The financial performance of rural banks in Ghana. The generalized method of moments approach

Published date21 February 2019
Pages2-18
Date21 February 2019
DOIhttps://doi.org/10.1108/WJEMSD-02-2018-0012
AuthorJoyce Patience Awo,Joseph Oscar Akotey
Subject MatterStrategy,Business ethics,Sustainability
The financial performance of
rural banks in Ghana
The generalized method of moments approach
Joyce Patience Awo
Department of Accounting and Finance, Catholic University College of Ghana,
Sunyani, Ghana, and
Joseph Oscar Akotey
Department of Accounting and Finance,
Kwame Nkrumah University of Science and Technology, Kumasi, Ghana
Abstract
Purpose Rural and community banks (RCBs) provide financial services to small enterprises in rural and
sub-urban areas. The purpose of this paper is to examine their financial performance through a case-specific
evaluation of a small bank situated in the northern part of Ghana.
Design/methodology/approach The authors employed a triangulation method comprising relative ratio
analysis, bivariate and generalized method of moments (GMM) techniques for the evaluation of the audited
annual financial statements of the bank covering a period of 15 years.
Findings The relative ratio analysis show that the bank's financial performance has generally been above the
average of the rural banking industry. The bivariate analysis indicates that although the loans portfolio is positive,
it is not properly fitted. That is, some of its loan portfolio deviates from the path of expectation. The GMM analysis
indicates that its financial performance is significantly influenced by liquidity management, bank capital and size
which have enhanced its expansion and intermediation to rural households and microenterprises. However, an
increase in the government treasury bill rate has a declining effect on the banks profitability.
Practical implications The findings have significant policy implications for the management and
supervision of RCBs. RCBs should deal with the spillover effects of the banking and MFIscrisis by educating
and re-assuring their customers of their financial integrity. Most importantly, they differentiate their services
from the other financial institutions within the space of the rural financial architecture.
Originality/value Majority of researchinto this area has focused heavily on largecommercial banks. This
researchadds value to the literature byre-focusing the searchlighton the financial performanceof small banks.
Keywords Ghana, Financial performance, Rural banks, GMM model
Paper type Research paper
1. Introduction
The recent global financial crisis has increased the intensity of the searchlight on the
performance of commercial banks in Ghana. Whereas large commercial banks, either
financially distressed or sound, have received significant attention from governments,
regulators, academia and civil society into their financial viability, small banks such as rural
and community banks (RCBs) have received little research into their financial performance
in the face of the global financial meltdown and the banking crisis in Ghana. More
importantly, when juxtapose to the fact that 23 RCBs were closed down in 2007, 70 MFIs
were closed down in January 2016, and 108 more have been identified by the Bank of Ghana
for closure, as well the disruptions of the economic and financial activities of a whole region
(Brong Ahafo) by three MFIs[1], it becomes very imperative to delve into the financial health
of rural banks and their ability to withstand the microfinance crisis.
Probing into RCBsfinancial performance will not only provide answers and insight into
the underlying context of some RCBsfinancial distress, but most importantly it will provide
World Journal of
Entrepreneurship, Management
and Sustainable Development
Vol. 15 No. 1, 2019
pp. 2-18
© Emerald PublishingLimited
2042-5961
DOI 10.1108/WJEMSD-02-2018-0012
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/2042-5961.htm
The authors thank the management of Naara Rural Bank for releasing the audited financial statements
of the bank for use in this research.
2
WJEMSD
15,1
lessons to repair the damage done to the public confidence by failed RCBs, MFIs and even
large commercial banks. In order for us to do an in-depth inquiry and get a firm grip on the
context-specific issues underlying RCBs performance, this paper has employed a case study
approach into the financial operations of Naara Rural Bank (NRB). In particular, the
research seeks to determine the soundness of NRBs financial performance in the face
of the MFIsfinancial crisis.
Our findings indicate that NRB has performed quite creditably above the industry
average. Its performance is specifically driven by strong liquidity management, rural
expansion and improved intermediation to households and microenterprises. However, a
rise in treasury bill (T.bill) rate tends to decrease its profitability possibly due to high cost of
deposits arising out of the contagion effects of the MFIsfinancial crisis. The spillover of the
crisis has certainly reduced MFIsdepositorsconfidence and thus most of them prefer to
invest their funds in T.bills to safeguard their investment and peace of mind. Thus,
financially healthy RCBs and MFIs need to educate and re-assure the public about their
financial soundness. It also implies that the spillover of the crisis and the possible preference
for T.bills by customers as a means of safeguarding their investments can exacerbate the
government clouding out of the private sector from the credit market.
The rest of the paper has a review of the relevant literature in Section 2; an overview of
the rural banking industry with special attention on NRB at Section 3; how the research was
done is captured in Section 4; and the discussion of the results and policy recommendations
have been set out in Sections 5 and 6, respectively.
2. Literature review
Harker and Zenios (1998) define the performance of financial institutions as an economic
performance which is measured in both short and long term by a number of financial indicators
and ratios. The financial indicators and ratios are in turn influenced by internal or bank-specific
factors and external factors. In the case of rural banks, the external factorscan be re-categorized
as macroeconomic and local socio-economic conditions. The findings of Mushonga et al. (2018)
lend support to this by indicating that the performance of small banks is mostly inhibited by
internal more than external factors. They suggest that the future of the industry in South Africa
will thrive on technology, culture shift, people and environmental policy.
Yaron et al. (1998) delved into three active Asian RCBs which have achieved leadership in
the provision of financial services at unprecedented levels to the millions of rural households
and microenterprises. Zaman (2004), on the other hand, conducted an in-depth study into
how four RCBs in Bangladesh have made great strikes in financial intermediation.
Both Zaman (2004) and Yaron et al. (1998) summarized the factors underpinning effective
financial performance in RCBs as visionary leadership, management autonomy in
formulating operational policies, efficient staff recruitment and remuneration systems,
innovative and technology-driven products, flexible low-cost delivery system and keen
supervision of loan portfolio, effective information management system that promotes
proper planning and enhances management ability to control operational expenses and
ensures adequate internal control systems. The crucial influence of microeconomic stability
and a conducive regulatory environment was also alluded to.
Aboagye and Otieku (2010) contended that for RCBs to continue in business, they must
make enough money through lending and fiduciary activities or services to cover their
operational and financing costs, plough back retained earnings to finance future operations.
This will enhance not only the survival of RCBs but their growth and profitability.
The position of Aboagye and Otieku (2010) has earlier been alluded to by Naceur (2003) that
loans have a significant positive relationship with profitability. That is, bank loans generate
interest income and are thus expected to have a positive impact on banksprofitability.
With respect to the relationship between liquidity and banks profitability, Buyinza (2010)
3
Rural banks
in Ghana

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