LONDON SCHOOL OF BUSINESS AND FINANCE

CREDIT RISK MANAGEMENT OF NON-BANKING FINANCIAL INSTITTUTION IN GHANA (A CASE STUDY OF TF FINANCIAL SERVICES)

BY

STEPHEN KWADWO NTIRI

A Thesis Submitted to the
London School of Business and Finance in Partial Fulfilment of the Requirement for the MBA Degree in Financial Services

MARCH 2010

DECLARATION
I Stephen Kwadwo Ntiri hereby declare that except for references to other people’s work, which have duly been acknowledged, the work presented here was carried out by me, MBA student of Financial Servies at the London School of Business and Finance (LSBF), under the supervision of Randolph Metz-Johnson. I also declare that this work has never been submitted partially or wholly to any other institution for the award of a certificate.

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Stephen Kwadwo Ntiri Date (Student)

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Randolph Metz-Johnson Date
(Supervisor)

Dedication
This research project is dedicated to Almighty God for His abundant blessings and protection given me throughout this study, and also to my family for the support I received from them.

Acknowledgement
I am most grateful to Almighty God who through His infinite mercy and love guided me throughout the duration of the programme.

I wish to acknowledge the help and encouragement I got from the entire staff of TF Financial Services, especially Mr. Benjamin Turkson, which has enabled me to complete this work. I also want to thank my wife, Esther Yamoaba Ntiri, for her invaluable contribution to this work.

Finally, I wish to thank all those, especially my supervisor, who in diverse ways assisted me to successfully complete this study.

Abstract
The recent global financial crises have seen most financial institution going out of business. Some financial experts attributed the crises to poor credit assessment and risk management. Even though Africa in general and Ghana in particular is yet to experience this economic downturn directly, it is envisaged that this will be a major disaster if it happens in this part of the world.

Therefore, this research sought to examine the credit risk management practices of TF Financial Services non bank financial institutions in Ghana with TF Financial Services as the case study. It was aimed at identifying the indicators used in providing credit facilities to its clients and mitigating factors it considers in avoiding or minimizing default rate. It further sought to identify the challenges facing NBFIs in Ghana and examine the role interest rate and pricing of facility play in credit risk management.

Relevant literature was reviewed to portray the concept or ideas of credit risk management and the regulatory framework of NBFIs in Ghana and recent development in the financial industry. Information were gathered through structured questionnaires which were self administered using a sample size of 50 and unstructured interview. The data so obtained for the research were analyzed both qualitatively (pictorial view of the data at first sight) and quantitatively (using tables and figures).

The study revealed that the most attractive type of financing provided by the NBFIs is also the most risky loan among the various types of financing provided. Because the loan portfolios of NBFIs are largely constituted of the most risky type of loan, average recovery rate of between 41%-60% is achieved by the NBFIs. This obviously heightens the credit risk of NBFIs. The study also found out that NBFIs largely provide short term financing with their majority of their loan tenor falling within six months. The study further revealed the loan tenors are prescribed in the product papers and credit policy manual exist because it is a regulatory requirement rather than a credit management tool. It was however worthy to note that although credit policy manual is developed to satisfy regulatory requirement, its provisions are widely disseminated to the staff of credit department. The study also discovered that the NBFIs adopt different methodologies in processing and management of personal and business loans. It is also worth noting from the study that cost of funds is the main driver of loan pricing and capacity of borrowers to pay and adequacy of collateral are the principal factors that inform credit decisions among NBFIs.

From the study, it could be concluded that there are some sound practices employed by NBFIs to manage credit risk management. However, these practices require continuous review and evaluation with the aim of strengthening them and ensuring their adequacies in dealing with credit risk.

Table of Content

Chapter One 1.1 Introduction.
Development in global financial environment has underscored the importance of credit risk management in financial institutions. Some alarming credit events in the past and present have resulted in massive losses. Recent international credit events such as the economic crisis in Asia, which began in 1997, and the Russian debt default in 1998, caused billions of dollars of bank losses. In United State of America, the fallout from the savings and loans industry scandals in the 1980s, estimated to have cost at least $125 billion, continued well into the 1990s. (www.riskinstitute.ch/)
In the past 18 months, we have witnessed a major credit and liquidity crisis in the banking system as losses from subprime mortgages, structured investment vehicles, and “covenantlite” leveraged loans generated significant knock-on effects worldwide. Major financial institutions have taken more than $500 billion in write-offs, and central banks around the globe have initiated emergency measures to restore liquidity. CEOs have been replaced at such venerable institutions as Citigroup, Merrill Lynch, and UBS. Bear Stearns, a firm once viewed as having a conservative approach to risk management, has been the target of a Federal Reserve-driven (and to some extent, sponsored) rescue by JPMorgan. Lehman Brothers has filed for bankruptcy. Goldman Sachs and Morgan Stanley have changed status to become bank holding companies.
Back in Africa, Ghana’s next door neighbor Nigeria has seen the Central Bank takes move to restore financial viability of leading banks in that country that have suffered serious credit mismanagement. The move included the replacement of top executives of the banks involved. Although Ghana is yet to experience visible credit crisis, it cannot be said that the credit operations of lending institutions in Ghana is immune from global crisis.

1.2 Context of the Study
Risk can be defined as the possibility of a negative deviation between that which is planned and the actual outcome. Companies and individual are exposed to different forms of risks, which include but not limited to, credit risk, interest rate risk, market risk, operational risk, sovereign risk and foreign exchange rate risk. However, according to Schuermann T. (2004), the usual risk taxonomy is market risk, credit risk and operational risk. He defines Credit risk as the risk that an obligor (borrower, counterparty) may be unable or unwilling to repay their debt. He further states that Credit risk makes up 50%-60% of the total risk in a typical banking or lending institution, thus making Credit risk commonest among the three. This view is shared by Ball and Stoll (1998) that Credit risk is prevalent in many business transactions undertaken by companies and individuals. Companies carry credit risk when, for example, they do not demand up-front cash payment for products or services. Individuals may face direct credit risk as depositors at banks or as investors/lenders.

Sources of Credit risk are diverse. However, according to Berger (Berger, Herring and Szego 1995), Lending – from credit cards to corporate loans – is the largest and most obvious source of Credit risk. The core business of Non-Banking Financial Institution in Ghana covers gathering of deposits and extending credits to clients. However, Loans and advances constitute the bulk of their operations. In making loans, Non-Banking Financial Institutions are faced with credit risk. Credit risk in this case is a function of the borrower’s probability of default.

1.3 The non-banking financial industry in Ghana
The various institutions falling under the Bank of Ghana’s direct control are categorized as either Banking institutions or Non-Bank Financial Institutions (NBFI’s). Currently, there are 28 licensed banks operating in Ghana and 45 licensed NBFI’s. NBFI’s are further classified into deposit taking and non-deposit taking institutions. Deposit taking NBFI’s are those whose operations have been licensed by the BOG to accept retail deposits from the public, including institutions offering savings accounts and time deposit products as well as providing credit to small business segments and target groups/members, linked to their savings or otherwise. Savings and loans companies, building societies and credit unions all belong to this group of NBFI’s. On the other hand, non-deposit NBFI’s are not authorized to accept deposits from the public and only permitted to raise funds through other investors by means of private placements and other financial institutions. Finance Houses, Mortgage Finance and Leasing Finance are the main constituents of this category of NBFI’s.
The table below shows the various NBFI’s and their numbers thereof, these include both deposit taking and non-deposit taking institutions:
Financial Service Provided No. of Institutions.
Savings and Loans 7
Leasing and Finance Companies 7
Mortgage Finance Companies 1
Finance Houses 30
Total 45

1.3.1 Finance Houses.
The Finance House sub-sector of NBFI has over the years increased its share of the total NBFI asset base due to its growing business demands and increased participation as a few more companies have acquired licenses to operate. The sector’s share of the total Assets of NBFI have increased from 30% in 2001 to 70% by close of 2009. As at the end of 2009 the Finance House sectors’ Gross Loans and Shareholders funds have double since 2005.
The table below represents the leading finance houses currently operating in Ghana and their respective core business lines.
No. Name of Finance House Core Business
1. UT Financial Services Consumer Credit/Trade Finance
2. NDK Financial Services Trade Finance
3. Ivory Financial Services Trade Finance
4. Bayport Financial Services Consumer Credit
5. Oak Financial Services Consumer Credit/Trade Finance
6. City Investments Company Consumer Credit/Trade Finance

1.4 Background of TF Financial Services

TF Financial Services was incorporated as a private limited liability company on the 8th of September 2006 and licensed by the Bank of Ghana on as a finance house. The company is a wholly-owned subsidiary of the Teachers Fund (a mutual fund of Ghana National Association of Teachers)
With its range of carefully designed financial products, TF aims to become a leading financial services provider in Ghana within a short time and be recognised in Africa as a whole.
The company has defined as its niche market salaried workers employed by both the private sector and civil service sectors of the economy and aims to concentrate its core activities on the provision of loans to this market segment. TF Financial Services also extends its activities into other financial services activities in response to market demands and growth potential in accordance with Bank of Ghana licensing requirements.
The company started operation in August 2008 and has since recorded a total loan portfolio of 3.5million Ghana cedis (approx. $2.5m) with greater potential for higher growth in 2010. Their non-performing asset stands at 2% against industry average of 5%. Their main products are;
Employee Salary Loan
Executive Salary Loan
Local Purchase Order Financing
Receivable Financing
Short Term Business Loan
The company currently operates through 2 branches.

1.5 Research Problem and Research Question
Due to the inability of some financial institutions to manage their risks very well, it is not surprising to read that banks that we all thought were strong and have good public image go bust suddenly leaving us with a question as to what went wrong? By 2000, Ghana had lost not less than 20 rural banks excluding the liquidation of Bank for Housing and Construction Ltd and Co-operative Bank Ltd during this same period. These banks could not manage the risks they faced during the course of business and as such they lost earnings and finally their capital and their reputations. Underlying many of the financial stress of these banks with sad stories in Ghana and around the globe is poor Credit risk management. Credit risk is a dominant risk for financial institutions. As a result, regulators such as Central Bank of Ghana pay particular attention to its measurement and management. According to Basle Committee, the worst problems in financial institutions are caused by insufficiently stringent credit standards for borrowers, poor credit risk management of the entire portfolio and a lack of attention to changes in economic or other circumstances that affect a client’s credit standing. The committee moves further to state that inadequate credit risk management continues to be the biggest source of serious banking and lending problems. This view is corroborated by result of a survey conducted by Risk Waters Group and SAS Institute Inc. of more than 250 financial institutions and regulators. The survey states that financial institutions are identifying credit risk as a far bigger issue than a simple matter of regulatory compliance. SAS further states that companies have identified longer-term benefits and economic rewards as top benefits for improving their credit risk management function, such as improved business and performance management and improved risk-based pricing. The purpose of this study is to discuss credit risk management issues in Non-Banking Financial Institutions in Ghana with particular reference to TF Financial Services.
The Research would also address the following questions: 1. What are the indicators used in approving credit to clients of TF Financial Services? 2. What mitigating factors does the credit committee in TF Financial service consider to avoid high default rate? 3. What role does interest rate and pricing of facility play in credit risk management? 4. What are the challenges facing Non-Banking Financial Institutios?

1.6 Research Objectives.
The main objective of this study is to evaluate the credit risk management of non-bank financial institutions in Ghana using TF Financial Services as a case study. Specifically, the study seeks to achieve the following objectives; 1. To determine the criteria for giving credit by non-bank financial institutions. 2. To determine whether non-bank financial institutions recover the credits within maturity date 3. To determine the challenges faced by non-bank financial institutions in their delivery of credit to customers

Chapter Two
Literature Review
2.1 What is Credit Risk?
Traditionally, credit risk refers to the risk that a borrower or counterparty will fail to meet its obligations. Undoubtedly, Lending – from credit cards to corporate loans- is the largest and most obvious source of credit risk. But credit risk in some guise exists throughout financial institutions activities, both on and off the balance sheet- from acceptances, interbank transactions, trade financing and derivatives trading to guarantees and settlement.
Credit risk as a dominant risk in financial institution is widely accepted by many writers and institutions including International financial risk institution (IFRI). In their view, among the risks that face financial institutions, credit risk is the most dominant risk and it is also the risk to which supervisors of financial institutions pay the closest attention because it is considered the risk most likely to cause a financial institution to fail. According to IFRI, credit risk creates bad loans and loss of fees, interest income and principal loan amount. This affects the capacity of the financial institution to continue to pay for its operations and therefore perform its functions as expected.
However, it must be noted that it is not just financial institutions that are subject to credit risk. Fund managers and investors are directly exposed to credit risk in their fixed-income investments. Insurance companies are exposed to it through their credit investments and credit gurantees. Companies are exposed to the risk that trading partners, distributors or suppliers may default- or fail to live up to critical obligations.
2.2 Approaches to Credit Risk Management
Due to its widespread interest, several writers from various fields ranging from traditional finance (asset pricing) to mathematical statistics and econometrics have propounded on credit risk management. According to Gemegah A, Credit risk management is the methodical and systematic process of analyzing risks associated with extending credits and the choice and application of those instruments in handling such risks. He further states that credit risk management is a process that involves; planning your credit portfolio, origination and approval process, credit documentation, disbursement and administration of credit, and repayment of the facility. Schaumann H almost agrees with the above view except that he uses cycle to describe the credit risk management process. He defines credit risk cycle as; credit origination, credit measurement, portfolio management, risk transfer decision and risk transfer for channel selection. Douglas Hubbard (2009), however situates the subject of credit risk management in the broader context of risk management. According to Douglas (2009), risk management is the means that is applicable for the identification, then assessment and ultimately the prioritization of risks. His view is shared by Ramos Jose (2000) who describes the idea of risk management as a contemporary entity that serves for the purpose of designing and thereby maintaining a particular kind of environment where individuals are led to work in groups. According to him, the purpose is to accomplish and attain all the predetermined goals and preconceived objectives for financial benefits.
In the view of Stephen Kealhofer the level of sophiscation in credit risk management mean that the traditional management of credit risk by financial institutions is the way of the past. Tom McNulty observed that credit risk management can be very analytical and statistical process. He called for the use of theoretical models to measure and manage credit risk. He further states that models that measure and manage credit risk serve three main functions. He said the models estimate the likelihood that a counterparty will default, the amount that might be lost if a counterparty defaults and the correlation of default risk across the entire credit exposure. Duffie & Singleton (1999) also opine that the fulcrum to managing credit risk is modeling the default likelihood of the obligor or borrower and default correlation. He termed the default probability as micro-credit risk and default correlation as macro-credit risk. They contended that probability of default drives almost everything else, from pricing to portfolio management to capital allocation.
Although risk modeling has been hailed in recent times, Roger W Ferguson observes that it has been around since centuries ago. He said the model was the heads of Users and was based on judgment and experience. He further stated that formal models for market and credit risk are designed to augment judgment and experience to help make exactly the same decisions. In his opinion, by measuring and managing risk in a formal and structure way, models when combined with sound judgment, have on balance, improved the resultant decisions. Derivatives have also been cited as one of the sophistication in credit risk management. According to Stephen Kealhofer, leading institutions now regularly isolate and package portions of their credit risk by means of new tools-credit derivatives and securitizations- and pass it to the financial markets.
The foregoing notwithstanding, Russell Huebsch however opine that modern credit risk management may need to return to the basic principles to solve much of the credit risks issues. His view is shared by Mohamed A. Ramady. He observes that much of today’s credit risk management relies on extremely complex equations and obscure information. He recommends that lenders reassesses their use of the basic principles of credit risk management and reduce their dependant on complex risk models.
The Basel committee on banking supervision also shares its views on credit risk management in their consultative paper issued in July 1999. According to the committee, the goal of credit risk management should be to maximize a bank’s risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters. It opines that lending institutions need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credits or transactions. It advises lending institutions to consider the relationships between credit risk and other risks. It believes that the effective management of credit risk is a critical component of a comprehensive approach to risk management and essential to the long-term success of any lending organization.

2.3 How Non-banking Financial Institution manages Risk
The 15th February edition of the Business and Financial Times journal explains how Non-banking financial institutions manage risk. According to Adu-Amoah (Dr); A Non-bank is a financial organization licensed to provide financial services to its customers. These services include making commercial loans and taking term deposits from other financial institutions and public. When performing these functions, NBFIs face a number of risks including credit, market, liquidity, operational, legal etc. Some of these risks can be eliminated, avoided or transferred to another party in the financial industry or they have to be managed by the bank itself. Non-Bank Financial Institutions avoid risks by establishing policies and procedures to guide contracts and efficient decisions taking at all levels of the organization. Risks can be transferred from one institution to another in the course of exchange of products or services. For example interest risk can be transferred from one financial institution to another through interest rates swap or derivatives. The term borrowing can be altered to change its duration if a financial institution anticipates that the original duration could lead to a loss of earnings. A non-bank financial institution can also diversify or concentrate its financial assets to eliminate risks associated with its product or services. Dr Adu-Amoah however concedes that there are some risks that cannot be eliminated due to the fact that they are inherent in the product or service being rendered. He explains that such risks are found in credit, operational, market, liquidity and legal risks. According to him, those risks have to be monitored and managed to the barest minimum as possible to enable the institution achieve its goals.

2.4 NBFI Business (BOG) Rules
BOG in exercising the right provided under section 14(1) of the FINB Law 1993 issued the NBFI Business Rules to govern the operation of all licensed NBFIs which do not take deposits from the public with the exception of Venture Capital Companies. The institutions that this business rule applies are stated as follow; a) Finance Houses, b) Mortgage Finance Companies, c) Leasing and/or Hire Purchase Companies and d) Acceptance. Significant provisions in the NBFI’s business rules are summarized below;
2.4.1 Restriction on Lending
1. No NBFI shall assume financial exposure by lending to a single person/borrower or a group of persons/borrowers which in the aggregate exceeds: 15% of the institution’s net worth, if the exposure is secured or collateralized or 10% of the institution’s net worth, if the exposure is unsecured.

2. The aggregate financial exposure an NBFI may assume on its subsidiaries by making loans and advances or assuming any other financial commitments to one or more of the latter, together with the equity investment, shall not exceed; a) in case of any one subsidiary, 15% and b) in the case of all subsidiaries and Associates, 25% of the institution’s net worth as per its latest audited financial statements. 3. An NBFI in credit business shall not grant to any firm/company in which any of the institution’s directors or Managers (i.e executive officials) is interested as a partner or as major or Principal shareholder or as director or as guarantor – any loan or credit or other financial facility which in the aggregate and outstanding at any time exceeds: a) 10% of the institution’s net worth if the exposure is secured, and b) 5% of the institution’s net worth, if the exposure is unsecured as per its latest financial statement.
4. An NBFI shall not grant unsecured advances or other credit facilities to: a) any of its directors, amounting to more than 2% of its net worth, and b) to any of its officials or employees, amounting to more than two years of consolidated salary of concerned employee.
2.4.2 Portfolio Management Norms
The portfolio management norms of NBFI rules set out the mandatory prudential norms relating to income recognition, classification of assets and provisioning for different types of loan assets in the credit portfolio of NBFIs. Summary of the norms are provided below; 1. A loan on which interest or schedule repayment of principal (instalment) has remained unpaid for 30 days from due date shall be considered overdue. 2. A loan which is overdue for 90 days shall be classified as non-performing asset. (A non-performing asset is one which ceases to yield interest or has stopped being an earning asset. 3. Interest or any form of income shall not be accrued on non-performing asset. 4. Interest shall only be recognized or taken as income when realized in payment. 5. When any of credit facilities to a borrower becomes non-performing, the total dues outstanding under all the credit facilities made available to the same borrower shall be considered “non-performing”. 6. Every NBFI shall review its loan portfolio at periodical intervals. For the purpose of such review it shall, after taking into account the degree of well defined credit weaknesses and the extent of dependence on collateral security for realization, classify its loans into: a) standard assets, b) Sub-standard assets, c) Doubtful assets and d) Loss assets.
2.4.3 Penalties
BOG may prescribe and notify the penalties for non-compliance of NBFI’s business rules
2.5 Principles of Credit Management
The Basel Committee on Banking Supervision in helping deal with increasing exposure by banks to credit risk issued guidelines to help banks and their supervisors to put in place a comprehensive credit risk management programme. The September 2000 paper, Principles for the Management of Credit Risk, highlighted four key areas any sound credit risk management practices must address. The four areas are: 1) establishing an appropriate credit risk environment; 2) operating under a sound credit granting process; 3) maintaining an appropriate credit administration, measurement and monitoring process; and 4) ensuring adequate controls over credit risk.
The aforementioned principles have been widely adopted by central banks around the globe in devising business rules for banks and evaluating credit risk management practices in banks. Although specific credit risk management practices within non banking financial institutions may differ with banks because of the nature and complexity of their credit activities, generally, credit management program in non-banking financial institutions will reflect the aforementioned principles. While agreeing with the committee members that credit risk management approach used by individual banks should be commensurate with the scope and sophistication of the bank activities, in the view of many practitioners limiting the application of the principles on the basis of scope and sophistication of bank’s activities may reduce the efficacy of the guidelines.

2.6 Credit risk management as a process
Although many writers have propounded on the subject of credit risk management from different perspectives, there is a common understanding that it is a process rather than an event. Perhaps what divides the opinions among writers is the issue of where the process begins. While writers like Schaumann H opines that the process begins with credit origination, others like Gemegah A, contend that the process begins with credit portfolio planning. However they all contend that the stages in credit risk management process are interlinked and the effective management of one stage should positively affects the others in the process.
Notwithstanding the differences in opinion on credit risk management process, the process can broadly be classified into three phases namely; credit risk analysis, credit risk administration and control and credit risk financing.

2.6.1 Credit Risk Analysis
The purpose of credit risk analysis is to determine the ability and willingness of the borrower to the pay the loan and it involves a) risk identification and b) risk evaluation (Gemegah A, 2000) a) Risk identification
Schaumann H states that the first step in the credit risk management process is for an institution to identify the risky credits in its portfolio of loans, deals or transactions. Risk identification therefore involves information gathering on loan application and the use of appropriate method or mechanism to analyze the information. i. Sources of information to determine client’s credit worthiness
Information gathering is critical in any credit decision. Information so obtained assist Credit Managers to assess the inherent risk in the transaction and enable them to propose a mutually acceptable loan structure. Banks and financial institutions require information on the type of business, how its operations work, the environment in which it operates, its legal form of organization, its ownership and management, the past financial performance of the business and the anticipated future performance of the business. These information are obtained from a number of sources including, the existing credit file, the loan application/ request, the results of the institution’s own credit investigation, credit bureau reports, meetings with management, site/plant visits, company brochures and/or website, industry publications and trade associations, annual financial statements, management accounts, budgets and cash flow projections.
Although each of the aforementioned sources of information can provide reliable information to aid credit decision, there are limitations to the quality of information provided. For instance, Michael Dennis advises credit practitioners not to rely too heavily on financial statement analysis to manage credit risk. He opines that a customer’s past financial performance-good or bad- is not a perfect indicator of future performance. He said that unless a customer or applicant provides a prior period financial statement for comparison, there is no starting point from which to determine whether or not the risk of offering open account terms, for example, is getting larger or smaller. Additionally, although there are wide sources of information for credit decision, a study conducted by Core Tech Consulting Group cited lack of timely accessibility to credit risk information, particularly from internal sources, as one of the greatest challenges facing Credit Managers. This challenge, they say, is due to the fact many lending institutions do not have a centralized database of credit information- relevant credit and risk information is housed in several different systems within the institution.

b.) Assessment of Credit Worthiness
i. Credit Scoring
One of the methods use to analyze credit information with the view of identifying risk associated with a transaction is credit scoring or rating.
A credit scoring is a statistical analysis performed by lenders and financial institutions to assess a person’s credit worthiness. Lenders use credit scoring, among other things, to arrive at a decision on whether to extend credit. A person’s credit score is a number between 300 and 850, 850 being the highest credit rating possible (www.investopedia.com). Many lending institutions screen credit applications by assigning a credit score or rating to each individual borrower, so they can begin to understand its credit risks and assess how best to manage them. While some assets are easier to assign a credit score, others are not. The most developed credit scoring techniques are for consumer loans, such as credit cards and auto loans. In fact, some aspects of consumer credit scores have become a commodity. Credit bureaus exist to provide scores which captures almost all the measurable risk inherent in a consumer relationship. These scores can be purchased readily and cheaply from the bureaus. However, in the view of Schaumann H (2004), consumer and small business credit scores must be augmented with data mining technology in analyzing credit information. He states that this helps the lending institutions to analyse the “reward” part of the risk/reward equation. For example, He says a customer segment analysis might rank customers in terms of their propensity to carry a revolving balance. According to him, it is important because a customer’s profitability is not only decided by the chance that they will default, but also by the likelihood that they will take up bank offerings. He concludes that “marginally risky customers are not always loss maker”.
Duncan Martin in contributing to the subject also observed that risk rating systems typically use a different combination of experience-based judgement and quantitative modeling depending on the lending sector. He states that most consumer loan rating systems rely entirely or almost entirely on models, while commercial loan rating systems presently rely more on judgement. He attributes this problem to data. According to him, information exists on hundreds of thousands of bad credit card debts and millions of good ones. In contrast, studies on commercial default models rely on relatively tiny numbers of defaulting companies- partly because the universe of potential defaulters is smaller, but partly because reliable data is difficult to obtain and filter.

ii. “5 Cs”
One other method that has gained popularity in analyzing credit application is the use of “Cs” which refers to the major elements in a credit application. Although there are differences in the number of “Cs” that is adequate in achieving effective credit assessment, the common number is “5Cs” which comprises of Capacity, Collateral, Capital Character and Conditions. Other writers like Gemegah A, adds Competition and Cordiality to make “7 Cs”.
According to Wikicfo, credit lenders use the “5Cs” in credit assessment to ascertain the following; (1) whether the applicant business or transaction generates enough cash flow to service the requested debt. In other words, whether the applicant has the capacity to service the loan, (2) there is sufficient collateral to cover the amount of the loan as a secondary source of repayment should the applicant fail in repayment, (3) the applicant have enough capital to weather a storm and ensure his/her commitment to the company, (4) the conditions surrounding the applicant do not pose any significant unmitigated risk, and (5) the applicant is of sound character, or can be trusted to honor his/her commitments in good times and bad.
Answers to the aforementioned questions may inform credit lenders decision to reject or process a credit application.

iii. The role of the credit rating agency and credit reference bureau in credit analysis

a.) Credit Rating Agency
Credit ratings have become vital to the credit industry because they offer consistent and publicly available credit scores, produced by independent agencies, for either the creditworthiness of a major entity or for a particular debt security or other financial obligation. Ratings help to determine how much companies and governments must pay for credit. Under the Basle Committee’s revised Capital Accord, credit rating has grown in importance.
Although the agencies are independent, they are paid by the companies they rate rather than by the users of rating information- a conflict of interest that has to be carefully managed. Rating agencies have also come under criticism for poor risk estimation, and for being too slow to downgrade their existing ratings when problems appear. For example, in 1994, both Standard and Poor and Moody gave Orange County their highest short-term rating for a $600 million taxable note issue, just months before it filed for bankruptcy. Another “rating problems is that outside the US market, many markets including Africa and for that matter Ghana do not have public credit ratings.
b. Credit Reference Bureau
Credit reference bureaus are institutions that specialize in collecting, collating and disseminating credit information. Credit information is collected from various traditional sources such as financial institutions, government departments, businesses and customers, as well as non-traditional sources such as utility providers and compiled into credit information reports which help creditors in assessing repayment capabilities of prospective and existing customers. Credit bureaus aid lenders, borrowers and the economy as a whole. Among others, credit bureaus function to prevent application fraud by authenticating application particulars. They also facilitate improved efficiency and turn-around-time of credit evaluation and decisions.

2.6.2 Credit risk administration and control
Having analyzed the credit risks of credit applications and decided to proceed, the next stage is the administration and control of the credit risk which normally involves loan structuring, loan pricing, loan documentation and portfolio management.

i. Loan Structuring
The importance of loan structuring in credit risk management cannot be over-emphasized. An effective loan structure set out terms of a lending relationship that is mutually satisfactory for the borrower and the lender. According to RiskGroup Consulting, the key to effective loan structuring is to find an acceptable balance between the risk and return, while still providing an arrangement that is attractive to the borrower. They opine that a systematic approach to structuring can reduce credit losses by ensuring that loans are structured to reflect the particular risks in making them. They add that such an approach observes five steps; 1) understand the customer’s borrowing needs and potential primary and secondary sources of repayment, 2) Minimize default risk by matching the facilities and repayment schedules to the customer’s needs and cash flow, 3) provide additional protection to the lending institution, if needed, through collateral or guarantees, 4) determine the interest rate and fees to give the lending institution an acceptable return on its risk, and 5) complete the proper documentation to legally enforce the agreement.

ii. Loan Pricing
When a loan is made, lending institution charges interest at a specified rate in addition to other fees as part of the negotiated loan structure. The interest and the fee income together make up the lending institution’s total return on the loan. Credit risk, traditionally, has been managed through setting different prices for different loan types. The difficulty occurs when attempting to set a risk premium for individual creditworthiness within the same loan type, such as an auto loan. However, single-price approach has fallen out of favor as lenders have realized that it has been a subtly form of discrimination as it leaves many borrowers who cannot afford. Response to this is risk-based pricing. According to RiskGroup Consulting, One of the primary determinants of the pricing of a loan is the perceived risk being incurred by the lending institution. Literature and industry have three ways to price credit risks namely; Static replication, structural approach and reduced form approach with the Black Scholes and Merton as the main contributors to the subject. iii. Loan Portfolio Management
Loan Portfolio Management is the process by which risks that are inherent in the total loan portfolio are managed and controlled. The identification and management of risk among groups of loans is as important as the risk inherent in individual loans. According to Comptroller of the Currency Administration of National Banks, Credit Lenders needs to understand not only the risk posed by each credit but also how the risks of individual loans and portfolios are interrelated. He says that these interrelationships can multiply risk many times beyond what it would be if the risks were not related. In 1997, the OCC Advisory letter 97-3 encouraged banks to view risk management in terms of the entire loan portfolio. In the view of Euromoney Institutional Investor PLC, there are numerous examples of commercial banks that have taken quite significant losses in their credit portfolio due to concentrations of risk as a result of poor planning of credit portfolio. Planning of credit portfolio has been cited by Gemegah A, as the first step towards effective management of credit portfolio. He opines that Credit Managers must first establish acceptable credit exposure limits and concentration mix before processing any credit application.
Notwithstanding the heavy emphasis on portfolio risk management, Comptroller of the Currency Administration of National Banks observes that the historical emphasis on controlling quality of individual loan approvals and managing the performance of loans is still essential. In his view, effective loan portfolio management still resides with oversight of the risk in individual loans. He states that prudent risk selection is vital to maintaining favourable loan quality.
The OCC Advisory letter 97-3 in 1997 identified nine elements that should be part of a loan portfolio management process. It listed the elements as * Assessment of the credit culture * Portfolio objectives and risk tolerance limits * Portfolio segmentation and risk diversification objective * Analysis of loans originated by other lenders * Aggregate policy and underwriting exception systems. * Stress testing portfolios * Independent and effective control functions * Analysis of portfolio risk/rewards trade offs.
The emergence of modeling tools have aided effective management of credit portfolio. In the view of Martin Duncan, the advent of credit risk modeling, pricing and transfer tools mean that banks can now actively manage their loan portfolios to ensure an efficient risk/reward ratio and sufficient diversification of loans- much as they would an investment portfolio. Credit risk models produce a portfolio loss distribution that is similar to that produced by VAR models for market risk. This is used to establish a VAR number indicating the maximum likely loss in a particular portfolio over a specified period, to a given confidence. The models use different methodologies to create a distribution of possible credit portfolio values at some future point in time. The portfolio’s risk is the outcome of each asset’s risk, its weight in the portfolio and the correlation between assets. The four commonly used models are KMV’s Portfolio Manager, JP Morgan’s Credit Metrics, Credit Suisse Financial Products’ Credit Risk+ and Mckinsey’s Credit Portfolio View. According to Robert Jarrow, the choice of model is an important decision for any financial institution actively managing its portfolio credit risk.
2.6.3 Credit Risk Financing
The liberation, such as the introduction of new instruments and the creation of new markets has caused a dramatic shift in the way banks run their portfolio. In the old order credit was not a tradable asset class. Banks lent money and retained credit risk on the balance sheet. This led to concentrations and an absence of market prices. The result was that banks became vulnerable, particularly during economic slowdowns. In the new order credit is a tradable asset class. Banks arrange and transfer credit risk, and increasingly use off balance sheet tools to create better diversification and market prices. The result is banks becoming more resilient and better able to survive economic downturns. (www.euromoneyplc.com).

Chapter Three
Research Methodology
3.1 Introduction
This chapter describes the methods and means that were employed to gather pieces of information for the study in order to achieve the objectives for this research work.

Sources of Data
Data for this research was obtained from primary and secondary sources.
The research population was undertaken from selected credit management practitioners in the non-banking financial industry. Most of these personnel were from the Finance Houses and a few from other NBFI such as Savings and Loans Companies and Leasing companies. In all a total of 50 persons were selected to make up the primary data. Of this number 15 were selected from TF Financial Services (management and staff), 15 from the NBFIs and the remaining 20 from 4 Finance Houses. A structured questionnaire was designed and administered for the achievement of this purpose. The questionnaires were made up of both open-ended questions and close-ended questions. Unstructured interview schedules were also employed on the Credit Managers and Officers in selected institutions to better understand their credit risk management and seek further clarification to some of the answers provided in the question.
Secondary data sources were obtained from officially documented sources. These are the TF Financial Services Management Report and Central Bank annual Reports on the performance of the non-banking industry. Financial Statements of TF Financial Services from 2008 to 2009 also formed part of the secondary data as well as internally generated accounting reports from the Accounts Department of TF Financial Services. The secondary data took the research to the libraries of the Central Bank and that of the UT Financial Services, the leading Non-banking financial institution in the country.

3.2 Scope of the Study

The scope of the study was limited to selected management personnel from TF Financial Services and other members of staff from the Credit department of other finance houses. It is believed that these persons are better placed in the operations of the selected companies. 3.3 Sampling Techniques
Two sampling techniques were employed for this study, namely simple random sample technique and convenience sampling technique. The simple random technique was used to obtain a fair view of all the sample members under consideration.
In other words, the ideas or views from the sample members will be a fair representation of the entire population. On the other hand, since not all the credit practitioners in NBFI could be covered by the survey and the fact that the researcher could not administer questionnaires on all credit practitioners in NBFI at the same time, the questionnaires were administered to only those credit practitioners who were easily accessible at the time of the survey. This is why the convenience sampling technique was used.
3.4 Method of Data Analysis
The data so obtained for the research were analysed both qualitatively (pictorial view of the data at first sight) and quantitatively (using tables and figures).
3.5 Limitations of the Study
The following were some of the constraints that limited the depth and scope of the study:
3.5.1 Time
An in-depth study of the credit risk management of NBFI would have given a better picture of how the players in NBFI sector of financial industry manage credit risk. However, the length of time required for this research would have exceeded the deadline for the submission of the study.
3.5.2 Perception and Attitude of Respondents to Academic Research
Some respondents referred to the demanding nature of their work as an excuse to either give little priority to schedule meetings with researchers or in some cases avoided such meetings entirely. It is possible that they perceived work initiated and undertaken by students to be a necessary requirement to a course of study only, and therefore was of no consequence or influence to their organization.

Chapter Four

5.0 Data Analysis 5.1 Introduction
The results and responses from interview have been presented in tables and charts to make the analysis clear. 5.2 Demographic of respondents
70% of respondents were male, confirming male dominance of the credit management profession. Majority of the respondents were located within the age groups 20- 25 and 25-30 with each group constituting 40% of the total sample population. This is followed by 35-40 age group constituting 12% and 40-45 age group constituting 8%. The age distribution of the sample population correlated with the number of years worked in the NBFI sector of financial industry. 50% of the data population have worked in the NBFI sector for between 5-10 years, 40% between 6-10 years, 16% between 11-15years and 4% between 16-20 years.
Figure 4.1 Age Distribution

Figure 4.2 No. of yrs worked in NBFI

4.3.1 Type of Financing by the NBFIs
All 50 respondents stated that commercial lending was a key source of earning to their companies, confirming the importance of effective credit risk management to the survival of their companies. This also reflects the nature of the NBFI. According to Central Bank of Ghana, the core business of NBFI’s is the provision of loan services to individuals and small and medium companies. The commonest type of financing provided by NBFI, according to the survey, is working capital financing with fixed asset purchase financing as the least financing provided. The study further revealed that the NBFIs prefer working capital financing because of its short term nature. In contrast, they shun fixed asset purchase financing because of its long term nature. According to them, most working capital financing takes the form of either stop-gap, receivable or inventory financing and have a tenor less than a year. This presents a perfect match for their deposits whose maturity tenors also have a maximum of 12 months. Personal loan is the second largest type of financing NBFIs provide because, according to them, it has the lowest default rate and its processing is simpler and easier. Personal loans are largely provided to salaried workers with either guarantee from employers to effect repayment from source or post-dated cheques as the mode of repayments. Requirements for personal loans have been standardized which makes the processing simpler and easier, and also because monthly deduction comes from source and sometimes employee’s terminal benefit are pledged against it, default rate is comparatively lower. Refinancing of existing debt is the third largest type of financing and it is provided when circumstance of defaulting clients is projected to change for the better.
The study found out that the types of financing have been broadly categorized into consumer loans and business loans. Working Capital Financing, Purchase of Fixed Asset Financing, Refinancing of Existing Debt are classified as business loans whiles personal loans constitute the consumer loans.

Figure 4.3 Type of financing by TFFS

4.2.2 Risk Profile of Types of Financing
Ironically, the most attractive type of financing, working capital financing, was identified as the riskiest loan type. This is attributed to the type of market the NBFI serve. Traditionally, NBFIs serves clientele who are either rejected by the commercial banks or do not qualify to deal with the commercial banks. This market is generally classified by the commercial banks as risky due non-existence of proper organizational structure and systems. Additionally, working capital finance is not a transactional based type of financing where monitoring mechanism can be put in place to track the flow of the transactions and resultant payment. Collateral security is often relied on to provide the needed secondary comfort but available collateral securities are always found to be weak or illiquid for easy sale when default occurs. For the foregoing, working capital financing is seen as the most risky because its monitoring and recovery are difficult to undertake. The second most risky type of financing is refinancing of existing debt. This often involves restructuring of existing debt or loan buy-out for defaulting clients whose circumstance is projected to change. The projection sometimes tends to be wrong causing a default. Purchase of fixed asset financing is deemed to have low risk because it is often a transaction based financing which uses the underlying asset as collateral and repayment is structured to match the return on the asset. Personal loan is considered the least risky type of financing because its repayment source – salary- is guaranteed so long as the customer remains in employment. Even when the customer leaves employment terminal benefits are used to defray the debt.
Figure 4.4 Risky loan types

4.2.3 Recovery Rate by the NBFI’s
The type of financing that presents the highest credit risk strongly correlate with ability of the NBFIs to collect their loans within maturity period. 60% of sample population stated that their companies only collect 41-60% of loans within maturity period. 20% stated that their companies only collect 21-40% of loans within maturing. 10% each stated that their companies collect 61-80% and 81-100% respectively within maturity. This obviously is understandable given the fact working capital financing which is considered the riskiest loan type constitutes the largest of the loan portfolio of NBFIs. Figure 4.5 Rate of loan recovery within maturity

% of recoverability with maturity | No. of Respondents | Percentage (%) | 1-20 | 0 | 0 | 21-40 | 10 | 20 | 41-60 | 30 | 60 | 61-80 | 5 | 10 | 81-100 | 5 | 10 | Total | 50 | 100 |

4.3 Credit Administration
4.3.1 Loan Tenor
The poor collection rate is partly attributed to the shorter tenor of the loan products offered by the NBFIs. The average loan tenor was put at 6 months. 80% of the respondents stated that the average loan tenor in their company was 6 months while 20% put their average loan tenor at 3 months. While many of the respondents concede that the 6 months loan tenor is steep for their client, they are unable to change it, explaining that that will constitute a violation of the provisions in the product paper. 70% of the respondents cited the product paper as the main determinant of maturity period for the loans. 20% stated that maturity period of their loans were structured to reflect the primary source of repayment while 10% stated that their loan tenors were driven by borrower’s requisition. The study discovered that even the 30% of the respondents who structures maturity period to either meet borrower’s request or reflect primary source of repayment are constraint by the maximum tenor prescribed by the product papers. Loan tenor flexibility is only permissible to the extent that it is within the tenor limit provided for in the product paper. The study further discovered that many of the loans are rather recovered within three months after the expiration of the tenor. However there is difficulty in structuring loan for a longer period because that will shorten the maturity gap between loan asset and liability and will also call for amendment to the product paper which often follows lengthy due process.
4.6 Loan Tenor

4.7 Loan Tenor Determinants

4.3.2 Credit Policy Manual
All the respondents confirmed the existence of credit policy manual in their companies for credit operations. Although 80% of the respondents stated the existence of credit policy manual has helped in effective credit risk management, it is seen more as a fulfillment of regulatory requirement than a credit risk management tool. 90% of the respondents attributed the existence of credit management policies to regulatory requirement. 8% assigned credit management tool as the reason for its existence while 2% assigned other reasons to its existence. This is not surprising in the sense that one of the documents required and evaluated by the central bank of Ghana before it grants license to any lending institution is credit policy manual. Even after a lending institution has succeeded in acquiring lending license, credit policy manual is among the documents reviewed by officials from central bank of Ghana during on-site examination. Non –compliance with credit policy manual requirement attracts a sanction from the central bank.
On the issue of whether the provision in the credit policy manual has been properly disseminated among the rank and file in the credit operation department, 80% of respondents stated that they are familiar with the contents of the credit policy manual while 15% stated that they were not too familiar with its content. 5% disclosed that they were not familiar because they joined their companies not long ago.
4.8 Reason for Credit Management Policy

Figure 4.9 Degree of dissemination of Credit Management Policy

4.3.3 Credit Administration Structure
The study found out that the credit Administration structure varies depending on the size of the institution. While the big NBFIs have appropriate organizational structure for credit operation which ensures proper segregation of duties and clearly outline the various functions within the structure, the small and medium NBFIs either have combined some of the roles or do not have them at all. For instance, credit processing and credit administration roles were found to have been combined by small and medium NBFIs when the preferred credit administration structure by the central bank separates the two roles. Also, conspicuously missing in the credit administration structure of small and medium NBFIs is the role of credit compliance Officer. For some of them, either this role is being performed by Officers in the Account department or does not exist at all. The study further discovered that these shortcomings have featured prominently, sometimes, with threatening sanctions in the field examination report by the central bank of Ghana.
The study found out 60% of the respondent use credit committee system to approve credit applications while 40% of the respondent uses individual approving system to approve credit applications. Individual approving system is where credit applications are reviewed in turns by authorized approving persons whereas the credit committee system creates a platform for approving persons to meet and discuss the credit applications. The central bank prefers the credit committee system because, according to them, it enhances the quality of credit decision since divergent opinions are exercised on the credit applications. However, those who use the individual approving system cites excessive delays in getting the committee to meet as their main motivation for not using the credit committee system.

Figure 4.10 Method of Approving Credit Applications

4.3.4 Loan Portfolio Management
All the respondents stated that their companies follow different methodology in the management of personal and business loan portfolios. This is so because, according to 70% of the respondents, there is minimal interrelationship among individual loans in the personal loan portfolio which in turn reduces the inherent risk in the loan portfolio. On the other hand, they believed business loan portfolio carries high inherent risk because the individual loans are interrelated. While there is a concentration mix management with the business loans portfolio, the personal loans portfolio has no concentration restriction. Also, 80% of respondents stated that different mode of repayment are adopted for personal loans and business loans. 90% of the respondents preferred “Source Deductions” mode of repayment for personal loan while 80% preferred “Daily Cash Collection” for business. 20% of the respondents use “Post-Dated Cheque” mode of repayment for both personal and business loans.

Figure 4.11 Preferred mode of repayment of personal loan

Figure 4.12 Preferred mode of repayment of personal loan

4.3.5 Credit Risk Mitigating factors
The study found out that the main factor used to mitigate against credit risk in personal loan is “guarantee by client’s employer” while “adequacy of collateral security” is used to mitigate against credit risk in business loan segments. According respondents interviewed, employers’ guarantee for personal loans provide a better assurance of repayment since employers would only guarantee a loan facility when they know the applicant has a terminal benefit which will be used to liquidate the facility in event of default or lost of employment. The second mitigating factor against credit risk with personal loans is “loan insurance”. The study found out that life insurance policy is taken for all personal loan clients but the risk insured is death of loan client. According to respondents interviewed, insurance claims take a long time to be paid and since it does not cover redundancy and default arising from resignations from employment, it does not mitigate effectively against credit risk. The third mitigating factor against credit risk with personal loans is the use of “personal guarantee”.
The use of collateral security as the mitigating factor for business is reflective of what is deemed as the most important factor that informs credit decision. Since collateral is considered as one of the most important factors that inform credit decision, it is not surprising that it is used to mitigate against credit risk. This has led to a phenomenon called “loan against collateral” where loans are granted on the basis of the adequacy of collateral.
Figure 4.13 Mitigant against default of personal loan

Figure 4.14 Mitigant against default of business loan

4.3.6 Loan Pricing
Cost of fund was cited as the main determinant of loan pricing among NBFIs. The second most important factor that drives the pricing of loans provided by the NBFIs is the perceived risk of the transaction or the client. The loan tenor constitutes the third most important influence of pricing while industry average rate is the least factor. 50% of the respondents think that pricing has not been too effective in aiding credit risk management. 20% however believe that pricing has been effective in credit risk management while 30% believe it has not been effective at all in credit risk management.

Figure 4.15 Determinants of Loan Pricing

4.4 Credit Appraisal
All respondents stated that the objective of their credit appraisal process is to identify and evaluate risk associated with credit application.
4.4.1 Sources of Credit information
Again, sources of information for credit appraisal process differ from personal loans to business loans. 80% of respondents used the combination of salary slips and bank statement to determine the credit worthiness of personal loan clients while 20% of the respondents used either salary slip or bank statement alone to assess client’s creditworthiness.
60% of respondents stated that they used past sales records to determine clients’ creditworthiness in the business loan segments. The remaining 10% use other sources of information to determine the credit worthiness of business clients. 80% of the people interview stated they prefer the sales record because the other sources information, with the exception of credit history from credit reference bureau, are unreliable. They contend that corporate clients in the sector within which they operate lacked the financial wherewithal to employ qualified accountant or engage the services of reputable accountant firm to either prepare or audit their financial statements. They further explained that the sales records which are picked from their sales books are less prone to manipulation and better present the repayment capacity of business loan clients.
Figure 4.16 Sources of information for personal loan

Figure 4.17 Sources of information for business loan

4.4.2 Credit Assessment Techniques
90% of the respondent stated that they used credit scoring method to assess personal loans while 80% used a combination of scoring method and qualitative analysis to assess credit applications in business loan segments. They explained that credit scoring method is solely used for personal loans because information about personal loan clients are standardized and easier to score. On the other hand, Business loan clients are assessed using both qualitative and quantitative methods because of the high inherent risk in their application and the complexities of the information presented. Choosing from the 5cs, all the respondents stated that “Character” and “Collateral” are the main factors that inform their credit decisions. Capacity is the second largest factor that informs their credit decisions while “Capital” and “Condition” are the third and fourth factors respectively.
Figure 4.18 Factors that inform credit decision

4.5 Credit Reference Bureau
All the respondents expressed knowledge of the operation of Credit Reference Bureau. 50% of the respondents were of the view that activities of Credit Reference Bureau can be effective in credit risk management. 30% believed that the activities of Credit Reference Bureau will not be too effective in credit risk management. 10% opined that the activities of Credit Reference Bureau will not be effective in credit risk. The remaining could not tell the impact of Credit Reference Bureau on credit risk management. Credit Reference Bureau is foreign to the financial industry in Ghana. As yet the one licensed Credit Reference Bureau, XDS data Credit Bureau, is yet to open its doors to the general public. All the people interviewed during the study have welcomed the introduction of Credit Reference Bureau into the financial market but are disappointed at the delay of XDS Data Credit Bureau to begin operations. XDS has also blamed their inability to start operation on unwillingness of some financial institutions to pass credit information of their clients to them. The central bank has been called to intervene with appropriate legal framework to facilitate the smooth operation of the Credit Reference Bureau.
4.19 Impact of Credit Reference Bureau on Credit Risk Management.

4.5 Challenges facing NBFIs
It is not surprising that NBFI see cost of funds as the main challenge in the industry. NBFI’s have often been criticized by the public for charging exorbitant interest rate on their lending. Recently the central bank of Ghana has to engage them to discuss the possibility of they reducing their interest. They have rebutted their critics, citing high cost of borrowing as the main factor driving their interest rate. Unlike the banks, the license of NBFI’s, with the exception of savings and loans, does not permit them to take retail deposit from the public and institutions. As a result, their lending is funded from wholesale deposit they received from public who usually require higher return because of the perceived high inherent risk in saving with NBFI. According to the NBFIs, sometimes they borrow from the same commercial banks the critics compare them with at their lending rate. Hence their funds can never be cheap. They therefore see cost of funds as the main challenge to their operations.
The other main challenges facing NBFIs, according to them, are inefficient court system and poor house address system. 70% of people interview explained, it takes too long a time for the courts in Ghana to dispose off cases brought before it. They contend that sometimes the process is so laborious and costly that they have to abandon the case due to lack of interest.
Poor house address system, according to them, hampers monitoring and recovery effort. They lament that the existing housing address system in Ghana make it difficult to trace clients who default as they are not able to identify residential address provided by the client. 10% of the respondents, however, cannot tell of any challenge facing NBFIs.
4.20 Challenges facing NBFIs

Chapter Five
Conclusion and Recommendations
5.1 Introduction This chapter deals with the conclusions based on the findings of this study. It also offer recommendations based on the conclusions.
5.2 Conclusion
NBFIs like all financial institutions are exposed to credit risk throughout their activities. This affects the capacity of the NBFIs to continue to pay for its operations and therefore perform its functions as expected. Their ability to effectively manage the credit risk inherent in their operations is therefore crucial to their survival. As shown in the literature, the subject of credit risk management has been propounded by many writers from different perspective and it is not different in practice. The research has revealed some differing approaches to credit risk management by NBFIs, though there are also similarities in the credit risk management practices among the NBFIs. The research has also highlighted the challenges facing NBFIs in Ghana and the important role credit referencing bureau can play in credit risk management of NBFIs.

The study revealed that the most attractive type of financing provided by the NBFIs is also the most risky loan among the various types of financing provided. Because the loan portfolios of NBFIs are largely constituted of the most risky type of loan, average recovery rate of between 41%-60% is achieved by the NBFIs. This obviously heightens the credit risk of NBFIs. The study also found out that NBFIs largely provide short term financing with their majority of their loan tenor falling within six months. The study further revealed the loan tenors are prescribed in the product papers and credit policy manual exist because it is a regulatory requirement rather than a credit management tool. It was however worthy to note that although credit policy manual is developed to satisfy regulatory requirement, its provisions are widely disseminated to the staff of credit department. The study also discovered that the NBFIs adopt different methodologies in processing and management of personal and business loans. It is also worth noting from the study that cost of funds is the main driver of loan pricing and capacity of borrowers to pay and adequacy of collateral are the principal factors that inform credit decisions among NBFIs.
From the study, it could be concluded that there are some sound practices employed by NBFIs to manage credit risk management. However, these practices require continuous review and evaluation with the aim of strengthening them and ensuring their adequacies in dealing with credit risk.
5.3 Recommendations
From the study, it is evident that the most attractive type of financing by the NBFIs also poses the highest risk. NBFIs as the major step towards managing their credit risk would need to explore ways of diversifying their products offering to reduce the level of credit risk they are exposed to.
There appear to be too much focus on collateral security as a means of mitigating against credit risk to the extent that it forms a key factor in credit decision making. Collateral security must be seen to be providing secondary comfort. Credit decisions must be made largely on the ability of the borrower to repay his/her debt.
It is also revealing from the study, that cost of funds and the tenor of those funds so obtained by NBFIs for their operations influence certain credit risk management practices by the NBFIs. NBFIs must recognize them as important credit risk items and seek ways of dealing with them. For instance, NBFIs must diversify its sources of funding with a change in focus from short-term funding to long-term funding.
NBFIs need to improve the way credit policy manuals are disseminated to the users. First of all, they must re-orient themselves to see the manuals as an important tool to credit risk management rather than just a regulatory compliance exercise. Dissemination of the manual need to be incorporated in orientation programmes for new staff in the credit department.
Given the important role of credit referencing bureau in assisting financial institutions with credit information on prospective borrowers, NBFIs must dialogue with the only licensed credit bureau agency to see what help they can offer to enable the agency begin operations. The central bank of Ghana must also create appropriate legal framework to facilitate the work of the agency.

Bibliography

1. Schuermann T. (2004); A Review of Recent Books on Credit Risk, available at http://www.ny.frb.org/research/economists/schuermann/jae_credit_risk_books_review_5.pdf. 2. Ball, Clifford A. and Hans R. Stoll (1998), “Regulatory Capital of Financial Institutions: A comparative Analysis,” Financial Markets, Institutions & Instruments 7 (3), 1-57. 3. Berger, Allen N., Richard J. Herring and Giorgio P. Szego (1995), “The Role of Capital in Financial Institutions,” Journal of Banking & Finance 19, 393-430 4. BIS, (1999), “Principles for the Management of Credit Risk,” Basel Committee on Banking Supervision, July; available at www.bis.org/publ/bcbs75.pdf 5. http://www.computerworld.com/spring/newletter/1004/computerworld 6. Gemegah A (2007), “Risk Management in Financial Institutions in Ghana”. Journal of Finance 7th Edition, 23-25 7. Douglas Hubbard (2009), “The Failure of Risk Management: Why It’s Broken and How to Fix It”, John Wiley & Sons, pg. 44-46. 8. Ramos, Jose A. Soler (2000) Financial Risk Management: A practical Approach for Emerging Markets (Inter-American Development Bank). Inter American Development Bank 9. Duffie, Darrell and Kenneth J. Singleton (1999), “Modeling the Term Structures of Defaultable Bonds,” Review of Financial Studies 12, 687-720. 10. Ferguson R.W. (2001), “Credit Risk Management- Models and Judgement”, speech available at http://www.federalreserve.gov/boarddocs/speeches/2001/20011016/default.htm 11. http://www.erisk.com/Learning/JigSaw/CreditRisk.asp

12. http://www.ehow.com/about_5705895_principles-credit-risk-management.html

13. http://www.ehow.com/about_5607690_theoretical-models-credit-risk-management.html?ref=fuel&utm_source=yahoo&utm_medium=ssp&utm_campaign=yssp_art 14. http://www.wikicfo.com/Wiki/default.aspx?Page=5+Cs+of+Credit&AspxAutoDetectCookieSupport=1 15. http://riskinstitute.ch/00013403.htm 16. http://www.bog.gov.gh/privatecontent/File/BankingSupervision/Non-deposit%20taking%20NBFIs%20Business%20Rules.pdf 17. www.bog.gov.gh

18. www.ghanabusinessnews.com

19. The Ghanaian banker, 3rd Quarter, July-September 2003, VOL. 3 ISSN 0855-1340, p.20-p.23

20. UT Financial Services annual reports 2004-2008

21. TF Financial Services annual reports 2008 - 2009

Appendix I
STUDENT NAME: STEPHEN KWADWO NTIRI
SCHOOL: UNIVERSITY OF EAST LONDON (MBA in FINANCIAL SERVICES)
TOPIC: CREDIT RISK MANAGEMENT OF NON-BANKING FINANCIAL INSTITTUTION (NBFI) IN GHANA (A CASE STUDY OF TF FINANCIAL SERVICES) INTRODUCTION
TICK WHERE APPLICABLE/ WRITE OTHERS 1.0 COMPANY PROFILE 2.1 Company Name:………………………………………………………………………………………………………… 2.2 Address:……………………………………………………………………………………………………………………..
…………………………………………………………………………………………………………………………………..
………………………………………………………………………………………………………………………………….. Fax Number:………………………………………………………………………………………………………………….. Telephone Number:………………………………………………………………………………………………………… Person Contacted:…………………………………………………………………………………………………………. 1.0 DEMOGRAPHIC DATA 1.1 Gender 1. Male 2. Female 1.2 Age 1.3 How many years have you worked in NBFI? * 1-5 yrs * 6-10 yrs * 11-16 yrs * 16-20 yrs * Above 20 yrs
2. COMPANY RISK PROFILE 2.1 Is commercial lending a key source of earnings to your company?
Yes No 2.3 What type of borrowing cause does your institution normally finance? * Purchase of fixed assets * Accounts Receivable financing * Working Capital financing * Inventory financing * Refinancing of existing debt * Personal loans 2.4 Which of the borrowing cause in your opinion presents the highest credit risk to your company? * Purchase of fixed assets * Accounts Receivable financing * Working Capital financing * Inventory financing * Refinancing of existing debt * Personal loans 2.5 What percentages of clients repay their loans within maturity date? * 1-20% * 21-40% * 41-60% * 61-80% * 81-100% 2 CREDIT ADMINISTRATION 3.1 What is the average tenor/ maturity date of loans in your company? * Three months * Six Months * One Year * Other ( Specify) ………………………………………. 3.2 What are the determinants of maturity dates of loan facilities? * Primary source of repayment * Expected life of the assets they finance * Fixed tenor prescribed by Product papers * Borrower’s requisition 3.3 Does your company have credit management policies & procedures?
Yes No 3.4 If yes, why does your company deem it important to have credit management policies & procedures?
Credit Management tool
Regulatory Requirement
Other Reasons, (please specify) 3.5 To what extent are you familiar with the credit policy manual of your company?

Familiar Not Too Familiar Not Familiar

3.6 If not familiar, state why ………………………………………………………………………………………..
……………………………………………………………………………………………………………………………………..
3.7 Does your company uses credit committee system to approve credit application?
Yes No 3.7 If no, state why ……………………………………………………………………………………………………..
..........................................................................................................................................
…………………………………………………………………………………………………………………………………….
3.8 Does your company uses different methodology in the management of personal loan portfolio and business loan portfolio?
Yes No 3.9 If no, state why ……………………………………………………………………………………………………..
..........................................................................................................................................
…………………………………………………………………………………………………………………………………….
3.10 Does your company uses the same mode of loan repayment for both personal and business loans? Yes No 3.11 Please state your preferred mode of loan repayment of Personal loans.
Monthly cash payment
Source Deduction
Post-dated Cheque
Bank Standing Order 3.12 Please state your preferred mode of loan repayment of Business loans.
Daily Cash Payment
Bullet Payment
Post-dated Cheque

Other, please state ………………………………….

3.13 How does your company mitigate against credit risk or enforce repayment of personal loans? * Employer guarantee * Close Monitoring * Debt Collection Agency * Personal Guarantee * Loan Insurance * Legal Action 3.14 How does your company mitigate against credit risk or enforce repayment of business loans? * Adequacy of Collateral * Close Monitoring * Debt Collection Agency * Personal Guarantee * Legal Action 3.15 What are the determinants of interest rates or pricing in your company? * Perceived risk * Loan Tenor * Cost of Funds * Other ( Specify) ………………………………

3.16 To what extent, has pricing or interest rate helped in mitigating credit risk?
Effective Not Too Effective Not Effective

3 CREDIT APPRAISAL 4.1 What is the objective of your company’s credit risk appraisal process? a. Risk identification b. Risk evaluation c. Both 4.2 Please state the main channel used to obtain clients credit information for Personal loan.
Bank Statement Pay slip Existing Credit History
Other
4.3 Please state the main channel used to obtain clients credit information for Business loan.
Bank Statement Sales Records Existing Credit History
Financial Statement Other 4.4 Please state the main credit assessment used for Personal loan.
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…………………………………………………………………………………………………………………………… 4.5 Please state the main credit assessment used for Business loan.
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4.6 What main factors inform the credit decision of your company?
Character
Capacity
Collateral
Capital
Condition
5.0 CREDIT REFERENCE BUREAU 5.1 Do you know about Credit Reference Bureau and their activities? Yes No 5.2 If yes, to what extent do you think their operations can aid credit risk management? Effective Not Too Effective Not Effective Do not Know
5.0 CHALLENGES FACING NBFI 5.1 What would you describe as the main challenges facing your company? * Poor address system * Inefficient Court System * High cost of funds * None
Appendix II
The following constitutes questions posed during unstructured Interview with 10 Credit Managers and Branch Managers of NBFIs. 1. What are the underlying reasons for the type of financing provided by the NBFIs? 2. Why do NBFIs find Working Capital financing most attractive? 3. What in your view explains the seemingly poor loan recovery rate by the NBFIs? 4. Briefly describe your credit administration structure? 5. If your company uses individual approving system, why does your company use individual approving system to approve credit applications? 6. If your company uses different methodology in the management of personal and business loan portfolios, why does your company use different methodology? 7. If your company uses different methodology in mitigating personal and business loan portfolios, why does your company use different methodology? 8. If your company uses sales records for credit assessment, why is sales record use to assess the credit worthiness of business loan clients? 9. How do you see the introduction of credit reference bureau into the financial market? 10. Explain the challenges facing the NBFIs?