Feature Article : "The views expressed here are those of the authors and do not necessarily represent or reflect the views of Modernghana.com."

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. Continued    Source: Bright B. Simons

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