THE IMPACT OF WORKING CAPITAL MANAGEMENT ON THE PROFITABILITY OF BANKS IN GHANA

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ABSTRACT

This study sought to bring to the fore, the impact of working capital management on the profitability of banks in Ghana via a case study of FBN Bank, Zenith Bank, Guaranty Trust Bank, GCB Bank, Cal Bank and Fidelity Bank.

In the study, the researcher identified the relationship that existed between the components of working capital and the profitability of banks. The researcher as well identified the level of correlation that excited between the components of working capital and profitability of selected banks in Ghana.

The researcher used the financial statements of FBN Bank, Zenith Bank, Guaranty Trust Bank, GCB Bank, Cal Bank and Fidelity Bank in the gathering of data for the study from which analysis was made.

The study discovered that a negative relationship existed between Return on Capital Employed (ROCE), Acid Ratio (AR) and Cash Conversion Cycle (CCC); whereas, a positive relationship existed between Loan to Deposit Ratio (LDR) and Return on Capital Employed (ROCE). The researcher recommended that there will be the need for banks to increase their cash conversion cycle periods and prolong the settlement of their financial obligations falling due as well as increase the amount of loans in their portfolio by giving loans out to borrowing customers.

CHAPTER ONE INTRODUCTION

    Background to the Study

According to (BOG Banking Sector Report November 2018), as at October 2018, the Ghanaian Banking industry was made up of thirty (30) universal banks. Thirteen (13) of which were locally – owned and the remaining seventeen (17) were owned by foreigners. The Ghanaian banking sector is currently recovering from the shock associated with the collapse of seven (7) locally-owned universal banks between 2017 and 2018. Some reasons were cited by the Governor of the Bank of Ghana in his press release on August 1, 2018. He stated that “from an Asset Quality Review (AQR) of banks conducted by the Bank of Ghana in 2015 and updated in 2016, a few indigenous banks were identified as vulnerable with inadequate capital, high levels of non-performing loans, and weak corporate governance”. He, again, pointed out during the press conference that some of these banks were faced with liquidity challenges. This resulted in these banks having to receive liquidity support from the Bank of Ghana in order to meet their short-term financial obligations that were falling due. The liquidity challenge faced by these banks can be attributed to their inadequate management of their working capital.

“Working capital management refers to the short-term financial planning of cash levels or liquidity of a firm”. This serves as an indicator for the short-term performance of a business; “hence the need to attach importance to the practice of efficient working capital management within businesses”. Yeboah and Agyei (2012) in their research paper defined “working capital management as a process which involves the supervision of the balance of current assets and

current liabilities of a firm in a manner that maturing obligations are met while fixed assets are properly serviced”. They further pointed out that liquidity with reference to banking businesses remained non-negotiable for at least two reasons. These include “meeting regulatory requirement and ensuring there are enough funds to meet customer withdrawals requests”.

Efficient working capital management in banks is important because it influences a bank’s return on assets, return on equity as well as the bank’s liquidity and profitability positions. When working capital is well managed with a bank, “it provides the following benefits: places the bank in a better position to meet its short term obligations falling due such as customer withdrawals, helps maintain customer confidence and leads to growth in the banking sector”. These benefits lead to an increase in job creation and contribute to the development of the nation.

“The objective of efficient working capital management is to ensure growth in the profitability of businesses; while providing the business with sound liquidity in order to meet its short-term obligations”. Owusu-Frimpong (2008), in his research discovered that “working capital related problems were mentioned as part of the most significant reasons for the failure of rural and community banks in Ghana”.

In as much as adequate working capital is necessary for the survival and sustainability of a business, Brealey, Myers and Allen (2011) opined that while inadequate working capital led to the bankruptcy of companies, having too much of working capital at the disposal of a business could also result in cash wastage and the ultimate decrease in profitability. This, as a result, leaves managers in a situation where they have to decide on what they deem fit as the optimal working capital need of the business. “To achieve this, they decide on the perfect payoff between liquidity and profitability; so as to, maximize the value of their firms”.

Banks are known to play a major role in the development of nations. Some of their contributions to the economy include but not limited to the provision of financial services to enterprises and customers as well as the provision of jobs to the country’s population. According to Abor (2005), “not only are banks important for continuity of retail and microfinance business sectors, but they also serve as major source of funding for non-financial institutions and provide jobs to citizens”.

Although there has not been enough empirical evidence to support the claim that “poor working capital management practices played a major role in the failures of these seven (7) locally-owned universal banks in Ghana”, it can be deduced from the press statement of the Governor of the Bank of Ghana on August 1, 2018 that some of these seven (7) collapsed banks failed as a result of liquidity challenges.

It is on this backdrop that the researcher sought to conduct a research into “the impact of working capital management on the profitability of banks in Ghana through a case study of Fidelity Bank, GCB Bank, Cal Bank, FBN Bank, Guaranty Trust Bank and Zenith Bank”.

  Research Problem

One of the challenges that faced these seven collapsed banks had to do mainly with liquidity. Smith (1973) pointed out that most businesses which have collapsed due to poor working capital management had been as a consequence of financial managers usually proving to be incapable of managing their firm’s working capital effectively.

The consolidation of five (5) and collapse of two (2) local banks within the banking industry in recent times, have resulted in loss of jobs and the state having to raise bonds in order to safeguard

depositors’ funds at the expense of the taxpayer. A total of 1200 UT Bank and Capital Bank staff

had their appointments terminated by the receiver after the liquidation of their banks (https://www.ghanaweb.com/GhanaHomePage/business/Ex-staff-of-UT-Capital-banks-demand- exit-pay-712335). It was also reported that four hundred workers of the nonexistent Beige Bank had their appointments terminated by the newly formed Consolidated Bank. Again, the newly formed Consolidated Bank was said to be ready to lay off about 1700 staff of the defunct banks. These were seven hundred mobile bankers of the erstwhile Beige Bank and one thousand former employees      of                Royal  Bank,            Construction                      Bank,             UniBank                          and         Sovereign   Bank (https://citinewsroom.com/2018/08/28/consolidated-bank-to-sack-1700-out-of-3700-staff/ ). )

The Government of Ghana capitalized the newly formed Consolidated Bank with GH¢ 450 million as well as provided financial support through the issuance of bond worth GH¢ 5.76 billion towards the Purchase and Assumption Agreement under which the Consolidated Bank acquired all deposits, specified   liabilities                   and              good            assets  of          the          five  defunct              banks (https://www.myjoyonline.com/business/2018/August-1st/govt-to-issue-57m-bond-to-support- newly-created-consolidated-bank.php). All of these investments were made at the expense of the tax payer. This, as a result, has made it necessary for this research to be conducted.

Based on the points discussed above, this research generally sought to establish the relationship between working capital management on the profitability of banks from 2015 to 2017 in Ghana.

  Research Purposes

The main purpose of this study was to:

  1. To ascertain the relationship between working capital management and profitability of banks in Ghana
  2. To ascertain whether or not, the components of working capital are well managed by

Banks in Ghana

  Research Questions

The study desired to answer these underlying questions:

  1. Does the management of working capital significantly affect the profitability of banks in Ghana? ii.Have the components of working capital of Banks in Ghana been efficiently managed?

  Research Hypothesis

Based on the goal of this research, the following null and alternative hypotheses were tested:

Ho: There is no significant relationship between components of working capital management and the profitability of Banks in Ghana

Ha: There is a significant relationship between components of working capital management and the profitability of Banks in Ghana

  Significance of the Research

The intent of this study was to “determine the impact of working capital management on the profitability of universal banks in Ghana”. Below are some of the reasons why this study would be of relevance to various stakeholders:

  • For bankers, financial controllers, managers etc. this research will broaden their scope of knowledge in relation to how efficiently working capital elements can be managed and optimized.
  • Other researchers will find this study very significant in that it will contribute to the enrichment of their literature on working capital management of banks from which they can tap ideas and obtain relevant information for further research.
    • Furthermore, this research would provide banks with a better understanding of how to allocate funds in order to maximize their profits. It will serve as a guide for banks within Ghana to comprehend the consequence of managing working capital in order to avoid running into liquidity challenges when short-term obligations arise.
    • Lastly, government and other key stakeholders such as the Bank of Ghana would be able to use the findings of this study in policymaking decisions for the banking industry. This will enhance the profitability of the banks through efficient working capital management.

  Research Scope

The study was limited to six (6) banks which are; Fidelity Bank, Cal Bank, GCB Bank, FBN Bank, Guaranty Trust Bank and Zenith Bank, because of easy access to available data. Secondary data such as the published annual financials of Fidelity Bank, Cal Bank, GCB Bank, FBN Bank, Guaranty Trust Bank and Zenith Bank were used by the researcher in order to extract the needed information for data analysis and relevant information related to the working capital management practices of these banks.