Investigating the impact of credit risk on financial performance of commercial banks in Ghana

Abstract

The financial performance of banks across the globe is of utmost importance to its shareholders, managers, investors, regulators, and the general public. This study therefore investigates the impact of credit risk with focus on non-performing loans on the financial performance of commercial banks in Ghana. Return on asset and economic value-added are used as measures of financial performance. Internal bank factors such as the age and size of the bank are also considered. Macroeconomic factors such as gross domestic product, inflation, and monetary policy rate are included in the analysis. Panel data spanning the period 2013 to 2018 on 15 commercial banks in Ghana is used for the analysis. The results from the random effect estimation technique show that non-performing loans have a negative impact on both measures of financial performance. Also, monetary policy rate has a negative impact on both measures of financial performance, albeit insignificant for economic value-added measure. It is further revealed that the size of bank, age of bank, and gross domestic product have a significant positive effect on both measures of financial performance although significant for return on asset. Based on the negative relationship between non-performing loans and financial performance, it is suggested that commercial banks should adopt stringent credit risk management policies, which should also be updated regularly to guide actions and processes to granting of loans and monitoring credit risk. Furthermore, it is suggested that the value of depreciable assets pledged as collaterals to the banks should be reviewed frequently (probably annually) to reflect a decline in their value. The novelty of the present study pertains to the use of economic value-added as a financial performance measure, which previous studies have virtually ignored in the analysis of credit risk and financial performance nexus.

Keywords:

• Credit risk
• financial performance
• non-performing loans
• economic value-added
• Ghana

PUBLIC INTEREST STATEMENT

The financial performance of commercial banks across the globe is key as far as economic growth is concerned. This is so because, a vibrant and robust financial sector ensures that funds are mobilized from the surplus units and subsequently given to the deficit units to facilitate investment activities which in turn promote economic growth. This important role notwithstanding, the financial sector continues to face some challenges and the notable among them is non-performing loans which has the tendency of collapsing financial institutions. As a result, issues pertaining to non-performing loans ought to be given utmost attention. Therefore, the present study examines the potential effect of non-performing loans on the financial performance of commercial banks in Ghana. The study has indeed shown that non-performing loans impact negatively on financial performance of commercial banks. Based on this, the study sheds lights on how non-performing loans can be reduced or eliminated in Ghana to ensure vibrant financial industry to facilitate economic growth and sustainable development.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Additional information

Funding

The authors received no direct funding for this research.