Ghana’s 'lactogen banks' or why all that glitters is not gold

It is reporting season for our illustrious corporate citizens, the Banks. End of year results for two of Ghana’s most respected banks – Ecobank and Calbank - have just been released. And what a spectacular set of figures they were. The combined year-on-year growth in revenues of the two financial institutions averages more than 55%.

Impressive though they are, the Calbank and Ecobank annual statements are generally in line with lay perception of the Ghanaian banking sector of nowadays: seemingly astounding expansion in assets, turnover, and the scope of credit facilities. From most perspectives Ghana’s banking sector is flourishing – wallowing in milk and honey as the idiom goes.

But is it?

The present exuberance is understandable when one considers whence the banking system has come. Well into the late 80s all domestic banks were majority owned by the government, which also maintained significant minority stakes in the major foreign banks as well.

We an only express our utmost respect for many of the key players in the Ghanaian financial industry. A respectable number of the principals, such as the senior management of the two banks mentioned above, and some of the technocrats at the Bank of Ghana, are undoubtedly of world-class stature. But this does not restrain us from a highly critical, some will say even acerbic, look at a range of sector-wide structural, regulatory and cultural practices and dynamics that in our view are colluding to prevent the industry from impacting more positively on the Ghanaian economy.

The aggregate effect of these realities has created a relationship between banks and the wider economy that is less savoury than has been dressed up to appear by the glittering announcements, TV ad spots and glossy marketing brochures. The use of “lactogen” in days gone by as an adjective implying an excess of solid fats over protein comes to mind as an apt expression in the context of our banking system.

No doubt the recent incidents involving AMAL Bank has influenced a part of our perception, but they are not the motivation behind the coming assessment, being in our view symptomatic of deeper flaws in the system that are better captured by a probing look into what in the jargon is known as “financial intermediation efficiency”.

Intermediation Spreads

Put very simply, “intermediation spreads” are “differences in rates” between different levels of the banking system and different levels of market activity. So the difference between the interest rate you receive on your deposit at your bank and the interest rate on your loan taken from the same bank is an example of one such “spread”. In the same vein, the difference between the “prime rate” – the interest rate charged on loans from the Bank of Ghana to commercial banks – and the “inter-bank rate” – the interest rate on loans provided by one commercial bank to the other – is another such spread. Of vital importance is the difference between the inter-bank rate and the interest rate your bank charges on your recent loan.

You probably know that your bank does not charge the same interest rate on all its loans or to all its customers. There is an iron law in finance that the riskier the loan the more profitable it is or should be. If you are more likely to default on your loan (or have “bad credit”) your bank will charge a higher rate to “offset some of the risk you pose”. So, in the above definitions we are referring to averages. A bank’s “lending rate” in this article is taken to mean its “average lending rate”.

With the boring preambles out of the way, we are ready to take on the most obnoxious of the indicators: the obscene spread between the Prime Rate and the lending rate of the banks in this country. Recently Tullow Oil received a rate of 3.75% above the London Inter-Bank Offered Rate (Libor) on a syndicated loan for the development of the Jubilee field, and this was considered worthy of comment because just a few months earlier it had been enjoying a rate of 1% above Libor. Yet, in this country some of our most respected blue chips must in some instances settle for as much as 15% above the Inter-bank rate! How on Earth, one is compelled to ask, is a light manufacturer in this country expected to compete with her Chinese counterparts for the plastic utensils market by relying on credit at that price? Especially when her on-demand cash holdings attract negative real rates of up to -5%? Even as deposits fund 60% of the banking system?

The return of government fiscal prudence and the massive entry of foreign banks since the early years of this decade may have forced some rethinking of business strategy on the part of the then lacklustre local banks, and many of them, even aristocratic Barclays, began to resort to unsecured lending, employing wagonloads of so called “sales officers” to literally flog their overpriced products by the roadside. Yet, credit spreads have not narrowed, leading to credit inflation rather than real growth and deepening in the sector.

Non-performing assets (NPA) as a percentage of assets (sector average) have almost halved over the past few years, supposedly a sign of improved risk management and balance sheet solidity. The only problem is that this indicator is easily manipulated by restructuring loans (considered “assets” by banks), or changing “recovery” terms so that said loans are technically not in arrears (a loan has to be in arrears between 90 and 540 days to be classed under one of the NPA categories, and thereafter considered a loss). A trend in financial wizardry that may account for the corresponding decline in profitability witnessed over the same period of time.

A ping-pong blame game has been going on between policy makers/regulators and bankers over this matter for a long time. We would offer to settle the matter by ascribing each category of well-paid professional their due portion of the blame.

Policy Environment

1. High inflation means that banks stand to lose out if they lend at overly lenient rates. Imagine that a Bank lends you GHC100 in January at an interest rate of 10% with both interest and principal repayable at the end of the year. Your liability will be GHC110 at the end of this period which will mean a “nominal” profit of GHC10 for the bank (assuming no costs for administering the loan). But if the rate of inflation over the period was significantly more than 10% then the “real” profit would in fact turn out to be negative. In the real world it is not just the prevailing inflation rate that matters but also the “expected trend of inflation” over the period. The connection with our account above is that inflation expectations is a significant component of the lending rate, and where the former are high the latter will diverge considerably from the prime rate.

2. A similar analysis plays out with exchange rate fluctuations. Since banks lend predominantly in Ghana Cedis but tend to informally mark their holdings to an international reserve rate, high expectations of Ghana Cedi depreciation will also find their way into the pricing of the lending rate. Points 1 and 2 above explain why at certain points the debate over the recent increase in the prime rate by the Bank of Ghana appeared more academic than anything else. Inflation and currency value stability effects are preeminent over the statutory rate effect (In the past three decades inflation has breached the frightful 100% mark thrice). Though, in counteraction, one might also argue that if the prime rate is relatively ineffective in its influence on the lending rate then it is also relatively ineffective in its influence on the rate of inflation, and therefore that quantitative tightening (limiting the actual flow of money) would have had more dominant effects. But we digress. Capital Adequacy regulations require that Banks keep 9% of their assets in primary reserves of cash lodged at the Bank of Ghana, and a further 35% in secondary reserves of Government securities and maturities (our understanding is also that there is a Government of Ghana stipulation that 15% of secondary reserves be held in long-term government bonds.)

Primary reserves receive no interest, while secondary reserves receive only the going market rate. It is unfashionable to say in this age of zealotry for hyper-regulation, but the obvious fact is that the capital adequacy rules have aided the government profligacy of recent years. But whatsoever be the justification, the fact remains that banks pass on the costs of these regulatory constraints on their liquid assets through high lending rates to consumers (borrowers).

We are not really advocating for a weakening of prudential regulations. For instance we argue that capital adequacy should be quoted in an international reserve currency, such as the dollar, to lock in inflation tracking, and we also concede that risk weighting should continue to be absolute and non-graded as has been the recent practice.

Our worry is whether given our peculiar circumstances we can continue to be conventional about prudential restraints. It seems to us that Bank risk-aversion is more pronounced in our setting than bank adventurism, and excepting outright fraud, insider dealings, and corruption – which are scarcely a matter of capital adequacy – banks in Ghana have tended to exhibit a kind of dour chastity and may require some prodding to become more forward in their hunt for opportunities.

Structural Environment

1. Notwithstanding the pressures of the surrounding environment (“exogenous factors” so to speak), a good chunk of the nasty spreads we have been discussing stem from factors internal to the banking system itself (so-called “endogenous factors”). We will argue that the high lending rates owe in part to lower than expected competition within the sector. The argument sounds problematic given the high absolute number of players in the industry. Surely competition flows naturally when you have a multiplicity of vigorous actors? Well, the situation in the sector is actually very oligopolistic. Three banks own over 40% of the entire asset base in the industry, and 5 banks own about 75% of the assets, nearly unchanged from two decades ago. 5 banks out of 23, that is. Furthermore, the central government owns nearly 40% of the sector. In other words decision making is concentrated in far fewer hands than would seem at first sight. Collusionist and cartelist behaviour can be justifiably inferred.

The underdevelopment of capital and money markets, and the extreme predominance of banking (nearly 75% of overall assets in the financial system) over other types of financial sector activity such as insurance represent another instance of “overconcentration”. As Mr. Pianim has said the oil sector promises very sound prospects for the insurance industry provided public policy exhibit the necessary innovativeness. Currently, premium levels are considered less than sufficient to enable vigorous growth, while concentration in “life assurance” and auto/building insurance remains a challenge to the deepening of the sector. A comparison of the current situation with the results of the joint IMF-World Bank Financial Sector Assessment Program in 2000 shows the need for increased urgency, since a decade on we are still lamenting the feebleness of private sector participation in the pension and broad insurance markets, and decrying the underperformance of the rural banking system.

2. The capacity constraints in the banking sector are another limitation on innovation. There are estimates that the total assets of the five biggest banks in Ghana still come up way short of the asset base of the 5th largest bank in Nigeria.

The observation above makes a detour into an analysis of the Nigerian situation worthwhile. Consider that in 2004, our West African neighbour had 89 banks, but today has only 24, with the Nigerian government, which part-funded and drove the reforms, fast disengaging from share ownership. Even this has not halted increasingly widespread speculation that many Nigerian banks are on the cusp of distress as reform momentum sags and the sustainability of gains prove ever more precarious.

The hazardous integration of Nigeria’s commercial banks and the country’s stock market helped bankroll a reckless debt-fuelled speculation in the capital markets in a manner that sharply illustrates the importance of regulation, when pursued appropriately. The crash of the Nigerian capital markets has therefore meant a collapse in the banking sector’s once unshakeable confidence-inspiring capacity. But this ought to be blamed on limited capacity and not liberalisation per se. Morocco, said by some to possess the continent’s most sophisticated banking system outside South Africa, has on the other hand benefited immensely from liberalization reforms and not experienced any of the hassles now dogging Nigeria’s reforms. Indeed, without the recent rationalisation of the system, there is no doubt that the Nigerian banking industry would have lost even more than the 60% of its capitalisation some experts calculate have been drained away by the ongoing crisis.

Ghana’s far lower level of consolidation means not only that our financial industry may be passed over when the sharing of the choicest pickings from the oil sector begins, but also that a shock several times smaller than what has just hit Nigeria would almost certainly destabilize the industry. The inability of our banks to openly compete in the foreign currency markets with low-capacity so-called “forex bureaux” indicates clearly their limited ability to operate outside their narrow confines of comfort. The continued opacity in the forex banking subsector is therefore another indication of a significant in Ghanaian banking sector innovation.

3. The continued woes of Ghana’s first credit rating agency provides yet more fodder for the kind of analysis that describes Ghana’s banks as too conservative and stuck in their ways. Their refusal to be proactive in this respect, given the obvious advantages to their business, beggars belief. Perhaps, they see in the development a trend towards the emergence of a commercial bank rating system in the short term and are mounting an early resistance. Surely, a rating system for commercial banks in this country would prove highly revelatory. It would be useful to independent analysts in more detailed assessments of, for instance, forward looking statements by the banks, merely one of the areas we should concentrate on in any endeavour to prevent the obfuscation of loan performance through skilled inter-weaving of provisioning, unpaid interest reporting and portfolio restructuring results. Recommendations

It will be tongue in the cheek to attempt to provide effective remedies for as complicated a patient as Ghana’s banking system in an article of this length, but the following should provide some material for further discussion and debate.

1. Government may want to seriously consider a greater use of Deposit Insurance as an alternative mechanism for satisfying at least a part of capital adequacy rules, in order to generate some relief for the more striving banks.

Since the USA introduced the first formal deposit insurance scheme (DIS) in the early 1930s, many countries around the world have followed in their footsteps to implement similar systems. Closer to home, Nigeria and Kenya operate formal schemes. The biggest obstacle to implementing an explicit deposit insurance scheme, apart from the technical challenges of creating a new sensitive institution from scratch, is obviously the issue of “moral hazard”. That is to say the notion that an insurance scheme could interfere with traditional restraints and weaken incentives for prudence and caution on the part of depositors and banks alike. The exact technical attributes of any deposit insurance program may influence what types of hazards emerge. Whether the scheme protects both principal and interest or not, whether it should cover foreign deposits or steer clear of such exposure, whether it is run by a subsidiary of the central bank or by another organization entirely, and whether it is voluntary or mandatory etc., are all relevant to its impact on risk perception by market actors. Nor is it being said that a Deposit Insurance scheme will serve all our needs. As we have mentioned above, both Nigeria and Kenya run their own. But it is surely a more flexible and adaptable tool in the hands of gifted central bankers than blanket reserve requirements.

2. The collapse of development finance banking in Ghana, spectacularly illustrated by the grand failure of Bank for Housing & Construction, is evident in the ongoing struggles of NIB (National Investment Bank) and ADB (Agricultural Development Bank), and a strong reminder that state direction of the financial sector is no guarantee of desirable social outcomes. Consider that the aggregate capital base of all our banks were negative C2 billion in 1989, according to the University of Ghana Economist, Augustine Gockel. Indeed our banking industry as we know it today is a product of a wholesale redesign of a completely rundown one at the start of the Financial Sector Adjustment Program (FINSAP). We should therefore not make a fetish about the use of state interventions to shape the conduct of the banks in the marketplace. We have tried that before and failed spectacularly. We should obey ordinary prudence in deciding what to do with banks like NIB, ADB (Agricultural Development Bank) and GCB (Ghana Commercial Bank) even as we try to channel more and better priced credit to favoured sections of the economy. Credit criteria must be designed with an eye not on intentions but on results. It would be much better for us as a nation to pre-empt any FINSAP-style demands from our so-called development partners now that it appears Ghana may eventually opt for another PRGF (Poverty Reduction & Growth Facility) type support from a revamped IMF.

3. The recent fake currency incidents have highlighted a potential systemic risk to the country’s banking sector and revealed a weakness on the part of the Bank of Ghana in addressing multi-dimensional risks. There has been a proliferation of sector-wide risk mitigation strategies in recent times, but scarcely any consolidation of strategy. The Commercial Crimes Unit of the Police C.I.D, the Bureau of National Investigations, the Serious Crimes Office, the Banking Supervision Department, and now the proposed Financial Intelligence Centre, are all interrelated in a certain manner in helping safeguard the country’s financial sector from attack. But what is the framework that triggers the roles and responsibilities of these various agencies, and in what sequencing?

Fake currency has contagion effects. With a third of bank holdings designated in forex, it is more than worrying to allow a perception to fester that bank vaults are porous to counterfeit coinage. We have similar inter-agency confusion in the area of national security for instance, with “terrorism” having been placed under the remit of the Directorate-General of Operations of the Police Service while “criminal intelligence” remains within the province of the C.I.D. We all realised, thus, during the AMAL Bank saga that “turf fatigue” (though luckily not “turf war”) ensued and none of the agencies appeared willing to step forward and clearly declare its interest.

Such laxity should not be permitted in the vital areas of our national life.

Another framework flaw that emerged was a grey area in the powers of the lead supervisor (the Governor) of the Bank of Ghana to push through his commitment to replace the Managing Director of AMAL. The law appears to endow the Governor with such powers only in the case of financial distress. Banking Act violations alone, even if they have wide-scale systemic effects, are not sufficient to trigger the Bank of Ghana’s “reorganisation” powers if the subject bank is not threatened with insolvency. Nor is there a requirement, even should the Governor acts, for enforcement action to be made public. This clearly limits one of the impetus to act: public attention.

These are matters that need clarity, even as the BOG focuses on more complex trends such as money laundering and crime proceeds sterilisation.

4. The Central Bank should acknowledge a growing perception in the industry about a convergence between the regulatory requirements of banks and nonbank financial institutions (NBFIs) and work to prevent a situation in which innovations in these more socially penetrative organizations (NBFIs, that is) are stifled by unsuitable prudential measures.

5. The spectacular slump in the EZwich’s implementation ambitions provides another account of grasp falling short of reach. Billed as a national switch – an infrastructure to enable financial institutions to innovate inclusively – it was instead rolled out as a consumer product to mediocre results.

The review of the Financial Sector Strategy Plan should address the EZwich issue; it should be interesting to know how much GhIPPs, the platform operators, has spent marketing this over-branded, overloaded, and overrated reform instrument. Our recommendation will be that the platform be returned to its original role of facilitating a national switch to the benefit of solution developers in the electronic payments space.

Conclusion

The gloss and glamour notwithstanding, there are considerable challenges confronting our financial system, particularly the banking sector, and these should merit close and detailed attention from the sector’s stakeholders as they embark on preparations towards the second phase of the Financial Sector Strategic Plan.

The Authors are affiliated with IMANI-Ghana, and AfricaLiberty.org