Borrowing from the bank is a good servant but a bad master – this alteration of the age-old adage that “fire is a good servant but a bad master”, encapsulates the dual nature of bank borrowing.
Banks in Ghana grant several credit facilities including loans, overdrafts, guarantees, letters of credit and in recent times, credit cards, to their individual and business customers. The demand for these credit facilities, which are simply referred to as bank loans in this article, has shown significant increase over the years. According to the 2024 PwC Ghana Banking Survey Report, bank loans grew from GHS46.86 billion in 2020 to GHS67.26 billion in 2023, an increase of 43.53%, which is an indication that borrowers continue to access more of these credit facilities to meet various needs.
Bank loans can be valuable tools for achieving personal financial goals and business growth, but they can also lead to financial servitude if they are not managed responsibly. The annual reports of Bank of Ghana for 2020 and 2023 reveal that non-performing loans increased from 14.8% in 2020 to 20.6% at the end of 2023, signalling the need for borrowers to have an understanding of the benefits and pitfalls of bank loans to effectively harness their potential.
The Good Servant: Benefits of Bank Loans
Bank loans provide benefits to individual and business borrowers, the community and the nation as a whole. They offer financial flexibility for borrowers, particularly with their structured repayment plans which help to manage cash flow.
Achievement of financial goals: Personal borrowing empowers individuals to achieve financial goals, improve well-being, and secure their future. For instance, personal loans can be used to fund educational goals to enhance employability, own homes or undertake improvements of existing properties, and home furnishing. Loans also enable individuals to cater for medical expenses, emergencies as well as vacations and holiday celebrations.
Promotion of business growth: Loans and other credit facilities represent a significant portion of SME financing in Ghana. Bank loans promote business growth by providing businesses with the requisite financial capacity to expand their operations through the acquisition of assets such as vehicles, business space, office and factory equipment or boosting of working capital to meet day to day operational expenses.
Development of savings habit: Apart from these direct benefits, bank loans promote financial planning, including the development of savings habits by borrowers. Settlement of loans involves regular payments which requires borrowers to make funds available in a timely manner. Setting funds aside to meet loan repayments fosters discipline and consistency and this can help borrowers to form a savings habit such that, even after paying off loans, borrowers can continue to set aside funds to cater for future needs and emergencies. Borrowers can also take loans and invest in other assets like Treasury Bills and real estates to make good returns, this however requires careful study of the financial market and financial planning.
Time value of money: Bank loans can be considered as a reverse form of savings based on the fundamental financial concept of the time value of money. This concept puts forward that money held presently has more value than the same amount of money when it is received in the future. In the case of bank loans, if a person or business needs to purchase a vehicle at a specified cost, they have the option to either set funds aside until the total amount required is achieved, or they can access a bank loan to purchase the vehicle immediately and use the funds that they would have set aside to meet the loan repayments. Accessing the bank loan gives the borrower the opportunity to purchase the vehicle now at a known cost. With inflation and market fluctuations, there is a possibility that the cost of the vehicle will increase over time which will make it more expensive and can potentially extend the time needed to acquire it through regular savings.
Stimulation of economic activity: Beyond the benefits to individuals and businesses, loans stimulate economic activity through job creation as they provide the needed resources to explore business opportunities in communities and the nation. Loans support economic development through financial inclusion as more people are attracted to other financial services when they access loans. For example, loans granted to SMEs in the agricultural sector promote food security through enhanced food production.
The Bad Master: Pitfalls of Bank Loans
Unfortunately, many individuals and businesses find themselves trapped in a cycle of debt due to their inability to repay loans on time, leading to further borrowing and financial distress. This situation illustrates how borrowing can quickly transition from being a helpful resource to a burdensome obligation. Some pitfalls of bank loans include:
Excessive and unsustainable borrowing: This can lead to debt traps, therefore, jumping at every opportunity to access loans, even when the rates are attractive, can be risky to a borrower, particularly in instances where they do not have a definite purpose or pressing need for it. This can lead to the misuse of this valuable tool and cause financial distress to the borrower.
Putting personal and business assets at risk: Defaulting in loan repayment puts assets used as collateral at risk. A bad credit decision can result in loss of property and assets such as residential properties or business operating assets that borrowers may have acquired over several years. In some cases, this can lead to homelessness, the collapse of businesses and embarrassment to the defaulting borrower.
Failure to observe interest rate trends: In Ghana, interest rates are linked to the Ghana Reference Rate (GRR) which is determined by the Bank of Ghana and announced on a monthly basis for the information of both lenders and borrowers. In 2023, the GRR increased from 25.76% in April to 32.16% in December. Borrowers with floating interest rates during this period experienced unforeseen and unpleasant increases in their loan repayments. This trend of rising interest rates has however reversed in 2024 with a decline from 32.17% in January to 28.31% as at October. Given the fluctuating nature of interest rates, failure to monitor the trends can be costly to a borrower, for instance, if a medium term was accessed in January 2024 at a fixed rate of 32.17%, this means that the borrower will continue to pay the loan at the high interest rate although rates had dropped from January to October, 2024. On the other hand, a loan which was accessed during the same period at a floating rate will experience a drop in repayment amounts in response to changes in the market.
Failure to pay attention to volatile exchange rates: Trends in exchange rates can also have adverse impact on borrowers. During times of fluctuating exchange rates, the cashflows of business borrowers engaged in the import of raw materials or finished goods can be adversely impacted if they fail to factor these fluctuations in their financial projections. Borrowers who access bank loans in foreign currency are also exposed to this risk. Volatile exchange rates have the potential to affect the borrower’s capacity to meet loan repayments and operate efficiently as they could end up making losses when import costs and other operational expenses increase significantly due to the changes in the exchange rates.
Exclusion of fees and other charges in financial planning: Borrowers often overlook the fees and other upfront charges related to loans as well as other expenses to be incurred in relation to the purpose of the loan in their planning, and this can affect the funds available for the borrowing purpose after disbursement. For example, if a borrower requires an amount of GHS100,000.00 to purchase a vehicle, the borrower must have funds available to cater for loan fees and charges that will be deducted upfront by the bank as well as vehicle registration and insurance costs, otherwise these charges and upfront costs related to the vehicle purchase will reduce the loan funds available, and the borrower will not be able to purchase the vehicle immediately after approval of the bank loan.
Breaking Free from the Bad Master
Borrowers can break free from poor loan management and its attendant consequences by making informed borrowing decisions throughout the life cycle of the bank loan, that is, from the time of requesting for the loan until the time the loan is fully repaid. Adopting these simple borrowing principles can help borrowers to navigate the complexities of borrowing and protect their financial health and treasured assets used as collaterals:
- Evaluating borrowing needs: Assessing the need for a loan, including seeking financial advice is an important stage of the borrowing cycle. Borrowers should have realistic budgets and prioritize needs over wants when requesting for a loan. Personal loans should be accessed for specific, essential expenses or investments such as education, healthcare and emergencies and not discretionary spending. Business loans should be used to meet business goals such as expansion, working capital, acquisition of equipment and even with this, business should engage in a thorough assessment to ensure that the returns outweigh the cost of the loan.
- Assessing financial capacity: Before accessing new or additional loans, borrowers must evaluate their ability to repay loans without compromising their financial stability. Attention should be paid to their capacity to meet other unavoidable financial obligations. Recurring expenses like utility bills, taxes and existing loan obligations are among the unavoidable financial obligations that borrowers should consider when assessing their capacity to take on new loan repayments.
- Disclosure of important information: Information such as exposure with other banks and other financial obligations should be disclosed before and during the tenure of the loan. Failure to disclose to lenders can have a negative impact on the borrower’s ability to meet loan repayment and other important financial obligations as this can result in poor loan structuring and cause repayment stress and financial anxiety for borrowers.
- Understanding loan terms: Borrowers frequently proceed to sign loan documents without carefully reviewing the associated terms and conditions. One should have a clear understanding of interest rates, repayment schedules, and loan related fees. The trend of interest rates should inform the decision for short-term or medium-term borrowing, and whether the borrower should opt for a floating or fixed interest rate. Seek professional financial advice if you require any clarification or guidance. It is important to constantly keep abreast with changes in the financial sector by reading business related books, watching quality online videos on financial planning and attending business related programmes.
- Prioritizing debt repayment and continuous cashflow management: Be intentional about loan repayments by setting aside funds for timely loan repayments. Ensure that loan repayments are made with careful planning and discipline. Timely loan repayment is essential to avoid debt accumulation and financial distress. Individual and business borrowers should continue to monitor and manage cash flows throughout the loan cycle and engage the bank or lender on any adverse changes in their cashflows that can potentially affect loan repayments. At Bank of Africa Ghana Ltd, there are special provisions available to assist clients in restructuring their loans where genuine and unforeseen circumstances impact their ability to repay their loans within the originally agreed tenure.
- Maintaining a good credit history and credit score: Credit reference bureaus have operated in Ghana since 2008. These institutions gather and maintain data on borrowers, including performance on existing loans, from banks and other lending institutions. A negative credit history report can inform the decision of banks to decline a loan request or grant loans at a higher rate to a borrower. In November 2024, a credit scoring system, MyCreditScore, was launched in Ghana. Unlike the credit reference bureaus which only provide the data, a credit scoring system uses the credit history data to compute a credit score for a borrower. A higher score indicates credit worthiness and can enable a borrower to access more loans at very favourable terms and pricing since the borrower will be deemed to be less likely to default.
Role of Other Key Stakeholders
Banks and regulators of the banking industry are key stakeholders in borrowing and loan management by individuals and businesses. They therefore have a role to play to ensure that borrowers effectively manage their loans to minimize the negative consequences of poor loan management.
- Commercial Banks in Ghana: As lending institutions, banks have a responsibility to support borrowers to manage their loans and minimize default. They can do this by organising targeted financial education programs to help borrowers make informed loan decisions. These financial education programs could be in the form of online sessions or sharing titbits on social media, radio and television. As lenders, banks are required to provide transparent loan terms and flexible repayment options to encourage responsible borrowing practices. One of the major banks operating in Ghana that is dedicated to providing accessible credit solutions while promoting responsible borrowing practices is Bank of Africa Ghana Ltd (BOA Ghana). BOA Ghana has credit products that are tailored to the varied needs of individuals and businesses, including specialized products for the SME market. Recently, BOA Ghana also collaborated with the International Finance Corporation (IFC) to train SMEs in Accra on loans and financial management and this is expected to be replicated across the country to benefit SMEs operating in other areas in Ghana.
- Bank of Ghana: Regulatory bodies have the two-fold responsibility to enforce responsible lending practices and ensure protection for borrowers. Bank of Ghana (BoG) as the regulator of banks and other lending institutions in Ghana has established guidelines such as the Borrowers and Lenders Act, 2020 (Act 1052) which provides a legal framework that governs transactions between borrowers and lenders. This Act enforces responsible lending practices by requiring banks to provide a pre-agreement disclosure to borrowers that gives adequate information on a potential loan before a loan agreement is executed. Through this provision, the Act 1052 also ensures protection for borrowers by prohibiting lenders from charging any fees beyond what has been clearly stated in the pre-disclosure agreement.
The dual nature of bank loans, that is, the capacity to serve as a good servant when used wisely and to become a bad master when mismanaged, highlights the importance of responsible borrowing practices and financial literacy.
Many bank customers have a false notion that simply having a long-standing relationship with a bank will automatically qualify them for a loan. Banks are however required to practice responsible lending by granting loans to individuals and businesses who demonstrate the ability to repay their loans on time. It is important to note that the funds provided as loans are made up of the banks’ own funds and deposits from customers who rely on the banks to manage their funds responsibly. A default in loan repayment does not only affect the borrower but it also has the potential to negatively affect the banks and depositors and result in loss of opportunity for potential borrowers who need to access loans to meet their various purposes.
Individual and business borrowers, banks as lending institutions and regulators have roles to play in fostering a culture of financial discipline and must work together to promote financial stability, economic growth, and a beneficial borrowing experience for all.
Author: Marian Yeboah, Head, Credit Administration, Bank of Africa Ghana Ltd
The post Marian Yeboah: Navigating the double-edged sword of bank loans and advances first appeared on 3News.
Read Full Story
Facebook
Twitter
Pinterest
Instagram
Google+
YouTube
LinkedIn
RSS