Lending principles of financial institutions
Recent statistics released by the United Nations Development Programme (UNDP) revealed that about 80 per cent of businesses operating in economies across the globe fall within the category of small and medium-scale enterprises (SMEs).
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It is worth noting that the percentage distribution of business categories in Ghana is not too different from the data released by the UNDP. Indeed, about 80 per cent of business establishments in Ghana are SMEs.
However, access to credit by SMEs from lending institutions have been a subject for debate in recent and prior years; it is increasingly becoming challenging for SMEs to access loans from the major banks to ease their expansion and growth and to contribute meaningfully to the socio-economic development of the Ghanaian economy.
Some finance experts believe several factors account for the banks’ reluctance to lend to SMEs in the economy. For instance, in 2015, the Central Bank of Ghana reported non-performing loans (NPLs) of GH¢4.2 billion. This amount surged to GH¢6.2 billion in 2016, representing about 48 per cent (47.6191%) increase in NPLs over the period. The experts are of the firm belief that the surge in NPLs and other extraneous factors account strongly for the banks’ decision to “relax” lending to SMEs.
It may not be out of place to lend credence to the foregoing arguments. However, it is worth emphasising that a financial institution’s decision to lend money to a borrower or borrowers may be based on adherence to a set of principles, including liquidity, safety, diversity, stability, profitability among other things of the borrower.
Lending principles liquidity
This is an essential principle of lending in banking. Banks lend money which can be withdrawn at any time by depositors. To this end, they prefer to lend for a short period of time. For processed loans, banks would like to accept as security, assets that are readily marketable and convertible into cash within a short period of time, usually three months.
Debentures and shares of large companies can be easily marketed or converted into cash. However, it is quite challenging to market the debentures and shares of small firms without adjusting their price downward. It is, therefore, imperative for banks to invest in government securities, stocks and debentures of renowned institutions rather than focus their investment attention on the securities of institutions that are unknown and non-performing.
Safety
This measures a borrower’s ability to repay loans with interest on a regular basis without default. Like any other investment, investments undertaken by banks involve risk; the type of security determines the level of risk. Generally, central governments’ securities are safer than those of municipalities because the financial resources of the former are more than those of the latter and individual corporations. Similarly, securities of municipalities are safer than those issued by corporations. Factors such as financial standing, character and ability to repay inform the borrower’s ability to pay back a contracted loan.
Debentures and shares of corporations are linked to their earnings. These earnings are likely to fluctuate with the level of business activities in the country. Peace, security and political stability are important factors that affect the safety of governments’ securities and securities issued by corporate bodies.
Diversity
The principle of diversity is important in the choice of an investment portfolio for a commercial bank. It is not advisable for a bank to invest all its surplus funds in a particular security. Rather, the funds should be invested in a number of securities. The purpose of diversification is to minimise risk inherent in the investment portfolio of a bank. It is important for a bank to choose and invest in shares and debentures of different firms in different parts of the country. This principle must be followed and applied in the case of government and municipal investments.
Banks must apply the diversity principle when advancing loans to various forms of trades, businesses, firms and industries. It is essential for a bank not to “put all its eggs in one basket”; loans must be extended to the foregoing organisations in different parts of the country to ensure diversity in banks’ investment.
Stability
The investment policy of a bank must consider the need to invest in stocks and debentures or securities with a high degree of price stability. The bank cannot afford to invest its excess funds in securities with fluctuating prices; it cannot afford to lose on its investments. Therefore, it is essential for banks to invest in businesses where the possibility of decline in value is remote.
The investment of banks in bonds and debentures is more stable than in the shares of organisations. This is because the respective bonds and debentures of governments and firms carry fixed interest rates. Values of these securities change with changes in the market interest rate. In times of financial crisis, banks are compelled to liquidate a portion of the securities to meet their cash requirements. In the absence of crises, the securities run their full term, usually more than five years, with minimal negative effect of changes in market interest rates.
Profitability
An important principle underlying a bank’s investment decision is maximising profits and minimising losses. This makes it imperative for banks to invest in securities that would assure them of a fairly stable return on their investments. Factors such as tax, dividend and interest rates determine the earning capacity of securities and stocks.
Generally, government and municipal securities and shares of some new corporations are exempted from taxes. However, it is advisable for banks to invest more in government and municipal securities than in corporate securities because the former are safer than the latter. Currently, in Ghana, municipal securities are not actively traded in the securities market, although the existing financial regulations allow Metropolitan, Municipal and District Assemblies (MMDAs) to access loans in the financial market using the District Assembly Common Fund (DACF) as a guarantee. It is hoped that government would adapt proactive measures to enhance the autonomy of MMDAs to ease their active participation in the securities market. — GB
The writer is the Lead Consultant/CEO
Eben Consultancy
Fellow Chartered Economist &
Council Member, ICEG
Email: ebenezer.ashley@gmail.com
Website: www.ebenezerashley.com