ABSTRACT
The banking industry plays a crucial role in the economic eco-system and its development means fostered growth for the country. For a financial system to be sound, a vibrant banking system needs to be present. Any shake in the banking system can send a ripple effect to the financial system and it can topple down, causing a recession. The collapse of two Ghanaian banks in 2017 and the consolidation of five other banks a year later raised concerns about the crucial role of risk management in the banking institutions. Therefore, the study sought to examine the effects of risk management on the profitability of universal banks in Ghana. Ten banks were sampled over the period 2006 to 2016. Using a random effect model, and performing all pre-estimation tests, the study revealed that credit risk had a negative effect on bank profitability (return on assets). Liquidity did not have a statistically significant effect on bank profitability. On the other hand, capital adequacy ratio, bank size and operational risk all had a positive effect on bank profitability whilst inflation was statically insignificant. Based on the findings, credit risk and capital adequacy are crucial indicators that impacted financial performance and easily resulted in banking failure. Operational risk is a dynamic factor that management can capitalize on to improve profitability, in our situation it is possible that whilst inadequate systems and processes contributed to poor performance some banks capitalized on it to make profits. Bank size improves performance; howbeit in this case profitability was small. The study recommends banks to make adjustments to reduce their credit risk for example through the use of credit rating bureaus when giving out loans. Also, good corporate governance is very important. Bank of Ghana must ensure compliance to the Basel Accords to maintain sound financial practice in the banking system. On the part of the central government, there should be effective regulations of the financial market.
CHAPTER ONE
INTRODUCTION
Background of Study
The Basel Committee on Banking Supervision (BCBS) is responsible for banking supervision and regulation issues. The promotion and supervision of risk management practices globally is their core mandate (BCBS, 2009). The role of Basel I which was enforced in 1992 to regulate the capital of banks aims at ensuring the maintenance of sufficient capital, cushion losses, ensure consistency amongst banks globally and most essentially, ensure effective risk management practices (Allen, 2013). Basel II accord essentially deals with the Internal Capital Adequacy Process (ICAP) by improving the structure for setting capital requirements and ensuring effective operational risk management processes (Chance & Brooks, 2011). Banks are therefore looking forward to combine the first two pillars, to create a consistent approach, and limit regulatory costs (BCBS, 2010).
Risk management guarantees ongoing operation and increases profitability in banking practice. There is an absolute need for efficient and effective risk management. In this respect, Allen (2013) points out that risk management in the economic industry is more crucial than in other areas of the economy. The mandate of financial institutions is to minimize risk and maximize income. They also need to give value for cash to their shareholders through their financial services, and in particular through risk management (Collier & Agyei-Ampomah, 2006). Authors who write on risk have combined the structure for their own analyzes in distinct respects, but the prevalent ones are credit risk, liquidity risk, operational risks that sometimes include legal risk, and more lately, strategic risk and e-bank risk (Marrison, 2012). The present research will
examine the impacts of risk management on Ghana’s universal bank profitability with a focus on credit risk, liquidity risk, operational risk, and capital adequacy risk.
Statement of the Problem
The collapse of UT bank and Capital Bank in August 2017 left in their wake discussions within the banking industry in Ghana, as to what possible conditions may have triggered the situation. The situation exposes universal banks in Ghana to operational risk, credit risk, market risk, liquidity risk, reputational risk, compliance risk and regulatory risks as sighted by Deloitte & Touche ( 2012).
Poor risk management of universal banks it reflect in banking failures, bank takeovers, mergers and acquisitions, low profit margins and weak performances (Allen, 2013), as was recently witnessed in Ghana. The above notwithstanding, the extant literature on the internal risk management of banks, have been limited to banks’ liquidity risk and their impact on financial performance (Sushil & Bivab, 2013), banking performance and their efficacy on risk management (Agbada & Osuji, 2013), and the relationship between risk management and business value of firms (Tahir & Razali, 2014).
Risk management issues, have been at the center of controversy and attracted lots of debate in recent times, First and foremost, with regards to the collapse of two Ghanaian banks in August 2017, and the consolidation of five other Ghanaian banks, a year later, in August, 2018. Research in this field of research conducted according to the researcher’s best understanding is insufficient. Previous studies include prospective obstacles to the application of Basel II (Masood & Fry, 2009), risk management in the Ghanaian insurance sector (Akotey & Abor, 2010), obstacles to family risk management (Collier & Agyei-Ampomah, 2006), and the effect of banks ‘ danger and performance (Bessis, 2009). But not much research has been performed widely on an evaluation of banks ‘ inner risk management and their general impact on economic results to the researcher’s highest understanding. Therefore, the present research aims to fill the existing literature knowledge gap by performing an initial job that will examine the impacts of risk leadership on the profitability of universal banks in Ghana.
Research Objectives
The main aim of the study is to examine the effects of risk management on the profitability of universal banks in Ghana.
Specific Objectives
In order to achieve the main objectives as stated above, the following specific objectives have been outlined:
- To examine the effects of credit risk on the profitability of universal banks in Ghana.
- To ascertain the influence of operational risk on the profitability of universal banks in Ghana.
- To ascertain the effects of liquidity risk on the profitability of universal banks in Ghana.
- To assess the effect of capital adequacy on the profitability of universal banks in Ghana.
Research Questions
The following research issues were described in order to attain the study’s particular goals:
- What is the effect of credit risk on the profitability of universal banks in Ghana?
- What is the influence of operational risks on the profitability of universal banks in Ghana?
- What is the effect of liquidity risk on the profitability of universal banks in Ghana?
- What is the effect of the capital adequacy ratio on the profitability of universal banks in Ghana?
Research Hypotheses
The research hypotheses will be stated in the alternative as follows:
H1: There is a significant relationship between credit risk and the profitability of universal banks in Ghana
H2: There is a significant relationship between liquidity risk and profitability of universal banks in Ghana
H3: There is a significant relationship between operational risk and the profitability of universal banks in Ghana
H4: There is a significant relationship between capital adequacy ratio and the profitability of universal banks in Ghana
Significance of the Study
The study will make the following contributions to academia, practice, and policy. Firstly, the study will add to the extant literature by carrying out an original work which will address the
effectiveness of the risk management practices of universal banks in Ghana, thereby serving as a reference material for future researchers. Secondly, an assessment of the operational, liquidity and credit risk practices of universal banks hopes to provide information about the financial institutions’ capability to handle the risks confronting their day-to-day operations. Finally, the regulator (Bank of Ghana) may use this study to design and improve upon the current risk management framework for all universal banks in Ghana, in order to reduce banking failures and improve upon the overall profitability of the banking industry in Ghana.
