1.1 BACKGROUND OF THE STUDY
Since the revelation of oil and gas in the Western region of Ghana, most partners principally household, have come into conclusion and of the view that, most Ghanaians would enhance themselves in the briefest conceivable time overlooking the dangers related with the newfound business and real players. We have seen real difficulties and monetary dangers that oil-delivering nations like Nigeria have looked throughout the years. In Ghana, political associations including the administration and other significant partners have just checked their profits without shaping the desires of the general population.
Banks, the major and key stakeholder(s) in both the upstream and downstream oil and gas assumes the main role in dealing with their investors’ values and the risks related with the exploration and production of oil and gas. Banks financing role in the oil and gas industry at all levels makes them exposed to credit risk in their everyday activities. Ghana, for a few years, has just been a net consumer of oil and other oil-related goods however with the discovery and creation of oil in commercial quantities accompanies its own advantages and dangers to players related with the “black gold”.
This work winds up plainly important to uncover the potential credit risk to the banks as around 85% of banks in Ghana now exchange oil and oil-related activities as part or entire business line as their centre business operations. I am therefore convinced that a number of banks without much exposure in the oil and gas trading activities in the emerging sector might be trapped by the sight of financial booms and face difficulties if the nature of credit risks and management associated with the sector are not identified and well understood and the necessary strategies adapted to mitigate against such happenings in order to prevent losses. The results of not mitigating and managing risks are huge losses such as what happened to Barings Bank Plc in 1995. Barings Bank Plc collapsed as a result of its inability to meet the enormous trading obligations that a staff exposed on behalf of the bank.
My primary objective is to identify appropriate credit risk management practices and its effect on banks profitability and be able to show how these effects affect such an emerging and young market. In achieving this objective, I will aim at tackling the following issues;
a. The nature of credit risks in the oil and gas industry and banking sector.
b. Risk management practices and its effect on banks profitability.
c. Relationship between the credit risk to banks and lending to the emerging oil and gas sector.
I intend to investigate the existing risk and its impact on the profitability of banks as well as credit risk effect on lending to the oil and gas sector in Ghana and also able to identify appropriate strategy or guidelines as build up guide on existing credit risk policies for managers and bank staffs for smooth operational flow. The guidelines shall be consistent with sound and prudent banking practices applicable on the global front. The credit risk policy guideline is not expected to cover every credit risk exposures due to the dynamic nature in the banking and energy markets. This will not intend to alter business judgement, sound assessment of borrower’s ability, integrity and wise structuring of credit facility appropriate to the needs of both a borrower and the bank.
1.2 PROBLEM OF STATEMENT:
Oil is apparently the most valuable commodity on the planet, it can be revile or gift to countries if not appropriately managed, at any rate, and the ‘Dutch disease’ is still new in literature. The ‘black gold’ on the planet is without a doubt the biggest source of energy presently. It is positioned among the most unpredictable non-agricultural commodities, especially in recent times. In the course of the last five (5) years, oil prices dropped from 110 USD/barrel in April 2014 to 64 USD/barrel in June 2015 and additionally dropped to 50 USD/barrel in August 2016. The present oil value remains at 56.63 USD/barrel (47.66 EUR/barrel) as at September 2017. This verifiable pattern indicates how unpredictable oil prices can be. Despite the fact that the oil prices is a noteworthy source of instability in the world economy, it is not a measure of credit risk, fear or a check of future financial wellbeing in the oil exploration and production areas, related sectors, for example, the natural gas, utility, chemicals and auto segments, or the security markets. Credit Default Swaps (CDS) for these oil and oil-related sectors measure expected credit risk, fear, greed and the future monetary strength of these sectors, which is significant data that the oil price may quantify. Risk management practices influence banks profitability and increases firm’s value and may decrease financial distress. Risk management is considered as a measuring tool for determining banks failure or success. As commercial banks in Ghana looks for opportunities to invest their capital and their investor’s value, the energy sector (oil and gas) turns into an emerging business sector for opportunities and also dangers as they are exposed to credit and counterparty risks. This work seeks to bring to limelight, the need for Banks to critically pay attention to credit risk management practices while achieving profitability. The problem of this study is to identify the potential credit risk to the banks and its effects on banks profitability as about 70%-80% of banks in Ghana currently trade in oil and oil related activities as part or wholly business line as their core business operations.
There has been a general conviction that the banking sector in Ghana is moderately steady with individual banks having good risk profiles and sound risk management structures. The banking industry had not experienced any misfortunes in the face of the global financial crisis until recently, the collapse of UT Bank Ghana limited and Capital Bank Ghana limited which has subsequently been acquired by Ghana Commercial Bank. Some financial analyst and experts have blamed huge outstanding debts owed to the banking sector by various energy companies such as Tema Oil Refinery (TOR), the Volta River Authority (VRA), the Electricity Company of Ghana (ECG) and the Bulk-oil Distribution Companies (BDCs) as a severe strain on the banking sector of which UT and Capital banks fall a victim. Also, the banking industry over the years has witnessed worsening asset quality in the face of weak macroeconomic factors such as depreciating of the local currency, high inflation rates and interest rates resulting in high default rates of major players in the energy sector (oil and gas). Moreover, there has, however, not been any major test to ascertain the resilience of the banking industry to withstand major shocks until recent policies by the Bank of Ghana to increase minimum capital requirements of banks. Also, the banking industry over the years has witnessed worsening asset quality in the face of weak macroeconomic factors such as depreciating of the local currency, high inflation rates and interest rates resulting in high default rates of major players in the energy sector (oil and gas). Moreover, there has, however, not been any major test to ascertain the resilience of the banking industry to withstand major shocks until recent policies by the Bank of Ghana to increase minimum capital requirements of banks. There is, accordingly, a vacuum between the general conviction on the risk position of the Ghanaian banking industry and the proof to back this conviction. It is additionally empirical that various banks without much exposure in the oil and gas business in the emerging market may be caught by the sight of financial booms and face difficulties if the nature of credit risks and management related with the sector are not identified and mitigated against such happenings keeping in mind to prevent financial distress. To do this, it requires an intensive appraisal of the risk profiles of banks in Ghana and the risks associated with lending to the oil and gas sector and also assess the ampleness of the risk management structures employed by the banks to deal with the different risk they are exposed to.