Post on 24-Mar-2018
Journal of Contemporary Integrative Ideas Volume 1(2), p. 9-21 www.novelpublications.com ISSN: 2343-6565
*Corresponding Author: Isaac Owusu-Dankwa. E-mail: iodankwa@yahoo.com
PRINCIPLES AND PRACTICE OF LENDING IN THE BANKING SECTOR: A
CASE STUDY OF SOME SELECTED BANKS IN GHANA
Isaac Owusu-Dankwa* and Gyamfi Prosper Badu School of Business, Valley View University, Dodowa road, Oyibi, Accra - Ghana.
ABSTRACT This study examined the principles and practice of lending in the banking sector of some selected banks. It
looked at the perceptions of respondents in these selected banks regarding principles and practice of
lending. A total number of twenty-five (25) questionnaires were administered to the credit department and
some staff of five (5) selected banks within the Accra Metropolis. The descriptive statistics was used to
draw conclusions on the opinions sampled from the respondents. The research found that the selected
banks used various types of lending models but the commonly used model was the CAMPARI model. Banks
also followed and ensured that laid down principles and practice of lending in granting loans were
enforced. Adhering to these principles and practices of giving out loans to customers, helped the banks to
increase its profitability and thereby reducing the extent of default.
Keywords: Lending, Principles and Practices, Banks, Lending Models, CAMPARI
1. INTRODUCTION
Modern banking is believed to have started in England and it grew out of the custom
of goldsmiths who took in their customers’ gold and silver for safe keeping. They then
discovered that they could lend such precious metals out, keeping just a certain customer
proportion as reserves. This was possible because not all the customers would come in
for collection for their assets at the same time. This is how lending came into existence
(Agyekum, 2010).
Since 2003, the banking industry in Ghana has experienced significant changes due
mainly to the introduction of universal banking laws that replaced “the three-pillar
banking model – development, merchant and commercial banking. It has levelled the
playing field, and opened up the system to competition, product innovation and entry”
(http://www.bog.gov.gh). Universal banking is defined as “a banking system made up of
large-scale banks that operate extensive networks of branches, provide many different
services, hold several claims on firms (including equity and debt), and participate directly
in the corporate governance of the firms that rely on the banks as sources of funding or
as securities underwriters” (Calomiris, 1997). In the midst of this development, lending
still remains an integral part of the operations of banks.
Lending is a major function of banks and is the main source of income to every
banking institution. However, most of the banks in the course of lending incur bad debt
or non-performing assets which lead to losses affecting the bank’s profitability. This is
attributable to noncompliance with lending principles and practices from banking
Dankwa and Badu, (2013). Principles and practice of lending in the banking sector: a case study of some selected banks in Ghana
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officials (Yushau, 2001). This study is aimed at examining whether banks follow the laid
down principles and practice of lending before granting loan to customers.
2. ROLE OF BANKS
Banks play a significant role in modern banking and are considered the most
important enabler of financial transactions as well as the principal source of credit in any
country’s economy (Rose, 2002). They are the custodians of a nation’s money, which
are accepted in the form of deposits and paid out on the client’s instructions (Harris,
2003). Lending, a fundamental function of the activities of the banking sector involves
the allocation of funds by the bank to a customer at a cost (interest), repayable within a
stipulated time. Valdez (2002) propounded that the principal activity of banks are no
longer limited to the taking of deposits and providing credit (lending) but has expanded
considerably to include the following activities:
• Money creators: Commercial banks create money by way of deposit liabilities.
In contrast to liabilities of other businesses, bank liabilities (cheques) are generally
accepted as a means of payment.
• Managers of the payment system: This refers to the payment of cheques through
the Automatic Clearing Bureau (ABC). It also facilitates payments of credit and
debit cards, internet and cell phone banking and automatic teller machines.
• Creators of indirect financial securities: Commercial banks hold assets that are
subject to specific risks, while issuing claims against them in which these risks
are largely eliminated through diversification.
• Information agents: Commercial banks developed sound databases of client
information and the information is not publicly available (asymmetric
information). The information is only shared with other banks by way of a bank
code or a full general bank report.
• Financial ‘spectrum fillers’: The capital market cannot supply the full range of
instruments required by borrowers. Commercial banks assist in this regard by
supplying specific instruments to fill the gap.
• Dealers in foreign currency: Due to the globalization of the world’s economies
this has become a very important function. Commercial banks assist in the
conversion of currencies, transfer of funds and negotiate foreign financing.
In carrying out its outlined activities aimed at providing the services outlined
above, there is the need to adhere to principles and practices that would add to the success
of the banks within the financial sector.
Dankwa and Badu, (2013). Principles and practice of lending in the banking sector: a case study of some selected banks in Ghana
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3. LENDING MODELS
A lending model describes the various structures of policies and procedures for
granting financial assistance that ought to be followed before loans are granted to
customers. Lending models tend to be very specific in terms of what they will consider
and how deals can be structured. They are also rather inflexible so as to maintain a certain
amount of integrity in the lending policies that have been established in the first place
(Brent, 2010). According to Korwa and Richard (2008), banks attach considerable
importance to screening loans through stringent lending principles requirement for the
following reasons: to screen out borrowers that is likely to default; to add an incentive for
the borrower to repay the loan; to offset the cost to the lender of a loan default; and, to
reduce the lending risk.
Some of the commonly used lending models are discussed below:
a. The CAMPARI Model
One of the oldest models used by banks to evaluate lending propositions is the
CAMPARI. This model looks at a range of aspects associated with lending which
covers not just the finance that is being sought but the people who are seeking it. The
model provides the banker with a tried and trusted model for credit analysis (Philip,
2003). It assesses the borrower on the basis of character, ability to pay, margin of
profit, purpose of the loan, amount being requested, the terms of repayment and the
insurance in case of default.
b. The Credit Scoring Model
A credit score is a numerical expression based on a statistical analysis of a person's
credit files, to represent the creditworthiness of that person. A credit score is primarily
based on credit report information typically sourced from credit bureaus
(www.wikipedia.org). Credit scoring models are developed by analyzing statistics
and picking out characteristics that are believed to relate to creditworthiness. Credit
Reporting Agencies (CRA) use different scoring models for different purposes. Auto
financing, for example, could employ a different model than instalment loans.
Lenders, such as banks and credit card companies, use credit scores to evaluate the
loan application in addition to the potential risk posed by lending money to the
applicant. This goes a long way to mitigate losses that may arise from non-payment
of the loan Lenders thus use credit scores to determine who qualifies for a loan, at
what interest rate, and what credit limits (Thomas et al, 2002).
c. The 5 C’s Model
This is a model used by lenders to determine the credit worthiness of potential
borrowers and it is based solely on the information declared by the applicant to the
bank. The system weighs five characteristics of the borrower in an attempt to gauge
the chance of default. The 5 c’s model emphasizes on the character, capacity, capital,
collateral and conditions of the applicant who requires the financial assistance. The
concept if correctly applied seeks to evaluate the key criteria of repayment ability, by
Dankwa and Badu, (2013). Principles and practice of lending in the banking sector: a case study of some selected banks in Ghana
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analyzing the stream of cash flows, the character of financial discipline, the financial
health of the borrower and other qualitative factors (Pride, et al, 2008).
d. Other Models
There are other models that have been equally used in lending besides the above
mentioned ones. One such model uses the acronym PARTLAMPS which emphasizes
on the purpose, amount, repayment, time, laws, accounts, management, profitability,
and security. PARSER is another model that analysis the person, amount, repayment,
security, expediency and remuneration. These other models “deal more or less with
the same elements and principles, and it is up to the individual bank to decide which
ones are most useful for its own circumstances or to devise a lending acronym of its
own” (The Hong Kong Institute of Bankers, 2012, p. 5).
4. METHODOLOGY
A descriptive form of research was conducted and the population was the financial
institutions within Ghana. The targeted population consisted of the Prudential Bank
Limited, Barclay’s Bank, Ghana Commercial Bank, National Investment Bank and
Unique Trust Bank. The respondents consisted of eighteen (18) employees purposely
sampled from the targeted banks. A well-structured questionnaire was administered to
generate the data to meet the objectives of the study. The questions were such that at the
end of the analysis of the data, the research objectives were met. In this study the
objectives being measured were quantified in terms of being of a higher or lower order
by scoring from 0 to 5. In scoring, 5 point was assigned to excellent, 4 point assigned to
very good, 3 point assigned to good, 2 points assigned to fair, 1 point assigned to poor,
and 0 point assigned to very poor. Higher values correspond to better principles and
practice of lending and lower values correspond to poor principles and practice of lending.
The parts of the data-gathering instrument were scored to provide information that
contributed to the overall solution of the research problem. The data was analyzed using
tables and frequencies with the aid of Microsoft Excel.
5. RESULTS AND DISCUSSION
5.1 General Characteristics of Respondents
The sample was made up of workers in the targeted financial institutions
comprising seven (7) females (38.9%) and eleven (11) males (61.1%). Majority of the
respondents, 9 (50%) were neither in the top management level nor in the middle
management but played vital roles within the banking setup, such as customer service
personnel, five (5) respondents representing 27.8% were in top management positions
and the remaining four (4) respondents (22.2%) were in the middle management.
Respondents were asked the number of years they have worked in the organization
and it was revealed that 66.7% of the respondents have been in the organization for 1-3
years, 22.2% of the respondents have been in the organization for 3-5 years, and 11.1%
have been working in the organization for 6 years. This indicated that majority of the
Dankwa and Badu, (2013). Principles and practice of lending in the banking sector: a case study of some selected banks in Ghana
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respondents have been working for a considerable number of years with their respective
institutions.
5.2 To identify the Lending model(s) used by the various selected Banks
All the respondents had heard about some types of lending models and they were
aware of their being used in their organizations in appraising loan applications
Table 1 Respondents view on lending models they know
Models Frequency Percent
Campari 8 44.4
5 C's 6 33.3
credit scoring
other specify
4
0
22.2
0
Total 18 100.0
Table 1 indicates that 44.4% respondents knew about the CAMPARI, 33.3%
indicated that they know 5 C’s model and 22.2% indicated that they knew credit scoring
model. Therefore most of the respondents knew the CAMPARI model.
Table 2 Respondents views on the type of lending model used in banks
Bank Model
GCB Campari
NIB Campari
PBL Campari, 5 C’s and credit
scoring
Barclays Bank
Campari and 5 C’s
UT Bank Campari
The following banks, Ghana Commercial Bank (GCB), National Investment Bank
(NIB), and Unique Trust (UT) Bank, which are local banks, used the CAMPARI model
in assessing applicants who have requested for loans. Barclays Bank Plc., an international
bank, employed the 5 C’s and 5 C’s models, whilst Prudential Bank Limited, a local bank,
used the CAMPARI, 5 C’s and credit scoring models for loan assessments. This implied
that banks used a variety of lending models but the common model being used was the
CAMPARI (Table 2).
Majority of the respondents, 88.9% indicated that the use of the lending model
had significant benefits accruing to the organization. These included the following: (i) it
helped to secure adequate collateral and assurance of the customer’s ability to repay the
loan, (ii) it helped to determine the character of the client, (iii) it helped to determine the
Dankwa and Badu, (2013). Principles and practice of lending in the banking sector: a case study of some selected banks in Ghana
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purpose of the loan, the profit to be made, and also the credit worthiness of the client, and
(iv) it helped the bank to reclaim the loaned money. The remaining 11.1% respondents
indicated that the selected model was not beneficial to the bank as the model used had no
bearing in retrieving the loan if the beneficiary defaulted. In addition, they expressed the
non-existence of insurance policy cover against non-payment of loans granted.
From the findings it was found that banks used different models that they were
conversant with. This did correspond to what Philip (2003) observed that any model used
by a bank was deemed to be tried and trusted and that it could enable the firm conduct the
required credit analysis. Hence the usage of the CAMPARI model which is common
among the targeted population.
5.3 To examine the enforcement of the lending principles and practices
in these Bank
The study sought to establish whether lending principles and practices were
followed in the granting of loans. The results are shown in the tables below.
Table 3 In acquiring loan from a bank there must be a loan application
Response Frequency Percent
Strongly agree 13 72.2
Agree
Not sure
Disagree
Strongly disagree
5
0
0
0
27.8
0
0
0
Total 18 100.0
As depicted in Table 3, 72.2% of respondents indicated they strongly agreed that
in securing loan from the bank there should be a loan application while 27.8% agreed
with the statement, indicating the importance attached to the fact that a loan application
by the applicant to the bank should be submitted to being the application process.
Respondents were also asked to indicate whether there was any relevance in having the
financial information of the applicant included in the application. Sixteen (16)
respondents agreed that loan application should contain financial information of the
borrower whiles the remaining two (2) disagreed that loan application should not contain
financial information.
Dankwa and Badu, (2013). Principles and practice of lending in the banking sector: a case study of some selected banks in Ghana
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Table 4 Response on real estate document before granting loan
Response Frequency Percent
Strongly agree 3 16.7
Agree 12 66.7
Not sure
Disagree
Strongly disagree
3
0
0
16.7
0
0
Total 18 100.0
Respondents view on how essential a real estate appraisal document was in the assessment
of a loan application showed that 16.7% strongly agreed to this principle that there should
be real estate appraisal before granting loan, and 66.7% agreed. On the other hand three
(3) respondents, representing 16.7% were not sure as to the relevancy of the real estate
document in the loan appraisal.
Table 5 Respondents views on the importance of a Loan agreement
Response Frequency Percent
Strongly agree 15 83.3
Agree
Not sure
Disagree
Strongly disagree
3
0
0
0
16.7
0
0
0
Total 18 100.0
Table 5 illustrated the views on the relevance of loan agreement, 83.3% strongly
agreed that there should be a preparation for loan agreement before granting loan to
customer, 16.7% of the respondents agreed that there should be a loan agreement before
granting loan to a customer, whiles significantly no respondent disagreed to the relevance
of a loan agreement being prepared before loans are disbursed.
Table 6 indicated that 72.2% and 16.7% of the respondents strongly agreed and
agreed respectively that a thorough credit analysis of the customer should be conducted
before approving and granting the loan application, whereas 11.1% were not sure about
the significance of conducting a credit analysis.
Dankwa and Badu, (2013). Principles and practice of lending in the banking sector: a case study of some selected banks in Ghana
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Table 6 There should be credit analysis before granting loan
Response Frequency Percent
strongly agree 13 72.2
Agree 3 16.7
not sure
disagree
strongly disagree
2
0
0
11.1
0
0
Total 18 100.0
Out of the eighteen (18) respondents, 8 respondents representing 44.4% strongly
agreed that there should be a loan disbursement order before releasing the approved loan
to customer, 6 respondent representing 33.3% agreed that there should be a loan
disbursement order in granting loan to a customer, 3 of the respondent representing 16.7%
were not sure or were neutral to this fact, and one of the respondent representing 5.6%
disagreed with the rest that a loan disbursement order should be received before loans are
disbursed (Table 6).
Table 7 There should be a loan disbursement order
Response Frequency Percent
strongly agree 8 44.4
Agree 6 33.3
not sure 3 16.7
Disagree
Strongly disagree
1
0
5.6
0
Total 18 100.0
Another significant outcome from the data was in relation to the role of the credit
committee in reviewing and evaluating loan applications and other submitted documents.
Table 8 The credit committee should review the customer's loan application
and submitted documents
Response Frequency Percent
strongly agree 3 16.7
Agree 9 50.0
not sure
disagree
strongly disagree
6
0
0
33.3
0
0
Total 18 100.0
Dankwa and Badu, (2013). Principles and practice of lending in the banking sector: a case study of some selected banks in Ghana
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From Table 8, 3 respondents, representing 16.7%, strongly agreed that loan application
and submitted document should be reviewed by the both the internal and consultative
body of the credit committee, whilst 9 respondents, representing 50%, agreed with this
procedure. However, 6 of the respondents, representing 33.3%, were neutral (not sure)
regarding the role to be played by the internal and consultative body regarding the review
of loan applications.
Table 9 The transfer of money to customer takes place after the loan
agreement and other documents have been assessed
Response Frequency Percent
Strongly agree 9 50.0
Agree 6 33.3
Not sure 2 11.1
Disagree
Strongly Disagree
1
0
5.6
0
Total 18 100.0
The information gathered from the questionnaire indicated that majority of the
respondents either strongly agreed or agreed that customers should receive their loan after
the loan agreement and other documents have been assessed as shown in Table 8. Two
(2) respondents representing 11.1% of the respondents indicated not sure, and one (1)
respondent representing 5.6% also disagreed that loan should be transferred after loan
agreement and other agreement whiles none strongly disagree to this fact. This implied
that most of the respondents agreed to the fact that loans should be transferred to
customers after loan agreement and other documents have been met.
One important assessment effected before loans were approved related to securing
collateral as a form of security against default. All respondents agreed that their
respective institutions required some form of collateral, depending upon the applicant,
before loans are disbursed. After all the required documents had been assessed, the
approved loan was channeled through the applicant’s bank account. All respondents also
confirmed that the principles and practices of lending as outlined by the various bank
were rigorously followed.
The findings confirmed the relevance of financial information in the loan
application process (Cole, et al, 2004). Of particular importance in the enforcement of
lending principles and practices was the need to secure adequate security for which Philip
(2003) observed that “security is taken as insurance against failure of the borrower to
repay. No self-respecting banker would make decisions to lend just on the value of the
security held”.
Dankwa and Badu, (2013). Principles and practice of lending in the banking sector: a case study of some selected banks in Ghana
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5.4 The importance of enforcing these principles and practice of lending
The tables below are to find out from the respondents the importance of enforcing the
principles and practices of lending.
Table 10 Does the loan application help you in granting loan to customers
Response Frequency Percent
Yes
No
17
1
94.4
5.6
Majority of the respondents (94.4%) confirmed that loan application helped banks
in granting loan to customers. Some of the reasons given by the respondents for their
affirmative answer were that such a process enabled the bank to establish the readiness
of the applicant and the desire to seek for the loan. In addition, the loan application gave
an idea about who the applicant was and the background information. The respondent
who dissented observed that a mere loan application did not give a fair idea whether to
grant a loan or not but more analysis and review was still needed.
Table 11 Does the loan agreement help the bank in collecting the loan granted?
Response Frequency Percent
Valid Yes 17 94.4
Missing System
No
1
0
5.6
0
Total 18 100.0
The result in table 11 indicated that 94.4% of the respondents were of the view
that loan agreement helped the bank to collect the funds loaned out. Some of the reasons
given to support the respondents’ response were as follows: (i) The signed agreement and
its terms could be implemented should the beneficiary default in repaying the loan; (ii)
The agreement made it difficult for beneficiaries to default; (iii) some also said the
customer cannot default base on the agreement as the consequences of default is deemed
too grievous; (iv) Fear of banks implementing actions on default would force applicants
not to default; (v) The bank can embark on a court action in case of default to retrieve its
funds.
Dankwa and Badu, (2013). Principles and practice of lending in the banking sector: a case study of some selected banks in Ghana
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Table 12 The laid down principle and practice of granting out loan to customer
help the bank increase its profitability
Response Frequency Percent
Strongly agree 12 66.7
Agree
Not sure
Disagree
Strongly disagree
6
0
0
0
33.3
0
0
0
Total 18 100.0
It was established from the data collected that 66.7% of the respondents strongly
agreed that the laid down principles and practice of granting loan to customer helped the
bank to increase its profitability. The remaining respondents (33.3%) agreed that the laid
down principles and practice of granting loans to customers helped the bank to increase
its profitability, none of the respondent indicated not sure or disagree or strongly disagree.
Thus, the enforcement of the lending principles and practices yielded positive returns.
Even though some of the customers defaulted in paying their loans, the default rate was
quite low and this did not affect the risk of lending (Korwa and Richard, 2008).
6. CONCLUSION AND RECOMMENDATIONS
Lending is an important component of the operations of a bank and all efforts should
be made to ensure that the procedures to be employed in lending are appropriately
followed. This would ensure that default rate among beneficiaries are kept very low and
banks would yield the needed profit to ensure sustainability of their operations. The
study revealed that the CAMPARI lending model was commonly used among local
banks. In addition, laid down principles and practices were adhered to by the banks in
the granting of credit.
It is recommended that combinations of lending models should be used by the banks
for assessment of loan applications due to the dynamics in the business environment. To
help reduce and minimize default risk, various banks should provide consultancy services
to borrowers to ensure that funds are utilized effectively and also used for their intended
purpose.
Dankwa and Badu, (2013). Principles and practice of lending in the banking sector: a case study of some selected banks in Ghana
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