Macroeconomic and Bank Specific Determinants of Non-performing Loans in Ghanaian Banking Sector

Abstract

Banks play an important role in the creation of capital for economic growth of a nation and their reliability is very critical for financial system stability. Nevertheless, banks face risks such as credit risk, which seem to have an impact on banks profitability. To determine credit risk, the ratio of Non-Performing Loans (NPLs) to total bank loans is the most common indicator used. Non-Performing Loans are loans that do not produce interest and principal amount for a minimum of 90 days and fundamentally reflects the performance of a bank. A high ratio indicates a greater risk of loss while a small ratio presents a low risk to the bank. NPLs systematically affects the whole banking system and if care is not taken will disturb its future development. The study examined the determinants of NPLs in the banking industry of Ghana using bank specific and macroeconomic variables. The study was based on monthly data covering the period January 2007 to December 2019 and employed the ARDL bounds test of co-integration to estimate the evidence of short run and long run relationship among the variables. The study results revealed that, bank’s lending rate, bank’s profitability, Cost to Income Ratio, Capital Adequacy Ratio and Net Interest Margin are the bank specific factors influencing non-performing loans. At the macroeconomic level, inflation and economic growth reduces non-performing loans. Furthermore, previous year’s non-performing loans and net interest margin depresses Current NPLs whereas credit adequacy ratio promotes Current NPLs in the short-run. The study recommends a firm policy reform that pays attention to credit appraisal mechanisms to improve the quality of bank loan portfolios through tougher regulations and guidelines to support healthier investment. Thus, management of banks should do well to cut interest rate on loans to make them less expensive for borrower’s to meet their commitments, whiles regulators undertake policies that can ensure efficiency in bank’s operations. Furthermore, Policymakers must consider GDP growth carefully by implementing a set of policies geared towards improving investment and finally profitability.