Banks facing continuing challenges

Research wing of Groupe Nduom (GN) conglomerate, GN Research, has stressed that reductions in the Monetary Policy Rate (MPR) will continue to have marginal effect on commercial bank rates so far as bank specific factors that are considered in the determination of commercial bank’s rates do not improve.

Key among these factors, GN Research disclosed in its research, include high cost of funds, high operating costs and high risk of default (high non – performing loans).

GN Research made these observations in a research titled: “Bank Specific Factors Are Keeping Lending Rates High.”

According to the research, external factors (such as inflation, Treasury bill and the MPR) in determining the lending rates have all fallen by at least 3 percentage points. However, the minimum lending rate (Base rate) for the banking industry declined marginally by 1% from 27.6% January 2017 to 26.6% by May 2017 relative to the considerable reductions in inflation, the policy rate and the Treasury bill rates. The current industry base rate is more than twice the inflation rate.

Inflation has been declining since June 2016, reaching 15.4% in December 2016 and further to 12.6%, representing 6.3 percentage points reduction from 18.9% in May 2016 and 2.8 percentage points in 2017. In addition, the central bank has reduced the MPR by 300 basis points (3 percentage point) from 25.5% to 22.5% between January and June this year.

Treasury bill rates on the other hand have also declined considerably in 2017. The 91 days and the 182 days Treasury bill rates reduced from an average of 16.81% and 18.50% in December 2016 to an average of 13.69% and 15.35% in May 2017 respectively.

This shows a 3.12 percentage point reduction for the 91 days Treasury bill and 3.15 for the 182 days. Meanwhile the one year Treasury bill 4.75 percentage point reduction within the same period.

This shows that, the key external determinants of the base rate recorded at least 3 percentage point reduction on average compared with the 1% reduction in the base rate. For instance, banks cannot attribute high interest rates to rising inflation and monetary policy rates. Banks therefore need to answer why they hanging on high rates.

We believe major reason for the disproportionate movement in the base rate and the MPR and the other rates is the bank’s internal factors (high cost of funds, operating costs and Non – performing loans).

The Bank of Ghana’s measure of banking efficiency, the banking sector’s cost to credit remained unchanged at 5.4 as at April 2017 relative to April 2016 according to the Bank of Ghana’s May banking sector report. However, the operational cost to total assets ratio declined marginally by 0.3 from 3.2 to 2.9.

This indicates that the banks are doing enough to increase their efficiency and to reduce operation cost. While efficiency seem not to increase fast, the industry’s profit after tax increased from increased from GH¢675.5 million in April 2016 to GH¢739.3 million in April 2017, representing a year-on-year growth of 9.4% in April 2017 relative to 0.7% growth a year ago.

This gives the impression that the profit motives of the banks is also responsible for the low responsiveness of the bank rates to the changes in the MPR.

Another reason for the low responsiveness is the high risk of loan default. Non – performing loans increase from 17.3% in December 2016 to 19.8% (2.5 percentage point increase) in April 2017. This is partially due to poor performance of business.

This is as a result of high cost of operation because of high energy and input costs. This can reduce the incomes of businesses which negatively affect their ability to pay loans they contracted.

Consequently, the private enterprise’s share of NPLs increased from 79% (foreign 7.6%, indigenous 71.4%) in April 2016 to 91.4% % (foreign 12.5%, indigenous 78.9. In addition, inadequate evaluation and monitoring by the banks due to lack of the proper skills usually leads to the selection of more risky borrowers.

Going forward, the banks must embrace modern technologies and work together to increase the industry’s efficiency. Where necessary, they must share skills and expertise. This will help reduce cost of funds (especially corporate funds) and their cost of operations

In addition, the banks with the help of government should work effectively to reduce the non – performing loans. Hopefully, the payment of the energy sector debts by government from the expected US$2.4 billion energy bond will improve the situation.

Also, the development of a comprehensive data base for identification will help the banks to track individuals who hitherto would have defaulted in paying their loans. However, the banks should also improve the methods adopted in assessing the risk of default of customers.

Furthermore, the banks and other stakeholders in the industry should adopt best practices that have worked elsewhere. For instance, the South African financial system is ranked the first in the sub region and seventh in the world by the World Economic Forum. We should note that South Africa and Ghana are the only countries in Sub Sahara Africa using the inflation targeting monetary policy framework. All things being equal, learning from the South African banking industry players should not have any difficulties for monetary policy.

One area that the Ghanaian banking industry should learn from the South African system is reducing NPLs. The NPLs of the South Africa’s banking industry declined from its highest of 5.94% in 2009 to 3.17% in 2016 and further to 2.9% in April 2017 relative to Ghana’s 19.8%.

The main reasons for the reduction are the increase in the quality of human resource, the advancement in technology in the banking system and improvement in the collection and recovery methods. This also includes financial product innovation to reduce the risk of default associated with the product. Aside helping to reduce the NPLs, these measures also help to reduce operation cost. It is also believed that the reduction in lending rates in itself reduces the risk of default.

Now, the movement of the lending rate in South Africa is proportionate to the changes in the South Africa Reserve Bank’s repo rate. For example, between January and April 2017, the South Africa’s repo rate and the base rate of commercial banks remained at 7.00 and 10.50% respectively indicating a strong relationship between the two variables. Ghana should be aiming establishing this strong relationship between the MRP and the commercial bank rates since it will lead to smooth transmission of monetary policy.

Finally, that sort of relationship will only be possible in Ghana if the challenges facing the banking industry are resolved. If not, the macroeconomic variables can improve with very low MPR, say 1%, lending rates will continue to remain too high to drive growth of the economy. This may necessitate a change in monetary policy framework since the MPR may not be the best tool for controlling monetary aggregates.