home
asset that can be converted to cash quickly at a fair price is liquid; if price concessions are
required for rapid sale the asset is illiquid. Many loans have been relatively illiquid; so that
once the loan is made the creditor was locked in. This lack of freedom of action increased the
risk of the lender, resulting in higher interest rates. More recently, a number of classes of
loans have been "securitized" by being bundled into portfolios against which securities are
issued. This added liquidity reduces lender risk and lowers the interest rate on the underlying
Banks are financial and profit-oriented entities that generate their profit from their traditional
functions of financial intermediation. Additionally, they stand to offer other services that
generate incomes and fees for them. Interest rate represents the cost of credit in the financial
from the financial market at relatively cheaper cost and lend at higher rate to generate profit.
Therefore, unless structured to take advantage of rising rates, falling interest rates have a
positive effect on banks for several reasons. One is that net interest margins can expand, at
17
least in the short-term. This is because banks can earn a higher-than-market yield on loans to
customers, while the cost of funds declines more quickly in response to the new, lower rates.
An interest rate decline also enhances the value of a bank’s fixed-rate investment portfolio,
since a bond with a higher stated interest rate becomes more valuable as prevailing rates drop.
Moreover, an environment of declining rates often motivates loan demand and reduces
delinquency rates, because the cost of credit declines, Of course, not all banks are affected
equally by rate decreases. Banks that rely more heavily on borrowed funds than on customer
deposits to fund loan growth typically reap greater benefits. Fluctuations in interest rates,
while important, don’t have an absolute influence over the net interest margins of banks,
primarily because banks can adjust in time to such fluctuations. In theory, banks can match
the maturities of their assets (loans and investments) and liabilities (deposits and borrowings)
so that rates earned and rates paid move more or less in tandem and net interest margins
remain relatively stable. In practice, however, banks can deviate from a perfectly balanced
position which results in risk taking with the objective of earning a reward.
Banks are financial and profit-oriented entities that generate their profit from their tradition
functions of financial intermediation. Additionally, they stand to offer other services that
generate incomes and fees for them. Interest rate represents the cost of credit in the financial
from the financial market at relatively cheaper cost and lend at higher rate to generate profit.
Therefore, unless structured to take advantage of rising rates, falling interest rates have a
positive effect on banks for several reasons. One is that net interest margins can expand, at
least in the short-term. This is because banks can earning a higher-than-market yield on loans
to customers, while the cost of funds declines more quickly in response to the new, lower
rates. An interest rate decline also enhances the value of a bank’s fixed-rate investment
portfolio, since a bond with a higher stated interest rate becomes more valuable as prevailing
18
rates drop. Moreover, an environment of declining rates often motivates loan demand and
reduces delinquency rates, because the cost of credit declines, Of course, not all banks are
affected equally by rate decreases. Banks that rely more heavily on borrowed funds than on
customer deposits to fund loan growth typically reap greater benefits. Fluctuations in interest
rates, while important, don’t have an absolute influence over the net interest margins of
banks, primarily because banks can adjust in time to such fluctuations. In theory, banks can
match the maturities of their assets (loans and investments) and liabilities (deposits and
borrowings) so that rates earned and rates paid move more or less in tandem and net interest
margins remain relatively stable. In practice, however, banks can deviate from a perfectly
balanced position which results in risk taking with the objective of earning a reward.
variables has attracted much attention in research. It has been pointed out that bank
ownership effects.
3.3 The link between commercial banks performance and bank specific factors
Bank performance can be explained by bank specific factors such as the size of the bank, net
profit to total asset ratio, loan to asset ratio, on interest expense to net revenue ratio. These
variables have been explained in details. Regarding the size, it would be expected that the
larger the bank, the higher the level of profitability due to economies of scale. Akhave et al
(1997) and Smir Lock find a positive relationship between the size of a bank and bank
performance since relatively large bank tend to raise less expensive capital hence become
19
(1992) all argued that bank size is positively related to bank performance. Many
otherresearchers such as Berger et al (1987) and argued that eventually very large banks
could face the problems of diseconomies of scale which amounts to inefficiency.Big banks
may also have lower degree of being bunkrupt hence size is considered as a determinant of
bank performance.Bikker and Hu (2002).The bigger a bank’s equity capital to total assets
ratio, the less tendency for the operations. This therefore will enhance the performance of the
bank.
According to Agbanzo (1997), the proxies for default risk, the opportunity cost of net interest
bearing reserves, leverage and management efficiency are all statistically significant and
positively related to bank interest margin. The bank characteristic variables used in the
performance studies into the area employ variables such as size, capital, risk management and
asset quality and low level of liquidity are the two main causes of bank failure. During
periods of increased uncertainty, financial institutions may decide diversify their portfolios
and raise their liquid holdings in order to reduce their risk. In this respect, risk can be divided
variables
Macroeconomic control variables that may influence bank’s performance include inflation
rate, interest rate of money supply Revell (1979). Revell admits that the effect of inflation on
bank performance depends on whether bank’s wage and other operating expenses increase at
a faster rate than inflation. Penny (1992) states that the extent to which inflation affects bank
performance depends on whether inflation expectations are fully anticipated .This implies
20
that when banks fully anticipate inflation changes, the management can appropriately adjust
interest rates in order to increase their revenue faster than their cost. The existing literature
indicates that performance of banks can be explained by the bank’s own specific
characteristics such as the size, proxy by the total assets, equity-capital-to-asset ratio, loan-to-
asset ratio, non-interest-expense-to-net-revenue ratio, and bank concentration ratio. These are
Explanations have been offered in support of these variables. For instance, in terms of the
size of the bank, it would be expected that large or big banks would enjoy economies of scale
and high efficiency in their operations hence high profitability compared to smaller banks.
Akhavein et al. (1997) and Smirlock (1985) find a positive and significant relationship
between size and bank profitability. Demirguc-Kunt and Maksimovic (1998) suggest that the
extent to which various financial, legal and other factors (e.g. corruption) affect bank
performance is closely linked to firm size. In addition, as Short (1979) argues, size is closely
related to the capital adequacy of a bank since relatively large banks tend to raise less
expensive capital and, hence, appear more profitable. Using similar arguments, Haslem
(1968), Short (1979), Bourke (1989), Molyneux and Thornton (1992) Bikker and Hu (2002)
and Goddard et al. (2004), all link bank size to capital ratios, which they claim to be
positively related to size, meaning that as size increases, especially in the case of small to
medium-sized banks, profitability rises. However, many other researchers suggest that little
cost saving can be achieved by increasing the size of a banking firm (Berger et al., 1987).
Big banks may also have lower degree of being bankrupt hence size is considered as a control
variable in studies that have attempted the determinants of banks performance. Furthermore,
the higher a bank’s equity capital to total assets ratio, the less tendency for the bank seeking
external financing for its operations. This will enhance its performance and net income
21
margin. It may represent risk or stability of the bank against external shocks. Specifically, in
a study of performance for a sample of banks in four European countries, Molyneux, Lloyd-
Williams and Thornton (1992) include a capital-to-asset ratio and a loan-to-asset ratio to
account for bank-specific risk, on the grounds that their dependent variable (total interest
revenue per dollar of assets) is not risk-adjusted. In a similar vein, Samolyk (1994) states that
“Differences in loan/asset ratios and bank capitalization are important factors in assessing the
interest margins using bank-level data for 80 countries in the years 1988-1995 using a set of
implicit bank taxation, deposit insurance regulation, overall financial structure, and
underlying legal and institutional indicators. Demirgüç-Kunt and Huizinga report that the
bank interest margin is positively influenced by the ratio of equity to total assets, by the ratio
of loans to total assets, by a foreign ownership dummy, by bank size as measured by total
bank assets, by the ratio of overhead costs to total assets and macroeconomic variables such
as inflation rate and the short-term market interest rate in real terms. The ratio of non-interest
earning assets to total assets, on the other hand, is negatively related to the bank interest
margin.
Angbazo (1997) studies the determinants of bank net interest margins for a sample of US
banks using annual data for 1989-1993. The results for the pooled sample suggest that the
proxies for default risk (ratio of net loan charge-offs to total loans), the opportunity cost of
non-interest bearing reserves, leverage (ratio of core capital to total assets), and management
efficiency (ratio of earning assets to total assets) are all statistically significant and positively
22
related to bank interest margins. The ratio of liquid assets to total liabilities, a proxy for low
Also, Brock and Rojas-Suarez (2000) explore the determinants of interest rate spread for a
sample of five Latin American countries (Argentina, Bolivia, Colombia, Chile, and Peru). For
each country, regressions for the bank interest spread include variables controlling for non-
performing loans, capital ratio, operating costs, a measure of liquidity (the ratio of short term
assets to total deposits) and time dummies. Their findings show positive coefficients for
capital ratio (statistically significant for Bolivia and Colombia), cost ratio (statistically
significant for Argentina and Bolivia), and the liquidity ratio (statistically significant for
Bolivia, Colombia, and Peru). As for the effects of non-performing loans, the evidence is
mixed. Apart from Colombia, where the coefficient for non-performing loans is positive and
statistically significant, for the other countries the coefficient is negative (statistically
significant for Argentina and Peru). The authors explain these findings as “a result of
inadequate provisioning for loan losses: higher non-performing loans would reduce banks’
income, thereby lowering the spread in the absence of adequate loan loss reserves”.
The bank characteristic variables used in the banking performance literature has been referred
determinants employ variables such as size, capital, risk management and expenses
management. The need for risk management in the banking sector is inherent in the nature of
the banking business. Poor asset quality and low levels of liquidity are the two major causes
of bank failures. During periods of increased uncertainty, financial institutions may decide to
diversify their portfolios and/or raise their liquid holdings in order to reduce their risk. In this
respect, risk can be divided into credit and liquidity risk. Molyneux and Thornton (1992),
23
among others, find a negative and significant relationship between the level of liquidity and
profitability. In contrast, Bourke (1989) reports an opposite result; while the effect of credit
risk on profitability appears clearly negative (Miller and Noulas, 1997). This result may be
explained by taking into account the fact that the more financial institutions are exposed to
high-risk loans, the higher is the accumulation of unpaid loans, implying that these loan
Bank ownership may be explained as to whether the ownership is n the hands of Ghanaians
or foreigners. According to Huizinga (2001), foreign banks provide the channel through
which capital inflows finance domestic activities .Again it has been argued that the increase
in competition among banks whether domestic or foreign will improve the performance of
banks and provide financial services at lower average cost. Levin and Min (1998) contended
that unlike the optimists about foreign banks’ entry, the capital flow channel may serve rather
as a path for capital flight. Another point raised by opponents was that foreign banks may
have competitive advantage that allows them to pick among the available domestic funding
options, choosing the better performing and low risk option and leaving the less profitable
and higher risk option for domestic institutions. Finally, foreign banks from developed
countries may introduce complexities not seen by domestic regulation and supervision
24
Using accounting decomposition as a well panel regression Al-Haschimi (2007), studies the
determinant of bank performance in sub Sahara African countries. He finds that credit risk
and operating inefficiencies explain most of the variation in net interest margins across the
region. Using bank level data for 80 countries in 1988, Husinga (1988) analysed how bank
characteristics and the overall banking environment affects bank performance. Results
suggest that macroeconomic and regulatory conditions have a very great impact on bank
performance. Existing results indicate that differences in bank ownership and characteristics
also influence Bank performance. Analysing the performance of foreign banks alongside that
of the local banks, foreign banks ere noted to have higher margins and profit than local banks
in developing countries whereas the opposite holds in the developing countries. In a study
conducted in the United States Angbanzo (1997) finds that net interest margins reflect credit
and macroeconomic risk. More recently a number of studies have emphasised the relationship
between macroeconomic variables and bank performance. Allen and Sanders (2004)
conducted a survey on the credit and market risk exposures. Their findings were that such a
The Banking Act (1970) provided the regulatory framework for the banking industry whilst
the Bank Examination Department (BED), established in the BOG in 1964, was to perform
supervisory functions. The Act imposed minimum paid up capital requirements for foreign
and locally owned banks of ¢2 million and ¢0.5 million respectively (the latter was
subsequently raised to ¢0.75 million). However, the minimum capital requirements were not
able to withstand the inflationary pressure in the system by the early. At the end of 1983, the
minimum paid up capital for a local bank was equivalent to only $16,000. Banks were also
25
required to maintain capital and reserves of at least 5% of their total deposits instead of their
risk adjusted assets which would be more relevant (Gockel and Brownbridge, 1996)
The prudential regulations did not incorporate clear accounting rules regarding the
recognition of loan losses, provisioning for non-performing assets and the accrual of unpaid
interest and thus the true state of banks’ balance sheets, including the erosion of their capital.
As a result, loan losses could be concealed. Although the Banking Act did provide some rules
to constrain imprudent behaviour by banks, penalties for infractions were minimal. There
were also important regulatory omissions, such as limits on single borrower loan exposures.
The activities of the Bank Examination Department (BED) were largely confined to ensuring
that banks complied with allocative and monetary policy directives, such as sectoral credit
directives, and reserve requirements, rather than prudential regulations. The BED also lacked
adequate resources to monitor and inspect the banks. On site examinations were infrequent
and off site supervision was impeded because of deficiencies in bank reporting. Hence the
BED lacked the information necessary to evaluate the condition of banks’ asset portfolios,
The pre-reform policies had important consequences for the banking system. Financial depth
declined, bringing down with it the ability of the banking system to supply credit, even to
priority sectors. With the exception of those banks which retained foreign equity participation
(i.e. Barclays Bank Limited (Barclays), Standard Chartered Bank Limited (SCB) and
26
Merchant Bank Ghana Limited (MBG)), all other banks became insolvent as a result of bad
Financial Depth
The policies in place severely dented the level of financial depth in Ghana. The broad
money/GDP ratio, which had been relatively stable at around 20% from 1964-74, rose briefly
in the mid 1970s (to a peak of 29% in 1976) and then shrunk to 11% in 1983 as presented in
Table 2.2 below. Moreover bank deposits became less attractive relative to cash as indicated
by a rise in the currency/M2 ratio from 35% in 1970 to 50% in 1983, reflecting a process of
disintermediation from the formal financial system (Aryeetey and Gockel, 1990). Bank
deposits amounted to only 7.4% of GDP in 1984, having fallen from 19.5% of GDP in 1977.
Aryeetey and Gockel (1990), in a study of the informal financial sector, found that “street
banking” was increasing in contrast to formal sector intermediation. The main causes of the
decline in financial depth included the sharply negative real deposit rates, which deterred
Banks were discouraged from active deposit mobilisation because interest rate controls and
the very high statutory reserve and liquid asset requirements prevented banks from
channeling depositors’ funds into lucrative outlets. At times the banks refused to open new
time and savings deposit accounts and refused to pay interest on accounts above a certain
During the period 1990-1995, the banking sector was characterised by the following: The
Central Bank, Commercial Banks, Merchant Banks, Development Banks and Rural Banks. In
1989 a new banking law, PNDC Law 225 was enacted to institute prudential and regulatory
27
requirements for the banking system. Thereafter the Financial Sector Adjustment Programme
(FINSAP) was introduced in 1990 to restructure the distressed banks and also to strengthen
the banking system to enable it play a more effective role in the economy. The banking sector
has experienced some significant developments over the years, especially within the past
• The entry of foreign banks, mainly from Nigeria bringing the total number of
• The Bank of Ghana deregulated some of the activities of the banks whilst
the key player in the economic development programme has already off-loaded a
began in 1995 when the government sold part of its equity stake in the SSB to the
• In view of high rates of inflation in the 1990s, the GHC200m ($1m in 1989)
required to open a locally owned commercial bank had fallen to only $117,000 by
mid 1996.
• Interest rates have been liberalised making it more responsive to market forces.
initiative and creativity has resulted in the restructuring of the operations of most
28
• The market witnessed new products such as: Cedi Travellers Cheques, Sika Card,
• The Bank for Credit & Commerce (the Ghanaian subsidiary of BCCI which was
closed down by regulators in the UK and USA in 1991) has been technically
liability, and has been managed under BOG supervision since then.
• The local subsidiary of Meridian BIAO was closed in 1995 after incurring a large
• The stock market outperformed most emerging markets in the world in 1993 and
1994 due to the relative stability in macro economic indicators such as low
inflation and interest rates had a favourable impact on the performance of the
GSE. Many new investors, both local and foreign took advantage of the situation
and shifted funds from the money market to invest on the stock market for
The Ghanaian economy experienced setbacks in the second half of the 1990s due to
inappropriate policies, delays in donor disbursements and adverse terms of trade shocks that
had serious deleterious effects on economic activity. Economic growth became weaker and
declined from the relatively impressive 5% in 1996 to 3.7% by close of 2000. The period saw
the value of the cedi depreciating more than four times from GHC1,740 in 1996 to
GHC7,312 by close of 2001. Domestic inflation rose significantly to 41% by December 2000,
falling to 22% by close of 2001. The difficult economic environment that prevailed in 2000
reflected in the performance of the stock market. High levels of inflation, the rapid
depreciation of the cedi, and high interest rates eroded investor interest in the market. Despite
the difficult situation, the GSE managed a 16.55% nominal rise compared to the negative
29
Central Bank, during the period 2002 to 2007 continued to hold tight the monetary position
through intensified open market operations and thereby ensured price and exchange rate
stability. During the period, economic aggregates made significant progress towards
macroeconomic stability. The period was characterised by a steady but consistent decline in
inflation and interest rates. Year-on-year inflation, which was 15.5% by end of Dec, 2000
Some recent achievements of the commercial banks in the financial market of Ghana
The banking sector has remained one of the best performing sectors in the economy. Despite
increasing competition and declining margins, the sector has continued to record significant
growth and increased profitability over the years. In the last 2 years, 4 new Nigerian banks
have been licensed to operate in the country and other new entrants are expected in the near
future. Competition within the industry is intense with banks introducing new products and
services, expanding branch networks and going into mergers and acquisitions. Low inflation
and interest rates have accounted for the narrowing margins. Banks are under intense pressure
Total Assets and Deposits grew by 67% between years 2004 to 2006. The sector is dominated
by 12 banks which controlled more than 90% of the industry’s assets and deposits in years
2004 and 2006. Increasing competition has reduced the share to an average of 85% in year
BOG’s desire to make Ghana the financial hub of West Africa and Government is therefore
30
pursuing policies that will facilitate the attainment of these goals. Key developments in the
industry include:
A Credit Reporting Bill, which will ensure that credit ratings are assigned to institutions and
individuals, has been passed into law. It is expected that this will enrich the lending process
for banks and improve the quality of bank loans. The BOG is also re-examining the Know-
Your-Customer (KYC) process in order to introduce new guidelines to ensure its conformity
with the prevailing environment while making sure they are consistent with anti-money
laundering procedures.
bodies such as the BOG and the Securities and Exchange Commission, introduced new
financial reporting standards, the International Financial Reporting Standards (IFRS), with
effect from January 1, 2007 for banks, listed companies and other large companies in Ghana.
are requiring and gaining access to banking services. There is also the huge untapped
informal sector, which controls significant funds. Government also estimates that significant
amounts of money remain outside the banking system. These present huge opportunities for
31
The stiff competition in Ghana’s banking sector has made it imperative for banks to focus on
product development and quality service delivery as the main channels for effective
competition. Banks are introducing new products aimed at satisfying the unique needs and
taste of their customers. Personal loan products have become very attractive due to the
declining interest rates and so is private banking and electronic banking services.
The BoG successfully embarked on the planned re-domination of the Cedi in July 2007. Ten
thousand cedis (¢10,000) was equated to one new Ghanaian cedi (GH¢1). This new
The Bank of Ghana has stated that the current reforms in the banking industry have enabled a
cluster of banks with relatively low capital base and depth that are inadequate to support
minor swings in macroeconomic fundamentals thus entry to the industry has to be selective,
well managed and paced over time. Clear exit rules and prudential supervision would be
The Bank of Ghana therefore proposes to increase the capital requirements of banks from GH
¢7.0 million to between GH¢ 50.0 – 60.0 million. Banks are expected to submit
capitalization plans by the end of June 2008. Submission of capitalization plans would
guarantee continued access to the settlement and primary dealership systems. After December
2008, participation in the settlement system will be restricted to institutions that have met the
32
capital requirements. The banking system would allow for lower tier banks after December
2008 which will comprise of Banks that do not meet the capital requirements.
CHAPTER FOUR
Research Methodology
4.0 Introduction
This research will employ appropriate statistical tools such as regression, correlation,
econometrics for the purpose of analyzing the results of this research paper. In statistical
analysis, relationships between two or more variables are often best tested in a regression
analysis. In a typical regression analysis, there is an assumption that one variable called
dependent variable is explained by one or more independent variables. This is the generally
accepted classical Ordinary Least Squares (OLS) regression analysis with the following
assumptions:
an error term,
• The disturbance or error terms all contain the same variance and not correlated
33
• The observations on the independent variables can be regarded as fixed,
Another form of regression analysis or method is panel data analysis. This study would
utilise, a panel data technique as the basis of the econometric modeling and data analysis. It
The data for this study is made up of bank-specific, macroeconomic specific and ownership
variables obtained from annual reports published by the Bank of Ghana for the period 2000-
2009. In order to test the accuracy of the results of this study, three performance measures in
banking literature are used, namely, Return on Assets (Earnings before interest and tax
divided by total assets), Return on Equity (Earnings after interest and tax divided by
shareholders fund) and Net Interest Margin (Net Interest divided by Total Asset).
We use the ratio of equity to assets (EA) to proxy the capital variable, when adopting ROA as
the profitability measure. Also, we relax the assumptions underlying the model of one-period
perfect capital markets with symmetric information. Firstly, the relaxation of the perfect
capital markets assumption allows an increase in capital to raise expected earnings. This
positive impact can be due to the fact that capital refers to the amount of own funds available
to support a bank’s business and, therefore, bank capital acts as a safety net in the case of
34
adverse developments. The expected positive relationship between capital and earnings
could be further strengthened due to the entry of new banks into the market. Secondly, the
increase in earnings to increase the capital ratio. Finally, the relaxation of the symmetric
information assumption allows banks that expect to have better performance to credibly
transmit this information through higher capital. In the light of the above, capital should be
modeled as an endogenous (as opposed to a strictly exogenous) variable. It can also be argued
that financial markets are not perfect and that, well-capitalized banks need to borrow less in
order to support a given level of assets, thus they may tend to face lower cost of funding due
well-capitalized bank could provide a signal to the financial market of a better than average
banks, in this regard, appear less risky and profits should be lower because they are perceived
to be safer. Again, EQUITY/TA is included in the model because domestic and foreign
banks may use different degrees of leverage. Lower capital ratios in banking imply higher
leverage and risk, and therefore greater borrowing costs. Berger and Mester (1997) have
pointed out that, it is an important control variable used to account for differences in risk
among banking institutions. In this regard, we would expect to observe a negative association
To proxy this variable we use the loan-loss provisions to loans ratio (PL). Theory suggests
that increased exposure to credit risk is normally associated with decreased firm profitability
and, hence, we expect a negative relationship between ROA (ROE) or net interest margin and
PL. Banks would, therefore, improve profitability by improving screening and monitoring of
35
credit risk and such policies involve the forecasting of future levels of risk. Other ratios that
have been used to measure credit risk and/or liquidity risk were loans/assets, loans/deposits
and provisions/assets. In this study, I proxy for this variable by using bad debt provision
The total cost of a bank (net of interest payments) can be separated into operating cost and
other expenses (including taxes, depreciation etc.). Only operating expenses can be viewed as
the outcome of bank management. The ratio of these expenses to total assets is expected to be
increase efficiency and therefore raise profits. In this study, I used operating expenses divided
by total income to examine the extent to which management efficiency influences bank
profitability. I expect negative relationship between this variable and bank profitability.
One of the most important questions underlying bank policy is which size optimizes bank
profitability. Generally, the effect of a growing size on profitability has been proved to be
positive to a certain extent. This may be due to the fact that there is scale economies
associated with larger size-firms in production. On the other hand, for banks that become
extremely large, the effect of size could be negative due to bureaucratic and other reasons.
Hence, the size-profitability relationship may be expected to be non-linear. We use the banks’
real assets (logarithm) and their square in order to capture this possible non-linear
36
relationship. I expect positive relationship between bank size and profitability variables used
in the model.
variables. The macroeconomic variables used in this study are GDP growth as a control for
cyclical output effects, which we expect to have a positive influence on bank profitability and
inflation. As GDP growth slows down, and, in particular, during recessions, credit quality
deteriorates, and defaults increase, thus reducing bank returns. Demirgüç-Kunt and Huizinga
(1998) find a positive correlation between bank profitability and the business cycle. By
employing a direct measure of business cycle, Athanasoglou, et al. (2005) find a positive,
effect on bank profitability in the Greek banking industry, with the cyclical output being
significant only in the upper phase of the cycle. In his study, Al-Haschimi (2007) finds that
the macroeconomic environment has only limited effect on net interest margins in SSA
countries.
Again, with regards to inflation, the extent to which inflation affects bank performance
depends on whether future movements in inflation are fully anticipated, which, in turn,
depend on the ability of firms to accurately forecast future movements in the relevant control
variables or not. An inflation rate that is fully anticipated raises profits as banks can
appropriately adjust interest rates in order to increase revenues, while an unexpected change
could raise costs due to imperfect interest rate adjustment. Other empirical studies, such as,
Molyneux and Thornton (1992), Demirgüç-Kunt and Huizinga (1998), have found a positive
relation between inflation and long term interest rates with bank performance.
37
4.2.6Bank performance measures: ROA, ROE (Net Interest Margin-Interest Revenue
Control variables: Bank Capital, Bank Credit Risk, Bank expenses management, Bank Size,
This study applies panel data approach which involves pooling twenty banks over a period of
ten years (2005-2009). The use of panel data does not only improve sample size and
able to capture effects that are dynamic other than either using cross-sectional or time-series
data alone (Hsiao, 1986; Baltagi, 1995). Because of the several data points in the use of panel
data approach, degrees of freedom are increased and collinearity among the explanatory
variables is reduced thus the efficiency of economic estimates is improved (Baltagi, 1995).
The panel regression equation differs from a regular time-series or cross-section regression
by the double subscript attached to each variable. There are different forms of panel data
estimation, namely, the fixed effects, random effects and constant coefficients effects model.
The constant coefficient effect model is appropriately utilized under the assumption that there
are no significant variations in both intercepts (cross-sectional units) and slopes (temporal
effects) in a model. In that regards, the data can be pooled and run an Ordinary Least Squares
(OLS) regression. However, in a situation whereby the slope is constant but there are varying
intercepts across the firms, the fixed effects model is applicable. While the intercepts vary
from firm to firm, they may not change over time. Essentially, the fixed effects estimation
makes it possible to control for individual characteristics of cross-sectional units that are
heterogeneity”.
38
Yit = β1 X it + ai + uit .......... .......... .......... .... 1
i =1…………………N
t=1…………………… T
Where i denotes firms and t, time. The uit is the error term which is subscripted with i and t.
The unobserved heterogeneity, ai., is not subscripted with t, implying that its effect varies
across cross sections but is fixed over time. The error term (what is unaccounted for in the
model) is thus the time-varying (or idiosyncratic) error and represents the unobserved factors
that change over time and affect our dependent variables. It is also assumed to be independent
When it is observed that the ai.is correlated with the included explanatory variables in the
model, the OLS and Generalised Least Squares (GLS)-the random effects estimates give
biased and inconsistent results. In that regards, the fixed effects provide consistent results and
vice versa. However, the use of the fixed effects depletes the model of degree of freedom. In
order to avoid this problem, the ai. is assumed random hence the use of the random effects
model. Furthermore, it is suggested that a choice between the fixed and random effects model
depends on the results of Hausman test (a test suggested by Hausman (1978) that decides on
Concerns have been raised with regards to estimations in which standard errors and residuals
are not dependent. Literature provided various means of dealing with standard errors in panel
data. Petersen (2007) argues that the chosen method is often incorrect and the literature
39
provides little guidance to researchers as to which method should be used. He further argues
that, some of the advice in the literature is simply wrong and sometimes produce incorrect
estimates. OLS estimation while common in literature may be biased, owing to a failure to
control for time-invariant firm-specific heterogeneity. When the residuals are correlated
across observations, OLS standard errors can be biased and either over or underestimate the
true variability of the coefficient estimates and produce t-statistics that are very large. This is
Petersen (2007) proved that both OLS and the Fama-MacBeth standard errors are biased
downward. His results show that only clustered standard errors approaches are unbiased as
they account for the residual dependence created by the firm effect. An alternative approach
for addressing the correlation of errors across observations is the Newey-West procedure
(Newey and West, 1987). The Newey-West standard errors are also biased but the bias is
small compared to the other methods. The mode of estimation used in this study is linear
40
CHAPTER FIVE
5.0 Introduction
and financial markets are necessary for overall economic development of a nation. This is
due to the fact that, financial intermediation plays an important role in accelerating the pace
of economic growth by allocating the flow of funds from the surplus spending unit to the
deficit spending unit. With this background, the efficiency and performance of banks
banks affects every area of an economy. The existing literature indicates that the performance
of banks is explained by bank specific factors and macroeconomic variables. This study
examines the determinants of bank interest margin and profitability in Ghana within a panel
data framework. This section discussed the results of the empirical investigation. Analysis of
bank performance starts with the discussion of summary statistics, correlation matrix and
finally the regression results. The table below shows the relevant statistics and variables used
in the study.
41
Table5.1 Summary Descriptive Statistics Bank specific and Macroeconomic variables
Std.
1
GDP 100 0.051770 0.0106335 0.0370000 0.0730000
Bank Assets 100 3.00000 3.0000 1436000 1.640000
91 Days T bills 100 0.209870 0.0997050 0.106000 0.0450000
Equity/Total assets 100 0.1274283 0.0844994 0.0008027 0.8028551
Operating Cost/Total 100 0.073775 0.0328117 0.0002877 0.3227021
assets 1
No of Branch 100 38.110000 35.00675 1.000000 0.322702136
Table 5.1 is a summary statistics which explains the mean, standard deviation, minimum and
maximum values. For a mean of 3.4%, the return on assets has a minimum loss of 2.8% and a
maximum profit 1.5% Thus, stakeholders with the banks under survey during that period of
the study will earn on average 3.4 with a maximum being 15%. There is some level of
variation in this earnings indicated by the standard deviation of 3.8%. With regards to return
on equity-earnings after interest and tax, it has a mean of 32% for shareholders within the
period under study, a minimum loss of 36% and a maximum gain of 87%, there is also some
level of variation within this statistics. The bank capital measure, equity divided by total
assets, poses a mean of 12.7% with minimum and maximum values 0.08% and 80%
respectively. Considering the level of variation, it appears the mean value of this variable
shows that the banks covered under the study are highly leveraged-they turn to finance their
42
asset base largely through the use of more debt as against equity. Also, the management
minimum value of 51.3%. This indicates that management expenses constitute larger
percentage of the banks expenses under the period covered. This is likely to have some
implication on the level of bank profitability. Bank credit risk measure, provision for bad debt
divided by total advances has a mean of 4.2% with a maximum 26.2%. On average, banks are
very much cautious about the impact of credit risk on their profitability. Inflation and GDP
growth rate have a mean of 18.2% and 5.2% respectively. The indication is that the current
Increase in the level of GDP and the fall in inflation rate have contributed to the improved
performance of the commercial banks in recent times as compared to the situation of the past.
Total Asset base of banks have increased recently following incorporation of more new bank
and the arrival of some foreign ones .This has also boosted the performance of the banking
industry as a whole and has made the industry more competitive. Considering operating cost
to total asset, one may conclude that the operating cost of commercial banks have increased
as a result of their effort to increase employee welfare, bank environment, and improved
quality of service. The mean is 0.74%, a maximum of 32.2% and a minimum of 0.029%.The
high operating cost coupled with high level of impairment losses as a result of non
performing loans have resulted in low level profit on the part of most of the banks such as
Considering the number of branches a bank operates, there is a mean of 38.11%, a standard
deviation of 35% a minimum of 1% and a maximum of 136%. This is an indication that the
more branches a bank operates the better its performance but this cannot be achieved without
carefully considering the site , the economic activities of the area, management competence
among other things. GCB and BBG seem to have the highest number of branches but this
43
44
Table 5.2 Correlation Results on Commercial Banks performance using available data
Variables ROA ROE CPI L.G L.A DAY EQTA OPCTA BRL
ROA 1.00
No. of Branches 0.4399 0.1482 0.0101 0.0413 0.4371 -0.0007 -0.2452 -0.2814 1.00
between two variables to explain the direction of a variable if that of the original data should
change or remain unchanged. Thus, the degree of correlation indicates the direction of
movement between the variables. Correlation enables a researcher to predict the effect of one
variable on the direction of the other. It is worth pointing out that correlation does not suggest
From the table above, there is a positive correlation between return on equity and return
asset, this means that when return on asset is increasing, return on equity is also increasing.
45
Inflation index has a positive correlation with return on asset, and return on equity
respectively. This means that when the level of inflation is rising in the country, the return
that investors make on their investment rises. The same applies to the return shareholder
Growth in GDP has a negative correlation with return on asset, return on equity, and inflation
respectively. Bank asset has a positive correlation with return on asset and growth in GDP.
This means that an increase in bank assets implies an increase in GDP or vice versa.
Regarding interest rate, an increase in 91 days Treasury bill for example would lead to an
increase in return on assets, return on equity, inflation rate since in each case there is a
positive correlation, but the same increase in the Treasury bill rate would lead to a fall in the
Equity to total asset has a negative correlation with return on assets, return on equity, GDP
growth rate and bank assets; however, it has a positive correlation with inflation and 91 days
Treasury bill rate. Operating Cost to total assets has a negative correlation with all the other
variables except equity to total assets. Number of branches has a positive correlation with all
the other variables apart from the 91days Treasury bill rate and equity to total assets.
46
Table 5.3 Panel-Corrected Standard Error Regression Result (ROA)
ROA
Variables co-eff Std error t-squre p-value 95% conf.
Inflation 0.0028114 0.0059668 0.47 0.638 -0.0088
GDP -0.0384301 0.01124 -3.42 0.001 -0.06046
Bank Asset 0.0017977 0.00088 2.04 0.041 0.00714
91day T bill 0.054918 0.24995 2.20 0.028 0.005929
EQTA -0.11209 0.045940 -2.44 0.015 -0.202136
OPCTA -0.591677 0.109372 -5.41 0.000 -0.806044
No of Branch 0.0144887 0.003358 4.31 0.000 0.007907
Constance -0.1076489 0.461416 -2.33 0.020 -0.198085
ROE
Variable co-eff Std error t-squre p-value 95% conf.
Inflation -0.0021643 0.0448147 -0.05 0.961 -0.08999
GDP -0.225036 0.082441 -2.73 0.006 -0.3866182
Bank Asset -0.0009091 0.0059656 -0.15 0.879 -0.0126014
91day T bill 0.2471264 0.1889273 1.31 0.191 -0.123164
EQTA -0.2235964 0.2227272 -1.00 0.315 -0.66013
OPCTA -2.580282 0.6050165 -4.26 0.000 -3.766093
No of Branch -0.0057893 0.016891 -0.34 0.731 -0.0388521
Constance -1.1547451 0.313351 -0.49 0.621 -0.7689018
Four bank specific profitability determinant variables are used here. The first is the equity-to-
asset ratio. From the table above, there is a positive and statistically significant relationship
between return on assets and equity-to-asset ratio. This may mean that, the high leverage
position of the banks under this study may not enhance bank Performance. On the other hand,
the higher equity-to-asset ratio, the lower the need for a bank to seek external funding to
augment its capital base and therefore better performance may be assured and vice versa. A
well capitalised bank can also withstand macroeconomic shocks and hence improves upon its
profitability. It also a sign that well capitalised banks face lower costs of going bankrupt and
47
then cost of funding is reduced. Lower cost of funding may translate into higher above
average market value and better performance. Financial market cannot be described as
perfect simply because there is some degree of asymmetric information on the market.
According to Athanasoglou et al., (2005) a well-capitalized bank could provide a signal to the
financial market that a better than average performance should be expected. On a similar
study by Berger (1995) and Dermerguç-Kunt and Huizingua (1999), they find a positive
relationship between bank performance and capitalization. Thus, this result seems consistent
with these studies. On the other had, lower capital ratios in banking may imply higher
leverage and risk, and therefore greater borrowing cost. An increase in equity implies a fall in
leverage which will further reduce ROE. In this regard, there will be a negative relationship
Another bank specific performance determinant is expenses divided by income that seeks to
maximise returns on invested funds is expected to lead to higher profit. The opposite is true.
efficiency and ROA and ROE. This means that improved management efficiency is likely to
enhance bank profitability whereas inefficient management that incur more expenses will
increase bank cost and lower profit. Thus, for bank managers aiming at enhancing the bottom
line for their shareholders, the magic is a conscious attempt to minimise cost. Another
variable that measures managerial efficiency is returns on earnings assets. From the results
above, ability of bank managers to enhance their managerial efficiency by enhancing earning
ability of assets that generate income to the bank is likely to translate into high profitability.
This study indicates positive and significant relationship between returns on earning assets
and both ROA and NIM but negative with regards to ROE. Furthermore, bank credit risk is
48
recognised as having negative impart on bank performance. The results above from the
regression table indicate that an increase in the provision for bad debt against total loans
advanced reduces both ROA and ROE. It is not clear where the result is positive with regards
to net interest margin. However, one can conclude that on a whole, to increase the
performance of banks, managers and more specifically, credit officers need to enhance their
credit administration capacity to enhance their loan monitoring and credit checks. This would
go along way to reduce the exposure of banks to credit risk-inability of customers to repay
loans on credit.
The last but one of the bank-specific control variables is the size measure. There are
advantages associated with large size even as there are disadvantages. In all the three
profitability measures, the size of the bank shows positive and statistically significant
relationship. Thus, large banks in Ghana can enhance their performance and net interest
margin by exploiting the economies of scale associated with large size in terms information
processing, research and development as well as better monitoring and screening credit
applicants at low cost. This will translate into higher profit and hence better performance.
Two macroeconomic variables used in this study are inflation and growth in Gross Domestic
Product (GDP). The effect of inflation on bank performance and hence depends on whether
the inflation is an expected or not. High inflation rates are generally associated with high
lending rates, and therefore, high incomes for banks. However, if increase in inflation is not
anticipated and banks are sluggish in adjusting their interest rates then there is a possibility
that bank costs may increase faster than bank revenues and hence inflation would adversely
affect bank profitability. This study reports the positive relationship between inflation and
49
ROA but negative with regards to ROE and NIM. The GDP growth rate is expected to have a
positive impact on bank’s performance according to the well documented literature on the
association between economic growth and financial sector performance. The findings from
this study indicate positive and statistically significant association between GDP growth and
ROA.
CHAPTER SIX
Conclusions/Recommendations
6.1 Conclusion
This research investigates bank performance in Ghana. The main objectives of the study are:
to examine the main determinants of bank performance, to explore the impact of key
control variables on bank performance. Using data covering a period 2007-2009 with ten
banks made up of foreign and domestic banks within panel data methodology, the results
from the study indicate that the key determinants of bank performance are: bank size, equity-
to-asset ratio (a proxy for bank capital), bank credit risk (provision for bad debt/advances),
bank expenses out of income and returns on earnings assets. Macroeconomic variables such
as inflation and GDP growth rate and inflation rate were also discovered as determinants of
bank performance.
The findings show that there is a positive and statistically significant relationship between
return on assets and equity-to-asset ratio. This means that, the higher equity-to-asset ratio, the
50
lower the need for a bank to seek external funding to augment its capital base and therefore
better performance and vice versa. Furthermore, a well capitalised bank face lower costs of
going bankrupt and the cost of funding is reduced. Lower cost of funding may translate into
higher above average market value and higher performance. Another bank specific
between management efficiency and ROA and ROE. This means that efficient management
is likely to enhance bank performance whereas inefficient management will increase bank
cost and lower profitability. Thus, for bank managers aiming at enhancing value for their
shareholders, the secret is a conscious attempt to minimise cost. Another variable that
measures bank performance in Ghana is returns on earnings assets. This study indicates
positive and significant relationship with bank performance. Furthermore, bank credit risk is
reported as having negative impart on bank performance. The findings from this study
indicate that an increase in the provision for bad debt against total loans advanced reduces
bank performance. By implication, to increase the profitability of banks, managers and more
specifically, credit officers need to enhance their credit administration capacity to enhance
their loan monitoring and credit checks. This would go along way to reduce the exposure of
The last but not the least of the bank-specific control variable is the size measure. There are
advantages associated with large size even as there are disadvantages. In this study, the size
of the bank shows positive and statistically significant relationship with bank performance.
Thus, large banks in Ghana can enhance their performance by exploiting the economies of
scale associated with large size in terms information processing, research and development as
well as better monitoring and screening credit applicants at low cost. The findings also
51
indicate that increase in inflation if not anticipated and banks being sluggish in adjusting their
interest rates adversely affect bank performance. With regards to the GDP growth rate, the
findings from this study indicate positive and statistically significant association between
6.2 Recommendations
Based on the findings from this study, the following are recommendations for policy and
makers in the banking as well as other industries to find appropriate ways of dealing
• The Central Bank should regularly review performance of banks that are in operation
• Increasing the capital based of the banks in Ghana would go along way to enhance
their performance and even their resilience to changes in external shocks. In this
regard, the recapitalisation policy of the central bank is appropriate. It will help
• Again, bank managers should attempt to minimise the expenses made in order to
enhance the wealth of stakeholders. This does not however mean, there should not be
incentives to motivate productive effort and behaviour. Rather, bank managers should
ensure that managerial expenses are kept within optimal levels consistent with profit
level of default on loans. Credit officers and loan officers should be well equipped
with the required skills needed to conduct proper and due diligence on loan
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applicants. Also, effective monitoring of credit would also help keep the level of
• Banks are profit-oriented entities and thus, appropriate response of their policy to
reflect the macroeconomic realities in the economy would enhance their performance
forecast and incorporate in their periodic credit policy changes, the effects of
changing general price level which is likely to affect their cost of operation and the
• Aggressive policy to increase the asset based of banks would also enhance their
profitability. Assets represent sources of revenue to banks and hence a credit policy
customised and flexible products that reflect customer needs, status and expectation is
banks.
• Logistical and time constraints however limited the scope of the study the few
commercial banks having the required financial data. The period covered was also
short. Further studies could increase the period and also add more variables as well as
more banks to provide interesting and enhance knowledge. These studies can also
53
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APPENDIX 1: LIST OF BANKS SELECTED FOR THE STUDY
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