Credit Risk and Financial Performance of Listed Banks in Ghana

Abstract

Credit creation process exposes banks to high default risk which could lead to financial distress including bankruptcy. The objective of the study is to identify the key determinants of credit risk faced by the banks in Ghana and to assess its impact on their financial performance in terms of profitability. The study is based on data from seven banks operating in Ghana for a 15-year period ranging 2001 to 2015. The study showed an inverse relationship between capital adequacy and credit risk at 1% validating the hypothesis. Also business operation efficiency measured by Management efficiency ratio (MER) and trading income to total revenue ratio showed a negative significant relationship with credit risk at 5% and at 10% level of significance respectively which also provided a strong argument for the stated hypothesis. Return on equity and return on asset showed a significant inverse relationship with credit risk at 1% significant level. similar observation was made on net interest ratio which also showed a significant inverse relationship with credit risk at 5% level of significance but was against the expected positive relationship from the literature. Considering the identified determinants of bank credit risk, combined with how credit risk impacts bank profitability, an efficient operational expense management of banks would not only increase the profit margin of these banks but also reduce the tendency of threat on the survival of these banks. This is due to the significant relationship between management expense ratio and credit risk and also with profitability. From the result of the study, conclusion was arrived on the basis that, though there may be other factors that affect the credit risk of banks in Ghana, capital adequacy, management operational efficiency, management of liquidity risk and the size of the bank, annualised changes in inflation and changes in GDP are major determinants of credit risk due to their high statistical significance level.