Effect of non-performing loans on banks’ profitability: evidence from Ghana

The enormous risks of non-performing loans (npls) faced by financial institutions especially commercial banks is a major concern in the industry. This has become topical in Ghana in the face of the recent banking sector clean up that resulted in the revocation of licenses of seven commercial banks. The general objective of the study was to assess the effects of npls on the performance of commercial banks in Ghana with specific intent on examining the factors contributing to the increase in npls as well as to examine the effect of npls on the profitability of commercial banks in Ghana for a seven year duration between 2012 and 2018. The study adopted the quantitative research design. The target population for the study was all 23 commercial banks in Ghana. A sample of eight (8) commercial banks were selected using the purposive approach for the study. This research used secondary data from audited financial statements of eight licensed and registered commercial banks in Ghana. The research used descriptive analysis and panel regression analysis methods to analyze data using the Statistical Package for Social Sciences (SPSS) software. The results showed that 2017 was the year in which the highest rate of npls occurred of 19% a percentage point higher than the average of 18% over the seven year duration under study. It came to light however, that the lowest rate of npls occurred in the 2014 financial year with a rate of 12% while the industry average was 21%. The measure of the profitability of the banks was through a proxy of return on assets (ROA). The results indicated that the lowest year of profitability was 2017 when a 12.7% return on asset was made. In 2013 however the banks recorded the best return on assets of 18.4% and an NPL of 13%. The years 2012, 2014, 2015, 2016 and 2018 saw roas of 14.7, 16.3, 17.5, 15.6 and 13.3 percent respectively. This shows the Return on Assets (ROA) and NPL have an inverse relationship. The findings also showed that the 2017 financial year was the worst year of npls which was 19% with corresponding adverse effect on the profitability of the banks and also on the capital adequacy ratios and loanable funds leading to liquidity crunch. The correlation between variables show that real significance exists between npls, capital adequacy ratio, liquidity ratio, Interest rate and total assets with return on assets. It was further revealed that interest rates, liquidity and npls are significantly correlated with ROA, but interest and liquidity ratio are not significantly correlated with NPL while liquidity ratio negatively and significantly influences the ROA. High interest rates are responsible for high npls and subsequently decrease in return on assets. The pro-active recommendations made to management to help reduce npls in banks include but not limited to: that there should be at all times regular and effective monitoring, ensuring frequency in refresher courses for credit officers and managers, there must be provision of security and guarantees for credit facilities, a strict use of credit reference bureau and finally regular supervision and sanctioning by the regulator in the industry to prevent blatant disregard for the laws of the industry.

Source: KNUST