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WJEMSD
15,1 The financial performance of
rural banks in Ghana
The generalized method of moments approach
2 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 bank’s 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 MFIs’ crisis 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 research into this area has focused heavily on large commercial banks. This
research adds value to the literature by re-focusing the searchlight on the financial performance of 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.
World Journal of
Entrepreneurship, Management
Probing into RCBs’ financial performance will not only provide answers and insight into
and Sustainable Development the underlying context of some RCBs’ financial distress, but most importantly it will provide
Vol. 15 No. 1, 2019
pp. 2-18
© Emerald Publishing Limited The authors thank the management of Naara Rural Bank for releasing the audited financial statements
2042-5961
DOI 10.1108/WJEMSD-02-2018-0012 of the bank for use in this research.
lessons to repair the damage done to the public confidence by failed RCBs, MFIs and even Rural banks
large commercial banks. In order for us to do an in-depth inquiry and get a firm grip on the in Ghana
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 NRB’s financial performance in the face
of the MFIs’ financial crisis.
Our findings indicate that NRB has performed quite creditably above the industry 3
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 ([Link]) rate tends to decrease its profitability possibly due to high cost of
deposits arising out of the contagion effects of the MFIs’ financial crisis. The spillover of the
crisis has certainly reduced MFIs’ depositors’ confidence and thus most of them prefer to
invest their funds in [Link] 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 [Link] 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 factors can 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 banks’ profitability.
With respect to the relationship between liquidity and banks profitability, Buyinza (2010)
WJEMSD posited that, liquidity has a significant relationship with profitability. However, this
15,1 relationship is a negative one.
Another variable which previous empirical studies have identified as having an impact
on banks’ profitability is size as represented by total assets. However, the available evidence
indicates that, the relationship between total assets (size) and banks’ profitability is an
inconclusive one. For instance, Berger et al. (1987) argued that a bank can achieve cost
4 savings as its size increases. The findings of Berger et al. (1987) lend support to that of
Shaffer (1985). Specifically, Shaffer showed that as a bank’s size increases, significant
economics of scales are achieved which enhances financial performance. However, other
studies have found a negative relationship between size and bank’s financial performance,
for example, Naceur (2003) revealed that large banks tend to have lower levels of profit as a
result of inefficiencies associated with the diseconomies of scale. Buyinza (2010) has
confirmed the findings of Naceur (2003) by indicating that bank size is negative and
significantly correlated with profitability.
Similarly, Marwa and Aziakpono (2016) argued that size can be a double-edged sword
because a smaller size does not spur the economies of scale nevertheless growth beyond a
certain threshold can also be self-destructive. In particular, they posited that whereas small
credit unions in Tanzania suffer from lack of economies of scale, the larger ones are
inhibited by diseconomies of scale.
Wong et al. (2007) outlined bank consolidation, cost efficiency and the ability of a bank to
take on more risk as the key determinants of banks’ profitability, whereas market structure,
as measured by market concentration, and size were found to have a negative association
with profitability. On the other hand, Sawada and Okazaki (2006) has a slightly different
opinion as his findings showed that policy-oriented consolidation has a positive impact on
deposits, though it may have a declining effect on bank’s profitability. Clair (2004)
established that proper management of lending activities, credit quality and expense control
enhance bank’s financial performance. The study also found that interest rates may place a
significant downward pressure on capital and liquidity, and that non-performing loans
(NPL) erode profits. As indicated by Robison and Barry (1977), liquidity challenges of rural
banks are mainly due to loan delinquencies and default as well as low levels of deposits.
They concluded that the level of asset quality and availability of liquidity may help to
reduce the risks of rural banks. Silva et al. (2017) also suggest that efficient co-operatives are
conservative and thus have less risky activities and lower impairment of assets.
Delis and Papanikolaou (2009) adopted a semi-parametric model to evaluate the impact
of bank-specific factors, industry-specific and macroeconomic variables on banks’
efficiency and performance. They discovered that bank size is statistically significant and
has a direct relationship with banks’ efficiency and performance. Similarly, Kosak and
Zajc (2006) researched into the cost efficiency of banks as a parameter of growth and
improved financial performance in the banking sector. Their findings were consistent with
that of Delis and Papanikolaou (2009). In particular, they found a direct association
between financial development and banks’ cost efficiency. Using efficiency–profitability
matrix, Marwa and Aziakpono (2014) also found that only 12 percent of credit unions are
best performers.
Hassan and Bashir (2003) showed that given a stable macroeconomic environment
and improved financial market system, high capital and improved loan-to-asset ratios
have positive effects on banks financial performance. In Asia, Malhotra (2002) delved into
the impact of location on the financial performance of regional rural banks in India.
He concluded that geographical location of rural banks is not a limiting factor of rural
banks’ performance.
In another study of the Indian rural banking industry, Ibrahim (2010) evaluated the
financial performance of regional rural banks (RRBs) in specific areas such as number of
agencies or branches, district coverage, deposits mobilization, loans portfolio and Rural banks
investments. The study concluded that bank consolidation has enhanced the financial in Ghana
performance of RRBs. This has facilitated growth in branch network, the closure of
underperforming RRBs and an increased coverage of the number of districts served by the
RRBs. Again, total capital funds have increased tremendously after amalgamation took
place in the years 2005–2006. He further discovered that credit–deposit ratio has grown over
the years indicating a remarkable deployment of credit facilities by RRBs in rural areas. 5
3. An overview of Naara Rural Bank
The rural and community banking industry has unique characteristics in terms of
ownership structure, management structure and operations features. Unlike the large
commercial banks, RCBs are community-owned and community-run unit banks. That is,
they are licensed to operate in a specific locality or district[2] (Aboagye and Otieku, 2010).
This gives them geographical advantages in terms of cultural orientation and access to first-
hand information about the economic conditions of households and microenterprises within
the locality. This enables RCBs to resolve some of the challenges link to information
asymmetry and thus facilitate the proper management of moral hazards and adverse
selection. The major adverse effect of this restriction to a locality is lack of portfolio
diversification and, therefore, a co-variate risk within a certain district can destabilize the
RCBs within that district.
The Association of Rural Banks (ARB), Apex Bank, is the umbrella body of all the RCBs in
Ghana. It coordinates the payments and cheques clearing systems among RCBs, and local and
international money transfer networks across RCBs. It also organizes capacity-building
programs for the various managements of RCBs in Ghana. It liaises with the Bank of Ghana to
license, supervise and regulate all RCBs. The main roles of RCBs are (Bank of Ghana, 2006):
(1) to mobilize savings in the rural communities and channel them into the provision of
credit to rural microenterprises, agro-based firms and cottage industries;
(2) monetize the rural communities by way of inculcating in rural folks the culture of
formal banking; and
(3) serve as tools for the growth and development of microenterprises in the rural
communities to facilitate rapid rural industrialization for the overall denhancement
of the national economy.
This paper attempts to delve into the financial performance of RCBs against the backdrop of
their mandate as stated above through a case study approach.
Since the inception of the rural banking system in 1976, some progress has been
attained. Currently, there are 137 rural banks operating in the country. The sector has
enhanced rural financial intermediation quite creditably. Rural banks are known to be the
principal suppliers of funds in rural communities and their branch network is about
50 percent of the banking outreach in Ghana (IFAD, 2008). The sector has consistently
mobilized an average of 5 percent share of the total[3] deposit of the banking industry.
Its rural deposit mobilization has grown from 15 percent in 2012 to 24 percent in 2015.
The sector’s loans and advances as a percentage of the total banking industry’s loans
portfolio has averaged around 4 percent and its loan portfolio to the rural economy has
inched up to 12 percent in 2015. Its asset size also grew from 13 percent in 2014 to
21.5 percent in 2015. This may be an indication that its rural presence is also very
significant. Table I presents the key financial intermediation indicators of the banking
industry of Ghana. Apart from financial intermediation, RCBs provide other services such
as microinsurance distribution (Akotey and Adjasi, 2014) local and international money
transfer, mobile banking to rural households.
WJEMSD Despite the general positive outlook of the sector indicated in Table I, a review
15,1 of their individual financial performance indicates a mixed outcome. As at June 2007, 23
out of the 145 RCBs have been closed down (Aboagye and Otieku, 2010) due to the
reasons identified by the Bank of Ghana as management incompetence, embezzlement and
fraud, negligence and ineffective board of directors, inefficient accounting procedures,
non-compliance with regulations in granting credits, persistent operational losses,
6 poor loan recovery and corruption, low deposits mobilization, use of unqualified staff,
non-submission of prudential returns, high unearning assets and high non-performing
credit portfolios.
Others have performed creditably and have thus been admitted into the prestigious
Ghana Club 100. NRB established in 1981 is one of the few rural banks in the Upper East
Region of Ghana which have performed quite remarkably despite the global financial
crisis. It has a vision of being the most efficient rural bank and leading poverty reduction
agent in Northern Ghana. It aims to accomplish its vision through the provision of
innovative products, the usage of modern technology, well-trained and motivated
staff who are proactive to customers’ needs. It currently operates through four
branches/agencies with its headquarters at Paga. The branches/agencies are located at
Bukere, Sirigu, Navrongo and Chiana.
A review of its annual reports from 2000 to 2014 indicates that the net profit recorded
an average yearly growth of 34 percent. The return on shareholders’ investment also
showed a steady growth of 29 percent on average. In addition, the bank recorded
81 percent growth in its loans portfolio. Much of its loan portfolio is advanced to
microenterprises for rural industrialization – a pre-requisite for the economic growth and
development of the rural areas.
In 2010 the Efficiency Monitoring Unit of ARB Apex Bank recognized NRB as the best
rural bank in maintaining satisfactory cost–income ratio. In 2013, it was also adjudged the
27th (out of 136) best rural bank in Ghana in terms of amount of deposits mobilized.
Despite the steady growth in its financial performance, it had challenges such as NPL,
declining capital adequacy ratio (CAR), competition from large commercial banks, as well as
the contagion effects of the MFIs’ crisis which have restricted deposits and profits levels.
Competition from telcos operating mobile money transfer has also adversely affected the
levels of profits that most RCBs generate from local money transfer.

4. Methodology
4.1 Data sources
The audited financial statements of NRB for a period of 14 years (2000–2014) were used for
this study. This period was chosen because of data challenges. Nevertheless the chosen data
set covers the time period of the global financial crisis and also the period during which

DMBs RCBs MFIsa

Financial
intermediation
indicators 2012 2013 2014 2015 2012 2013 2014 2015 2013 2014 2015

Loans and advances 11,686.9 15,442.3 22,212.7 27,094.7 648.5 716.8 777.5 871.6 177.7 481.1 551.7
Table I. Deposits 19,581.1 23,331.7 32,413.8 41,258.8 1,185.6 1,372.5 1,604.5 1,993.4 94.3 520.6 719.5
Financial Investments 7,493.5 10,905.3 11,875.3 14,289.7 461.2 537.7 649.7 913.9 n/a 59.2 120.6
intermediation Assets 27,237.1 36,169.9 51,445.0 63,303.7 1,524.0 1,852.9 2,099.5 2,551.5 316.2 958.8 1,248.9
indicators of the Notes: aThe 2012 data for the MFIs are not available. DMBs, deposit money banks represented by the large
banking sector of commercial banks; RCBs, rural and community banks; MFIs, microfinance institutions
Ghana (GHS millions) Source: Bank of Ghana Annual Reports (2013, 2015a)
many banks including 23 RCBs and some MFIs were closed down due to financial distress. Rural banks
Thus, the analysis covering this period will enable us to ascertain the financial resilience or in Ghana
otherwise of NRB.

4.2 Data analysis

A triangulate analytical procedure comprising ratios, bivariate and generalized method of
moments (GMM) regressions were used to delve into NRB’s financial health and the drivers 7
of its performance.
Financial ratios. Financial ratios enable analysts to deduce meaningful relationships
between two financial values (Brigham and Ehrhardt, 2002; Reilly and Brown, 2006) and
this provides essential information about a firm’s financial strategy and structure (Reilly
and Brown, 2006) as well as a sound basis for evaluating its financial performance. It is,
however, noteworthy that “an individual ratio has little value except in relation to
comparable ratios for other entities. That is, only relative financial ratios are relevant”
(Reilly and Brown, 2006). Hence, we have used relative ratio analysis for the financial
performance evaluation of NRB. The relative ratio analysis consists of time-series
analysis – to estimate the time-varying effects of NRB’s performance to determine whether it
is progressing or declining; industry comparative analysis comprising comparison with its
major competitors within the rural finance industry; and cross-sectional analysis in relation
with the nationwide rural banking industry.
Two bivariate analytical techniques – scatter graphs and bivariate regression – were used to
estimate the separate effects of each variable on NRB’s financial performance. This technique
helps us to isolate the effects of each variable on NRB’s performance. Thus, we are able to
identify the variables which are most important for explaining NRB’s financial soundness.
However, the variables do not operate in isolation, but affect the bank’s performance
concurrently; we thus need a model to account for the combined effects of the variables on
NRB’s performance. The performance of a company can also be affected by certain
unobservable factors generated by the top management, employees or even customers.
These unobservable factors create endogeneity problems and restrict the ordinary least
squares (OLS) from yielding efficient consistent estimations. Thus, we have adopted
Hansen’s (1982) GMM model to control for endogeneity bias and measurement error which
the OLS cannot resolve efficiently. See Greene (2003) and Wooldridge (2002) for information
on GMM. The GMM model is also good for handling the challenges associated with our
relatively short period of data set.
The basic model is:

y ¼ x0 b þm; (1)

where y is the dependent variable, x′ represents the independent variables, β indicates the
co-efficient of the parameters and μ is the error term. But E (xμ)≠0, because the error term, μ,
correlates with some of the independent variables. Thus, the OLS is not the appropriate
estimator. The GMM corrects this problem by using the independent variables as
instruments to estimate the model consistently and efficiently. In this case, the instruments,
z, should satisfy three conditions: it should not correlate with the error term; but should
correlate with the independent variables sufficiently and finally, there should not be perfect
collinearity between the instruments (StataCorp, 2009). The empirical model estimated
through the GMM technique for this paper is as follows:
X
m X
n
yi ¼ b0 þ bm int i þ an ext i þmi ; (2)
m¼1 n¼1
WJEMSD where inti and exti are internal and external factors that affect the financial performance of
15,1 NRB. They are further decomposed into the following equations:

int i ¼ b0 þb1 liqi þb2 loni þ b3 npl i þ b4 sizi þb5 bcapi þb6 levi þb7 expi ; (3)

ext i ¼ b0 þ b1 tbill i þb2 inf i ; (4)

8
where yi denotes financial performance and it measures the return on assets (ROA). That is
the net income returned on each cedi of assets. ROA is widely used by many researchers
(e.g. Buyinza, 2010; Naceur, 2003; Haron, 2004; Ramlall, 2009; Athanasoglou et al., 2008;
Javaid et al., 2011) to measure overall profitability from investment in assets. Higher rates of
ROA are desirable. liqi denotes the liquidity position of the bank. It is the current assets
divided by current liabilities. That is, its ability to meet short term claims as they fall due. In
addition, it indicates the capacity of the bank to meet depositors demand for withdrawals.
Most importantly, it helps a bank to assess it strength in avoiding “bank-run.” loni denotes
the annual loan portfolio of the bank. It is also an indicator of financial intermediation as it
measures the total loan advanced to customers annually. It is measured by the natural log of
the total loans per annum. npli denotes non-performing loans. NPL is the total loan default
by debtors of the bank per year. It is a credit risk management indicator as it measures loan
losses such as impaired loans and bad debts of the bank. sizi denotes total assets. It is
measured as the natural log of the total current and non-current assets of the bank per year.
Theoretically, size in the form of earning assets has a positive relationship with profitability,
however high levels of unearning assets can have adverse effects on profitability. Hence, the
effect of size on profitability is an empirical puzzle. bcapi is a measure of the shareholders’
fund. Bank capital is very crucial not only for regulatory purposes but for the avoidance of
bank failure during periods of financial crisis. It also affects the shareholders’ return
through the equity multiplier. Hence, it is expected to have a positive association with
financial performance. levi denotes the effects of leverage in the form of long-term liabilities
on the bank’s financial performance.
The external variables are represented by two macroeconomic factors, inflation and the
annualized interest rate on the government’s [Link]. The error term is e.

5. Results and discussion

5.1 Bivariate analysis
In a two-stage approach, this analysis deals with the individual effects of the key
variables on NRB’s financial performance. In the first stage, four scatter diagrams were
ran (Figures 1(a)–(d)) to provide a pictorial effects of loans, bad debt, liquidity and total
assets on its profitability. Whereas total assets and liquidity have a near perfect fitted
values and positive associations with NRB’s profitability, the loans portfolio though
positive is not properly fitted. That is, some of its loan portfolio deviates from the path of
expectation and hence do not add much to profitability. This finding is confirmed by the
relatively low adjusted R2 of 78 percent for loans as against 94 and 92 percent for liquidity
and total assets, respectively.
Ranking the results of the bivariate regression by adjusted R2 indicates that liquidity has
the highest influence on NRB’s financial performance. The other relatively important
variables are total assets and expenses. The result of the bivariate regression is presented
in Table II.
Despite the analytical appeal of the bivariate technique in simplifying the analysis, it
does not account for the simultaneous influence of the variables nor the effects of
endogeneity bias, therefore we have included a GMM model to deal with these limitations.
 (a) (b) Rural banks
300,000 300,000
in Ghana
200,000 200,000

100,000 100,000

0 0
9
0 2.0e+06 4.0e+06 6.0e+06 8.0e+06 0 20,000 40,000 60,000

Total assets Bad debts

Profit Fitted values Profit Fitted values

(c) (d)
300,000 300,000

200,000
200,000

100,000
100,000

0
–100,000

8 10 12 14 16 0 100,000 200,000 300,000 400,000 500,000

Loans Liquidity

Profit Fitted values Profit Fitted values

Notes: (a) Effects of total assets on net profit; (b) effects of bad debts on net profit; (c) effect of
Figure 1.
loans on net profit; (d) effect of liquidity on net profit Bivariate diagrams
Source: Authors’ constructions based on Naara Rural Bank’s Financial Statements, 2000–2010

The results of the GMM estimation and the OLS have been presented in Table III.
Even though the co-efficients of each variable under the OLS are the same as that of the
GMM, their levels of statistical significance are relatively weaker than those under the GMM
model. This is due to the inability of the OLS model to resolve the challenges of unobserved
variables, measurement errors and endogeneity bias. Thus, our preferred results are those
under the GMM model.
From Table III, liquidity (LIQ) is positive and significant at 1 percent significance level.
This confirms the bivariate findings that the bank’s liquidity management is robust and
thus it derives more benefits from its investment in short-term instruments. This is in
support of the theory that banks will usually lend on a short-term basis in order to increase
profitability but contradicts Buyinza’s (2010) finding that liquidity reduces profitability.
However, in order for rural banks to have real positive impacts on the development of their
catchment areas it is imperative that they lend on a long-term basis to microenterprises.
Bank capital is also positive and statistically significant. Bank capital enables banks to
open new branches/agencies, finance bank’s technological operations to spur its customer
base and also fund certain long-term loans. These activities, most of which are financed
from the bank’s capital, add economic value to the bank leading to growth in its
profitability. It also implies that well-capitalized banks have the capacity to absorb loan
losses and thus face lower risks of experiencing financial distress. This is in line with the
theory that bank capital affects returns and prevents bank failure (Mishkin, 2007).
Similarly, rural banking intermediation functions, captured by total loans as well as rural
banking expansion, measured by total assets were found to have positive and significant
effects. This implies that the continual mobilization of funds within rural communities and
the expansion of rural banking to those previously excluded from the formal financial sector
 10
15,1

Table II.
The bivariate
WJEMSD

regression results
Variable Fin_Perform Fin_Perform Fin_Perform Fin_Perform Fin_Perform Fin_Perform Fin_Perform

Liquidity 0.4877 (0.000)***

Loans 39,280 (0.000)***
Total assets 0.0301 (0.000)***
NPL −606,670 (0.035)**
Expenses 0.2707 (0.000)***
Leverage 1.4563 (0.096)*
Inflation −413,722.2 (0.278)
Constant 11,115 (0.207) −379,778 (0.001)*** −2,341 (0.819) 128,367 (0.002)*** −7,427 (0.494) 48,803 (0.107) 14,996.9 (0.055)
R2 0.95 0.80 0.93 0.40 0.93 0.27 0.129
2
Adj. R 0.94 0.78 0.92 0.34 0.92 0.20 0.032
F_ Statistic 0.000*** 0.002*** 0.000*** 0.034 0.000*** 0.09 0.277
Notes: *,**,***Significant at 10, 5 and 1 percent respectively
Source: Authors’ computation based upon Naara Rural Bank Financial Reports
ROA GMM estimation OLS estimation
Rural banks
Coeff. p-value Coeff. p-value in Ghana
Internal factors
Liquidity 0.6387 0.000*** 0.6387 0.012**
Loan advances 0.0703 0.000*** 0.0703 0.014**
NPL 0.1074 0.000*** 0.1074 0.047**
Size 0.0066 0.000*** 0.0066 0.186 11
Expenses −1.41e-06 0.000*** −1.41e-06 0.025**
Bank capital 1.04e-06 0.000*** 1.04e-06 0.029**
Leverage 1.65e-07 0.000*** 1.65e-07 0.052*
External factors
Inflation 0.5287 0.000*** 0.5287 0.009**
Treasury bill rate −0.8780 0.000*** −0.8780 0.020**
Constant −1.3034 0.000*** −1.3034 0.023**
Notes: (For the OLS Estimation: R2 ¼ 0.9999; [Link] ¼ 0.0034). *,**,***Significant at 10, 5 and 1 percent Table III.
levels, respectively The result of the
Source: Authors’ analysis based on the financial statements of Naara Rural Bank GMM model

can help stimulate more economic activities within rural communities, and hence lead to the
improvement in the standard of living and welfare of rural dwellers. Whereas this finding
confirms the positions of Shaffer (1985), Berger et al. (1987) and Marwa and Aziakpono
(2016), it contradicts the claims of Buyinza (2010) and Naceur (2003).
Even though theoretically, we expect NPL to decrease banks’ profitability, the finding here
shows otherwise. This may point to two issues: the bank may be passing on the cost of bad
debts on previously approved loans as margins on the price of new loans to new customers.
This approach is not an efficient credit risk management system and certainly not helpful to
genuine borrowers. On the other hand, it may also mean that the bank’s credit risk
management unit has an effective recovery system for retrieving bad and doubtful debts. It
will, however, be helpful to interrogate this issue further through a qualitative research
technique. Our finding lends support to the results of Afriyie and Akotey (2013) and Hosna
et al. (2009), but contradicts that of Clair (2004) and Achou and Tenguh (2008).
The two external factors, inflation and government [Link] rate, have significant
association with NRB’s financial performance. Whereas the effect of the general price level
measured by inflation is positive, that of the [Link] rate is surprisingly negative.
During periods of high [Link] rate, the bank is forced to increase the rate it pays on fixed
deposits and on its borrowings from other banks. Customers’ deposits also decline because
the high [Link] rate becomes more favorable to some customers. Another possible reason
may be the contagion effects of the MFIs’ financial crisis which have reduced the confidence
of some depositors in the financial system. Thus some depositors may prefer to invest their
funds in [Link] to safeguard their investment and peace of mind. Although the bank also
invests in [Link], the benefit during such periods seems to have been dwarfed by the
negative consequences. The possibility of the spillover effects connected to this finding is,
however, limited by the study’s scope and data challenges.

5.2 Ratio analysis

Profitability ratios. One of the objectives of the study is to examine the bank’s financial
performance in terms of its income, expenditure and profitability trends over the period.
Primarily, banks are run to make profit in order to keep their going concern alive.
Besides this, shareholders expect to be paid dividends when necessary and other investors
WJEMSD (debt holders) expect interest payment to be made on time. Therefore, profitability ratios of
15,1 the bank were required to inform management, potential investors, shareholders,
the general public and other stakeholders about how well the bank is doing. In terms
of the bank’s ROA, performance was high (6.75 percent) in the year 2000. The subsequent
year (2001) had a poor performance of 0.01 percent. From 2002 to 2010, performance ranged
from negative 2.07 percent to positive 3 percent.
12 The bank’s ROE, which was 45 percent in 2000, recorded its highest performance of
49 percent in 2001. There was, however, a significant drop in the subsequent years resulting
in negative 43 percent in 2004. After the 2004 challenges, its financial performance witness a
remarkable improvement as it recorded a 30 percent return on shareholders’ investment.
Altogether, the trend of both the ROA and ROE indicate a typical U curve or a three-stage
movement of high–low–high. Interestingly its ROE from 2012 to 2014 has witnessed a
persistent decline since the start of the MFIs’ crisis. Although a direct link may not be
established between the MFIs’ crisis and Naara reduced performance during the crisis
period, a possible contagion effect might have influenced the decrease in its ROE.
It is noteworthy that between the periods 2006 and 2010 (see Table V ), NRB’s ROE was
twice more than the average of the RCBs’ industry. Its ROA within the same period
was also far better than the national average. Whereas it recorded a positive ROA of 0.54
percent, the industry average was an abysmal negative 0.57 percent. The key financial
indicators of both NRB and the RCBs’ industry have been calculated and presented
in Tables IV and V, respectively.
Liquidity ratios. Liquidity ratios are used to assess the capacity of an institution to meet
its short-term debt obligations. Liquidity challenges can lead to bank run due to multiple or
panic withdrawals, bank failure and closure. Our analyses indicate that the bank’s average
liquidity position over the study period is 1.08. Although this may reflect a sound solvency
status, its primary and secondary liquidity position as defined by Bank of Ghana[4] is less
than the RCBs’ industry average by 10.81 percent (see Table V ).
Capital adequacy ratio. The management of bank capital is very crucial because it has a
direct effect on the minimum regulatory capital, the return to equity holders and the
prevention of insolvency (Mishkin, 2007). NRB’s CAR is significantly higher than
the 10 percent minimum requirement of the Bank of Ghana. Nevertheless, its CAR and the

Year ROE ROA Liquidity

2000 0.45 0.07 1.14

2001 0.49 0.09 1.18
2002 0.18 0.02 1.12
2003 0.26 0.03 1.05
2004 −0.43 −0.02 0.99
2005 0.46 0.03 1.03
2006 0.45 0.04 1.05
2007 0.33 0.03 1.02
2008 0.38 0.03 1.06
2009 0.30 0.03 1.07
2010 0.30 0.03 1.06
2011 0.40 0.04 1.11
2012 0.29 0.03 1.09
Table IV. 2013 0.28 0.03 1.12
Key financial 2014 0.27 0.04 1.15
indicators of Naara Average 0.29 0.04 1.08
Rural Bank Source: Authors’ analysis based on the financial statements of Naara Rural Bank
CAR per return are not just below the industry average but the CAR in particular has Rural banks
recorded a consistent downward trend since 2007. It will, therefore, be very helpful for in Ghana
NRB’s management to initiative proactive actions to curtail it continuous decline. Table VI
presents the capital adequacy indicators of NRB and the nationwide network of RCBs
from 2006 to 2010.

5.3 Financial intermediation efforts of Naara Rural Bank 13

Its financial intermediation indicators are above the national average. In particular, its
deposits, loans and advances have been consistently above the average of the RCB
industry. Its size measured by the total assets also exceeds the average of the nationwide
network of RCBs.
These findings may imply that NRB has done quite creditably in the mobilization of
savings from surplus units and the allocation of credit to rural households and
microenterprises for investments. The financial intermediation indicators and total assets
are presented in Figures 2–4.

6. Conclusions and policy recommendations

This study shows that there is a significant relationship between financial performance and
bank-specific factors such as bank capital, loan advances, liquidity and macroeconomic
factors such as inflation and [Link] rates. The study concludes that the financial performance
of NRB has been stable over the past fifteen (15) years. Its financial performance is above the
average of the nationwide network of RCBs. However, the contagion effect of the MFIs’
crisis which has compiled some customers to divert their deposits into [Link] seems to have
affected its performance adversely especially during periods of increasing [Link] rates.

Ratio Naara Rural Bank RCB industry average

Return on equity (%) 5.09 2.48

Return on asset (%) 0.54 −0.57
Return on earning assets (%) 0.63 0.26
Net worth per return (GHS) 485,700 521,633
Capital adequacy ratio (CAR, %) 14.62 17.90
CAR per return (%) 14.60 17.90
Table V.
Non-performing loans (%) 0.03 1.82 Five year (2006–2010)
Expense per income (GHS) 66.10 92.72 averages of key
Liquidity (primary and secondary, %) 51.98 62.79 performance
Source: Bank of Ghana data on RCBs, 2006–2010 indicators

Capital adequacy ratio (CAR, %) CAR per return (%)

Year NRB RCB industry NRB RCB industry

2006 15.59 12.77 15.59 12.77

2007 15.14 19.70 15.14 19.70
2008 13.77 18.26 13.77 18.26
2009 15.05 19.75 15.05 19.03 Table VI.
2010 13.56 19.03 13.46 19.03 Capital adequacy
Source: Bank of Ghana data on RCBs, 2006–2010 indicators, 2006–2010
WJEMSD 5,000,000
4,500,000
15,1
4,000,000
3,500,000
3,000,000
2,500,000 Naara Rural Bank
2,000,000 Industry Average
14 1,500,000
1,000,000
Figure 2. 500,000
Comparison of loans 0
of NRB with industry 2006 2007 2008 2009 2010
average
Source: Authors’ construction based on Bank of Ghana data on RCBs

8,000,000

7,000,000

6,000,000

5,000,000

4,000,000 Naara Rural Bank

Industry Average
3,000,000

2,000,000

1,000,000
Figure 3.
Comparison of 0
deposits of NRB with 2006 2007 2008 2009 2010
industry average
Source: Authors’ construction based on Bank of Ghana data on RCBs

9,000,000
8,000,000
7,000,000
6,000,000
5,000,000
Naara Rural Bank
4,000,000
Industry Average
3,000,000
2,000,000
1,000,000
Figure 4.
Comparison of assets 0
of NRB with industry 2006 2007 2008 2009 2010
average
Source: Authors’ construction based on Bank of Ghana data on RCBs
In line with the findings of the study and for the bank to continue to survive through growth Rural banks
and profitability, we recommend the following to NRB: in Ghana
(1) The bank should intensify its loan screening and monitoring activities to increase
the loans recovery rate. It can improve upon its loan recovery rate by designing
group lending models. The group lending schemes can be designed along the lines of
ROSCAS, susu and nnobua. These traditional/informal financial groupings have
inbuilt peer and social monitoring systems which can reduce moral hazards, adverse 15
selection, information asymmetry and hence reduce loan delinquencies.
(2) Individual loans should be secured by microinsurance products and marketable
securities so that in the event of default, such securities can be sold to defray
the debt.
(3) The bank may need to conduct qualitative research into the trend of its NPL and the
effects of the [Link] rate on its profitability.
(4) The prudential measures should be tightened to prevent the decline in the CAR.

6.1 Policy recommendations for the RCB sector

The findings are also very essential for policy guidance. A raise in the minimum capital of
RCBs will enhance their capacity to mitigate the likelihood of losses that interrupt rural
financial intermediation and triggers RCBs’ failures. Also, increasing the capital
requirement will equip rural banks to finance bigger projects. It is, therefore, interesting
that the Central Bank has decided to increase the regulatory capital of RCBs.
The new regulatory capital has a transition period of three years during which RCBs
are required to raise their capital to GHS300,000 ($75,000) by December 2015 to
GHS500,000 ($125,000) by December 2016 and to GHS1,000,000 ($250,000) by December
2017 (Bank of Ghana, 2015b). Although the raise in the regulatory capital is good, the
transitional arrangement should be done carefully to avoid high bank consolidation and
the folding up of the relatively smaller RCBs in the remotest parts of the country. A high
consolidation and mergers due to the new capital requirements may compel some RCBs to
reduce their rural presence.
Even though RCBs were set up to serve the rural population, a critical review of their
branch network shows a greater movement of many RCBs to urban and sub-urban centers
to the detriment of the rural areas. This trend is likely to defeat the original idea
underlying the rural banking concept. It is, therefore, imperative that certain policies such
as the tax incentive that exempt rural banks from corporate tax for ten years should be
revised to focus solely on those banks which are predominantly rural in financial
intermediation and operations.
The recent universal banking and microfinance crisis that Ghana experienced has
shaken the confidence of the general public not only in those specific universal banks and
MFIs but in rural banks as well. This negative spillover effect can reduce not only the
deposits and savings rate that RCBs mobilize from rural households but it can destroy
the whole financial system. Hence RCBs under the auspices of ARB Apex Bank[5] will need
to educate and re-assure their customers of the financial integrity of the rural banking
system and most importantly differentiate their services from the other financial institutions
within the space of the rural financial architecture.
This study is limited by scope because of data challenges so future research can take a
different angle of this topic by conducting a longitudinal study into RCBs’ performance.
A qualitative research can also be undertaken into the extent of the banking and MFIs’
financial on household welfare and on RCBs’ performance.
WJEMSD Notes
15,1 1. Certain microenterprises and households savings running into more that GHS700m ($184.21 m)
have been destroyed by microfinance firms through Ponzi and pyramid schemes. This
necessitated the Parliament of the Republic of Ghana to summon the Finance Minister and the
Governor of the Bank of Ghana to explain the events that led to the MFIs’ crisis. The situation was
so serious to the extent that the President of the Republic of Ghana in the 2016 State of the Nation
Address to Parliament had to use much time to explain the crisis and how the government intends
16 to resolve it.
2. Ghana is divided into 216 administrative districts.
3. The total banking industry is defined here to include deposit money banks (DMBs, i.e. large
commercial banks), microfinance institutions (MFIs) and rural and community banks (RCBs).
4. The Bank of Ghana is the central bank and regulator of the banking industry in Ghana.
5. ARB Apex Bank is the mini-central bank of the rural banking sector. It supervises the RCBs under
the regulation of the main Central Bank (Bank of Ghana).

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Further reading
Naara Rural Bank (2006), “Silver jubilee report”, Naara Rural Bank Limited, Navrongo.

Corresponding author
Joseph Oscar Akotey can be contacted at: jesujuva1987@[Link]

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