PRINCIPLES AND PRACTICE OF LENDING IN THE BANKING …

Journal of Contemporary Integrative Ideas Volume 1(2), p. 9-21 www.novelpublications.com ISSN: 2343-6565

*Corresponding Author: Isaac Owusu-Dankwa. E-mail: [email protected]

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

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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.


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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

http://www.wikipedia.org/


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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


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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


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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.


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Table 4 Response on real estate document before granting loan



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



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.


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Table 6 There should be credit analysis before granting loan


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



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



Agree 9 50.0

not sure

disagree

strongly disagree

6

0

0

33.3

0

0

Total 18 100.0


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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



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”.


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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


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?


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.


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Table 12 The laid down principle and practice of granting out loan to customer

help the bank increase its profitability



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.


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PRINCIPLES AND PRACTICE OF LENDING IN THE BANKING …

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