The Causes Of Loan Default & Its Effects On The Performance Of Microfinance Institutions In Ghana: [Essay Example], 962 words GradesFixer

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The Causes of Loan Default & Its Effects on the Performance of Microfinance Institutions in Ghana

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In the effort of successive Ghanaian government to reduce poverty, several poverty reduction programs have been implemented over the years including Growth and Poverty Reduction Strategy (GPRS II), whose main goal is to ensure “sustainable equitable growth, accelerated poverty reduction and the protection of the vulnerable and excluded within a decentralized, democratic environment”.The 2010 Population and Housing Census, estimates that 80% of the working population is found in the private informal sector. The lack of access to credit by this category of the population constrains the development and growth of the private sector of the economy. This observation has been stressed upon by several international bodies, such as the International Monetary Fund and the World Bank.

The International Monetary Fund Country report on Ghana in May 2014 stressed that “weaknesses in the financial sector that restrict financing opportunities for productive private investments are a particular impediment to business expansion in Ghana.” Access to financial services is therefore imperative for the development of the informal sector and also helps to mop up excess liquidity through savings that can be made available as investment capital for national development. The availability of loan facilities, especially to small scale businesses constitutes one of the key economic growth tools of a developing country. The more credit is availed to various economic entities (individuals, businesses and government), the higher the economic empowerment of these entities.

Microfinance institutions which are one of the non-bank financial institutions in Ghana have always been cited as a major player in the provision of loan facilities for economic development of most developing countries. Most microfinance companies today offer a wide range of products and services than ever before, and their central functions of putting the community’s surplus funds (deposits) to work by lending to people remain unchanged as it has always been. The role of microfinance institutions in developing local economies cannot be underestimated especially in developing countries like Ghana. As at 2006, the total loans advanced to clients by the non-bank financial institutions in Ghana was GH¢115.10 million, an increase from GH¢71.63 million in 2005, thus indicating 35.4 per cent increase (Bank of Ghana, 2007). It is known that loans advanced by microfinance institutions are normally for purposes such as, petty trading, and as “start-up” loans for businesses.

There are other instances where credit is given to groups consisting of a number of borrowers for collective enterprises (Aryeetey et al, 1994). The upward-trending of Non-Bank Financial Institutions (NBFIs) credit to individuals, small businesses, groups and others indicates improvements in level of microfinance in the country (Bank of Ghana, 2015).Extension of credit facilities is one of the major activities of all Microfinance institutions including Savings and Loans Companies, Rural banks, Financial Non-Governmental Organizations (FNGOs) and Credit Unions. This is usually evidenced by the large proportion that loans constitute in the overall operating assets of these lending institutions. Healthy loan portfolios are therefore vital for lending institutions in view of their impact on liquidity, lending capacity, earnings and profitability of the Microfinance Institutions.

Microfinance Institutions (MFIs) currently provide financial services to an estimated 15 per cent of the country’s total population as compared with 10 per cent for the commercial banking sector. (Obuobi & Polio, 2010). However, the loan default rate among financial services sector in Ghana reveals an increasing trend as reported by Bank of Ghana.Nonperforming advance proportion which estimates the proportion of bad loans to net advances disintegrated from 16.2% in December 2009 to 17.6% as at December 2010 according to Bank of Ghana. It again increased from 18.8% in 2016 to 21.22% in 2017. It further deteriorated to 23.4 % in April 20 18- a new record high, the BOG’s report published in May noted.

Default is the failure to pay interest or principal on a loan or security when due. (Investopedia) The dictionary defines Default as the occurrences of a debtor being unable to meet the legal obligation of debt repayment. Loan default is the inability of the borrower to make required instalments as and when due. As indicated by Murray (2011) default happens when the borrower does not make required portions or in some other way does not follow after the terms of the loan arrangements.

According to Chowdhury etal, (2002).Cited by Malik M. Sheheryar Khan (2015) Loan default is associated with the inability of repayment of loans. At the point when an account holder (debtor) can’t pay back both the principal and interest after it is considered as outstanding, it can then be termed a loan default or a non-performing loan (NPL) Past studies reasons that there are various variables that causes NPLs over time. These variables includes, insider lending, lending to related parties, poor credit appraisal, poor credit culture, high interest rate, aggressive lending, compromised integrity, weak institutional capacity, funds diversion, capital adequacy ratio, real GDP growth rate, ROA, Inflation among others. Empirical study finds evidence for these factors.

A study conducted in Serbia by Nikola R etal, (2017) examined the determinants of NPL ratio using a cross-county analysis from a sample of 25 emerging countries and came to a conclusion that that NPLs rate can be explained by significant macroeconomic variables, for example, the GDP and expansion rate, return on assets, CAP and lagged NPLs. Ahlem S etal, (2015) in a study to detect the determinants of non-performing loans for a sample of 85 banks in three countries (Italy, Greece and Spain) for the time of 2004-2008, utilized macroeconomic variables and bank particular variables. The macroeconomic variables incorporated the rate of development of GDP, joblessness rate and genuine financing cost with respect to bank specific factors selected the return on ROA, the adjustment in advances and the advance loss reserves to total advances proportion.

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